As filed with the Securities and Exchange Commission on 8 March 201625 February 2019

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 20-F

o REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended 31 December 2015

2018
OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

o SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-15246

LLOYDS BANKING GROUP plc

(previously Lloyds TSB Group plc)

(Exact name of Registrant as Specified in Its Charter)

 

Scotland

(Jurisdiction of Incorporation or Organization)

 

25 Gresham Street

London EC2V 7HN

United Kingdom

(Address of Principal Executive Offices)

 

Malcolm Wood, Company Secretary

Tel +44 (0) 20 7356 1274, Fax +44 (0) 20 7356 1808

25 Gresham Street

London EC2V 7HN

United Kingdom

(Name, telephone, e-mail and/or facsimile number and address of Company contact person)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

Title of each class Name of each exchange on which registered
Ordinary shares of nominal value 10 pence each, represented by American Depositary Shares The New York Stock Exchange
$1,500,000,000 4.344% Subordinated Securities due in 2048The New York Stock Exchange
$824,033,000 5.3% Subordinated Securities due 2045The New York Stock Exchange
$1,750,000,000 3.574% Senior Notes due in 2028 (callable in 2027)The New York Stock Exchange
$1,500,000,000 4.375% Senior Notes due 2028The New York Stock Exchange
$1,250,000,000 4.55% Senior Notes due 2028The New York Stock Exchange
$1,250,000,000 3.75% Senior Notes due 2027The New York Stock Exchange
$1,500,000,000 4.65% Subordinated Securities due 2026The New York Stock Exchange
$1,500,000,000 4.45% Senior Notes due 2025The New York Stock Exchange
$1,327,685,000 4.582% Subordinated Securities due 2025The New York Stock Exchange
$1,250,000,000 3.5% Senior Notes due 2025 The New York Stock Exchange
$1,000,000,000 4.5% Subordinated Securities due 2024The New York Stock Exchange
$1,750,000,000 4.05% Senior Notes due 2023The New York Stock Exchange
$2,250,000,000 2.907% Senior Notes due 2023 (callable in 2022)The New York Stock Exchange
$1,500,000,000 3.0% Senior Notes due 2022The New York Stock Exchange
$1,250,000,000 3.3% Senior Notes due 2021The New York Stock Exchange
$1,000,000,000 Floating Rate Senior Notes due 2021The New York Stock Exchange
$500,000,000 Floating Rate Senior Notes due 2021The New York Stock Exchange
$1,000,000,000 3.1% Senior Notes due 2021 The New York Stock Exchange
$2,500,000,000 6.375% Senior Notes due 2021 The New York Stock Exchange
$1,000,000,000 2.7% Senior Notes due 2020 The New York Stock Exchange
$1,000,000,000 2.4% Senior Notes due 2020 The New York Stock Exchange
$1,000,000,000 2.35% Senior Notes due 2019 The New York Stock Exchange
$1,000,000,000 2.3%750,000,000 2.05% Senior Notes due 20182019 The New York Stock Exchange
$700,000,000 2% Senior Notes due 2018The New York Stock Exchange
$300,000,000450,000,000 Floating Rate Notes due 2018The New York Stock Exchange
$1,250,000,000 1.75% Senior Notes due 2018The New York Stock Exchange
$400,000,000 Floating Rate Notes due 2018The New York Stock Exchange
$1,000,000,000 1.75% Senior Notes due 2018The New York Stock Exchange
$500,000,000 Floating Rate Notes due 2018The New York Stock Exchange
$1,500,000,000 4.20% Senior Notes due 2017The New York Stock Exchange
$2,250,000,000 4.875% Senior Notes due 20162019 The New York Stock Exchange

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

7.50% Fixed Rate Reset Additional Tier 1 Perpetual Subordinated Contingent Convertible Securities

 

The number of outstanding shares of each of Lloyds Banking Group plc’s classes of capital or common stock as of 31 December 20152018 was:

Ordinary shares, nominal value 10 pence each71,373,735,357
Limited voting shares, nominal value 10 pence each80,921,05171,163,592,264
Preference shares, nominal value 25 pence each412,204,151
Preference shares, nominal value 25 cents each1,206,888809,160
Preference shares, nominal value 25 euro cents eachNil

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yesx   Noo

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 19341934.

Yeso   Nox

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yesx   Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or (or for such shorter period that the registrant was required to submit and post such files).

Yesox   Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. filer, or an emerging growth company.

See definitionthe definitions of “large accelerated filer,” “accelerated filer,” and large accelerated filer”“emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filerx   Accelerated filero   Non-Accelerated filero   Emerging Growth Companyo

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act.

Yeso   Noo

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements including in this filing:


U.S. GAAPo International Financial Reporting Standards as issued by the International Accounting Standards Boardx Othero

If ‘Other’ has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow:

Item 17o   Item 18o

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yeso   Nox

†The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 
 

TABLE OF CONTENTS

 

Presentation of information1
Business overview2
Selected consolidated financial data3
Exchange rates4
Business4
Operating and financial review and prospects1211
Management and employees125107
Compensation129111
Corporate governance156131
Major shareholders and related party transactions183157
Regulation187158
Listing information191161
Dividends194162
Memorandum and articlesArticles of association of Lloyds Banking Group plc195163
Exchange controls200168
Taxation201169
Where you can find more information204171
Enforceability of civil liabilities204171
Risk factors205172
Forward looking statements221189
Lloyds Banking Group structure222190
Index to the consolidated financial statementsF-1
Glossary223192
Form 20-F cross-reference sheet225194
Exhibit index227196
Signatures228197

PRESENTATION OF INFORMATION

 

In this annual report, references to the ‘Company’ are to Lloyds Banking Group plc; references to ‘Lloyds Banking Group’, ‘Lloyds’ or the ‘Group’ are to Lloyds Banking Group plc and its subsidiary and associated undertakings; references to ‘Lloyds Bank’ are to Lloyds Bank plc (previously Lloyds TSB Bank plc);plc; and references to the ‘consolidated financial statements’ or ‘financial statements’ are to Lloyds Banking Group’s consolidated financial statements included in this annual report. References to the ‘Financial Conduct Authority’ or ‘FCA’ and to the ‘Prudential Regulation Authority’ or ‘PRA’ are to the United Kingdom (the UK) Financial Conduct Authority and the UK Prudential Regulation Authority. References to the ‘Financial Services Authority’ or ‘FSA’’FSA’ are to their predecessor organisation, the UK Financial Services Authority.

 

The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB).

 

In this annual report, amounts described as ’statutory’‘statutory’ refer to amounts included within the Group’s consolidated financial statements.

 

Lloyds Banking Group publishes its consolidated financial statements expressed in British pounds (‘pounds sterling’, ’sterling’‘sterling’ or ’£‘£’), the lawful currency of the UK. In this annual report, references to ‘pence’ and ‘p’ are to one-hundredth of one pound sterling; references to ‘US dollars’, ‘US$’ or ’$‘$’ are to the lawful currency of the United States (the US); references to ‘cent’ or ‘c’ are to one-hundredth of one US dollar; references to ‘euro’ or ’€‘€’ are to the lawful currency of the member states of the European Union (EU) that have adopted a single currency in accordance with the Treaty establishing the European Communities, as amended by the Treaty of European Union; references to ‘euro cent’ are to one-hundredth of one euro; and references to ‘Japanese yen’, ‘Japanese ¥’ or ’¥‘¥’ are to the lawful currency of Japan. Solely for the convenience of the reader, this annual report contains translations of certain pounds sterling amounts into US dollars at specified rates. These translations should not be construed as representations by Lloyds Banking Group that the pounds sterling amounts actually represent such US dollar amounts or could be converted into US dollars at the rate indicated or at any other rate. Unless otherwise stated, the translations of pounds sterling into US dollars have been made at the noon buying rate in New York City for cable transfers in pounds sterling as certified for customs purposes by the Federal Reserve Bank of New York (the Noon Buying Rate) in effect on 31 December 2015, which was $1.4746 = £1.00.2018. The Noon Buying Rate on 31 December 20152018 differs from certain of the actual rates used in the preparation of the consolidated financial statements, which are expressed in pounds sterling, and therefore US dollar amounts appearing in this annual report may differ significantly from actual US dollar amounts which were translated into pounds sterling in the preparation of the consolidated financial statements in accordance with IFRS.

The comparative information included in the consolidated financial statements presented in this Form 20-F differs from the comparative information provided in the Group’s UK results for the year ended 31 December 2018. As reported in the Company’s 2016 Form 20-F, an adjusting post balance sheet event that occurred between the signing of the Group’s 2016 UK Annual Report and Accounts and its 2016 Form 20-F resulted in the charge recognised in respect of PPI complaints in the Company’s 2016 Form 20-F being £350 million greater than that recorded in the Group’s 2016 UK Annual Report and Accounts. Consequently, the charge recognised by the Group in its UK basis results for 2017 was £350 million greater than on a US basis. The Group has reported the same net assets on a US basis and on a UK basis since 31 March 2017.


1

BUSINESS OVERVIEW

 

Lloyds Banking Group is a leading provider of financial services to individual and business customers in the UK. At 31 December 2015,2018, total Lloyds Banking Group assets were £806,688£797,598 million and Lloyds Banking Group had 75,30664,928 employees (on a full-time equivalent basis). Lloyds Banking Group plc’s market capitalisation at that date was £52,153£36,898 million. The Group reported a profit before tax for the 12 months to 31 December 20152018 of £1,644£5,960 million, and its capital ratios at that date were 21.522.9 per cent for total capital, 16.418.2 per cent for tier 1 capital and 12.814.6 per cent for common equity tier 1 capital.

 

Set out below is the Group’s summarised income statement for each of the last three years:

 

 2015  2014 2013  2018  2017 2016 
 £m  £m £m  £m  £m £m 
Net interest income  11,318   10,660   7,338   13,396   10,912   9,274 
Other income  11,832   19,232   30,647   8,695   23,325   30,337 
Total income  23,150   29,892   37,985   22,091   34,237   39,611 
Insurance claims  (5,729)  (13,493)  (19,507)  (3,465)  (15,578)  (22,344)
Total income, net of insurance claims  17,421   16,399   18,478   18,626   18,659   17,267 
Operating expenses  (15,387)  (13,885)  (15,322)  (11,729)  (12,346)  (12,627)
Trading surplus  2,034   2,514   3,156   6,897   6,313   4,640 
Impairment  (390)  (752)  (2,741)  (937)  (688)  (752)
Profit before tax  1,644   1,762   415   5,960   5,625   3,888 

 

Lloyds Banking Group’s main business activities are retail and commercial banking and long-term savings, protection and investment.investment and it operates primarily in the UK. Services are offered through a number of well recognised brands including Lloyds Bank, Halifax, Bank of Scotland and Scottish Widows, and through a range of distribution channels including the largest branch network and digital bank in the UK and a comprehensive digital proposition.UK.

 

At 31 December 2015,2018, the Group’s fourthree primary operating divisions, which are also reporting segments, were: Retail; Commercial Banking; Consumer Finance and Insurance.Insurance and Wealth. Retail provides banking, mortgages, personal loans, motor finance, credit cards and other financial services to personal and small business customers in the UK.customers. Commercial Banking provides banking and related services to business clients, from SMEssmall and medium-sized entities (SMEs) to large corporates. Consumer Finance provides a range of products including motor finance, credit cards,Insurance and European mortgages and deposit taking. InsuranceWealth provides long-term savings, protection and investment products as well as general insurance products in the UK.products.

 

Profit before tax is analysed on pages 1513 to 1822 on a statutory basis and, in order to provide a more comparable representation of business performance of the Group’s segments, on pages 2624 to 3631 on an underlying basis. The key principles adopted in the preparation of this basis of reporting are described on page 26.24. The Group Executive Committee, which is the chief operating decision maker for the Group, reviews the Group’s internal reporting based around these segments (which reflect the Group’s organisational and management structures) in order to assess performance and allocate resources; this reporting is on an underlying basis. IFRS 8,Operating Segmentsrequires that the Group presents its segmental profit before tax on the basis reviewed by the chief operating decision maker that is most consistent with the measurement principles used in measuring the Group’s statutory profit before tax. Accordingly, the Group presents its segmental underlying basis profit before tax in note 4 to the financial statements in compliance with IFRS 8. The table below shows the results of Lloyds Banking Group’s segments in the last three fiscal years, and their aggregation. Further information on non-GAAP measures and the reconciliations required by the Securities and Exchange Commission’s Regulation G are set out on pages F-23F-21 to F-26.

 

 2015  2014 2013   2018   20171   20161 
 £m  £m £m   £m   £m   £m 
Retail  3,514   3,228   3,015   4,272   3,770   3,303 
Commercial Banking  2,431   2,206   1,890   2,160   2,231   2,246 
Consumer Finance  1,005   1,010   965 
Insurance  962   922   1,088 
Insurance and Wealth  927   899   809 
Other  200   390   (792)  707   728   424 
Profit before tax – underlying basis  8,112   7,756   6,166   8,066   7,628   6,782 

1Segmental analysis restated, as explained on page 24.

 

Lloyds Banking Group plc was incorporated as a public limited company and registered in Scotland under the UK Companies Act 1985 on 21 October 1985 with the registered number 95000. Lloyds Banking Group plc’s registered office is The Mound, Edinburgh EH1 1YZ, Scotland, and its principal executive offices in the UK are located at 25 Gresham Street, London EC2V 7HN, United Kingdom, telephone number + 44 (0) 20 7626 1500.

2

SELECTED CONSOLIDATED FINANCIAL DATA

 

The financial information set out in the tables below has been derived from the annual reports and accounts of Lloyds Banking Group plc for each of the past five years adjusted, where restatement was required, for subsequent changes in accounting policy and presentation. The financial statements for each of the years shown have been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm.

 

   2015   2014   2013   20121   20111 
Income statement data for the year ended 31 December (£m)                    
Total income, net of insurance claims  17,421   16,399   18,478   20,517   20,802 
Operating expenses  (15,387)  (13,885)  (15,322)  (15,974)  (13,259)
Trading surplus  2,034   2,514   3,156   4,543   7,543 
Impairment losses  (390)  (752)  (2,741)  (5,149)  (8,094)
Profit (loss) before tax  1,644   1,762   415   (606)  (551)
Profit (loss) for the year  956   1,499   (802)  (1,387)  (554)
Profit (loss) for the year attributable to equity shareholders  466   1,125   (838)  (1,471)  (627)
Dividends for the year2,3  1,962   535   –   –   – 
Balance sheet data at 31 December (£m)                    
Share capital  7,146   7,146   7,145   7,042   6,881 
Shareholders’ equity  41,234   43,335   38,989   41,896   45,506 
Other equity instruments  5,355   5,355   –   –   – 
Customer deposits  418,326   447,067   439,467   426,216   413,906 
Subordinated liabilities  23,312   26,042   32,312   34,092   35,089 
Loans and advances to customers  455,175   482,704   492,952   516,764   565,638 
Total assets1  806,688   854,896   842,380   933,064   970,609 
Share information                    
Basic earnings (loss) per ordinary share  0.8p   1.7p   (1.2)p  (2.1)p  (0.9)p
Diluted earnings (loss) per ordinary share  0.8p   1.6p   (1.2)p  (2.1)p  (0.9)p
Net asset value per ordinary share  57.9p   60.7p   54.6p   59.5p   66.1p 
Dividends per ordinary share2,4  2.75p   0.75p   –   –   – 
Equivalent cents per share2,4,5  3.91c   1.16c   –   –   – 
Market price per ordinary share (year end)  73.1p   75.8p   78.9p   47.9p   25.9p 
Number of shareholders (thousands)  2,563   2,626   2,681   2,733   2,770 
Number of ordinary shares in issue (millions)6  71,374   71,374   71,368   70,343   68,727 
Financial ratios (%)7                    
Dividend payout ratio8  359.3   45.1   –   –   – 
Post-tax return on average shareholders’ equity  1.3   2.9   (2.0)  (3.3)  (1.4)
Post-tax return on average assets  0.11   0.17   (0.09)  (0.14)  (0.06)
Average shareholders’ equity to average assets  5.1   4.7   4.7   4.6   4.5 
Cost:income ratio9  88.3   84.7   82.9   77.9   63.7 
Capital ratios (%)10,11,12                    
Total capital  21.5   22.0   20.8   17.3   15.6 
Tier 1 capital  16.4   16.5   14.5   13.8   12.5 
Common equity tier 1 capital/Core tier 1 capital  12.8   12.8   14.0   12.0   10.8 

   2018   20171   20161   20151   20141 
Income statement data for the year ended 31 December (£m)                    
Total income, net of insurance claims  18,626   18,659   17,267   17,421   16,399 
Operating expenses  (11,729)  (12,346)  (12,627)  (15,387)  (13,885)
Trading surplus  6,897   6,313   4,640   2,034   2,514 
Impairment losses  (937)  (688)  (752)  (390)  (752)
Profit before tax  5,960   5,625   3,888   1,644   1,762 
Profit for the year  4,400   3,897   2,164   956   1,499 
Profit for the year attributable to ordinary shareholders  3,869   3,392   1,651   466   1,125 
Dividends for the year2,3  2,288   2,195   2,175   1,962   535 
Balance sheet data at 31 December (£m)                    
Share capital  7,116   7,197   7,146   7,146   7,146 
Shareholders’ equity  43,434   43,551   42,670   41,234   43,335 
Other equity instruments  6,491   5,355   5,355   5,355   5,355 
Customer deposits  418,066   418,124   415,460   418,326   447,067 
Subordinated liabilities  17,656   17,922   19,831   23,312   26,042 
Loans and advances to customers  484,858   472,498   457,958   455,175   482,704 
Total assets  797,598   812,109   817,793   806,688   854,896 
Share information                    
Basic earnings per ordinary share  5.5p   4.9p   2.4p   0.8p   1.7p 
Diluted earnings per ordinary share  5.5p   4.8p   2.4p   0.8p   1.6p 
Net asset value per ordinary share  61.0p   60.5p   59.8p   57.9p   60.7p 
Dividends per ordinary share2,4  3.21p   3.05p   3.05p   2.75p   0.75p 
Equivalent cents per share1,4,5  4.16c   4.06c   3.95c   4.03c   1.16c 
Market price per ordinary share (year end)  51.9p   68.1p   62.5p   73.1p   75.8p 
Number of shareholders (thousands)  2,404   2,450   2,510   2,563   2,626 
Number of ordinary shares in issue (millions)6  71,164   71,973   71,374   71,374   71,374 
Financial ratios (%)7                    
Dividend payout ratio8  57.6   62.8   124.9   359.3   45.1 
Post-tax return on average shareholders’ equity  9.3   8.0   4.1   1.3   2.9 
Post-tax return on average assets  0.54   0.48   0.26   0.11   0.17 
Average shareholders’ equity to average assets  5.3   5.3   5.2   5.1   4.7 
Cost:income ratio9  63.0   66.2   73.1   88.3   84.7 
Capital ratios (%)                    
Total capital  22.9   21.2   21.2   21.5   22.0 
Tier 1 capital  18.2   17.2   16.8   16.4   16.5 
Common equity tier 1 capital/Core tier 1 capital  14.6   14.1   13.4   12.8   12.8 

 

1Restated, where appropriate, in 2013 for IAS 19 (Revised)The Group has adopted IFRS 9 and IFRS 10.15 with effect from 1 January 2018; in accordance with the transition requirements comparative information has not been restated.
2Annual dividends comprise both interim and estimated final dividend payments. The total dividend for the year represents the interim dividend paid during the year and the final dividend, which is paid and accounted for in the following year.
3Dividends for the year in 2015 include2016 included a recommended special dividend totalling £356 million; (2015: £357 million.million).
4Dividends per ordinary share in 2015 include2016 included a recommended special dividend of 0.5 pence.pence (2015: 0.5 pence).
5Translated into US dollars at the Noon Buying Rate on the date each payment was made, with the exception of the final and special dividendsdividend in respect of 2015,2018, which havehas been translated at the Noon Buying Rate on 2615 February 2016.2019.
6This
6For 2016 and previous years, this figure excludesexcluded the limited voting ordinary shares owned by the Lloyds Bank Foundations. The limited voting ordinary shares were redesignated as ordinary shares on 1 July 2017.
7Averages are calculated on a monthly basis from the consolidated financial data of Lloyds Banking Group.
8Total dividend for the year divided by earnings attributable to ordinary shareholders adjusted for tax relief on distributions to other equity holders.
9The cost:income ratio is calculated as total operating expenses as a percentage of total income (net of insurance claims).
10Capital ratios for 2012 and earlier years were not restated to reflect the adoption of IAS 19 (Revised) in 2013.
11Capital ratios for 2013 and earlier years are in accordance with modified Basel II framework as implemented by the PRA.
12Capital ratios for 2014 are in accordance with the CRD IV rules implemented by the PRA on 1 January 2014.

3

EXCHANGE RATES

In this annual report, unless otherwise indicated, all amounts are expressed in pounds sterling. For the months shown the US dollar high and low Noon Buying Rates per pound sterling were:

  2016 2015 2015 2015 2015 2015
  January December November October September August
US dollars per pound sterling:            
High 1.47 1.52 1.54 1.55 1.56 1.57
Low 1.42 1.47 1.50 1.52 1.51 1.54
             

For each of the years shown, the average of the US dollar Noon Buying Rates per pound sterling based on the last day of each month was:

             
    2015 2014 2013 2012 2011
US dollars per pound sterling:            
Average   1.53 1.65 1.57 1.59 1.61

On 26 February 2016, the latest practicable date, the US dollar Noon Buying Rate was $1.39 = £1.00. Lloyds Banking Group makes no representation that amounts in pounds sterling have been, could have been or could be converted into US dollars at that rate or at any of the above rates.

BUSINESS

 

HISTORY AND DEVELOPMENT OF LLOYDS BANKING GROUP

 

The history of the Group can be traced back to the 18th century when the banking partnership of Taylors and Lloyds was established in Birmingham, England. Lloyds Bank Plc was incorporated in 1865 and during the late 19th and early 20th centuries entered into a number of acquisitions and mergers, significantly increasing the number of banking offices in the UK. In 1995, it continued to expand with the acquisition of the Cheltenham and Gloucester Building Society (C&G).Society.

 

TSB Group plc became operational in 1986 when, following UK Government legislation, the operations of four Trustee Savings Banks and other related companies were transferred to TSB Group plc and its new banking subsidiaries. By 1995, the TSB Group had, either through organic growth or acquisition, developed life and general insurance operations, investment management activities, and a motor vehicle hire purchase and leasing operation to supplement its retail banking activities.

 

In 1995, TSB Group plc merged with Lloyds Bank Plc. Under the terms of the merger, the TSB and Lloyds Bank groups were combined under TSB Group plc, which was re-named Lloyds TSB Group plc, with Lloyds Bank Plc, which was subsequently re-named Lloyds TSB Bank plc, the principal subsidiary. In 1999, the businesses, assets and liabilities of TSB Bank plc, the principal banking subsidiary of the TSB Group prior to the merger, and its subsidiary Hill Samuel Bank Limited were vested in Lloyds TSB Bank plc, and in 2000, Lloyds TSB Group acquired Scottish Widows. In addition to already being one of the leading providers of banking services in the UK, the acquisition of Scottish Widows also positioned Lloyds TSB Group as one of the leading suppliers of long-term savings and protection products in the UK.

 

The HBOS Group had been formed in September 2001 by the merger of Halifax plc and Bank of Scotland. The Halifax business began with the establishment of the Halifax Permanent Benefit Building Society in 1852; the society grew through a number of mergers and acquisitions including the merger with Leeds Permanent Building Society in 1995 and the acquisition of Clerical Medical in 1996. In 1997 the Halifax converted to plc status and floated on the London stock market. Bank of Scotland was founded in July 1695, making it Scotland’s first and oldest bank.

 

On 18 September 2008, with the support of the UK Government, the boards of Lloyds TSB Group plc and HBOS plc announced that they had reached agreement on the terms of a recommended acquisition by Lloyds TSB Group plc of HBOS plc. The shareholders of Lloyds TSB Group plc approved the acquisition at the Company’s general meeting on 19 November 2008. On 16 January 2009, the acquisition was completed and Lloyds TSB Group plc changed its name to Lloyds Banking Group plc.

 

Pursuant to two placing and open offers which were completed by the Company in January and June 2009 and the Rights Issue completed in December 2009, the UK Government acquired 43.4 per cent of the Company’s issued ordinary share capital. As announced, at 4 December 2015 UKFI held approximately 6.6 billionFollowing sales of shares in the Group representing a stake of approximately 9.2 per cent, following a sale of 4,282 million shares on 20 September 2013 a further sale of 5,555 million shares on 31and March 2014 and the effectscompletion of a trading planplans with Morgan Stanley & Co. International plc (Morgan Stanley) that was announced on 17 December 2014 and extended on both 1 June 2015 and 4 December 2015, and the effects of issues of ordinary shares. The trading plan provides Morgan Stanley with full discretion to effect a measured and orderly sell down of shares in the Group on behalf of, the UK Government above a share pricecompleted the sale of 73.6 pence. The trading plan will terminate no later than 30 June 2016. The plan may be stopped earlier than 30 June 2016, for example to ensure that HMT retains sufficientits shares for the proposed retail offer, which was originally expected to be launched in Spring 2016 but has been delayed following recent market volatility. The UK Government has instructed Morgan Stanley that up to but no more than 15 per cent of the aggregate total trading volume inMay 2017, returning the Group is to be sold over the duration of the trading plan. Although the UK government may have sold shares since its last notification (approximately 9.2 per cent) on 4 December 2015 its holding remains above 9 per cent.full private ownership.

 

Pursuant to its decision approving state aid to the Group, the European Commission required the Group to dispose of a retail banking business meeting minimum requirements for the number of branches, share of the UK personal current accounts market and proportion of the Group’s mortgage assets. Following disposals in 2014, the Group retained an interest of approximately 50 per cent in TSB as at 31 December 2014. The Group sold its remaining interest in TSB to Banco de Sabadell (Sabadell) in 2015, with the acquisition becoming unconditional inand all respects onEC state aid requirements were met by 30 June 20152017.

On 1 June 2017, following the receipt of all relevantcompetition and regulatory clearances.approval, the Group acquired 100 per cent of the ordinary share capital of MBNA Limited, which together with its subsidiaries operates a UK consumer credit card business, from FIA Jersey Holdings Limited, a wholly-owned subsidiary of Bank of America.

The Group successfully launched its new non ring-fenced bank, Lloyds Bank Corporate Markets plc in 2018, transferring in the non ring-fenced business from the rest of the Group, thereby meeting its legal requirements under ring-fencing legislation.

On 23 October 2018, the Group announced a strategic partnership with Schroders plc to create a market-leading wealth management proposition. The three key components of the partnership are: (i) the establishment of a new financial planning joint venture; (ii) the Group taking a 19.9 per cent stake in Schroders high net worth UK wealth management business; and (iii) the appointment of Schroders as the active investment manager of approximately £80 billion of the Scottish Widows and Lloyds Banking Group insurance and wealth related assets.

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STRATEGY OF LLOYDS BANKING GROUP

 

The Group is a leading provider of financial services to individual and business customers in the UK. The Group’s main business activities are retail and commercial banking, and long-term savings, protection and investment. Services are provided through a number of well recognised brands including Lloyds Bank, Halifax, Bank of Scotland and Scottish Widows and through a range of distribution channels, including the largest branch network and digital bank in the UK and a comprehensive digital proposition.UK.

 

TheIn 2017 the Group operates a simple, low-risk, customersuccessfully completed the second phase of its strategic plan, which focused retail and commercial banking business primarily in the UK. The Group’s corporate strategy is built around beingon creating the best bank for individualcustomer experience, becoming simpler and business customers across the UKmore efficient and creating value by investing in areas that make a real difference to these customers.delivering sustainable growth.

 

FollowingAs the successful deliveryGroup looks to the future, it sees the external environment evolving rapidly. Changing customer behaviours, the pace of technological evolution and changes in regulation all present opportunities. Given the Group’s 2011 strategy that underpinnedstrong capabilities and the Group’s low cost, low risk, customer focused, UK retail and commercial banking business model,significant progress made in recent years, the Group outlinedbelieves that it is in a unique position to compete and win in this environment by developing additional competitive advantages. The Group will continue to transform itself to succeed in this digital world and the next phase of its strategy will ensure that the Group has the capabilities to deliver future success.

STRATEGIC PRIORITIES

In early 2018 the Group launched the third phase of its strategic plan. The Group identified four strategic priorities focused on the financial needs and behaviours of the customer of the future: further enhancing the Group’s leading customer experience; further digitising the Group; maximising Group capabilities; and transforming ways of working. The Group will invest more than £3 billion in October 2014. these strategic initiatives through the plan period that will drive the Group’s transformation into a digitised, simple, low risk, customer-focused UK financial services provider.

Delivering a leading customer experience

The Group will drive stronger customer relationships through best in class propositions while continuing to provide the Group’s strategy is focused upon delivering valuecustomers with brilliant servicing and high quality experiencesa seamless experience across all channels. This will include:

– remaining the number 1 digital bank in the UK with open banking functionality;
– unrivalled reach with UK’s largest branch network serving complex needs; and
–data-driven and personalised customer propositions.

Digitising the Group

The Group will deploy new technology to drive additional operational efficiencies that will make banking simple and easier for customers alongside superiorwhilst reducing operating costs, pursuing the following initiatives:

– deeper end-to-end transformation targeting over 70 per cent of cost base;
–simplification and progressive modernisation of our data and IT infrastructure; and
–technology enabled productivity improvements across the business.

Maximising the Group’s capabilities

The Group will deepen customer relationships, grow in targeted segments and sustainablebetter address our customers’ banking and insurance needs as an integrated financial performance within a prudent risk and conduct framework.services provider. This will be achieved through three strategic priorities whichinclude:

– increasing Financial Planning and Retirement (FP&R) open book assets by more than £50 billion by 2020 with more than 1 million new pension customers;
–implementing an integrated FP&R proposition with single customer view; and
–start-up, SME and Mid Market net lending growth (more than £6 billion in the plan period).

Transforming ways of working

The Group is making its biggest ever investment in people, increasing colleague training and development by 50 per cent to 4.4 million hours per annum and embracing new technology to drive better customer outcomes. The hard work, commitment and expertise of the Group’s colleagues has enabled it to deliver to date and the Group will be consistently applied across all divisions:further invest in capabilities and agile working practices. The Group has already restructured the business and reorganised the leadership team to ensure effective implementation of the new strategy.

 

CREATING THE BEST CUSTOMER EXPERIENCEBUSINESS AND ACTIVITIES OF LLOYDS BANKING GROUP

 

The Group’s activities are organised into three financial reporting segments: Retail; Commercial Banking; and Insurance and Wealth. In 2018 charges in relation to other conduct provisions (referred to as remediation) have been reclassified so that they are now included in underlying profit. In addition, results in relation to certain assets which are outside the Group’s risk appetite, previously reported as part of run-off within Other, have been reclassified into Retail and Commercial.

Further information on the Group’s segments is set out on pages 24 to 31 and in note 4 to the financial statements.

MATERIAL CONTRACTS

The Company and its subsidiaries are party to various contracts in the ordinary course of business.

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ENVIRONMENTAL MATTERS

Helping the transition to a sustainable low carbon economy

Following a Board level review of our approach to environmental sustainability, we have developed a new sustainability strategy which focuses on the opportunities and threats related to climate change and the need for the UK to transition to a sustainable low carbon economy.

This strategy supports the Task Force on Climate Related Financial Disclosures (TCFD) recommendations and incorporates an implementation plan to address them and achieve full disclosure within five years. The strategy maps to the key headings used in the TCFD framework.

STRATEGY

Our commitment

The UK is committed to the vision of a sustainable, low carbon economy, and has placed clean growth at the heart of its industrial strategy. This will require a radical reinvention of the way people, work, live and do business.

We have a unique position within the UK economy with our purpose of Helping Britain Prosper. The successful transition to a sustainable, low carbon economy that is resilient to climate change impacts and sustainably uses resources is of strategic importance to us. We support the aims of the 2015 Paris Agreement on Climate Change, and the UK Government’s Clean Growth Strategy.

Our approach

To meet our commitment, we will:

Take a strategic approach to identifying new opportunities to support our customers and clients and to finance the UK transition to a sustainable low carbon economy, embedding sustainability into Group strategy across all activities
Identify and manage material sustainability and climate related risks across the Group, disclosing these and their impacts on the Group and its financial planning processes in line with the TCFD recommendations
Use our scale and reach to help drive progress towards a sustainable and resilient UK economy, environment and society through our engagement with industry, Government, investors, suppliers and customers
Embed sustainability into the way we do business and manage our own operations in a more sustainable way

Our ambition

Our goal is to createbe a leader in supporting the best customer experienceUK to successfully transition to a more sustainable, low carbon economy. We have set ourselves seven ambitions anchored to the goals laid out in the UK Government’s Clean Growth Strategy, as these align closely to our business priorities:

Business: become a leading UK commercial bank for sustainable growth, supporting our clients to transition to sustainable business models and operations, and to pursue new clean growth opportunities
Homes: be a leading UK provider of customer support on energy efficient, sustainable homes
Vehicles: be a leading UK provider of low emission/green vehicle fleets
Pensions & investments: be a leading UK pension provider that offers our customers and colleagues sustainable investment choices, and challenges companies we invest in to behave more sustainably and responsibly
Insurance: be a leading UK insurer in improving the resilience of customers’ lives against extreme weather caused by climate change
Green bonds: be a leading UK bank in the green/sustainable bonds market
Our Own Footprint: be a leading UK bank in reducing our own carbon footprint and challenging our suppliers to ensure our own consumption of resources, goods and services is sustainable

For each ambition we will consider the Government’s targets and current plans.

We will use forward looking scenarios to identify risks and opportunities over short, medium and long term time horizons and assess how they impact the resilience of our strategy. We are developing a series of propositions against each ambition and have defined an implementation plan to achieve a leadership position within three years. We will work with Government and other stakeholders on thought leadership to help inform the creation of the policies and market conditions required for large scale investment in the transition to a sustainable, low carbon economy. To support these propositions, we are equipping our business relationship managers and other colleagues with training and tools to have more informed conversations on climate related issues. As part of our TCFD implementation plan, we will also develop a forward looking approach to systematically reporting material financial risk and opportunity aggregated across the Group.

Improving our own environmental footprint is an important foundation for our activity. We’ve consistently reduced our environmental impacts, thanks to the ambitious Environmental Action Plan we launched in 2010. To ensure this plan supports the UK’s climate change priorities and our long term strategy, we have a set of market leading targets to improve the sustainability of our own operations and supply chain. These include reducing our operational waste by 70 per cent by 2020 and 80 per cent by 2025 (compared to 2014/15), and reducing our CO2e by 60 per cent by 2030 and 80 per cent by 2050 (compared to 2009) www.lloydsbankinggroup.com/our-group/responsible-business/sustainability-in-lloyds-banking-group. We anticipate achievement of the 2050 target well before this date, driven by both our energy efficiency improvements, direct investment in renewable energy on our sites and through its multi brand, multi channelpurchasing Renewable Energy Guarantees of Origin (REGOs) to cover our UK electricity consumption. We are now able to state that 100 per cent of our UK electricity comes from renewable sources and to show our commitment to supporting the transition to the low carbon economy, we have joined the RE100 campaign, a collaborative, global initiative uniting businesses committed to 100 per cent renewable energy.

Governance

We have established a dedicated governance process to provide oversight and ownership of the sustainability strategy. This includes the Responsible Business Committee (RBC), a sub-committee of the Board, which meets quarterly and provides Board level oversight. This committee is chaired by Sara Weller, Group Non-Executive Director and includes the Chairman, Lord Blackwell as a member. At Executive level, we have established a Group Executive Sustainability Committee (GESC), which is a sub-committee of our Group Executive Committee (GEC) and provides oversight and recommends decisions to the GEC. The RBC, GEC and GESC have all been informed on key climate related issues by external industry experts.

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We have created a Group sustainability team, supported by divisional Governance Forums and working groups led by divisional Managing Directors. This enables us to have a coordinated approach combining comprehensive onlineto oversight, delivery and mobile capabilitiesreporting of the Group sustainability strategy to the GESC, along with facea mechanism for keeping management and the Board updated on climate related issues impacting the Group.

For the implementation of the TCFD recommendations across the Group, we have established a senior executive group TCFD forum. We aim to face services.expand the consideration of sustainability and climate related issues into relevant Board and governance committees including processes to monitor and oversee progress against goals and targets related to climate issues. We will also consider how sustainability might be incorporated into our remuneration policies.

Risk Management

Each division within the Group is responsible for identifying and prioritising relevant climate related risks and opportunities and integrating them into their risk management processes, which determine materiality and classify risks into traditional risk categories. This involves transformingincludes identifying potential risks through horizon scanning of changes in regulation, technology and consumer demand. Risks are classified in terms of whether they impact the Group in the short, medium or long term. Examples include possible changes in the sustainability of homes, how vehicles are powered, changes in UK energy mix, through to changes in the frequency and severity of extreme weather events. The Group sustainability team facilitates collaboration across divisions to increase understanding of consistent issues, as well as our risk, opportunities and financial impact on an aggregated basis.

During 2018, we reviewed our external sector statements to confirm that they align to our sustainability strategy and consider appropriate climate related risk. We introduced a position statement for coal and revised statements for defence, mining, oil and gas, power, and forestry. For more information on our sector statements www.lloydsbankinggroup.com/our-group/responsible-business/sustainability-in-lloyds-banking-group. In 2019, we will review these statements again, and consider developing statements for other sectors and topics. We will review ways to embed sustainability in the Group’s digital presencekey policies.

Forward looking scenario analysis incorporating physical and transition risk will be utilised across the Group to systematically identify risks and opportunities. During 2018, Commercial Banking undertook forward looking scenario analyses including business as usual and low carbon transition scenarios, identifying sectors with a higher level of climate related risk and opportunity. Detailed assessments are now being undertaken on higher risk sectors to understand the potential financial impact to our customers and to the Group. We will be completing further reviews of higher risk sectors in 2019 to inform portfolio analytics, counterparty risk and financial product development, while sustaining extensiveincreasing the scope to also include other divisions.

Metrics and Targets

As part of our TCFD implementation plan we are developing our approach to reporting metrics and targets. This will include a long term reporting framework, enabling us to track our performance against our sustainability strategy, and disclose the financial impact of climate change related risks and opportunities. We will define metrics linked to our green finance propositions and the carbon exposure of our activities. Our targets will have specific time horizons against defined baseline years and will consider the level of historical and forward looking projections that can be made available. We aim to develop this new reporting framework in the first half of 2019 and will start to include key quantified metrics in our next annual report.

We have made sustainability a focus area in our Helping Britain Prosper Plan and have defined metrics for it. We disclose our in-house greenhouse gas emissions, as shown below, and our set of in house environmental targets on our website www.lloydsbankinggroup.com/our-group/responsible-business/ sustainability-in-lloyds-banking-group.

Clean Growth Finance Initiative

In 2018 we launched a £2 billion Clean Growth Finance Initiative (CGFI) to help British businesses reduce their environmental impacts and benefit from the transition to a low carbon economy. The CGFI aims to be the most inclusive UK green funding proposition available, incentivising all types of businesses to invest in low carbon projects by providing discounted financing for capital expenditure or investment with a green purpose.

CO2emissions (tonnes) Oct 17-Sept 18 Oct 16-Sept 17 Oct 15-Sept 161
Total CO2e (market-based)  115,467  303,065   340,2612 
Total CO2e (location-based)  244,407  286,892   340,261 
Total Scope 1  48,461  51,419   53,023 
Total Scope 2 (market-based)  1,976  178,771   202,3192 
Total Scope 2 (location-based)  130,916  162,598   202,319 
Total Scope 3  65,030  72,876   84,918 

1Restated 2017/2016 and 2016/2015 emissions data to improve the accuracy of reporting, using actual data to replace estimates.
2Note our market based emissions are equal to location based for 2016/15. This is in accordance with GHG protocol guidelines in absence of appropriate residual factors.
Emissions in tonnes CO2e in line with the GHG Protocol Corporate Standard (2004). We are now reporting to the revised Scope 2 guidance, disclosing a market-based figure in addition to the location-based figure. The measure and reporting criteria for Scope 1, 2, 3 emissions is provided in the Lloyds Banking Group Reporting Criteria statement available online at
www.lloydsbankinggroup.com/ResponsibleBusiness
Scope 1 emissions include mobile and stationary combustion of fuel and operation of facilities.
Scope 2 emissions have been calculated in accordance with GHG Protocol guidelines, in both location and market based methodologies.
 Indicator is subject to Limited ISAE3000 (revised) assurance by Deloitte LLP for the 2018 Annual Responsible Business Reporting. Deloitte’s 2018 assurance statement and the 2018 Reporting Criteria are available online at
www.lloydsbankinggroup.com/our-group/responsible-business

PROPERTIES

At 31 December 2018, Lloyds Banking Group occupied 1,891 properties in the UK. Of these, 405 were held as freeholds and 1,486 as leasehold. The majority of these properties are retail branches, widely distributed throughout England, Scotland, Wales and Northern Ireland. Other buildings include the Lloyds Banking Group’s head office in the City of London with other customer reach through a branch network focused on delivering high quality service and the right outcomes for customers.support centres located to suit business needs but clustered largely in eight core geographic conurbations – London, Edinburgh, Glasgow, Midlands (Birmingham), Northwest (Chester and Manchester), West Yorkshire (Halifax and Leeds), South (Brighton and Andover) and Southwest (Bristol and Cardiff).

 

BECOMING SIMPLERIn addition, there are 114 properties which are either sub-let or vacant. There are also a number of ATM units situated throughout the UK, the majority of which are held as leasehold. The Group also has business operations elsewhere in the world, primarily holding property on a leasehold basis.

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LEGAL ACTIONS AND MORE EFFICIENTREGULATORY MATTERS

During the ordinary course of business the Group is subject to threatened or actual legal proceedings and regulatory reviews and investigations both in the UK and overseas. Set out below is a summary of the more significant matters.

PAYMENT PROTECTION INSURANCE (EXCLUDING MBNA)

 

The Group increased the provision for PPI costs by a further £750 million in the year ended 31 December 2018, of which £200 million was in the fourth quarter, bringing the total amount provided to £19,425 million.

The charge in 2018 related to a number of factors including higher expected complaint volumes, which increased to 13,000 per week, and associated administration costs, an increase in average redress per complaint, additional operational costs to deal with potential complaint volatility and continued improvements in data interrogation and the Group’s ability to identify valid complaints. The remaining provision is focusedconsistent with an average of approximately 13,000 complaints per week to the industry deadline of the end of August 2019.

At 31 December 2018, a provision of £1,329 million remained unutilised relating to complaints and associated administration costs. Total cash payments were £1,859 million during the year ended 31 December 2018.

Sensitivities

The Group estimates that it has sold approximately 16 million PPI policies since 2000. These include policies that were not mis-sold and those that have been successfully claimed upon. Since the commencement of the PPI redress programme in 2011 the Group estimates that it has contacted, settled or provided for approximately 53 per cent of the policies sold since 2000.

The total amount provided for PPI represents the Group’s best estimate of the likely future cost. However a number of risks and uncertainties remain including with respect to future complaint volumes. The cost could differ from the Group’s estimates and the assumptions underpinning them, and could result in a further provision being required. There is also uncertainty around the impact of the regulatory changes, Financial Conduct Authority media campaign and Claims Management Company and customer activity, and potential additional remediation arising from the continuous improvement of the Group’s operational practices.

For every additional 1,000 reactive complaints per week above 13,000 on creating operational capabilityaverage from January 2019 through to the industry deadline of the end of August 2019, the Group would expect an additional charge of approximately £85 million.

PAYMENT PROTECTION INSURANCE (MBNA)

As announced in December 2016, the Group’s exposure is capped at £240 million, which is simpleralready provided for through an indemnity received from Bank of America. MBNA increased its PPI provision by £100 million in the year ended 31 December 2018 but the Group’s exposure continues to remain capped at £240 million under the arrangement with Bank of America, notwithstanding this increase by MBNA.

OTHER PROVISIONS FOR LEGAL ACTIONS AND REGULATORY MATTERS

In the course of its business, the Group is engaged in discussions with the PRA, FCA and more efficient than todayother UK and will become more responsiveoverseas regulators and other governmental authorities on a range of matters. The Group also receives complaints in connection with its past conduct and claims brought by or on behalf of current and former employees, customers, investors and other third parties and is subject to changing customer expectations while maintaininglegal proceedings and other legal actions. Where significant, provisions are held against the costs expected to be incurred in relation to these matters and matters arising from related internal reviews. During the year ended 31 December 2018 the Group charged a further £600 million in respect of legal actions and other regulatory matters, and the unutilised balance at 31 December 2018 was £861 million (31 December 2017: £1,292 million). The most significant items are as follows.

Arrears handling related activities

The Group has provided an additional £151 million in the year ended 31 December 2018 for the costs of identifying and rectifying certain arrears management fees and activities, taking the total provided to date to £793 million. The Group has put in place a number of actions to improve its cost leadership amongst UK high street banks. This includeshandling of customers in these areas and has made good progress in reimbursing arrears fees to impacted customers.

Packaged bank accounts

The Group has provided a second phasefurther £45 million in the year ended 31 December 2018 (£245 million was provided in the year ended 31 December 2017) in respect of complaints relating to alleged mis-selling of packaged bank accounts, raising the total amount provided to £795 million. A number of risks and uncertainties remain particularly with respect to future volumes.

Customer claims in relation to insurance branch business in Germany

The Group continues to receive claims in Germany from customers relating to policies issued by Clerical Medical Investment Group Limited (subsequently renamed Scottish Widows Limited), with smaller numbers received from customers in Austria and Italy. The industry-wide issue regarding notification of contractual ‘cooling off’ periods continued to lead to an increasing number of claims in 2016 and 2017 levelling out in 2018. Up to 31 December 2017 the Group had provided a total of £639 million, with no further amounts provided during the year ended 31 December 2018. The validity of the Simplification programmeclaims facing the Group depends upon the facts and circumstances in respect of each claim. As a result the ultimate financial effect, which could be significantly different from the current provision, will be known only once all relevant claims have been resolved.

HBOS Reading – customer review

The Group has now completed its compensation assessment for all 71 business customers within the customer review, with more than 96 per cent of these offers accepted. In total, more than £96 million has been offered of which £78 million has so far been accepted, in addition to achieve run-rate savings£9 million for ex-gratia payments and £5 million for the reimbursements of £1 billion per annumlegal fees.

The review follows the conclusion of a criminal trial in which a number of individuals, including two former HBOS employees, were convicted of conspiracy to corrupt, fraudulent trading and associated money laundering offences which occurred prior to the acquisition of HBOS by the Group in 2009. The Group has provided a further £15 million in the year ended 31 December 2018 for customer settlements, raising the total amount provided to

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£115 million and is now nearing the end of the process of paying compensation to the victims of the fraud, including ex-gratia payments and reimbursements of legal fees.

INTERCHANGE FEES

With respect to multi-lateral interchange fees (MIFs), the Group is not directly involved in the ongoing investigations and litigation (as described below) which involve card schemes such as Visa and Mastercard. However, the Group is a member/licensee of Visa and Mastercard and other card schemes:

– The European Commission continues to pursue competition investigations against Mastercard and Visa probing, amongst other things, MIFs paid in respect of cards issued outside the EEA;
–Litigation brought by retailers continues in the English Courts against both Visa and Mastercard;
–Any ultimate impact on the Group of the above investigations and litigation against Visa and Mastercard remains uncertain at this time.

Visa Inc completed its acquisition of Visa Europe on 21 June 2016. As part of this transaction, the Group and certain other UK banks also entered into a Loss Sharing Agreement (LSA) with Visa Inc, which clarifies the allocation of liabilities between the parties should the litigation referred to above result in Visa Inc being liable for damages payable by Visa Europe. The maximum amount of liability to which the Group may be subject under the LSA is capped at the cash consideration which was received by the Group at completion. Visa Inc may also have recourse to a general indemnity, previously in place under Visa Europe’s Operating Regulations, for damages claims concerning inter or intra-regional MIF setting activities.

LIBOR AND OTHER TRADING RATES

In July 2014, the Group announced that it had reached settlements totalling £217 million (at 30 June 2014 exchange rates) to resolve with UK and US federal authorities legacy issues regarding the manipulation several years ago of Group companies’ submissions to the British Bankers’ Association (BBA) London Interbank Offered Rate (LIBOR) and Sterling Repo Rate. The Group continues to cooperate with various other government and regulatory authorities, including the Swiss Competition Commission, and a number of US State Attorneys General, in conjunction with their investigations into submissions made by panel members to the bodies that set LIBOR and various other interbank offered rates.

Certain Group companies, together with other panel banks, have also been named as defendants in private lawsuits, including purported class action suits, in the US in connection with their roles as panel banks contributing to the setting of US Dollar, Japanese Yen and Sterling LIBOR and the Australian BBSW Reference Rate. Certain of the plaintiffs’ claims, have been dismissed by the US Federal Court for Southern District of New York (subject to appeals).

Certain Group companies are also named as defendants in (i) UK based claims; and (ii) in 2 Dutch class actions, raising LIBOR manipulation allegations. A number of the claims against the Group in relation to the alleged mis-sale of interest rate hedging products also include allegations of LIBOR manipulation.

It is currently not possible to predict the scope and ultimate outcome on the Group of the various outstanding regulatory investigations not encompassed by the settlements, any private lawsuits or any related challenges to the interpretation or validity of any of the Group’s contractual arrangements, including their timing and scale.

UK SHAREHOLDER LITIGATION

In August 2014, the Group and a number of former directors were named as defendants in a claim by a number of claimants who held shares in Lloyds TSB Group plc (LTSB) prior to the acquisition of HBOS plc, alleging breaches of duties in relation to information provided to shareholders in connection with the acquisition and the recapitalisation of LTSB. The defendants refute all claims made. A trial commenced in the English High Court on 18 October 2017 and concluded on 5 March 2018 with judgment to follow. It is currently not possible to determine the ultimate impact on the Group (if any).

TAX AUTHORITIES

The Group has an open matter in relation to a claim for group relief of losses incurred in its former Irish banking subsidiary, which ceased trading on 31 December 2010. In 2013 HMRC informed the Group that their interpretation of the UK rules which allow the offset of such losses denies the claim. If HMRC’s position is found to be correct management estimate that this would result in an increase in current tax liabilities of approximately £770 million (including interest) and a reduction in the Group’s deferred tax asset of approximately £250 million. The Group does not agree with HMRC’s position and, having taken appropriate advice, does not consider that this is a case where additional tax will ultimately fall due. There are a number of other open matters on which the Group is in discussion with HMRC (including the tax treatment of certain costs arising from the divestment of TSB Banking Group plc), none of which is expected to have a material impact on the financial position of the Group.

RESIDENTIAL MORTGAGE REPOSSESSIONS

In August 2014, the Northern Ireland High Court handed down judgment in favour of the borrowers in relation to three residential mortgage test cases concerning certain aspects of the Group’s practice with respect to the recalculation of contractual monthly instalments of customers in arrears. The FCA has been actively engaged with the industry in relation to these considerations and has published Guidance on the treatment of customers with mortgage payment shortfalls. The Guidance covers remediation for mortgage customers who may have been affected by the way firms calculate these customers’ monthly mortgage instalments. The Group is implementing the Guidance and has now contacted nearly all affected customers with any remaining customers anticipated to be contacted by the end of 2017. In order to achieve these savings,March 2019.

MORTGAGE ARREARS HANDLING ACTIVITIES – FCA INVESTIGATION

On 26 May 2016, the Group will invest around £1.6 billion over three years on initiativeswas informed that an enforcement team at the FCA had commenced an investigation in connection with the Group’s mortgage arrears handling activities. This investigation is ongoing and the Group continues to simplify processes and increase automation.cooperate with the FCA. It is not currently possible to make a reliable assessment of any liability that may result from the investigation including any financial penalty or public censure.

 

DELIVERING SUSTAINABLE GROWTHHBOS READING – FCA INVESTIGATION

 

On 7 April 2017 the FCA announced that it had resumed its investigation into the events surrounding the discovery of misconduct within the Reading-based Impaired Assets team of HBOS. The investigation is ongoing and the Group continues to cooperate with the FCA. It is not currently possible to make a reliable assessment of any liability that may result from the investigation including any financial penalty or public censure.

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BUSINESS

CONTINGENT LIABILITIES RELATING TO OTHER LEGAL ACTIONS AND REGULATORY MATTERS

In addition, during the ordinary course of business the Group is subject to other complaints and threatened or actual legal proceedings (including class or group action claims) brought by or on behalf of current or former employees, customers, investors or other third parties, as well as legal and regulatory reviews, challenges, investigations and enforcement actions, both in the UK and overseas. All such material matters are periodically reassessed, with the assistance of external professional advisers where appropriate, to determine the likelihood of the Group incurring a liability. In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management’s best estimate of the amount required at the relevant balance sheet date. In some cases it will not be possible to form a view, for example because the facts are unclear or because further time is needed properly to assess the merits of the case, and no provisions are held in relation to such matters. In these circumstances, specific disclosure in relation to a contingent liability will be made where material. However the Group does not currently expect the final outcome of any such case to have a material adverse effect on its financial position, operations or cash flows.

COMPETITIVE ENVIRONMENT

The Group provides financial services to individual and business customers, predominantly in the UK but also overseas. The main business activities of the Group are retail and commercial banking and long-term savings, protection and investment.

In the retail banking market, the Group competes with banks and building societies, major retailers and internet-only providers. In the mortgage market, competitors include the traditional banks and building societies and specialist mortgage providers. The Group competes with both UK and foreign financial institutions along with emerging forms of lending in the commercial banking markets and with bancassurance, life assurance and general insurance companies in the UK insurance market.

The markets for UK financial services, and the other markets within which the Group operates, are competitive, and management expects such competition to continue or intensify in response to competitor behaviour, including non-traditional competitors, consumer demand, technological changes such as the growth of digital banking, and the impact of regulatory actions and other factors.

For more information see “Risk Factors – Business and economic risks – The Group’s businesses are conducted in competitive environments, with increased competition scrutiny, and the Group’s financial performance depends upon management’s ability to respond effectively to competitive pressures.”

10

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The results discussed below are not necessarily indicative of Lloyds Banking Group’s results in future periods. The following information contains certain forward looking statements. For a discussion of certain cautionary statements relating to forward looking statements, seeForward looking statements.

The following discussion is based on and should be read in conjunction with the consolidated financial statements and the related notes thereto included elsewhere in this annual report. For a discussion of the accounting policies used in the preparation of the consolidated financial statements, seeAccounting policiesin note 2 to the financial statements.

TABLE OF CONTENTS

Overview and trend information12
Critical accounting policies12
Future accounting developments12
Results of operations – 2018, 2017 and 201613
Line of business information24
Average balance sheet and net interest income32
Changes in net interest income – volume and rate analysis34
Risk overview35
Risk management41
Credit risk51
Loan portfolio66
Risk elements in the loan portfolio70
Regulatory and legal risk75
Conduct risk75
Operational risk76
People risk78
Insurance underwriting risk78
Capital risk79
Funding and liquidity risk88
Governance risk95
Market risk96
Model risk102
11

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

OVERVIEW AND TREND INFORMATION

ECONOMY

Highlights

Given our UK focus, the Group’s prospects are closely linked to the fortunes of the UK economy.
The economy faces significant uncertainty around the UK’s departure from the EU. With the expectation that the UK leaves in an orderly fashion, the economy should be able to grow in 2019 at a similar pace to 2018.
Our low risk business model and focus on efficiency positions us well irrespective of macro conditions but if the UK economy sees significant sustained deterioration this is likely to impact Group performance.

Overview

As the largest provider of UK banking services, our prospects are closely aligned to the outlook for the UK economy. In the period following the decision to leave the EU, the economy has been resilient. Growth has slowed only slightly below its trend rate, the unemployment rate has continued to fall to a 43 year low, and property prices have continued to rise slowly. This resilience is expected to continue in 2019 and the next few years, barring any sudden shocks to business or consumer confidence particularly in connection with the UK’s exit from the EU during 2019.

Market dynamics

Households’ spending power has been improving in recent months as pay growth has begun to pick up and outpace inflation, which is falling back towards the medium term target of 2 per cent. Inflation adjusted pay is now slightly above its previous peak in early 2016. This improvement is expected to continue through 2019, supported by a reduction in planned fiscal tightening announced in the 2018 Budget in November and the end of the cap to public sector pay growth. The improvement in spending power should help support growth in consumer spending and borrowing, whilst also increasing growth in households’ savings.

The UK housing market has been broadly flat in 2018 in aggregate, although weakness has been centred around London and the South East where high prices are constraining affordability. Improved households’ spending power should support the housing market in 2019, as would resolution of uncertainty about the immediate political and economic concerns.

Operational impacts of the UK’s exit from the EU present risks for some of our customers’ businesses. With the future trading arrangements between the UK and EU unlikely to become finalised for a few years, businesses’ investment decisions are more difficult and postponement of investment may weigh on future growth capacity of the economy. Uncertainty is also challenging the UK’s attractiveness to foreign investors, although many qualities that have attracted investors in the past remain.

More widely, the global economy is transitioning away from the exceptionally low interest rates in place in most advanced economies since the financial crisis. This process will not always be constant, with different countries at different stages of their economic cycle, and unwinding of ‘quantitative easing’ may increase volatility in financial markets. The widespread trend to increasingly populist politics, of which the US-China trade war is a prime example, poses a challenge to appropriate economic policy.

Barring sudden shocks stemming from these challenges, the UK economy continuesis expected to recover,grow through 2019 to 2021 at a pace similar to 2018. The unemployment rate is expected to rise only a little from its current 43 year low, and further mild increases in house prices are expected. The Bank Rate is expected to rise only slowly, as the Group will seek Group-wideuncertainty drag on the economy fades. Growth in many of our markets is expected to pick up, although the consumer credit market should continue to slow after its strong growth opportunities whilst maintaining its prudent risk appetite. This will be achieved by maintaining market leadershipthrough 2014 to 2017. Impairments are expected to increase in its retail business lines while also focusing on areas where the Group is currently under represented.2019 as we continue to see lower write-backs and recoveries but remain at relatively low levels.

 

Our response

Given our UK focus, the Group’s prospects are closely linked to the performance of the UK economy. Our low risk, stable business model and focus on efficiency positions us well to continue to support customers irrespective of macro conditions.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported therein. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates.

The accounting policies that are deemed critical to the Group’s results and financial position, based upon materiality and significant judgements and estimates, are set out in note 3 to the financial statements.

FUTURE ACCOUNTING DEVELOPMENTS

Future developments in relation to the Group’s IFRS reporting are discussed in note 56 to the financial statements.

12

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

RESULTS OF OPERATIONS – 2018, 2017 AND 2016

SUMMARYLEGAL ACTIONS AND REGULATORY MATTERS

During the ordinary course of business the Group is subject to threatened or actual legal proceedings and regulatory reviews and investigations both in the UK and overseas. Set out below is a summary of the more significant matters.

PAYMENT PROTECTION INSURANCE (EXCLUDING MBNA)

 

The Group increased the provision for PPI costs by a further £750 million in the year ended 31 December 2018, of which £200 million was in the fourth quarter, bringing the total amount provided to £19,425 million.

The charge in 2018 related to a number of factors including higher expected complaint volumes, which increased to 13,000 per week, and associated administration costs, an increase in average redress per complaint, additional operational costs to deal with potential complaint volatility and continued improvements in data interrogation and the Group’s ability to identify valid complaints. The remaining provision is creating a simpler, more agile, efficient and responsive customer focused organisation which operates sustainably and responsibly and Helps Britain Prosper. The achievementconsistent with an average of our strategy could not happen withoutapproximately 13,000 complaints per week to the support of our colleagues. We are therefore committed to ‘building the best team’ to create a high performance organisation. The Group believes that the successful executionindustry deadline of the next phaseend of its strategy will enable delivery of superior and sustainable returns for shareholders.

BUSINESS AND ACTIVITIES OF LLOYDS BANKING GROUPAugust 2019.

 

At 31 December 20152018, a provision of £1,329 million remained unutilised relating to complaints and associated administration costs. Total cash payments were £1,859 million during the Group’s activities were organised into four financial reporting segments: Retail; Commercial Banking; Consumer Finance and Insurance.year ended 31 December 2018.

 

Further information onSensitivities

The Group estimates that it has sold approximately 16 million PPI policies since 2000. These include policies that were not mis-sold and those that have been successfully claimed upon. Since the Group’s segments is set out on pages 26 to 36 andcommencement of the PPI redress programme in note 4 to2011 the financial statements.

MATERIAL CONTRACTSGroup estimates that it has contacted, settled or provided for approximately 53 per cent of the policies sold since 2000.

 

The total amount provided for PPI represents the Group’s best estimate of the likely future cost. However a number of risks and uncertainties remain including with respect to future complaint volumes. The cost could differ from the Group’s estimates and the assumptions underpinning them, and could result in a further provision being required. There is also uncertainty around the impact of the regulatory changes, Financial Conduct Authority media campaign and Claims Management Company and its subsidiaries are party to various contracts incustomer activity, and potential additional remediation arising from the ordinary coursecontinuous improvement of business.the Group’s operational practices.

 

For informationevery additional 1,000 reactive complaints per week above 13,000 on average from January 2019 through to the industry deadline of the end of August 2019, the Group would expect an additional charge of approximately £85 million.

PAYMENT PROTECTION INSURANCE (MBNA)

As announced in December 2016, the Group’s exposure is capped at £240 million, which is already provided for through an indemnity received from Bank of America. MBNA increased its PPI provision by £100 million in the year ended 31 December 2018 but the Group’s exposure continues to remain capped at £240 million under the arrangement with Bank of America, notwithstanding this increase by MBNA.

OTHER PROVISIONS FOR LEGAL ACTIONS AND REGULATORY MATTERS

In the course of its business, the Group is engaged in discussions with the PRA, FCA and other UK and overseas regulators and other governmental authorities on a range of matters. The Group also receives complaints in connection with its past conduct and claims brought by or on behalf of current and former employees, customers, investors and other third parties and is subject to legal proceedings and other legal actions. Where significant, provisions are held against the costs expected to be incurred in relation to these matters and matters arising from related internal reviews. During the year ended 31 December 2018 the Group charged a further £600 million in respect of legal actions and other regulatory matters, and the unutilised balance at 31 December 2018 was £861 million (31 December 2017: £1,292 million). The most significant items are as follows.

Arrears handling related activities

The Group has provided an additional £151 million in the year ended 31 December 2018 for the costs of identifying and rectifying certain arrears management fees and activities, taking the total provided to date to £793 million. The Group has put in place a number of actions to improve its handling of customers in these areas and has made good progress in reimbursing arrears fees to impacted customers.

Packaged bank accounts

The Group has provided a further £45 million in the year ended 31 December 2018 (£245 million was provided in the year ended 31 December 2017) in respect of complaints relating to alleged mis-selling of packaged bank accounts, raising the Company’s relationshiptotal amount provided to £795 million. A number of risks and uncertainties remain particularly with the UK Government seeMajor Shareholders and Related Party Transactions – Information about the Lloyds Banking Group’s relationship with the UK Government. For informationrespect to future volumes.

Customer claims in relation to insurance branch business in Germany

The Group continues to receive claims in Germany from customers relating to policies issued by Clerical Medical Investment Group Limited (subsequently renamed Scottish Widows Limited), with smaller numbers received from customers in Austria and Italy. The industry-wide issue regarding notification of contractual ‘cooling off’ periods continued to lead to an increasing number of claims in 2016 and 2017 levelling out in 2018. Up to 31 December 2017 the Group’s relationshipGroup had provided a total of £639 million, with no further amounts provided during the TSByear ended 31 December 2018. The validity of the claims facing the Group seeMajor Shareholdersdepends upon the facts and Related Party Transactionscircumstances in respect of each claim. As a result the ultimate financial effect, which could be significantly different from the current provision, will be known only once all relevant claims have been resolved.

HBOS Reading – Information aboutcustomer review

The Group has now completed its compensation assessment for all 71 business customers within the Lloyds Banking Group’s relationshipcustomer review, with more than 96 per cent of these offers accepted. In total, more than £96 million has been offered of which £78 million has so far been accepted, in addition to £9 million for ex-gratia payments and £5 million for the TSBreimbursements of legal fees.

The review follows the conclusion of a criminal trial in which a number of individuals, including two former HBOS employees, were convicted of conspiracy to corrupt, fraudulent trading and associated money laundering offences which occurred prior to the acquisition of HBOS by the Group. in 2009. The Group has provided a further £15 million in the year ended 31 December 2018 for customer settlements, raising the total amount provided to

58

BUSINESS

 

ENVIRONMENTAL MATTERS£115 million and is now nearing the end of the process of paying compensation to the victims of the fraud, including ex-gratia payments and reimbursements of legal fees.

 

The Group’s abilityINTERCHANGE FEES

With respect to help Britain prospermulti-lateral interchange fees (MIFs), the Group is inextricably linked to wider environmental issues. Man-made climate changenot directly involved in the ongoing investigations and global trendslitigation (as described below) which involve card schemes such as resource scarcity, extreme weatherVisa and rising energyMastercard. However, the Group is a member/licensee of Visa and commodity pricesMastercard and other card schemes:

– The European Commission continues to pursue competition investigations against Mastercard and Visa probing, amongst other things, MIFs paid in respect of cards issued outside the EEA;
–Litigation brought by retailers continues in the English Courts against both Visa and Mastercard;
–Any ultimate impact on the Group of the above investigations and litigation against Visa and Mastercard remains uncertain at this time.

Visa Inc completed its acquisition of Visa Europe on 21 June 2016. As part of this transaction, the Group and certain other UK banks also entered into a Loss Sharing Agreement (LSA) with Visa Inc, which clarifies the allocation of liabilities between the parties should the litigation referred to above result in Visa Inc being liable for damages payable by Visa Europe. The maximum amount of liability to which the Group may be subject under the LSA is capped at the cash consideration which was received by the Group at completion. Visa Inc may also have anrecourse to a general indemnity, previously in place under Visa Europe’s Operating Regulations, for damages claims concerning inter or intra-regional MIF setting activities.

LIBOR AND OTHER TRADING RATES

In July 2014, the Group announced that it had reached settlements totalling £217 million (at 30 June 2014 exchange rates) to resolve with UK and US federal authorities legacy issues regarding the manipulation several years ago of Group companies’ submissions to the British Bankers’ Association (BBA) London Interbank Offered Rate (LIBOR) and Sterling Repo Rate. The Group continues to cooperate with various other government and regulatory authorities, including the Swiss Competition Commission, and a number of US State Attorneys General, in conjunction with their investigations into submissions made by panel members to the bodies that set LIBOR and various other interbank offered rates.

Certain Group companies, together with other panel banks, have also been named as defendants in private lawsuits, including purported class action suits, in the US in connection with their roles as panel banks contributing to the setting of US Dollar, Japanese Yen and Sterling LIBOR and the Australian BBSW Reference Rate. Certain of the plaintiffs’ claims, have been dismissed by the US Federal Court for Southern District of New York (subject to appeals).

Certain Group companies are also named as defendants in (i) UK based claims; and (ii) in 2 Dutch class actions, raising LIBOR manipulation allegations. A number of the claims against the Group in relation to the alleged mis-sale of interest rate hedging products also include allegations of LIBOR manipulation.

It is currently not possible to predict the scope and ultimate outcome on the Group of the various outstanding regulatory investigations not encompassed by the settlements, any private lawsuits or any related challenges to the interpretation or validity of any of the Group’s contractual arrangements, including their timing and scale.

UK SHAREHOLDER LITIGATION

In August 2014, the Group and a number of former directors were named as defendants in a claim by a number of claimants who held shares in Lloyds TSB Group plc (LTSB) prior to the acquisition of HBOS plc, alleging breaches of duties in relation to information provided to shareholders in connection with the acquisition and the recapitalisation of LTSB. The defendants refute all claims made. A trial commenced in the English High Court on 18 October 2017 and concluded on 5 March 2018 with judgment to follow. It is currently not possible to determine the ultimate impact on the Group’s stakeholders and its own operations.Group (if any).

TAX AUTHORITIES

 

The Group recognises the global challenge posed by these wider issues, and its responsibility to reduce the environmental impacts of its business operations. The Group is committed to managing its direct environmental impacts in a responsible manner and reducing its greenhouse gas emissions. The Group does this through its Environmental Action Plan, through which it aims to maximise the opportunity to create business value and minimise business riskhas an open matter in relation to its direct environmental impact.

The Group’s approach towards managing its environmental impact is set outa claim for group relief of losses incurred in its Environmental Statement, availableformer Irish banking subsidiary, which ceased trading on 31 December 2010. In 2013 HMRC informed the Responsible Business sectionGroup that their interpretation of the Group’s corporate website.

Greenhouse gas emissions

The Group has voluntarily reported greenhouse gas emissionsUK rules which allow the offset of such losses denies the claim. If HMRC’s position is found to be correct management estimate that this would result in an increase in current tax liabilities of approximately £770 million (including interest) and environmental performance since 2009, and since 2013 this has been in line with the requirements of the Companies Act 2006. Deloitte LLP has reviewed a selection of non-financial KPIs, indicated by providing limited assurance using the International Standard on Assurance Engagements (ISAE) 3000 (Revised). Their full, independent assurance statement is available online at www.lloydsbankinggroup.com/RBdownloads.

CO2e emissions (tonnes)

Oct 2014 –Oct 2013 –
Sept 2015Sept 2014
Total CO2e398,191441,703
Total scope 157,76160,019
Total scope 2241,008264,252
Total scope 399,422117,432

Restated 2013/2014 emissions data to improve the accuracy of reporting, using actual data to replace estimations and the re-categorisation of the emissions from the Group’s owned vehicles.

Emissions in tonnes CO2e in line with the GHG Protocol Corporate Standard revised issue (2004). Criteria used to measure and report Scope 1, 2, 3 emissions is provided in the Lloyds Banking Group criteria statement available online at www.lloydsbankinggroup.com/ResponsibleBusiness

 Indicator is subject to limited ISAE 3000 (Revised) assurance by Deloitte LLP for the 2015 Annual Responsible Business Reporting. Deloitte LLP’s 2015 assurance statement and the 2015 Reporting Criteria are available online at www.lloydsbankinggroup.com/RBdownloads

Methodology

The Group follows the principles of the Greenhouse Gas (GHG) Protocol Corporate Accounting and Reporting Standard to calculate its Scope 1, 2 and 3 emissions from its worldwide operations.

The reporting period is 1 October 2014 to 30 September 2015, which is different to that of the Group’s Directors’ Report (January 2015 – December 2015). This is in line with Regulations in that the majority of the emissions reporting year falls within the period of the Directors’ Report. Emissions are reported based on an operational boundary. The scope of reporting is in line with the GHG Protocol and covers Scope 1, Scope 2 and Scope 3 emissions. Reported Scope 1 emissions cover emissions generated from gas and oil used in buildings, emissions from UK company-owned vehicles used for business travel and emissions from the use of air conditioning and chiller/refrigerant plant. Reported Scope 2 emissions cover emissions generated from the use of electricity. Reported Scope 3 emissions relate to business travel undertaken by colleagues and emissions associated with the extraction and distribution of each of the Group’s energy sources – electricity, gas and oil. A detailed definition of these emissions can be foundreduction in the Group’s 2015 Reporting Criteria online at www.lloydsbankinggroup.com/RBdownloads.

Intensity ratio

An intensity ratiodeferred tax asset of GHG gases per £m of underlying income has been selected.

  Oct 2014 – Oct 2013–
  Sept 2015 Sep 2014
GHG emissions per unit of underlying income 22.3 24.0

Omissions

Emissions associated with joint ventures and investments are not included in this disclosure as they fall outside the scope of the Group’s operational boundary.approximately £250 million. The Group does not agree with HMRC’s position and, having taken appropriate advice, does not consider that this is a case where additional tax will ultimately fall due. There are a number of other open matters on which the Group is in discussion with HMRC (including the tax treatment of certain costs arising from the divestment of TSB Banking Group plc), none of which is expected to have a material impact on the financial position of the Group.

RESIDENTIAL MORTGAGE REPOSSESSIONS

In August 2014, the Northern Ireland High Court handed down judgment in favour of the borrowers in relation to three residential mortgage test cases concerning certain aspects of the Group’s practice with respect to the recalculation of contractual monthly instalments of customers in arrears. The FCA has been actively engaged with the industry in relation to these considerations and has published Guidance on the treatment of customers with mortgage payment shortfalls. The Guidance covers remediation for mortgage customers who may have been affected by the way firms calculate these customers’ monthly mortgage instalments. The Group is implementing the Guidance and has now contacted nearly all affected customers with any emissions associatedremaining customers anticipated to be contacted by the end of March 2019.

MORTGAGE ARREARS HANDLING ACTIVITIES – FCA INVESTIGATION

On 26 May 2016, the Group was informed that an enforcement team at the FCA had commenced an investigation in connection with heat, steam or coolingthe Group’s mortgage arrears handling activities. This investigation is ongoing and the Group continues to cooperate with the FCA. It is not awarecurrently possible to make a reliable assessment of any other material sourcesliability that may result from the investigation including any financial penalty or public censure.

HBOS READING – FCA INVESTIGATION

On 7 April 2017 the FCA announced that it had resumed its investigation into the events surrounding the discovery of omissionsmisconduct within the Reading-based Impaired Assets team of HBOS. The investigation is ongoing and the Group continues to cooperate with the FCA. It is not currently possible to make a reliable assessment of any liability that may result from its reporting.the investigation including any financial penalty or public censure.

69

BUSINESS

 

PROPERTIES

At 31 December 2015, Lloyds Banking Group occupied 2,388 properties in the UK. Of these, 696 were held as freeholds and 1,692 as leasehold. The majority of these properties are retail branches, widely distributed throughout England, Scotland, Wales and Northern Ireland. Other buildings include the Lloyds Banking Group’s head office in the City of London with other customer service and support centres located to suit business needs but clustered largely in eight core geographic conurbations – London, Edinburgh, Glasgow, Midlands (Birmingham), Northwest (Chester and Manchester), West Yorkshire (Halifax and Leeds), South (Brighton and Andover) and Southwest (Bristol and Cardiff).CONTINGENT LIABILITIES RELATING TO OTHER LEGAL ACTIONS AND REGULATORY MATTERS

 

In addition, there are 122 properties which are either sub-letduring the ordinary course of business the Group is subject to other complaints and threatened or vacant. There are also a numberactual legal proceedings (including class or group action claims) brought by or on behalf of ATM units situated throughoutcurrent or former employees, customers, investors or other third parties, as well as legal and regulatory reviews, challenges, investigations and enforcement actions, both in the UK and overseas. All such material matters are periodically reassessed, with the majorityassistance of external professional advisers where appropriate, to determine the likelihood of the Group incurring a liability. In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management’s best estimate of the amount required at the relevant balance sheet date. In some cases it will not be possible to form a view, for example because the facts are unclear or because further time is needed properly to assess the merits of the case, and no provisions are held in relation to such matters. In these circumstances, specific disclosure in relation to a contingent liability will be made where material. However the Group does not currently expect the final outcome of any such case to have a material adverse effect on its financial position, operations or cash flows.

COMPETITIVE ENVIRONMENT

The Group provides financial services to individual and business customers, predominantly in the UK but also overseas. The main business activities of the Group are retail and commercial banking and long-term savings, protection and investment.

In the retail banking market, the Group competes with banks and building societies, major retailers and internet-only providers. In the mortgage market, competitors include the traditional banks and building societies and specialist mortgage providers. The Group competes with both UK and foreign financial institutions along with emerging forms of lending in the commercial banking markets and with bancassurance, life assurance and general insurance companies in the UK insurance market.

The markets for UK financial services, and the other markets within which the Group operates, are competitive, and management expects such competition to continue or intensify in response to competitor behaviour, including non-traditional competitors, consumer demand, technological changes such as the growth of digital banking, and the impact of regulatory actions and other factors.

For more information see “Risk Factors – Business and economic risks – The Group’s businesses are conducted in competitive environments, with increased competition scrutiny, and the Group’s financial performance depends upon management’s ability to respond effectively to competitive pressures.”

10

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The results discussed below are not necessarily indicative of Lloyds Banking Group’s results in future periods. The following information contains certain forward looking statements. For a discussion of certain cautionary statements relating to forward looking statements, seeForward looking statements.

The following discussion is based on and should be read in conjunction with the consolidated financial statements and the related notes thereto included elsewhere in this annual report. For a discussion of the accounting policies used in the preparation of the consolidated financial statements, seeAccounting policiesin note 2 to the financial statements.

TABLE OF CONTENTS

Overview and trend information12
Critical accounting policies12
Future accounting developments12
Results of operations – 2018, 2017 and 201613
Line of business information24
Average balance sheet and net interest income32
Changes in net interest income – volume and rate analysis34
Risk overview35
Risk management41
Credit risk51
Loan portfolio66
Risk elements in the loan portfolio70
Regulatory and legal risk75
Conduct risk75
Operational risk76
People risk78
Insurance underwriting risk78
Capital risk79
Funding and liquidity risk88
Governance risk95
Market risk96
Model risk102
11

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

OVERVIEW AND TREND INFORMATION

ECONOMY

Highlights

Given our UK focus, the Group’s prospects are closely linked to the fortunes of the UK economy.
The economy faces significant uncertainty around the UK’s departure from the EU. With the expectation that the UK leaves in an orderly fashion, the economy should be able to grow in 2019 at a similar pace to 2018.
Our low risk business model and focus on efficiency positions us well irrespective of macro conditions but if the UK economy sees significant sustained deterioration this is likely to impact Group performance.

Overview

As the largest provider of UK banking services, our prospects are closely aligned to the outlook for the UK economy. In the period following the decision to leave the EU, the economy has been resilient. Growth has slowed only slightly below its trend rate, the unemployment rate has continued to fall to a 43 year low, and property prices have continued to rise slowly. This resilience is expected to continue in 2019 and the next few years, barring any sudden shocks to business or consumer confidence particularly in connection with the UK’s exit from the EU during 2019.

Market dynamics

Households’ spending power has been improving in recent months as pay growth has begun to pick up and outpace inflation, which is falling back towards the medium term target of 2 per cent. Inflation adjusted pay is now slightly above its previous peak in early 2016. This improvement is expected to continue through 2019, supported by a reduction in planned fiscal tightening announced in the 2018 Budget in November and the end of the cap to public sector pay growth. The improvement in spending power should help support growth in consumer spending and borrowing, whilst also increasing growth in households’ savings.

The UK housing market has been broadly flat in 2018 in aggregate, although weakness has been centred around London and the South East where high prices are constraining affordability. Improved households’ spending power should support the housing market in 2019, as would resolution of uncertainty about the immediate political and economic concerns.

Operational impacts of the UK’s exit from the EU present risks for some of our customers’ businesses. With the future trading arrangements between the UK and EU unlikely to become finalised for a few years, businesses’ investment decisions are more difficult and postponement of investment may weigh on future growth capacity of the economy. Uncertainty is also challenging the UK’s attractiveness to foreign investors, although many qualities that have attracted investors in the past remain.

More widely, the global economy is transitioning away from the exceptionally low interest rates in place in most advanced economies since the financial crisis. This process will not always be constant, with different countries at different stages of their economic cycle, and unwinding of ‘quantitative easing’ may increase volatility in financial markets. The widespread trend to increasingly populist politics, of which are held as leasehold. The Group also has business operations elsewhere in the world, primarily holding property onUS-China trade war is a leasehold basis.prime example, poses a challenge to appropriate economic policy.

 

Barring sudden shocks stemming from these challenges, the UK economy is expected to grow through 2019 to 2021 at a pace similar to 2018. The unemployment rate is expected to rise only a little from its current 43 year low, and further mild increases in house prices are expected. The Bank Rate is expected to rise only slowly, as the uncertainty drag on the economy fades. Growth in many of our markets is expected to pick up, although the consumer credit market should continue to slow after its strong growth through 2014 to 2017. Impairments are expected to increase in 2019 as we continue to see lower write-backs and recoveries but remain at relatively low levels.

Our response

Given our UK focus, the Group’s prospects are closely linked to the performance of the UK economy. Our low risk, stable business model and focus on efficiency positions us well to continue to support customers irrespective of macro conditions.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported therein. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates.

The accounting policies that are deemed critical to the Group’s results and financial position, based upon materiality and significant judgements and estimates, are set out in note 3 to the financial statements.

FUTURE ACCOUNTING DEVELOPMENTS

Future developments in relation to the Group’s IFRS reporting are discussed in note 56 to the financial statements.

12

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

RESULTS OF OPERATIONS – 2018, 2017 AND 2016

LEGAL ACTIONS AND REGULATORY MATTERS

 

During the ordinary course of business the Group is subject to threatened or actual legal proceedings and regulatory reviews and investigations both in the UK and overseas. Set out below is a summary of the more significant matters. Further details are included in notes 39 and 49 to the financial statements.

INTERCHANGE FEES

With respect to multi-lateral interchange fees (MIFs), the Group is not directly involved in the on-going investigations and litigation (as described below) which involve card schemes such as Visa and MasterCard. However, the Group is a member of Visa and MasterCard and other card schemes.

–The European Commission continues to pursue certain competition investigations into MasterCard and Visa probing, amongst other things, MIFs paid in respect of cards issued outside the EEA;
–Litigation continues in the English Courts against both Visa and MasterCard. This litigation has been brought by several retailers who are seeking damages for allegedly ‘overpaid’ MIFs. From publicly available information, it is understood these damages claims are running to different timescales with respect to the litigation process, and their outcome remains uncertain. It is also possible that new claims may be issued.

On 2 November 2015, Visa Inc announced its proposed acquisition of Visa Europe, which remains subject to completion. As set out in the announcement by the Group on 2 November, the Group’s share of the sale proceeds will comprise upfront consideration of cash (the amount of which remains subject to adjustment prior to completion) and preferred stock. The preferred stock will be convertible into Class A Common Stock of Visa Inc or its equivalent upon occurrence of certain events. As part of this transaction, the Group and certain other UK banks also entered into a Loss Sharing Agreement (LSA) with Visa Inc, which clarifies how liabilities will be allocated between the parties should the litigation referred to above result in Visa Inc being liable for damages payable by Visa Europe. Visa Inc may only have recourse to the LSA once €1 billion of damages have been applied to the value of the UK preferred stock received by Visa UK members (including the Group) as part of the consideration to the transaction. The value of the preferred stock will be reduced (by making a downward adjustment to the conversion rate) in an amount equal to any covered losses. The maximum amount of liability to which the Group may be subject under the LSA is capped at the cash consideration to be received by the Group. Visa Inc may also have recourse to a general indemnity, currently in place under Visa Europe’s Operating Regulations, for damages claims concerning inter or intra-regional MIF setting activities.

The ultimate impact on the Group of the above investigations and the litigation against Visa and MasterCard cannot be known before the conclusion of these matters.

 

PAYMENT PROTECTION INSURANCE (EXCLUDING MBNA)

 

The Group increased the provision for PPI costs by a further £4,000£750 million in 2015,the year ended 31 December 2018, of which £200 million was in the fourth quarter, bringing the total amount provided to £16,025£19,425 million. This included

The charge in 2018 related to a number of factors including higher expected complaint volumes, which increased to 13,000 per week, and associated administration costs, an increase in average redress per complaint, additional £2,100 millionoperational costs to deal with potential complaint volatility and continued improvements in data interrogation and the fourth quarter, largelyGroup’s ability to reflectidentify valid complaints. The remaining provision is consistent with an average of approximately 13,000 complaints per week to the impact of our interpretationindustry deadline of the proposals contained within the Financial Conduct Authority’s (FCA) consultation paper regarding a potential time bar and the Plevin case. As atend of August 2019.

At 31 December 2015, £3,4582018, a provision of £1,329 million or 22 per cent of the total provision, remained unutilised with £2,950 million relating to reactive complaints and associated administration costs.

The volume of reactive PPI complaints has continued to fall, with an 8 per cent reduction in 2015 compared with 2014, to approximately 8,000 complaints per week. Whilst direct customer complaint levels fell 30 per cent year-on-year, those from Claims Management Companies (CMCs) have remained broadly stable and as a result, CMCs now account for over 70 per cent of complaints.

On 26 November 2015, the FCA published a consultation paper (CP15/39: Rules and guidance on payment protection insurance complaints) proposing (i) the introduction of a deadline by which consumers would need to make their PPI complaints including an FCA led communications campaign, and (ii) rules and guidance about how firms should handle PPI complaints in light of the Supreme Court’s decision in Plevin v Paragon Personal Finance Limited [2014] UKSC 61 (Plevin).

Based on recent trends, and in light of the proposals from the FCA, the Group now expects a higher level of complaints than previously assumed including those related to Plevin. As a result the Group has increased the total expected reactive complaint volumes to 4.7 Total cash payments were £1,859 million with approximately 1.3 million still expected to be received. This is equivalent to approximately 10,000 net complaints per week on average through to the proposed time bar of mid-2018.

Monthly complaints trends could vary significantly throughout this period, given they are likely to be impacted by a number of factors including the potential impact of the FCA’s proposed communication campaign as well as changes in the regulation of CMCs.

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The provision includes an estimate to cover redress that would be payable under the FCA’s proposed new rules and guidance in light of Plevin.

  Average monthly  Quarter on   
  reactive complaint  quarter Year on year
Quarter volume  % %
Q1 2013  61,259   (28%)    
Q2 2013  54,086   (12%)    
Q3 2013  49,555   (8%)    
Q4 2013  37,457   (24%)    
Q1 2014  42,259   13%  (31%)
Q2 2014  39,426   (7%)  (27%)
Q3 2014  40,624   3%  (18%)
Q4 2014  35,910   (12%)  (4%)
Q1 2015  37,791   5%  (11%)
Q2 2015  36,957   (2%)  (6%)
Q3 2015  37,586   2%  (7%)
Q4 2015  33,998   (10%)  (5%)

The Group continues to progress the re-review of previously handled cases and expects this to be substantially complete by the end of the first quarter of 2016. Duringduring the year the scope has been extended by 0.5 million to 1.7 million cases relating largely to previously redressed cases, in addition to which, higher overturn rates and average redress have been experienced. At the end of January 2016, 77 per cent of cases had been reviewed and 77 per cent of all cash payments made.

The Group has completed its Past Business Review (PBR) where it has been identified that there was a risk of potential mis-sale for certain customers, albeit monitoring continues. No further change has been made to the amount provided.

The Group expects to maintain the PPI operation on its current scale for longer than previously anticipated given the update to volume related assumptions and the re-review of previously handled cases continuing into the first quarter of 2016. The estimate for administrative expenses, which comprise complaint handling costs and costs arising from cases subsequently referred to the FOS, is included in the provision increase outlined above.ended 31 December 2018.

 

Sensitivities

The Group estimates that it has sold approximately 16 million PPI policies since 2000. These include policies that were not mis-sold.mis-sold and those that have been successfully claimed upon. Since the commencement of the PPI redress programme in 2011 the Group estimates that it has contacted, settled or provided for almost 49approximately 53 per cent of the policies sold since 2000, covering both customer-initiated complaints and actual and PBR mailings undertaken by the Group.2000.

 

The total amount provided for PPI represents the Group’s best estimate of the likely future cost. However a number of risks and uncertainties remain in particularincluding with respect to future complaint volumes. The cost could differ materially from the Group’s estimates and the assumptions underpinning them, and could result in a further provision being required. There is significantalso uncertainty around the impact of the proposed FCAregulatory changes, Financial Conduct Authority media campaign and CMCClaims Management Company and customer activity, inand potential additional remediation arising from the lead up tocontinuous improvement of the proposed time bar.Group’s operational practices.

 

Key metrics and sensitivities are highlightedFor every additional 1,000 reactive complaints per week above 13,000 on average from January 2019 through to the industry deadline of the end of August 2019, the Group would expect an additional charge of approximately £85 million.

PAYMENT PROTECTION INSURANCE (MBNA)

As announced in December 2016, the Group’s exposure is capped at £240 million, which is already provided for through an indemnity received from Bank of America. MBNA increased its PPI provision by £100 million in the table below:year ended 31 December 2018 but the Group’s exposure continues to remain capped at £240 million under the arrangement with Bank of America, notwithstanding this increase by MBNA.

 

  To date unless    
Sensitivities1 noted Future Sensitivity
Customer initiated complaints since origination (m)2 3.4 1.3 0.1 = £200m
Average uphold rate per policy3 76% 89% 1% = £35m
Average redress per upheld policy4 £1,810 £1,400 £100 = £170m
Administrative expenses (£m) 2,710 665 1 case = £450

OTHER PROVISIONS FOR LEGAL ACTIONS AND REGULATORY MATTERS

In the course of its business, the Group is engaged in discussions with the PRA, FCA and other UK and overseas regulators and other governmental authorities on a range of matters. The Group also receives complaints in connection with its past conduct and claims brought by or on behalf of current and former employees, customers, investors and other third parties and is subject to legal proceedings and other legal actions. Where significant, provisions are held against the costs expected to be incurred in relation to these matters and matters arising from related internal reviews. During the year ended 31 December 2018 the Group charged a further £600 million in respect of legal actions and other regulatory matters, and the unutilised balance at 31 December 2018 was £861 million (31 December 2017: £1,292 million). The most significant items are as follows.

Arrears handling related activities

The Group has provided an additional £151 million in the year ended 31 December 2018 for the costs of identifying and rectifying certain arrears management fees and activities, taking the total provided to date to £793 million. The Group has put in place a number of actions to improve its handling of customers in these areas and has made good progress in reimbursing arrears fees to impacted customers.

Packaged bank accounts

The Group has provided a further £45 million in the year ended 31 December 2018 (£245 million was provided in the year ended 31 December 2017) in respect of complaints relating to alleged mis-selling of packaged bank accounts, raising the total amount provided to £795 million. A number of risks and uncertainties remain particularly with respect to future volumes.

Customer claims in relation to insurance branch business in Germany

The Group continues to receive claims in Germany from customers relating to policies issued by Clerical Medical Investment Group Limited (subsequently renamed Scottish Widows Limited), with smaller numbers received from customers in Austria and Italy. The industry-wide issue regarding notification of contractual ‘cooling off’ periods continued to lead to an increasing number of claims in 2016 and 2017 levelling out in 2018. Up to 31 December 2017 the Group had provided a total of £639 million, with no further amounts provided during the year ended 31 December 2018. The validity of the claims facing the Group depends upon the facts and circumstances in respect of each claim. As a result the ultimate financial effect, which could be significantly different from the current provision, will be known only once all relevant claims have been resolved.

HBOS Reading – customer review

The Group has now completed its compensation assessment for all 71 business customers within the customer review, with more than 96 per cent of these offers accepted. In total, more than £96 million has been offered of which £78 million has so far been accepted, in addition to £9 million for ex-gratia payments and £5 million for the reimbursements of legal fees.

The review follows the conclusion of a criminal trial in which a number of individuals, including two former HBOS employees, were convicted of conspiracy to corrupt, fraudulent trading and associated money laundering offences which occurred prior to the acquisition of HBOS by the Group in 2009. The Group has provided a further £15 million in the year ended 31 December 2018 for customer settlements, raising the total amount provided to

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£115 million and is now nearing the end of the process of paying compensation to the victims of the fraud, including ex-gratia payments and reimbursements of legal fees.

INTERCHANGE FEES

With respect to multi-lateral interchange fees (MIFs), the Group is not directly involved in the ongoing investigations and litigation (as described below) which involve card schemes such as Visa and Mastercard. However, the Group is a member/licensee of Visa and Mastercard and other card schemes:

 

1– All sensitivities exclude claims where no PPI policy was held.The European Commission continues to pursue competition investigations against Mastercard and Visa probing, amongst other things, MIFs paid in respect of cards issued outside the EEA;
  
2–Sensitivity includes complaint handling costs. Future volume includes complaints falling intoLitigation brought by retailers continues in the Plevin rulesEnglish Courts against both Visa and guidance. As a result, the sensitivity per 100,000 complaints includes cases where the average redress would be lower than historical trends.Mastercard;
  
3–The percentage of complaints whereAny ultimate impact on the Group finds in favour of the customer excluding PBR. The 76 per cent uphold rate per policy is based on the six months to 31 December 2015. Future uphold rateabove investigations and sensitivities are influenced by a proportion of complaints falling under the Plevin ruleslitigation against Visa and guidance which would otherwise be defended.
4The amount that is paid in redress in relation to a policy found to have been mis-sold, comprising, where applicable, the refund of premium, compound interest charged and interestMastercard remains uncertain at 8 per cent per annum. Actuals are based on the six months to 31 December 2015. Future average redress is influenced by expected compensation payments for complaints falling under the Plevin rules and guidance.this time.

 

INVESTIGATIONS AND LITIGATION RELATING TO INTERBANK OFFERED RATES,Visa Inc completed its acquisition of Visa Europe on 21 June 2016. As part of this transaction, the Group and certain other UK banks also entered into a Loss Sharing Agreement (LSA) with Visa Inc, which clarifies the allocation of liabilities between the parties should the litigation referred to above result in Visa Inc being liable for damages payable by Visa Europe. The maximum amount of liability to which the Group may be subject under the LSA is capped at the cash consideration which was received by the Group at completion. Visa Inc may also have recourse to a general indemnity, previously in place under Visa Europe’s Operating Regulations, for damages claims concerning inter or intra-regional MIF setting activities.

LIBOR AND OTHER REFERENCETRADING RATES

In July 2014, the Group announced that it had reached settlements totalling £217 million (at 30 June 2014 exchange rates) to resolve with UK and US federal authorities legacy issues regarding the manipulation several years ago of Group companies’ submissions to the British Bankers’ Association (BBA) London Interbank Offered Rate (LIBOR) and Sterling Repo Rate. The Group continues to cooperate with various other government and regulatory authorities, including the Serious Fraud Office, the Swiss Competition Commission, and a number of US State Attorneys General, in conjunction with their investigations into submissions made by panel members to the bodies that set LIBOR and various other interbank offered rates.

 

Certain Group companies, together with other panel banks, have also been named as defendants in private lawsuits, including purported class action suits, in the US in connection with their roles as panel banks contributing to the setting of US Dollar, Japanese Yen and Sterling LIBOR. The lawsuits, which contain broadly similar allegations, allege violations of the Sherman Antitrust Act, the Racketeer Influenced and Corrupt Organizations ActLIBOR and the Commodity Exchange Act, as well as various state statutes and common law doctrines.Australian BBSW Reference Rate. Certain of the plaintiffs’ claims, including those asserted under US anti-trust laws, have been dismissed by the US Federal Court for Southern District of New York (the District Court). That court’s

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dismissal of plaintiffs’ anti-trust claims has been appealed(subject to the New York Federal Court of Appeal. The OTC and Exchange – Based plaintiffs’ claims were dismissed in November 2015 for lack of personal jurisdiction against the Group.appeals).

 

Certain Group companies are also named as defendants in (i) UK based claimsclaims; and (ii) in 2 Dutch class actions, raising LIBOR manipulation allegationsallegations. A number of the claims against the Group in connection withrelation to the alleged mis-sale of interest rate hedging products.products also include allegations of LIBOR manipulation.

 

It is currently not possible to predict the scope and ultimate outcome on the Group of the various outstanding regulatory investigations not encompassed by the settlements, any private lawsuits or any related challenges to the interpretation or validity of any of the Group’s contractual arrangements, including their timing and scale.

 

CUSTOMER CLAIMS IN RELATION TO INSURANCE BRANCH BUSINESS IN GERMANY

The Group has received a number of claims from customers relating to policies issued by Clerical Medical Investment Group Limited (recently renamed Scottish Widows Limited) but sold by independent intermediaries in Germany, principally during the late 1990s and early 2000s. Following decisions in July 2012 from the Federal Court of Justice (FCJ) in Germany the Group recognised provisions totalling £520 million during the period to 31 December 2014. Recent experience has been slightly adverse to expectations and the Group has noted decisions of the FCJ in 2014 and 2015 involving German insurers in relation to a German industry-wide issue regarding notification of contractual ‘cooling off’ periods. Accordingly, a provision increase of £25 million has been recognised giving a total provision of £545 million. The remaining unutilised provision as at 31 December 2015 is £124 million (31 December 2014: £199 million).

The validity of the claims facing the Group depends upon the facts and circumstances in respect of each claim. As a result the ultimate financial effect, which could be significantly different from the current provision, will only be known once all relevant claims have been resolved.

INTEREST RATE HEDGING PRODUCTS

In June 2012, a number of banks, including the Group, reached agreement with the FSA (now FCA) to carry out a review of sales made since 1 December 2001 of interest rate hedging products (IRHP) to certain small and medium-sized businesses. As at 31 December 2015 the Group had identified 1,735 sales of IRHPs to customers within scope of the agreement with the FCA which have opted in and are being reviewed and, where appropriate, redressed. The Group agreed that it would provide redress to any in-scope customers where appropriate. The Group continues to review the remaining cases within the scope of the agreement with the FCA and has met all of the regulator’s requirements to date.

During 2015, the Group has charged a further £40 million in respect of redress and related administration costs, increasing the total amount provided for redress and related administration costs for in-scope customers to £720 million (31 December 2014: £680 million). As at 31 December 2015, the Group has utilised £652 million (31 December 2014: £571 million), with £68 million (31 December 2014: £109 million) of the provision remaining.

FCA REVIEW OF COMPLAINT HANDLING

On 5 June 2015 the FCA announced a settlement with the Group totalling £117 million following its investigation into aspects of the Group’s PPI complaint handling process during the period March 2012 to May 2013. The FCA did not find that the Group acted deliberately. The Group has reviewed all customer complaints fully defended during the Relevant Period. The remediation costs of reviewing these affected cases are not materially in excess of existing provisions.

PROVISIONS FOR OTHER LEGAL ACTIONS AND REGULATORY MATTERS

In the course of its business, the Group is engaged in discussions with the PRA, FCA and other UK and overseas regulators and other governmental authorities on a range of matters. The Group also receives complaints and claims from customers in connection with its past conduct and, where significant, provisions are held against the costs expected to be incurred as a result of the conclusions reached. During 2015, the Group charged an additional £655 million (2014: £430 million), including £225 million (2014: £nil) in response to complaints concerning packaged bank accounts and £282 million (2014: £318 million) in respect of other matters within the Retail division. In addition, the Group has charged a further £148 million (2014: £112 million) in respect of a number of product rectifications primarily in Insurance and Commercial Banking.

At 31 December 2015, provisions for other legal actions and regulatory matters of £813 million (31 December 2014: £521 million) remained unutilised, principally in relation to the sale of bancassurance products and packaged bank accounts and other Retail provisions.

UK SHAREHOLDER LITIGATION

 

In August 2014, the Group and a number of former directors were named as defendants in a claim filed in the English High Court by a number of claimants who held shares in Lloyds TSB Group plc (LTSB) prior to the acquisition of HBOS plc, alleging breaches of fiduciary and tortious duties in relation to information provided to shareholders in connection with the acquisition and the recapitalisation of LTSB. The defendants refute all claims made. A trial commenced in the English High Court on 18 October 2017 and concluded on 5 March 2018 with judgment to follow. It is currently not possible to determine the ultimate impact on the Group (if any), but the Group intends to defend the claim vigorously.

FINANCIAL SERVICES COMPENSATION SCHEME

The Financial Services Compensation Scheme (FSCS) is the UK’s independent statutory compensation fund of last resort for customers of authorised financial services firms and pays compensation if a firm is unable or likely to be unable to pay claims against it. The FSCS is funded by levies on the authorised financial services industry. Each deposit-taking institution contributes towards the FSCS levies in proportion to their share of total protected deposits on 31 December of the year preceding the scheme year, which runs from 1 April to 31 March.

Following the default of a number of deposit takers in 2008, the FSCS borrowed funds from HM Treasury to meet the compensation costs for customers of those firms. At 31 March 2015, the end of the latest FSCS scheme year, the principal balance outstanding on these loans was £15,797 million (31 March 2014: £16,591 million). Although the substantial majority of this loan will be repaid from funds the FSCS receives from asset sales, surplus cash flow or other recoveries in relation to the assets of the firms that defaulted, any shortfall will be funded by deposit-taking participants of the FSCS. The amount of future levies payable by the Group depends on a number of factors including the amounts recovered by the FSCS from asset sales, the Group’s participation in the deposit-taking market at 31 December, the level of protected deposits and the population of deposit-taking participants.

 

TAX AUTHORITIES

 

The Group provides for potential tax liabilities that may arise on the basis of the amounts expected to be paid to tax authorities including open matters where Her Majesty’s Revenue and Customs (HMRC) adopt a different interpretation and application of tax law. The Group has an open matter in relation to a claim for group relief of losses incurred in its former Irish banking subsidiary, which ceased trading on 31 December 2010. In 2013 HMRC informed

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the Group that their interpretation of the UK rules permittingwhich allow the offset of such losses denies the claim; ifclaim. If HMRC’s position is found to be correct management estimate that this would result in an increase in current tax liabilities of approximately £600£770 million (including interest) and a reduction in the Group’s deferred tax asset of approximately £400£250 million. The Group does not agree with HMRC’s position and, having taken appropriate advice, does not consider that this is a case where additional tax will ultimately fall due. There are a number of other open matters on which the Group is in discussion with HMRC;HMRC (including the tax treatment of certain costs arising from the divestment of TSB Banking Group plc), none of thesewhich is expected to have a material impact on the financial position of the Group.

 

RESIDENTIAL MORTGAGE REPOSSESSIONS

 

In August 2014, the Northern Ireland High Court handed down judgment in favour of the borrowers in relation to three residential mortgage test cases concerning certain aspects of the Group’s practice with respect to the recalculation of contractual monthly instalments of customers in arrears. The FCA has indicated that it will issue a Consultation Paperbeen actively engaged with the industry in relation to industry practice in this area in February 2016.these considerations and has published Guidance on the treatment of customers with mortgage payment shortfalls. The Guidance covers remediation for mortgage customers who may have been affected by the way firms calculate these customers’ monthly mortgage instalments. The Group will respond as appropriateis implementing the Guidance and has now contacted nearly all affected customers with any remaining customers anticipated to this and any investigations, proceedings, or regulatory action that may in due course be instigated as a resultcontacted by the end of these issues.March 2019.

 

THE FINANCIAL CONDUCT AUTHORITY’S ANNOUNCEMENT ON TIME-BARRING FOR PPI COMPLAINTS AND PLEVIN V PARAGON PERSONAL FINANCE LIMITEDMORTGAGE ARREARS HANDLING ACTIVITIES – FCA INVESTIGATION

 

On 26 November 2015May 2016, the Group was informed that an enforcement team at the FCA issued a Consultation Paper onhad commenced an investigation in connection with the introduction of a deadline by which consumers would needGroup’s mortgage arrears handling activities. This investigation is ongoing and the Group continues to cooperate with the FCA. It is not currently possible to make their PPI complaintsa reliable assessment of any liability that may result from the investigation including any financial penalty or else lose their right to have them assessed by firms orpublic censure.

HBOS READING – FCA INVESTIGATION

On 7 April 2017 the Financial Ombudsman Service, and proposed rules and guidance concerningFCA announced that it had resumed its investigation into the handlingevents surrounding the discovery of PPI complaints in lightmisconduct within the Reading-based Impaired Assets team of the Supreme Court’s decision in Plevin v Paragon Personal Finance Limited [2014] UKSC 61 (Plevin).HBOS. The Financial Ombudsman Serviceinvestigation is also considering the implications of Plevin for PPI complaints. The implications of potential time-barringongoing and the Plevin decision in terms ofGroup continues to cooperate with the scopeFCA. It is not currently possible to make a reliable assessment of any court proceedingsliability that may result from the investigation including any financial penalty or regulatory action remain uncertain.public censure.

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CONTINGENT LIABILITIES IN RESPECT OFRELATING TO OTHER LEGAL ACTIONS AND REGULATORY MATTERS

 

In addition, during the ordinary course of business the Group is subject to other complaints and threatened or actual legal proceedings (including class or group action claims) brought by or on behalf of current or former employees, customers, investors or other third parties, as well as legal and regulatory reviews, challenges, investigations and enforcement actions, both in the UK and overseas. All such material matters are periodically reassessed, with the assistance of external professional advisers where appropriate, to determine the likelihood of the Group incurring a liability. In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management’s best estimate of the amount required at the relevant balance sheet date. In some cases it will not be possible to form a view, for example because the facts are unclear or because further time is needed properly to assess the merits of the case, and no provisions are held in relation to such matters. In these circumstances, specific disclosure in relation to a contingent liability will be made where material. However the Group does not currently expect the final outcome of any such case to have a material adverse effect on its financial position, operations or cash flows.

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COMPETITIVE ENVIRONMENT

 

The Group provides financial services to individual and business customers, predominantly in the UK but also overseas. The main business activities of the Group are retail and commercial banking and corporate banking, general insurance,long-term savings, protection and life, pensions and investment provision.investment.

 

In the retail banking market, the Group competes with banks and building societies, major retailers and internet-only providers. In the mortgage market, competitors include the traditional banks and building societies and specialist mortgage providers. The Group competes with both UK and foreign financial institutions along with emerging forms of lending in the commercial banking markets and with bancassurance, life assurance and general insurance companies in the UK insurance market.

 

The markets for UK financial services, and the other markets within which the Group operates, are competitive, and management expects such competition to continue or intensify in response to competitor behaviour, including non-traditional competitors, consumer demand, technological changes such as the growth of digital banking, and the impact of regulatory actions and other factors.

 

For more information see “See Risk Factors – Business and Economic Riskseconomic risks – The Group’s businesses are conducted in competitive environments, with increased competition scrutiny, and the Group’s financial performance depends upon management’s ability to respond effectively to competitive pressures.

See Regulation – Competition Regulation.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

The results discussed below are not necessarily indicative of Lloyds Banking Group’s results in future periods. The following information contains certain forward looking statements. For a discussion of certain cautionary statements relating to forward looking statements, seeForward looking statements.

 

The following discussion is based on and should be read in conjunction with the consolidated financial statements and the related notes thereto included elsewhere in this annual report. For a discussion of the accounting policies used in the preparation of the consolidated financial statements, seeAccounting policiesin note 2 to the financial statements.

 

TABLE OF CONTENTS

TABLE OF CONTENTS
Overview and trend information1312
Critical accounting policies1412
Future accounting developments1412
Results of operations – 2015, 20142018, 2017 and 201320161513
Line of business information2624
Average balance sheet and net interest income3732
Changes in net interest income – volume and rate analysis3934
Risk overview4035
Risk management46
Risk governance5341
Credit risk5651
Loan portfolio8066
Risk elements in the loan portfolio8970
Regulatory and legal risk75
Conduct risk93
Market risk9475
Operational risk10176
People risk78
Insurance underwriting risk78
Capital risk79
Funding and liquidity risk103
Capital risk111
Regulatory and legal risk117
Insurance risk117
People risk118
Financial reporting risk11988
Governance risk12095
Market risk96
Model risk102
1211

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

OVERVIEW AND TREND INFORMATION

GIVEN THE GROUP’S UK FOCUS, ITS FINANCIAL PERFORMANCE IS INEXTRICABLY LINKED TO THE PERFORMANCE OF THE UK ECONOMY AND ITS REGULATORY AND COMPETITIVE ENVIRONMENT

UK ECONOMIC TRENDS

RESILIENCE IN THE FACE OF A FRAGILE GLOBAL ECONOMY

Initial estimates indicate that the UK economy grew by 2.2 per cent in 2015, close to its 25-year average, at a time when global growth slowed. UK economic growth was the second strongest of the G7 countries, only marginally behind the US. Eurozone growth improved during 2015, back to its 25-year average, but at 1.5 per cent it remains significantly slower than the UK.

Leadership of global growth is shifting back to developed economies as they emerge from a period of private sector debt reduction, government cuts and tax increases. The slowdown in emerging markets as their credit cycle turns is pushing inflation down across the world as their currencies and commodity prices fall. UK inflation has hovered close to zero throughout 2015, and as a result, consumers’ inflation-adjusted incomes have increased, ending a seven year period in which they had been broadly flat. That has boosted consumer spending growth to an eight year high in 2015, and helped push unemployment down to pre-crisis levels.

Low inflation and risks from the slowdown in emerging markets are complicating central banks’ setting of interest rates. The US increased rates in December 2015 for the first time since 2006, much later than had been expected at the start of the year. And the UK hasn’t yet raised rates, contrary to consensus expectations at the start of 2015 of two increases during that year. Low interest rates, along with limited supply, have boosted property prices with UK house prices up 10 per cent during 2015, surpassing their 2007 peak, and commercial property prices up 7.8 per cent.

MARKET GROWTH

Growth in the markets in which the Group operates has improved but in aggregate remains much weaker than pre-crisis. Mortgage volumes for house purchases rose 4.7 per cent to a post-crisis high, and their value rose by 10.7 per cent, pushing growth in balances up from 1.6 per cent in 2014 to 2.6 per cent in 2015, its strongest since 2008. Growth in consumer unsecured borrowing balances rose from 4.1 per cent in 2014 to 6.0 per cent in 2015, the strongest since 2005. Small and medium-sized companies (SMEs) have started to increase borrowing from banks again in 2015 for the first time since 2008, while companies’ deposits continued to

grow rapidly, up 11.5 per cent in 2015 after an average of 9.3 per cent across 2013-14. Consumer deposits growth fell back slightly from 4.3 per cent in 2014 to 3.8 per cent in 2015, but this was mainly due to the government’s launch of pensioner bonds.

MARGIN PRESSURE

Competition and the delay in Bank Rate increases are keeping banks’ margins under pressure. The spread between average lending and deposit rates has held fairly flat in 2015 close to its pre-crisis level, having improved from the very low level of 2011-12 when wholesale funding costs were exceptionally high. Lending rates have fallen to a record low in 2015, and whilst deposit rates have fallen during the year they are still higher than short term financial-market rates, opposite to pre-crisis. Mortgage pricing has been particularly aggressive in 2015, with spreads on new loans over market funding costs falling around 50 basis points through the year.

LOW LEVEL IMPAIRMENT

Improving indebtedness, along with the continued low interest rate environment, is continuing to reduce impairments which are below expected through-the-cycle levels. The share of highly indebted consumers has fallen further in 2015, and consumers’ concerns over their level of debt and mortgage payments are back to pre-crisis lows. Personal and corporate insolvency rates are low, both around half their 2009-10 peaks. Rising property prices have also sharply reduced potential losses from defaults on property lending.

OUTLOOK FOR 2016

Despite challenges from slowing emerging markets and rising US interest rates, the most likely outlook for the UK in 2016 is another year similar to 2015. Consensus expectations are for gdp growth of 2.2 per cent, CPI inflation rising to 1.1 per cent by the end of the year, house prices up 5 per cent, and another year without a rise in Bank Rate. As the recovery matures, borrowing is rising and domestic consumption will be the primary driver of economic growth. Lending has been subdued for five years and corporate and household balance sheets have strengthened, so that credit has room to grow without threatening macroeconomic stability. Low inflation will keep real household incomes growing, sustaining economic growth despite headwinds from the elevated level of sterling, weak manufacturing activity, tightening benefit payments and uncertainty over the future of the UK’s membership of the EU.

There are, however, risks to those expectations, stemming from the deflationary impact of the slowdown in emerging markets, the associated recent volatility in financial markets that might weaken consumer and business confidence; and the referendum on UK membership of the EU which, if the vote is to leave, may create a period of uncertainty and impact companies’ investment plans. Crystallisation of any of these risks could impact the UK economy, which in turn would have a negative impact on the Group’s income, funding costs and impairment charges.


GROWTH IN THE GROUP’S MARKETS

(yearly % change in UK market balances)

 

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

OVERVIEW AND TREND INFORMATION

ECONOMY

Highlights

Given our UK focus, the Group’s prospects are closely linked to the fortunes of the UK economy.
The economy faces significant uncertainty around the UK’s departure from the EU. With the expectation that the UK leaves in an orderly fashion, the economy should be able to grow in 2019 at a similar pace to 2018.
Our low risk business model and focus on efficiency positions us well irrespective of macro conditions but if the UK economy sees significant sustained deterioration this is likely to impact Group performance.

Overview

As the largest provider of UK banking services, our prospects are closely aligned to the outlook for the UK economy. In the period following the decision to leave the EU, the economy has been resilient. Growth has slowed only slightly below its trend rate, the unemployment rate has continued to fall to a 43 year low, and property prices have continued to rise slowly. This resilience is expected to continue in 2019 and the next few years, barring any sudden shocks to business or consumer confidence particularly in connection with the UK’s exit from the EU during 2019.

Market dynamics

Households’ spending power has been improving in recent months as pay growth has begun to pick up and outpace inflation, which is falling back towards the medium term target of 2 per cent. Inflation adjusted pay is now slightly above its previous peak in early 2016. This improvement is expected to continue through 2019, supported by a reduction in planned fiscal tightening announced in the 2018 Budget in November and the end of the cap to public sector pay growth. The improvement in spending power should help support growth in consumer spending and borrowing, whilst also increasing growth in households’ savings.

The UK housing market has been broadly flat in 2018 in aggregate, although weakness has been centred around London and the South East where high prices are constraining affordability. Improved households’ spending power should support the housing market in 2019, as would resolution of uncertainty about the immediate political and economic concerns.

Operational impacts of the UK’s exit from the EU present risks for some of our customers’ businesses. With the future trading arrangements between the UK and EU unlikely to become finalised for a few years, businesses’ investment decisions are more difficult and postponement of investment may weigh on future growth capacity of the economy. Uncertainty is also challenging the UK’s attractiveness to foreign investors, although many qualities that have attracted investors in the past remain.

More widely, the global economy is transitioning away from the exceptionally low interest rates in place in most advanced economies since the financial crisis. This process will not always be constant, with different countries at different stages of their economic cycle, and unwinding of ‘quantitative easing’ may increase volatility in financial markets. The widespread trend to increasingly populist politics, of which the US-China trade war is a prime example, poses a challenge to appropriate economic policy.

Barring sudden shocks stemming from these challenges, the UK economy is expected to grow through 2019 to 2021 at a pace similar to 2018. The unemployment rate is expected to rise only a little from its current 43 year low, and further mild increases in house prices are expected. The Bank Rate is expected to rise only slowly, as the uncertainty drag on the economy fades. Growth in many of our markets is expected to pick up, although the consumer credit market should continue to slow after its strong growth through 2014 to 2017. Impairments are expected to increase in 2019 as we continue to see lower write-backs and recoveries but remain at relatively low levels.

Our response

Given our UK focus, the Group’s prospects are closely linked to the performance of the UK economy. Our low risk, stable business model and focus on efficiency positions us well to continue to support customers irrespective of macro conditions.

CRITICAL ACCOUNTING POLICIES

 

The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported therein. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates.

 

The accounting policies that are deemed critical to the Group’s results and financial position, based upon materiality and significant judgements and estimates, are discussedset out in note 3 to the financial statements.

 

FUTURE ACCOUNTING DEVELOPMENTS

 

Future developments in relation to the Group’s IFRS reporting are discussed in note 5756 to the financial statements.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

RESULTS OF OPERATIONS – 2015, 20142018, 2017 AND 20132016

 

SUMMARY         
  2015  2014  2013 
  £m  £m  £m 
Net interest income  11,318   10,660   7,338 
Other income  11,832   19,232   30,647 
Total income  23,150   29,892   37,985 
Insurance claims  (5,729)  (13,493)  (19,507)
Total income, net of insurance claims  17,421   16,399   18,478 
Operating expenses  (15,387)  (13,885)  (15,322)
Trading surplus  2,034   2,514   3,156 
Impairment  (390)  (752)  (2,741)
Profit before tax  1,644   1,762   415 
Taxation  (688)  (263)  (1,217)
Profit (loss) for the year  956   1,499   (802)
             
Profit (loss) attributable to ordinary shareholders  466   1,125   (838)
Profit attributable to other equity holders1  394   287   – 
Profit (loss) attributable to equity holders  860   1,412   (838)
Profit attributable to non-controlling interests  96   87   36 
Profit (loss) for the year  956   1,499   (802)

1 The profit after tax attributable to other equity holders of £394 million (2014: £287 million; 2013: £nil) is partly offset in reserves by a tax credit attributable to ordinary shareholders of £80 million (2014: £62 million; 2013: £nil).SUMMARY

 

  2018  2017  2016 
  £m  £m  £m 
Net interest income  13,396   10,912   9,274 
Other income  8,695   23,325   30,337 
Total income  22,091   34,237   39,611 
Insurance claims  (3,465)  (15,578)  (22,344)
Total income, net of insurance claims  18,626   18,659   17,267 
Operating expenses  (11,729)  (12,346)  (12,627)
Trading surplus  6,897   6,313   4,640 
Impairment  (937)  (688)  (752)
Profit before tax  5,960   5,625   3,888 
Tax expense  (1,560)  (1,728)  (1,724)
Profit for the year  4,400   3,897   2,164 
             
Profit attributable to ordinary shareholders  3,869   3,392   1,651 
Profit attributable to other equity holders1  433   415   412 
Profit attributable to equity holders  4,302   3,807   2,063 
Profit attributable to non-controlling interests  98   90   101 
Profit for the year  4,400   3,897   2,164 

2015

1The profit after tax attributable to other equity holders of £433 million (2017: £415 million; 2016: £412 million) is partly offset in reserves by a tax credit attributable to ordinary shareholders of £106 million (2017: £102 million; 2016: £91 million).

2018 COMPARED WITH 20142017

 

During the year ended 31 December 2015,2018, the Group recorded a profit before tax of £1,644£5,960 million, an increase of £335 million, or 6 per cent, compared with a profit before tax in 20142017 of £1,762£5,625 million. The result in 2015 included provisions in respect of redress to customers relating to both past sales of Payment Protection Insurance and other matters of £4,837 million compared to a charge of £3,125 million in the year ended 31 December 2014; 2014 also included a past service pension credit of £822 million and a loss of £1,362 million in relation to the exchange and repurchase of Enhanced Capital Notes, neither of which were repeated in 2015. Excluding these items from both years, profit before tax was £1,054 million, or 19 per cent, higher at £6,481 million in the year ended 31 December 2015 compared to £5,427 million in the previous year, reflecting a significant reduction in expenditure in relation to the Group’s Simplification programme and lower impairment charges.

The comparison of results for 2015 to 2014 is also impacted by the sale of TSB Banking Group plc (TSB), which ceased to be consolidated in March 2015, with the sale of the Group’s remaining holding becoming unconditional on 30 June 2015. The Group recognised a net loss of £660 million in 2015, relating to both the disposal of its shareholding and commitments under agreements entered into with TSB (see also note 55 on page F-104).

 

Total income, net of insurance claims, decreased by £6,742£33 million or 23 per cent, to £23,150£18,626 million in 20152018 compared with £29,892£18,659 million in 2014,2017, comprising a £7,400£2,517 million decrease in other income, partlynet of insurance claims, largely offset by an increase of £2,484 million in net interest income.

 

Net interest income was £11,318£13,396 million in 2015;2018; an increase of £658£2,484 million, or 623 per cent compared to £10,660£10,912 million in 2014.2017. There was a significant reduction in the amounts payable to unit holders in those Open-Ended Investment Companies (OEICs) included in the consolidated results of the Group from an expense of £1,435 million in 2017 to a credit of £844 million in 2018. This decrease reflects the relatively poor investment performance of the consolidated OEICs in the year, with losses on debt securities and equities. FTSE All Share investments returned losses of 9.5 per cent over 2018 compared to gains of 13.1 per cent over 2017 and sterling corporates returned losses of 2.3 per cent compared to gains of 5.2 per cent in 2017. The change in population of consolidated OEICs in 2018 compared to 2017 did not have a significant impact. After adjusting for this, net interest income was £205 million, or 2 per cent higher. Average interest-earning assets decreased by £5,153 million, or 1 per cent, to £580,221 million in 2018 compared to £585,374 million in 2017 as growth in targeted segments has been more than offset by the impact of the sale of the Group’s Irish mortgage portfolio and reductions in the closed mortgage book. The net interest margin improved, excluding the impact of amounts payable to OEIC unitholders, as a result of lower deposit costs and hedging benefits more than offsetting continued pressure on asset margins.

Other income, net of insurance claims, was £2,517 million, or 32 per cent, lower at £5,230 million in 2018 compared to £7,747 million in 2017. There were substantially reduced gains within trading income on policyholder assets in the insurance business, as a result of market performance over the year, particularly in equities, but this was offset by a lower level of insurance claims. Insurance claims expense was £12,113 million lower at £3,465 million in 2018 compared to £15,578 million in 2017. The insurance claims expense in respect of life and pensions business was £12,111 million lower at £3,130 million in 2018 compared to a charge of £15,241 million in 2017. Insurance claims in respect of general insurance business were £2 million or 1 per cent, lower at £335 million in 2018 compared to £337 million in 2017.

Fee and commission income was £117 million or 4 per cent, lower at £2,848 million compared to £2,965 million in 2017 as increased levels of card fees, reflecting both the inclusion of MBNA for a full year and higher levels of card usage, were more than offset by lower current account fees, reflecting reduced volumes of added-value accounts and changes in pricing structure. Fee and commission expense increased by £4 million to £1,386 million compared with £1,382 million in 2017. Net trading income decreased by £15,693 million to a deficit of £3,876 million in 2018 driven by reduced gains on policyholder assets. Insurance premium income was £1,259 million, or 16 per cent, higher at £9,189 million in 2018 compared with £7,930 million in 2017; there was an increase of £1,332 million in life insurance premiums offset by a £73 million decrease in general insurance premiums. The increase in life insurance premiums reflects higher levels of bulk annuity deals and business growth. General insurance premiums decreased as a result of reduced new business and the continued run-off of closed books. Other operating income was £75 million, or 4 per cent, lower at £1,920 million in 2018 compared to £1,995 million in 2017.

Operating expenses decreased by £617 million, or 5 per cent to £11,729 million in 2018 compared with £12,346 million in 2017 reflecting a reduction of £815 million in charges for redress payments to customers in respect of PPI and other conduct related matters from £2,165 million in 2017 to £1,350 million in 2018. Excluding these charges from both years, operating expenses were £198 million, or 2 per cent, higher at £10,379 million in 2018 compared to £10,181 million in 2017 as increased restructuring costs and the impact of the ownership of MBNA for a full year in 2018 have more than offset the operating cost savings driven by increased efficiency from digitalisation and process improvements. Staff costs were £152 million, or 3 per cent, higher at £4,762 million in 2018 compared with £4,610 million in 2017; as cost savings arising from headcount reductions have been offset by increased

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

pension charges and redundancy costs. Premises and equipment costs were £1 million lower at £729 million in 2018 compared with £730 million in 2017. Other expenses were £20 million, or 1 per cent, higher at £2,483 million in 2018 compared with £2,463 million in 2017. Depreciation and amortisation costs were £35 million, or 1 per cent, higher at £2,405 million in 2018 compared to £2,370 million in 2017, as reduced charges in respect of property, plant and equipment were more than offset by increased charges relating to intangible assets, reflecting increased investment in software.

Impairment losses increased by £249 million, or 36 per cent, to £937 million in 2018 compared with £688 million in 2017. Impairment losses in respect of loans and advances to customers were £325 million, or 47 per cent, higher at £1,022 million in 2018 compared with £697 million in 2017; this includes the impact of a full year charge for the MBNA business, acquired part way through 2017, and lower levels of releases and write-backs than in 2017. There was a credit of £73 million in respect of undrawn commitments in 2018, compared to a credit of £9 million in 2017.

In 2018, the Group recorded a tax expense of £1,560 million compared to a tax expense of £1,728 million in 2017. The effective tax rate was 26.2 per cent, compared to the standard UK corporation tax rate of 19.0 per cent. The higher rate was principally as a result of the banking surcharge and restrictions on the deductibility of conduct provisions, more than offsetting the benefit of tax-exempt gains.

Total assets were £14,511 million, or 2 per cent, lower at £797,598 million at 31 December 2018 compared to £812,109 million at 31 December 2017. After adjusting for the impact of adoption of IFRS 9, which required the reclassification of certain lending assets to fair value through profit or loss, loans and advances to customers increased in the year by £23,842 million to £484,858 million, compared to £461,016 million at 1 January 2018, mainly as a result of a £23,651 million increase in holdings of reverse repurchase agreement balances, as part of a rebalancing of the Group’s liquid asset portfolio. There was continued growth in targeted segments such as SME and motor finance which more than offset a reduction of some £4 billion on sale of the Group’s Irish residential mortgage portfolio; the open mortgage book was broadly flat reflecting continued focus on margin in a highly competitive market environment. Financial assets held at fair value through profit or loss decreased by £17,479 million, after taking into account the transition to IFRS 9, largely as a result of adverse market movements on policyholder assets in the insurance business. Financial assets held at fair value through other comprehensive income have reduced by £18,102 million since the start of 2018 following sales of some of the Group’s gilt holdings, as part of the rebalancing of the Group’s liquid asset portfolio.

Customer deposits were little changed at £418,066 million at 31 December 2018 compared to £418,124 million at 31 December 2017 as an £820 million reduction in repurchase agreement balances and reductions in maturing retail savings products have largely offset growth in retail current account balances and in Commercial Banking. Financial liabilities at fair value through profit or loss were £20,330 million, or 40 per cent, lower at £30,547 million at 31 December 2018 compared to £50,877 million at 31 December 2017 following reductions in trading book repurchase agreements, a result of growth in other funding sources. Debt securities in issue were £18,718 million higher at £91,168 million at 31 December 2018 compared to £72,450 million at 31 December 2017 following new issuances to maintain funding levels at relatively attractive rates. Insurance and investment contract liabilities have fallen by £6,133 million, or 5 per cent, from £118,860 million at 31 December 2017 to £112,727 million at 31 December 2018 as new business flows have been more than offset by the impact of adverse market performance on investment values.

Total equity has increased by £1,056 million, or 2 per cent, despite a reduction of £1,005 million as a result of the Group’s share buyback programme. There was a reduction of £1,191 million on implementation of IFRS 9 and IFRS 15 but this has been more than offset by retained profits, after dividends; and the issue of £1,136 million of Additional Tier 1 securities.

The Group’s common equity tier 1 (CET1) capital ratio has strengthened to 14.6 per cent (31 December 2017: 14.1 per cent; 1 January 2018: 14.0 per cent) primarily driven by retained profit, dividends received from the Insurance business and the reduction in risk-weighted assets. The total capital ratio increased to 22.9 per cent (31 December 2017: 21.2 per cent; 1 January 2018: 21.2 per cent), primarily reflecting the increase in CET1 capital, the reduction in risk-weighted assets, the issuance of Additional Tier 1 securities and dated subordinated debt instruments and foreign exchange movements on subordinated debt instruments, partially offset by the amortisation of dated instruments and the reduction in the transitional limit applied to grandfathered Additional Tier 1 securities.

Risk-weighted assets reduced by £4,553 million, or 2 per cent, to £206,366 million (31 December 2017: £210,919 million), largely reflecting the sale of the Irish mortgage portfolio. The UK leverage ratio increased to 5.5 per cent (31 December 2017: 5.3 per cent; 1 January 2018: 5.3 per cent), primarily as a result of the issuance of the Additional Tier 1 securities.

The Group’s liquidity surplus continues to exceed the regulatory minimum and internal risk appetite with the liquidity coverage ratio at 130 per cent (31 December 2017: 127 per cent).

The Group has recommended a final ordinary dividend of 2.14 pence per share (2017: 2.05 pence per share). This is in addition to the interim ordinary dividend of 1.07 pence per share (2017: 1.0 pence per share) that was paid in September 2018. The total ordinary dividend per share for 2018 of 3.21 pence per share has increased by 5 per cent, from 3.05 pence in 2017.

The Group is planning on the basis of an orderly EU withdrawal and, given the resilience of the UK economy, intends to implement a share buyback of up to £1.75 billion (2017: £1 billion) which will commence in March 2019 and is expected to be completed by 31 December 2019. The Group’s current preference is to return surplus capital by way of a buyback programme given the amount of surplus capital, the normalisation of ordinary dividends, and the flexibility that a buyback programme offers.

2017 COMPARED WITH 2016

During the year ended 31 December 2017, the Group recorded a profit before tax of £5,625 million compared with a profit before tax in 2016 of £3,888 million.

Total income decreased by £5,374 million, or 14 per cent, to £34,237 million in 2017 compared with £39,611 million in 2016, comprising a £7,012 million decrease in other income only partly offset by an increase of £1,638 million in net interest income.

Net interest income was £10,912 million in 2017; an increase of £1,638 million, or 18 per cent compared to £9,274 million in 2016. There was a positive impact of £358£622 million in 20152017 from a decrease in the amounts payable to unit holders in those Open-Ended Investment Companies (OEICs) included in the consolidated results of the Group, particularly in relation to fixed income securities;reflecting different levels of investment returns on the assets held by the OEICs; the change in population of consolidated OEICs in 20152017 compared to 2014 caused an increase of £27 million in this interest expense.2016 did not have a significant impact. After adjusting for this, net interest income was £300£1,016 million, or 39 per cent higher at £11,562 million in 2015 compared to £11,262 million in 2014 reflecting an improvement in margin in the Group’s banking operations, driven by a combination of lower deposit and wholesale funding costs, partly offset by continued pressure on asset prices.higher. Average interest-earning assets fell as a result of the sale of TSBdecreases in average UK mortgage balances, lending to global corporates and the continued run down ofin the portfolio of assets which are outside of the Group’s risk appetite.appetite, more than offsetting the impact of the acquisition of MBNA. Net interest margin improved, excluding the impact of amounts payable to OEIC unitholders, as a result of lower deposit and wholesale funding costs and a positive impact from the acquisition of MBNA, more than offsetting continued pressure on asset margins.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Other income was £7,400£7,012 million, or 3823 per cent, lower at £11,832£23,325 million in 20152017 compared to £19,232£30,337 million in 2014.2016. Fee and commission income was £407£80 million or 113 per cent, lower at £3,252£2,965 million compared to £3,659£3,045 million in 2014.2016 as increased levels of card fees, reflecting both the acquisition of MBNA and higher levels of card usage, were more than offset by lower current account fees, reflecting reduced volumes of added-value accounts and changes in pricing structure, and lower levels of other fees receivable. Fee and commission expense increased by £40£26 million, or 32 per cent, to £1,442£1,382 million compared with £1,402£1,356 million in 2014. The decrease in net fee and commission income largely reflects the disposals of TSB and Scottish Widows Investment Partnership.2016. Net trading income decreased by £6,445£6,728 million, or 6336 per cent, to £3,714£11,817 million in 20152017 compared to £10,159£18,545 million in 2014;2016; this decrease reflected a reduction of £6,146£6,630 million in gains on policyholder investments held within the insurance business as a result of market conditions over 20152017 relative to those in 2014. The reduction in trading income within the insurance business was coupled with a small decrease of £266 million in the Group’s other operations.2016. Insurance premium income was £2,333£138 million, or 332 per cent, lower at £4,792£7,930 million in 20152017 compared with £7,125£8,068 million in 2014;2016; there was a decrease of £2,334£23 million in life insurance premiums and a £1£115 million increasedecrease in general insurance premiums. Premium incomeThe decrease in 2015 has been reducedlife insurance premiums reflected the fact that good growth in corporate pensions business was offset by a chargelower level of £1,959 million relatingbulk annuity deals, compared to the recapture byactivity in 2016. General insurance premiums decreased as a third party insurerresult of a portfoliomarket conditions and the continued run-off of policies previously reassured with the Group; excluding this item life insurance premiumclosed books. Other operating income was £375£40 million, or 62 per cent, lower at £5,880£1,995 million in 20152017 compared to £6,255£2,035 million in 2014. Other operating income was £1,825 million higher at £1,516 million in 2015 compared to a deficit of £309 million in 2014. Other operating income includes the results of liability management from which the Group incurred a loss of £28 million in 2015 compared to a loss of £1,386 million in 2014, which was principally in relation to exchange and repurchase transactions in respect of the Group’s Enhanced Capital Notes. Excluding the impact of liability management activities, other operating income was £467 million, or 43 per cent, higher at £1,544 million in 2015 compared to £1,077 million in 2014; in part reflecting a reduction in the losses arising from the movement in the value of in-force insurance business.2016.

 

Insurance claims expense was £7,764£6,766 million, or 5830 per cent, lower at £5,729£15,578 million in 20152017 compared to £13,493£22,344 million in 2014.2016. The insurance claims expense in respect of life and pensions business was £7,804£6,737 million or 59 per cent, lower at £5,359£15,241 million in 20152017 compared to £13,163£21,978 million in 2014;

15

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

2016; this decrease was matched by a similar declinereduction in net trading income, reflecting the relative performance of policyholder investments. Insurance claims in respect of general insurance business were £40£29 million, or 128 per cent, higherlower at £370£337 million in 20152017 compared to £330£366 million in 2014.2016 as a result of the continued run-down of closed books and relatively benign weather conditions in 2017 compared to 2016.

 

Operating expenses increaseddecreased by £1,502£281 million, or 112 per cent to £15,387£12,346 million in 20152017 compared with £13,885£12,627 million in 2014;2016; the main reasonsreason for the increasethis decrease being the £1,712£209 million increasereduction in charges for redress payments to customers in respect of PPI and other conduct relatedconduct-related matters from £3,125£2,374 million in 20142016 to £4,837£2,165 million in 2015, a charge of £665 million in 2015 in relation to the disposal of TSB and a net past service pension credit of £822 million in 2014 which was not repeated in 2015.2017. Excluding these itemscharges from both years, operating expenses were £1,697£72 million, or 151 per cent, lower at £9,885£10,181 million in 20152017 compared to £11,582£10,253 million in 2014. On this basis staff costs were £8902016 as operating expenses of £172 million or 16 per cent, lower at £4,677 millionarising in 2015 compared with £5,567 million in 2014; annual pay rises beingMBNA since acquisition have been more than offset by the impact of underlying cost reductions. Staff costs were £207 million, or 4 per cent, lower at £4,610 million in 2017 compared with £4,817 million in 2016; increases in pension charges being more than offset by headcount related reductions resulting from business disposalsin salaries and the Group’s rationalisation programmes and a reduction inlower levels of severance costs as this phase of the Simplification programme draws to a close.costs. Premises and equipment costs were £176 million or 20 per cent, lower at £715 million in 2015 compared with £891 million in 2014. Other expenses, excluding the charges in respect of customer redress provisions and the charge relating to the TSB disposal, were £808 million, or 25 per cent, lower at £2,381 million in 2015 compared with £3,189 million in 2014 as a result of lower levels of technology spend, advertising and professional fees, in particular relating to Simplification and the costs of TSB separation in 2014. Depreciation and amortisation costs were £177£58 million or 9 per cent, higher at £2,112£730 million in 20152017 compared with £672 million in 2016. Other expenses were £79 million, or 3 per cent, higher at £2,463 million in 2017 compared with £2,384 million in 2016. Depreciation and amortisation costs were £10 million lower at £2,370 million in 2017 compared to £1,935£2,380 million in 2014.2016, as increased charges in respect of property, plant and equipment were more than offset by reduced charges relating to intangible assets.

 

Impairment losses decreased by £362£64 million, or 489 per cent, to £390£688 million in 20152017 compared with £752 million in 2014.2016; this reflected the fact that in 2016 there was an impairment charge of £173 million in respect of certain equity investments in the Group’s available-for-sale portfolio which was not repeated in 2017. Impairment losses in respect of loans and advances to customers were £292£105 million, or 4018 per cent, lowerhigher at £443£697 million in 20152017 compared with £735£592 million in 2014. The overall performance2016; this included a charge of £118 million in the portfolio reflects a significant reduction in lending which is outside of the Group’s risk appetiteMBNA business since acquisition and improvements in all divisions. The net charge has also benefited from significant provision releases but atthere were lower levels of releases and write-backs than seen in 2014.2016. There was a credit of £55£9 million in respect of undrawn commitments in 2015,2017, compared to a chargecredit of £10£13 million in 2014, a result of improvements in credit quality in a number of corporate relationships.2016.

 

In 2015,2017, the Group recorded a tax chargeexpense of £688£1,728 million compared to a tax chargeexpense of £263£1,724 million in 2014,2016, an effective tax rate of 4231 per cent, which was higher thancompared to the standard UK corporation tax rate of 20.2519.25 per cent;cent, principally as a result of the disallowance of a substantial proportion of the Group’s charge in respect of PPIbanking surcharge and other conduct risk issues. The tax charge of £263 million in 2014 arose on a profit before tax of £1,762 million; this tax charge reflected tax exempt gainsrestrictions on the saledeductibility of businesses.conduct provisions.

 

On the balance sheet, totalTotal assets were £48,208£5,684 million, or 61 per cent, lower at £806,688£812,109 million at 31 December 20152017 compared to £854,896£817,793 million at 31 December 2014, largely due to the disposal of TSB. Loans and advances to customers were £27,529 million, or 6 per cent, lower at £455,175 million at 31 December 2015 compared to £482,704 million at 31 December 2014, with £21,643 million of the reduction being due to the sale of TSB, the continued reduction in the portfolio of assets which are outside of the Group’s risk appetite and a £5,148 million reduction in reverse repurchase agreement balances have more than offset growth in the UK consumer finance business. An increase of £7,925 million in cash and balances at central banks has been more than offset by an £11,395 million reduction in trading2016. Trading and other financial assets at fair value through profit or loss and a £6,661 million reduction in derivative assets. Total liabilities were £45,285£11,704 million, or 68 per cent, higher at £162,878 million compared to £151,174 million at 31 December 2016 due to the inclusion of a number of investments in OEICs which were de-consolidated during the year. However, loans and advances to banks were £20,291 million, or 75 per cent, lower at £759,708£6,611 million compared to £26,902 million at 31 December 2015 compared to £804,9932016 following the de-consolidation of these OEICs. Derivative assets were £10,304 million, or 29 per cent, lower at £25,834 million at 31 December 2014, again2017 compared to £36,138 million at 31 December 2016, largely dueas a result of exchange rate movements. Loans and advances to the sale of TSB. Customer depositscustomers were £28,741£14,540 million, or 63 per cent, higher at £472,498 million at 31 December 2017 compared to £457,958 million at 31 December 2016; the addition of £8,144 million of lending following the acquisition of MBNA and an £8,528 million increase in reverse repurchase agreement balances together with the impact of the reacquisition of a portfolio of mortgages from TSB and growth in consumer finance and SME lending more than offset reductions in the larger corporate sector, as the Group focused on optimising capital and returns, and in closed mortgage books. Available-for-sale financial assets were £14,426 million, or 26 per cent, lower at £418,326£42,098 million at 31 December 20152017 compared to £447,067£56,524 million at 31 December 2014 with £24,625 million2016 reflecting reductions in the Group’s holdings of the reduction being due to the sale of TSB. Decreases of £10,239 million in trading and other financialUK government securities.

Total liabilities at fair value through profit or loss and £11,095 million in insurance and investment contract liabilities have been partly offset by increases of £6,038 million in deposits by banks and £5,823 million in debt securities in issue as the Group took advantage of favourable funding opportunities. Total equity was £2,923were £6,362 million, or 61 per cent, lower at £46,980£762,966 million at 31 December 20152017 compared to £49,903£769,328 million at 31 December 2014; this reflected the fact that retained profit for the year has been2016. Deposits from banks were £13,420 million, or 82 per cent, higher at £29,804 million at 31 December 2017 compared to £16,384 million at 31 December 2016 as a result of an increase of £15,896 million in repurchase agreements. Customer deposits were £2,664 million, or 1 per cent, higher at £418,124 million compared to £415,460 million at 31 December 2016 as reductions in non-relationship deposit balances were more than offset by negative reserve movementsstrong inflows from Commercial clients. Derivative liabilities were £8,800 million, or 25 per cent, lower at £26,124 million at 31 December 2017 compared to £34,924 million at 31 December 2016, largely as a result of exchange rate movements. Debt securities in respectissue were £3,864 million, or 5 per cent, lower at £72,450 million at 31 December 2017 compared to £76,314 million at 31 December 2016 following maturities of available-for-sale revaluationsome tranches of securitisation notes and cash flow hedging reserves, dividends paid and the adjustmentcovered bonds. Other liabilities were £8,463 million, or 29 per cent, lower at £20,730 million at 31 December 2017 compared to non-controlling interests on£29,193 million at 31 December 2016 reflecting the deconsolidation of TSB.a number of OEICs. Subordinated liabilities were £1,909 million, or 10 per cent, lower at £17,922 million at 31 December 2017 compared to £19,831 million at 31 December 2016 reflecting redemptions in the year.

Total equity was £678 million, or 1 per cent, higher at £49,143 million at 31 December 2017 compared to £48,465 million at 31 December 2016 as retained profits for the year more than offset the Group’s dividend payments, distributions on its AT1 securities and other reserve movements.

 

The Group has maintainedhad strengthened its capital position, with a common equity tier 1 (CET1) ratio of 12.814.1 per cent (31 December 2014: 12.82016: 13.4 per cent) as, largely driven by the impactincrease in equity, offset in part by the increase in the deduction for goodwill and other intangible assets following the acquisition of the lower capital base (as a result of reduced levels of equity) has been offset byMBNA, and a reduction in risk-weighted assets. The total capital ratio was unchanged at 21.2 per cent.

 

Risk-weighted assets reduced by £16,986£4,527 million, or 72 per cent, to £222,747£210,919 million at 31 December 20152017 compared to £239,734£215,446 million at 31 December 2014, primarily driven by the sale of TSB, reductions in the 2016, largely relating to updates made to both mortgage and unsecured retail Internal Ratings Based (IRB) models, continued active

15

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

portfolio of assets which are outside of the Group’s risk appetitemanagement, foreign exchange movements, disposals and continued improvements in credit qualitycapital efficient securitisation activity, partly offset by targeted lending growth.growth in key customer segments and the acquisition of MBNA.

 

The Group’s liquidity position remains good, with liquidity coverage ratio (LCR) eligible assets of £123 billion. LCR eligible assets represent almost 5.7 timessurplus exceeded the Group’s money-market fundingregulatory minimum and internal risk appetite with a maturityLiquidity Coverage Ratio of less than one year and were in excess of total wholesale funding127 per cent based on the EU Delegated Act at 31 December 2015 thus providing2017. Wholesale funding reduced by 9 per cent to £101 billion compared with £111 billion at 31 December 2016. In addition, the Group made use of central bank funding schemes and by the end of 2017 the Group had fully utilised its £20 billion capacity from the Bank of England’s Term Funding Scheme.

The Group recommended a bufferfinal ordinary dividend of 2.05 pence per share. This was in addition to the eventinterim ordinary dividend of market dislocation.1.0 pence per share that was paid in September 2017. The Group’s LCR ratio already exceeds regulatory requirements and is greater than 100total ordinary dividend per cent.share for 2017 of 3.05 pence per share had increased by 20 per cent, from 2.55 pence in 2016.

16

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

2014NET INTEREST INCOME

  2018  2017  2016 
Net interest income £m  13,396   10,912   9,274 
Average interest-earning assets £m  580,221   585,374   600,435 
Average rates:            
Gross yield on interest-earning assets %1  2.82   2.73   2.77 
Interest spread %2  2.22   1.67   1.33 
Net interest margin %3  2.31   1.86   1.54 

1Gross yield is the rate of interest earned on average interest-earning assets.
2Interest spread is the difference between the rate of interest earned on average interest-earning assets and the rate of interest paid on average interest-bearing liabilities.
3The net interest margin represents the interest spread together with the contribution of interest-free liabilities. It is calculated by expressing net interest income as a percentage of average interest-earning assets.

2018 COMPARED WITH 2013

During the year ended 31 December 2014, the Group recorded a profit before tax of £1,762 million compared with a profit before tax in 2013 of £415 million. The result in 2014 included provisions in respect of redress to customers relating to past sales of Payment Protection Insurance and other issues of £3,125 million compared to a charge of £3,455 million in the year ended 31 December 2013; and 2014 also includes a past service pension credit of £822 million, compared to a charge of £104 million in 2013. Excluding these items from both years, profit before tax was £91 million, or 2 per cent, higher at £4,065 million in the year ended 31 December 2014 compared to £3,974 million in the previous year.

Total income decreased by £8,093 million, or 21 per cent, to £29,892 million in 2014 compared with £37,985 million in 2013, comprising an £11,415 million decrease in other income partly offset by an increase of £3,322 million in net interest income.2017

 

Net interest income was £10,660£13,396 million in 2014;2018, an increase of £3,322£2,484 million, or 4523 per cent, compared to £7,338£10,912 million in 2013. There was2017. Net interest income in 2018 includes a positive impactcredit of £2,489£844 million in 2014 from a decreaserespect of amounts attributable to third party investors in the amounts payable to unit holders in thoserespect of its consolidated Open-Ended Investment Companies (OEICs) included in the consolidated results of the Group. After adjusting for this, net interest income was £833 million, or 8 per cent, higher at £11,262 million in 2014 compared to £10,429 million in 2013 reflecting the continued improvement in margins and loan growth in targeted customer segments,partly offset by the effect of disposals and the reduced portfolio of assets which are outside of the Group’s risk appetite. The net interest margin benefited from improved deposit pricing and lower funding costs, partly offset by continued pressure on asset prices.

Other income was £11,415 million, or 37 per cent, lower at £19,232 million in 2014 compared to £30,647 million in 2013. Fee and commission income was £460 million, or 11 per cent, lower at £3,659 million compared to £4,119 million in 2013. Fee and commission expense increased by £17 million, or 1 per cent, to £1,402 million compared with £1,385 million in 2013. The decrease in net fee and commission income largely reflects the impact of business disposals. Net trading income decreased by £6,308 million,or 38 per cent, to £10,159 million in 2014 compared to £16,467 million in 2013; this decrease reflected a reduction of £7,384 million in gains on policyholder investments held within the insurance business as a result of movements in financial markets. The reduction in trading income within the insurance business was partly offset by an increase of £1,076 million in the Group’s other operations, principally because of an improvement of £610 million in valuation gains on the equity conversion feature embedded in the Group’s Enhanced Capital Notes. Insurance premium income was £1,072 million, or 13 per cent, lower at £7,125 million in 2014 compared with £8,197 million in 2013; there was a decrease of £945 million in life insurance premiums and a £127 million decrease in general insurance premiums. Other operating income was £3,558 million lower at a deficit of £309 million in 2014 compared to £3,249 million in 2013. Other operating income includes gains and losses on disposal of available-for-sale financial assets which were £498 million, or 79 per cent, lower at £131 million in 2014 compared to £629 million in 2013 following the completion of the repositioning of the Group’s government bond portfolio. Other operating income also includes gains and losses on liability management from which the Group incurred a loss of £1,362 million in 2014 in relation to exchange and repurchase transactions in respect of its Enhanced Capital Notes. Excluding gains and losses on sale of available-for-sale financial assets and the impact of liability management activities,other operating income was £1,816 million lower at £946 million in 2014 compared to £2,762 million in 2013; income in 2013 included the gains of £540 million from the sales of shares in St James’s Place and £538 million following the sale of the Group’s portfolio of US Residential Mortgage-Backed Securities.

Insurance claims expense was £6,014 million, or 31 per cent, lower at £13,493 million in 2014 compared to £19,507 million in 2013. The insurance claims expense in respect of life and pensions business was £5,988 million, or 31 per cent, lower at £13,163 million in 2014 compared to £19,151 million in 2013; this decrease in claims was matched by a similar decline in net trading income, reflecting the relative performance of policyholder investments. Insurance claims in respect of general insurance business were £26 million, or 7 per cent, lower at £330 million in 2014 compared to £356 million in 2013.

Operating expenses decreased by £1,437 million, or 9 per cent to £13,885 million in 2014 compared with £15,322 million in 2013; the main reasons for the decrease being the £330 million reduction in charges for regulatory provisions from £3,455 million in 2013 to £3,125 million in 2014 and, a net past service pension credit of £822 million compared to a charge in 2017 of £104 million in 2013. Excluding these items from both years, operating expenses were £181 million, or 2 per cent, lower at £11,582 million in 2014 compared to £11,763 million in 2013. On this basis staff costs were £170 million, or 3 per cent, lower at £5,567 million in 2014 compared with £5,737 million in 2013; annual pay rises being more than offset by the impact of headcount reductions resulting from business disposals and the Group’s rationalisation programmes. Premises and equipment costs were £79 million, or 8 per cent, lower at £891 million in 2014 compared with £970 million in 2013. Other expenses excluding the charges in respect of payment protection insurance and other regulatory provisions were £73 million, or 2 per cent, higher at £3,189 million in 2014 compared with £3,116 million in 2013. Depreciation and amortisation costs were £5 million lower at £1,935 million in 2014 compared to £1,940 million in 2013.

Impairment losses decreased by £1,989 million, or 73 per cent, to £752 million in 2014 compared with £2,741 million in 2013. Impairment losses in respect of loans and advances to customers were £1,990 million, or 73 per cent, lower at £735 million in 2014 compared with £2,725 million in 2013. The overall performance of the portfolio reflects a significant reduction in lending which is outside of the Group’s risk appetite and improvements in all divisions. The improvements reflect lower levels of new impairment as a result of effective risk management, improving economic conditions and the continued low interest rate environment. The net charge has also benefited from significant provision releases but at lower levels than seen in 2013. The impairment charge in respect of debt securities classified as loans and receivables was a charge of £2 million in 2014 compared to a charge of £1 million in 2013 and the impairment charge in respect of available-for-sale financial assets was £10 million lower at £5 million in 2014 compared to £15 million in 2013.

In 2014, the Group recorded a tax charge of £263 million compared to a tax charge of £1,217 million in 2013. The tax charge in 2014 was £116 million lower than the charge that would arise at the standard UK corporation tax rate of 21.5 per cent; principally as a result of a tax exempt gains on sales of businesses and a lower deferred tax liability in respect of the value of in-force assets for the life business partially offset by the effect of non-deductible expenses. The tax charge of £1,217 million in 2013 arose on a profit before tax of £415 million; this tax charge reflected a £594 million charge arising from the reduction in the corporation tax rate, a £348 million write-off of deferred tax assets following the sale of the Group’s Australian operations and a £251 million policyholder tax charge.

17

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

On the balance sheet, total assets were £12,516 million, or 1 per cent, higher at £854,896 million at 31 December 2014 compared to £842,380 million at 31 December 2013. Loans and advances to customers were £10,248 million, or 2 per cent, lower at £482,704 million at 31 December 2014 compared to £492,952 million at 31 December 2013 as the impact of focused growth in mortgages, unsecured personal lending and the small to medium-sized businesses sector has been more than offset by the continuing reduction in the portfolio of assets which are outside of the Group’s credit risk appetite, including the disposal of tranches of lending in Ireland. Available-for-sale financial assets were £12,517 million, or 28 per cent, higher at £56,493 million at 31 December 2014 compared to £43,976 million at 31 December 2013 as the Group continues to build up its holding of high quality government and other securities for liquidity purposes. Trading assets were £11,144 million higher at £48,494£1,435 million as a result of an increase in reverse repo activity. Deposits by banks were £3,095 million, or 22 per cent, lower at £10,887 million at 31 December 2014 compared to £13,982 million at 31 December 2013 and debt securities in issue were £10,869 million, or 12 per cent, lower at £76,233 million at 31 December 2014 compared to £87,102 million at 31 December 2013 as the Group reduced its reliance on wholesale funding; however, customer deposits was £7,600 million, or 2 per cent, higher at £447,067 million at 31 December 2014 compared to £439,467 million at 31 December 2013 following growth in relationship deposits. Total equity was £10,567 million, or 27 per cent, higher at £49,903 million at 31 December 2014 compared to £39,336 million at 31 December 2013; this reflected the issue of £5,355 million of other equity instruments, retained profit and positivenegative market movements in cash flow hedging and available-for-sale reserves.

The Group continued to strengthen its capital position, with a common equity tier 1 (CET1) ratio of 12.8 per cent, driven by a combination of retained profit, further dividends from the Insurance business, changes to and improved valuations of the Group’s defined benefit pension arrangements, and a reduction in risk-weighted assets. The positive effect of these items was partly offset by the impact of the recommended dividend of 0.75 pence per share.

Risk-weighted assets reduced in the year, to £239,734 million, primarily due to asset reductions in the portfolio of assets which are outside of the Group’s risk appetite, active portfolio management in Commercial Banking and improvements in economic conditions.

The Group’s liquidity position remained strong, with primary liquid assets of £109.3 billion (31 December 2013: £89.3 billion). Primary liquid assets represented almost six times the Group’s money-market funding with a maturity of less than one year, and just under three times the Group’s total short-term wholesale funding, in turn providing a substantial buffer in the event of market dislocation. In addition to primary liquid assets, the Group had significant secondary liquidity holdings of £99.2 billion (31 December 2013: £105.4 billion). Total liquid assets represented approximately five times the Group’s short-term wholesale funding with primary liquid assets broadly equivalent to total wholesale funding.

18

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

NET INTEREST INCOME

  2015  2014  2013 
Net interest income £m  11,318   10,660   7,338 
Average interest-earning assets £m  614,917   634,910   661,793 
Average rates:            
Gross yield on interest-earning assets %1  2.86   3.03   3.20 
Interest spread %2  1.67   1.52   0.88 
Net interest margin %3  1.84   1.68   1.11 

1 Gross yield is the rate of interest earned on average interest-earning assets.

2 Interest spread is the difference between the rate of interest earned on average interest-earning assets and the rate of interest paid on average interest-bearing liabilities.

3 The net interest margin represents the interest spread together with the contribution of interest-free liabilities. It is calculated by expressing net interest income as a percentage of average interest-earning assets.

2015 COMPARED WITH 2014

Net interest income was £11,318 million in 2015 an increase of £658 million, or 6 per cent, compared to £10,660 million in 2014. Net interest income in 2015 includes a charge of £244 million in respect of amounts payable to unitholders in consolidated Open-Ended Investment Companies compared to a charge in 2014 of £602 million;during 2018; the change in population of consolidated OEICs in 20152018 compared to 2014 caused an increase of £27 million in this interest expense.2017 did not have a significant impact. After adjusting for this,the amounts payable to unitholders, net interest income was £300£205 million, or 32 per cent, higher at £11,562£12,552 million in 20152018 compared to £11,262£12,347 million in 2014.2017.

 

Average interest-earning assets were £19,993£5,153 million, or 31 per cent, lower at £614,917£580,221 million in 20152018 compared to £634,910£585,374 million in 2014.2017. The reduction reflecteddecrease reflects the sale of TSB (leading to a year-on-year reduction of £17,309 million) and the continuing run-off of assets which are outside of the Group’s risk appetite.

Average interest-earning assetsIrish mortgage book and reductions in Retail were £1,766 million lower at £315,801 million in 2015 compared to £317,567 million in 2014 and average interest-earning assets in Commercial Banking were £3,854 million lower at £89,299 million in 2015 compared to £93,153 million in 2014. Average interest-earning assets across the rest of the Group were £14,373 million, or 6 per cent, lower at £209,817 million in 2015 compared to £224,190 million in 2014. The main driver for this reduction being the decrease of £17,309 million resulting from the sale of TSBclosed mortgage book and in the portfolio of assets which are outside of the Group’s risk appetite, partly offset bymore than offsetting the impact of a full year’s ownership of MBNA and growth in Consumer FinanceSME and mid-markets lending and in non-relationship balances.Motor Finance. Average interest-earning assets in Retail were £3,792 million, or 1 per cent, higher at £342,328 million in 2018 compared to £338,536 million in 2017 and average relationship lending and similar interest-earning assets in Commercial Banking were £155 million higher at £91,230 million in 2018 compared to £91,075 million in 2017. Average interest-earning assets across the rest of the Group were £9,100 million, or 6 per cent, lower at £146,663 million in 2018 compared to £155,763 million in 2017.

 

The net interest margin was 1645 basis points higher at 1.842.31 per cent in 20152018 compared to 1.681.86 per cent in 2014, however2017, and adjusting net interest income for the amounts allocated to unitholders in Open-Ended Investment Companies, the net interest margin was 115 basis points higher at 1.882.16 per cent in 20152018 compared to 1.772.11 per cent in 2014.2017. The improvement in net interest margin reflected lower deposit costs and an increased contribution from the structural hedge, more than offsetting continued pressure on asset margins. Margins in Retail increased, driven by improved deposit marginwith the benefits of a full year of MBNA and mix,lower funding costs more than offsetting reduced lending rates; however margins in Consumer Finance were down due to the acquisition of lower risk but lower margin new business and the impact of the planned reduction in deposits in line with Group’s funding strategy.ongoing mortgage pricing pressure. Margins on relationship lending and similar interest-earning assets in Commercial Banking increased due to disciplined pricing on new lending and deposits, with a reduction in wholesale funding costs led by continued progress in attracting high quality deposits.were stable.

 

20142017 COMPARED WITH 20132016

 

Net interest income was £10,660£10,912 million in 20142017, an increase of £3,322£1,638 million, or 4518 per cent, compared to £7,338£9,274 million in 2013.2016. Net interest income in 2014 includes2017 included a charge of £602£1,435 million in respect of amounts payableattributable to unitholdersthird party investors in respect of its consolidated Open-Ended Investment Companies compared to a charge in 20132016 of £3,091 million.£2,057 million as a result of positive market movements in the year, with gains ranging from (1.0) per cent to 37.2 per cent in UK and global equity markets as well as in fixed income indices. The change in population of consolidated OEICs in 2017 compared to 2016 did not have a significant impact on this figure, contributing a net decrease of £65 million attributable to third party investors. After adjusting for this,the amounts payable to unitholders, net interest income was £833£1,016 million, or 89 per cent, higher at £11,262£12,347 million in 20142017 compared to £10,429£11,331 million in 2013.2016.

 

Average interest-earning assets were £26,883£15,061 million, or 43 per cent, lower at £634,910£585,374 million in 20142017 compared to £661,793£600,435 million in 2013.2016. The reductiondecrease reflected the continuing run-off of assets which were outside of the Group’s risk appetite, including business disposals, more than offsetting the impact of focused new lending.

Average interest-earning assetsreductions in Retail were £1,371 million higher at £317,567 millionclosed mortgage books, lending to global corporates and in 2014 compared to £316,196 million in 2013 and average interest-earning assets in Commercial Banking were £207 million lower at £93,153 million in 2014 compared to £93,360 million in 2013. Average interest-earning assets across the rest of the Group were £28,047 million, or 11 per cent lower at £224,190 million in 2014 compared to £252,237 million in 2013. The main driver for this reduction was the continuing run-down of the portfolio of assets which are outside of the Group’s risk appetite, more than offsetting the impact of the acquisition of MBNA. Average interest-earning assets in Retail were £2,871 million, or 1 per cent, higher at £338,536 million in 2017 compared to £335,665 million in 2016 and average interest-earning assets in respect of whichCommercial Banking were £27,711£3,920 million, at 48or 4 per cent, lower at £29,921£91,075 million in 20142017 compared to £57,632£94,995 million in 2013.2016. Average interest-earning assets across the rest of the Group were £14,012 million, or 8 per cent, lower at £155,763 million in 2017 compared to £169,775 million in 2016.

 

The net interest margin was 5732 basis points higher at 1.681.86 per cent in 20142017 compared to 1.111.54 per cent in 2013, however2016, and adjusting net interest income for the amounts paidallocated to unitholders in Open-Ended Investment Companies, the net interest margin was 1922 basis points higher at 1.772.11 per cent in 20142017 compared to 1.581.89 per cent in 2013.2016. The improvement in net interest margin reflected lower deposit and wholesale funding costs and a positive impact from the acquisition of MBNA, more than offsetting continued pressure on asset margins. Margins in Retail improved driven by further improvements in deposit mix, more than offsetting reduced lending rates however margins in Consumer Finance fell as a result of business growth being focused on higher quality, but lower margin, lending ondeposit repricing in the new vehicle marketfirst quarter of 2017 and credit card balances, more than offsetting favourable deposit repricing.the positive impact of the acquisition of MBNA. Margins on relationship lending and similar interest-earning assets in Commercial Banking also improved as a result of disciplined pricing of new lending, deposit repricing and a reduction inthe lower funding costs.

19

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

OTHER INCOME         
  2015  2014  2013 
  £m  £m  £m 
Fee and commission income:            
Current account fees  804   918   973 
Credit and debit card fees  918   1,050   984 
Other  1,530   1,691   2,162 
   3,252   3,659   4,119 
Fee and commission expense  (1,442)  (1,402)  (1,385)
Net fee and commission income  1,810   2,257   2,734 
Net trading income  3,714   10,159   16,467 
Insurance premium income  4,792   7,125   8,197 
Gains on sale of available-for-sale financial assets  51   131   629 
Liability management  (28)  (1,386)  (142)
Other  1,493   946   2,762 
Other operating income  1,516   (309)  3,249 
Total other income  11,832   19,232   30,647 

2015 COMPARED WITH 2014

Other income was £7,400 million, or 38 per cent, lower at £11,832 million in 2015 compared to £19,232 million in 2014.

Fee and commission income was £407 million, or 11 per cent, lower at £3,252 million in 2015 compared with £3,659 million in 2014. Current account fees were £114 million, or 12 per cent, lower at £804 million in 2015 compared to £918 million in 2014, with £75 million of the reduction being a result of the sale of TSB. A decrease of £132 million, or 13 per cent, in credit and debit card fees from £1,050 million in 2014 to £918 million in 2015 resulted from the sale of TSB (£51 million of the decrease) and reduced interchange income due to changes in regulation. Other fees and commissions receivable were £161 million, or 10 per cent lower at £1,530 million in 2015 compared with £1,691 million in 2014; again partly reflecting the sale of TSB and also Scottish Widows Investment Partnership in 2014.

Fee and commission expense was £40 million, or 3 per cent, higher at £1,442 million in 2015 compared to £1,402 million in 2014; despite a £63 million decrease as a result of the sale of TSB and Scottish Widows Investment Partnership; the underlying increase reflects increased levels of fees payable in respect of transactions in Commercial Banking and for asset management services in Insurance.

Net trading income was £6,445 million, or 63 per cent, lower at £3,714 million in 2015 compared with £10,159 million in 2014. Net trading income within the insurance businesses was £6,146 million, or 69 per cent, lower at £2,774 million in 2015 compared to £8,920 million in 2014, which reflects lower levels of returns on policyholder investments as a result of market conditions over 2015 relative in those in 2014. However this decrease, along with the decrease in long-term insurance premium income, was largely offset by the decrease in insurance claims expense and the £358 million decrease in the amounts payable to unit holders in those Open-Ended Investment Companies consolidated into the Group’s results within net interest income. Net trading income within the Group’s banking activities was £299 million, or 24 per cent, lower at £940 million in 2015 compared to £1,239 million in 2014; in particular this decrease reflected a charge of £101 million for the movement in fair value of the equity conversion feature of the Group’s Enhanced Capital Notes, compared to a gain of £401 million in the year ended 31 December 2014.

Insurance premium income was £4,792 million in 2015 compared with £7,125 million in 2014; a decrease of £2,333 million, or 33 per cent. Premium income in 2015 has been reduced by a charge of £1,959 million relating to the recapture by a third party insurer of a portfolio of policies previously reassured with the Group. Excluding this item earned premiums in respect of the Group’s long-term life and pensions business were £375 million, or 6 per cent, lower at £5,880 million in 2015 compared to £6,255 million in 2014 with the impact of regulatory and market change more than offsetting income from the new bulk annuities business. General insurance earned premiums were little changed, just £1 million higher at £871 million in 2015 compared with £870 million in 2014 reflecting competitive market conditions and the run-off of products closed to new customers.

Other operating income was £1,825 million higher at £1,516 million in 2015 compared to a deficit of £309 million in 2014. In April 2014, the Group had completed exchange offers with holders of certain series of its Enhanced Capital Notes (ECNs) to exchange the ECNs for new Additional Tier 1 (AT1) securities and a tender offer to eligible retail holders outside the United States to sell their Sterling-denominated ECNs for cash; a loss of £1,362 million was recognised in relation to these exchange and tender transactions in the year ended 31 December 2014. Excluding this item, other operating income was £463 million, or 44 per cent, higher at £1,516 million in 2015 compared to £1,053 million in 2014; this reflected a £266 million improvement in the movement in value of in-force insurance business and a £39 million increase in operating lease rental income.

2014 COMPARED WITH 2013

Other income was £11,415 million, or 37 per cent, lower at £19,232 million in 2014 compared to £30,647 million in 2013.

Fee and commission income was £460 million, or 11 per cent, lower at £3,659 million in 2014 compared with £4,119 million in 2013. Current account fees were £55 million, or 6 per cent, lower at £918 million in 2014 compared to £973 million in 2013. An increase of £66 million, or 7 per cent, in credit and debit card fees from £984 million in 2013 to £1,050 million in 2014 resulted from increased customer activity and merchanting charges. Other fees and commissions receivable were £471 million, or 22 per cent lower at £1,691 million in 2014 compared with £2,162 million in 2013; this reduction principally reflects the disposal of St James’s Place plc in March 2013 and the sale of Scottish Widows Investment Partnership during the first half of 2014.

Fee and commission expense was £17 million, or 1 per cent, higher at £1,402 million in 2014 compared to £1,385 million in 2013.

Net trading income was £6,308 million, or 38 per cent, lower at £10,159 million in 2014 compared with £16,467 million in 2013. Net trading income within the insurance businesses was £7,384 million,or 45 per cent, lower at £8,920 million in 2014 compared to £16,304 million in 2013, which reflects relatively lower returns on policyholder investments. However this decrease, along with the decrease in long-term insurance premium income, was largely offset

2017

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

byOTHER INCOME

  2018
£m		  2017
£m		  2016
£m		 
Fee and commission income:            
Current account fees  650   712   752 
Credit and debit card fees  993   953   875 
Commercial banking and treasury fees  305   321   303 
Unit trust and insurance broking  221   224   244 
Private banking and asset management  97   98   99 
Factoring  83   91   112 
Other fees and commissions  499   566   660 
   2,848   2,965   3,045 
Fee and commission expense  (1,386)  (1,382)  (1,356)
Net fee and commission income  1,462   1,583   1,689 
Net trading income  (3,876)  11,817   18,545 
Insurance premium income  9,189   7,930   8,068 
Gains on sale of financial assets at fair value through other comprehensive income (2017 and 2016: available-for-sale financial assets)  275   446   575 
Liability management  –   (14)  (598)
Other  1,645   1,563   2,058 
Other operating income  1,920   1,995   2,035 
Total other income  8,695   23,325   30,337 

2018 COMPARED WITH 2017

Other income was £14,630 million, or 63 per cent, lower at £8,695 million in 2018 compared to £23,325 million in 2017.

Fee and commission income was £117 million, or 4 per cent, lower at £2,848 million in 2018 compared with £2,965 million in 2017. Current account fees were £62 million, or 9 per cent, lower at £650 million in 2018 compared to £712 million in 2017, due to lower volumes of added-value accounts and changes in pricing structure. An increase of £40 million, or 4 per cent, in credit and debit card fees from £953 million in 2017 to £993 million in 2018 resulted from the decreaseinclusion of MBNA for a full year and higher levels of card usage. Commercial banking and treasury fees were £16 million, or 5 per cent, lower at £305 million in 2018 compared to £321 million in 2017 and other fees and commissions receivable were £67 million, or 12 per cent, lower at £499 million in 2018 compared to £566 million in 2017.

Fee and commission expense was £4 million, higher at £1,386 million in 2018 compared to £1,382 million in 2017 as increased credit and debit card fees payable, in part reflecting the full year impact of MBNA, have more than offset reductions in value-added account package costs and other fees payable.

Net trading income was £15,693 million, lower at a deficit of £3,876 million in 2018 compared with income of £11,817 million in 2017. Net trading income within the insurance claims expensebusinesses was £15,971 million, lower at a deficit of £5,030 million in 2018 compared to gains of £10,941 million in 2017, which reflects market losses in 2018 on both debt security and the £2,489 million decrease in the amounts payable to unit holders in those Open-Ended Investment Companies consolidated into the Group’s results within net interest income.equity investments. Net trading income within the Group’s banking activities was £1,076£278 million, or 32 per cent, higher at £1,239£1,154 million in 20142018 compared to £163£876 million in 2013. The principal reason for this was a £610 million improvement in the mark-to-market movement in the embedded derivative related to the Group’s Enhanced Capital Notes from a loss of £209 million in 2013 to a gain of £401million in 2014; there was also an improvement in2017, reflecting gains recognised on interest rate derivatives and foreign exchange contracts in the banking book not mitigated through hedge accounting.

 

Insurance premium income was £7,125£9,189 million in 20142018 compared with £8,197£7,930 million in 2013; a decrease2017; an increase of £1,072£1,259 million, or 1316 per cent. Earned premiums in respect of the Group’s long-term life and pensions business were £945£1,332 million, or 19 per cent, higher at £8,519 million in 2018 compared to £7,187 million in 2017 reflecting an increased level of bulk annuity deals in 2018 and growth in the corporate pensions product. General insurance earned premiums were £73 million, or 10 per cent, lower at £670 million in 2018 compared with £743 million in 2017 as a result of reduced new business and the continued run-off of closed books.

Other operating income was £75 million, or 4 per cent, lower at £1,920 million in 2018 compared to £1,995 million in 2017 as an improvement of £110 million in the movement in value of in-force business was offset by a loss of £105 million on the sale of the Group’s Irish mortgage portfolio. Gains on sale of financial assets held at fair value through other comprehensive income in 2018 include a gain of £270 million on sales of UK government securities; gains on sales of available-for-sale financial assets in 2017 included a gain of £146 million on the sale of the Group’s investment in Vocalink and £274 million from the sale of UK government securities.

2017 COMPARED WITH 2016

Other income was £7,012 million, or 23 per cent, lower at £23,325 million in 2017 compared to £30,337 million in 2016.

Fee and commission income was £80 million, or 3 per cent, lower at £2,965 million in 2017 compared with £3,045 million in 2016. Current account fees were £40 million, or 5 per cent, lower at £712 million in 2017 compared to £752 million in 2016, due to lower volumes of added-value accounts and changes in pricing structure. An increase of £78 million, or 9 per cent, in credit and debit card fees from £875 million in 2016 to £953 million in 2017 resulted from the acquisition of MBNA and higher levels of card usage. Commercial banking and treasury fees were £18 million, or 6 per cent, higher at £321 million in 2017 compared to £303 million in 2016, but this was more than offset by a £20 million reduction in unit trust and insurance broking fees and a £21 million reduction in factoring income. Other fees and commissions receivable were £94 million, or 14 per cent, lower at £566 million in 2017 compared with £660 million in 2016.

Fee and commission expense was £26 million, or 2 per cent, higher at £1,382 million in 2017 compared to £1,356 million in 2016 as increased fees payable in card services, in part reflecting the acquisition of MBNA, more than offset reductions in other fees payable.

18

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Net trading income was £6,728 million, or 36 per cent, lower at £11,817 million in 2017 compared with £18,545 million in 2016. Net trading income within the insurance businesses was £6,630 million, or 38 per cent, lower at £10,941 million in 2017 compared to £17,571 million in 2016, which reflected reduced market gains over 2017 compared to 2016 in both debt security and equity investments. Net trading income within the Group’s banking activities was £98 million, or 10 per cent, lower at £876 million in 2017 compared to £974 million in 2016, reflecting the change in fair value of interest rate derivatives and foreign exchange contracts in the banking book not mitigated through hedge accounting.

Insurance premium income was £7,930 million in 2017 compared with £8,068 million in 2016; a decrease of £138 million, or 2 per cent. Earned premiums in respect of the Group’s long-term life and pensions business were £23 million lower at £7,187 million in 2017 compared to £7,210 million in 2016 reflecting the fact that good growth in corporate pensions business was offset by a lower level of bulk annuity deals, compared to the activity in 2016. General insurance earned premiums were £115 million, or 13 per cent, lower at £6,255£743 million in 20142017 compared to £7,200with £858 million in 2013 following changes in2016 as a result of market conditions and the pensions and annuities markets and lower protection sales through branches. General insurance earned premiums were £127 million, or 13 per cent, lower at £870 million in 2014 compared with £997 million in 2013 due to competitive market conditions.continued run-off of closed books.

 

Other operating income was £3,558£40 million, or 2 per cent, lower at a deficit of £309£1,995 million in 20142017 compared to £3,249£2,035 million in 2013.2016. In April 2014,2016 there was a loss of £721 million arising on the Group completed concurrent Sterling, EuroGroup’s tender offers and Dollar exchange offers with holders of certain seriesredemptions in respect of its Enhanced Capital Notes (ECNs) to exchangewhich completed in March 2016; in 2017 there was a reduction of £637 million in the ECNs for new Additional Tier 1 (AT1) securities. In addition, the Group completedmovement in value of in-force business from a tender offer to eligible retail holders outside the United States to sell their Sterling-denominated ECNs for cash. The exchange offers completed with the equivalentgain of £4.0 billion of Sterling and Euro ECNs and approximately US$1.6 billion of US Dollar ECNs being exchanged for approximately £5.35 billion of AT1 securities. The retail tender offer completed with approximately £58.5£472 million of ECNs being repurchased for cash. A loss of £1,362 million has been recognised in relation to these exchange and tender transactions in the year ended 31 December 2014. During 20132016 to a charge of £165 million in 2017. The reduction in the Group incurred liability management lossesmovement in value of £142 million, following a planned exit from repurchase agreement facilitiesin-force business reflected the negative impact of assumption changes and redemptionexperience variances. Gains on sales of a tranche of covered bonds.

During 2013, the Group had recognisedavailable-for-sale financial assets in 2017 included a gain of £540 million following the sale of its shareholding in St. James’s Place plc and gains of £538 million on the sale of a portfolio of US residential mortgage-backed securities partly offset by a loss of £256£146 million on the sale of the Group’s Spanish retail banking operationsinvestment in Vocalink and £274 million (2016: £112 million) from the sale of UK government securities; 2016 included a lossgain of £382£484 million related to theon sale of the Group’s German life assurance business. In 2014 there was a gain of £128 million on the sale of Scottish Widows Investment Partnership which completed during the year.

Other operating income also includes gains and losses on sale of available-for-sale financial assets, which were £498 million, or 79 per cent, lower at £131 millioninvestment in 2014 compared to £629 million in 2013; of this £787 million in 2013 related to the sale of government securities following the repositioning of the Group’s government bond portfolio which substantially completed in the first half of 2013.VISA Europe.

2119

operating and financial review and prospectsOPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

OPERATING EXPENSES             
  2015
£m		   2014
£m		    2013
£m		  
Administrative expenses:             
Staff:             
Salaries  2,808    3,178    3,331  
Performance-based compensation  409    390    473  
Social security costs  349    398    385  
Pensions and other post-retirement benefit schemes:               
Past service credits and curtailment gains  –    (822)   104  
Other  548    596    654  
   548    (226)   758  
Restructuring costs  104    264    111  
Other staff costs  459    741    783  
   4,677    4,745    5,841  
Premises and equipment:               
Rent and rates  368    424    467  
Repairs and maintenance  173    221    178  
Other  174    246    325  
   715    891    970  
Other expenses:               
Communications and data processing  893    1,118    1,169  
Advertising and promotion  253    336    313  
Professional fees  262    481    425  
UK bank levy  270    237    238  
TSB disposal  665    –    –  
Other  703    1,017    971  
   3,046    3,189    3,116  
Depreciation and amortisation:               
Depreciation of tangible fixed assets  1,534    1,391    1,374  
Amortisation of acquired value of in-force non-participating investment contracts  41    43    54  
Amortisation of other intangible assets  537    501    512  
   2,112    1,935    1,940  
Total operating expenses, excluding regulatory provisions  10,550    10,760    11,867  
Regulatory provisions:               
Payment protection insurance provision  4,000    2,200    3,050  
Other regulatory provisions  837    925    405  
   4,837    3,125    3,455  
Total operating expenses  15,387    13,885    15,322  
Cost:income ratio (%)1  88.3    84.7    82.9  

OPERATING EXPENSES

  2018
£m		  2017
£m		  2016
£m		 
Administrative expenses:            
Staff:            
Salaries  2,482   2,679   2,750 
Performance-based compensation  509   473   475 
Social security costs  343   361   363 
Pensions and other post-retirement benefit schemes  705   625   555 
Restructuring costs  249   24   241 
Other staff costs  474   448   433 
   4,762   4,610   4,817 
Premises and equipment:            
Rent and rates  370   365   365 
Repairs and maintenance  190   231   187 
Other  169   134   120 
   729   730   672 
Other expenses:            
Communications and data processing  1,121   882   848 
Advertising and promotion  197   208   198 
Professional fees  287   328   265 
UK bank levy  225   231   200 
Other  653   814   873 
   2,483   2,463   2,384 
Depreciation and amortisation:            
Depreciation of tangible fixed assets  1,852   1,944   1,761 
Amortisation of acquired value of in-force non-participating investment contracts  40   34   37 
Amortisation of other intangible assets  513   392   582 
   2,405   2,370   2,380 
Goodwill impairment  –   8   – 
Total operating expenses, excluding regulatory provisions  10,379   10,181   10,253 
Regulatory provisions:            
Payment protection insurance provision  750   1,300   1,350 
Other regulatory provisions1  600   865   1,024 
   1,350   2,165   2,374 
Total operating expenses  11,729   12,346   12,627 
Cost:income ratio (%)2  63.0   66.2   73.1 

 

1In 2016, regulatory provisions of £61 million were charged against income.
2Total operating expenses divided by total income, net of insurance claims.

 

20152018 COMPARED WITH 20142017

 

Operating expenses increaseddecreased by £1,502£617 million, or 115 per cent, to £15,387£11,729 million in 20152018 compared with £13,885£12,346 million in 2014.2017. This increasedecrease being principally reflecteddue to the fact that 2014 included a past service pension credit of £822 million and 2015reduction in the charge for conduct related matters; 2018 includes a regulatory provisions charge of £4,837£1,350 million, which was £1,712£815 million, or 5438 per cent, higherlower than the charge of £3,125£2,165 million in 2014.2017.

Staff costs were £152 million, or 3 per cent, higher in 2018 at £4,762 million compared to £4,610 million in 2017. On a full-time equivalent basis, the Group had 64,928 employees at the end of 2018, a reduction of 2,977 from 67,905 employees at 31 December 2017 representing an underlying reduction of 3,167 employees offset by an increase of 190 employees as a result of the acquisition of the Zurich workplace pensions business. Salaries were £197 million, or 7 per cent, lower at £2,482 million in 2018 compared with £2,679 million in 2017 as the benefit of the underlying reduction in staff numbers has more than offset the effect of annual pay rises, the acquisition of the Zurich work place pensions business and a full year’s ownership of MBNA. Pension costs were £80 million, or 13 per cent, higher at £705 million in 2018 compared to £625 million in 2017 and include a past service charge of £108 million following legal clarification of requirements regarding Guaranteed Minimum Pension benefits. Social security costs were £18 million, or 5 per cent, lower at £343 million in 2018 compared with £361 million in 2017, in line with the lower salary levels. Restructuring costs were £225 million higher at £249 million in 2018 compared to £24 million in 2017 reflecting charges in relation to the Group’s strategic investment plans and other staff costs were £26 million, or 6 per cent, higher at £474 million in 2018 compared with £448 million in 2017.

Premises and equipment costs were little changed at £729 million in 2018 compared to £730 million in 2017. Rent and rates were £5 million, or 1 per cent, higher at £370 million in 2018 compared to £365 million in 2017; repairs and maintenance costs were £41 million, or 18 per cent, lower at £190 million in 2018 compared to £231 million in 2017, as a result of equipment now being provided and maintained by a third party, and other premises and

20

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

equipment costs increased by £35 million, or 26 per cent, from £134 million in 2017 to £169 million in 2018 reflecting a lower level of gains on disposal of premises and other fixed assets.

Other expenses, excluding the regulatory provisions charges, were £20 million, or 1 per cent, higher at £2,483 million in 2018 compared with £2,463 million in 2017. Communications and data processing costs were £239 million, or 27 per cent, higher at £1,121 million in 2018 compared with £882 million in 2017 as a result of the integration of MBNA, increased costs relating to the Group’s ring-fencing programme and the Group’s digitalisation initiatives. Professional fees were £41 million, or 13 per cent, lower at £287 million in 2018 compared to £328 million in 2017 and advertising and promotion costs were £11 million, or 5 per cent, lower at £197 million in 2018 compared with £208 million in 2017. The cost of the Bank levy was £6 million, or 3 per cent, lower at £225 million in 2018 compared to £231 million in 2017. Other costs were £161 million, or 20 per cent, lower at £653 million in 2018 compared with £814 million in 2017.

Depreciation and amortisation costs were £35 million, or 1 per cent, higher at £2,405 million in 2018 compared with £2,370 million in 2017. Charges for the depreciation of tangible fixed assets were £92 million, or 5 per cent, lower at £1,852 million in 2018 compared to £1,944 million in 2017, following a reduced level of operating lease additions. The charge for the amortisation of intangible assets was £121 million, or 31 per cent, higher at £513 million in 2018 compared to £392 million in 2017, reflecting a full year charge relating to the purchased credit card receivable established on the MBNA acquisition and the impact of increased levels of software capitalisation.

 

The past service pension creditGroup incurred a regulatory provisions charge in operating expenses of £822£1,350 million in 2014 followed2018 compared to £2,165 million in 2017 of which £750 million (2017: £1,300 million) related to payment protection insurance; this charge was largely driven by an increase in average redress per case, additional operational costs to deal with potential complaint volatility and continued improvements in data interrogation and the Group’s decision, announced on 11 March 2014ability to reduceidentify valid claims. Reactive complaint volumes have been 12,000 per week in the cap on increasessecond half of 2018, compared with the Group’s assumption of 13,000 per week. The outstanding balance sheet provision at 31 December 2018, excluding the provision in pensionable pay usedMBNA, was £1,329 million and continues to assume around 13,000 complaints per week until the time-bar in calculating the pension benefitAugust 2019. The charge in relation to nil with effect from 2 April 2014.other conduct issues was £600 million in 2018, compared to £865 million in 2017; this charge included £151 million (2017: £245 million) in respect of arrears handling activities and £45 million (2017: £245 million) relating to packaged bank accounts.

 

Despite2017 COMPARED WITH 2016

Operating expenses decreased by £281 million, or 2 per cent, to £12,346 million in 2017 compared with £12,627 million in 2016. This decrease principally reflected the past service pension creditfact that 2017 included a regulatory provisions charge of £2,165 million, which was £209 million, or 9 per cent, lower than the charge of £2,374 million in 2014, staff2016.

Staff costs were £68£207 million, or 4 per cent, lower in 2017 at £4,610 million compared to £4,817 million in 2016, reflecting, in particular, the impact of reduced headcount. On a full-time equivalent basis, the Group had 67,905 employees at the end of 2017, a reduction of 2,528 from 70,433 employees at 31 December 2016; and this represents an underlying reduction of 4,231 employees offset by an increase of 1,703 employees as a result of the acquisition of MBNA. Salaries were £71 million, or 3 per cent, lower at £2,679 million in 2017 compared with £2,750 million in 2016; pension costs were £70 million, or 13 per cent, higher at £625 million in 2017 compared to £555 million in 2016; social security costs were £2 million, or 1 per cent, lower in 2015 at £4,677 million compared to £4,745£361 million in 2014. Excluding the pension credit,2017 compared with £363 million in 2016; and other staff costs were £890£15 million, or 3 per cent, higher at £448 million in 2017 compared with £433 million in 2016.

Premises and equipment costs were £58 million, or 9 per cent, higher at £730 million in 2017 compared to £672 million in 2016. Rent and rates were unchanged at £365 million; repairs and maintenance costs were £44 million, or 24 per cent, higher at £231 million in 2017 compared to £187 million in 2016, as a result of charges relating to property rationalisation, and other premises and equipment costs increased by £14 million, or 12 per cent, from £120 million in 2016 to £134 million in 2017.

Other expenses, excluding the regulatory provisions charges, were 79 million, or 3 per cent, higher at £2,463 million in 2017 compared with £2,384 million in 2016. Communications and data processing costs were £34 million, or 4 per cent, higher at £882 million in 2017 compared with £848 million in 2016 as a result of the acquisition of MBNA and project costs; professional fees were £63 million, or 24 per cent, higher at £328 million in 2017 compared to £265 million in 2016 as a result of costs in relation to regulatory developments such as ring-fencing; and advertising and promotion costs were £10 million, or 5 per cent, higher at £208 million in 2017 compared with £198 million in 2016, in part reflecting the acquisition of MBNA. The cost of the Bank levy was £31 million, or 16 per cent, lowerhigher at £4,677£231 million in 20152017 compared to £5,567£200 million in 2014 reflecting, in particular, the impact of business disposals and a significant reduction in expenditure in relation to the Group’s Simplification programme. As a result, salaries2016. Other costs were £370£59 million, or 127 per cent, lower at £2,808£814 million in 20152017 compared with £3,178£873 million in 2014; pension2016.

Depreciation and amortisation costs excludingwere £10 million lower at £2,370 million in 2017 compared with £2,380 million in 2016. Charges for the past service pension credit from 2014,depreciation of tangible fixed assets were £48£183 million, or 810 per cent, higher at £1,944 million in 2017 compared to £1,761 million in 2016, in line with increased operating lease asset balances. The charge for the amortisation of intangible assets was £190 million, or 33 per cent, lower at £548£392 million in 20152017 compared to £596£582 million in 2014; social security costs were £492016, reflecting the fact that the core deposit intangible arising from the HBOS acquisition became fully amortised in the early part of 2017, only partly offset by charges relating to the purchased credit card receivable established on the MBNA acquisition and to software.

The Group incurred a regulatory provisions charge in operating expenses of £2,165 million in 2017 compared to £2,374 million in 2016 (in addition there was £61 million in the year ended 31 December 2016 which was charged against income) of which £1,300 million (2016: £1,350 million) related to payment protection insurance.

21

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

IMPAIRMENT

  2018  2017  2016 
  £m  £m  £m 
Impairment losses on financial assets carried at amortised cost            
Loans and advances to banks  1   –   – 
Loans and advances to customers  1,022   697   592 
Debt securities  –   (6)  – 
Other assets  1   –   – 
Total impairment losses on financial assets carried at amortised cost  1,024   691   592 
Impairment of financial assets carried at fair value through other comprehensive income (2017 and 2016: available-for-sale financial assets)  (14)  6   173 
Loan commitments and financial guarantees (2017 and 2016: other credit risk provisions)  (73)  (9)  (13)
Total impairment charged to the income statement  937   688   752 

The Group has adopted IFRS 9 with effect from 1 January 2018 and, in accordance with the transition requirements of IFRS 9, comparatives have not been restated.

2018 COMPARED WITH 2017

Impairment losses increased by £249 million, or 1236 per cent, lower at £349to £937 million in 20152018 compared with £398to £688 million in 2014; staff restructuring costs were £1602017. Credit quality remains strong with no deterioration in credit risk. The Group’s loan portfolios continue to be well positioned, reflecting the Group’s continued prudent, through the cycle approach to credit risk, and benefiting from continued low interest rates and a resilient UK economy.

The impairment charge in respect of loans and advances to customers was £325 million, or 6147 per cent, lowerhigher at £104£1,022 million in 20152018 compared with £264to £697 million in 2014;2017. In Retail, overall credit performance in the UK mortgage book remains strong with average mortgage loan to value ratios broadly stable at 44.1 per cent and new to arrears as a proportion of total book remaining low. New business average loan to value was 62.5 per cent and around 88 per cent of the portfolio continues to have loan to value ratios of less than 80 per cent. The consumer finance portfolios continue to perform well with credit card business new to arrears as a proportion of total book remaining low whilst the UK motor finance book continues to benefit from the Group’s conservative approach to residual values and resilient used car prices. In Commercial Banking, the book continues to benefit from effective risk management, including reduced single name and key sector exposures. Together with a resilient economic environment, this has resulted in impairment charges remaining at a low level.

There was an impairment credit in respect of financial assets held at fair value through other staff costs were £282comprehensive income in 2018 of £14 million, compared to an impairment charge in respect of available-for-sale financial assets of £6 million in 2017. There was a credit of £73 million (2017: credit of £9 million) in respect of other credit risk provisions.

2017 COMPARED WITH 2016

Impairment losses decreased by £64 million, or 389 per cent, lower at £459to £688 million in 20152017 compared with £741to £752 million in 2014,2016, as a charge of £118 million in particular duethe MBNA business since acquisition offset the impact of the charge in respect of available-for-sale financial assets in 2016 which was not repeated in 2017.

The impairment charge in respect of loans and advances to customers was £105 million, or 18 per cent, higher at £697 million in 2017 compared to £592 million in 2016. In Retail, overall credit performance in the mortgage book remained stable. The average indexed loan to value (LTV) improved to 43.6 per cent (31 December 2016: 44.0 per cent) while the percentage of lending with an indexed LTV of greater than 100 per cent fell to 0.6 per cent (31 December 2016: 0.7 per cent). The UK Motor Finance book continued to benefit from conservative residual values and prudent provisioning and impaired loans as a percentage of closing advances were stable. The credit card book also continued to perform strongly with reductions in persistent debt while the MBNA portfolio performed in line with both the Group’s expectations and the existing credit card book. Impaired credit card balances as a percentage of closing advances improved. Increased charges in Commercial Banking were driven by a lower levelslevel of agency staff costsreleases and recoveries rather than a deterioration in relationthe underlying portfolio, both 2016 and 2017 included material charges against a single customer (2016: oil and gas sector, 2017: construction sector), but otherwise gross charges remained relatively low. The Commercial Banking portfolio continued to benefit from effective risk management, a relatively benign economic environment and continued low interest rates. The impairment charge relating to assets which are outside of the Simplification programme.Group’s risk appetite increased.

The impairment charge in respect of available-for-sale financial assets was £6 million in 2017, compared to £173 million in 2016, as a result of a charge in 2016 in respect of certain equity investments; and there was a credit of £9 million (2016: credit of £13 million) in respect of other credit risk provisions.

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PremisesTAXATION

  2018  2017  2016 
  £m  £m  £m 
UK corporation tax:            
Current tax on profits for the year  (1,386)  (1,346)  (1,010)
Adjustments in respect of prior years  11   126   156 
   (1,375)  (1,220)  (854)
Foreign tax:            
Current tax on profits for the year  (34)  (40)  (20)
Adjustments in respect of prior years  5   10   2 
   (29)  (30)  (18)
Current tax charge  (1,404)  (1,250)  (872)
Deferred tax  (156)  (478)  (852)
Tax expense  (1,560)  (1,728)  (1,724)

2018 COMPARED WITH 2017

In 2018, a tax expense of £1,560 million arose on the profit before tax of £5,960 million and equipment costsin 2017 a tax expense of £1,728 million arose on the profit before tax of £5,625 million. The statutory corporation tax rates were £17619.0 per cent for 2018 and 19.25 per cent for 2017.

The tax expense for 2018 represents an effective tax rate of 26.2 per cent compared to 30.7 per cent in 2017. The reduction in effective tax rate compared to 2017 was largely due to higher non-deductible conduct risk provisions in the prior year.

2017 COMPARED WITH 2016

In 2017, a tax expense of £1,728 million orarose on the profit before tax of £5,625 million and in 2016 a tax expense of £1,724 million arose on the profit before tax of £3,888 million. The statutory corporation tax rates were 19.25 per cent for 2017 and 20 per cent lower at £715 million in 2015 compared to £891 million in 2014, again reflecting business disposals and reduced Simplification expenditure. Rent and rates was £56 million, or 13 per cent, lower at £368 million in 2015 compared to £424 million in 2014; repairs and maintenance costs were £48 million, or 22 per cent, lower at £173 million in 2015 compared to £221 million in 2014, in part due to a lower level of dilapidation provisions on vacation of properties in 2015 than in 2014; and other premises and equipment costs decreased by £72 million, or 29 per cent, from £246 million in 2014 to £174 million in 2015, reflecting lower levels of losses on sale of equipment and a reduced level of activity in the property portfolio.

Other expenses, excluding the regulatory provisions charges, were £143 million, or 4 per cent, lower at £3,046 million in 2015 compared with £3,189 million in 2014. Communications and data processing costs were £225 million, or 20 per cent, lower at £893 million in 2015 compared with £1,118 million in 2014 as a result of a significant reduction in Simplification spend on systems and technology; professional fees were £219 million, or 46 per cent, lower at £262 million in 2015 compared to £481 million in 2014, reflecting both the reduced Simplification spend and a lower level of professional fees in respect of TSB; and advertising and promotion costs were £83 million, or 25 per cent, lower at £253 million in 2015 compared with £336 million in 2014 due to spend in relation to TSB in 2014. The cost of the Bank levy was £33 million, or 14 per cent, higher at £270 million in 2015 compared to £237 million in 2014, as a result of the increase in rate with effect from 1 April 2015. In 2015 the Group incurred a charge of £665 million relating to the disposal of TSB, reflecting the net costs of the Transitional Service Agreement between Lloyds and TSB and the contribution to be provided by Lloyds to TSB in moving to alternative IT provision. Other costs were £314 million, or 31 per cent, lower at £703 million in 2015 compared with £1,017 million in 2014.

Depreciation and amortisation costs were £177 million, or 9 per cent, higher at £2,112 million in 2015 compared with £1,935 million in 2014. Charges for the depreciation of tangible fixed assets were £143 million, or 10 per cent, higher at £1,534 million in 2015 compared to £1,391 million in 2014, in line with increased asset balances. The charge for the amortisation of acquired value of in-force non-participating investment contracts was £2 million, or 5 per cent, lower at £41 million in 2015 compared to £43 million in 2014. The charge for the amortisation of other intangible assets was £36 million, or 7 per cent, higher at £537 million in 2015 compared to £501 million in 2014, reflecting increased capitalised software balances.2016.

 

The Group incurred a regulatory provisions chargetax expense for 2017 represented an effective tax rate of 30.7 per cent. The high effective tax rate in operating expenses of £4,837 million in 2015 compared to £3,125 million in 2014 of which £4,000 million (2014: £2,200 million) related to payment protection insurance. For further details see note 39 to the financial statements.

2014 COMPARED WITH 2013

Operating expenses decreased by £1,437 million, or 9 per cent, to £13,885 million in 2014 compared with £15,322 million in 2013. This decrease principally reflected a past service pension credit of £822 million, compared to a charge of £104 million in 2013 and the reduced regulatory provisions charge of £3,125 million in 2014, which2017 was £330 million, or 10 per cent, lower than the charge of £3,455 million in 2013.

The past service pension credit of £822 million in 2014 followed the Group’s announcement on 11 March 2014 to freeze pensionable pay with effect from 2 April 2014. The effect of this change was to reduce the Group’s retirement benefit obligations recognised on the balance sheet by £843 million with a corresponding curtailment gain recognised in the income statement. This has been partly offset by a charge of £21 million following changes to pension arrangements for staff within the TSB business.

As a result of the past service pension credit, staff costs were £1,096 million, or 19 per cent, lower in 2014 at £4,745 million compared to £5,841 million in 2013. Excluding this, staff costs were lower by £170 million, or 3 per cent, at £5,567 million in 2014 compared to £5,737 million in 2013. Salaries were £153 million, or 5 per cent, lower at £3,178 million in 2014 compared with £3,331 million in 2013 as the impact of annual pay rises was more than offset by staff reductions, in part due to business disposals. Pension costs, excluding the past service pension items, were £58 million, or 9 per cent, lower at £596 million in 2014 compared to £654 million in 2013 primarily due to lower current service costs. Social security costs were £13 million, or 3 per cent, higher at £398 million in 2014 compared with £385 million in 2013. Staff restructuring costs were £153 million, higher at £264 million in 2014 compared with £111 million in 2013 reflecting a number of initiatives in the year, and other staff costs were £42 million, or 5 per cent, lower at £741 million in 2014 compared with £783 million in 2013.

Premises and equipment costs were £79 million, or 8 per cent, lower at £891 million in 2014 compared to £970 million in 2013. Rent and rates was £43 million, or 9 per cent, lower at £424 million in 2014 compared to £467 million in 2013 as the Group continues to rationalise its property portfolio, in part through business disposals. Repairs and maintenance costs were £43 million, or 24 per cent, higher at £221 million in 2014 compared to £178 million in 2013 in part reflecting increased dilapidation charges on a·number of properties; other premises and equipment costs decreased by £79 million,or 24 per cent, from £325 million in 2013 to £246 million in 2014, partly due to reduced charges in relation to the Group’s Simplification programme.

Other expenses excluding the regulatory provisions charges, were £73 million, or 2 per cent, higher at £3,189 million in 2014 compared with £3,116 million in 2013. Communications and data processing costs were £51 million, or 4 per cent, lower at £1,118 million in 2014 compared with £1,169 million in 2013largely due to the high levelbanking surcharge, and restrictions on the deductibility of costs supporting the TSB separation in 2013; professional fees were £56 million, or 13 per cent, higher at £481 million in 2014 compared to £425 million in 2013, in part due to charges in relation to the restructuring of the staff remuneration package and the rationalisation of the Group’s overseas presence; and advertising and promotion costs were £23 million, or 7 per cent, higher at £336 million in 2014 compared with £313 million in 2013 due to the promotion of the TSB brand. Other costs were £46 million, or 5 per cent, higher at £1,017 million in 2014 compared with £971 million in 2013.

Depreciation and amortisation costs were £5 million, lower at £1,935 million in 2014 compared with £1,940 million in 2013. Charges for the depreciation of tangible fixed assets were £17 million, or 1 per cent, higher at £1,391 million in 2014 compared to £1,374 million in 2013, in line with increased asset balances. The charge for the amortisation of acquired value of in-force non-participating investment contracts was £11 million, or 20 per cent, lower at £43 million in 2014 compared to £54 million in 2013 following the sale of St James’s Place plc in March 2013. The charge for the amortisation of other intangible assets was £11 million, or 2 per cent, lower at £501 million in 2014 compared to £512 million in 2013, partly as certain core deposit intangibles have become fully amortised.

The Group incurred a regulatory provisions charge of £3,125 million in 2014 compared to £3,455 million in 2013 of which £2,200 million (2013: £3,050 million) related to payment protection insurance. For further details see note 40 to the financial statements.conduct provisions.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

IMPAIRMENT         
  2015  2014  2013 
  £m  £m  £m 
Impairment losses on loans and receivables:         
Loans and advances to customers  443   735   2,725 
Debt securities classified as loans and receivables  (2)  2   1 
Total impairment losses on loans and receivables  441   737   2,726 
Impairment of available-for-sale financial assets  4   5   15 
Other credit risk provisions  (55)  10   – 
Total impairment charged to the income statement  390   752   2,741 

2015 COMPARED WITH 2014

Impairment losses decreased by £362 million, or 48 per cent, to £390 million in 2015 compared to £752 million in 2014, largely due to reduced charges in relation to the portfolio of assets which are outside of the Group’s risk appetite.

The impairment charge in respect of loans and advances to customers was £292 million, or 40 per cent, lower at £443 million in 2015 compared to £735 million in 2014. In Retail, a reduced impairment charge reflected continued low risk underwriting discipline, strong portfolio management and a favourable credit environment with low unemployment, increasing house prices and continued low interest rates. The improvement in Commercial Banking was driven by lower levels of new impairment as a result of effective risk management, improving UK economic conditions and the continued low interest rate environment; as well as provision releases, but at lower levels than seen during 2014. The Consumer Finance impairment charge reduced, driven by a continued underlying improvement in portfolio quality, supported by an increased level of write-backs from the sale of recoveries assets in the credit card portfolio compared to 2014 due to favourable market conditions. The impairment charge relating to assets which are outside of the Group’s risk appetite reduced significantly, reflecting the Group’s ongoing exit from these positions.

The impairment charge in respect of debt securities classified as loans and receivables was a credit of £2 million in 2015 compared to a charge of £2 million in 2014. The impairment charge in respect of available-for-sale financial assets was £1 million, or 20 per cent, lower at £4 million in 2015 compared to £5 million in 2014; and there was a credit of £55 million (2014: charge of £10 million) in respect of other credit risk provisions as a result of improved credit quality in a number of corporate relationships.

2014 COMPARED WITH 2013

Impairment losses decreased by £1,989 million, or 73 per cent, to £752 million in 2014 compared to £2,741 million in 2013 with a significant reduction in the portfolio of assets which are outside of the Group’s risk appetite and improvements in all Divisions. The improvements reflect lower levels of new impairment as a result of effective risk management, improving economic conditions and the continued low interest rate environment. The net charge has also benefited from significant provision releases but at lower levels than seen in 2013.

The impairment charge in respect of loans and advances to customers was £1,990 million, or 73 per cent, lower at £735 million compared to £2,725 million in 2013. In Retail, the impairment charge on unsecured lending reduced in line with lower impaired loan and arrears balances, in part reflecting the sale of a tranche of recoveries balances, and coverage in the secured book improved. The charge in Commercial Banking reduced as a result of the higher quality of recent new lending, the improving economy and continuing low interest rates, and provision releases as the Division progresses with its strategy of building a low-risk commercial bank. The Consumer Finance impairment charge was lower as a result of improving portfolio quality and the Division also had a benefit from the sale of recoveries balances. The impairment charge relating to assets which are outside of the Group’s risk appetite fell substantially following successful run-down of the portfolio, and in particular the sale of the majority of the Group’s impaired mortgage assets in Ireland.

The impairment charge in respect of debt securities classified as loans and receivables was £2 million in 2014 compared to £1 million in 2013. The impairment charge in respect of available-for-sale financial assets was £10 million, or 67 per cent, lower at £5 million in 2014 compared to £15 million in 2013; and there was a charge of £10 million (2013: £nil) in respect of undrawn commitments.

24

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

TAXATION         
  2015  2014  2013 
  £m  £m  £m 
UK corporation tax:         
Current tax on profits for the year  (485)  (162)  (226)
Adjustments in respect of prior years  (90)  213   (205)
   (575)  51   (431)
Foreign tax:            
Current tax on profits for the year  (24)  (39)  (60)
Adjustments in respect of prior years  27   3   26 
   3   (36)  (34)
Current tax credit (charge)  (572)  15   (465)
Deferred tax  (116)  (278)  (752)
Taxation charge  (688)  (263)  (1,217)

2015 COMPARED WITH 2014

In 2015, a tax charge of £688 million arose on the profit before tax of £1,644 million and in 2014 a tax charge of £263 million arose on the profit before tax of £1,762 million. The statutory corporation tax rates were 20.25 per cent for 2015 and 21.5 per cent for 2014.

The tax charge for the 2015 represented an effective tax rate of 42 per cent. The effective tax rate was higher than the UK corporation tax rate largely due to the introduction in 2015 of restrictions on the deductibility of conduct related provisions which resulted in an additional tax charge of £459 million. Adjusting for this charge, the effective tax rate would have been 14 per cent reflecting non-taxable and relieved gains and a number of positive one-off items.

The low tax charge in 2014 was driven by tax exempt gains on sales of businesses and a lower deferred tax liability in respect of the value of in-force assets in the life business.

2014 COMPARED WITH 2013

In 2014, a tax charge of £263 million arose on the profit before tax of £1,762 million and in 2013 a tax charge of £1,217 million arose on the profit before tax of £415 million. The statutory corporation tax rates were 21.5 per cent for 2014 and 23.25 per cent for 2013.

The tax charge for the 2014 represented an effective tax rate of 15 per cent. The effective tax rate was lower than the UK corporation tax rate largely as a result of tax exempt gains on sales of businesses and a lower deferred tax liability in respect of the value of in-force assets for the life business partially offset by the effect of non-deductible expenses.

The high tax charge in 2013 was driven by the write down of deferred tax assets following the changes in corporation tax rates and the sale of the Australian business.

25

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

LINE OF BUSINESS INFORMATION

 

The requirements for IFRS segmental reporting are set out in IFRS 8,Operating Segmentswhich mandates that an entity’s segmental reporting should reflect the way in which its operations are viewed and judged by its chief operating decision maker. As a consequence, the Group’s statutory segmental reporting follows the underlying basis as explained below (see also note 4 to the financial statements).

 

The Group Executive Committee, which is the chief operating decision maker for the Group, reviews the Group’s internal reporting based around these segments (which reflect the Group’s organisational and management structures) in order to assess performance and allocate resources.

The segments are differentiated by the type of products provided and by whether the customers are individuals or corporate entities and by the geographical location of the customer and the performance assessment includes a consideration of each segment’s net interest revenue; consequently the total interest income and expense for all reportable segments is presented on a net basis. The internal reporting is on an underlying profit before tax basis. The Group Executive Committee believes that this basis better represents the underlying performance of the Group. IFRS 8 requires that the Group presents its segmental profit before tax on the basis reviewed by the chief operating decision maker that is most consistent with the measurement principles used in measuring the Group’s statutory profit before tax. Accordingly, the Group presents its segmental underlying basis profit before tax in note 4 to the financial statements.

 

The aggregate total of the underlying basis segmental results constitutes a non-GAAP measure as defined in the United States Securities and Exchange Commission’s Regulation G. Management uses aggregate underlying profit before tax, a non-GAAP measure, as a measure of performance and believes that it provides important information for investors because it is a comparable representation of the Group’s performance. Profit before tax is the comparable GAAP measure to aggregate underlying profit before tax. The table below sets out the reconciliation of this non-GAAP measure to its comparable GAAP measure.

 

The Group’s activities are organised into fourthree financial reporting segments: Retail; Commercial Banking; Consumer Finance and Insurance.Insurance and Wealth.

With the exception of PPI, charges in relation to conduct provisions (referred to as remediation) are included in underlying profit. In addition, results in relation to certain assets which are outside the Group’s risk appetite, previously reported as part of run-off within Other, have been transferred into Retail and into Commercial. Comparatives have been restated accordingly.

 

Comparisons of results on a historical consolidated statutory basis are distortedimpacted by a number of items. In order to provide more meaningful and relevant comparatives, the results of the Group and divisions are presented on an ‘underlying’ basis. The following items are excluded in arriving at underlying profit:

 

–– losses on redemption of the amortisation of purchased intangible assetsEnhanced Capital Notes in 2016 and the unwindvolatility in the value of acquisition-related fair value adjustments arising from the HBOS acquisition;embedded equity conversion feature;
  
–restructuring, including severance-related costs, the costs of implementing regulatory reform including ring-fencing, the rationalisation of the non-branch property portfolio, the integration of MBNA and Zurich’s UK workplace pensions and savings business;
–market volatility and other items, which includes the effects of certain asset sales, the impact of liability management actions and the volatility relating to the Group’s own debt and hedging arrangements as well asand that arising in the insurance businesses and insurance gross up;up, the unwind of acquisition-related fair value adjustments and the amortisation of purchased intangible assets; and
  
–Simplification costs, which for 2015 are limited to severance costs relating to the programme announced in October 2014. Costs in 2014 and 2013 included severance, IT and business costs relating to the programme started in 2011;
 
–TSB build and dual running costs and the loss relating to the TSB sale;
–payment protection insurance provision and other conduct provisions; and
–certain past service pensions charges and credits in respect of the Group’s defined benefit pension arrangements.provisions.

Readers should be aware that the underlying basis has been presented for comparative purposes only and is not intended to provide proforma information or show the results of the Group as if the acquisition of HBOS had taken place at an earlier date.

 

The results of the businesses are set out below on the underlying basis:

 

 2015 2014 2013   2018   20171   20161 
 £m  £m  £m   £m   £m   £m  
Retail  3,514   3,228   3,015   4,272   3,770   3,303 
Commercial Banking  2,431   2,206   1,890   2,160   2,231   2,246 
Consumer Finance  1,005   1,010   965 
Insurance  962   922   1,088 
Insurance and Wealth  927   899   809 
Other  200   390   (792)  707   728   424 
Underlying profit before tax  8,112   7,756   6,166   8,066   7,628   6,782 

1Segmental analysis restated, as explained above.
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Reconciliation of underlying profit to statutory profit (loss) before tax for the year
     2015  2014  2013 
  Note  £m  £m  £m 
Profit before tax – Underlying basis      8,112   7,756   6,166 
Asset sales  1   54   138   (687)
Sale of government securities  2   –   –   787 
Liability management  3   (28)  (1,386)  (142)
Own debt volatility  4   26   398   (221)
Other volatile items  5   (129)  (112)  (457)
Volatility arising in insurance businesses  6   (105)  (228)  668 
Fair value unwind  8   (192)  (529)  (228)
Simplification costs and TSB build and dual running costs  9   (255)  (1,524)  (1,517)
Charge relating to TSB disposal  10   (660)  –   – 
Payment protection insurance provision  11   (4,000)  (2,200)  (3,050)
Other conduct provisions  12   (837)  (925)  (405)
Past service pension credit (charge)  13   –   710   (104)
Amortisation of purchased intangibles  14   (342)  (336)  (395)
Profit before tax – Statutory      1,644   1,762   415 
Reconciliation of underlying profit to statutory profit before tax for the year
     2018  2017  2016 
  Note  £m  £m  £m 
Underlying profit before tax      8,066   7,628   6,782 
Enhanced Capital Notes  1   –   –   (790)
Market volatility and asset sales  2   (50)  279   439 
Amortisation of purchased intangibles  3   (108)  (91)  (340)
Restructuring costs  4   (879)  (621)  (622)
Fair value unwind and other items  5   (319)  (270)  (231)
Payment protection insurance provision  6   (750)  (1,300)  (1,350)
Statutory profit before tax      5,960   5,625   3,888 

 

1.Asset salesEnhanced Capital Notes

Asset sales comprise the gains and losses on asset disposals (2015: gains of £54 million; 2014: gains of £138 million; 2013: losses of £687 million), principally of assets which were outside of the Group’s risk appetite.

2.Sale of government securities

These reflected gains on bond sales (2015: £nil; 2014: £nil; 2013: £787 million) as the Group took the opportunity afforded by the continuing low interest rate environment to reposition its holdings of available-for-sale government securities.

3.Liability management

In April 2014, theThe Group completed concurrent Sterling, Eurotender offers and Dollar exchange offers with holders of certain seriesredemptions in respect of its Enhanced Capital Notes (ECNs) in March 2016, resulting in a net loss to exchange the ECNs for new Additional Tier 1 (AT1) securities. In addition the Group completed a tender offer to eligible retail holders outside the United States to sell their Sterling-denominated ECNs for cash. The exchange offers completed with the equivalent of £5.0 billion of ECNs being exchanged for the equivalent of £5.35 billion of AT1 securities, before issue costs. The retail tender offer completed with approximately £58.5£721 million of ECNs being repurchased for cash. A loss of £1,362 million was recognised in relation to these exchange and tender transactions in the year ended 31 December 2014.

Losses of £28 million (2014: losses of £24 million; 2013: losses of £142 million) arose on other transactions undertaken as part2016, principally comprising the write-off of the Group’s managementembedded equity conversion feature and premiums paid under the terms of wholesale funding and capital. The liability management losses were included in other income.

4.Own debt volatility

Own debt volatility includesthe transaction. In addition there was a losscharge of £101£69 million (2014: gain of £401 million; 2013: loss of £209 million) relating toreflecting the change in fair value of the embedded equity conversion feature ofin the Enhanced Capital Notes, which principally reflects the ongoing amortisation of the value of the conversion feature over its life. Own debt volatility also includes a £114 million gain (2014: gain of £33 million; 2013: gain of £41 million) relatingperiod prior to the change in fair value of the small proportion of the Group’s wholesale funding which was designated at fair value at inception.transaction.

 

5.2.Other volatile itemsMarket volatility and asset sales

Other volatile items includeMarket volatility and asset sales of £50 million included the change in fair valueloss on sale of interest rate derivativesthe Irish mortgage portfolio of £105 million and foreign exchange hedges inan adjustment to the banking book not mitigated through hedge accounting. A charge of £99 million was included in 2015 (2014: charge of £138 million; 2013: charge of £489 million).past service pension liability. Also included in 2015 was a negative net derivative valuation adjustment of £30 million (2014: credit of £26 million; 2013: credit of £32 million), reflecting movements in the market implied credit risk associated with customer derivative balances.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

6.Volatility arising in insurance businesses

The Group’s statutory result before tax is affected by insurance volatility, caused by movements in financial markets, and policyholder interests volatility.

In 2015, the Group’s statutory result before tax included negative insurance and policyholder interests volatility totalling £105£103 million compared to positive volatility of £286 million in 2017 and negative volatility of £228£91 million in 2014 and positive volatility of £668 million in 2013.2016.

 

Volatility comprises the following:

 

 2015  2014 2013  2018  2017 2016 
 £m  £m  £m  £m  £m £m 
Insurance volatility  (303)  (219)  218   (506)  196   (152)
Policyholder interests volatility  87   17   564   46   190   241 
Insurance hedging arrangements  111   (26)  (114)  357   (100)  (180)
Total  (105)  (228)  668   (103)  286   (91)

 

Management believes that excluding volatility from underlying profit before tax provides useful information for investors on the performance of the business as it excludes amounts included within profit before tax which do not accrue to the Group’s equity holders and excludes the impact of changes in market variables which are beyond the control of management.

 

The most significant limitations associated with excluding volatility from the underlying basis results are:

 

(i)Insurance volatility requires an assumption to be made for the normalised return on equities and other investments; and
  
(ii)Insurance volatility impacts on the Group’s regulatory capital position, even though it is not included within underlying profit before tax.

 

Management compensates for the limitations above by:

 

(i)Monitoring closely the assumptions used to calculate the normalised return used within the calculation of insurance volatility; these assumptions are disclosed below; and
  
(ii)Producing separate reports on the Group’s current and forecast capital ratios.

 

Insurance volatility

The Group’s insurance business has policyholder liabilities that are supported by substantial holdings of investments. IFRS requires that the changes in both the value of the liabilities and investments are reflected within the income statement. The value of the liabilities does not move exactly in line with changes in the value of the investments. As the investments are substantial, movements in their value can have a significant impact on the profitability of the Group. Management believes that it is appropriate to disclose the division’s results on the basis of an expected return in addition to results based on the actual return. The impact of the actual return on these investments differing from the expected return is included within insurance volatility.

 

The expected gross investment returns used to determine the underlying profit of the business are based on prevailing market rates and published research into historical investment return differentials for the range of assets held. Where appropriate, rates are updated throughout the year to reflect changing market conditions and changes in the asset mix. In 2015 theThe basis for calculating these expected returns has been enhanced to reflectreflects an average of the 15 year swap rate over the preceding 12 months and rates were updated throughout the year to reflect changing market conditions. The negativevolatility movements in the period were largely driven by insurance volatility during 2015arising from equity market movements and credit spreads. The capital impact of £303 million primarily reflects lower equity returns than expected, widening credit spreadsmarket movements is hedged within Insurance and low returns on cash investments.this also reduces the IFRS earnings exposure.

 

Policyholder interests volatility

The application of accounting standards results in the introduction of other sources of significant volatility into the pre-tax profits of the life, pensions and investments business. In order to provide a clearer representation of the performance of the business, and consistent with the way in which it is managed, adjustments are made to remove this volatility from underlying profits. The effect of these adjustments is separately disclosed as policyholder interests volatility.

 

Accounting standards require that tax on policyholder investment returns relating to life products should be included in the Group’s tax charge rather than being offset against the related income. The result is, therefore, to either increase or decrease profit before tax with a related change in the tax charge. Timing and measurement differences exist between provisions for tax and charges made to policyholders. Consistent with the expected approach taken in respect of insurance volatility, differences in the expected levels of the policyholder tax provision and policyholder charges are

25

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

adjusted through policyholder interests volatility. In 2015,2018, the statutory results before tax included a credit to other income which relates to policyholder interests volatility totalling £87£46 million (2014: £17 million) reflecting offsetting movements in equity, bond and gilt returns.returns relating to life products.

 

Insurance hedging arrangements

The Group purchased put option contracts in 2015actively manages its exposures to protect against deterioration in equityinterest rate, foreign currency exchange rate, inflation and market conditionsmovements within the banking book through a comprehensive hedging strategy. This helps to mitigate earnings volatility and reduces the consequent negative impact of market movements on the value of in-force business on the Group balance sheet. These were financed by selling some upside potential from equity market movements. A gain of £111 million was recognised in relation to these contracts in 2015.capital position.

 

7.3.Insurance gross-upAmortisation of purchased intangibles

The Group’s insurance businesses’ income statements include income and expenditure which are attributable toGroup incurred a charge for the policyholdersamortisation of intangible assets, principally those recognised on the Group’s long-term assurance funds. These items have no impact in total upon the profit attributable to equity shareholders and, in order to provide a clearer representationacquisition of the underlying trends within the business, these items are shown net on a separate line. These policyholder amounts relate principally to returns on policyholder investments (within net interest income and net trading income) and insurance premiums receivable, together with a matching amount within the insurance claims expense representing the allocationHBOS, of these items to policyholders.£108 million (2017: £91 million; 2016: £340 million).

 

8.4.Restructuring costs

Restructuring costs were £879 million (2017: £621 million; 2016: £622 million) and included severance costs relating to the Group’s strategic investment plans as well as the costs of the integration of MBNA and Zurich’s UK workplace pensions and savings business, the costs of implementing regulatory reform including ring-fencing and the rationalisation of the non-branch property portfolio. The charge in 2017 and 2016 also included severance costs relating to the Simplification programme.

5.Fair value unwind and other items

The statutory (IFRS) results include the impact of the acquisition-related fair value adjustments, arising from the acquisition of HBOS in 2009; these adjustments affect a number of line items.

28

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Theand MBNA. In 2018 the principal financial effectseffect of the fair value unwind areis to reflect the effective interest rates applicable at the date of acquisition, on assets and liabilities that were acquired at values that differed from their original book value, and to recognise the reversal of credit and liquidity risk adjustments as underlying instruments mature or become impaired. Generally, this leads to higher interest expense as the value of HBOS’s own debt accretes to par and a lower impairment charge reflecting the impact of acquisition balance sheet valuation adjustments.value.

 

9.Simplification costs and TSB build and dual-running costs

Simplification programme costs in 2015 were £170 million (2014: £966 million; 2013: £830 million) relating to the next phase of simplification announced in October 2014. This had delivered annual run-rate cost savings of £373 million by 31 December 2015. The costs in 2014 and 2013 related to phase 1 of the simplification programme which was completed in 2014.

During 2015, the Group completed the European Commission (EC) mandated business disposal of TSB. TSB costs in the year ended 31 December 2015 totalled £85 million (2014: £558 million; 2013: £687 million) relating to dual-running costs. The dual-running costs include the costs of TSB’s standalone treasury, finance, human resources and other head office functions.

10.Charge relating to TSB disposal

On 20 March 2015 the Group announced that it had agreed to sell a 9.99 per cent interest in TSB Banking Group plc (TSB) to Banco de Sabadell S.A. (Banco Sabadell) and that it had entered into an irrevocable undertaking to accept Banco Sabadell’s recommended cash offer in respect of its remaining 40.01 per cent interest in TSB. The offer by Banco Sabadell was conditional upon, amongst other things, regulatory approval.

The sale of the 9.99 per cent interest completed on 24 March 2015, reducing the Group’s holding in TSB to 40.01 per cent; this sale led to a loss of control and the deconsolidation of TSB. The Group’s residual investment in 40.01 per cent of TSB was then recorded at fair value, as an asset held for sale. The Group recognised a loss of £660 million reflecting the net costs of the Transitional Service Agreement between Lloyds and TSB, the contribution to be provided by Lloyds to TSB in moving to alternative IT provision and the net result on sale of the 9.99 per cent interest and fair valuation of the residual investment.

The Group announced on 30 June 2015 that all relevant regulatory clearances for the sale of its remaining 40.01 per cent holding in TSB had been received and that the sale was therefore unconditional in all respects; the proceeds were received on 10 July 2015.

11.6.Payment protection insurance (PPI) provision

The Group increased the provision for PPI costs by a further £4,000payment protection insurance charge was £750 million (2017: £1,300 million). The charge in 2015, bringing the total amount provided to £16,025 million. This included an additional £2,100 million in the fourth quarter, largely to reflect the impact of its interpretation of the proposals contained within the Financial Conduct Authority’s (FCA) consultation paper regarding a potential time bar and the Plevin case. As at 31 December 2015, £3,458 million or 22 per cent of the total provision, remained unutilised with approximately £2,950 million relating to reactive complaints and associated administration costs.

The volume of reactive PPI complaints has continued to fall, with an 8 per cent reduction in 2015 compared with 2014, to approximately 8,000 complaints per week. Whilst direct customer complaint levels fell 30 per cent year-on-year, those from Claims Management Companies (CMCs) have remained broadly stable and as a result, CMCs now account for over 70 per cent of complaints.

Assuming current FCA proposals are implemented and an average of approximately 10,000 complaints per week, including those2018 related to Plevin, the outstanding provision should be sufficient to cover all future PPI related complaints and associated administration costs through to mid-2018.

Weekly complaint trends could vary significantly throughout this period, given they are likely to be impacted by a number of factors including thehigher expected complaint volumes, which increased to 13,000 per week, and associated administration costs, an increase in average redress per complaint, additional operational costs to deal with potential impact of the FCA’s proposed communication campaign as well as changescomplaint volatility and continued improvements in the regulation of CMCs.

12.Other conduct provisions

In 2015, the Group incurred a charge of £837 million, of which £302 million was recognised in the fourth quarter relating to a number of non-material items including packaged bank accountsdata interrogation and a number of other product rectifications primarily in Retail, Insurance and Commercial Banking. Within the full year charge, £720 million of provisions related to potential claims and remediation in respect of products sold through the branch network and continuing investigation of matters highlighted through industry wide regulatory reviews, as well as legacy product sales and historical systems and controls such as those governing legacy incentive schemes. This includes a full year charge of £225 million in respect of complaints relating to packaged bank accounts. The full year charge also included the previously announced settlement of £117 million that the Group reached with the FCA with regard to aspects of its PPI complaint handling process during the period March 2012 to May 2013.

13.Past service pension credit (charge)

On 11 March 2014 the Group announced a change to its defined benefit pension arrangements, revising the existing cap on the increases in pensionable pay used in calculating the pension benefit, from 2 per cent to nil with effect from 2 April 2014. The effect of this change was to reduce the Group’s retirement benefit obligations recognised on theability to identify valid complaints. The outstanding balance sheet by £843provision at 31 December 2018, excluding the provision in MBNA, was £1,329 million with a corresponding curtailment gain recognisedand continues to assume around 13,000 complaints per week until the timebar in the income statement. This was partly offset by a charge of £133 million relating to the cost of other changes to the pay, benefits and reward offered to employees to give a net credit of £710 million recognised in 2014.

In 2013 the Group recorded a charge of £104 million as a result of changes to early retirement and commutation factors in two of its principal defined benefit schemes.

14.Amortisation of purchased intangibles

The Group incurred a charge for the amortisation of intangible assets, recognised on the acquisition of HBOS in 2009, of £342 million (2014: £336 million; 2013: £395 million).August 2019.

2926

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

DIVISIONAL RESULTS

 

RETAIL

 

Retail offers a broad range of financial service products to personal and business banking customers, including current accounts, savings, personal loans and mortgages, to UK personal customers, including Wealth and small business customers. It is also a distributor of insurance, protection and credit cards, unsecured loans, motor finance and a range of long-term savings and investment products.leasing solutions. Its aim is to be the best bank for customers in the UK, by building deep and enduring relationships that deliver real value, to customers, and by providing them with greater choice and flexibility. It will maintain itsflexibility with propositions increasingly personalised to their needs. Retail operates a multi-brand and multi-channel strategy and continuecontinues to simplify theits business and provide more transparent products, helping to improve service levels and reduce conduct risks.risks, whilst working within a prudent risk appetite.

 

 2015 2014 2013 
 £m  £m  £m  2018
£m		  2017
£m		1 2016
£m		1
Net interest income  7,397   7,079   6,500   9,066   8,706   8,074 
Other income  1,122   1,212   1,435   2,171   2,221   2,165 
Total income  8,519   8,291   7,935   11,237   10,927   10,239 
Operating expenses  (4,573)  (4,464)  (4,160)
Operating lease depreciation  (921)  (947)  (777)
Net income  10,316   9,980   9,462 
Operating costs  (4,915)  (4,866)  (4,761)
Remediation  (267)  (633)  (750)
Total costs  (5,182)  (5,499)  (5,511)
Impairment  (432)  (599)  (760)  (862)  (711)  (648)
Underlying profit  3,514   3,228   3,015   4,272   3,770   3,303 

1Restated, as explained on page 24.

 

20152018 COMPARED WITH 20142017

 

Underlying profit increased by £286£502 million, or 913 per cent, to £3,514£4,272 million in 20152018 compared to £3,228£3,770 million in 2014, driven by improved margins and reduced impairments.2017.

 

Net interest income increased £318by £360 million, or 4 per cent, to £7,397£9,066 million in 20152018 compared to £7,079£8,706 million in 2014. Margin performance was strong, increasing 11bps to 2.40 per cent in 2015 compared to 2.29 per cent in 2014, driven by improved deposit mix2017, reflecting the benefits of a full year of MBNA and margin,lower funding costs more than offsetting reduced lending rates.ongoing mortgage pricing pressure.

 

Other income decreased £90£50 million, or 72 per cent, to £1,122£2,171 million in 20152018 compared to £1,212£2,221 million in 2014,2017, driven by current account transaction related income and regulatory changes,implementation of a simpler overdraft fee structure.

Operating lease depreciation decreased £26 million, or 3 per cent, to £921 million in particular, impacting the Wealth business.2018 compared to £947 million in 2017, reflecting improved used car market prices.

 

Operating expenses increased £109by £49 million, 2or 1 per cent, to £4,573£4,915 million in 20152018 compared to £4,464£4,866 million in 2014. The increase reflects continued2017 as increased investment in the business investment and simplification to improve customer experiences and enable staff numbers to be reducedis partly offset by 7efficiency savings.

Remediation costs decreased by £366 million, or 58 per cent to £267 million in 2015.2018 compared to £633 million in 2017, driven by lower provision charges across existing programmes.

 

Impairment reducedincreased by £167£151 million, or 2821 per cent, to £432£862 million in 20152018 compared to £599£711 million in 2014, driven by continued low risk underwriting discipline, strong portfolio management2017, largely due to the full year inclusion of MBNA and a favourable credit environment.non-repeat of UK mortgages write-backs.

 

20142017 COMPARED WITH 20132016

 

Underlying profit increased by £213£467 million, or 714 per cent, to £3,228£3,770 million in 20142017 compared to £3,015£3,303 million in 2013, driven by improved margins and reduced impairments.2016, including MBNA which was acquired on 1 June 2017.

 

Net interest income increased £579by £632 million, or 98 per cent, to £7,079£8,706 million in 20142017 compared to £6,500£8,074 million in 2013. Margin performance was strong, increasing 20 basis points to 2.29 per cent in 2014 compared to 2.09 per cent in 2013,2016, reflecting the acquisition of MBNA and driven by improved deposit mix andrepricing offsetting mortgage margin more than offsetting reduced lending rates.pressures.

 

Other income increased £56 million, or 3 per cent, to £2,221 million in 2017 compared to £2,165 million in 2016, driven by continued fleet growth in Lex Autolease.

Operating lease depreciation increased £170 million, or 22 per cent, to £947 million in 2017 compared to £777 million in 2016, again driven by continued fleet growth in Lex Autolease and increased conservatism in residual value management.

Operating expenses increased by £105 million, or 2 per cent, to £4,866 million in 2017 compared to £4,761 million in 2016 mainly due to the inclusion of MBNA as well as increased investment spend and pay-related growth, partly offset by underlying efficiency savings.

Remediation costs decreased £223by £117 million, or 16 per cent, to £1,212£633 million in 20142017 compared to £1,435£750 million in 2013, as a result of2016, driven by lower other operating income from protection sales partly due to fewer advised sales roles in branches. Lower Wealth other operating income following the Retail Distribution Review.provisions across existing conduct issues.

 

Total costsImpairment increased £304by £63 million, 7or 10 per cent, to £4,464£711 million in 20142017 compared to £4,160£648 million in 2013, driven by higher indirect costs previously absorbed within TSB and depreciation costs associated with ongoing investment in the business.

Impairment reduced £161 million, or 21 per cent, to £599 million in 2014 compared to £760 million in 2013, driven by lower write-offs and impaired loans in the unsecured book. Secured coverage strengthened to 37 per cent, resulting in a 13 per cent increase2016, largely due to the impairment charge.addition of MBNA, partly offset by a lower charge reflecting the resilient economic environment.

3027

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

COMMERCIAL BANKING

 

Commercial Banking has been supporting British business for 250 years. It has a client-led, low risk, capital efficient strategy, helpingcommitted to supporting UK-based clients and international clients with a link to the UK. Through its foursegmented client facing divisions – SME, Mid Markets, Global Corporates and Financial Institutions –coverage model it provides clients with a range of products and services such as lending, transactional banking, working capital management, risk management and debt capital markets services, as well as access to private equity through Lloyds Development Capital.services. Continued investment in capabilities and digital propositions enables the delivery of a leading customer experience, supported by increasingly productive relationship managers, with more time spent on value-adding activities.

          
  2018
£m		  2017
£m		1 2016
£m		1
Net interest income  3,004   3,030   2,863 
Other income  1,653   1,798   1,875 
Total income  4,657   4,828   4,738 
Operating lease depreciation  (35)  (105)  (118)
Net income  4,622   4,723   4,620 
Operating costs  (2,167)  (2,230)  (2,215)
Remediation  (203)  (173)  (148)
Total costs  (2,370)  (2,403)  (2,363)
Impairment  (92)  (89)  (11)
Underlying profit  2,160   2,231   2,246 

 

  2015  2014  2013 
  £m  £m  £m 
Net interest income  2,510   2,480   2,113 
Other income  2,066   1,956   2,259 
Total income  4,576   4,436   4,372 
Operating expenses  (2,167)  (2,147)  (2,084)
Impairment  22   (83)  (398)
Underlying profit  2,431   2,206   1,890 
1Restated, as explained on page 24.

 

20152018 COMPARED WITH 20142017

 

Commercial Banking underlying profit increaseddecreased by £225£71 million, or 103 per cent, to £2,431£2,160 million in 20152018 compared to £2,206£2,231 million in 2014 due to2017 reflecting lower impairments and increased total underlying income partially offset by lower expenses.

Net interest income decreased by £26 million, or 1 per cent, to £3,004 million in 2018 compared to £3,030 million in 2017 with the net interest margin lower and partly offset by higher operating costs.average interest-earning assets.

Other income decreased by £145 million to £1,653 million in 2018 compared to £1,798 million in 2017 reflecting challenging market conditions leading to lower levels of client activity. 2017 included a number of significant one-off refinancing and hedging transactions.

Operating lease depreciation decreased by £70 million to £35 million in 2018 compared to £105 million in 2017 due to lower accelerated charges on a number of legacy and discontinued assets.

Operating expenses decreased by £63 million to £2,167 million in 2018 compared to £2,230 million in 2017 reflecting efficiency savings despite increased investment.

Remediation costs increased by £30 million to £203 million in 2018 compared to £173 million in 2017.

Impairments increased by £3 million, to £92 million in 2018 compared to £89 million in 2017 with the increase driven by expected lower releases and write backs.

2017 COMPARED WITH 2016

Commercial Banking underlying profit decreased by £15 million, to £2,231 million in 2017 compared to £2,246 million in 2016.

 

Net interest income increased by £30 million, or 1 per cent, to £2,510 million in 2015 compared to £2,480 million in 2014 driven by reduced funding costs and higher net interest margin due to disciplined new lending and an increase in deposits.

Other income increased by £110£167 million, or 6 per cent, to £2,066£3,030 million in 20152017 compared to £1,956£2,863 million in 2014 driven2016 with an improvement in net interest margin supported by refinancing support providedbroad based franchise growth.

Other income decreased by £77 million to Global Corporate clients£1,798 million in 2017 compared to £1,875 million in 2016 as a result of fewer significant transactions in the second half of the year and increasesreduced client activity compared to 2016.

Operating lease depreciation decreased slightly by £13 million to £105 million in Mid Markets.2017 compared to £118 million in 2016.

 

Operating expenses increased by £20£15 million or 1 per cent, to £2,167£2,230 million in 20152017 compared to £2,147£2,215 million in 2014.2016 due to continued investment in the business partially offset by efficiencies.

Remediation costs increased by £25 million to £173 million in 2017 compared to £148 million in 2016.

 

Impairments improvedincreased by £105£78 million to a £22charge of £89 million release in 2015 compared to an £83 million2017 reflecting expected lower levels of releases and recoveries, and a large single name charge in 2014 reflecting lower gross charges and a number of write-backs and releases.

2014 COMPARED WITH 2013

Commercial Banking underlying profit increased by £316 million, or 17 per cent, to £2,206 million in 2014 compared to £1,890 million in 2013 due to lower impairments and increased net interest income, partially offset by reduced other income and increased operating expenses.

Net interest income increased by £367 million, or 17 per cent, to £2,480 million in 2014 compared to £2,113 million in 2013 driven by reduced funding costs and net interest margin expansion as a result of disciplined pricing of new business.

Other income decreased by £303 million, or 13 per cent, to £1,956 million in 2014 compared to £2,259 million in 2013 reflecting reduced client activity in Debt Capital Markets and Financial Markets in addition to lower revaluation gains within Lloyds Development Capital.

Operating expenses increased by £63 million, or 3 per cent, to £2,147 million in 2014 compared to £2,084 million in 2013 as a result of continued investment in developing product capabilities.

Impairments decreased by £315 million, or 79 per cent, to £83 million in 2014 compared to £398 million in 2013 reflecting lower gross charges, and improved credit quality.2017.

31

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

CONSUMER FINANCE

Consumer Finance provides a range of products including motor finance, credit cards, and European mortgages and deposit taking, aiming to deliver sustainable growth within risk appetite. Motor Finance seeks to achieve this through improving customer service by building digital capability and continuing to create innovative propositions. Credit Cards aims to attract customers through better use of Group customer relationships and insight, underpinned by improvements to customer experience.

  2015
£m		  2014
£m		  2013
£m		 
Net interest income 1,287  1,290  1,333 
Other income 1,358  1,364  1,359 
Total income 2,645  2,654  2,692 
Operating expenses (1,488) (1,429) (1,384)
Impairment (152) (215) (343)
Underlying profit 1,005  1,010  965 

2015 COMPARED WITH 2014

Underlying profit was £1,005 million in 2015 compared to £1,010 million in 2014 with growth in better quality but lower margin lending resulting in lower income but lower impairments, offset by increased cost of investment in growth initiatives.

Total income decreased by £9 million to £2,645 million in 2015 compared to £2,654 million in 2014.

Net interest margin decreased by 55 basis points to 5.94 per cent, contributing to a small reduction in net interest income to £1,287 million in 2015 compared to £1,290 million in 2014. Net interest margin was down due to the acquisition of lower risk but lower margin new business, an increased proportion of Cards interest free balance transfer balances and the impact of the planned reduction in deposits in line with the Group’s balance sheet funding strategy.

Other income reduced by £6 million to £1,358 million in 2015 compared to £1,364 million in 2014, as higher income from growing the Lex Autolease fleet was offset by the impact of lower interchange income in Cards following the recent EU ruling.

Operating expenses increased by £59 million, or 4 per cent, to £1,488 million in 2015 compared to £1,429 million in 2014 as operating cost savings were offset by continued investment in growth initiatives and increased operating lease depreciation as a result of growth in the Lex Autolease fleet.

The impairment charge reduced by £63 million, or 29 per cent, to £152 million in 2015 compared to £215 million in 2014. This has been driven by a continued underlying improvement in portfolio quality and supported by the sale of recoveries assets in the Credit Cards portfolio. The asset quality ratio improved by 37 basis points.

2014 COMPARED WITH 2013

Underlying profit increased by £45 million to £1,010 million in 2014 compared to £965 million in 2013 primarily due to a reduction of £128 million in impairment charges across the portfolio and growth in total income from Asset Finance partly offset by a fall in total income from Credit Cards and investments for future growth in the businesses.

Total income decreased by £38 million to £2,654 million in 2014 compared to £2,692 million in 2013.

Net interest margin decreased by 45 basis points to 6.49 per cent, resulting in a 3 per cent reduction in net interest income to £1,290 million in 2014 compared to £1,333 million in 2013. New business growth and deposit repricing have been offset by a change in the composition of the portfolio with an increase in higher quality, lower margin lending to the new vehicle market and the impact of the current year’s strategic focus on growing the volume of new credit cards. Consistent with the strategy of acquiring high quality new business, the asset quality ratio improved by 71 basis points.

Other income increased by £5 million to £1,364 million in 2014 compared to £1,359 million in 2013 as a result of the growth strategy.

Operating expenses increased by £45 million, or 3 per cent, to £1,429 million in 2014 compared to £1,384 million in 2013 driven by investment in growth initiatives and increased operating lease depreciation as a result of growth in the Lex Autolease fleet, offset by cost savings and increased gains from end of life lease asset sales. In 2014 a further £45 million was invested in improving propositions and customers’ digital experience.

The impairment charge reduced by £128 million, or 37 per cent, to £215 million in 2014 compared to £343 million in 2013. This has been driven by a continued underlying improvement of portfolio quality supported by the sale of recoveries assets in the Credit Cards and Asset Finance portfolios.

3228

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

INSURANCE AND WEALTH

 

Insurance providesand Wealth offers insurance, investment and wealth management products and services. It supports around 10 million customers with assets under administration of £141 billion and annualised annuity payments in retirement of over £1 billion. The Group continues to invest significantly in the development of the business, with the aims of capturing considerable opportunities in pensions and financial planning, offering customers a broad range of long term savings, retirementsingle home for their banking and protection products to retailinsurance needs and corporate customers, either direct ordriving growth across intermediary and relationship channels through intermediary networks or through the Group’s banking branches .a strong distribution model.

          
  2018
£m		  2017
£m		1 2016
£m		1
Net interest income  123   133   80 
Other income  1,865   1,846   1,878 
Total income, net of insurance claims  1,988   1,979   1,958 
Operating costs  (1,021)  (1,040)  (1,046)
Remediation  (39)  (40)  (103)
Total costs  (1,060)  (1,080)  (1,149)
Impairment  (1)  –   – 
Underlying profit  927   899   809 

1Restated, as explained on page 24.

 

Life, Pensions and Investments

The Life, Pensions and Investments business provides long-term savings, retirement solutions and protection products primarily distributed through intermediaries and direct channels of Scottish Widows.

General Insurance

The General Insurance business is a leading provider of home insurance in the UK, with products sold through the branch network, direct channels and strategic corporate partners. The business also has brokerage operations for personal and commercial insurances. It operates primarily under the Lloyds Bank, Halifax and Bank of Scotland brands.

  2015
£m		  2014
£m		  2013
£m		 
Net interest expense (163) (131) (107)
Other income 1,827  1,725  1,864 
Total income, net of insurance claims 1,664  1,594  1,757 
Operating expenses (702) (672) (669)
Underlying profit 962  922  1,088 

20152018 COMPARED WITH 20142017

 

Underlying profit from insuranceInsurance and Wealth was £40£28 million, or 43 per cent, higher at £962£927 million compared to £922£899 million in 2014. The2017 as a result of an increase was driven by bulk annuity dealsof £9 million in total income, net of insurance claims and the net benefit from a number of assumption updates, partly offset by increased costs reflecting significant investment spend, adverse economics, and reduced general insurance income.£19 million decrease in operating costs.

 

Net interest expense increasedincome decreased by £32£10 million, or 248 per cent, to £163£123 million from £131£133 million in 20142017 due to holding increased debt whilst a tranche of subordinated debt was re-financed.higher net interest charge within Insurance primarily reflecting higher LIBOR rates.

 

Other income increased by £102£19 million, or 61 per cent to £1,827£1,865 million from £1,725£1,846 million in 2014. The increase2017. Life and pensions new business income was driven by bulk annuity deals and the net benefit from a number of assumption updates,up 87 per cent to £526 million partly offset by adverse economics and reduceda £26 million decrease in total general insurance income.income net of claims, including around £60 million impact from higher weather related claims. Lower experience and other items primarily due to the non-recurrence of £170 million income from the addition of death benefits in 2017.

 

2014Operating costs were £19 million lower, with cost savings more than offsetting higher investment in the business.

Remediation decreased by £1 million, or 3 per cent, to £39 million from £40 million.

2017 COMPARED WITH 20132016

 

Underlying profit from insuranceInsurance and Wealth was £166£90 million, or 1511 per cent lowerhigher at £922£899 million compared to £1,088£809 million in 2013. This was impacted by the cost of structural changes in the corporate pensions book, primarily the cap on pension charges and lower life new business and general insurance premiums offset by improved economics and an increase in yields on assets backing annuity business2016 as a result of the strategy to invest in long-term, low risk, higher yielding assets.Insurance income and lower remediation costs, partly offset by lower Wealth income. Operating costs remained flat, with higher investment costs offset by lower business as usual costs.

 

Net interest expenseincome increased by £24£53 million, or 2266 per cent, to £131£133 million from £107£80 million in 2013, primarily2016 due to higher intra group charges.a lower net interest expense within Insurance reflecting reduced funding costs.

 

Other income decreased by £139£32 million, or 72 per cent, to £1,725£1,846 million from £1,864£1,878 million in 2013. This was impacted by2016 reflecting lower new business, reduced generalmargins in Insurance as a result of the competitive environment, strengthening of underlying assumptions and lower bulk annuity sales. General insurance income and structural changes infell due to the corporate pensions book, offset by benefits arising fromcontinued competitiveness of the strategy of acquiring attractive, higher yielding assets to back the annuities business, improved economics and lower weather related claims.home insurance marketplace.

 

Operating expenses of £672costs were £6 million increasedlower, with higher investment costs offset by £3lower business as usual costs.

Remediation decreased by £63 million, or 61 per cent, to £40 million from £669£103 million as no provisions were made in 2013 where increased investment2017 in strategic initiatives has been funded by a reductionrespect of customer claims in the underlying cost base.relation to insurance branch business in Germany.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

UNDERLYING PROFITINCOME BY PRODUCT GROUP

                            
  2018  20171  20161 
  New
business
income
£m		  Existing
business
income
£m		  Total
income
£m		  New
business
income
£m		  Existing
business
income
£m		  Total
income
£m		  New
business
income
£m		  Existing
business
income
£m		  Total
income
£m		 
Workplace, planning and retirement  333   153   486   131   125   256   146   122   268 
Individual and bulk annuities  160   84   244   125   88   213   207   92   299 
Protection  20   22   42   13   20   33   19   17   36 
Longstanding life, pensions and investments  13   414   427   12   440   452   9   441   450 
   526   673   1,199   281   673   954   381   672   1,053 
Life and pensions experience and other items          143           358           141 
General Insurance          272           298           354 
           1,614           1,610           1,548 
Wealth          374           369           410 
Total income          1,988           1,979           1,958 

 

  2015 2014  2013 
  Pensions &
investments
£m		  Protection &
retirement
£m		  Bulk annuities
£m		  General
insurance
£m		  Other
£m		  Total
£m		  Total
£m		  Total
£m		 
New business income 168  33  125  –  –  326  268  423 
Existing business income 630  122  –  –  28  780  882  795 
Long-term investment strategy –  73  102  –  –  175  160  118 
Assumption changes and  experience variances (208) 240  30  –  (2) 60  (134) (48)
General insurance income net  of claims –  –  –  323  –  323  418  469 
Total income 590  468  257  323  26  1,664  1,594  1,757 
Total costs (414) (133) (10) (145) –  (702) (672) (669)
Underlying profit 2015 176  335  247  178  26  962  922  1,088 
Underlying profit 2014 236  344  –  274  68  922       
1Restated, as explained on page 24.

 

20152018 COMPARED WITH 20142017

 

New business income has increased by £58£245 million to £326£526 million, with the primary driver being thedriven by increases in new bulk annuity business. This was offset by a reductionmembers in Protection income, following the removal of face-to-face advice in branch standalone protection sales and reduced annuity income following the introduction of Pensions Freedoms in 2015. Corporate pension income remained robust despite lower sales following theexisting workplace schemes, increased auto enrolment driven increases in 2014.workplace contributions and bulk annuities.

 

The £102 million fall in existingExisting business income reflects a reduction in the expected rateis unchanged at £673 million, with positive impact of return used to calculate life and pensions income. The rate of return is largely seteconomics offset by reference to an average 15 year swap rate (2.57 per cent in 2015 and 3.48 per cent in 2014).legacy products run-off.

 

Long-term investment strategy includes theExperience and other items contributed a net benefit of £143 million. This was £215 million lower than 2017 primarily due to £170 million of income from the successful acquisitionaddition of a further £1.4 billion of higher yielding assets to match long duration annuity liabilities.death benefits in 2017.

 

Assumption changes2017 COMPARED WITH 2016

New business income has decreased by £100 million to £281 million. Excluding bulk annuities and experience variances include an adverse2016 with profits fund annuity transfer within planning and retirement, new business income remained stable.

Existing business income increased by £1 million to £673 million, with positive impact of £208 million in Pensions and Investments as a result of the strengthening of lapse assumptions on the pensions book to allow for the impact of the recent pension reforms. This was more thaneconomics offset by the £240legacy products run-off.

Experience and other items contributed a net benefit of £358 million, of benefit recognised within Protection and Retirement, primarilyincluding benefits as a result of changes to assumptions on longevity.longevity assumptions. These longevity changes reflectinclude both experience in the annuity portfolio and the adoption of a new industry model reflecting an updated view of future life expectancy.

General Insurance income net of claims has fallen by £95 million. This reflects the run-off of products closed to new customers, the impact of becoming a sole underwriter of the home insurance business (which has resulted in a short term reduction from the loss of commission recognised upfront) and the impact of adverse weather. The anticipated launch in early 2016 of a more flexible Home product is expected to lead to an improvement in general insurance sales going forward.

Total costs were £30 million higher, reflecting significant investment spend as part of an ongoing programme of growth and simplification initiatives. In 2015 this included the launch of Protection to IFAs and the bulk annuities business alongside the Part VII transfer as well as a significant regulatory change agenda in particular to support pensions freedoms and transition to Solvency II. Excluding investment related expenditure, underlying costs fell by 3 per cent during 2015 reflecting ongoing operational efficiencies.

2014 COMPARED WITH 2013

New business income reduced by £155 million to £268 million driven by a reduction in pensions new business income due to lower volumes relative to the spike in 2013 sales (as Retail Distribution Review sales completed). In calculating new business income on auto-enrolment schemes, allowance has been made for low initial contribution levels and does not include future automatic increases in contribution levels. These increases will be reported in future years. In addition protection and retirement new business income has reduced following the 2014 Budget announcement which led to industry wide reductions in annuities volumes following changes to the freedoms consumers have in accessing their pension savings.

Existing business income has increased by £87 million reflecting improved economics benefiting the life and pensions business.

2014 underlying profit in the protection and annuities business included a benefit of £277 million, largely from investing in higher yielding assets to match long duration liabilities and benefits from assumption changes. This was offset by a charge of £219 million in the pensions and investments business driven primarily by assumption changes within the existing book including actions being taken to prepare for the structural changes arising from the Department for Work and Pensions’ announcement which introduced a cap on pension charges. These changes to corporate pensions will ensure that future new business is less capital intensive.

General Insurance underlying profit has fallen by £35 million, due to the continued run off of legacy books and the impact of storms in the first quarter, offset by good prior year experience. During the year, underwriting of the home insurance business was brought in-house, ensuring delivery of a first class service to all customers and continued sustainable growth in the underwritten customer base.

3430

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

OTHER

 

Other comprises Run-off,Central items which include income and expenditure not attributed to divisions, including the resultscosts of TSB up until loss of control in March 2015certain central and Central items.head office functions and the Group’s private equity business, Lloyds Development Capital.

 

  2018
£m		  20171
£m		  20161
£m		 
Total income  842   791   504 
Operating lease depreciation  –   (1)  – 
Net income  842   790   504 
Operating costs  (62)  (48)  (71)
Remediation  (91)  (19)  (23)
Total costs  (153)  (67)  (94)
Impairment release  18   5   14 
Underlying profit  707   728   424 

Run-off

1Restated, as explained on page 24.

 

Run-off includes assets classified as outside the Group’s risk appetite and the results and gains on sale relating to businesses disposed in 2013 and 2014.

  

2015

£m

  2014
£m		  2013
£m		 
Net interest income (88) (116) 138 
Other income 145  451  1,266 
Total income 57  335  1,404 
Operating expenses (164) (308) (726)
Impairment (8) (203) (1,389)
Underlying loss (115) (176) (711)

20152018 COMPARED WITH 20142017

 

The underlying loss of £115profit in Central items was £21 million, was £61 millionor 3 per cent, lower than the loss of £176at £707 million in 2014 as2018 compared to £728 million in 2017.

Net income was £52 million, or 7 per cent, higher at £842 million in 2018 compared to £790 million in 2017; this includes an increased level of venture capital gains in Lloyds Development Capital and gains on sales of liquid assets, including gilts, of £270 million (2017: £274 million) and 2017 also included the gain on sale of the Group’s investment in Vocalink of £146 million.

Total costs were £86 million higher at £153 million in 2018 compared to £67 million in 2017 due mainly to a result£72 million increase in remediation charges.

There was an impairment release of both lower operating expenses and lower impairment charges as the run-off portfolios were managed down.£18 million in 2018 compared to £5 million in 2017.

2017 COMPARED WITH 2016

 

The reductionunderlying profit in total income from £335Central items was £304 million, or 72 per cent, higher at £728 million in 20142017 compared to £57£424 million in 2015 was due to the sale of Scottish Widows Investment Partnership during 2014 and the continued reduction in run-off assets.2016.

 

Operating costs were £164Total income increased by £287 million, down £144 million as a result of business disposals in 2014.

The reduction in the impairment chargeor 57 per cent, from £203£504 million in 20142016 to £8£791 million in 2015 reflects the continued progress in managing down the run-off portfolios.

2014 COMPARED WITH 2013

Underlying loss of £176 million was £535 million lower than the loss of £711 million in 20132017 largely as a result of the reductiongain of £146 million on the sale of the Group’s interest in impairment charges as the run-off portfolios were managed down.

Total income was £335 million, down £1,069 million or 76 per cent from £1,404 million in 2013 reflecting the disposal of businesses during 2013Vocalink and the reduction in run-off assets. 2013 included £662gains on sales of liquid assets, including gilts, of £ 274 million of income relating to St James’s Place which was sold in the year.

Operating expenses were £308 million, £418 million or 58 per cent lower than 2013 as a result of business disposals during 2013.

TSB

TSB is a separately listed multi-channel retail banking business with branches in England, Wales and Scotland. It serves retail and small business customers; providing a full range of retail banking products.

As explained in note 55 to the financial statements, the Group sold its controlling interest in TSB in March 2015 and ceased to consolidate TSB’s results at that point.

  

2015

£m

  2014
£m		  2013
£m		 
Net interest income 192  786  615 
Other income 31  140  163 
Total income 223  926  778 
Operating expenses (86) (370) (563)
Impairment (19) (98) (109)
Underlying profit 118  458  106 

TSB results are shown on a Lloyds Banking Group reporting basis. The costs of TSB’s head office functions are excluded from underlying profit.

2015 COMPARED WITH 2014

Underlying profit was £340 million, or 74 per cent, lower at £118 million in 2015 compared to £458 million in 2014; this principally reflects the fact that TSB was only consolidated for three months in 2015, compared to a full year in 2014.

Total income was £703 million, or 76 per cent, lower at £223 million in 2015 compared to £926 million in 2014; operating expenses were £284 million, or 77 per cent, lower at £86 million in 2015 compared to £370 million in 2014; and the impairment charge was £79 million, or 81 per cent, lower at £19 million in 2015 compared to £98 million in 2014.

2014 COMPARED WITH 2013

Underlying profit was £458 million, up £352 million compared to £106 million in 2013 as a result of higher income and reduced costs.

Total income was £926 million, up £148 million or 19 per cent compared to £778 million in 2013 driven by improved net interest income. This was largely due to a reduction in funding costs following the creation of TSB as a separate stand alone bank.

Operating expenses were £370 million, down £193 million or 34 per cent compared to £563 million in 2013. This was largely explained by the change in the basis of cost allocation to TSB following the creation of TSB as a separate stand alone bank.

35

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

OTHER (continued)

Central items

Central Items includes income and expenses not recharged to the divisions. These largely comprise residual income from the Group’s processes to allocate funding and liquidity costs to the divisions and the charge for payments to the Group’s charitable foundations.

  

2015

£m

  2014
£m		  2013
£m		 
Total income 176  132  (133)
Operating expenses 19  (22) (49)
Impairment release (charge) 2  (2) (5)
Underlying profit (loss) 197  108  (187)

2015 COMPARED WITH 2014

Underlying profit was £197 million in 2015, £89 million higher than the £108 million profit in 2014.

Total income was £176 million, £44 million higher than 2014 as it included a full year benefit in net interest income from the exchange of the Enhanced Capital Notes in 2014.(2016: £112 million).

 

Operating costs were a credit of £19£23 million, compared with a charge of £22or 32 per cent, lower at £48 million in 2014 and represent the residual amount after allocations2017 compared to the divisions.£71 million in 2016.

 

There was a netsmall impairment release of impairment of £2 million compared with a charge of £2 million in 2014.

2014 COMPARED WITH 2013

Underlying profit was £108 million in 2014, £295 million higher than the £187 million loss in 2013.

Total income was £265 million higher at £132 million in 2014, compared to negative income of £133 million in 2013 mainly as a result of the favourable impact on net interest income of the exchange of approximately £5 billion of the Group’s Enhanced Capital Notes for Additional Tier 1 securities and structural interest rate hedging activities.

Operating expenses were £27 million, or 55 per cent, lower at £22 million in 2014 compared to £49 million in 2013.

The impairment charge was £3 million, or 60 per cent, lower at £2 million in 2014 compared to £5 million in 2013.2017 (2016: £14 million).

3631

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

AVERAGE BALANCE SHEET AND NET INTEREST INCOME

 

 2015 2014 2013 2018 2017 2016
 Average
balance
£m		  Interest
income
£m		    Yield
%		  Average
balance
£m		  Interest income £m    Yield
%		  Average
balance
£m		  Interest
income
£m		    Yield
%		  Average
balance
£m		 Interest
income
£m		 Yield
%		  Average
balance
£m		 Interest
income
£m		 Yield
%		 Average
balance
£m		 Interest
income
£m		 Yield
%		 
Assets                                                               
Loans and receivables:                           
Financial assets at amortised cost:                                    
Loans and advances to banks 94,543  397  0.42  78,762  406  0.52  102,190  457  0.45   67,609   565   0.84   67,049   271   0.40   82,409   381   0.46 
Loans and advances to customers 464,012  16,256  3.50  504,246  17,806  3.53  518,734  19,928  3.84   476,149   15,078   3.17   464,944   14,712   3.16   457,622   15,190   3.32 
Debt securities 2,139  40  1.87  1,633  42  2.57  2,102  32  1.52   4,129   66   1.60   3,332   43   1.29   3,797   56   1.47 
Held-to-maturity investments              –   –   –   16,003   231   1.44 
Financial assets at fair value through other comprehensive income  32,334   640   1.98                         
Available-for-sale financial assets 40,967  725  1.77  50,269  957  1.90  38,767  746  1.92               50,049   980   1.96   40,604   762   1.88 
Held-to-maturity investments 13,256  197  1.49  –  –  –  –  –  – 
Total interest-earning assets of banking book 614,917  17,615  2.86  634,910  19,211  3.03  661,793  21,163  3.20   580,221   16,349   2.82   585,374   16,006   2.73   600,435   16,620   2.77 
Total interest-earning trading securities and other financial assets at fair value through profit or loss 87,583  1,955  2.23  82,018  1,993  2.43  68,763  2,076  3.02 
Total interest-earning financial assets at fair value through profit or loss  83,887   1,758   2.10   79,754   1,772   2.22   81,961   1,594   1.94 
Total interest-earning assets 702,500  19,570  2.79  716,928  21,204  2.96  730,556  23,239  3.18   664,108   18,107   2.73   665,128   17,778   2.67   682,396   18,214   2.67 
Allowance for impairment losses on loans and receivables (4,729)       (10,051)       (14,381)      
Allowance for impairment losses on financial assets held at amortised cost  (3,074)          (2,161)          (2,536)        
Non-interest earning assets 145,224        158,584        175,228         157,026           155,853           148,965         
Total average assets and interest income 842,995  19,570  2.32  865,461  21,204  2.45  891,403  23,239  2.61   818,060   18,107   2.21   818,820   17,778   2.17   828,825   18,214   2.20 
                                                            
 2015 2014 2013 2018 2017 2016
 Average
interest
earning
assets
£m		  Net
interest
income
£m		  Net
interest
margin
%		  Average
interest
earning
assets
£m		  Net
interest
income
 £m		  Net
interest
margin
%		  Average
interest
earning
assets
£m		  Net
interest
income
£m		  Net
interest
margin
%		   Average
interest
earning
assets
£m		   Net
interest
income
£m		   Net
interest
margin
%		   Average
interest
earning
assets
£m		   Net
interest
income
£m		   Net
interest
margin
%		   Average
interest
earning
assets
£m		   Net
interest
income
£m		   Net
interest
margin
%		 
Average interest-earning assets and net interest income:                                             
Banking business 614,917  11,318  1.84  634,910  10,660  1.68  661,793  7,338  1.11   580,221   13,396   2.31   585,374   10,912   1.86   600,435   9,274   1.54 
Trading securities and other financial assets at fair value through profit or loss 87,583  1,205  1.38  82,018  1,464  1.78  68,763  1,757  2.56   83,887   1,191   1.42   79,754   1,294   1.62   81,961   1,060   1.29 
 702,500  12,523  1.78  716,928  12,124  1.69  730,556  9,095  1.24   664,108   14,587   2.20   665,128   12,206   1.84   682,396   10,334   1.51 
3732

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

 2015 2014 2013 2018 2017 2016
 Average
balance
£m		  Interest
expense
£m		    Cost
%		  Average
balance
£m		  Interest
expense
£m		    Cost
%		  Average
balance
£m		  Interest
expense
£m		  Cost
 %		  Average
balance
£m		 Interest
expense
£m		 Cost
%		  Average
balance
£m		 Interest
expense
£m		 Cost
%		 Average
balance
£m		 Interest
expense
£m		 Cost
%		 
Liabilities and shareholders’ funds                                                               
Deposits by banks 10,442  43  0.41  11,604  86  0.74  19,845  129  0.65   8,405   117   1.39   6,758   80   1.18   10,540   68   0.65 
Customer deposits 380,137  3,299  0.87  416,651  4,781  1.15  397,881  6,119  1.54   342,970   1,813   0.53   348,683   1,722   0.49   366,178   2,520   0.69 
Liabilities to banks and customers under sale and repurchase agreements 5,960  34  0.57  2,104  55  2.61  6,515  79  1.21   25,634   245   0.96   18,943   110   0.58   8,342   38   0.46 
Debt securities in issue 85,462  586  0.69  88,289  552  0.63  111,264  1,451  1.30 
Debt securities in issue1  86,099   234   0.27   72,762   266   0.37   85,030   799   0.94 
Amounts payable to unitholders in consolidated open-ended investment vehicles 21,059  244  1.16  18,620  602  3.23  25,585  3,091  12.08   13,915   (844)  (6.07)  15,675   1,435   9.15   18,961   2,057   10.85 
Subordinated liabilities 24,975  2,091  8.37  29,332  2,475  8.44  34,486  2,956  8.57   18,193   1,388   7.63   18,674   1,481   7.93   22,330   1,864   8.35 
Total interest-bearing liabilities of banking book 528,035  6,297  1.19  566,600  8,551  1.51  595,576  13,825  2.32   495,216   2,953   0.60   481,495   5,094   1.06   511,381   7,346   1.44 
Total interest-bearing liabilities of trading book 61,560  750  1.22  54,980  529  0.96  37,760  319  0.84   44,101   567   1.29   55,288   478   0.86   50,700   534   1.05 
Total interest-bearing liabilities 589,595  7,047  1.20  621,580  9,080  1.46  633,336  14,144  2.23   539,317   3,520   0.65   536,783   5,572   1.04   562,081   7,880   1.40 
Interest-free liabilities                                                               
Non-interest bearing customer accounts 45,294        42,049        35,994         72,913           66,276           54,379         
Other interest-free liabilities 158,852        157,824        178,836         157,072           166,403           163,688         
Non-controlling interests and shareholders’ funds 49,254        44,008        43,237         48,758           49,358           48,677         
Total average liabilities and interest expense 842,995  7,047  0.84  865,461  9,080  1.05  891,403  14,144  1.59   818,060   3,520   0.43   818,820   5,572   0.68   828,825   7,880   0.95 

1The impact of the Group’s hedging arrangements is included on this line; excluding this impact the weighted average effective interest rate in respect of debt securities in issue would be 2.68 per cent (2017: 2.43 per cent; 2016: 2.70 per cent).

 

Loans and advances to banks and customers include impaired lending; interest on this lending has been recognised using the effective interest rate method, as required by IAS 39.

 

Following the reduction in the Group’s non-UK activities, an analysis between domestic and foreign operations is not provided.

3833

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

CHANGES IN NET INTEREST INCOME – VOLUME AND RATE ANALYSIS

 

The following table allocates changes in net interest income between volume and rate for 20152018 compared with 20142017 and for 20142017 compared with 2013.2016. Where variances have arisen from both changes in volume and rate these are allocated to volume.

 

  2015 compared with 2014
Increase/(decrease)		 2014 compared with 2013
Increase/(decrease)
  Total change
 £m		  Volume
 £m		  Rate
£m		  Total change
 £m		  Volume
£m		  Rate
£m		 
Interest receivable and similar income                  
Loans and receivables:                  
Loans and advances to banks (9) 66  (75) (51) (122) 71 
Loans and advances to customers (1,550) (1,408) (142) (2,122) (511) (1,611)
Debt securities (2) 9  (11) 10  (12) 22 
Available-for-sale financial assets (232) (165) (67) 211  219  (8)
Held-to-maturity investments 197  –  197  –  –  – 
Total banking book interest receivable and similar income (1,596) (1,498) (98) (1,952) (426) (1,526)
Total interest receivable and similar income on trading securities and other financial assets at fair value through profit or loss (38) 124  (162) (83) 322  (405)
Total interest receivable and similar income (1,634) (1,374) (260) (2,035) (104) (1,931)
Interest payable                  
Deposits by banks (43) (5) (38) (43) (61) 18 
Customer deposits (1,481) (318) (1,163) (1,338) 216  (1,554)
Liabilities to banks and customers under sale and repurchase agreements (21) 22  (43) (24) (115) 91 
Debt securities in issue 34  (20) 54  (899) (145) (754)
Amounts payable to unitholders in consolidated open-ended investment vehicles (358) 28  (386) (2,489) (225) (2,264)
Subordinated liabilities (384) (365) (19) (481) (435) (46)
Total banking book interest payable (2,253) (653) (1,600) (5,274) (753) (4,521)
Total interest payable on trading and other liabilities at fair value through profit or loss 221  80  141  210  165  45 
Total interest payable (2,032) (573) (1,459) (5,064) (588) (4,476)

  2018 compared with 2017
Increase/(decrease)		 2017 compared with 2016
Increase/(decrease)
  Total change
£m		  Volume
£m		  Rate
£m		  Total change
£m		  Volume
£m		  Rate
£m		 
Interest receivable and similar income                        
At amortised cost:                        
Loans and advances to banks  294   5   289   (110)  (61)  (49)
Loans and advances to customers  366   355   11   (478)  231   (709)
Debt securities  23   13   10   (13)  (6)  (7)
Held-to-maturity investments              (231)  (231)  – 
Financial assets at fair value through other comprehensive income (2017 and 2016: available-for-sale financial assets)  (340)  (351)  11   218   185   33 
Total banking book interest receivable and similar income  343   22   321   (614)  118   (732)
Total interest receivable and similar income on financial assets at fair value through profit or loss  (14)  87   (101)  178   (49)  227 
Total interest receivable and similar income  329   109   220   (436)  69   (505)
Interest payable                        
Deposits by banks  37   23   14   12   (45)  57 
Customer deposits  91   (30)  121   (798)  (86)  (712)
Liabilities to banks and customers under sale and repurchase agreements  135   64   71   72   60   12 
Debt securities in issue  (32)  36   (68)  (533)  (45)  (488)
Amounts payable to unitholders in consolidated open-ended investment vehicles  (2,279)  107   (2,386)  (622)  (301)  (321)
Subordinated liabilities  (93)  (37)  (56)  (383)  (290)  (93)
Total banking book interest payable  (2,141)  163   (2,304)  (2,252)  (707)  (1,545)
Total interest payable on trading and other liabilities at fair value through profit or loss  89   (144)  233   (56)  39   (95)
Total interest payable  (2,052)  19   (2,071)  (2,308)  (668)  (1,640)
3934

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

RISK OVERVIEW

 

EFFECTIVE RISK MANAGEMENT GOVERNANCE AND CONTROL

 

How we manage risk is a fundamental part of our strategy. We operate as a simple, low risk, UK focused, retail and commercial bank with a culture founded on a prudent through the cycle appetite for risk.

Our approach to risk is founded on an effective control framework and a strong risk management culture which guides how our employees approach their work, the way they behave and the decisions they make. Risk appetite, defined as the amount and type of risk that we are prepared to seek, accept or tolerate, works

THE GROUP’S APPROACH TO RISK

As a Group, managing risk effectively is fundamental to the Group’s strategy and future success. The Group is a simple, low risk, UK-focused financial services provider with a culture founded on strong risk management and a prudent through the cycle risk appetite. These are at the heart of everything the Group does, and ensure constructive challenge takes place across the business and underpins sustainable growth.

The Group’s approach to risk is founded on an effective control framework, which guides how the Group’s colleagues work, behave and the decisions they make. As part of this framework, risk appetite – the amount and type of risk that the Group is prepared to seek, accept or tolerate in delivering Group Strategy – is embedded in tandem with our strategy and is approved by the Board. Our risk appetite is then embedded within policies, authorities and limits across the Group.

 

The Group’s prudent risk culture and appetite, along with close collaboration between Risk division and the business, supports decision-making and has enabled the Group to continue to deliver against its strategic priorities in 2018.

The Group’s approach to risk plays a key role in its strategy of becoming the best bank for customers, colleagues and shareholders.

RISK AS A STRATEGIC DIFFERENTIATOR

Group strategy and risk appetite are developed together to ensure one informs the other and creates a strategy that delivers on becoming the best bank for our customers whilst helping Britain prosper and creating sustainable growth over time.

 

Risks are identified, managed and mitigated using ourthe Group’s comprehensive Risk Management Framework, (see page 41).and the Group’s well-articulated risk appetite provides a clear framework for decision-making. The principal risks we face,the Group faces, which could significantly impact the delivery of ourGroup strategy, are discussed on pages 4237 to 45.40.

 

We believeThe Group believes effective risk management can be a strategic differentiator, in particular:

 

Sustainable growth

Embedding a risk culture that ensures proactive support and constructive challenge takes place across the business in order to deliver sustainable growth.

Prudent approach to risk

Implementing a prudent approachBeing low risk is fundamental to the Group’s business model and drives its participation choices. Strategy and risk appetite acrossare developed in tandem and together outline the parameters within which the Group aligned to the embedding of a strong risk culture, driven both from the top and across the wider business, ensures we operate within risk appetite.operates.

 

Strong control framework

The Group’s Risk Management Framework (RMF) acts asis the foundation for the delivery of effective risk control and ensures that the Group risk appetite is adhered to.continually developed and controlled.

The Board is responsible for approving the Group’s risk appetite statement at least annually. Group Board-level metrics are cascaded into more detailed business appetite metrics and limits.

Business focus and accountability

Risk management is an integral feature of how the Group measures and manages performance – for individuals, businesses and the Group. In the first line of defence, business units are accountable for managing risk with oversight from a strong and independent second line of defence Risk division.

 

Effective risk analysis, management and reporting

CloseRegular close monitoring and stringentcomprehensive reporting to all levels of management and the Board ensures appetite limits are maintained and are subject to stressed analysis at a risk type and portfolio level.level, as appropriate.

 

Business focus and accountability

Effective risk management is a key focus and is included in key performance measures against which individual business units are assessed. The business areas in the first line are accountable for risk but with oversight from a strong and importantly, independent, Second Line Risk Division.

ACHIEVEMENTS IN 2015

We have continued our strategic journey and created a foundation to deliver our objectives, through reacting to changing customer behaviour, maintaining our strong capital position and increasing dividend payments, whilst continuing to adapt to the ever changing regulatory environment. Close and collaborative working across the Group within risk culture and appetite has supported key risk-related deliverables in the year. These included:

Conduct

Deploying a consistent and relentless approach under the Group conduct strategy to ensure we deliver customer needs with an open and transparent culture.

Credit rating

In recognition of the delivery of the Group’s strategy, the three main credit rating agencies have either reaffirmed or upgraded our credit rating in the year.

State aid commitments

We have satisfied all material structural and behavioural commitments following the successful carve-out and disposal of TSB with respect to the State Aid commitments agreed with the European Commission under the State Aid regime in 2009. We are therefore no longer subject to restrictive behavioural commitments including the constraint on acquisitions, but continue to be bound by two remaining limited ancillary commitments which means that we remain subject to supervision by the European Commission with respect to these commitments until they cease to have effect on or before June 2017. Our strong risk management has assisted in the government’s continued sell-down of shares to a holding which is approximately 9 per cent.

Capital strength

We have maintained our strong capital position through a combination of increased underlying profit and lower risk-weighted assets, partially offset by PPI and other conduct charges, which enabled the Group to pay both an interim dividend at half year and to recommend the payment of both a full year ordinary dividend and a special dividend whilst maintaining strong capital ratios. In 2015 the Group participated in the UK-wide concurrent stress testing run by the Bank of England, comfortably exceeding both the capital and leverage minimum thresholds set.

Impairments

Through effective risk management our impairment charge has fallen to £568 million, while the impairment ratio fell to 0.14 per cent. Reduction in run-off assets and the sustained improvement in asset quality across the Group reflects our robust risk management framework which is ingrained across the entire business, as detailed on page 41.

40

THE GROUP’S RISK MANAGEMENT FRAMEWORK

The diagram below outlines the framework in place for risk management across the Group.

Accountability for ensuring risk is managed consistently within the Risk Management Framework approved by the Board Confirmation of the effectiveness of the Risk Management Framework and underlying risk and control Setting risk appetite and strategy. Approval of the Risk Management Framework and Group-wide risk principles Review risk appetite, frameworks and principles to be recommended to the Board. Be exemplars of risk management Determined by the Board and senior management. Business units formulate their strategy in line with the Group’s risk appetite Supporting a consistent approach to Group-wide behaviour and risk decision-making. Consistency is delivered through the policy framework and risk committee structures Monitoring, oversight and assurance ensure effective risk management across the Group Defined processes exist to identify, measure and control the Group’s current and emerging risks In line with the Group’s code of responsibility. Culture ensures performance, risk and reward are aligned Risk-specific needs defined in detail for implementation by each business Board authorities Through Board-delegated executive authorities there is effective oversight of risk management consistent with risk appetite The risk appetite framework ensures the Group’s risks are managed in line with the Group’s risk appetite Supports a consistent approach to enterprise-wide behaviour and decision-making Maintains a robust control framework, identifying and escalating emerging risks and supporting sustainable growth Carried out by all three lines of defence and is an integral part of the Group’s control effectiveness assessment Processes and infrastructure are being invested in to further improve the Group’s risk management capabilities Risk type specific sub-frameworks e.g. credit risk Board role Senior management role Risk appetite Governance framework Three lines of defence Risk and control cycle from identification to reporting Risk culture Risk resources and capabilities Primary risk categories

35

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

RISK GOVERNANCE2018 THEMES

 

The Board approves the Group’s overall RMF and setspriorities for risk appetite, both of which are designedmanagement have continued to ensure that we manage our risks in the right way to achieve our agreed strategic objectives. It has a dedicated risk committee of non-executive directors who keep the design and performanceevolve, alongside progression of the Group’s RMF under closestrategy and regular scrutiny, and interact closely with the executive risk management committee operating at Group Executive Committee level. The Board and senior management encourage a culturedevelopment of transparency and openness to ensure that issues are escalated promptly to them where required.external factors.

 

The Board approved RMFGroup’s principal risks are outlined over the next few pages but a number of themes have been particularly prevalent in 2018.

EU exit

Given the vast majority of its business is in the UK, the direct impact on its from leaving the EU is relatively small and risk appetite are put into effect using an enterprise-wide framework which appliesthe Group is well prepared to every areaensure continuity of its limited EU business activities.

Given the Group’s UK focus, its performance is inextricably linked to the health of the businessUK economy. Economic performance has remained resilient in recent years and covers all types of risk. The framework is designed to ensure we follow a consistent approach to risk management and reporting throughoutwhilst the near-term outlook for the UK economy remains unclear given the ongoing EU withdrawal negotiations, the Group so that all risks are fully understood and managedhas contingency plans in relation to our agreed risk appetite. It includes our policies, procedures, controls and reporting.

A high level structure is shown in the diagram below.place.

 

The framework is periodically reviewed, updatedGroup has also taken a prudent approach to its balance sheet, increasing the amount of liquidity held and approvedpre-funding some issuance.

Irrespective of the outcome, the Group’s customer focused strategy remains the right one. The Group will continue to support its personal and business customers and has already announced that it will lend up to £18 billion to UK businesses in 2019, reaffirming the Group’s support for the UK economy.

Guided by the Boardoverriding principle of Helping Britain Prosper, the Group will seek to reflect any changes in

minimise the nature of our business and external regulations, law, corporate governance and industry best practice. This helps usimpact on its customers. The Group has also been working hard to ensure we continueit is well prepared to meet our responsibilities to ourprovide customers shareholderswith effective and regulators. Our risk appetite and the policy framework define clear parameters within which our business units must operate in order to deliver the best outcome for customers and stakeholders.timely support.

 

Data

The Board delegates authorities for risk managementGroup is trusted with large volumes of data, which must be protected, whilst providing customers with ease of access through the Group Chief Executive and the management hierarchy to individuals, an approach which is consistent with the focus of the Senior Managers and Certification Regime (SM&CR) on the principle of individual accountability. At a senior level, executives are supported in their decision-making by a committee-based governance structure. The concept of individual accountability for risk management is embedded in the RMF and culture at every level, and guides the way all employees approach their work, behave and make decisions. An important element of the frameworkGroup’s multi-channel model. Data is the maintenance of strong internal controls which are ownedGroup’s most valuable asset and operated by individual business areas.so the Group must ensure that the information it holds is accurate, secure and managed appropriately. The Group’s risk governance arrangements will support the effective implementation ofGroup meets the requirements of the SM&CR which comesGeneral Data Protection Regulation (GDPR) that came into force in 2016.May 2018. The Group has taken this opportunity to implement new governance structures and demonstrate increased levels of accountability and transparency, as establishing trust is critical to the Group’s vision of being the best bank for customers. The Group has created a Group Data Protection Office (GDPO) to independently oversee compliance, reporting on this to Group and Board Risk Committees.

 

41

OPERATING AND FINANCIAL REVIEW AND PROSPECTSThe Group drives a culture of compliance through its Data Privacy policy and control framework and has implemented robust governance to oversee compliance with GDPR, as well as enhanced staff training. During 2019 the Group will continue to drive enhancements to the maturity of its data control environment.

 

THE MOST SIGNIFICANT RISKS WE FACE WHICH COULD IMPACT THE DELIVERY OF OUR STRATEGY, TOGETHER WITH KEY MITIGATING ACTIONS, ARE OUTLINED BELOW.Cyber

Cyber threats are increasingly complex and like all financial services providers, attempts

are made on a regular basis to attack the Group’s systems and services, and to steal customer and bank data. Given the significant threat the Group continues to strengthen the resilience of its IT systems and invest in its cyber control framework.

The Group is simplifying and modernising its IT architecture, alongside deploying technologies such as cloud computing which offer greater levels of resilience, capacity management and speed of processing. The Group is a member of the UK’s Cyber Defence Alliance, where a number of UK-based banks and law enforcement agencies collaborate in the fight against cyber-attacks, sharing expertise, intelligence and knowledge. Within Lloyds Banking Group, the Chief Security Office engenders a culture whereby colleagues are considered to be the Group’s first line of defence. Vigilance and training are key to preventing cyber-attacks.

Sustainability

The Group has been developing its sustainability strategy, to address more broadly the opportunities and threats related to climate change, and the need for the UK to transition to a sustainable, lower carbon economy. This is in line with the Group’s commitment to implement the Task Force for Climate-related Financial Disclosures’ recommendations. For risk management, addressing the potential impacts of climate change plays a key role in the Group’s approach to sustainability, and this year the Group has identified climate change as a top emerging risk.

RISK MANAGEMENT – ENHANCING THE CUSTOMER EXPERIENCE

The Group recognises that the primary role of risk management is to protect the Group’s customers, colleagues and the Group, whilst enabling sustainable growth. Risk management is able to fulfil this purpose whilst also supporting the Group’s strategic priorities and delivering better outcomes for customers. Here are some of the ways Risk Division has contributed to the Group’s strategic priorities and enhancing the customer experience this year.

Credit riskOperational risk

LEADING CUSTOMER EXPERIENCE

The Group is committed to adapting to changing customer expectations. With increasing competition and digital propositions in the market, customers expect great service and a frictionless experience.

 

This year weRisk division increased the use of automated property valuations for the mortgage application process through Halifax, reducing the time it takes for the Group to offer customers a mortgage to buy a property by an average of one week. By speeding up this part of the process and removing an extra step, customers have added two new principal risks:more time to focus on what matters most during life-changing events such as buying a home.

 

–Insurance risk, reflecting that we are increasing our exposure to longevity risk, following our entry into the bulk annuity market in 2015; and

MAXIMISING THE GROUP’S CAPABILITIES

–Governance risk, given increasing societal and regulatory focus on governance arrangements.

 

AllThe Group remains committed to supporting its customers and their businesses across the country.

Within Commercial Banking, teams look specifically at how industry risks impact success, and tailor advice and lending based on the dynamics of a segment or sector. One such example is in the Group’s SME dairy sector which has experienced significant pressures due to falling milk prices. The Group’s relationship managers and risk teams have been working together to understand each client’s farm and its changing needs so the potentialGroup can provide the best support possible. This may be through extending working capital or restructuring facilities, in order to impact our strategic prioritiesdrive better outcomes for the businesses the Group serves.

DIGITISING THE GROUP

Deploying new technology to make banking simpler and safer for customers is a key priority for the Group.

The Group has already implemented a number of significant enhancements across various products and services. For example, from a risk perspective the Group has changed how it authenticates suspicious transactions across personal debit and credit cards. Rather than decline the payment and request that the customer contact the Group, the Group sends a text with a unique code which enables the customer to quickly and easily verify that the transaction is genuine. This has helped to protect the Group’s customers and made the experience simpler by communicating in a method convenient to them.

TRANSFORMING WAYS OF WORKING

The Group’s nationwide Fraud analytics and insight team looks after the systems which detect fraud for the Group.

The team has embraced agile working due to the nature of its role: at short notice they might be called upon to respond to a new fraud attack, which can require working long hours or into the night. The team also supports a large number of the Group’s change programmes, often working outside regular hours. To meet the needs of the colleague, the team and the summary below illustrates the most predominant strategic priority impacted by the principal risks and uncertainties detailed.Group, working patterns are agreed on an individual basis.

 

PRINCIPAL RISKSKEY MITIGATING ACTIONS

Credit risk

The risk that customers to whom we have lent money or other counterparties with whom we have contracted, fail to meet their financial obligations, resulting in loss to the Group.

Adverse changes in the economic and market environment we operate in or the credit quality and/or behaviour of our customers and counterparties could reduce the value of our assets and potentially increase our write downs and allowances for impairment losses, adversely impacting profitability.

Example:

– Whilst we have a deep understanding of credit risks across our commercial, mortgage and other portfolios; a changing economic environment, e.g. interest rate rises, can impact on customer affordability and therefore our performance.

– Credit policy, incorporating prudent lending criteria, aligned with Board approved risk appetite, to effectively manage risk.

– Robust risk assessment and credit sanctioning, with clearly defined levels of authority to ensure we lend appropriately and responsibly.

– Extensive and thorough credit processes and controls to ensure effective risk identification, management and oversight.

– Effective, well-established governance process supported by independent credit risk assurance.

– Early identification of signs of stress leading to prompt action in engaging the customer.

There has been a strong reduction in fraud losses over the last five years; while some of this is due to investment in systems, the Group places great reliance on having well trained, engaged and motivated teams.

 

Regulatory and legal risk

The risks of changing legislation, regulation, policies, voluntary codes of practice and their interpretation in the markets in which we operate can have a significant impact on the Group’s operations, business prospects, structure, costs and/or capital requirements and ability to enforce contractual obligations.

Examples:

– Increased regulatory oversight and Prudential regulatory requirements.

– Increased legislative requirements, such as ring-fencing legislation.

– The Legal, Regulatory and Mandatory Change Committee ensures we develop plans for delivery of all legal and regulatory changes and tracks their progress. Groupwide projects implemented to address significant impacts.

– Continued investment in people, processes, training and IT to assess impact and help meet our legal and regulatory commitments.

– Engage with regulatory authorities and relevant industry bodies on forthcoming regulatory changes, market reviews and Competition and Markets Authority investigations.

Conduct risk

Conduct risk can arise from a number of areas including selling products to customers which do not meet their needs; failing to deal with customers’ complaints effectively; not meeting customers’ expectations; and exhibiting behaviours which do not meet market or regulatory standards.

Example:

– The most significant conduct cost in recent years has been PPI mis-selling.

– Customer focused conduct strategy implemented to ensure customers are at the heart of everything we do.

– Product approval, review processes and outcome testing supported by conduct management information.

– Clear customer accountabilities for colleagues, with rewards driven by customer-centric metrics.

– Learning from past mistakes through root cause analysis of crystallised issues.

Operational risk

We face significant operational risks which may result in financial loss, disruption or damage to our reputation. These include the availability, resilience and security of our core IT systems and the potential for failings in our customer processes.

Examples:

– A resilient IT environment is critical to providing reliable services to customers and enabling sustainable growth.

– The dynamic threat posed by cyber risk and the potential for external attacks on the integrity of electronic data or the availability of systems.

– Continual review of our IT environment to ensure that systems and processes can effectively support the delivery of services to customers.

– Addressing the observations and associated resilience risks raised in the Independent IT Resilience Review (2013), with independent verification of progress on an annual basis.

– Investing in enhanced cyber controls to protect against external threats to the confidentiality or integrity of electronic data, or the availability of systems. Responding to findings from third party industry testing.

People risk

Key people risks include the risk that we fail to lead responsibly in an increasing competitive marketplace, particularly with the introduction of the SM&CR in 2016. This may dissuade capable individuals from taking up senior positions within the industry.

Example:

– Lack of colleague capacity and capability could impact the achievement of business objectives. Additional colleague stretch (including increased dependency on key staff) could result in a loss of expertise.

– Focused action on strategy to attract, retain and develop high calibre people.

– Maintain compliance with legal and regulatory requirements relating to the SM&CR, embedding compliant and appropriate colleague behaviours.

– Continued focus on our culture, delivering initiatives which reinforce behaviours to generate the best long-term outcomes for customers and colleagues.

– Maintain organisational people capability and capacity levels in response to increasing volumes of organisational and external market changes.

42
36

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

KEY RISK INDICATORSALIGNMENT TO STRATEGIC PRIORITIES AND FUTURE FOCUS

THE GROUP’S PRINCIPAL RISKS

The most significant risks which could impact the delivery of the Group’s long-term strategic objectives and the Group’s approach to each risk are detailed below.

There remains continued uncertainty around both the UK and global political and macroeconomic environment. The potential impacts of external factors have been considered in all principal risks to ensure any material uncertainties continue to be monitored and are appropriately mitigated.

As part of the Group’s ongoing assessment of the potential implications of the UK leaving the European Union, the Group continues to consider the impact to its customers, colleagues and products – as well as legal, regulatory, tax, financial and capital implications.

Principal risks and uncertainties are reviewed and reported regularly. As part of a review of the Group’s risk categories, the secondary risk categories of Change, Data management and Operational resilience have been elevated to primary risk categories, and Strategic risk has been included as a new primary risk category, in the Group’s Risk Management Framework. These changes will be embedded during 2019 and reflected within the Group’s principal risks.

CREDIT
Impairment charge

Delivering sustainable growth
We have a UK customer focused, low risk, conservative and well balanced credit portfolio, managed through the economic cycle and supported by strong credit portfolio management.

Credit risk decisions are consistent, fair and responsible, taking account of customers’ circumstances.
Impaired assets

We support sustainable growth and meet our targets in the Helping Britain Prosper Plan while staying within prudent risk appetite.

Impairments remain below long term levels and are expected to normalise over time. Emerging credit risks that have the potential to increase impairment include the global and UK economic environment as it can impact customer and counterparties’ affordability.

Legal, regulatory andmandatory investment spend

Delivering sustainable growth
We are committed to operating sustainably and responsibly, and commit significant resource and expense to ensure we meet our legal and regulatory obligations.

We respond as appropriate to impending legislation and regulation and associated consultations and participate in industry bodies. We continue to be subject to significant ongoing and new legislation, regulation and court proceedings, with numerous developments in each of these areas.

FCA reportable complaintsper 1,000 accounts (excl. PPI)1

Creating the best customer experience
As we transform and simplify our business, minimising conduct risk is critical to achieving our strategic goals and meeting market and regulatory standards. Our customer focused conduct strategy forms the foundation of our vision to be the best bank for customers, allowing us to create the best customer experience through learning from past mistakes.
1 This key risk indicator is also a key performance indicator (KPI).
Availability of core systems

Creating the best customer experience
We recognise the role that resilient technology plays in enabling us to create the best customer experience, and in maintaining banking services and trust across the wider industry. As such, the availability, resilience and security of our IT systems remains a key focus.

Our Cyber Programme continues to focus on improving the Groupwide cyber security controls and we regularly assess our cyber control environment, through both internal and third party testing.

 

Best bank for customers index

Creating the best customer experience
We continue to focus on developing colleagues, their capabilities and skills in order to create the best customer experience and to respond quickly to the rapidly evolving change in customers’ decision making.

The current regulatory regime presents some far reaching people implications in terms of personal accountability and remuneration arrangements. This coincides with the ongoing challenge of maintaining colleague capacity and capability to deliver our change agenda.

 

 
The risk that parties with whom the Group has contracted, fail to meet their financial obligations (both on and off balance sheet).

Example

Observed or anticipated changes in the economic environment could impact profitability due to an increase in delinquency, defaults, write-downs and/or expected credit losses

Key mitigating actions

Credit policy, incorporating prudent lending criteria, aligned with Board-approved risk appetite, to effectively manage risk

Robust risk assessment and credit sanctioning to ensure the Group lends appropriately and responsibly

Extensive and thorough credit processes and controls to ensure effective risk identification, management and oversight

During the year the Group strengthened affordability buffers and improved controls to restrict lending to consumers with higher risk of over-indebtedness

Effective, well-established governance process supported by independent credit risk oversight and assurance

Early identification of signs of stress leading to prompt engagement with the customer

Key risk indicators

£937m£5,741m
Impairment charge
2017: £795m		Stage 3 assets
1 Jan 2018: £5,140m

Alignment to strategic priorities and future focus

Maximising the Group’s capabilities

The Group seeks to support sustainable growth in its targeted segments. The Group has a conservative and well-balanced credit portfolio, managed through the economic cycle and supported by strong credit portfolio management.

The Group is committed to better addressing its customers’ banking needs through consistent, fair and responsible credit risk decisions, aligned to customers’ circumstances, whilst staying within prudent risk appetite.

Impairments remain below long-term levels and are expected to increase as the level of write-backs and releases reduces and impairments normalise.

43
REGULATORY AND LEGAL
The risk that the Group is exposed to financial loss, fines, censure, or legal or enforcement action; or to civil or criminal proceedings in the courts (or equivalent) and/or the Group is unable to enforce its rights due to failing to comply with applicable laws (including codes of practice which could have legal implications), regulations, codes of conduct or legal obligations, or a failure to adequately manage actual or threatened litigation, including criminal proceedings.

Example

Failure to deliver key regulatory changes or to comply with ongoing requirements

Key mitigating actions

Implementation of compliance and legal risk management policies and procedures to ensure appropriate controls and processes are in place to comply with legislation, rules and regulation

Embedding Group-wide processes to monitor ongoing compliance with new legislation, rules and regulation

Continued investment in people, processes, training and IT to help meet the Group’s legal and regulatory commitments

Ongoing engagement with regulatory authorities and industry bodies on forthcoming regulatory changes, market reviews and investigations, ensuring programmes are established to deliver new regulation and legislation

Ongoing horizon scanning to identify changes in regulatory and legal requirements

Key risk indicators

£993m

Mandatory, legal and regulatory investment spend 2017: £886m

Alignment to strategic priorities and future focus

Delivering a leading customer experience

The Group is committed to operating sustainably and responsibly, and commits significant resource and expense to ensure it meets its legal and regulatory obligations.

The Group responds as appropriate to impending legislation, regulation and associated consultations and participates in industry bodies. The Group continues to be proactive in responding to significant ongoing and new legislation, regulation and court proceedings.


37

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

PRINCIPAL RISKSKEY MITIGATING ACTIONS
CONDUCT
The risk of customer detriment due to poor design, distribution and execution of products and services or other activities which could undermine the integrity of the market or distort competition leading to unfair customer outcomes, regulatory censure and financial and reputational loss.

Insurance risk

Key insurance risks within the Insurance business are longevity, persistency and property insurance. Longevity risk is expected to increase with the 2015 entry into the bulk annuity market. Longevity is also the key insurance risk in the Group’s Defined Benefit Pension Schemes.

Examples:
Increases in life expectancy (longevity) beyond current assumptions will increase the cost of annuities and pension scheme benefits.

Example

The most significant conduct cost in recent years has been PPI mis-selling

Key mitigating actions

Conduct policies and procedures are in place to ensure appropriate controls and processes that deliver fair customer outcomes

Conduct risk appetite metrics provide a granular view of how the Group’s products and services are performing for customers through the customer lifecycle

Product approval, continuous product review processes and customer outcome testing in place (across products and services)

Learning from past mistakes through root cause analysis

Clear customer accountabilities for colleagues, with rewards driven by customer-centric metrics

Further enhancements and embedding of the Group’s framework to support all customers, including those in vulnerable circumstances

Key risk indicators

92.5%

Conduct risk appetite metric performance-Group 2017: 92.3%

Alignment to strategic priorities and future focus

Delivering a leading customer experience

As the Group transforms its business, minimising conduct risk is critical to achieving the Group’s strategic goals and meeting regulatory standards.

The Group has senior committees that ensure the Group’s focus on embedding a customer-centric culture and delivering fair outcomes across the Group. Further enhancements to the Group’s conduct risk framework continue to support this through robust and effective management of conduct risk. Together these support the Group’s vision of being the best bank for customers, enabling the delivery of a leading customer experience through effective root cause analysis and learning from customer feedback.

OPERATIONAL
The Group faces significant operational risks which may disrupt services to customers, cause reputational damage, and result in financial loss. These include the availability, resilience and security of the Group’s core IT systems, unlawful or inappropriate use of customer data, theft of sensitive data, fraud and financial crime threats, and the potential for failings in the Group’s customer processes.

Example

The dynamic threat posed by cyber risk to the confidentiality and integrity of electronic data or the availability of systems

Key mitigating actions

Investing in enhanced cyber controls to protect against external threats to the confidentiality or integrity of electronic data, or the availability of systems, and to ensure effective third-party assurance

Enhancing the resilience of systems that support critical business processes with independent verification of progress on an annual basis

Significant investment in compliance with General Data Protection Regulation and Basel Committee on Banking Supervision standards

Working with industry bodies and law enforcement agencies to identify and combat fraud and money laundering

Key risk indicators

99.97%

Availability of core systems
2017: 99.98%

Alignment to strategic priorities and future focus

Delivering a leading customer experience

The Group recognises that resilient and secure technology, and appropriate use of data, is critical to delivering a leading customer experience and maintaining trust across the wider industry.

The availability and resilience of IT systems remains a key strategic priority and the Cyber programme continues to focus on enhancing cyber security controls. Internal programmes ensure that data is used correctly, and the control environment is regularly assessed through both internal and third-party testing.

PEOPLE
Key people risks include the risk that the Group fails to maintain organisational skills, capability, resilience and capacity levels in response to organisational, political and external market change and evolving business needs.

Example

Inability to attract or retain colleagues with key skills could impact the achievement of business objectives

Key mitigating actions

Focused action to attract, retain and develop high calibre people. Delivering initiatives to reinforce behaviours which generate the best outcomes for customers and colleagues

Managing organisational capability and capacity to ensure there are the right skills and resources to meet the Group’s customers’ needs

Effective remuneration arrangements to promote appropriate colleague behaviours and meet regulatory expectations

During 2018 the Group enhanced its colleague wellbeing strategies to ensure support is in place to meet colleague needs, and to help achieve the skills and capability growth required to build a workforce for the ‘Bank of the Future’

Key risk indicators

79%

Values and behaviours index1
2017: 80%

Alignment to strategic priorities and future focus

Transforming ways of working

Regulatory requirements relating to personal accountability and remuneration rules could affect the Group’s ability to attract and retain the calibre of colleagues required to meet changing customer needs. The Group recognises the challenges in delivering its strategic priorities and will continue to invest in the development of colleague capabilities and agile working practices. This investment will deliver a leading customer experience and allow the Group to respond quickly to customers’ rapidly changing decision-making in a digital era.

 

– Uncertain property insurance claims impact Insurance earnings and capital, e.g. extreme weather conditions, such as flooding, can result in high property damage claims.

– Insurance processes on underwriting, claims management, pricing and product design seek to control exposure to these risks. A team of longevity and bulk pricing experts has been built to support the new bulk annuity proposition.

– The merits of longevity risk transfer and hedging solutions are regularly reviewed for both the Insurance business and the Group’s Defined Benefit Pension Schemes.

– Property insurance exposure to accumulations of risk and possible catastrophes is mitigated by a broad reinsurance programme.

1Formerly known as Best bank for customers index.

Capital risk

The risk that we have a sub-optimal amount or quality of capital or that capital is inefficiently deployed across the Group.

Example:

– A worsening macroeconomic environment could lead to adverse financial performance, which could deplete capital resources and/or increase capital requirements due to a deterioration in customers’ creditworthiness.

– A comprehensive capital management framework that sets and monitors capital risk appetite using a number of key metrics.

– Close monitoring of capital and leverage ratios to ensure we meet current and future regulatory requirements.

– Comprehensive stress testing analysis to evidence sufficient levels of capital adequacy under various adverse scenarios.

– Accumulation of retained profits and managing dividend policy appropriately.

Funding and liquidity risk

The risk that we have insufficient financial resources to meet our commitments as they fall due, or can only secure them at excessive cost.

Example:

– Our funding and liquidity position is supported by a significant and stable customer deposit base. A deterioration in either the Group’s or the UK’s credit rating, or a sudden and significant withdrawal of customer deposits, would adversely impact our funding and liquidity position.

– Holding a large portfolio of unencumbered LCR eligible liquid assets to meet cash and collateral outflows and regulatory requirements and maintaining a further large pool of secondary assets that can be used to access central bank liquidity facilities.

– Undertaking daily monitoring against a number of market and Group-specific early warning indicators and regular stress tests.

– Maintaining a contingency funding plan detailing management actions and strategies available in stressed conditions.

Governance risk

Against a background of increased regulatory focus on governance and risk management, the most significant challenges arise from the SM&CR in force from March 2016 and the requirement to improve the resolvability of the Group and to ring-fence core UK financial services and activities from January 2019.

Example:

– Non-compliance with or breaches of ring-fencing, resolution and SM&CR requirements will result in legal and regulatory consequences.

– Our response to the SM&CR is managed through a programme with work streams addressing each of the major components.

– A programme is in place to address the requirements of ring-fencing and resolution and we are in close and regular contact with regulators to develop plans for our anticipated operating and legal structures.

– Our aim is to ensure that evolving risk and governance arrangements continue to be appropriate across the range of business in the Group in order to comply with regulatory objectives.

Market risk

The risk that our capital or earnings profile is affected by adverse market rates, in particular interest rates and credit spreads in the Banking business and equity and credit spreads in the Insurance business and the Group’s Defined Benefit Pension Schemes.

Examples:

– Earnings are impacted by our ability to forecast and model customer behaviour accurately and establish appropriate hedging strategies.

– The Insurance business is exposed indirectly to equity and credit markets through the value of future management charges on policyholder funds. Credit spread risk within the Insurance business primarily arises from bonds and loans used to back annuities. Credit spreads affect the value of the Group’s Defined Benefit Pension Schemes’ liabilities.

– Structural hedge programmes have been implemented to manage liability margins and margin compression, and the Group’s exposure to Bank Base Rate.

– Equity and credit spread risks are inherent within Insurance products and are closely monitored to ensure they remain within risk appetite. Where appropriate, asset liability matching is undertaken to mitigate risk.

– The allocation to credit assets has been increased and equity holdings reduced within the Group’s Defined Benefit Pension Schemes. A hedging programme is also in place to minimise exposure to nominal rates/inflation.

– Stress and scenario testing of Group risk exposures.

44


38

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

KEY RISK INDICATORS  ALIGNMENT TO STRATEGIC PRIORITIES AND FUTURE FOCUS

Insurance (Life and Pensions)
present value of new business premiums

 

Insurance (General Insurance)
gross written premiums

Creating the best customer experience
We are committed to meeting the changing needs of customers by working to provide a range of insurance products via multiple channels. The focus is on creating the best customer experience by helping customers protect themselves today whilst preparing for a secure financial future.

Strategic growth initiatives within Insurance are developed and managed in line with a defined risk appetite, aligned to the Group risk appetite and strategy.

Common equity tier 1 ratio1

Leverage ratio

1  This key risk indicator is also a key performance indicator (KPI).

2  Ratios are post interim and recommended full year dividends and adjusted, reflecting dividend paid by Insurance in February 2016 in respect of 2015 earnings.

Delivering sustainable growth
Ensuring we hold an appropriate level of capital to maintain financial resilience and marketconfidence, underpins our strategic objectives of supporting the UK economy and delivering sustainable growth.

Looking ahead, the Basel Committee is continuing to review aspects of the regulatory capital framework, and the Bank of England has consulted on its approach for setting minimum requirements for own funds and eligible liabilities. There is a risk that these could lead to higher capital requirements than we have anticipated in our strategic plans.

Regulatory liquidity

 

Loan to deposit ratio

3  Individual liquidity adequacy standards eligible primary liquid assets.

Delivering sustainable growth
We maintain a strong funding position in line with our low risk strategy. Our funding position has been significantly strengthened in recent years and our loan to deposit ratio remains within the target range.

Liquid assets are broadly equivalent to our total wholesale funding and thus provide a substantial buffer in the event of continued market dislocation.

There is a risk that our options to fund our balance sheet are reduced in future, or that the cost of funding may increase which could impact our performance versus our strategic plans.

 

N/ABecoming simpler and more efficient
Ring-fencing requirements ensure we become simpler and continue to create the best customer experience, through providing further protection to core Retail and SME deposits, provide transparency on our operations and facilitate the options available in resolution.

Resolution requirements are aimed at reducing the probability of failure and its impact on customers should we fail through continuity of critical banking services, helping rebuild trust in the financial services sector.

We already have a strong culture of ownership and accountability, and compliance with the SM&CR will enable us to further strengthen our ability to clearly demonstrate the responsibilities of Senior Managers and how these are discharged.

Pension surplus


Delivering sustainable growth
We manage our exposure to movements in market rates throughout the year, leading us to promote low volatility earnings and offer a comprehensive customer proposition with market risk hedging strategies to support strategic aims, including delivering sustainable growth.

Mitigating actions are implemented to reduce the impact of market movements, resulting in a stable capital position. This allows us to more efficiently utilise available capital resources to deliver sustainable growth.

By reducing the volatility in the Group’s Defined Benefit Pension Schemes through hedging in 2014, we have taken a conservative approach to risk in line with our strategy.

INSURANCE UNDERWRITING
 
Key insurance underwriting risks within the Insurance business are longevity, persistency and property insurance. Longevity risk is expected to increase as the Group’s presence in the bulk annuity market increases.

Example

Uncertain property insurance claims impact Insurance earnings and capital, e.g. extreme weather conditions, such as flooding, can result in high property damage claims

Key mitigating actions

Strategic decisions made consider the maintenance of the current well-diversified portfolio of insurance risks

Processes for underwriting, claims management, pricing and product design seek to control exposure. Experts in demographic risk (for example longevity) support the propositions

Reinsurance and other risk transfer arrangements are actively reviewed for their efficacy, including monitoring the strength of third-parties with whom the risk is shared

Key risk indicators

£14,384m£690m
Insurance (Life and Pensions
present value of new
business premiums)
2017: £9,951m		General Insurance
underwritten
total gross written
premiums
2017: £733m

Alignment to strategic priorities and future focus

Delivering a leading customer experience

The Group is committed to meeting the changing needs of customers by working to provide a range of insurance products via multiple channels. The focus is on delivering a leading customer experience by helping customers protect themselves today whilst preparing for a secure financial future.

Strategic growth initiatives within Insurance are developed and managed in line with a defined risk appetite, aligned to the Group risk appetite and strategy.

CAPITAL
The risk that the Group has a sub-optimal quantity or quality of capital or that capital is inefficiently deployed across the Group.

Example

A worsening macroeconomic environment could lead to adverse financial performance, which could deplete capital resources and/or increase capital requirements due to a deterioration in customers’ creditworthiness

Key mitigating actions

A comprehensive capital management framework that includes setting of capital risk appetite and dividend policy

Close monitoring of capital and leverage ratios to ensure the Group meets regulatory requirements and risk appetite

Comprehensive stress testing analyses to evidence capital adequacy

Key risk indicators

13.9% 5.6%
Common equity tier 1
ratio1,2
2017: 13.9%		 UK leverage ratio1
2017: 5.4%

Alignment to strategic priorities and future focus

Maximising the Group’s capabilities

Ensuring the Group holds an appropriate level of capital to maintain financial resilience and market confidence underpins the Group’s strategic objectives of supporting the UK economy, and growth in targeted segments through the cycle.

1Adjusted.
  
2CET1 ratio after ordinary dividends and share buyback.

45
FUNDING AND LIQUIDITY

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Funding risk is the risk that the Group does not have sufficiently stable and diverse sources of funding. Liquidity risk is the risk that the Group has insufficient financial resources to meet its commitments as they fall due.

Example

A deterioration in either the Group’s or the UK’s credit rating, or a sudden and significant withdrawal of customer deposits, would adversely impact the Group’s funding and liquidity position

Key mitigating actions

Holding liquid assets to cover potential cash and collateral outflows and to meet regulatory requirements. In addition, maintaining a further pool of assets that can be used to access central bank liquidity facilities

Undertaking daily monitoring against a number of market and Group-specific early warning indicators

Maintaining a contingency funding plan detailing actions and strategies available in stressed conditions

Key risk indicators

 

£129bn107%
LCR eligible assets
2017: £121bn		Loan to deposit ratio
1 Jan 2018: 107%

Alignment to strategic priorities and future focus

Maximising the Group’s capabilities

The Group maintains a strong funding position in line with its low risk strategy, and the loan to deposit ratio remains within the Group’s target range. The Group’s funding position allows the Group to grow targeted business segments, and better address its customers’ needs.


39

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

GOVERNANCE
Against a background of increased regulatory focus on governance and risk management, the most significant challenges arise from ensuring that the Group continues to demonstrate compliance with the requirements to ring-fence core UK financial services and activities, the potential impact of EU exit and further requirements under the Senior Manager & Certification Regime (SM&CR).

Examples

Inadequate or complex governance arrangements to address ring-fencing requirements and the potential impact of EU exit could result in a weaker control environment, delays in decision-making and lack of clear accountability

Non-compliance with, or breaches of SM&CR requirements could result in lack of clear accountability, and legal and regulatory consequences

Key mitigating actions

To meet ring-fencing requirements, core UK financial services and activities have been ring-fenced from other activities of the Group and an appropriate control environment and governance structures are in place to ensure compliance

A dedicated change programme is in place and addressing the additional SM&CR requirements which will come into force during 2019

A dedicated programme is in place to assess and address the potential impacts of EU exit on the Group’s operations in Europe. The Group is in close and regular contact with regulators to develop and deploy its planned operating and legal structure to mitigate the potential impacts of EU exit

Evolving risk and governance arrangements to ensure they continue to be appropriate to comply with regulatory objectives

Key risk indicators

N/A

Alignment to strategic priorities and future focus

Delivering a leading customer experience

Ring-fencing ensures that the Group is safer and continues to deliver a leading customer experience by providing further protection to core retail and SME deposits, increasing transparency of the Group’s operations and facilitating the options available in resolution.

The Group’s governance framework and strong culture of ownership and accountability enabled effective, on time, compliance with the SM&CR requirements and enable the Group to demonstrate clear accountability for decisions.

MARKET
The risk that the Group’s capital or earnings profile is affected by adverse market rates, in particular interest rates and credit spreads in the banking business, equity and credit spreads in the Insurance business, and credit spreads in the Group’s defined benefit pension schemes.

Examples

Earnings are impacted by the Group’s ability to forecast and model customer behaviour accurately and establish appropriate hedging strategies

The Insurance business is exposed indirectly to equity risk through the value of future management charges on policyholder funds. Credit spread risk within the Insurance business primarily arises from bonds and loans used to back annuities

Narrowing credit spreads will increase the cost of pension scheme benefits

Key mitigating actions

Structural hedge programmes implemented to manage liability margins and margin compression

Equity and credit spread risks are closely monitored and, where appropriate, asset and liability matching is undertaken

The Group’s defined benefit pension schemes continue to monitor their credit allocation as well as the hedges in place against nominal rate and inflation movements

Key risk indicators

£1,146m

IAS 19 Pension surplus
2017: £509m

Alignment to strategic priorities and future focus

Maximising the Group’s capabilities

The Group actively manages its exposure to movements in market rates, to drive lower volatility earnings and offer a comprehensive customer proposition with hedging strategies to support strategic aims. Mitigating actions are implemented to reduce the impact of market movements, resulting in a more stable capital position. Effective interest rate and inflation hedging has kept volatility in the Group’s defined benefit pension schemes low. This combined with improved market conditions has helped keep the schemes in IAS 19 surplus in 2018. This allows the Group to more efficiently utilise available capital resources to better enable the Group to maximise its capabilities.

MODEL
The risk of financial loss, regulatory censure, reputational damage or customer detriment, as a result of deficiencies in the development, application and ongoing operation of models and rating systems.

Example

The consequences of inadequate models could include: inappropriate levels of capital or impairments; inappropriate credit or pricing decisions; and adverse impacts on funding or liquidity, or the Group’s earnings and profits

Key mitigating actions

A comprehensive model risk management framework

Defined roles and responsibilities, with clear ownership and accountability

Principles regarding the requirements of data integrity, development, validation, implementation and ongoing maintenance

Regular model monitoring

Independent review of models

Periodic validation and re-approval of models

Key risk indicators

N/A

Alignment to strategic priorities and future focus

Digitising the Group

The Group’s models play a vital role in supporting Group strategy to ensure profitable growth in targeted segments and the Group’s drive toward automation and digital solutions to enhance customer outcomes. Model risk management helps ensure these models are implemented in a controlled and safe manner for both the Group and customers.


40

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

RISK MANAGEMENT

Risk management is at the heart of the Group’s strategy to become the best bank for customers.

The Group’s mission is to protect its customers, colleagues and the Group, whilst enabling sustainable growth in targeted segments. This is achieved through informed risk decision-making and superior risk and capital management, supported by a consistent risk-focused culture.

The risk overview (pages 35 to 40) provides a summary of risk management within the Group. It highlights the important role of risk as a strategic differentiator, key areas of focus for risk during 2018, and the role of risk management in enhancing the customer experience, along with an overview of the Group’s Risk Management Framework, and the principal risks faced by the Group and key mitigating actions.

This full risk management section provides a more in-depth picture of how risk is managed within the Group, detailing the Group’s emerging risks, approach to stress testing, risk governance, committee structure, appetite for risk (pages 41 to 50) and a full analysis of the primary risk categories (pages 50 to 103) – the framework by which risks are identified, managed, mitigated and monitored.

Each risk category is described and managed using the following standard headings: definition, exposures, measurement, mitigation and monitoring.

THE GROUP’S APPROACH TO RISK

The Group operates a prudent approach to risk with rigorous management controls to support sustainable business growth and minimise losses. Through a strong and independent risk function (Risk division), a robust control framework is maintained to identify and escalate current and emerging risks, support sustainable growth within Group risk appetite, and to drive and inform good risk reward decision-making.

To meet ring-fencing requirements from 1 January 2019, core UK retail financial services and ancillary retail activities have been ring-fenced from other activities of the Group. The Group Risk Management Framework and Group Risk Appetite apply across the Group and are supplemented by risk management frameworks and risk appetites for the sub-groups to meet sub-group specific needs. In each case these are aligned to the Group position. The Group’s Corporate Governance Framework applies across Lloyds Banking Group plc, Lloyds Bank plc, Bank of Scotland plc and HBOS plc. It is tailored where needed to meet the entity specific needs of Lloyds Bank plc and Bank of Scotland plc, and supplementary Corporate Governance Frameworks are in place to address sub-group specific requirements of the other sub-groups (LBCM, Insurance and LBG Equity Investments). See revised Group governance arrangements and Group restructure to comply with ring-fencing on page 135.

 

Risk management is at the heart of our strategy to become the best bank for customers.

Our mission is to support the business in delivering sustainable growth. This is achieved through informed risk decision making and superior risk and capital management, supported by a consistent risk-focused culture.

The risk overview (pages 40 to 45) provides a summary of risk management within the Group. It highlights the important role of risk as a strategic differentiator, risk achievements in 2015 and priorities for 2016 along with a brief overview of the Group’s risk governance structure and the principal risks faced by the Group and key mitigating actions.

This full risk management section provides a more in-depth picture of how risk is managed within the Group, detailing the Group’s emerging risks, approach to stress testing, risk governance, committee structure, appetite for risk (pages 46 to 54) and a full analysis of the primary risk drivers (pages 55 to 120) – the framework by which risks are identified, managed, mitigated and monitored.

Each risk driver is described and managed using the following standard headings: definition, appetite, exposures, measurement, mitigation and monitoring.

THE GROUP’S APPROACH TO RISK

The Group operates a prudent approach to risk with rigorous management controls to support sustainable business growth and minimise losses. Through a strong and independent risk function (Risk Division) a robust control framework is maintained to identify and escalate emerging risks to support sustainable business growth within risk appetite and through good risk reward decision making.

RISK CULTURE

 

The Board ensures that senior management implements risk policies and risk appetites that either limit or, where appropriate, prohibit activities, relationships and situations that could be detrimental toBased on the Group’s risk profile.

As part of a conservative business model, that embodies a risk culture founded on a prudent approach to managing risk management, and guided by the Board, the senior management articulates the core risk values to which the Group refreshed its Codes of Businessaspires, and Personal Responsibility in 2015 reinforcing its approach where colleagues are accountable forsets the risks they take and wheretone at the needs of customers are paramount.

Thetop, with a strong focus remains on building and sustaining long-term relationships with customers cognisant ofthrough the economic climate.cycle. The Group’s code of responsibility reinforces colleague accountability for the risks they take and their responsibility to prioritise their customers’ needs.

 

RISK APPETITE

 

–Defined as ‘the amount and type of risk that the Group is prepared to seek, accept or tolerate.’

The Group’s risk appetite is defined as ‘the amount and type of risk that the Group is prepared to seek, accept or tolerate’ in delivering the Group’s strategy.

 

–The Group’s strategy operates in tandem with its high level risk appetite which is supported by more detailed metrics and limits. An updated Risk Appetite Statement was approved by the Board in 2015. This incorporated challenge and recommendations from the Board Risk Committee and is fully aligned with Group strategy.

Group strategy and risk appetite are developed in tandem. Business planning aims to optimise value within risk appetite parameters and deliver on the Group’s promise to Help Britain Prosper.

 

–Risk appetite is embedded within principles, policies, authorities and limits across the Group and continues to evolve to reflect external market developments and composition of the Group.

The Group’s risk appetite statement details the risk parameters within which the Group operates. The statement forms part of the Group’s control framework and is embedded into its policies, authorities and limits, to guide decision-making and risk management. The Board is responsible for approving the Group’s risk appetite statement at least annually. Group Board-level metrics are cascaded into more detailed business appetite metrics and limits.

 

–Performance is optimised by allowing business units to operate within approved risk appetite and limits.

Group risk appetite includes the following areas:

Credit– the Group has a conservative and well-balanced credit portfolio through the economic cycle, generating an appropriate return on equity, in line with the Group’s target return on equity in aggregate.

Regulatory and legal– the Group complies with all relevant regulation and all applicable laws (including codes of practice which have legal implications) and/or legal obligations.

Conduct – the Group’s product design and sales practices ensure that products are transparent and meet customer needs.

Operational – the Group has robust controls in place to manage operational losses, reputational events and regulatory breaches. It identifies and assesses emerging risks and acts to mitigate these.

People – the Group leads responsibly and proficiently, manages its people resource effectively, supports and develops colleague talent, and meets legal and regulatory obligations related to its people.

Capital – the Group maintains capital levels commensurate with a prudent level of solvency, and aims to deliver consistent and high quality earnings.

Funding and liquidity – the Group maintains a prudent liquidity profile and a balance sheet structure that limits its reliance on potentially volatile sources of funding.

Governance – the Group has governance arrangements that support the effective long-term operation of the business, maximise shareholder value and meet regulatory and societal expectations.

Market – the Group has robust controls in place to manage its inherent market risk and does not engage in any proprietary trading, reflecting the customer focused nature of the Group’s activities.

Model – the Group has embedded a framework for the management of model risk to ensure effective control and oversight, compliance with all regulatory rules and standards, and to facilitate appropriate customer outcomes.

 

GOVERNANCE AND CONTROL

 

–The Group’s approach to risk is founded on a robust control framework and a strong risk management culture which are the foundation for the delivery of effective risk management and guide the way all employees approach their work, behave and make decisions.

The Group’s approach to risk is founded on a robust control framework and a strong risk management culture which are the foundation for the delivery of effective risk management and guide the way all employees approach their work, behave and make decisions.

–Governance is maintained through delegation of authority from the Board down to individuals through the management hierarchy. Senior executives are supported by a committee-based structure which is designed to ensure open challenge and support effective decision making.

–The Group’s risk appetite, principles, policies, procedures, controls and reporting are regularly reviewed and updated where needed to ensure they remain fully in line with regulations, law, corporate governance and industry good-practice.

–The interaction of the executive and non-executive governance structures relies upon a culture of transparency and openness that is encouraged by both the Board and senior management.

–Board-level engagement, coupled with the direct involvement of senior management in Groupwide risk issues at Group Executive Committee level, ensures that escalated issues are promptly addressed and remediation plans are initiated where required.

–Line management is directly accountable for identifying and managing risks in their individual businesses, ensuring that business decisions strike an appropriate balance between risk and reward consistent with the Group’s risk appetite.

–Clear responsibilities and accountabilities for risk are defined across the Group through a Three Lines of Defence model which ensures effective independent oversight and assurance in respect of key decisions.

 

RISK DECISION MAKING AND REPORTINGGovernance is maintained through delegation of authority from the Board down to individuals through the management hierarchy. Senior executives are supported by a committee based structure which is designed to ensure open challenge and support effective decision-making.

 

–Taking risks which are well understood, consistent with strategy and with appropriate return is a key driver of shareholder value.

The Group’s risk appetite, principles, policies, procedures, controls and reporting are regularly reviewed and updated where needed to ensure they remain fully in line with regulations, law, corporate governance and industry good-practice.

 

–Risk analysis and reporting supports the identification of opportunities as well as risks.

The interaction of the executive and non-executive governance structures relies upon a culture of transparency and openness that is encouraged by both the Board and senior management.

–An aggregate view of the Group’s overall risk profile, key risks and management actions, and performance against risk appetite, is reported to and discussed monthly at the Group Risk Committee (and a subset at the Group Asset and Liability Committee), with regular reporting to the Board Risk Committee and the Board.

–Rigorous stress testing exercises are carried out to assess the impact of a range of adverse scenarios with different probabilities and severities to inform strategic planning.

–The Chief Risk Officer regularly informs the Board Risk Committee (BRC) of the aggregate risk profile and as a member of the Board, has direct access to the Chairman and members of BRC.
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Board-level engagement, coupled with the direct involvement of senior management in Group-wide risk issues at Group Executive Committee level, ensures that escalated issues are promptly addressed and remediation plans are initiated where required.

Line managers are directly accountable for identifying and managing risks in their individual businesses, ensuring that business decisions strike an appropriate balance between risk and reward and are consistent with the Group’s risk appetite.

Clear responsibilities and accountabilities for risk are defined across the Group through a three lines of defence model which ensures effective independent oversight and assurance in respect of key decisions.

FINANCIAL REPORTING RISK MANAGEMENT SYSTEMS AND INTERNAL CONTROLS

The Group maintains risk management systems and internal controls relating to the financial reporting process which are designed to:

– ensure that accounting policies are appropriately and consistently applied, transactions are recorded accurately, and undertaken in accordance with delegated authorities, that assets are safeguarded and liabilities are properly stated;
–enable the calculation, preparation and reporting of financial, prudential regulatory and tax outcomes in accordance with applicable International Financial Reporting Standards, statutory and regulatory requirements;
–enable annual certifications relating to maintenance of appropriate tax accounting by the Senior Accounting Officer in accordance with the 2009 Finance Act;
–ensure that disclosures are made on a timely basis in accordance with statutory and regulatory requirements (for example UK Finance Code for Financial Reporting Disclosure; US Sarbanes Oxley Act) and, as far as possible, consistent with best practice;
–ensure ongoing monitoring to assess the impact of emerging regulation and legislation on financial, prudential regulatory and tax reporting; and
–ensure an accurate view of the Group’s performance to allow the Board and senior management to appropriately manage the affairs and strategy of the business as a whole and each of its sub-groups.

The Group has a Disclosure Committee which assists the Group Chief Executive and Chief Financial Officer in fulfilling their disclosure responsibilities under relevant listing and other regulatory and legal requirements. In addition, the Audit Committee reviews the quality and acceptability of the Group’s financial disclosures. For further information on the Audit Committee’s responsibilities relating to financial reporting see pages 147 to 150.

RISK DECISION-MAKING AND REPORTING

Risk analysis and reporting enables better understanding of risks and returns, supporting the identification of opportunities as well as better management of risks.

An aggregate view of the Group’s overall risk profile, key risks and management actions, and performance against risk appetite is reported to and discussed monthly at the Group Risk Committee with regular reporting to the Board Risk Committee and the Board.

Rigorous stress testing exercises are carried out to assess the impact of a range of adverse scenarios with different probabilities and severities to inform strategic planning.

The Chief Risk Officer regularly informs the Board Risk Committee of the aggregate risk profile and has direct access to the Chairman and members of Board Risk Committee.

Table 1.1:Exposure to risk arising from the business activities of the Group

The table below provides a high level guide to how the Group’s business activities are reflected through its risk-weighted assets. Details of the business activities for each division are provided in its risk measures and balance sheet.the Divisional Results on pages 24 to 31.

 

 Lloyds Banking Group    Commercial Insurance and Central    
   Commercial Consumer   Central     Retail Banking Wealth1 items2 Group 
 Retail Banking Finance Run-off Items1 Insurance2 Total £bn  £bn  £bn  £bn  £bn 
Division £bn £bn £bn £bn £bn £bn £bn
Risk-weighted assets (RWAs)                                           
– Credit risk3  48.8   83.4   17.6   10.0   12.7   –   172.5 
– Credit risk  74.5   74.7   0.6   11.7   161.5 
– Counterparty credit risk3  –   9.1   –   –   0.6   –   9.7   –   4.7   –   2.5   7.2 
– Market risk  –   2.0   –   0.1   2.1 
– Operational risk  17.1   6.3   2.5   0.2   –   –   26.1   19.8   4.6   0.6   0.5   25.5 
– Market risk  –   3.7   –   –   0.1   –   3.8 
Total (excluding threshold)  65.9   102.5   20.1   10.2   13.4   –   212.1   94.3   86.0   1.2   14.8   196.3 
– Threshold4  –   –   –   –   10.6   –   10.6   –   –   –   10.1   10.1 
Total  65.9   102.5   20.1   10.2   24.0   –   222.7   94.3   86.0   1.2   24.9   206.4 

 

1Central items include assets held outside the main operating divisions, including exposures relating to Group Corporate Treasury which holds the Group’s liquidity portfolio, and Group Operations.

2As a separate regulated business, Insurance (excluding Wealth) maintains its own regulatory solvency requirements, including appropriate management buffers, and reports directly to the Insurance Board. Insurance does not hold any RWAs, as its assets are removed from the Banking Group’s regulatory capital calculations. However, in accordance with Capital Requirements Directive and Regulation (CRD IV) rules, part of the Group’s investment in Insurance is included in the calculation of Thresholdthreshold RWAs, subject to the CRD IV rules, while the remainder is taken as a capital deduction.

2Central Items include assets held outside the main operating divisions, including assets relating to Group Corporate Treasury which holds the Group’s liquidity portfolio, and other supporting functions.
3Exposures relating to the default fund of a central counterparty and credit valuation adjustmentsadjustment risk are included in Credit Risk and Counterparty Credit Risk respectively for the purposes of this table.counterparty credit risk.

4Threshold is presented on a fully loaded CRD IV basis. Threshold risk-weighted assetsRWAs reflect the elementproportion of significant investments and deferred tax assets that are permitted to be risk-weighted instead of deducted from CET1common equity tier 1 (CET1) capital. Significant investments primarily arise from the investment in the Group’s Insurance business.

 

PRINCIPAL RISKS

 

The Group’s principal risks are shown in the risk overview (pages 4037 to 45)40). The Group’s emerging risks are shown overleaf. Full analysis of the Group’s risk driverscategories is on pages 5550 to 120.103.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

EMERGING RISKS

 

The Group considers the following to be risks that have the potential to increase in significance and affect the performance of the Group.

These risks are considered alongside the Group’s operating plan.

 

RiskKey mitigating actions

Regulatory and legal change:legal: The financial sector continues to witness an increased pace, volume and volumecomplexity of oversight and regulation from various bodies including government and regulators.

Increasing regulatory rules and laws from both the UK and overseas may affect the Group’s operation, placing pressure on expert resource and investment priorities.

There continues to be uncertainty as to the impact of EU exit or the impact of a no deal outcome on the regulatory and legal change and developments including: competition; pensions; capital requirements; payments; accounting standards changes; Senior Managers and Certification Regime (SM&CR); and consumer protection laws, all havelandscape. One impact of EU exit will be that the potentialUK loses its ability to impactmake use of the deliveryEU Passport for provision of our strategic objectives.banking services into the EU.

–

Continue to implement our conduct strategy ensuring the customer is at the heart of our business planning whilst working  The Group works closely with regulatory authorities and industry bodies to ensure that the Group can identify and respond to the evolving regulatory and legal landscape.

–  The Group actively implements programmes to deliver legal, regulatory and mandatory change requirements.

–  The Group has implemented a programme to assess the legal impacts and risks of an EU exit (including a no deal outcome) and to identify appropriate mitigants, such as establishing EU entities to ensure continuity of certain business activities.

–Programmes

Cyber: Increases in placethe volume and sophistication of cyber-attacks alongside the growth in connected devices continues to deliver SM&CR by March 2016 implementation and ring-fencing and resolution by January 2019.

Low interest rate environment: Continuation of the present low interest rate environment hasheighten the potential to negatively impactfor cyber-enabled crime.

Increases in geopolitical tensions increase the deliveryindirect threat of a sophisticated attack on the Group. The capability of organised crime groups is growing rapidly, which along with the commoditisation of cyber- crime increases the likelihood that the Group or one of its suppliers will be the direct target of a sophisticated attack. This increases the risk of the Group’s strategicexposure through the supply chain.

–  Continued investment and operational objectives. As a resultpriority focus on the Group’s Cyber Programme to ensure confidentiality and integrity of data and availability of systems. Key areas of focus relate to access controls, network security, disruptive technology, and denial of service capability.

–  Embedding of Group Cyber control framework aligned to industry recognised cyber security framework (NIST: National Institute of Standards and Technology).

–  Three year cyber strategy to deliver an industry-leading approach across the Group and to embed innovation in the Group’s approach to cyber.

–  Increased business and colleague engagement through education and awareness, phishing testing and security culture initiatives. Cyber risk is governed through all key risk committees and there may be a requirement to review our cost and investment priorities.

–Regularare quarterly reviews and updates to strategic milestones provide opportunity to reposition and reprioritise to minimise and negate potential impacts.  of all cyber risks.

Response to market changes (agility):Political uncertainties including EU exit: The dynamic naturecontinued lack of external influencesclarity over the UK’s eventual relationship with the EU allied to ongoing challenges in the Eurozone, including protests in France and changes in government in Italy, raise additional uncertainty for the UK economic outlook. Growing public concern over perceived income inequality has also led to a rise in political populism. There also remains the possibility of a further referendum on Scottish independence.

There is a risk of a no deal EU exit outcome or a delay to EU exit, which could result in continuing business uncertainty across the whole UK banking sector.

–  Internal contingency plans recalibrated and regularly reviewed for potential strategic, operational and reputational impacts.

–  Engagement with politicians, officials, media, trade and other bodies to reassure the Group’s commitment to Helping Britain Prosper.

Specifically for the potential impacts of EU exit:

–  Executive forum considering and tracking developments and activity.

–  Committed investments to impactestablish new Group entities in the deliveryEU to ensure continuity of certain business activities, and contingency planning in relation to wider areas of impact.

–  Group Corporate Treasury tracking market conditions closely and actively managing the Group’s balance sheet.

–  Credit applications and sector reviews include assessment of EU exit risk. Initiatives to help clients effectively identify and manage associated risks.

–  Review of the strategyGroup’s top EU suppliers to identify any impact on service provision and risk profiledrive appropriate mitigating action.

–  No deal EU exit outcome analysed to identify impacts and assess robustness of the Group. As technology advances,Group’s contingency plans.

Competition: Adoption of technological trends is accelerating with customer preferences increasingly shaped by tech giants and other challengers who are able to exploit their own infrastructure and are impacted by different market dynamics. Regulation is focusing on lowering barriers for new entrants, which could have an adverse impact on the typical banking model is evolving, and as such, operationalGroup’s market position.

Operational complexity has the potential to restrict the Group’s speed of response.response to market trends. Inability to leverage data and innovate could lead to loss of market share as challengers capitalise on Open Banking. Timely delivery of GSR3 objectives remains key to addressing the competitive challenges facing the Group.

–

Organisational  The Group is transforming the business to improve customer experience by digitising customer journeys and behavioural effectiveness is reviewed through regularleveraging branches for complex needs, in response to customers’ evolving needs and expectations.

–  The Group Strategic Reviews, ensuring the continued drive for simplicitywill deepen insight into customer segments, their perception of brands and efficiency,what they value.

–  Agility will be increased by consolidating platforms and the building of new capabilities to support sustainable growth.

–Sustained and continuing investment in digital capability and customer channels with our plans progressively updated to reflect market trends and customer behaviour.
Conduct risk: In a low growth environment we cannot compromise on our Conduct Strategy for revenue growth. Further provisions for legacy issues may be required if issues emerge which require remediation.–Rigorous implementation of our conduct strategyarchitecture aligned with customer needs at the centre rather than a product driven model.
journeys.

–

Programmes in place  The Group is responsive to deliver redress to customers with Groupwide rectification governance in place to enhance effectiveness.
Data integrity, ITchanging customer behaviour/business models and cyber: Cyber remains an evolving threat to the Group andadjusts its strategic objectives. Increased digital interconnectivity across the Group, its customers and suppliers has the potential to heighten our vulnerability to cyber-attacks, which could disrupt service for customers, and cause financial loss and reputational damage.risk management approach as appropriate

–

Delivery of the Group cyber control framework, aligned to industry-recognised cyber security framework, and continued investment in the Group’s Cyber Programme to ensure integrity of key systems and processes remains a priority.
–Resilience programmes in place to protect the integrity and availability of the Group’s systems and mitigate the impacts of cyber-attacks.
Market liquidity: Financial markets continue to exhibit signs of a lack of liquidity and potential impacts include the speed at which structural hedging can be undertaken and relevant asset portfolio liquidated.–Market liquidity  GSR3 is reviewed on a regular basis through specific committees which approve funding plans, based on detailed analysis to ensure regulatory compliance and future liquidity requirements are satisfied.
Ring-fencing and resolution: UK ring-fencing legislation, regulation and rules impact the Group’s business and operating model and could impact the ability to, and cost of, serving customers effectively to a greater extent than current assumptions, with potential changes in the competitive landscape and changes to customer and market behaviour.  –Engagement with relevant governmental and regulatory bodies and other agencies to deliver compliance by January 2019.
–Business model design will optimise delivery of the full range of services to ring-fenced Bank customers through the provision of certain propositions from Group entities outside the ring-fence.
Leveraging data: Increasing regulatory scrutiny under EU Data Protection Regulation may limit the extent to which customer data can be useddesigned to support the Group to strengthen its competitive position.

Data:Advancements in achieving its strategic objectives.–Assessment ofnew technologies and new services, an increasing external threat landscape, and changing regulatory requirements increase the possible impacts of legislation is ongoing andneed for the Group expects to deliver enhanced systemseffectively govern, manage, and protect its data (or the data shared with third-party suppliers). Failure to fulfil related regulatory requirements.manage data risk will impact the accuracy, access to and availability of data, ultimately leading to poor customer outcomes, loss of value to the bank and reputational damage.

–  The Group’s strategy is to introduce advanced data management practices, based on Group-wide standards, data-first culture and modern enterprise data platforms, supported by a simplified modern IT architecture.

–  The Group has implemented Open Banking and actively monitors implications for its customers, including protection from fraud.

–  We are making a significant investment to improve data privacy, including the security of data and oversight of third-parties.

Macroeconomic headwinds: The UK economic outlook is uncertain. Business investment is lower than historical averages with early signs of pressure in Retail and high street sectors. High levels of credit market liquidity have reduced spreads and weakened terms in some sectors, creating a potential under-pricing of risk and heightened risk of a market correction. These factors could lead to downward pressure on credit quality.

–

Chief Data Officer reviewing Groupwide operating model  Wide array of risks considered in setting strategic plans.

–  Capital and aligning the Group’s appetite appropriately.

UK political uncertainty: An EU in-out referendum has been called for the 23 June 2016. In the event that the referendum outcome determines an exit from the EU, there may be an impact on UK trade, the domestic economy and inward investment and, in the short term, the potential for market volatility.–The Group will monitor and assess the potential impacts on an on-going basis, manage exposures according to its currentliquidity are reviewed regularly through committees, ensuring compliance with risk appetite and continueregulatory requirements.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

RiskKey mitigating actions

Uncertainty remains over UK monetary policy, and tightening US monetary policy is pressuring some emerging markets with potential spill over effects on growth and asset prices in other markets.

Policy tightening in the US and China has weakened global growth prospects; this is likely to review our existing contingency plans forbring a pause to US policy normalisation and Chinese deleveraging of its high debt levels, in turn weakening crisis management tools.

–  The Group has a robust through the cycle credit risk appetite, including appropriate product, sector and single name concentration parameters, robust sector appetite statements and policies, as well as affordability and indebtedness controls at origination. In addition to ongoing focused monitoring, the Group conducts portfolio deep dives and quarterly larger exposure reviews. The Group has enhanced its use of early warning indicators including sector specific indicators.

–  The Group is well positioned against an uncertain economic outlook and is able to withstand potential market volatility beforeand/or downturn due to its selective and after the referendum.  pre-emptive credit tightening, robust affordability controls and close monitoring of internal and external trends.

Geopolitical shocks: Current uncertainties could further impede the global economic recovery and adjustment from a period of ultra-accommodative monetary policy. Events in China, Russia and the Middle-East,recovery. Global events, as well as terrorist activity including cyber-attacks, have the potential to trigger changes in the economic outlook, market risk pricing which could lead to risingand funding costs.conditions.

–

Current risk  Risk appetite criteria limits single counterparty bank and non-bank exposures complemented by a UK-focused strategy.

–  The Chief Security Office develops and maintains an Emerald Response Process to respond to external crisis events. This is a rapid reaction group, incorporating Financial Stability Response where appropriate.

–  The Chief Security Office also maintains the operational resilience framework to embed resilience activities across the Group and limit the impact of internal or external events.

–  Hedging of market risk considers, inter alia, potential shocks as a result of geopolitical events.

Financial services transformation impact on customers: The risk that transformation of the financial services industry and the Group does not adequately consider vulnerable customers. As technology and innovation move at increasing pace, the more vulnerable could be at a disadvantage.

The increase in execution only propositions due to digitisation may lead to increased conduct risk where customers (including vulnerable customers) choose unsuitable products. The Group’s approach to customer segmentation will need to ensure conduct and reputational risks are well managed.

Further, there is an emerging risk of unintended consequences within decision-making undertaken by machine learning which could occur on a large scale in a short period of time, creating new operational risks that affect financial and non-financial outcomes, for example credit portfolio anomalies or conduct impacts. This is relevant for the Group at present as the delivery of GSR3 utilises new technologies.

–  Group vulnerability strategy and associated actions being developed throughout the transformation programme.

–  Digital principles are being agreed across the Group, primarily aimed at preventing material conduct residual risk and giving customers an optimal, informative and fair buying journey to mitigate the increased risks.

–  Technology risks, including those related to machine learning, are escalated and discussed through governance to ensure ongoing monitoring of any emerging unintended consequences.

–  Emerging customer risks, including those pertaining to vulnerable customers, are managed through customer segmentation strategy governance throughout the change lifecycle.

–

Climate change: The key risks associated with climate change are physical risks arising from climate and weather-related events, and transition risks, which are the financial risks resulting from the process of adjustment towards a lower carbon economy. Both of these risks may cause the impairment of asset values and impact the creditworthiness of the Group’s clients, which could result in currently profitable business deteriorating over the term of agreed facilities. Conversely propositions currently outside of appetite may constitute an acceptable opportunity in the future.

There is increased focus on these risks by key stakeholders including businesses, clients and investors, and the regulatory landscape is evolving to reflect these risks.

There is also a risk that campaign groups or other bodies could seek to take legal action (including indirect action) against the Group and/or the financial services industry for investing in or lending to organisations that they deem to be responsible for, or contributing to, climate change.

–  The Group’sGroup has embedded Sustainability in its Helping Britain Prosper Plan and Group Property Objectives.

–  The Group is taking a strategic approach to align with the UK Government’s Clean Growth Strategy and have committed to adopting the approach set out by the Financial Stability ForumBoard’s Task Force on Climate-related Financial Disclosures (TCFD).

–  The Group is identifying new opportunities to support customers and clients and to finance the UK’s transition to a lower carbon economy.

–  The Group will embed sustainability into the way it does business and manage its own operations in placea more sustainable way, identifying and managing material sustainability-related risks across the Group, and disclosing these in line with the TCFD recommendations.

–  The Group will ensure that appropriate training is provided to developRelationship managers and maintainRisk colleagues to enable them to have effective sustainability conversations with their clients.

Transition from IBORs to Alternative Risk Free Reference Rates: Widely used benchmark rates, such as the London Interbank Offered Rate (‘LIBOR’), have been subject to increasing regulatory scrutiny, with regulators signalling the need to use alternative benchmark rates. As a result, existing benchmark rates may be discontinued or the basis on which they are calculated may change.

There is uncertainty across the whole UK Banking sector as to the impact such discontinuation or changes may have and they may adversely affect a broad array of financial products, including any LIBOR-based securities, loans and derivatives.

Any discontinuation or changes could have important implications for both the Group and its customers, for example: necessitating amendments to existing documents and contracts; changes to systems and infrastructures; and the possibility of disputes.

–  The Group is working closely with the Bank of England initiated Working Group on Sterling Risk-Free Reference Rates on the transition away from LIBOR in the UK.

–  Maintain close engagement with the FCA on potential impacts.

–  Working closely with industry bodies to understand and manage the impact of benchmark transition in other geographies.

–  Transition project established and the appointment of an IBOR Transition Director as accountable executive.

–  Working with the Group’s Stability Response Plan, whilst also actingcustomers to ensure they understand the risks or outcomes they might face from transition.

–  Establish a clear client communication strategy for all new IBOR linked products. Consider appropriate client communications for legacy contracts as a Rapid Reaction Group, meeting when external crises occur.the market end-state position evolves.

–  Implement an internal communication strategy and ensure that all relevant staff are aware and have the tools and training required.

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CAPITAL STRESS TESTING

 

OVERVIEWOverview

Stress testing is recognised as a key risk management tool within the Group by the Board,Boards, senior management, the businesses and the Risk and Finance functions. Stress testingfunctions of all parts of the Group and its legal entities. It is fully embedded in the planning process of the Group and its legal entities as a key activity in medium term planning. Seniormedium-term planning, and senior management is actively involved in stress testing activities via a strict governance process.

 

The Group uses scenarioScenario stress testing to:is used for: Risk Identification:

 

–Assess its strategic plans to adverse economic conditions and understandUnderstand key vulnerabilities of the Group.Group and its key legal entities under adverse economic conditions.
Risk Appetite:
  
–Assess results against Board risk appetite to ensure the Group is managed within its risk parameters, allowing senior management and the Board to adjust strategies if the plan does not meet risk appetite in a stressed scenario. At the same time, the results of the stress tests will also informtest against the risk appetite of all parts of the Group to ensure the Group and its legal entities are managed within their risk parameters.
–Inform the setting of risk appetite by assessing the underlying risks under stress conditions.
  
Strategic and Capital Planning:
–DriveAllow senior management and the developmentBoards of potential actionsthe Group and contingency plansits applicable legal entities to mitigateadjust strategies if the impact of adverse scenarios. Stress testing also links directly to the Group’s Recovery Planning process.plan does not meet risk appetite in a stressed scenario.
  
–Support the Internal Capital Adequacy Assessment Process (ICAAP) by demonstrating capital adequacy, and meet the requirements of regulatory stress tests that are used to inform the setting of the Group’s PRA bufferPrudential Regulation Authority (PRA) and management buffers (see Capital Riskcapital risk on pages 11179 to 116).88) of the Group and its separately regulated legal entities.
Risk Mitigation:
  
–MeetDrive the required standardsdevelopment of potential actions and contingency plans to mitigate the information needsimpact of internaladverse scenarios. Stress testing also links directly to the recovery planning process of the Group and external stakeholders, including regulators.its legal entities.

REGULATORY STRESS TESTS

 

During 2015,Regulatory stress tests

In 2018 the Group was subject toparticipated in both the UK-wide concurrent UK stress test run by the Bank of England. AsEngland (BoE) and in the European Banking Authority’s (EBA) bi-annual EU-wide stress test. The EBA stress test did not contain a pass/fail threshold and as announced in December,November, the Group comfortablydemonstrated its ability to meet applicable capital requirements under stress conditions. In the case of the BoE stress test, despite the severity of the scenario, the Group exceeded the capital thresholds set byand leverage hurdles after the regulatorapplication of management actions and as a consequence was not required to take any action as a result of this test.capital actions.

 

INTERNAL STRESS TESTSInternal stress tests

AtOn at least on an annual basis, the Group conducts a detailed macroeconomic stress testtests of the operating plan, which isare supplemented with higher-levelhigher level refreshes if necessary. The exercise aims to highlight the key vulnerabilities of the GroupGroup’s and its legal entities’ business plans to adverse changes in the economic environment, and to ensure that there are adequate financial resources in the event of a downturn. The internal stress test includes different economic scenarios, both in terms of severity and focus (for example exploring the impacts of both low and high interest rate environments).

 

REVERSE STRESS TESTINGReverse stress testing

Reverse stress testing is used to explore the vulnerabilities of the Group’s and its key legal entities’ strategies and plans to extreme adverse events that would cause the businessbusinesses to fail, in order to facilitate contingency planning. The scenarios used are those that would cause the Groupbusinesses to be unable to carry on its businesstheir activities. Where reverse stress testing reveals plausible scenarios with an unacceptably high risk when considered against the Group’s or its entities’ risk appetite, the Groupthey will adopt measures to prevent or mitigate that risk, which are then reflected in strategic plans.

 

OTHER STRESS TESTING ACTIVITYOther stress testing activity

The Group’s stress testing programme also involves undertaking assessmentassessments of operational risk scenarios, liquidity scenarios, market risk sensitivities and scenarios, and business specific scenarios (see the principal risksprimary risk categories on pages 5550 to 120103 for further information on risk specificrisk-specific stress testing). If required, ad hoc stress testing exercises are also undertaken to assess emerging risks, as well as in response to regulatory requests. This wide ranging programme provides a comprehensive view of the potential impacts arising from the risks to which the Group is exposed and reflects the nature, scale and complexity of the Group.

 

METHODOLOGYMethodology

The stress tests at all levels must comply with all regulatory requirements, achieved through comprehensive construction of macroeconomic scenarios and a rigorous divisional, functional, risk and executive review and challenge process, supported by analysis and insight into impacts on customers and business drivers.

 

The Chief Economist’s Office develops the internal macroeconomic scenarios used by the Group, based on key uncertainties for the Group’s economic outlook. A wide set of economic parameter assumptions is constructed, with over 150 metrics provided such as Gross Domestic Product, Base Rate, unemployment, property indices, insolvencies and corporate failures to facilitate modelling of scenarios across the Group. Where an external scenario is provided, as was the case with the UK-wide concurrent Bank of England stress exercise, the Chief Economist’s Office broadens the externally supplied parameters to the level of detail required by the Group.

The engagement of all required business, Risk and controlFinance areas is built into the preparation process, so that the appropriate analysis of each risk driver’scategory’s impact upon the business plans is understood and documented. The methodologies and modelling approach used for stress testing ensure that a clear link is shown between the macroeconomic scenarios, the business drivers for each area and the resultant stress testing outputs. All material assumptions used in modelling are documented and justified, with a clearly communicated review and sign-off process. Modelling is supported by expert judgement and is subject to the Group Model Governance Policy.

Below is an overview of the principal output responsibilities by team:

–Finance teams in the business prepare and review finance related stress testing results including, but not limited to, income, margins, costs, lending and deposit volumes.
–Credit risk and market risk teams prepare and review risk-related stress outputs, including, but not limited to, impairment charges, risk-weighted assets, expected loss and trading losses.
–The Group Corporate Treasury team reviews the stress outputs and evaluates the impact upon the Group’s Capital and Funding Plan.
–The Central Finance and Tax teams consolidate the Group position and assess the tax and regulatory capital impacts.
–The Group Financial Risk team provides oversight of the Finance and Risk stress submissions as well as the consolidated Group position and capital ratios, and produces analysis packs for the Group’s senior committees.
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GOVERNANCEGovernance

Clear accountabilities and responsibilities for stress testing are assigned to senior management and the Risk and Finance functions throughout the Group.Group and its key legal entities. This is formalised through the Group Business Planning and Stress Testing Policy and Procedures,Procedure, which are reviewed at least annually.

 

The Group Financial Risk Committee (GFRC), chaired by the Chief Risk Officer and attended by the Chief FinanceFinancial Officer and other senior Risk and Finance colleagues, is the Committeecommittee that has primary responsibility for overseeing the development and execution of the Group’s stress tests. Lloyds Bank Corporate Markets (LBCM) Risk Committee performs a similar function within the scope of LBCM.

 

The review and challenge of the Group’s detailed stress forecasts, the key assumptions behind these, and the methodology used to translate the economic assumptions into stressed outputs are finalised byconclude with the divisional Finance Director’s,Directors’, appropriate Risk Director’sDirectors’ and Managing Director’sDirectors’ sign-off. The outputs are then presented to GFRC Group Risk Committee/Group Executive Committee and Board Risk Committee for Group-level executive review and challenge, before being approved by the Board. There is a similar process within LBCM for the governance of the LBCM-specific results.

 

HOW RISK IS MANAGED IN LLOYDS BANKING GROUP

 

The Group’s Risk Management Framework (RMF) (see risk overview, page 41)35) is structured around the following nine components which meet and align with the industry-accepted internal control framework issuedstandards.

The RMF applies to every area of the business and covers all types of risk. It is reviewed, updated and approved by the Committee of Sponsoring OrganisationsBoard at least annually to reflect any changes in the nature of the Treadway Commission.Group’s business and external regulations, law, corporate governance and industry best practice. The RMF provides the Group with an effective mechanism for developing and embedding risk policies and risk management strategies which are aligned with the risks faced by its businesses. It also seeks to facilitate effective communication on these matters across the Group.

 

Role of the Board and senior management – key

Key responsibilities of the Board and senior management include:

 

–setting risk appetite and approval of the RMF;
  
–approval of GroupwideGroup-wide risk principles and policies;
  
–the cascade of delegated authority (for example to Board sub-committees and the Group Chief Executive); and
  
–effective oversight overof risk management consistent with the risk appetite.

 

RISK APPETITERisk appetite

–Risk appetite is defined within the Group as ‘the amount and type of risk that the Group is prepared to seek, accept or tolerate’.
–Risk appetite is documented in a Board Risk Appetite Statement reviewed by the Board Risk Committee and approved annually by the Board. The Board Risk Appetite is aligned to the Risk Appetite Framework, and in turn the RMF and Group Risk Principles. An updated Board Risk Appetite Statement was approved by the Board in 2015.
–The Board metrics are supported by more detailed sub-Board appetite functional risk metrics and sub-Board appetite divisional risk metrics.
–The Group’s strategy operates in tandem with the Board Risk Appetite and business planning is undertaken with a view to meeting the requirements of the Board Risk Appetite.
–Risk appetite is embedded within principles, policies, authorities and limits across the Group and continues to evolve to reflect external market developments and composition of the Group.
–The Board Risk Committee is responsible for overseeing the development, implementation and maintenance of the Group’s overall risk management framework and its risk appetite, to ensure they are in line with emerging regulatory, corporate governance and industry best practice.

Accountabilities under the Risk Appetite Framework are apportioned as follows:

Board:

–Approves the type and level of risk the Group is prepared to accept and the boundaries within which management must operate when setting strategy and executing the business plan.
–Holds the Group Chief Executive and other Senior Executives accountable for the integrity of the Board Risk Appetite Statement.
–Reviews and approves reporting against the Board Risk Appetite Statement.
–Ensure executive remuneration is aligned with risk appetite adherence.
Group Chief Executive and Group Executive Committee members (GEC):
–Ensure that the Board Risk Appetite Statement is developed in collaboration with the Chief Risk Officer and is fully embedded in the business.
–Ensure resources and processes are in place to support the Board Risk Appetite framework.
–Are accountable for the integrity of the Board Risk Appetite Statement, including the timely identification and escalation of breaches and for developing mitigating actions.
–Ensure risk appetite is fully embedded across strategy, planning, decision-making processes and remuneration.
–Monitor compliance with Board Risk Appetite.

Group Chief Risk Officer:

–Develops the Board Risk Appetite Statement in collaboration with the Group Chief Executive and other GEC members.
–Obtains the Board’s support and approval of the Board Risk Appetite Statement.
–Oversees that the metrics are fully embedded by the business and reported on a monthly basis.
–Ensures breaches are identified, escalated and appropriate mitigating action is taken by the business.
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Risk appetite is embedded acrossdefined within the Group as ‘the amount and type of risk that the Group is prepared to seek, accept or tolerate’ in delivering its Group Strategy (see the following ways:Group’s approach to risk page 41).

 

–Communication – Board Risk Appetite metrics developed and agreed with business and operational teams. In addition Board Risk Appetite cascaded down into more detailed metrics and limits within Functional and Divisional sub-Board Risk Appetite Statements along with additional supporting metrics which should be used to drive local decision making and behaviours.
–Policies – Group policies are aligned with Risk Appetite Statement.
–Reporting – Performance against Board Risk Appetite metrics reported to Divisional, Functional, and Group Risk Committees and the BRC and Board.
–Performance Management – Group and Divisional Scorecards include adherence to risk appetite as a general measure and include more detailed risk appetite measures which are pertinent for that area of the Group.
–Key Decision Making – Strategy operates in tandem with risk appetite and the Group’s annual Operating Plan is developed within the boundaries set by risk appetite.

Governance frameworks – the Policy

The policy framework is founded on Board-approved key principles for the overall management of risk in the organisation, whichorganisation. These are aligned with Group strategy and risk appetite and based on a current and comprehensive risk profile that identifies all material risks to the organisation. The principles are underpinned by a hierarchy of policies which define mandatory requirements for risk management and control whichcontrol. These are consistently implemented across the Group.

Robust processes and controls to identify and report policy breaches are in place. These include clear materiality criteria and escalation procedures which ensure an appropriate level of visibility and prioritisation of remedial actions.

The risk committee governance framework is outlined below.on page 48.

 

Three Lineslines of Defencedefence model – the

The RMF is implemented through a ‘Three Lines‘three lines of Defence’defence’ model which defines clear responsibilities and accountabilities and ensures effective independent oversight and assurance activities take place covering key decisions.

 

Business lines (first line) have primary responsibility for risk decisions, identifying, measuring, monitoring and controlling risks within their areas of accountability. They are required to establish effective governance and control frameworks for their business to be compliant with Group policy requirements, to maintain appropriate risk management skills, mechanisms and toolkits, and to act within Group risk appetite parameters set and approved by the Board.

–Business lines (first line) have primary responsibility for risk decisions, identifying, measuring, monitoring and controlling risks within their areas of accountability. They are required to establish effective governance, and control frameworks for their business to be compliant with Group Policy requirements, to maintain appropriate risk management skills, mechanisms and toolkits, and to act within Group risk appetite parameters set and approved by the Board.
–Risk Division

Risk division (second line) is a centralised function, headed by the Chief Risk Officer, providing oversight and independent constructive challenge to the effectiveness of risk decisions taken by business management, providing proactive advice and guidance, reviewing challenging and reporting on the risk profile of the Group and ensuring that mitigating actions are appropriate.

–Group Audit (third line) provides independent, objective assurance and consulting activity designed to add value and improve the organisation’s operations. It helps the Group accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes. Group Audit provides independent assurance to the Audit Committee and the Board that risks within the Group are recognised, monitored and managed within acceptable parameters. Group Audit is fully independent of the Risk Division and the business, and seeks to ensure objective challenge to the effectiveness of the risk governance framework.

Mandate of the Risk Division – the objective of Risk Division is to provide both proactive advice and constructive challenge to the business. effectiveness of risk decisions taken by business management, providing proactive advice and guidance, reviewing, challenging and reporting on the risk profile of the Group and ensuring that mitigating actions are appropriate.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

It also has a key role in promoting the implementation of a strategic approach to risk management reflecting the risk appetite and RMF agreed by the Board that encompasses:

 

–embeddedoversighting embedding of effective risk management processes;
  
–transparent, focused risk monitoring and reporting;
  
–provision of expert and high quality advice and guidance to the Board, executives and management on strategic issues and horizon scanning, including pending regulatory changes; and
  
–a constructive dialogue with the first line through provision of advice, development of common methodologies, understanding, education, training, and development of new risk management tools.

Risk Division, headed by the Chief Risk Officer, consists of six risk directors and their specialist teams. These teams provide oversight and independent challenge to business management and support senior management and the Board with independent reporting on risks and opportunities. Risk directors, responsible for each risk type, meet on a regular basis under the chairmanship of the Chief Risk Officer to review and challenge the risk profile of the Group and to ensure that mitigating actions are appropriate.

 

The Chief Risk Officer is accountable for developing and leading an industry-wide recognised Risk function that adds value to the Group by:

 

–providing a regular comprehensive view of the Group’s risk profile key risksfor both current and emerging key risks, and associated management actions;
  
–(with input from the business areas and Risk Division) proposing Group risk appetite to the Board for approval (with input from the business areas and Risk division), and overseeing performance of the Group against risk appetite;
  
–developing an effective RMF which meets regulatory requirements for approval by the Board, and overseeing its execution and compliance; and
  
–challenging management on emerging risks and providing expert risk and control advice to help management maintain an effective risk and control framework.

 

The Risk Directors:Directors reporting to the Chief Risk Officer:

 

–provide independent advice, oversight and challenge to the business;
  
–design, develop and maintain policies, specific functional risk type frameworks and guidance to ensure alignment with business imperatives and regulatory requirements;
  
–establish and maintain appropriate governance structures, culture, oversight and monitoring arrangements which ensure robust and efficient compliance with relevant risk-typerisk type risk appetites and policies;
  
–lead regulatory liaison on behalf of the Group including horizon scanning and regulatory development for their risk type; and
  
–proposerecommend risk appetite and provide oversight of the associated risk profile across the Group.
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The primary role of Group Internal Audit (third line) is to help the Board and executive management protect the assets, reputation and sustainability of the Group. Group Internal Audit is led by the Group Chief Internal Auditor. Group Internal Audit provides independent assurance to the Audit Committee and the Board through performing reviews and engaging with committees/executive management, providing opinion and challenge on risk and the state of the control environment. Group Internal Audit is a single independent internal audit function, reporting to the Board Audit Committee of the Group and the Board Audit Committee of the key subsidiaries.

 

Risk identification, measurement and control – cycle from identification to reporting

To allow senior management to make informed risk decisions, the business follows a continuous risk management approach which includes producing appropriate, accurate and focused risk reporting. The risk and control cycle sets out how this should be approached, with the appropriate controls and processes in place. This cycle, from identification to reporting, ensures consistency and is intended to manage and mitigate the risks impacting the Group.

The process for risk identification, measurement and control is integrated into the overall framework for risk governance. Risk identification processes are forward lookingforward-looking to ensure emerging risks are identified. Risks are captured in comprehensive risk logs/registers, and measured using robust and consistent quantification methodologies. The measurement of risks includes the application of stress testing and scenario analysis, and considers whether relevant controls are in place before risks are incurred.

 

Risk monitoring, aggregation and reporting – identifiedIdentified risks are logged and reported on a monthly basis or as frequently as necessary to the appropriate committee. The extent of the risk is compared to the overall risk appetite as well as specific limits or triggers. When thresholds are breached, committee minutes are clear on the actions and timeframes required to resolve the breach and bring risk within given tolerances. There is a clear process for escalation of risks and risk events.

 

All business areas complete a Control Effectiveness Review (CER) annually, reviewing the effectiveness of their internal controls and putting in place a programme of enhancements where appropriate. Executives from each business area and each GECThe CER reports are approved at divisional risk committees or directly by the relevant member challenge and certifyof the Group Executive Committee to confirm the accuracy of theirthe assessment. This key process is overseen and independently challenged by Policy Owners, Risk Division anddivision, reviewed by Group Internal Audit against the findings of its assurance activities, and reported to the Board.

 

Culture – supportingRisk culture

Supporting the formal frameworks of the RMF is the underlying culture, or shared behaviours and values, which sets out in clear terms what constitutes good behaviour and good practice. In order to effectively manage risk across the organisation, the functions encompassed within the Three Linesthree lines of Defencedefence have a clear understanding of risk appetite, business strategy and an understanding of (and commitment to) the role they play in delivering it. A number of levers are used to reinforce the risk culture, including tone from the top, clear accountabilities, effective communication and challenge and an appropriately aligned performance incentive and structure.incentive.

 

ResourcesRisk resources and capabilities – appropriate

Appropriate mechanisms are in place to avoid over-reliance on key personnel or system/technical expertise within the Group. Adequate resources are in place to serve customers both under normal working conditions and in times of stress, and monitoring procedures are in place to ensure that the level of available resource can be increased if required. Colleagues undertake appropriate training to ensure they have the skills and knowledge necessary to enable them to deliver fair outcomes for customers, being mindful of the Group’s Conduct Strategy, Customer Treatment Policy/Standards and Financial Conduct Authority requirements.customers.

 

There is ongoing investment in risk systems and models alongside the Group’s investment in customer and product systems and processes. This drives improvements in risk data quality, aggregation and reporting leading to effective and efficient risk decisions.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

RISK GOVERNANCE

 

The risk governance structure below is integral to effective risk management across the Group. Risk Divisiondivision is appropriately represented on key committees to ensure that risk management is discussed in these meetings. This structure outlines the flow and escalation of risk information and reporting from business areas and Risk Divisiondivision to GECGroup Executive Committee and Board. Conversely, strategic direction and guidance is cascaded down from the Board and GEC.Group Executive Committee.

 

Company Secretariat supportsupports senior and Board levelBoard-level committees, and supportsupports the Chairs in agenda planning. This gives a further line of escalation outside the Three Linesthree lines of Defence.defence.

 

Table 1.2:Risk governance structure

 

Third line of defence – assurance Group Internal Audit Second Reporting Aggregation, escalation Independent challenge Independent challenge Reporting Audit Committee Board Board Risk Committee Group Chief Executive Group Chief Executive Committees Primary escalation Business area principal Enterprise Risk Committees First line of defence – risk management Independent challenge of both first and second lines of defence Reporting Aggregation, escalation Independent challenge Independent challenge Reporting Risk Division Committees and Governance Second line of defence – risk oversight

Group Chief Executive Committees

Group Executive Committee (GEC)

Group Risk Committee (GRC)

Group Asset and Liability Committee (GALCO)

Group Customer First Committee

Group Cost Management Committee

Conduct Review Committee

Group People Committee

Sustainability Committee

Senior Independent Performance

Adjustment and Conduct Committee

Group Strategic Review 3 Committee

Business area principal Enterprise Risk Committees

Commercial Banking Risk Committee

Retail Risk Committee

Insurance and Wealth Risk Committee

Community Banking Risk Committee

Group Transformation Risk Committees

Finance Risk Committee

People and Productivity Risk Committee

Group Corporate Affairs Risk Committee

Risk Division Committees and Governance

Credit risk

–Executive Credit Approval Committees
–Commercial Banking Credit Risk Committees
–Retail Credit Risk Committees

Market risk

–Group Market Risk Committee

Conduct, compliance and operational risk

–Group Conduct, Compliance and Operational Risk Committee

Fraud and financial crime risk

–Group Fraud and Financial Crime Prevention Committee

Financial risk

–Group Financial Risk Committee

Capital risk

–Group Capital Risk Committee

Model risk

–Group Model Governance Committee

Insurance underwriting risk through the governance arrangements for Insurance Group (Insurance Group is a separate regulated entity with its own Board, governance structure and Chief Risk Officer)


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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

BOARD, EXECUTIVE AND RISK COMMITTEES

 

The Group’s risk governance structure (see table 1.2) strengthens risk evaluation and management, while also positioning the Group to manage the changing regulatory environment in an efficient and effective manner.

 

Assisted by the Board Risk and Audit Committees, the Board approves the Group’s overall governance, risk and control frameworks and risk appetite. Refer to the Corporate Governance section on pages 156133 to 182,155, for further information on Board committees.

 

The divisional/Group’s Corporate Governance Framework applies across Lloyds Banking Group plc, Lloyds Bank plc, Bank of Scotland plc and HBOS plc. It is tailored where needed to meet the entity specific needs of Lloyds Bank plc and Bank of Scotland plc, and supplementary Corporate Governance Frameworks are in place to address sub-group specific requirements of the other sub-groups (LBCM, Insurance and LBG Equity Investments).

The divisional and functional risk committees review and recommend divisional/divisional and functional risk appetite and monitor local risk profile and adherence to appetite.

 

Insurance, which is subject to separate regulation, has its own Board and governance structure. The Insurance Board, assisted by a Risk Oversight Committee and Audit Committee, approves the governance, risk and control frameworks for the Insurance business and the Insurance business risk appetite, ensuring it aligns with the Group’s framework and risk appetite.

Table 1.3:Executive and Risk Committees

 

TheIn relation to the operation of Lloyds Banking Group plc, the Group Chief Executive is supported by the following:

 

Committees Risk focus
Group Executive Committee (GEC) SupportsAssists the Group Chief Executive in exercising his authority in relation to material matters having strategic, cross-business area or GroupwideGroup-wide implications.
Group Risk Committee (GRC) ReviewsResponsible for the development, implementation and recommendseffectiveness of the Group’s Risk Management Framework, the clear articulation of the Group’s risk appetite and governance, riskmonitoring and control frameworks, material Group policies andreviewing of the allocation of risk appetite. The committee also regularly reviewsGroup’s aggregate risk exposures and risk/ reward returns and approves material risk models.concentrations of risk.
Group Asset and Liability Committee (GALCO) Responsible for the strategic managementdirection of the Group’s assets and liabilities and the profit and loss implications of balance sheet management actions. It is also responsible forThe committee reviews and determines the risk management framework forappropriate allocation of capital, funding and liquidity and market risk liquidity risk, capitalresources and makes appropriate trade-offs between risk and earnings volatility.reward.
Group Customer First Committee (GCFC) Provides a GroupwideGroup-wide perspective on the progress of Group’s, Divisions’ and Functions’ implementation of initiatives whichto enhance the delivery of customer outcomes and customer trust, and setsets and promotepromotes the appropriate tone from the top to fulfil the Group’s visionvision.
Group Cost Management CommitteeLeads and shapes the Group’s approach to becomecost management, ensuring appropriate governance and process over Group-wide cost management activities and effective control of the Best BankGroup’s cost base.
Conduct Review CommitteeProvides senior management oversight, challenge and accountability in connection with the Group’s engagement with conduct review matters as agreed with the Group Chief Executive.
Group People CommitteeOversees the Group’s colleague policy, remuneration policy and Group-wide remuneration matters, oversees compliance with Senior Manager and Certification Regime (SM&CR) and other regulatory requirements, monitors colleague engagement surveys and ensures that colleague-related issues are managed fairly, effectively and compliantly.
Sustainability CommitteeRecommends and implements the strategy and plans for Customers and Helpdelivering the Group’s aspiration to be viewed as a trusted responsible business as part of the objective of Helping Britain Prosper.
Group Product GovernanceSenior Independent Performance Adjustment and Conduct Committee Provides strategicResponsible for providing recommendations regarding performance adjustment, including the individual risk-adjustment process and senior oversight over design, launchrisk-adjusted performance assessment, and managementmaking final decisions on behalf of products including new product approval, periodic product reviews and managementthe Group on the appropriate course of risk inaction relating to conduct breaches, under the back book.formal scope of the SM&CR.
Executive CompensationGroup Strategic Review 3 Committee Provides governanceResponsible for monitoring the progress of transformation across the Group, acting as a clearing house to resolve issues and oversight for Groupwide remuneration mattersfacilitate resolution of issues where necessary and policies.to drive the execution of the Group’s transformation agenda as agreed by the Group Chief Executive.
Pensions CommitteeSupports the Chief Financial Officer in relation to Group pension arrangements.
The Group Risk Committee is supplementedsupported through escalation and ongoing reporting by business area risk committees, cross-divisional committees addressing specific matters of Group-wide significance and the following second line of defence Risk committees towhich ensure effective oversight of risk management:
Credit Risk Committees Responsible for the development and effectiveness of the relevantReview material credit risk, management framework, clear descriptionboth current and emerging, and adherence to agreed risk appetite; approve or note the delegated approval of the Group’sdivisional and business level credit risk appetite, setting of credit policy and compliance with regulatory credit requirements.risk appetite; identify portfolio trends and risk appetite breaches and escalate to Group Risk Committee as appropriate; sanction new credit initiatives for automated and manual decisioning and collection and recoveries; oversight new business and portfolio credit risk performance, risks, opportunities, and concentrations; and oversight performance of collections and recoveries.
Group Market Risk Committee (GMRC) Reviews and recommends market risk appetites. Monitors and reviews the Group’s aggregateoversights market risk exposures across the Group and concentrationsadherence to Board Risk Appetite. Approves the framework and provides a proactivedesignation of books between the Trading Book and robust challenge around business activities giving rise to market risks.the Banking Book for regulatory purposes.
Group Conduct, Compliance and Operational Risk Committee Responsible for monitoring breaches,Acts as a Risk community forum to independently challenge and oversee the Group-wide risk and control environment, focusing on read-across of material events, key areas of regulatory focus and emerging horizon risks. Uses lessons learned and undertakes read-across from the three lines of defence to ensure that the Group-wide risk issuesprofile adapts to emerging risks, trends and conducting deep dive assessments on specific Conduct, Compliance or Operational Risk subjects to inform corrective action along with the sharing of information and best practice.
Group Financial Crime CommitteeReviews and challenges the management of financial crime risk including the overall strategy and performance and engagement with financial crime authorities. The committee is accountable for ensuring that, at Group level, financial crime risks are effectively identified and managed within risk appetite and that strategies for financial crime prevention are effectively co-ordinated and implemented across the Group.
Group Financial Risk CommitteeResponsible for reviewing, challenging and recommending to GEC/GRC, the Group Individual Liquidity Adequacy Assessment and Internal Capital Adequacy Assessment Process submissions, the Group Recovery Plan,themes, and the annual stress testingcontrol environment is sustainable to deliver the Bank of the Group’s operating plan, PRA and EBA stress tests, and any other analysis as required.
Group Model Governance CommitteeResponsible for setting the framework and standards for model governance across the Group, including establishing appropriate levels of delegated authority and principles underlying the Group’s risk modelling framework, specifically regarding consistency of approach across business units and risk types. It approves risk models other than material models which are approved by GRC.Future.
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

CommitteesRisk focus
Group Fraud and Financial Crime Prevention CommitteeEnsures development and application of fraud and financial crime risk management complies with the Group’s strategic aims, Group Corporate Responsibility, Group Risk Appetite and Group Fraud and Financial Crime Policies. Provides direction and appropriate focus on priorities to enhance the Group’s fraud and financial crime risk management capabilities in line with business and customer objectives whilst aligning to the Group’s target operating model.
Group Financial Risk CommitteeResponsible for oversighting, reviewing, challenging and recommending to senior executives and Board committees internal and Regulatory stress tests, Internal Capital Adequacy Assessment Process, Pillar 3 Disclosures, Recovery and Resolution Plans, and other analysis as required.
Group Capital Risk CommitteeResponsible for providing oversight of all relevant capital matters within the Group including the Group’s latest capital position and plans, risk appetite proposals, Pillar 2 developments, and the impact from regulatory reforms and accounting developments specific to capital.
Group Model Governance CommitteeResponsible for setting the model governance framework, the associated policy and related principles and procedures; reviewing and approving models, model changes, model extensions and capital post model adjustments; recommending approval to Group Risk Committee (GRC) of those models which require GRC approval; monitoring summary of model performance, approving any appropriate corrective actions; and monitoring performance against risk appetite and escalating as required.
Ring-Fenced Bank Perimeter Oversight CommitteeThe Committee escalates perimeter control breaches to the Ring-Fenced Banks’ Board Risk Committee and Boards.

FULL ANALYSIS OF RISK DRIVERSCATEGORIES

 

The Group’s risk framework covers all types of risk which affect the Group and could impact on the achievement of its strategic objectives. A detailed description of each category is provided below.on pages 51 to 103.

 

PRIMARY RISK DRIVERS

Credit
risk1		Conduct
risk1		Market
risk1		Operational
risk1		Funding
and liquidity
risk1		Capital
risk1		Regulatory
and legal
risk1		Insurance
risk1		People
risk1		Financial
reporting
risk		Governance
risk1
Page 56Page 93Page 94Page 101Page 103Page 111Page 117Page 117Page 118Page 119Page 120
1The Group considers these to be principal risks. See risk overview pages 42 to 45 for further details.

SECONDARY RISK DRIVERSRisk categories recognised by the Group are periodically reviewed to ensure that they reflect the Group risk profile in light of internal and external factors, such as the Group Strategy and the regulatory environment in which it operates. As part of a review of the Group’s risk categories, the secondary risk categories in the table below of Change, Data management and Operational resilience have been elevated to primary risk categories, and Strategic risk has been included as a new primary risk category, in the Group’s Risk Management Framework. These changes will be embedded during 2019.

 

Portfolio concentration

Primary risk

Counterparty credit

categories

Secondary risk

Country

risk

Collateral

management risk

categories		 

Customer risk

Product risk

Product

distribution/

advice risk

 

Interest rate

Credit risk

Equity risk

Foreign

exchange risk

Credit spread

risk

Inflation risk

Property risk

Alternative

assets risk

Basis risk

Commodity risk

– Retail credit– Commercial credit
Page 51 

Regulatory and

legal risk

– Regulatory compliance– Legal
Page 75
Conduct risk– Conduct
Page 75
Operational risk– Business process

Client money/

fiduciary

obligations

Conduct

process

– External service provision– Internal service provision
Page 76– Change– Financial crime

Fraud

People

process

Sourcing

Service
provision

Physical

security

– IT systems
– Cyber and information security– Financial reporting– Operational resilience
– Data management– Fraud– Physical security/health and safety

Information and

cyber security

IT systems

Change

Business

process

Financial

reporting

process

Governance

process

Risk process

Operational resilience

– Sourcing 

Funding risk

Liquidity risk

 

Capital

sufficiency

Capital

efficiency

People risk– People 

Compliance risk

Competition risk

Legal risk

Page 78 

Longevity risk

Mortality risk

Morbidity risk

Customer

behaviour

risk (including

persistency

risk)

Property

insurance risk

Expenses risk

 

Resourcing

Performance

and reward

Culture and

engagement

Talent and

succession

Learning

Wellbeing

Legal and

regulatory

(people)

Insurance underwriting risk– Insurance underwriting 

Financial and

prudential

regulatory

reporting

Tax reporting

and compliance

Pillar 3
disclosure

Financial delegated

authorities

Page 78 

Capital risk– Capital
Page 79
Funding and liquidity risk– Funding and liquidity
Page 88
Governance

Disclosure

risk

– Governance
Page 95
Market risk– Trading book– Pensions
Page 96– Banking book– Insurance
Model risk

Ethics

– Model
Page 102

 

The Group considers both reputational and financial impact in the course of managing all its risks and therefore does not classify reputational impact as a separate risk driver.category.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

CREDIT RISK

 

DEFINITION

 

TheCredit risk is defined as the risk that customers to whom we have lent money or other counterpartiesparties with whom we havethe Group has contracted fail to meet their financial obligations (both on and off balanceoff-balance sheet), resulting in loss to the Group.

RISK APPETITE

Credit risk appetite is described and reported on a monthly basis through a suite of Board metrics derived from credit portfolio performance measures. The Board metrics are supported by more detailed sub-Board appetite metrics at Divisional and Business level and by a comprehensive suite of credit risk appetite statements, credit policies, sector caps, and product and country limits to manage concentration risk and exposures within the Group’s approved risk appetite. The metrics cover but are not limited to geographic concentration, single name customer concentration, product exposure, Loan to Value ratios (LTVs), higher risk sector concentration, limit utilisation, leveraged exposure, equity exposure, affordability and the obligor quality of new to bank lending.

Credit risk appetite statements and credit policies are regularly reviewed to ensure that the metrics continue to reflect the Group’s risk appetite appropriately. For further information on risk appetite, refer to page 46..

 

EXPOSURES

 

The principal sources of credit risk within the Group arise from loans and advances, contingent liabilities, commitments, debt securities and derivatives to customers, financial institutions and sovereigns. The credit risk exposures of the Group are set out in note 5352 on page F-91. Credit risk exposures are categorised as ‘retail’, arising primarily in the Retail, Consumer Finance and Run-off divisions, and some small and medium sized enterprises (SMEs) and ‘corporate’ (including corporates, banks, financial institutions, sovereigns and larger SMEs) arising primarily in the Commercial Banking, Run-off and Insurance divisions and Group Corporate Treasury (GCT).F-88.

 

In terms of loans and advances (for example mortgages, term loans and overdrafts) and contingent liabilities (for example credit instruments such as guarantees and standby, documentary and commercial letters of credit), credit risk arises both from amounts advanced and commitments to extend credit to a customer or bank as required within documentation.bank. With respect to commitments to extend credit, the Group is potentially exposed to a loss inup to an amount equal to the total unusedunutilised commitments. However, the likely amount of loss ismay be less than the total unusedunutilised commitments, as most retail and certain commercial lending commitments to extend credit canmay be cancelled without notice andbased on regular assessment of the prevailing creditworthiness of customers is monitored regularly.customers. Most commercial term commitments to extend credit are also contingent upon customers maintaining specific credit standards, which together with the creditworthiness of customers are monitored regularly.standards.

 

Credit risk also arises from debt securities and derivatives. The total notional principal amount of interest rate, exchange rate, credit derivative and other contracts outstanding at 31 December 20152018 is shown on page 65.64. The notional principal amount does not, however, represent the Group’s credit risk exposure, which is limited to the current cost of replacing contracts with a positive value to the Group. Such amounts are reflected in note 5352 on page F-90.F-88.

Additionally, credit risk arises from leasing arrangements where the Group is the lessor. Note 2(J) on page F-14 provides details on the Group’s approach to the treatment of leases.

 

Credit risk exposures in the Insurance businessand Wealth division largely result from holding bond and loan assets, in thetogether with some related swaps, shareholder funds (including the annuity portfolio) and from exposure to reinsurers.

 

The investments held in the Group’s defined benefit pension schemes also expose the Group to credit risk. Note 3135 on page F-46F-52 provides further information on the defined benefit pension schemes’ assets and liabilities.

 

Loans and advances, contingent liabilities, commitments, debt securities and derivatives also expose the Group to refinance risk. Refinance risk is the possibility that an outstanding exposure cannot be repaid at its contractual maturity date. If the Group does not wish to refinance the exposure then there is refinance risk if the obligor is unable to repay by securing alternative finance. This may be becauseoccur for a number of reasons which may include: the borrower is in financial difficulty, or because the terms required to refinance are outside acceptable appetite at the time.time or the customer is unable to refinance externally due to a lack of market liquidity. Refinance risk exposures are managed in accordance with the Group’s existing credit risk policies, processes and controls and are not considered to be material given the Group’s prudent and through the cycle credit risk appetite. Where heightened refinance risk exists (such as in Commercial Banking’s Business Support Unit (BSU) or the Run-off book) exposures are minimised through intensive account management and, would bewhere appropriate, are impaired and/or forborne where appropriate.classed as forborne.

 

MEASUREMENT

 

In measuring theThe process for credit risk identification, measurement and control is integrated into the Board-approved framework for credit risk appetite and governance.

Credit risk is measured from different perspectives using a range of loansappropriate modelling and advancesscoring techniques at a number of levels of granularity, including total balance sheet, individual portfolio, pertinent concentrations and individual customer – for both new business and existing lending. Key metrics such as total exposure, risk-weighted assets, new business quality, concentration risk and portfolio performance, are reported monthly to customersRisk Committees.

Measures such as expected credit loss (ECL), risk-weighted assets, observed credit performance, predicted credit quality (usually from predictive credit scoring models), collateral cover and quality and other credit drivers (such as cash flow, affordability, leverage and indebtedness) are used to enable effective risk measurement across the Group.

In addition, stress testing and scenario analysis are used to estimate impairment losses and capital demand forecasts for both regulatory and internal purposes and to banks at a counterparty level, the Group reflects three components:

(i) the ‘probability of default’ by the counterparty on its contractual obligations; (ii) current exposures to the counterparty and their likely future development, from which the Group derives the ‘exposure at default’; and (iii) the likely loss ratio on the defaulted obligations (the ‘loss given default’).

For regulatory capital purposes the Group’s rating systems assess probability of default and if appropriate, exposure at default and loss given default, in order to derive an expected loss. If not appropriate, regulatory prescribed exposure at default and loss given default values are used in order to derive Risk-Weighted Assets (RWAs) and regulatory Expected Loss (EL). In contrast, impairment allowances are recognised for financial reporting purposes only for loss events that have occurred at the balance sheet date, based on objective evidence of impairment. Due to the different methodologies applied, the amount of incurred credit losses provided forassist in the financial statements differs from the amount determined from the regulatory expected loss models. Note 2(H) on page F-15 provides details of the Group’s approach to the impairment of financial assets.

The obligor quality measurement of both retail and commercial counterparties is largely based on the outcomesformulation of credit risk (probability of default – PD) models. The Group operates a number of different regulatory rating models, typically developed internally using statistical analysis and management judgement – retail models rely more on the former, commercial models include moreappetite.

As part of the latter, especially‘three lines of defence’ model, Risk division is the second line of defence providing oversight and independent challenge to key risk decisions taken by business management. Risk division also tests the effectiveness of credit risk management and internal credit risk controls. This includes ensuring that the control and monitoring of higher risk and vulnerable portfolios/sectors is appropriate and confirming that appropriate loss allowances for impairment are in the larger corporateplace. Output from these reviews help to inform credit risk appetite and more specialised lending portfolios. Internal data is supplemented with external data in model development, where appropriate.credit policy.

 

As the third line of defence, Group Internal Audit undertakes regular risk-based reviews to assess the effectiveness of credit risk management and controls. The models vary, inter alia, in the extent to which they are ‘point in time’ versus ‘through the cycle’. The models are subject to rigorous validation and oversight/governance including, where appropriate, benchmarking toGroup’s external information.auditors also review adequacy at each quarter-end.

 

In commercial portfoliosFollowing the PD models segment counterparties into a numberintroduction of rating grades,IFRS 9, underlying processes and key controls have been updated with each grade representing a defined rangeadditional management information produced to assist in monitoring portfolio quality and provision coverage. Group governance and oversight of default probabilities, and there are a number of different model rating scales. Counterparties/exposures migrate between rating grades if the assessment of the PD changes. The modelled PDs ‘map’ through local scales to a single Corporate (non-retail) Master Scale comprising of 19 non-default ratings. Together with four default ratings the Corporate Master Scale forms the basis on which internal reporting is completed.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

In the principal retail portfolios, exposure at default and loss given default models are also in use. For regulatory reporting purposes, counterparties are also segmented into a number of rating grades, each representing a defined range of default probabilities and exposures migrate between rating grades if the assessment of the counterparty probability of default changes. The Retail Master scale comprises 13 non-default ratings and 1 default rating.impairments remains largely unchanged.

 

MITIGATION

 

The Group uses a range of approaches to mitigate credit risk.

 

Prudent, through the cycle credit principles, risk policies and appetite statements:The the independent Risk Divisiondivision sets out the credit principles, credit risk policies and credit risk appetite statements. Principles and policies are reviewed regularly, and any changesThese are subject to aregular review and governance, with any changes subject to an approval process. Policies and risk appetite statements, where appropriate, are supported by procedures, which provide a disciplined and focused benchmark for credit decisions. Risk oversight teams monitor credit performance trends, review and challenge exceptions to planned outcomes, and test the adequacy ofand adherence to credit risk infrastructurepolicies and governance processes throughout the Group, whichGroup. This includes tracking portfolio performance against an agreed set of keycredit risk appetite tolerances. Oversight and reviews are also undertaken by Group Audit and Credit Risk Assurance.

 

Strong rating systemsRobust models and controls:The Group has established an independent team in the Risk Division that sets common minimum standards, designed to ensure see Model risk models and associated rating systems are developed consistently and are of sufficient quality to support business decisions and meet regulatory requirements. Internal rating systems are developed and owned by the Risk Division. The designated model owner takes responsibility for ensuring the validation of the rating systems, supported and challenged by an independent specialist Group function.on page 102.

 

Limitations on concentration risk: Credit risk management includesthere are portfolio controls on certain industries, sectors and product linesproducts to reflect risk appetite as well as individual, customer and bank limit guidelines.risk tolerances. Credit policies and appetite statements are aligned to the Group’s risk appetite and restrictsrestrict exposure to higher risk countries and morepotentially vulnerable sectors and segments.asset classes. Note 1852 on page F-38F-88 provides an analysis of loans and advances to customers by industry (for commercial customers) and product (for retail customers). Exposures are monitored to prevent both an excessive concentration of risk and single name concentrations. These concentration risk controls are not necessarily in the form of a maximum limit on exposure, but may instead require new business in concentrated sectors to fulfil additional certain minimum policy and/or guideline requirements. The Group’s largelargest exposures are detailed toregularly monitored by the Board Risk Committee and reported in accordance with regulatory reporting requirements.

 

RobustDefined country risk management:management framework:The the Board sets a broad maximum country risk appetite. Within this, country limits are authorised by the Executive Credit Approval Committee approves the Group country risk framework and sovereign limits on an annual basis. Risk based appetite committee,for all countries is set within the independent Risk division, taking into account economic, financial, political and social factors. Group policies stipulate that these limits must be consistent with, and support,factors as well as the approved business and strategic plans of the Group.

51

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Specialist expertise:Credit credit quality is managed and controlled by a number of specialist units within the business and Risk Division providing,division, which provide for example: intensive management and control (see Intensive carecontrol; security perfection; maintenance of customers in financial difficulty); security perfection, maintenancecustomer and retention;facility records; expertise in documentation for lending and associated products; sector specific expertise; and legal services applicable to the particular market placesegments and product rangeranges offered by the business.Group.

 

Stress testing and scenario analysis:testing: Thethe Group’s credit portfolios are also subjectedsubject to regular stress testing, withtesting. In addition to the Group led, PRA, EBA and other regulatory stress scenario assessments run at various levels of the organisation. Exercisestests, exercises focused on individual divisions and portfolios are performed in addition to the Group led and regulatory stress tests.also performed. For further information on the stress testing process, methodology and governance refer tosee page 49.45.

 

Frequent and robust credit risk oversight and assurance:Undertaken oversight and assurance of credit risk is undertaken by independent Credit Risk Assurancecredit risk oversight functions operating within Retail and Consumer Credit Riskcredit risk and Commercial Bankingbanking risk which are part of the Group’s second line of defence. ItsTheir primary objective is to provide reasonable and independent oversight that credit risk is being effectively managed withand to ensure that appropriate and effective controls.

Group Audit performs the third line of credit risk assurance. A specialist team within Group Audit, comprising experienced credit professionals, iscontrols are in place and being adhered to. Group Internal Audit also provides assurance to carry out independent risk based internal control audits, providing an assessment of the effectiveness of internal credit controls, credit risk classification and the raising of impairment provisions. These audits cover the diverse range of the Group’s businesses and activities, and include both ’standard’ risk based audits and reviews as well as bespoke assignments to respond to any emerging risks or regulatory requirement. The work of Group Audit therefore continues to provide executive, senior management and Board Audit Committee with assurance on the effectiveness of credit risk management controls as well as appropriateness of impairments.

Additional mitigation for Retail and Consumer Finance customers

The Group uses a variety of lending criteria when assessing applications for mortgages and unsecured lending. The general approval process uses credit acceptance scorecards and involves a review of an applicant’s previous credit history using information held by Credit Reference Agencies (CRA). The Group also assesses the affordability of the borrower under a stressed interest rate scenario. In addition, the Group has in place quantitative limits such as product maximum limits, the level of borrowing to income and the ratio of borrowing to collateral. Some of these limits relate to internal approval levels and others are hard limits above which the Group will reject the application. The Group also has certain criteria that are applicable to specific products such as for applications for a mortgage on a property that is to be let by the applicant, Retail and Consumer Finance affordability assessments are compliant with relevant regulatory conduct guidelines.

For UK mortgages,across the Group’s policy is to reject all standard applications with a Loan to Value (LTV) greater than 90 per cent. Applications with a LTV up to 95 per cent are permitted for certain schemes, for example the UK government’s Help to Buy scheme. For mainstream mortgages the Group has maximum per cent LTV limits which depend upon the loan size. These limits are currently:

Table 1.4: UK mainstream loan to value analysis

Loan size FromToMaximum LTV
£1£570,00095%
£570,001£750,00090%
£750,001£1,000,00085%
£1,000,001£2,000,00080%
£2,000,001£5,000,00070%

For mainstream mortgages greater than £5,000,000 the maximum LTV is 50 per cent. Buy-to-let mortgages are limited to a maximum of £1,000,000 and 75 per cent LTV. All mortgage applications above £500,000 are subject to manual underwriting.

57

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The Group’s approach to underwriting applications for unsecured products ensures that lending is affordable and sustainable. The Group takes reasonable steps to validate information used in the assessment of a customer’s income and expenditure. The Group rejects any application for an unsecured lending product where a customer is registered as bankrupt or insolvent, or has a County Court Judgment in excess of £1,000 registered at a CRA used by the Group. In addition, the Group rejects any applicant with total unsecured debt greater than £50,000 registered at the CRA; policy rules are also in place to provide additional scrutiny to applications where an applicant’s total unsecured debt-to-income ratio greater than 100 per cent.

Where credit acceptance scorecards are used, Risk Division reviews model effectiveness, while new models and model changes are referred by them to the appropriate Model Governance Committees for approval. All changes are approved in accordance with the governance framework set by the Group Model Governance Committee.

Additional mitigation for Commercial customers

Individual credit assessment and independent sanction of customer and bank limits: with the exception of small exposures to SME customers where relationship managers have limited delegated sanctioning authority, credit risk in commercial customer portfolios are subject to sanction by the independent Risk Division, which considers the strengths and weaknesses of individual transactions, the balance of risk and reward, and how credit risk aligns to the Group’s risk appetite. Exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities and limit guidelines. Approval requirements for each decision are based on a number of factors including the transaction amount, the customer’s aggregate facilities, credit risk ratings and the nature and term of the risk. The Group’s credit risk appetite criteria for counterparty and customer underwriting is generally the same as that for assets intended to be held to maturity. All underwriting must be sanctioned via credit limits.

Counterparty limits: Limits are set against all types of exposure in a counterparty name, in accordance with an agreed methodology for each exposure type. This includes credit risk exposure on individual derivative transactions, which incorporates potential future exposures from market movements against agreed confidence intervals. Aggregate facility levels by counterparty are set and limit breaches are subject to escalation procedures.

Daily settlement limits: Settlement risk arises in any situation where a payment in cash, securities or equities is made in the expectation of a corresponding receipt in cash, securities or equities. Daily settlement limits are established for each counterparty to cover the aggregate of all settlement risk arising from the Group’s market transactions on any single day.activities.

 

Collateral

The principal types of acceptable collateral types for loans and advances, contingent liabilities and derivatives with commercial and bank counterparties/customers are:include:

 

– properties;

– charges over business assets such as premises, inventory and accounts receivables;

– financial instruments such as debt securities;

– vehicles;

– cash; and

– guarantees received from third parties.

– residential and commercial properties;
–charges over business assets such as premises, inventory and accounts receivable;
–financial instruments such as debt securities;
–vehicles;
–cash; and
–guarantees received from third-parties.

 

The Group maintains appetite guidelinesparameters on the acceptability of specific classes of collateral.

For non-mortgage retail lending to small businesses, collateral may include second charges over residential property and the assignment of life cover.

 

Collateral held as security for financial assets other than loans and advances is determined by the nature of the underlying exposure. Debt securities, including treasury and other bills, are generally unsecured, with the exception of asset-backed securities and similar instruments such as covered bonds, which are secured by portfolios of financial assets. Collateral is generally not held against loans and advances to financial institutions, except whereinstitutions. However, securities are held as part of reverse repurchase or securities borrowing transactions or where a collateral agreement has been entered into under a master netting agreement. Derivative transactions with wholesalefinancial counterparties are typically collateralised under a Credit Support Annex (CSA) in conjunction with the ISDAInternational Swaps and Derivatives Association (ISDA) Master Agreement. Derivative transactions with non-banknon-financial customers are not usually supported by a CSA.

 

No collateral is held in respect of retail credit card or unsecured personal lending. For non-mortgage retail lending to small businesses, collateral may include second charges over residential property and the assignment of life cover.

It is policy that commercialCommercial lending decisions must be based on an obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. The types ofrequirement for collateral taken and the requirement for which collateral is requiredtype to be taken at origination is dependentwill be based upon the nature of the transaction and the credit quality, size and structure of the borrower. For non-retail exposures if required, the Group will often require theseek that any collateral to include a first charge over land and buildings owned and occupied by the business, a mortgage debenture over the company’s undertaking and one or more of itsthe assets of a company or limited liability partnership, personal guarantees, limited in amount, from the directors of a company or limited liability partnership and key man insurance. The Group maintains policies setting out acceptable collateral bases for valuation, maximum LTVloan to value (LTV) ratios and other criteria that are to be considered when reviewing an application. The decision as to whether or not collateral is required will be based upon the nature of the transaction and the credit worthiness of the customer/counterparty. Other than for project finance, object finance and income producing real estate where charges over the subject assets are a basic requirement,required, the provision of collateral will not determine the outcome of an application. Notwithstanding this, the fundamental business proposition must evidence the ability of the business to generate funds from normal business sources to repay a customer/customer or counterparty’s financial commitment.

 

The extent to which collateral values are actively managed will depend on the credit quality and other circumstances of the obligor and type of underlying transaction. Although lending decisions are based on expected cash flows, any collateral provided may impact the pricing and other terms of a loan or facility granted. This will have a financial impact on the amount of net interest income recognised and on internal loss given default estimates that contribute to the determination of asset quality and returns.

 

Collateral values are rigorously assessed at the time of loan origination. It is the Group’s policy thatThe Group requires collateral should alwaysto be realistically valued by an appropriately qualified source, independent of both the credit decision process and the customer, at the time of borrowing. In certain circumstances, for Retail residential mortgages this may include the use of automated valuation models based on market data, subject to accuracy criteria and LTV limits. Where third-parties are used for collateral valuations, they are subject to regular monitoring and review. Collateral values are reviewed on a regular basis andsubject to review, which will vary according to the type of lending, collateral involved and account performance. Such reviews are undertaken to confirm that the value recorded remains appropriate and whether revaluation is required, considering for example, account performance, market conditions and any information available that may indicate that the value of the collateral involved. For residential mortgages,has materially declined. In such instances, the Group may seek additional collateral and/or other amendments to the terms of the facility. The Group adjusts openestimated market property values to take account of the costs of realisation and any discount associated with the realisation of the collateral when estimating credit losses. In order to minimise the credit loss, the Group may seek additional collateral from the counterparty as soon as early warning signs are identified for the relevant individual loans and advances.

 

The Group considers risk concentrations by collateral providers and collateral type as appropriate, with a view to ensuring that any potential undue concentrations of risk are identified and suitably managed by changes to strategy, policy and/or business plans.

 

Credit policies are in placeThe Group seeks to avoid correlation or wrong way risk.wrong-way risk where possible. Under the repo policies,Group’s repurchase (repo) policy, the issuer of the collateral and the repo counterparty should be neither the same nor connected. The same rule applies for derivatives under collateral policies. Thederivatives. Risk Divisiondivision has the necessary discretion to

58

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

extend this rule to other cases where there is significant correlation. Countries with a rating equivalent to AA- and aboveor better may be considered to have no adverse correlation between the counterparty domiciled in thethat country and thatthe country of risk (issuer of securities).

 

Refer to note 5352 on page F-88 for further information on collateral.

 

Additional mitigation for Retail customers

The Group uses a variety of lending criteria when assessing applications for mortgages and unsecured lending. The general approval process uses credit acceptance scorecards and involves a review of an applicant’s previous credit history using internal data and information held by Credit Reference Agencies (CRA).

The Group also assesses the affordability and sustainability of lending for each borrower. For secured lending this includes use of an appropriate stressed interest rate scenario. Affordability assessments for all lending are compliant with relevant regulatory and conduct guidelines. The Group takes reasonable steps to validate information used in the assessment of a customer’s income and expenditure.

In addition, the Group has in place quantitative limits such as maximum limits for individual customer products, the level of borrowing to income and the ratio of borrowing to collateral. Some of these limits relate to internal approval levels and others are policy limits above which the Group will typically reject borrowing applications. The Group also applies certain criteria that are applicable to specific products for example applications for buy-to-let mortgages.

52

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

For UK mortgages, the Group’s policy permits owner occupier applications with a maximum LTV of 95 per cent. Applications with an LTV above 90 per cent are subject to enhanced underwriting criteria, including higher scorecard cut-offs and loan size restrictions.

Buy-to-let mortgages within Retail are limited to a maximum loan size of £1,000,000 and 75 per cent LTV. Buy-to-let applications must pass a minimum rental cover ratio of 125 per cent under stressed interest rates, after applicable tax liabilities. Portfolio Landlords (customers with four or more mortgaged buy-to-let properties) are subject to additional controls including evaluation of overall portfolio resilience.

The Group’s policy is to reject any application for a lending product where a customer is registered as bankrupt or insolvent, or has a recent County Court Judgment or financial default registered at a CRA used by the Group above de minimis thresholds. In addition, the Group typically rejects applicants where total unsecured debt, debt-to-income ratios, or other indicators of financial difficulty exceed policy limits.

Where credit acceptance scorecards are used, new models, model changes and monitoring of model effectiveness are independently reviewed and approved in accordance with the governance framework set by the Group Model Governance Committee.

Additional mitigation for Commercial customers

Individual credit assessment and independent sanction of customer and bank limits:with the exception of small exposures to SME customers where certain relationship managers have limited delegated sanctioning authority, credit risk in commercial customer portfolios is subject to sanction by the independent Risk division, which considers the strengths and weaknesses of individual transactions, the balance of risk and reward and how credit risk aligns to the Group and Divisional risk appetite. Exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities and risk based recommended maximum limit parameters. Approval requirements for each decision are based on a number of factors including, but not limited to, the transaction amount, the customer’s aggregate facilities, credit policy, risk appetite, credit risk ratings and the nature and term of the risk. The Group’s credit risk appetite criteria for counterparty and customer underwriting is generally the same as that for assets intended to be held to maturity. All hard underwriting must be sanctioned by Risk division. A pre-approved credit matrix may be used for ‘best efforts’ underwriting.

Counterparty credit limits:limits are set against all types of exposure in a counterparty name, in accordance with an agreed methodology for each exposure type. This includes credit risk exposure on individual derivatives and securities financing transactions, which incorporates potential future exposures from market movements against agreed confidence intervals. Aggregate facility levels by counterparty are set and limit breaches are subject to escalation procedures.

Daily settlement limits: settlement risk arises in any situation where a payment in cash, securities or equities is made in the expectation of a corresponding receipt in cash, securities or equities. Daily settlement limits are established for each relevant counterparty to cover the aggregate of all settlement risk arising from the Group’s market transactions on any single day.

Master netting agreements

 

Where itIt is appropriate and likely to be effective, thecredit policy that a Group seeks to enter intoapproved master netting agreements. Although masteragreement must be used for all derivative and traded product transactions and must be in place prior to trading. This requirement extends to trades with clients and the counterparties used for the Bank’s own hedging activities, which may also include clearing trades with Central Counterparties (CCPs). Any exceptions must be approved by the appropriate credit sanctioner. Master netting agreements do not generally result in an offset of balance sheet assets and liabilities for accounting purposes, as transactions are usually settled on a gross basis, theybasis. However, within relevant jurisdictions and for appropriate counterparty types master netting agreements do reduce the credit risk to the extent that, if an event of default occurs, all amountstrades with the counterparty aremay be terminated and settled on a net basis. The Group’s overall exposure to credit risk on derivative instruments subject to master netting agreements can change substantially within a short period, since this is the net position of all trades under the master netting agreement.

 

Other credit risk transfers

 

The Group also undertakes asset sales, credit derivative based transactions and securitisations as a means of mitigating or reducing credit risk, taking into account the nature of assets and the prevailing market conditions.

 

MONITORING

 

In conjunction with Risk Division,division, businesses identify and define portfolios of credit and related risk exposures and the key benchmarks, behaviours and characteristics by which those portfolios are managed and monitored in terms of credit risk exposure.monitored. This entails the production and analysis of regular portfolio monitoring reports for review by senior management. Risk Divisiondivision in turn produces an aggregated reviewview of credit risk throughoutacross the Group, including reports on significantmaterial credit exposures, concentrations, concerns and other management information, which areis presented to the Divisional Risk Committees,divisional risk committees, Group Risk Committee and the Board Risk Committee.

 

Models

The performance of all rating models used in credit risk is monitored on a regular basis, in order to seek to ensure that models provide appropriate risk differentiation capability, the generated ratings remain as accurate and robust as practical, and the models assign appropriate risk estimates to grades/pools. All models are monitored against a series of agreed key performance indicators. In the event that the monitoring identifies material exceptions or deviations from expected outcomes, these will be escalated in accordanceline with the Group’s governance framework set by the Group– see Model Governance Committee.risk on page 102.

 

Intensive care of customers in financial difficulty

 

The Group operates a number of treatmentssolutions to assist borrowers who are experiencing financial stress. The material elements of these treatmentssolutions through which the Group has granted a concession, whether temporarily or permanently, are set out below.

 

Retail and Consumer Finance customers

Forbearance

The Group’s aim in offering forbearance and other assistance to retail customers in financial distress is to benefit both the customer and the Group by discharging the Group’s regulatory and social responsibilities to supportsupporting its customers and actacting in their best long-term interests and by, where possible, bringing customer facilities back into a sustainable position which, for residential mortgages, also means keeping customers in their homes. position.

The Group offers a range of tools and assistance to support retail customers who are encountering financial difficulties. Cases are managed on an individual basis, with the circumstances of each customer considered separately and the action taken judged as being affordableappropriate and sustainable for both the customer. Operationally,customer and the Group.

The provision and review of such assistance is controlled through the application of an appropriate policy framework controls around the execution of policy, regularand associated controls. Regular review of the different treatmentsassistance offered to customers is undertaken to confirm that they remainit remains appropriate, alongside monitoring of customers’ performance and the level of payments received, and management visibility of the nature and extent of assistance provided and the associated risk.

Assistance is provided through trained colleagues in branches and dedicated telephony units, and via online guidance material. For those customers requiring more intensive help, assistance is provided through dedicated support units where tailored repayment programmes can be agreed. Customers are actively supported and referred to free money advice agencies when they have multiple credit facilities, including those at other lenders that require restructuring. Within the Collections and Recoveries functions, the sharing of best practice and alignment of policies across the Group has helped to drive more effective customer outcomes and achieve operational efficiencies.received.

 

The specific tools available to assist customers vary by product andGroup classifies accounts as forborne at the customer’s status. In definingtime a customer in financial difficulty is granted a concession. Accounts are classified as forborne for a minimum of two or three years, dependent on whether the treatments offered to customers who have experienced financial distress,exposure is performing or non-performing when the Group distinguishes between the following categories:concession is applied.

 

Forbearance measures consist of concessions towards a debtor that is experiencing or about to experience difficulties in meeting its financial commitments. This can include modification of the previous terms and conditions of a contract or a total or partial refinancing of a troubled debt contract, either of which would not have been required had the debtor not been experiencing financial difficulties.

Non-performing exposures can be reclassified as Performing Forborne after a minimum 12 month cure period, providing there are no past due amounts or concerns regarding the full repayment of the exposure. A minimum of a further 24 months must pass from the date the forborne exposure was reclassified as Performing Forborne before the account can exit forbearance. If conditions to exit forbearance are not met at the end of this probation period, the exposure shall continue to be identified as forborne until all the conditions are met.

–Reduced payment arrangements: a temporary arrangement for customers in financial distress where arrears accrue at the contractual payment, for example short-term arrangements to pay.
–Term extensions: a permanent account change for customers in financial distress where the overall term of the mortgage is extended, resulting in a lower contractual monthly payment.
–Repair: a permanent account change used to repair a customer’s position when they have emerged from financial difficulty, for example capitalisation of arrears.53

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

CUSTOMERS RECEIVING SUPPORT FROM

The Group’s treatment of loan renegotiations is included in the impairment policy in note 2(H) on page F-13.

Customers receiving support from UK GOVERNMENT SPONSORED PROGRAMMESgovernment sponsored programmes

To assist customers in financial distress, the Group also participates in or benefits from, the following UK government sponsored programmes for households:households, including the Income Support for Mortgage Interest programme, under which the government paid all or part of the interest on the mortgage on behalf of the customer. The Income Support for Mortgage Interest programme changed from a benefit to a government loan, with effect from 6 April 2018. The Group estimates that customers representing approximately £0.4 billion (2017: £1.6 billion) of its mortgage exposures are receiving such support.

 

THE GROUP CREDIT RISK PORTFOLIO IN 2018

Overview

–Income Support for Mortgage Interest – This isCredit quality remains strong with no deterioration in credit risk. Flow to arrears remains stable at low levels. The Group’s loan portfolios continue to be well positioned, reflecting the Group’s continued prudent, through the cycle approach to credit risk and benefiting from continued low interest rates and a government medium term initiative that provides certain defined categories of customers, principally those who are unemployed, access to a benefit scheme, paid for by the government, which covers all or part of the interest on the mortgage. Qualifying customers are able to claim for mortgage interest on up to £200,000 of the mortgage. All decisions regarding an individual’s eligibility and any amounts payable under the scheme rest solely with the government. Payments are made directly to the Group by the Department of Work and Pensions.resilient UK economy.
  
–Mortgage Rescue Schemes The gross asset quality ratio remains stable at 28 basis points, in line with 2017 and 2016.
– This isThe net asset quality ratio increased to 21 basis points (2017: 18 basis points) and the impairment charge increased to £937 million in 2018 (2017: £795 million), driven by expected lower releases and write-backs, the inclusion of MBNA for a government initiative for borrowersfull year and a low impairment charge in difficulty and facing repossession, who would have priority for re-housingSecured compared to one-off write-backs in 2017.
–The closed mortgage book continued to run off, reducing by a local authority (e.g. the elderly, disabled, single parents)further £2.4 billion during 2018. Eligible
–Stage 2 loans as a proportion of total loans and advances to customers can have their property bought in full or partreduced to 5.2 per cent (1 January 2018: 8.0 per cent), with Stage 2 loans and advances down by £11.9 billion to £25.3 billion driven by the social rented sectorsale of the Irish mortgage portfolio, model refinements to the Stage 2 transfer approach for Secured and then remain in their homeportfolio improvements. Coverage of Stage 2 drawn balances increased to 4.2 per cent (1 January 2018: 3.4 per cent).
–Stage 3 loans as a tenant or shared equity partner. Ifproportion of total loans and advances to customers have remained broadly stable at 1.2 per cent (1 January 2018: 1.1 per cent), with Stage 3 loans and advances up £0.6 billion to £5.7 billion. Coverage of Stage 3 drawn balances decreased to 28.4 per cent (1 January 2018: 29.8 per cent).

Low risk culture and prudent risk appetite

– The Group continues to take a prudent approach to credit risk, with robust credit quality and affordability controls at origination and a prudent through the propertycycle credit risk appetite.
–Credit portfolios are well positioned against an uncertain economic outlook and potential market volatility, including that related to the UK’s exit from the EU.
–The Group continues to grow lending to targeted segments while maintaining a prudent risk appetite.
–The Group’s effective risk management ensures early identification and management of customers and counterparties who may be showing signs of distress.
–Sector concentrations within the portfolios are closely monitored and controlled, with mitigating actions taken where appropriate. Sector and product caps limit exposure to certain higher risk and vulnerable sectors and asset classes.

Table 1.4: Group impairment charge

  Loans
and
advances
to banks
and other assets
£m		  Loans
and
advances
to customers
£m		  Financial
assets at
fair value
through other
comprehensive
income
£m		  Undrawn
balances
£m		  2018
Total
£m		 
Retail  –   889   –   (27)  862 
Commercial Banking  1   150   (14)  (45)  92 
Insurance and Wealth  –   1   –   –   1 
Central Items  1   (18)  –   (1)  (18)
Total impairment charge  2   1,022   (14)  (73)  937 
Asset quality ratio                  0.21% 
Gross asset quality ratio                  0.28% 
                     
Table 1.5:Group total expected credit loss allowance
                     
          At 31 Dec
2018
£m		  At 1 Jan
2018
£m		  At 31 Dec
20171
£m		 
Customer related balances                    
Drawn          3,150   3,223   2,201 
Undrawn          193   273   30 
           3,343   3,496   2,231 
Other assets          19   37   26 
Total ECL allowance          3,362   3,533   2,257 

1Prior period comparatives are on an IAS 39 basis.
54

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Group loans and advances to customers

The following pages contain analysis of the Group’s loans and advances to customers by sub-portfolio. Loans and advances to customers are categorised into the following stages:

Stage 1 assets comprise newly originated assets (unless purchased or originated credit impaired), as well as those which have not experienced a significant increase in credit risk. These assets carry an expected credit loss (ECL) allowance equivalent to the ECL that results from those default events that are possible within 12 months of the reporting date (12 month ECL).

Stage 2 assets are those which have experienced a significant increase in credit risk since origination. These assets carry an ECL equivalent to the ECL arising over the lifetime of the asset (lifetime ECL).

Stage 3 assets have either defaulted or are otherwise considered to be credit impaired. These assets carry a lifetime ECL.

Purchased or originated credit impaired assets (POCI) are those that have been originated or acquired in a credit impaired state. This includes within the definition of credit impaired the purchase of a financial asset at a deep discount that reflects impaired credit losses.

Table 1.6:Group loans and advances to customers

  Total
£m		  Stage 1
£m		  Stage 2
£m		  Stage 3
£m		  Purchased or
originated
credit-impaired
£m		  Stage 3
as % of
total
%		 
At 31 December 20181                        
Retail  341,682   305,160   18,741   2,390   15,391   0.7 
Commercial Banking  101,890   92,002   6,592   3,296   –   3.2 
Insurance and Wealth  865   804   6   55   –   6.4 
Central items  43,571   43,565   6   –   –   – 
Total gross lending  488,008   441,531   25,345   5,741   15,391   1.2 
ECL allowances on drawn balances  (3,150)  (525)  (994)  (1,553)  (78)    
Net balance sheet carrying value  484,858   441,006   24,351   4,188   15,313     
ECL allowance (drawn and undrawn) as a percentage of gross lending (%)2  0.7   0.1   4.2   28.4         
                         
At 1 January 20181,3                        
Retail  341,661   296,264   25,319   2,105   17,973   0.6 
Commercial Banking  100,820   90,341   7,765   2,714   –   2.7 
Insurance and Wealth  819   724   67   28   –   3.4 
Central items  20,939   16,552   4,094   293   –   1.4 
Total gross lending  464,239   403,881   37,245   5,140   17,973   1.1 
ECL allowances on drawn balances  (3,223)  (597)  (1,148)  (1,446)  (32)    
Net balance sheet carrying value  461,016   403,284   36,097   3,694   17,941     
ECL allowance (drawn and undrawn) as a percentage of gross lending (%)2  0.8   0.2   3.4   29.8         

1Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances include the impact of the HBOS and MBNA acquisition related adjustments.
2Total and Stage 3 expected credit loss allowances as a percentage of drawn balances are calculated excluding loans in recoveries for Retail (31 December 2018: £250 million; 1 January 2018: £291 million).
3Certain balances have been reallocated between segments. This includes the incorporation of International Wealth into Commercial Banking and the allocation of Run-off across Retail and Commercial Banking.
55

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.7:Group expected credit loss allowances (drawn and undrawn) as a percentage of loans and advances to customers

  Total  Stage 1  Stage 2  Stage 3  Purchased or originated
credit-impaired		 
  £m  as % of
drawn
balances
%		  £m  as % of
drawn
balances
%		  £m  as % of
drawn
balances
%		  £m  as % of
drawn
balances1
%		  £m  as % of
drawn
balances
%		 
At 31 December 20182                              
Retail  1,768   0.5   493   0.2   713   3.8   484   22.6   78   0.5 
Commercial Banking  1,513   1.5   111   0.1   338   5.1   1,064   32.3   –   – 
Insurance and Wealth  18   2.1   6   0.7   1   16.7   11   20.0   –   – 
Central items  44   0.1   38   0.1   6   100.0   –   –   –   – 
Total  3,343   0.7   648   0.1   1,058   4.2   1,559   28.4   78   0.5 
At 1 January 20182                                        
Retail  1,685   0.5   538   0.2   716   2.8   399   22.0   32   0.2 
Commercial Banking  1,521   1.5   132   0.1   432   5.6   957   35.3   –   – 
Insurance and Wealth  17   2.1   6   0.8   2   3.0   9   32.1   –   – 
Central items  273   1.3   67   0.4   125   3.1   81   27.6   –   – 
Total  3,496   0.8   743   0.2   1,275   3.4   1,446   29.8   32   0.2 
1Total and Stage 3 ECL allowances as a percentage of drawn balances are calculated excluding loans in recoveries for Retail (31 December 2018: £250 million; 1 January 2018: £291 million).
2Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances include the impact of the HBOS and MBNA related acquisition adjustments.

Table 1.8:Group Stage 2 loans and advances to customers

  Up to date  1-30 days past due  Over 30 days past due 
  Gross
lending
£m		  Expected
credit
loss
£m		  As % of
gross
lending
%		  Gross
lending
£m		  Expected
credit
loss
£m		  As % of
gross
lending
%		  Gross
lending
£m		  Expected
credit
loss
£m		  As % of
gross
lending
%		 
At 31 December 20181                                    
Retail  14,505   498   3.4   2,441   113   4.6   1,795   102   5.7 
Commercial Banking  6,020   287   4.8   455   42   9.2   117   9   7.7 
Insurance and Wealth  4   –   –   –   –   –   2   1   50.0 
Central items  6   6   100.0   –   –   –   –   –   – 
Total  20,535   791   3.9   2,896   155   5.4   1,914   112   5.9 
At 1 January 20181,2                                    
Retail  21,773   535   2.5   2,005   90   4.5   1,541   91   5.9 
Commercial Banking  7,420   401   5.4   250   31   12.4   95   –   – 
Insurance and Wealth  61   2   3.3   1   –   –   5   –   – 
Central items  4,014   111   2.8   62   10   16.1   18   4   22.2 
Total  33,268   1,049   3.2   2,318   131   5.7   1,659   95   5.7 
1Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances include the impact of the HBOS and MBNA acquisition related adjustments.
2Certain balances have been reallocated between segments. This includes the incorporation of International Wealth into Commercial Banking and the allocation of Run-off across Retail and Commercial Banking.

The Group’s assessment of a significant increase in credit risk, and resulting categorisation of Stage 2, includes customers moving into early arrears as well as a broader assessment that an up to date customer has experienced a level of deterioration in credit risk since origination. A more sophisticated assessment is required for up to date customers, which varies across divisions and product type. This assessment incorporates specific triggers such as a significant proportionate increase in probability of default relative to that at origination, recent arrears, forbearance activity, internal watch lists and external bureau flags. Up to date exposures in Stage 2 are likely to show lower levels of expected credit loss (ECL) allowance relative to those that have already moved into arrears given that an arrears status typically reflects a stronger indication of future default and greater likelihood of credit losses.

56

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Retail

– The credit quality of the Retail portfolios remains strong and continues to benefit from robust credit risk management, including affordability and indebtedness controls at origination and a prudent approach to risk appetite. The economic environment remains resilient with record employment rates, falling inflation, positive real wage growth and household indebtedness remaining below pre-crisis levels.
– New business quality remains strong;
–The flow of loans entering arrears remains at low levels;
–Stage 3 balances are broadly flat at 0.7 per cent; and
–Stage 2 balances have reduced to 5.5 per cent of the portfolio, largely due to model refinements to the Stage 2 transfer approach for Secured.
–Loans and advances remained flat during the period at £342 billion as of 31 December 2018.
– The impairment charge increased by £151 million (21.2 per cent) to £862 million for 2018 (2017: £711 million). The increase is sold outrightattributable to the inclusion of MBNA for a full year and a low impairment charge in Secured compared to one-off write-backs in 2017.
–Expected credit loss (ECL) allowance as a percentage of drawn balances for Stage 3 increased to 22.6 per cent from 22.0 per cent relating to prudent provisioning in Secured. Coverage for Stage 2 has increased to 3.8 per cent from 2.8 per cent, largely due to model refinements to the Stage 2 transfer approach for Secured resulting in a reclassification of better quality Stage 2 assets into Stage 1.

Table 1.9:Retail impairment charge

2018
£m
Secured38
Unsecured1683
UK Motor Finance113
Other228
Total impairment charge862
Asset quality ratio0.25%
1Unsecured includes Credit cards, Loans and Overdrafts.
2Other includes Business Banking, Europe and Retail run-off.

Table 1.10:Retail loans and advances to customers

  Total
 £m		  Stage 1
£m		  Stage 2
£m		  Stage 3
 £m		  Purchased
or originated
credit-impaired
£m		  Stage 3 as
% of
total
%		 
At 31 December 20181                  
Secured  288,235   257,797   13,654   1,393   15,391   0.5 
Unsecured2  28,115   24,705   2,707   703   –   2.5 
UK Motor Finance  14,933   13,224   1,580   129   –   0.9 
Other3  10,399   9,434   800   165   –   1.6 
Total gross lending  341,682   305,160   18,741   2,390   15,391   0.7 
ECL allowances on drawn balances  (1,613)  (389)  (662)  (484)  (78)    
Net balance sheet carrying value  340,069   304,771   18,079   1,906   15,313     
ECL allowances (drawn and undrawn) as a percentage of gross lending (%)4  0.5   0.2   3.8   22.6         
 
At 1 January 20181,5                        
Secured  291,021   251,707   20,109   1,232   17,973   0.4 
Unsecured2  27,886   24,197   3,052   637   –   2.3 
UK Motor Finance  13,738   12,176   1,456   106   –   0.8 
Other3  9,016   8,184   702   130   –   1.4 
Total gross lending  341,661   296,264   25,319   2,105   17,973   0.6 
ECL allowances on drawn balances  (1,495)  (424)  (640)  (399)  (32)    
Net balance sheet carrying value  340,166   295,840   24,679   1,706   17,941     
ECL allowances (drawn and undrawn) as a percentage of gross lending (%)  0.5   0.2   2.8   22.0         
                         
1Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances include the impact of the HBOS and MBNA acquisition related adjustments.
2Unsecured includes Credit cards, Loans and Overdrafts.
3Other includes Business Banking, Europe and Retail run-off.
4Total and Stage 3 ECL allowances as a percentage of drawn balances are calculated excluding loans in recoveries for Unsecured (31 December 2018: £233 million; 1 January 2018: £277 million) and Business Banking within Other (31 December 2018: £17 million; 1 January 2018: £14 million).
5Certain balances have been reallocated between segments. This includes the incorporation of International Wealth into Commercial Banking and the allocation of Run-off across Retail and Commercial Banking.
57

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.11:Retail expected credit loss allowances (drawn and undrawn) as a percentage of loans and advances to customers

  Total  Stage 1  Stage 2  Stage 3  Purchased
or originated
credit-impaired
£m		 
     As % of
drawn
balances		     As % of
drawn
balances		     As % of
drawn
balances		     As % of
drawn
balances1		     As % of
 drawn
balances		 
  £m  %  £m  %  £m  %  £m  %  £m  % 
At 31 December 20182                                        
Secured  460   0.2   38   –   226   1.7   118   8.5   78   0.5 
Unsecured3  896   3.2   287   1.2   379   14.0   230   48.9   –   – 
UK Motor Finance4  290   1.9   127   1.0   78   4.9   85   65.9   –   – 
Other5  122   1.2   41   0.4   30   3.8   51   34.5   –   – 
Total  1,768   0.5   493   0.2   713   3.8   484   22.6   78   0.5 
At 1 January 20182,6                                        
Secured  385   0.1   31   –   236   1.2   86   7.0   32   0.2 
Unsecured3  933   3.3   350   1.4   382   12.5   201   55.8   –   – 
UK Motor Finance4  258   1.9   113   0.9   73   5.0   72   67.9   –   – 
Other5  109   1.2   44   0.5   25   3.6   40   34.5   –   – 
Total  1,685   0.5   538   0.2   716   2.8   399   22.0   32   0.2 
                                         
1Total and Stage 3 ECL allowance as a percentage of drawn balances are calculated excluding loans in recoveries for Unsecured (31 December 2018: £233 million; 1 January 2018: £277 million), and Business Banking within Other (31 December 2018: £17 million; 1 January 2018: £14 million).
2Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances include the impact of the HBOS and MBNA related acquisition adjustments.
3Unsecured includes Credit cards, Loans and Overdrafts.
4UK Motor Finance for Stages 1 and 2 include £99 million (1 January 2018: £84 million) relating to provisions against residual values of vehicles subject to finance leasing agreements. These provisions are included within the calculation of coverage ratios.
5Other includes Business Banking, Europe and Retail run-off.
6Certain balances have been reallocated between segments. This includes the incorporation of International Wealth into Commercial Banking and the allocation of Run-off across Retail and Commercial Banking.

Table 1.12:Retail Stage 2 loans and advances to customers

  Up to date  1-30 days past due  Over 30 days past due 
  Gross
lending
£m		  Expected
credit
loss
£m		  As % of
gross
lending
%		  Gross
lending
 £m		  Expected
 credit
 loss
£m		  As % of
gross
lending
%		  Gross
lending
£m		  Expected
credit
 loss
£m		  As % of
gross
 lending
%		 
At 31 December 20181                           
Secured  10,118   139   1.4   1,955   30   1.5   1,581   57   3.6 
Unsecured2  2,355   293   12.4   258   53   20.5   94   33   35.1 
UK Motor Finance  1,403   47   3.3   146   23   15.8   31   8   25.8 
Other3  629   19   3.0   82   7   8.5   89   4   4.5 
Total  14,505   498   3.4   2,441   113   4.6   1,795   102   5.7 
At 1 January 20181,4                                    
Secured5  17,264   172   1.0   1,506   20   1.3   1,339   44   3.3 
Unsecured2  2,678   303   11.3   253   43   17.0   121   36   29.8 
UK Motor Finance  1,279   45   3.5   137   21   15.3   40   7   17.5 
Other3  552   15   2.7   109   6   5.5   41   4   9.8 
Total  21,773   535   2.5   2,005   90   4.5   1,541   91   5.9 
                                     
1Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances include the impact of the HBOS and MBNA related acquisition adjustments.
2Unsecured includes Credit cards, Loans and Overdrafts.
3Other includes Business Banking, Europe and Retail run-off.
4Certain balances have been reallocated between segments. This includes the incorporation of International Wealth into Commercial Banking and the allocation of Run-off across Retail and Commercial Banking.
5Secured days past due segmentation restated to align with IFRS 9 classifications.

Portfolios

– Secured credit quality remained strong, with flow to arrears stable at low levels. The average indexed loan to value (LTV) remained stable at 44.1 per cent (1 January 2018: 43.6 per cent) and the proportion of balances with an LTV of greater than 90 per cent remained low at 2.9 per cent (1 January 2018: 2.5 per cent). The average LTV of new business improved to 62.5 per cent (31 December 2017: 63.0 per cent). The closed Specialist mortgage portfolio continued to run off, reducing by a further £1.7 billion (11.0 per cent). Total Secured loans and advances decreased by £2.8 billion (1.0 per cent) to £288 billion (1 January 2018: £291 billion), due to reductions in the Buy-to-let and closed Specialist portfolios. The impairment charge was £38 million compared to a release of £15 million in 2017 arising from one-off write-backs. Total expected credit loss allowance as a percentage of loans and advances (coverage) remained broadly flat.
–Unsecured loans and advances were broadly flat for the year ending 31 December 2018. The impairment charge increased by £91 million to £683 million (2017: £592 million), mainly due to the inclusion of MBNA for a full year. Coverage decreased slightly to 3.2 per cent at 31 December 2018 (1 January 2018: 3.3 per cent), with model refinements in Stage 2 offset by those in Stage 3.
58

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

– The UK Motor Finance portfolio continued to grow, with loans and advances increasing by 8.7 per cent to £14.9 billion at 31 December 2018 (1 January 2018: £13.7 billion). Increases in Stage 2 and Stage 3 balances reflect growth in the retail portfolio. The impairment charge in the period was broadly flat at £113 million (2017: £111 million). The portfolio continues to benefit from a conservative approach to residual values at origination and through the loan lifecycle, with prudent residual value provisions accounting for £99 million of Stage 1 and Stage 2 expected credit loss allowance at 31 December 2018. Coverage for the portfolio was flat at 1.9 per cent.
–Other loans and advances increased by £1.4 billion to £10.4 billion driven by a transfer of largely Stage 1 assets from SME into Business Banking. The impairment charge increased by £5 million to £28 million in the year due to the non-repeat of one-off write-backs in 2017 relating to a closed portfolio. Coverage remained flat at 1.2 per cent.

Table 1.13:Retail secured loans and advances to customers

  At 31 Dec
20181
£m		  At 1 Jan
20181
£m		 
Mainstream  223,230   222,814 
Buy-to-let  51,322   52,834 
Specialist  13,683   15,373 
Total  288,235   291,021 
         
1The balances include the impact of HBOS related acquisition adjustments.

Table 1.14:Mortgages greater than three months in arrears (excluding repossessions)

  Number of cases Total mortgage accounts Value of loans1 Total mortgage balances
  2018  2017  2018  2017  2018  2017  2018  2017 
At 31 December Cases  Cases  %  %  £m  £m  %  % 
Mainstream  30,106   32,383   1.5   1.6   3,262   3,502   1.5   1.6 
Buy-to-let  4,544   4,710   1.0   1.0   576   581   1.1   1.1 
Specialist  7,966   8,313   7.8   7.3   1,282   1,354   9.3   8.7 
Total  42,616   45,406   1.7   1.7   5,120   5,437   1.8   1.9 
                                 
1Value of loans represents total gross book value of mortgages more than three months in arrears; the balances exclude the impact of HBOS related acquisition adjustments.

The stock of repossessions decreased to 763 cases at 31 December 2018 compared to 777 cases at 31 December 2017.

Table 1.15:Period end and average LTVs across the Retail mortgage portfolios

  Mainstream  Buy-to-let  Specialist  Total 
  %  %  %  % 
At 31 December 2018            
Less than 60%  54.2   55.7   59.7   54.7 
60% to 70%  16.0   22.8   16.5   17.3 
70% to 80%  15.9   15.7   12.0   15.7 
80% to 90%  10.7   4.6   6.6   9.4 
90% to 100%  2.8   0.7   2.0   2.4 
Greater than 100%  0.4   0.5   3.2   0.5 
Total  100.0   100.0   100.0   100.0 
Average loan to value1:                
Stock of residential mortgages  42.5   52.1   45.8   44.1 
New residential lending  63.1   58.6   n/a   62.5 
 
   Mainstream   Buy-to-let   Specialist   Total 
   %   %   %   % 
At 31 December 2017                
Less than 60%  57.1   53.9   57.6   56.4 
60% to 70%  16.9   25.0   18.4   18.5 
70% to 80%  14.5   15.7   12.8   14.6 
80% to 90%  9.0   4.1   6.4   8.0 
90% to 100%  2.1   0.7   1.6   1.9 
Greater than 100%  0.4   0.6   3.2   0.6 
Total  100.0   100.0   100.0   100.0 
Average loan to value1:                
Stock of residential mortgages  41.7   53.0   47.4   43.6 
New residential lending  63.7   59.1   n/a   63.0 
                 
1Average loan to value is redeemed in full. Government sponsored Mortgage Rescue Scheme (MRS) options are currently available in Walescalculated as total loans and Scotland (in Scotlandadvances as a percentage of the MRS option is calledtotal indexed collateral of these loans and advances; the balances exclude the impact of HBOS related acquisition adjustments.
59

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Interest only mortgages

The Group provides interest only mortgages to owner occupier mortgage customers whereby only payments of interest are made for the term of the mortgage with the customer responsible for repaying the principal outstanding at the end of the loan term. At 31 December 2018, owner occupier interest only balances as a proportion of total owner occupier balances had reduced to 26.7 per cent (31 December 2017: 29.0 per cent). The average indexed loan to value improved to 41.3 per cent (31 December 2017: 41.7 per cent).

For existing interest only mortgages, a contact strategy is in place throughout the term of the mortgage to ensure that customers are aware of their obligations to repay the principal upon maturity of the loan.

Treatment strategies are in place to help customers anticipate and plan for repayment of capital at maturity and support those who may have difficulty in repaying the principal amount. A dedicated specialist team supports customers who have passed their contractual maturity date and are unable to fully repay the principal. A range of treatments are offered such as full (or part) conversion to capital repayment and extension of term to match the maturity dates of any associated repayment vehicles.

Table 1.16:Analysis of owner occupier interest only mortgages

  At 31 December  At 1 January 
  20181  20181 
   Total   Total 
Interest only balances (£m)  63,138   69,129 
Stage 1 (%)  79.1   75.4 
Stage 2 (%)  6.6   9.5 
Stage 3 (%)  1.0   0.8 
Purchased or originated credit impaired (%)  13.3   14.3 
         
Average loan to value (%)  41.3   41.7 
         
Maturity profile (£m)        
Due  1,144   1,043 
1 year  2,405   2,612 
2-5 years  10,229   10,158 
6-10 years  18,562   17,913 
>11 years  30,798   37,403 
         
Past term interest only balances (£m)2  1,635   1,474 
Stage 1 (%)  2.8   2.9 
Stage 2 (%)  16.8   15.3 
Stage 3 (%)  17.9   15.6 
Purchased or originated credit impaired (%)  62.5   66.2 
         
Average loan to value (%)  35.2   33.4 
Negative equity (%)  2.8   2.1 
         
1Balances are stated on an IFRS 9 basis and include the Home Owner’s Support Fund). No MRS optionsimpact of HBOS acquisition related adjustments.
2Balances where all interest only elements have moved past term. Some may subsequently have had a term extension, so are available in Northern Ireland although one may be launched by the government in the future. In England, the government ceased funding and closed its MRS option in the second quarter of 2015.no longer classed as due.

 

Retail forbearance

The Group assesses whetherbasis of disclosure for forbearance has changed compared to previous years to be aligned to definitions used in the European Banking Authority’s FINREP reporting. On a loan benefiting from a UK government sponsored programme is impaired usinglike-for-like basis, the same accounting policies and practices as it does for loans not benefiting from such a programme. There is no direct impact on the impairment statuschange leads to an increase in disclosed forbearance of a loan benefiting from the Mortgage Rescue schemes, as these schemes involve the purchase, and eventual sale, of the property. The loans included within the Income Support for Mortgage Interest scheme may be impaired, in accordance£5.6 billion, with the normal definitionmain drivers being longer probation periods before a customer can return to order and the inclusion of impairment.Past Term Interest Only for Secured.

 

The Income Support for Mortgage Interest scheme remainsmain customer treatments included are: repair, where arrears are written on to the most successful of the government backed schemes. It is the longest-running, is the most widely known and provides both the customerloan balance and the Group with an assurance as to the maintenance of at least two years’ wortharrears position cancelled; instances where there are suspensions of interest payments. The Group estimates that customers representing approximately £2.2 billion of its mortgage exposures are receiving this benefit. This includes those who are also receiving other treatments for financial difficulty.and/or capital repayments; Past Term Interest Only mortgages; and refinance personal loans.

 

FORBEARANCE IDENTIFICATION, CLASSIFICATION AND MEASUREMENT

The Group classifies a retail account as forborne at the time a customer in financial difficulty is granted a concession. Accounts are classified as forborne onlyTotal forbearance for the periodmajor retail portfolios has improved by £569 million to £6.6 billion driven by customers exiting probation and returning to order on the Secured portfolio. As a percentage of time which the exposure is knownloans and advances, forbearance loans improved to be,2.1 per cent at 31 December 2018 (1 January 2018: 2.2 per cent). 98.0 per cent of forbearance loans are captured in Stage 2, Stage 3 or may still be, in financial difficulty. Where temporary forbearance is granted, exit criteria are applied to include accounts until they are known to no longer be in financial difficulty. Details of the exit criteria are shown in the analysisPOCI and hold provision on page 61. Where the treatment involves a permanent change to the contractual basis of the customer’s account suchlifetime basis. Total expected credit losses (ECL) as a capitalisationproportion of arrears or term extension,loans and advances which are forborne has increased to 3.6 per cent (1 January 2018: 3.2 per cent) due to prudent provisioning on the Group classifies the balance as forborne for a period of 24 months, after which no distinction is made between these accounts and others where no change has been made.Secured portfolio.

 

Those forborne loans which fall below individual assessment limits are grouped with other assets of similar characteristics and assessed collectively for impairment in accordance with the Group impairment policy detailed in note 2(H). The Group’s approach is to ensure that provisioning models, supported by management judgement, appropriately reflect the underlying loss risk of exposures. The performance and output of models are monitored and challenged on an ongoing basis, in line with the Group’s model governance policies.

CUSTOMERS IN FINANCIAL DIFFICULTY RECEIVING SUPPORT UNDER OTHER SCHEMES

The Group measures the success of a forbearance scheme for Retail Secured customers based upon the proportion of customers performing (less than or equal to three months in arrears) over the 24 months following the exit from a forbearance treatment. For temporary treatments, 7980.4 per cent of UK Secured customers accepting reduced payment arrangements are performing. For permanent treatments, 8283.2 per cent of UK Secured customers who have accepted capitalisations of arrears and 8484.4 per cent of customers who have accepted term extensions are performing.

Commercial customers

Early identification, control and monitoring are key in order to support the customer and protect the Group. With the exception of small exposures in SME all non-retail exposures in the Commercial Banking and Run-off divisions are reviewed at least annually by the independent Risk Division (and more frequently where required). As part of the Group’s established Credit Risk Classification system, every exposure in the good book is categorised as either ‘good’ or ‘watchlist’. This complements the Group’s risk rating tools and is designed to identify and highlight portfolio levels of asset quality as well as individual problem credits. All watchlist names are reviewed by the business and Risk Division regularly, and the classification is updated if required. This process seeks to ensure that relationship managers act promptly to identify, and highlight to senior management those customers who have the possibility to become higher risk in the future.

Those customers deemed higher risk where there is cause for concern over future repayment capability or where there is a risk of impairment will lead to the customer being transferred to the Business Support Unit (BSU) at an early stage. The over-arching aim of the BSU is to provide support and work consensually with each customer to try and resolve the issues, to restore the business to a financially viable position and thereby bring about a business turnaround. This may involve a combination of restructuring, work out strategies and other types of forbearance.

BSU case officers manage non-retail distressed assets in Commercial Banking and Run-off divisions, and are part of the independent Risk Division. They are highly experienced and operate in a closely controlled and monitored environment, including regular oversight and close scrutiny by senior management.

A detailed assessment is undertaken for cases in BSU to assist in reducing and minimising risk exposure and to also highlight potential strategic options. A range of information is required to fully appraise and understand the customer’s business, cashflow (and therefore debt serviceability) and will involve the Group, in addition to using its own internal sector experts, engaging professional advisers to perform asset valuations, strategic reviews and where applicable, independent business reviews. The assessment may also involve:

–critically assessing customer’s ability to successfully manage the business effectively in a distressed situation where turnaround is required;
–analysis of market sector factors, i.e. products, customers, suppliers, pricing and margin issues;
–performance review of operational areas that should be considered in terms of current effectiveness and efficiency and scope for improvements;
–financial analysis to model plans and factor in potential sensitivities, vulnerabilities and upsides; and
–determining the most appropriate corporate and capital structure suitable for the work-out strategy concerned.

The above assessment, monitoring and control processes continue throughout the period the case is managed within the BSU. All the analysis performed around cash flows is used to determine appropriate impairment provisions.

The level of Commercial Banking division BSU gross lending to customers reduced from £5.0 billion to £4.2 billion between 31 December 2014 and 31 December 2015. The net reduction of £0.8 billion in BSU managed lending in Commercial Banking was driven by returns to mainstream, disposals, write-offs and repayments.

The Group’s accounting policy for loan renegotiations is set out in note 2(H) on page F-16. Income statement information set out in the credit risk tables is on an underlying basis (see page 26).

FORBEARANCE

A key factor in determining whether the Group treats a commercial customer as forborne is the granting of a concession to a borrower who experiences, or is believed to be about to experience, financial difficulty and which is outside the Group’s current risk appetite. Where a concession is granted to a customer that is not in financial difficulty or the risk profile is considered within the Group’s current risk appetite, the concession would not be considered

60

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

to be an act of forbearance. The Group does not believe forbearance reporting is appropriate for derivatives, available for sale assets and the trading book where assets are marked to market daily.

The Group recognises that forbearance alone is not necessarily an indicator of impaired status, but it is a trigger for the review of the customer’s credit profile. If there is any concern over the future cash flows and/or the Group incurring a loss, thenTable 1.17:Retail forborne loans will be classified as impaired in accordance with the Group’s impairment policy. All impaired loans, including recoveries portfolios, are reported as forborne.

Recovery can sometimes be through improvement in market or economic conditions, or the customer may benefit from access to alternative sources of liquidity, such as an equity injection. These can be especially relevant in real estate or other asset backed transactions where a fire sale of assets in a weak market may be unattractive.

Depending on circumstances and when operated within robust parameters and controls, the Group believes forbearance can help support the customer in the short to medium-term. The Group expects to have unimpaired forborne assets within its portfolios, where default has been avoided, or when no longer considered impaired, although the majority of these cases will be managed in the BSU, where more intensive management and monitoring is available.

Unimpaired forborne assets are included in calculating the overall collective unidentified impairment provision, which uses the historical observed default rate and loss emergence period of the relevant portfolio as a whole as part of its calculation.

Whilst the material portfolios have been reviewed for forbearance, some non-retail loans and advances in Commercial Banking and Run-Off divisions have not been reviewed on the basis that the level of unimpaired forbearance is relatively immaterial, or because the concept of forbearance is not relevant.(audited)

 

TYPES OF FORBEARANCE

The Group’s strategy and offer of forbearance is largely dependent on the individual situation and early identification, control and monitoring are key to supporting the customer and protecting the Group. Concessions are often provided to help the customer with their day to day liquidity and working capital. A number of options are available to the Group where a customer is facing financial difficulty, and each case is treated depending on its own specific circumstances.

For commercial customers, the Group currently looks at forbearance concessions including changes to:

  Total
£m		  Of which
Stage 2
£m		  Of which
Stage 3
£m		  Of which
purchased
or originated
credit-
impaired
£m		  Expected credit
losses as a % of
total loans and
advances which
are forborne1
%		 
At 31 December 20182                    
Secured  6,089   1,136   642   4,241   1.6 
Unsecured3  435   173   200   –   27.8 
UK Motor Finance (Retail)  56   30   25   –   34.8 
Total  6,580   1,339   867   4,241   3.6 
At 1 January 20182                    
Secured  6,676   1,367   562   4,693   1.1 
Unsecured3  422   130   230   –   32.7 
UK Motor Finance (Retail)  51   26   24   –   36.1 
Total  7,149   1,523   816   4,693   3.2 

 

–1Contractual payment terms (for example loan maturity extensions, or changesECL as a percentage of total loans and advances which are forborne are calculated excluding loans in recoveries for Unsecured (31 December 2018: £107 million; 1 January 2018: £147 million).
2The balances include the impact of HBOS related acquisition adjustments.
3Excludes MBNA.

Commercial Banking

– The overall credit quality of the portfolio and new business remains good with the portfolio benefiting from effective risk management, a through the cycle approach to capital and/orrisk appetite and continued low interest servicing arrangements, including capital repayment holidays or conversion to interest only terms); andrates. Notwithstanding the current competitive market conditions, the Group is maintaining its prudent risk appetite.
  
–Non-payment contractual terms (for example covenant amendments or waivers) whereUncertainty persists around the concession enables defaultUK and global economic outlook, including the outcome of EU exit negotiations, the sustainability of global economic growth, trade wars and geopolitical risks. Allied to be avoided.

The main types of forbearance concessions to commercial customers in financial difficulty are set out below:

–Covenants: This includes temporarythis are headwinds in a number of sectors including construction, support services and permanent waivers, amendment or resetting of non-payment contractual covenants (including LTVconsumer-related sectors, such as retail. However, the portfolios remain well positioned and interest cover). The granting of this type of concession in itself would not resultthe Group’s through the cycle risk appetite approach is unchanged. Monitoring indicates no material deterioration in the loan being classified as impaired andcredit quality of the customer is kept under review in the event that further forbearance is necessary;portfolio.
  
–Extensions/Alterations: This includes extension and/or alterationInternal and external key performance indicators are monitored closely to help identify early signs of repayment termsany deterioration. Portfolios remain subject to a level outside of market or the Group’songoing risk appetite due to the customer’s inability to make existing contractual repayment terms; amendments to an interest rate to a level considered outside of market or the Group’s risk appetite, or other amendments suchmitigation actions as changes to capital and/or interest servicing arrangements including capital repayment holidays or conversion to interest only terms; andappropriate.
  
–Planning for any EU exit outcome is well advanced and continues to evolve in Commercial Banking to ensure portfolio quality is maintained whilst supporting the Group’s Helping Britain Prosper strategy.
– Net impairment charge for 2018 of £92 million compared with a net charge of £89 million in 2017.
– Stage 3 gross charges included the impact of IFRS 9 model refinements and were broadly flat year on year. Stage 3 net charges increased, driven by lower impairment releases and write-backs.
– Net impairment releases in Stage 1 and 2 were weighted towards non-SME portfolios and reflect a number of factors including transfers between stages (including to and from Stage 3), refinements to the IFRS 9 model methodology as well as adjustments to Multiple type of forbearance (a combinationEconomic Scenario impacts to reflect any changes to the underlying economic outlook.
– The size and nature of the above two)commercial portfolio results in some volatility as cases move between stages. Stage 3 loans as a proportion of total loans and advances to customers has increased to 3.2 per cent (1 January 2018: 2.7 per cent). Stage 3 expected credit loss (ECL) allowance as a percentage of Stage 3 drawn balances has reduced to 32.3 per cent (1 January 2018: 35.3 per cent) largely as a result of a transfer in of assets to impaired status on which lower ECL allowances are assessed.
– Stage 2 loans as a proportion of total loans and advances to customers reduced to 6.5 per cent (1 January 2018: 7.7 per cent) as a result of transfers to Stage 1 and Stage 3. The proportion of Stage 1 loans increased to 90.3 per cent (1 January 2018: 89.6 per cent). Stage 2 ECL allowances as a percentage of Stage 2 drawn balances were lower at 5.1 per cent (1 January 2018: 5.6 per cent) due to changes in the mix of assets classified as Stage 2 and revisions to model assumptions.
– Notwithstanding the current stable performance of the portfolio, impairments are likely to increase from their current levels, driven mainly by lower levels of releases and write-backs and an element of credit normalisation.

FORBEARANCE IDENTIFICATION, CLASSIFICATION AND MEASUREMENT

All non-retail loans and advances on the watchlist are further categorised depending on the current and expected credit risk attaching to the customer and the transaction. All watchlist names are reviewed by the business and independent Risk function regularly, and the classification is updated if required.

Any event that causes concern over future payments is likely to result in the customer being assessed for impairment and, if required, an impairment allowance recognised. If impairment is identified, the customer is immediately transferred to BSU (if not already managed there) and the lending will be treated as impaired.

All of a customer’s impaired loans are treated as forborne as they are considered as having been (or will be) granted some form of forbearance. Most impaired loans and advances exist only in the BSU within Commercial Banking division, and Run-off division.

A portfolio approach is taken for SME customers with exposures below £1 million managed in BSU. All customers with exposures below £1 million are reported as forborne whilst they are managed by SME BSU (whether impaired or unimpaired).

All reviews performed in the good book, BSU within Commercial Banking or in the Run-off division include analysis of latest financial information, a consideration of the market and sector the customer operates in, performance against plan and revised terms and conditions granted as part of the forbearance concession.

EXIT FROM FORBEARANCE

A customer where forbearance has been granted will remain treated and recorded as forborne until it evidences acceptable performance over a period of time. This period will depend on a number of factors such as whether the customer is trading in line with its revised plan, it is operating within the new terms and conditions (including observation to revised covenants and contractual payments), its financial performance is stable or improving, and there are no undue concerns over its future performance. As a minimum, this cure period is currently expected to be at least 12 months following a forbearance event.

The exception to this 12 month minimum period is where a permanent structural cure is made (for example, an injection of new collateral security or a partial repayment of debt to restore an LTV back to within a covenant). In this case, the customer may exit forbearance once the permanent cure has been made.

However, notwithstanding this, the overriding requirement for exit from forbearance in all cases is that the customer is not impaired and the reason for the forbearance event is no longer present.

Upon exit from forbearance the customer may be returned to the mainstream good classification. It is important to note that such a decision can be made only by the independent Risk Division.

61

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

THE GROUP CREDIT RISK PORTFOLIO IN 2015Table 1.18:Commercial Banking impairment charge

 

  2018
£m		 2017¹
£m		 Change
%		 
SME 63 7   
Other 29 82   
Total impairment charge 92 89 (3) 
Asset quality ratio 0.09% 0.10% (1)bp 

Significant reduction in impairments and impaired assets

–1Excluding TSB, the impairment charge decreased by 48 per cent to £568 million in 2015 compared to £1,102 million in 2014. The impairment charge is lower across all divisions and benefited from provision releases, but at lower levels than seen during 2014.
–The reduction reflects lower levels of new impairmentPrior period comparatives are on an IAS 39 basis. Includes Run-off, previously reported as a resultseparate segment.

Table 1.19:Commercial Banking loans and advances to customers

  Total
£m		  Stage 1
£m		  Stage 2
£m		  Stage 3
£m		  Stage 3
as % of
total
%		 
At 31 December 2018                    
SME  30,296   26,099   3,484   713   2.4 
Other  71,594   65,903   3,108   2,583   3.6 
Total gross lending  101,890   92,002   6,592   3,296   3.2 
ECL allowance on drawn balances  (1,476)  (93)  (325)  (1,058)  – 
Net balance sheet carrying value  100,414   91,909   6,267   2,238   – 
ECL allowances (drawn and undrawn) as a percentage of gross lending (%)  1.5   0.1   5.1   32.3     
At 1 January 20181                    
SME  30,510   26,397   3,262   851   2.8 
Other  70,310   63,944   4,503   1,863   2.6 
Total gross lending  100,820   90,341   7,765   2,714   2.7 
ECL allowance on drawn balances  (1,440)  (101)  (382)  (957)    
Net balance sheet carrying value  99,380   90,240   7,383   1,757     
ECL allowances (drawn and undrawn) as a percentage of gross lending (%)  1.5   0.1   5.6   35.3     

1Certain balances have been reallocated between segments. This includes the incorporation of effective risk management, a favourableInternational Wealth into Commercial Banking and the allocation of Run-off across Retail and Commercial Banking.

Table 1.20: Commercial Banking expected credit environment, improving UK economic conditionsloss allowances (drawn and continued low interest rates.
–The asset quality ratio (impairment chargeundrawn) as a percentage of average loans and advances to customers) improved to 0.14 per cent compared to 0.23 per cent during 2014.
–At the Group Strategic Update in October 2014, we outlined that although it would be lower between 2015 to 2017, we expect the Group asset quality ratio to be c.40 basis points through the economic cycle.
–In 2016, the Group expects to benefit from its continued disciplined approach to the management of credit and the resilient UK economy. Write-backs and provision releases, however, are expected to be at a lower level and as a result, the Group expects the asset quality ratio for the 2016 full year to be around 20 basis points.
–Impaired loans as a percentage of closing loans and advances reduced to 2.1 per cent at 31 December 2015, from 2.9 per cent at 31 December 2014 driven by reductions within the continuing and run-off portfolios, including the sale of Irish commercial loans during the third quarter. Provisions as a percentage of impaired loans reduced from 56.4 per cent to 46.1 per cent reflecting the disposal of highly covered assets during the year.
–Retail division impairment provisions as a percentage of impaired loans have increased to 40.4 per cent from 38.8 per cent at 31 December 2014, with Secured increasing by 0.5 percentage points to 37.5 per cent. Consumer Finance division impairment provisions as a percentage of impaired loans have increased to 72.8 per cent from 70.5 per cent at 31 December 2014, with Credit Cards increasing by 5.3 percentage points to 81.8 per cent and Asset Finance UK decreasing by 2.8 percentage points to 67.2 per cent.customers

  Total  Stage 1  Stage 2  Stage 3 
  £m  As % of
drawn
balances
%		  £m  As % of
drawn
balances
%		  £m  As % of
drawn
balances
%		  £m  As % of
drawn
balances
%		 
At 31 December 2018                                
SME  384   1.3   40   0.2   231   6.6   113   15.8 
Other  1,129   1.6   71   0.1   107   3.4   951   36.8 
Total  1,513   1.5   111   0.1   338   5.1   1,064   32.3 
At 1 January 20181                                
SME  375   1.2   51   0.2   206   6.3   118   13.9 
Other  1,146   1.6   81   0.1   226   5.0   839   45.0 
Total  1,521   1.5   132   0.1   432   5.6   957   35.3 

Low risk culture and prudent risk appetite

–1The Group is delivering sustainable lending growth by maintaining its lower risk origination discipline and underwriting standards, despite terms and conditions in someCertain balances have been reallocated between segments. This includes the incorporation of the Group’s markets being impacted by increased competition. The overall quality of the portfolio has improved over the last 12 months.
–Credit performance of the UK Retail secured portfolio has been good, with improvements in LTVs, arrears, impaired loans and impairment charge on both Mainstream and Buy-to-let portfolios. Loans and advances to mainstream customers were broadly flat during the year at £227.3 billion with the Buy-to-let portfolio growing by 4 per cent to £55.6 billion. The closed specialist portfolio has continued to run-off, reducing by 10 per cent to £19.5 billion.
–The Group’s UK Direct Real Estate gross lending (defined internally as exposure which is directly supported by cash flows from property activities) at 31 December 2015 in Commercial Banking,International Wealth (within Retail division) and Run-off divisions was £19.5 billion (31 December 2014: gross £21.6 billion). The portfolio continues to reduce significantly, and the higher risk Run-off element of the book has reduced from gross £3.3 billion to gross £1.1 billion during 2015. The remaining gross lending of £18.4 billion (31 December 2014: £18.3 billion) is the lower risk element ininto Commercial Banking and Wealth, where the Group continues to write new business within conservative risk appetite parameters.
–Ourallocation of Run-off across Retail and Commercial Banking portfolios continue to benefit from our robust focus on credit at origination and our through the cycle risk appetite.
–Sector concentrations within the lending portfolios are closely monitored and controlled, with mitigating actions taken. Sector and product caps limit exposure to certain higher risk sectors and asset classes.
–The Group’s extensive and thorough credit processes and controls ensure effective risk management, including early identification and management of potential concern customers and counterparties.

Re-shaping of the group is substantially complete

–The run-off portfolio has materially reduced through de-risking and the strategic desire to exit the residual portfolio still remains. There was a 38 per cent reduction in gross loans and advances in 2015 to £11,422 million (31 December 2014: £18,316 million).
–Run-off net external assets have reduced from £16,857 million to £12,154 million during 2015. The portfolio now represents only 2.3 per cent of the overall Group’s loans and advances (31 December 2014: 3.0 per cent).Banking.
62

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Table 1.5: Group impairment charge     
  2015  
  Loans and
advances to
customers
 £m		  Debt securities
classified as
loans and
receivables
£m		  Available-for-sale
financial assets
£m		  Other credit risk
provisions
£m		  Total
£m		  2014
£m		  Change
 %		 
Retail 432  –  –  –  432  599  28 
Commercial Banking 9  –  –  (31) (22) 83    
Consumer Finance 152  –  –  –  152  215  29 
Run-off 28  (2) 4  (22) 8  203  96 
Central items –  –  –  (2) (2) 2    
Total impairment charge excluding TSB 621  (2) 4  (55) 568  1,102  48 
TSB             –  98    
Total impairment charge             568  1,200  53 
Impairment charge as a % of average advances1             0.14%  0.23%  (9)bps 

Table 1.21:Commercial Banking Stage 2 loans and advances to customers

  Up to date  1-30 days past due  Over 30 days past due 
  Gross
lending
£m		  Expected
credit
loss
£m		  As % of
gross
lending
%		  Gross
lending
£m		  Expected
credit
loss
£m		  As % of
gross
lending
%		  Gross
lending
£m		  Expected
credit
loss
£m		  As % of
gross
lending
%		 
At 31 December 2018                                    
SME  3,037   181   6.0   383   41   10.7   64   9   14.1 
Other  2,983   106   3.5   72   1   1.4   53   –   – 
Total  6,020   287   4.8   455   42   9.2   117   9   7.7 
At 1 January 20181                                    
SME  2,969   180   6.1   227   26   11.5   66   –   – 
Other  4,451   221   5.0   23   5   21.7   29   –   – 
Total  7,420   401   5.4   250   31   12.4   95   –   – 

1Certain balances have been reallocated between segments. This includes the incorporation of International Wealth into Commercial Banking and the allocation of Run-off across Retail and Commercial Banking.

Portfolios

– The SME and Mid Markets portfolios are domestically focused and reflect both our prudent credit risk appetite and the underlying performance of the UK economy. Whilst certain sectors of the market are showing some emerging signs of stress, the overall credit quality of the portfolios has remained broadly stable with levels of impairment remaining low.
– The Global Corporates business continues to have a predominance of multi-national investment grade clients who are primarily UK-based. The portfolio remains of good quality and is well positioned for the current economic outlook.
– Through clearly defined sector strategies, Financial Institutions serves predominantly investment grade counterparties with whom relationships are either client driven or held to support the Group’s funding, liquidity or general hedging requirements.
– The commercial real estate business within the Group’s Mid Markets and Global Corporates portfolio is focused on clients operating in the UK commercial property market ranging in size from medium-sized private real estate entities up to publicly listed property companies. Credit quality remains good with minimal impairments/stressed loans. Recognising this is a cyclical sector, appropriate caps are in place to control exposure and business propositions continue to be written in line with a prudent, through the cycle risk appetite with conservative LTVs, strong quality of income and proven management teams.
Commercial Banking UK Direct Real Estate LTV analysis
– The Group classifies Direct Real Estate as exposure which is directly supported by cash flows from property activities (as opposed to trading activities, such as hotels, care homes and housebuilders). Exposures to social housing providers are also excluded.
– Focus remains on the UK market, on good quality customers, with a proven track record in Real Estate and where cash flows are robust.
– Commercial Banking UK Direct Real Estate gross lending stood at £17.2 billion at 31 December 2018 (excludes exposures subject to protection through Significant Risk Transfer securitisations). The Group has a further £0.54 billion of UK Direct Real Estate exposure in Business Banking within Retail.
– Approximately 70 per cent of loans and advances to UK Direct Real Estate relate to commercial real estate with the remainder related to residential real estate. The portfolio continues to be heavily weighted towards investment real estate (c. 90 per cent) over development.
– The LTV profile of the UK Direct Real Estate portfolio in Commercial Banking continues to improve.
– Development lending is subject to specific credit risk appetite criteria, including maximum loan to gross development value and maximum loan to cost, with funding typically only released against completed works as confirmed by the Group’s monitoring quantity surveyor.

Table 1.22:LTV – Commercial Banking UK Direct Real Estate

  At 31 December 20181,2    At 31 December 20171,2,3   
   Stage 1/2
£m		   Stage 3
£m		   Total
£m		   %   Unimpaired
£m		   Impaired
£m		   Total
£m		   % 
Investment Exposures > £1m                                
Less than 60%  8,838   101   8,939   79.8   8,392   169   8,561   78.8 
60% to 70%  1,190   7   1,197   10.7   1,012   20   1,032   9.5 
70% to 80%  267   41   308   2.7   236   44   280   2.6 
80% to 100%  79   11   90   0.8   74   42   116   1.1 
100% to 120%  27   25   52   0.5   103   2   105   1.0 
120% to 140%  –   1   1   0.0   61   2   63   0.6 
Greater than 140%  18   46   64   0.6   22   49   71   0.7 
Unsecured4  520   31   551   4.9   586   51   637   5.9 
Total Investment >£1m  10,939   263   11,202       10,486   379   10,865     
Investment <£1m5  3,679   105   3,784       4,988   133   5,121     
Total Investment  14,618   368   14,986       15,474   512   15,986     
Development  1,698   111   1,809       1,655   147   1,802     
Total  16,316   479   16,795       17,129   659   17,788     
1Excludes TSB.Commercial Banking UK Direct Real Estate exposures subject to protection through Significant Risk Transfer transactions.
  
2Excludes Islands Commercial UK Direct Real Estate of £0.45 billion (31 December 2017: £0.45bn).
3Prior period comparatives are on an IAS 39 basis. Includes run-off, previously excluded.
4Predominantly Investment grade lending where the Group is relying on the corporate covenant.
5December 2018 investment exposures <£1m have an LTV profile broadly similar to the investment exposures >£1m.

Table 1.6: Movement in gross impaired loans      
  2015 
    Retail
£m		  Commercial
Banking
£m		  Consumer
Finance
£m		    Run-off
 £m		    TSB
£m		    Total
£m		  

2014

Total
£m

 
At 1 January 4,927  3,241  720  5,215  205  14,308  32,259 
Classified as impaired during the year 2,008  631  179  583  –  3,401  4,825 
Transferred to not impaired during the year (1,080) (146) (72) (60) –  (1,358) (4,526)
Repayments (831) (693) (68) (137) –  (1,729) (3,075)
Amounts written off (523) (225) (107) (648) –  (1,503) (7,004)
Impact of disposal of business and asset sales (3) (48) (55) (3,092) (205) (3,403) (7,288)
Exchange and other movements (4) (232) (54) 164  –  (126) (883)
At 31 December 4,494  2,528  543  2,025  –  9,590  14,308 
63

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Table 1.7: Group impaired loans and provisions     
  Loans and
advances to
customers
£m		  Impaired
loans
£m		  Impaired loans
as % of closing
advances
%		  Impairment
provisions1
£m		  Impairment
provision as % of
impaired
loans2
%		 
At 31 December 2015               
Retail 316,036  4,494  1.4  1,670  40.4 
Commercial Banking 102,435  2,528  2.5  1,087  43.0 
Consumer Finance 23,938  543  2.3  265  72.8 
Run-off 11,422  2,025  17.7  1,150  56.8 
TSB               
Reverse repos and other items3 5,798  –     –    
Total gross lending 459,629  9,590  2.1  4,172  46.1 
Impairment provisions (4,172)            
Fair value adjustments4 (282)            
Total Group 455,175             
At 31 December 2014               
Retail 317,347  4,927  1.6  1,734  38.8 
Commercial Banking 102,459  3,241  3.2  1,594  49.2 
Consumer Finance 21,273  720  3.4  309  70.5 
Run-off 18,316  5,215  28.5  3,927  75.3 
TSB 21,729  205  0.9  88  42.9 
Reverse repos and other items3 9,635             
Total gross lending 490,759  14,308  2.9  7,652  56.4 
Impairment provisions (7,652)            
Fair value adjustments4 (403)            
Total Group 482,704             
1Impairment provisions include collective unidentified impairment provisions.
2Impairment provisions as a percentage of impaired loans are calculated excluding Retail and Consumer Finance loans in recoveries (31 December 2015: £335 million in Retail Loans and Overdrafts, £28 million in Retail other and £179 million in Consumer Finance credit cards; 31 December 2014: £437 million in Retail loans and overdrafts, £26 million in Retail other and £282 million in Consumer Finance Credit Cards).
3Includes £5.7 billion (31 December 2014: £4.4 billion) of lower risk loans sold by Commercial Banking and Retail to Insurance to back annuitant liabilities.
4The fair value adjustments relating to loans and advances were made on the acquisition of HBOS to reflect the fair value of the acquired assets and took into account both the expected losses and market liquidity at the date of acquisition. The unwind relating to future impairment losses requires management judgement to assess whether the losses incurred in the current period were expected at the date of the acquisition and assessing whether the remaining losses expected at the date of the acquisition will still be incurred. The element relating to market liquidity unwinds to the income statement over the estimated expected lives of the related assets (until 2014 for commercial loans and 2018 for retail loans) although if an asset is written-off or suffers previously unexpected impairment then this element of the fair value will no longer be considered a timing difference (liquidity) but permanent (impairment). The fair value unwind in respect of impairment losses incurred was £97 million for the period ended 31 December 2015 (31 December 2014: £251 million). The fair value unwind in respect of loans and advances is expected to continue to decrease in future years as fixed-rate periods on mortgages expire, loans are repaid or written-off, and will reduce to zero over time.
64

OPERATING AND FINANCIAL REVIEW AND PROSPECTSCommercial Banking forbearance

 

Table 1.8:1.23: Commercial Banking forborne loans and advances (audited)

  Total
£m		  Of which
Stage 3
£m		 
At 31 December 2018
Type of forbearance		        
Refinancing  38   29 
Modification  3,834   2,949 
Total  3,872   2,978 
At 31 December 2017
Type of forbearance		        
Refinancing  27     
Modification  3,644     
Total  3,671     

Table 1.24:Derivative credit risk exposures

     2015
Traded over the counter		       2014
Traded over the counter		   
   Traded on
recognised
exchanges
£m		   Settled
by central
counterparties
£m		   Not settled
by central
counterparties
£m		   Total
£m		   Traded on
recognised
exchanges
£m		   Settled by central
counterparties
£m		   Not settled
by central
counterparties
£m		   Total
£m		 
Notional balances                                
Foreign exchange  6,568   –   383,722   390,290   –   –   456,215   456,215 
Interest rate  31,128   3,598,307   791,351   4,420,786   82,201   5,768,373   972,531   6,823,105 
Equity and other  4,837   –   9,337   14,174   4,808   –   10,034   14,842 
Credit  –   –   4,566   4,566   –   –   18,063   18,063 
Total  42,533   3,598,307   1,188,976   4,829,816   87,009   5,768,373   1,456,843   7,312,225 
 
Fair values                                
Assets      103   28,811           127   35,322     
Liabilities      (131)  (26,149)          (117)  (32,988)    
Net asset      (28)  2,662           10   2,334     

      2018
Traded over the counter		         2017
Traded over the counter		    
  Traded on
recognised
exchanges
£m		  Settled
by central
counterparties
£m		  Not settled
by central
counterparties
£m		  Total
£m		  Traded on
recognised
exchanges
£m		  Settled
by central
counterparties
£m		  Not settled
by central
counterparties
£m		  Total
£m		 
Notional balances                                
Foreign exchange  –   45   385,680   385,725   –   19   278,833   278,852 
Interest rate  128,221   4,950,912   689,882   5,769,015   109,492   2,903,481   324,834   3,337,807 
Equity and other  9,247   –   5,898   15,145   15,455   –   9,695   25,150 
Credit  –   –   13,757   13,757   –   –   4,568   4,568 
Total  137,468   4,950,957   1,095,217   6,183,642   124,947   2,903,500   617,930   3,646,377 
Fair values                                
Assets      144   23,448           280   25,155     
Liabilities      (150)  (21,222)          (592)  (25,454)    
Net asset      (6)  2,226           (312)  (299)    

 

The total notional principleprincipal amount of interest rate, exchange rate, credit derivative and equity and other contracts outstanding at 31 December 20152018 and 31 December 20142017 is shown in the table above. The notional principleprincipal amount does not, however, represent the Group’s credit risk exposure, which is limited to the current cost of replacing contracts with a positive value to the Group. Such amounts are reflected in note 5352 on page F-90.F-88.

RETAIL

–The impairment charge was £432 million in 2015, a decrease of 28 per cent against 2014. The decrease reflects continued low risk underwriting discipline, strong portfolio management and a favourable credit environment with low unemployment, increasing house prices and continued low interest rates.
–The impairment charge, as a percentage of average loans and advances to customers, improved to 14 basis points in 2015 from 19 basis points in 2014.
–Impaired loans decreased by £433 million to £4,494 million, which represented 1.4 per cent of closing loans and advances to customers at 31 December 2015 (31 December 2014: 1.6 per cent).
–Retail Division Impairment coverage has increased to 40.4 per cent from 38.8 per cent at the end of 2014, with Secured coverage increasing 0.5 per cent to 37.5 per cent.

Table 1.9: Retail impairment charge

  2015
£m		  2014
£m		  Change
%		 
Secured  98   281   65 
Loans and overdrafts  311   279   (11)
Wealth  2   8   75 
Retail Business Banking  21   31   32 
Total impairment charge  432   599   28 
Impairment charge as a % of average advances  0.14%  0.19%   (5)bps
65

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.10: Retail impaired loans and provisions

  Loans and
advances to
customers
£m		  Impaired
loans
£m		  Impaired loans
as a %
of closing
advances
%		  Impairment
provisions1
£m		  Impairment
provisions as a
% of impaired
loans2
%		 
At 31 December 2015               
Secured  302,413   3,818   1.3   1,431   37.5 
Loans and overdrafts:                    
Collections      243       197   81.8 
Recoveries3      335       –   – 
   9,917   578   5.8   197   81.1 
Wealth  2,811   55   2.0   23   41.8 
Retail Business Banking:                    
Collections      15       19     
Recoveries3      28       –     
   895   43   4.8   19   126.7 
Total gross lending  316,036   4,494   1.4   1,670   40.4 
Impairment provisions  (1,670)                
Fair value adjustments  (273)                
Total  314,093                 
At 31 December 2014                    
Secured  303,121   3,911   1.3   1,446   37.0 
Loans and overdrafts:                    
Collections      258       220   85.3 
Recoveries3      437       –   – 
   10,395   695   6.7   220   85.3 
Wealth  2,962   270   9.1   40   14.8 
Retail Business Banking:                    
Collections      25       28     
Recoveries3      26       –     
   869   51   5.9   28   112.0 
Total gross lending  317,347   4,927   1.6   1,734   38.8 
Impairment provisions  (1,734)                
Fair value adjustments  (392)                
Total  315,221                 
1Impairment provisions include collective unidentified impairment provisions.
2Impairment provisions as a percentage of impaired loans are calculated excluding unsecured loans in recoveries.
3Recoveries assets are written down to the present value of future expected cash flows on these assets.

SECURED

–The impairment charge was £98 million, a decrease of 65 per cent against 2014. The impairment charge as a percentage of average loans and advances to customers, improved to 3 basis points from 9 basis points in 2014.
–Loans and advances to Mainstream customers were broadly flat during the year at £227.3 billion with the Buy-to-let portfolio growing by 4 per cent to £55.6 billion. The closed Specialist portfolio has continued to run-off, reducing by 10 per cent to £19.5 billion.
–Impaired loans reduced by £93 million in 2015 to £3,818 million at 31 December 2015 with reductions in both the Mainstream and Buy-to-let portfolios. Impairment provisions as a percentage of impaired loans increased to 37.5 per cent from 37.0 per cent at 31 December 2014.
–The value of mortgages greater than three months in arrears (excluding repossessions) decreased by £439 million to £5,905 million at 31 December 2015 (31 December 2014: £6,344 million), with reductions in both the Mainstream and Buy-to-let portfolios.
–The average indexed loan to value (LTV) of the residential mortgage portfolio at 31 December 2015 decreased to 46.1 per cent compared with 49.2 per cent at 31 December 2014. The percentage of closing loans and advances with an indexed LTV in excess of 100 per cent decreased to 1.1 per cent at 31 December 2015, compared with 2.2 per cent at 31 December 2014.
–The average LTV for new residential mortgages written in 2015 was 64.7 per cent compared with 64.8 per cent for 2014.

LOANS AND OVERDRAFTS

–The impairment charge was £311 million, an increase of 11 per cent against 2014.
–The impairment charge as a percentage of average loans and advances to customers, increased to 3.0 per cent in 2015 from 2.6 per cent in 2014.
–Impaired loans reduced by £117 million in 2015 to £578 million representing 5.8 per cent of closing loans and advances to customers, compared with 6.7 per cent at 31 December 2014.
66

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.11: Retail secured and unsecured loans and advances to customers

   At
31 Dec 2015
£m		   At
31 Dec 2014
£m		 
Secured:        
Mainstream  227,267   228,176 
Buy-to-let  55,598   53,322 
Specialist1  19,548   21,623 
   302,413   303,121 
Loans and overdrafts:        
Loans  7,889   8,204 
Overdrafts  2,028   2,191 
   9,917   10,395 
Wealth  2,811   2,962 
Retail Business Banking  895   869 
Total gross lending  316,036   317,347 
1Specialist lending has been closed to new business since 2009.

Table 1.12: Mortgages greater than three months in arrears (excluding repossessions)

  Number of cases Total mortgage accounts % Value of loans1 Total mortgage balances %
  2015
cases		  2014
cases		  2015
%		  2014
%		  2015
£m		  2014
£m		  2015
%		  2014
%		 
Mainstream  34,850   37,849   1.6   1.7   3,803   4,102   1.7   1.8 
Buy-to-let  5,021   5,077   1.0   1.1   626   658   1.1   1.2 
Specialist  8,777   9,429   6.4   6.3   1,476   1,584   7.6   7.3 
Total  48,648   52,355   1.7   1.8   5,905   6,344   2.0   2.1 
1Value of loans represents total gross book value of mortgages more than three months in arrears.

The stock of repossessions decreased to 654 cases at 31 December 2015 compared to 1,740 cases at 31 December 2014.

67

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.13: Period end and average LTVs across the Retail mortgage portfolios

  Mainstream
%		  Buy-to-let
%		  Specialist
%		  Total
%		  Unimpaired
%		  Impaired
%		 
At 31 December 2015                  
Less than 60%  52.2   45.4   43.7   50.4   50.7   30.9 
60% to 70%  19.1   26.8   19.7   20.6   20.6   17.5 
70% to 80%  15.5   15.0   15.5   15.4   15.4   16.9 
80% to 90%  9.0   8.0   11.6   9.0   8.9   13.3 
90% to 100%  3.2   3.9   5.5   3.5   3.4   9.5 
Greater than 100%  1.0   0.9   4.0   1.1   1.0   11.9 
Total  100.0   100.0   100.0   100.0   100.0   100.0 
Outstanding loan value (£m)  227,267   55,598   19,548   302,413   298,595   3,818 
Average loan to value:1                        
Stock of residential mortgages  43.6   56.3   53.3   46.1         
New residential lending  65.2   63.0   n/a   64.7         
Impaired mortgages  55.6   74.6   66.8   60.0         
At 31 December 2014                        
Less than 60%  44.6   32.4   31.4   41.5   41.7   22.5 
60% to 70%  19.9   27.3   19.5   21.2   21.3   15.3 
70% to 80%  18.5   21.8   19.8   19.2   19.2   17.8 
80% to 90%  10.6   9.4   14.9   10.7   10.6   16.7 
90% to 100%  4.5   6.8   8.7   5.2   5.2   11.9 
Greater than 100%  1.9   2.3   5.7   2.2   2.0   15.8 
Total  100.0   100.0   100.0   100.0   100.0   100.0 
Outstanding loan value (£m)  228,176   53,322   21,623   303,121   299,210   3,911 
Average Loan to value:1                        
Stock of residential mortgages  46.3   61.3   59.2   49.2         
New residential lending  65.3   62.7   n/a   64.8         
Impaired mortgages  60.1   81.0   72.6   64.9         
1Average loan to value is calculated as total loans and advances as a percentage of the indexed total collateral of these loans and advances.

INTEREST-ONLY MORTGAGES

The Group provides interest-only mortgages to customers, whereby payments of interest only are made for the term of the mortgage, with the customer responsible for repaying the principal outstanding at the end of the loan term.

Retail has reduced its exposure to owner occupier interest-only mortgages throughout 2015. New owner occupier interest only mortgages are limited to a maximum loan to value of 75 per cent, with a verifiable repayment vehicle sufficient to repay the loan. Interest-only mortgages represented 0.1 per cent of new residential mortgages in 2015 (0.1 per cent in 2014).

Table 1.14: Analysis of owner occupier interest-only mortgages

  2015  2014 
Interest-only balances (£m)1  81,558   90,649 
Impaired Loans (£m)  2,071   2,012 
Interest-only balances as a % of owner occupier balances  33.9   37.2 
Average loan to value (%)  46.6   51.0 
1In addition the Group has Buy-to-let interest only balances of £49,751 million (2014: £47,761 million) and certain other interest only balances of £3,705 million (2014: £4,153 million).

For existing interest-only mortgages, a contact strategy is in place throughout the term of the mortgage to ensure that customers are aware of their obligations to repay the principal upon maturity of the loan. The weighted-average term to maturity of the interest-only balances included in the table above is 11 years; the profile of owner occupier interest-only maturities is shown below.

Table 1.15: Analysis of owner occupier interest-only mortgages maturities

  1 Year
£bn		  2-5 Years
£bn		  6-10 Years
£bn		  > 11 Years
£bn		 
Value of loans as at 31 December 20151  2.0   9.1   14.5   45.2 
Value of loans as at 31 December 20141  1.8   9.2   14.6   52.7 
1Excludes mortgage accounts which consist of partial interest only and partial capital repayment.
68

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Treatment strategies exist to help customers who may not be able to fully repay the principal balance at maturity. Of the owner occupier interest only mortgages that have missed the payment of principal at the end of term, balances of £1,313 million remain at 31 December 2015 (£1,117 million at 31 December 2014). The average indexed loan to value of these accounts is 28.0 per cent at 31 December 2015 (28.7 per cent at 31 December 2014). Of these accounts, 9.1 per cent are impaired (8.4 per cent at 31 December 2014).

FORBORNE LOANS

At 31 December 2015, UK secured loans and advances currently or recently subject to forbearance were 1.0 per cent (31 December 2014: 1.4 per cent) of total UK secured loans and advances. The reduction in forbearance is due to the overall improvement of credit quality of the portfolio. Loans and overdrafts currently or recently subject to forbearance were 1.5 per cent (31 December 2014: 1.6 per cent) of total loans and overdrafts.

Further analysis of the forborne loan balances is set out below:

Table 1.16: UK retail forborne loans and advances (audited)

  Total loans and advances which
are forborne1		 Total forborne loans and
advances which are impaired1		 Impairment provisions
as % of loans and advances
which are forborne1
  2015
£m		  2014
£m		  2015
£m		  2014
£m		  2015
%		  2014
%		 
UK secured lending:                        
Temporary forbearance arrangements                        
Reduced contractual monthly payment2  –   146   –   29   –   6.0 
Reduced payment arrangements3  414   552   41   69   4.2   3.4 
   414   698   41   98   4.2   4.0 
                         
Permanent treatments                        
Repair and term extensions4  2,688   3,696   132   168   4.2   3.5 
Total  3,102   4,394   173   266   4.2   3.5 
                         
Loans and overdrafts5:  147   162   119   139   40.0   39.4 
1Includes accounts where the customer is currently benefiting from a forbearance treatment or the treatment has recently ended.
2Includes temporary interest-only arrangements and short-term payment holidays granted in collections where the customer is currently benefiting from the treatment and where the concession has ended within the previous six months (temporary interest-only) and previous 12 months (short-term payment holidays).
3Includes customers who had an arrangement to pay less than the contractual amount at 31 December or where an arrangement ended within the previous three months.
4Includes capitalisation of arrears and term extensions which commenced during the previous 24 months and where the borrowers remain as customers at 31 December.
5Includes temporary treatments where the customer is currently benefiting from the change or the treatment has ended within the previous six months. Permanent changes which commenced during the last 24 months for existing customers as at 31 December are also included.

UK secured forborne loans and advances have reduced by £1,292 million in 2015 to £3,102 million, driven primarily by an improvement in the underlying quality of the portfolio, with a greater value exiting forbearance than entering. Loans and Overdrafts forborne loans and advances have reduced by £15 million in 2015.

Further analysis of the movements in UK retail lending forborne loans and advances during the year is as follows:

Table 1.17: Movement in UK retail forborne loans and advances (audited)

     
  2015 2014
  Secured
lending
£m		  Loans and
Overdrafts
lending
£m		  Secured
lending
£m		  Loans and
Overdrafts
lending
£m		 
At 1 January  4,394   162   6,153   191 
Classified as forborne during the year  1,290   69   1,805   123 
Written-off/sold  (25)  (55)  (93)  (77)
Good exit from forbearance  (2,252)  (25)  (2,957)  (35)
Redeemed or repaid  (263)  (6)  (462)  (10)
Exchange and other movements  (42)  2   (52)  (30)
At 31 December  3,102   147   4,394   162 
69

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

COMMERCIAL BANKING

–There was a net impairment release of £22 million in 2015, compared to a charge of £83 million in 2014. This has been driven by lower levels of new impairment as a result of effective risk management, improving UK economic conditions and the continued low interest rate environment; as well as write backs and provision releases, but at lower levels than seen during 2014.
–The credit quality of the portfolio and new business remains good. Surplus market liquidity continues to lead to some relaxation of credit conditions in the marketplace, although the Group remains disciplined within its low risk appetite approach.
–Impaired loans reduced by 22 per cent to £2,528 million at 31 December 2015 compared with 31 December 2014 (£3,241 million) and as a percentage of closing loans and advances reduced to 2.5 per cent from 3.2 per cent at 31 December 2014.
–Impairment provisions reduced to £1,087 million at 31 December 2015 (December 2014: £1,594 million) and includes collective unidentified impairment provisions of £229 million (31 December 2014: £338 million). Provisions as a percentage of impaired loans reduced from 49.2 per cent to 43.0 per cent, predominantly due to the change in the mix of impaired assets during 2015, with newly impaired connections having lower coverage levels compared to the portfolio average. The decrease is also partly due to the reduction in the collective unidentified impairment provisions fund during the year as a result of improved conditions.
–The Group expects to benefit from its continued disciplined approach to the management of credit, and sustained UK economic growth. Nevertheless, market volatility and the uncertain global economic outlook such as the continued slowdown in Chinese economic growth and the fall in commodity prices may impact the Commercial portfolios.
–The Group manages and limits exposure to certain sectors and asset classes, and closely monitors credit quality, sector and single name concentrations. This together with our conservative through the cycle risk appetite approach, means our portfolios are well positioned.

Table 1.18: Commercial Banking impairment charge

  2015  2014  Change 
  £m  £m  % 
SME  (22)  15     
Other  –   68     
Total impairment (release)/charge  (22)  83     
Impairment charge as a % of average advances1  0.01%  0.08%  (7)bps
1In respect of loans and advances to customers.

Table 1.19: Commercial Banking impaired loans and provisions

  Loans and
advances to
customers
£m		  Impaired
loans
£m		  Impaired loans
as a % of
closing
advances
%		  Impairment
provisions1
£m		  Impairment
provisions
as a % of
impaired
loans
%		 
At 31 December 2015               
SME  29,393   1,149   3.9   213   18.5 
Other  73,042   1,379   1.9   874   63.4 
Total gross lending  102,435   2,528   2.5   1,087   43.0 
Reverse repos  –                 
Impairment provisions  (1,087)                
Total  101,348                 
                     
At 31 December 2014                    
SME  28,256   1,546   5.5   398   25.7 
Other  74,203   1,695   2.3   1,196   70.6 
Total gross lending  102,459   3,241   3.2   1,594   49.2 
Reverse repos  5,145                 
Impairment provisions  (1,594)                
Total  106,010                 
1Impairment provisions include collective unidentified impairment provisions.

70

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

SME

–The SME Banking portfolio continues to grow within prudent credit risk appetite parameters.
–Portfolio credit quality has remained stable or improved across all key metrics.
–There was a net impairment release of £22 million compared to a net charge of £15 million in 2014 with lower new impairment offset by writebacks and releases.

OTHER COMMERCIAL BANKING

–Other Commercial Banking comprises £73,042 million of gross loans and advances to customers in Mid Markets, Global Corporates and Financial Institutions.
–In the Mid Markets portfolio, credit quality has remained stable. The portfolio is focused on UK businesses and dependent on the performance of the domestic economy and to some extent, the global economy. The oil and gas services element of the portfolio has been reviewed given ongoing low oil prices and this review has not revealed any material concerns with portfolio quality at this time.
–The Global Corporate business continues to have a predominance of investment grade clients, primarily UK based. As a result of this profile, allied to our conservative risk appetite, our portfolio remains of good quality despite the current global economic headwinds particularly relating to the energy and mining sectors. We continue to monitor the portfolio closely to ensure there is no material deterioration.
–The real estate business within the Group’s Mid Markets and Global Corporate portfolio is focused on clients operating in the UK commercial property market ranging in size from medium sized private real estate entities up to publicly listed property companies. The market for UK real estate has been buoyant and credit quality remains good with minimal impairments/stressed loans. All asset classes are attracting investment but, recognising this is a cyclical sector, appropriate caps are in place to control exposure and business propositions continue to be written in line with prudent risk appetite with conservative LTV, strong quality of income and proven management teams.
–Financial Institutions serves predominantly investment grade counterparties with whom relationships are either client focused or held to support the Group’s funding, liquidity or general hedging requirements.
–Trading exposures continue to be predominantly short-term and/or collateralised with inter-bank activity mainly undertaken with acceptable investment grade counterparties.
–The Group continues to adopt a conservative stance across the Eurozone maintaining close portfolio scrutiny and oversight particularly given the current macro environment and horizon risks.

Commercial Banking UK Direct Real Estate LTV analysis

–The Group classifies Direct Real Estate as exposure which is directly supported by cash flows from property activities (as opposed to trading activities such as hotels, care homes and housebuilders).
–The Group manages its exposures to Direct Real Estate across a number of different coverage segments.
–Approximately 70 per cent of loans and advances to UK Direct Real Estate relate to commercial real estate with the remainder residential real estate.
–The Group makes use of a variety of methodologies to assess the value of property collateral, where external valuations are not available. These include use of market indices, models and subject matter expert judgement.
–The LTV profile of the UK Direct Real Estate portfolio in Commercial Banking continues to improve.

Table 1.20: LTV – UK Direct Real Estate

  At 31 December 20151 At 31 December 20141
   Unimpaired
£m		   Impaired
£m		   Total
£m		   %   Unimpaired
£m		   Impaired
£m		   Total
£m		   % 
UK exposures >£5 million                                
Less than 60%  4,989   72   5,061   63.7   3,985   52   4,037   47.8 
60% to 70%  1,547   6   1,553   19.5   1,644   62   1,706   20.2 
70% to 80%  610   13   623   7.9   964   17   981   11.6 
80% to 100%  75   36   111   1.4   66   211   277   3.3 
100% to 120%  –   8   8   0.1   –   –   –   – 
120% to 140%  –   –   –   –   130   6   136   1.6 
Greater than 140%  5   100   105   1.3   –   95   95   1.1 
Unsecured  487   –   487   6.1   1,222   –   1,222   14.4 
   7,713   235   7,948   100.0   8,011   443   8,454   100.0 
UK exposures <£5 million  9,656   508   10,164       8,833   644   9,477     
Total  17,369   743   18,112       16,844   1,087   17,931     
1Exposures exclude £0.3 billion (31 December 2014: £0.4 billion) of gross UK Direct Real Estate lending in Wealth (within Retail division) and £1.1 billion (31 December 2014: £3.3 billion) of UK Direct Real Estate lending in Run-off. Also excludes Social Housing and Housebuilder lending.
71

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

FORBORNE LOANS

Commercial Banking forbearance

At 31 December 2015, £3,514 million (31 December 2014: £5,137 million) of total loans and advances were forborne of which £2,528 million (31 December 2014: £3,241 million) were impaired. Impairment provisions as a percentage of forborne loans and advances decreased marginally from 31.0 per cent at 31 December 2014 to 30.9 per cent at 31 December 2015.

Table 1.21: Commercial Banking forborne loans and advances (audited)

  Total loans and advances which
are forborne		 Impairment provisions as % of
loans and advances which are
forborne
  2015
£m		  2014
£m		  2015
%		  2014
%		 
Impaired  2,528   3,241   43.0   49.2 
Unimpaired  986   1,896   –   – 
Total  3,514   5,137   30.9   31.0 

All impaired assets are considered forborne.

Impaired loans and advances

The movements in Commercial Banking impaired forborne loans and advances were as follows:

Table 1.22: Movement in Commercial Banking impaired forborne loans and advances (audited)

  2015
£m		  2014
£m		 
At 1 January  3,241   5,047 
Classified as impaired during the year:        
Exposures >£5m  505   775 
Exposures <£5m  126   188 
   631   963 
Transferred to unimpaired:        
Exposures >£5m but still reported as forborne  (15)  (268)
Exposures >£5m no longer reported as forborne  (20)  – 
Exposures <£5m  (111)  (477)
   (146)  (745)
Written-off  (225)  (719)
Asset disposal/sales of impaired assets  (48)  (357)
Drawdowns/repayments  (693)  (732)
Exchange and other movements  (232)  (216)
At 31 December  2,528   3,241 

Unimpaired loans and advances

Unimpaired forborne loans and advances were £986 million at 31 December 2015 (31 December 2014: £1,896 million).

The table below sets out the largest unimpaired forborne loans and advances to Commercial Banking customers (exposures over £5 million) as at 31 December 2015 by type of forbearance:

Table 1.23: Commercial Banking unimpaired forborne loans and advances (audited)

  31 December
2015
£m		  31 December
2014
£m		 
Exposures >£5 million:      
Covenants  310   1,018 
Extensions/alterations  350   426 
Multiple  9   6 
   669   1,450 
Exposures < £5 million  317   446 
Total  986   1,896 
72

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.24: Movement in Commercial Banking unimpaired forborne loans and advances >£5m1(audited)

  31 December
2015
£m		  31 December
2014
£m		 
At 1 January  1,450   1,654 
Classified as impaired during the year  (141)  (147)
Cured no longer forborne  (655)  (1,004)
Classified as forborne during the year  156   709 
Transferred from impaired but still reported as forborne2  15   743 
Asset disposal/sales  –   (451)
Net drawdowns/repayments  (153)  (6)
Exchange and other movements  (3)  (48)
At 31 December  669   1,450 
1Balances exclude intra-year movements.
22014 included £475 million in respect of two loans transferred from Run-off.

CONSUMER FINANCE

–The impairment charge reduced by 29 per cent to £152 million from £215 million in 2014. The reduction was driven by a continued underlying improvement of portfolio quality supported by an increased level of write-backs from the sale of recoveries assets in the Credit Cards portfolio.
–Impairment provisions as a percentage of impaired loans have increased to 72.8 per cent from 70.5 per cent at 31 December 2014, with Credit Cards increasing by 5.3 percentage points to 81.8 per cent and Asset Finance UK decreasing by 2.8 percentage points to 67.2 per cent.
–Loans and advances increased by £2,665 million to £23,938 million during 2015. The growth was achieved in both Asset Finance UK and Credit Cards portfolio with no relaxation in risk appetite and underwriting standards. Impaired loans decreased by £177 million in 2015 to £543 million which represented 2.3 per cent of closing loans and advances to customers (31 December 2014: 3.4 per cent).

Table 1.25: Consumer Finance impairment charge

  2015
£m		  2014
£m		  Change
%		 
Credit Cards  129   186   31 
Asset Finance UK  22   30   27 
Asset Finance Europe  1   (1)    
Total impairment charge  152   215   29 
Impairment charge as a % of average advances  0.68%  1.05%  (37) bps 
73

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.26: Consumer Finance impaired loans and provisions

  Loans and
advances to
customers
£m		  Impaired
loans
£m		  Impaired
loans as a %
of closing
advances
%		  Impairment
provisions1
£m		  Impairment
provisions
as a % of
impaired
loans2
%		 
At 31 December 2015               
Credit Cards:               
Collections      187       153   81.8 
Recoveries3      179       –     
   9,425   366   3.9   153   81.8 
Asset Finance UK  9,582   134   1.4   90   67.2 
Asset Finance Europe  4,931   43   0.9   22   51.2 
   14,513   177   1.2   112   63.3 
   23,938   543   2.3   265   72.8 
Impairment provisions  (265)                
Fair value adjustments  (9)                
Total  23,664                 
 
At 31 December 2014                    
Credit Cards:                    
Collections      217       166   76.5 
Recoveries3      282       –     
   9,119   499   5.5   166   76.5 
Asset Finance UK  7,204   160   2.2   112   70.0 
Asset Finance Europe  4,950   61   1.2   31   50.8 
   12,154   221   1.8   143   64.7 
   21,273   720   3.4   309   70.5 
Impairment provisions  (309)                
Fair value adjustments  (30)                
Total  20,934                 
1Impairment provisions include collective unidentified impairment provisions.
2Impairment provisions as a percentage of impaired loans are calculated excluding unsecured loans in recoveries.
3Recoveries assets are written down to the present value of expected cash flows on these assets.

FORBORNE LOANS

At 31 December 2015, Consumer Credit Card loans and advances currently or recently subject to forbearance were 2.4 per cent (31 December 2014: 2.6 per cent) of total Consumer Credit Card loans and advances. At 31 December 2015, Asset Finance UK Retail loans and advances on open portfolios currently or recently subject to forbearance were 1.4 per cent (31 December 2014: 2.1 per cent) of total Asset Finance UK Retail loans and advances. Further analysis of the forborne loans and advances is set out below:

Table 1.27: Consumer Finance forborne loans and advances (audited)

  Total loans and advances which
are forborne1		 Total forborne loans and
advances which are impaired1		 Impairment provisions
as % of loans and advances
which are forborne1
  2015
£m		  2014
£m		  2015
£m		  2014
£m		  2015
%		  2014
%		 
Consumer Credit Cards2  225   234   120   140   26.8   29.1 
Asset Finance UK Retail2  100   109   51   53   25.5   20.5 
1Includes accounts where the customer is currently benefiting from a forbearance treatment or the treatment recently ended.
2Includes temporary treatments where the customer is currently benefiting from the change or the treatment has ended within the last six months. Permanent changes which commenced during the last 24 months for existing customers as at 31 December are also included.
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Consumer Credit Cards and Asset Finance UK Retail forborne loans have reduced in 2015 by £9 million and £9 million respectively, driven primarily by improvements in the underlying quality of the portfolios. The movements in forborne loans and advances during the year were as follows:

Table 1.28: Movement in Consumer Finance forborne loans and advances (audited)

  2015 2014
  Consumer credit
cards
£m		  Asset
Finance
£m		  Consumer
credit
cards £m		  Asset Finance £m 
At 1 January  234   109   326   149 
Classified as forborne during the year  108   61   128   56 
Written off/sold  (48)  (14)  (93)  (25)
Good exit from forbearance  (36)  (17)  (92)  (19)
Redeemed or repaid  (9)  (19)  (14)  (26)
Exchange and other movements  (24)  (20)  (21)  (26)
At 31 December  225   100   234   109 

RUN-OFF

–With the exception of a small residual book (£37 million of which £5 million is impaired), the Irish Wholesale book (which contained the Commercial Real Estate portfolio), is now effectively exited following completion of the divestment announced on 30 July 2015. The Ireland Retail portfolio has reduced from £4,464 million at 31 December 2014 to £4,040 million at 31 December 2015.
–The Corporate real estate and other corporate portfolio has continued to reduce significantly ahead of expectations. Net loans and advances reduced by £1,908 million, from £3,036 million to £1,128 million for 2015.
–Net loans and advances for the specialist finance asset based run-off portfolio stood at £4,001 million at 31 December 2015 (gross £4,190 million), and include Ship Finance, Aircraft Finance and Infrastructure, with around half of the remaining lending in the lower risk leasing sector. Including the reducing Treasury Asset Legacy investment portfolio, and operating losses, total net external assets reduced to £5,552 million at 31 December 2015 (gross £5,742 million).
–Ireland retail loans and advances with an indexed LTV in excess of 100 per cent decreased to £1,269 million (31.4 per cent) at 31 December 2015, compared with £1,737 million (38.9 per cent) at 31 December 2014. Of this amount £71 million were impaired (31 December 2014: £78 million).

Table 1.29: Run-off impairment charge

  2015
£m		  2014
£m		  Change
%		 
Ireland retail  (5)  (6)  (17)
Ireland commercial real estate  11   67   84 
Ireland corporate  61   247   75 
Corporate real estate and other corporate  21   (28)    
Specialist finance  (45)  22     
Other  (35)  (99)  (65)
Total  8   203   96 
Impairment charge as a % of average advances1  0.20%  0.64%  (44)bps
1In respect of loans and advances to customers.
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.30: Run-off impaired loans and provisions

  Advances to
customers
£m		  Impaired
loans
£m		  Impaired
loans as a %
of closing
advances
%		  Impairment
provisions
£m		  Impairment
provisions
as a % of
impaired
loans
%		 
At 31 December 2015                    
Ireland retail  4,040   132   3.3   120   90.9 
Ireland commercial real estate  8   5   62.5   –     
Ireland corporate  29   –       –     
Corporate real estate and other corporate  1,873   1,410   75.3   745   52.8 
Specialist finance  4,190   361   8.6   189   52.4 
Other  1,282   117   9.1   96   82.1 
   11,422   2,025   17.7   1,150   56.8 
Impairment provisions  (1,150)                
Fair value adjustments  –                 
Total  10,272                 
At 31 December 2014                    
Ireland retail  4,464   120   2.7   141   117.5 
Ireland commercial real estate  1,797   1,659   92.3   1,385   83.5 
Ireland corporate  1,639   1,393   85.0   1,095   78.6 
Corporate real estate and other corporate  3,947   1,548   39.2   911   58.9 
Specialist finance  4,835   364   7.5   254   69.8 
Other  1,634   131   8.0   141   107.6 
   18,316   5,215   28.5   3,927   75.3 
Impairment provisions  (3,927)                
Fair value adjustments  19                 
Total  14,408                 

FORBORNE LOANS

RUN-OFF IRELAND RETAIL LENDING

At 31 December 2015, £169 million or 4.2 per cent (31 December 2014: £280 million or 6.3 per cent) of Irish retail secured loans and advances were subject to current or recent forbearance. Of this amount £26 million (31 December 2014: £41 million) were impaired.

RUN-OFF CORPORATE REAL ESTATE, OTHER CORPORATE AND SPECIALIST FINANCE

At 31 December 2015 £1,780 million (31 December 2014: £1,998 million) of total loans and advances were forborne of which £1,771 million (31 December 2014: £1,912 million) were impaired. Impairment provisions as a percentage of forborne loans and advances decreased from 58.3 per cent at 31 December 2014 to 52.5 per cent at 31 December 2015.

Unimpaired forborne loans and advances were £9 million at 31 December 2015 (31 December 2014: £86 million).

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Impaired loans and advances

The movements in Run-off corporate real estate, other corporate and Specialist Finance impaired forborne loans and advances were as follows:

Table 1.31: Movement in Run-off corporate real estate, other corporate and Specialist Finance impaired forborne loans and advances (audited)

  2015
£m		  2014
£m		 
At 1 January  1,912   9,499 
Classified as impaired during the year:        
Exposures >£5m  414   557 
Exposures <£5m  11   46 
   425   603 
Transferred to unimpaired but still reported as forborne during the year:        
Exposures >£5m1  (13)  (961)
Exposures <£5m  (11)  (12)
   (24)  (973)
Write offs  (238)  (2,565)
Asset disposal/sales of impaired assets  (763)  (4,363)
Drawdowns/repayments  (19)  (248)
Exchange and other movements  478   (41)
At 31 December  1,771   1,912 
12014 included £475 million in respect of two loans classified as impaired during the year and subsequently transferred to Commercial Banking.

Run-off Ireland commercial real estate and corporate

All loans and advances (whether impaired or unimpaired) are treated as forborne. At 31 December 2015, £37 million (31 December 2014: £3,436 million) of total loans and advances were forborne of which £5 million (31 December 2014: £3,052 million) were impaired. Impairment provisions as a percentage of forborne loans and advances decreased from 72.2 per cent at 31 December 2014 to nil at 31 December 2015.

The movements in forborne loans and advances were:

Table 1.32: Movement in Run-off: Ireland commercial real estate and corporate forborne loans and advances (audited)

  2015
£m		  2014
£m		 
At 1 January  3,436   9,430 
Write-offs  (419)  (2,589)
Asset disposal/sales  (2,563)  (1,444)
Drawdowns/repayments  (99)  (1,413)
Exchange and other movements  (318)  (548)
At 31 December  37   3,436 

 

Eurozone exposures

The following section summarises the Group’s direct exposure to Eurozone countries at 31 December 2015. The exposures comprise on-balance sheet exposures based on their balance sheet carrying values and off-balance sheet exposures, and are based on the country of domicile of the counterparty unless otherwise indicated.

The Group manages its exposures to individual countries, both within and without the Eurozone, through authorised country limits which take into account economic, financial, political and social factors. In addition, the Group manages its direct risks to the selected Eurozone countries Ireland, Spain, Italy and Greece by establishing and monitoring risk limits for individual banks, financial institutions, corporates and individuals.

 

Identified indirect exposure information, where available, is also taken into account when setting limits and determining credit risk appetite for individual counterparties. This forms part of the Group’s credit analysis undertaken at least annually for counterparty and sector reviews, with interim updates performed as necessary. Interim updates would usually be triggered by specific credit events such as rating downgrades, sovereign events or other developments such as spread widening. Examples of indirect risk which have been identified, where information is available, are: European Bankingbanking groups with lending and other exposures to certain Eurozone Countries;countries; corporate customers with operations or significant trade in certain European jurisdictions; major travel operators known to operate in certain Eurozone Countries;countries; and international banks with custodian operations based in certain European locations.

 

The Group Financial Stability Forum (GFSF)Chief Security Office monitors developments within the Eurozone, carries out stress testing through detailed scenario analysis and completes appropriate due diligence on the Group’s exposures.

The GFSF has carried out a number of scenario analyses and rehearsals to test the Group’s resilience in the event of further instability in certain Eurozone countries. The Group has developed and refined pre-determined action plans that would be executed in such scenarios. The planscertain scenarios which set out governance requirements and responsibilities for the key actions which would be carried out and cover risk areas such as payments, liquidity and capital, communications, suppliers and systems, legal, credit, delivery channels and products, employees and the impact on customers.

 

Exposures to Eurozone countries are detailed in the following tables and are based on balance sheet exposures, net of provisions. Derivative balances are included within exposures to financial institutions or corporates, as appropriate, at fair value adjusted for master netting agreements at obligor level

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

and net of cash collateral in line with legal agreements. Exposures in respect ofExcluding reverse repurchase agreements are included on a gross IFRS basis and are disclosed based on the counterparty rather than the collateral (repos and stock lending are excluded); reverse repurchase exposures are not, therefore, reduced as a result of collateral held. Reverse repurchase exposuresexposure to Institutional funds secured by UK Gilts are excluded from all Eurozone exposures as detailed ingilts, the footnotes. Exposures to central clearing counterparties are shown net.

For multi-country asset backed securities exposures, the Group has reported exposures based on the largest country exposure. The country of exposure for asset backed securities is based on the location of the underlying assets which are predominantly residential mortgages not on the domicile of the issuer.

For Insurance, the Group has reported shareholder exposures i.e. where the Group is directly exposed to risk of loss. These shareholder exposures relate to direct investments where the issuer is resident in the named Eurozone country and the credit rating is consistent with the tight credit criteria defined under the appropriate investment mandate. Insurance also has interests in two funds domiciled in Ireland (Global Liquidity Fund and the Investment Cash Fund) where, in line with the investment mandates, cash is invested in short term financial instruments. For these funds, the exposure is analysed on a look through basis to the country risk of the obligors of the underlying assets rather than treating the insurance holding in the funds as exposure to Ireland.

EXPOSURES TO SELECTED EUROZONE COUNTRIES

The Group continues to have minimal exposure, in aggregate, which could be considered to be direct recourse to the sovereign risk of the selected countries.

Table 1.33: Selected Eurozonecountries Ireland, Spain, Portugal, Italy and Greece and following the £4 billion sale of the Irish residential mortgage portfolio during the year, exposures

  Sovereign debt                      
  Direct  Cash at  Financial institutions  Asset             
  sovereign  central        backed        Insurance    
  exposures  banks  Banks  Other1  securities  Corporate  Personal  assets  Total 
  £m  £m  £m  £m  £m  £m  £m  £m  £m 
At 31 December 2015                                    
Ireland  –   –   748   445   87   731   3,921   –   5,932 
Spain  –   –   77   102   –   870   39   9   1,097 
Portugal  –   –   7   –   –   86   6   –   99 
Italy  –   –   32   –   –   51   –   73   156 
Greece  –   –   –   –   –   1   –   –   1 
   –   –   864   547   87   1,739   3,966   82   7,285 
At 31 December 2014                                    
Ireland  –   –   359   –   115   1,672   4,325   –   6,471 
Spain  –   –   57   116   –   1,160   49   13   1,395 
Portugal  –   –   9   5   –   133   6   –   153 
Italy  –   –   354   5   –   93   –   34   486 
Greece  –   –   –   –   –   3   –   –   3 
   –   –   779   126   115   3,061   4,380   47   8,508 
1Excludes reverse repurchase exposure to Institutional funds domiciled in Ireland secured by UK gilts of £11,267 million (2014: £10,456 million) on a gross basis.

In addition to the exposures detailed in table 1.33, the Group has the following exposures to sovereigns, financial institutions, asset backed securities, corporates and personal customers in the following Eurozone countries:selected countries are significantly reduced.

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Table 1.34: Other Eurozone exposures

  Sovereign debt                      
  Direct  Cash at        Asset             
   sovereign   central  Financial institutions   backed         Insurance    
  exposures  banks  Banks  Other1  securities  Corporate  Personal  assets  Total 
  £m  £m  £m  £m  £m  £m  £m  £m  £m 
At 31 December 2015                                    
Netherlands  281   11,515   328   164   37   1,275   4,863   428   18,891 
France  173   –   1,809   216   98   1,953   64   953   5,266 
Germany  151   97   888   21   66   1,924   177   573   3,897 
Luxembourg  –   –   74   1,178   618   1,614   –   36   3,520 
Belgium  20   –   830   1   –   298   –   51   1,200 
Austria  –   –   3   –   –   280   –   –   283 
All other Eurozone countries  15   –   400   –   –   62   –   80   557 
   640   11,612   4,332   1,580   819   7,406   5,104   2,121   33,614 
At 31 December 2014                                    
Netherlands  320   5,611   597   129   307   1,682   4,888   432   13,966 
France  245   –   3,198   1,435   134   2,453   73   1,069   8,607 
Germany  181   133   806   1,180   339   1,729   32   877   5,277 
Luxembourg  –   –   8   799   74   2,241   –   11   3,133 
Belgium  75   –   906   2  ��–   404   –   27   1,414 
Austria  311   –   913   –   –   163   –   –   1,387 
All other Eurozone countries  116   –   449   –   –   64   –   94   723 
   1,248   5,744   6,877   3,545   854   8,736   4,993   2,510   34,507 
1Excludes reverse repurchase exposure to Institutional funds secured by UK gilts of £1,955 million (2014: £1,455 million) on a gross basis.

ENVIRONMENTAL RISK MANAGEMENT

Environmental risk management

The Group ensures appropriate management of the environmental impact, including climate change, of its lending activities. The GroupwideGroup-wide credit risk principles require all credit risk to be incurred with due regard to environmental legislation and the Group’s Codecode of Business Responsibility.

Within Commercial Banking, an electronic environmental risk screening system has been the primary mechanism for assessing environmental risk in lending transactions. This system provides screening of location specific and sector based risks that may be present in a transaction. Identified risk results in the transaction referred to the Group’s expert in-house environmental risk team for further review and assessment, as outlined below. Where required, the Group’s panel of environmental consultants provide additional expert support.responsibility.

 

The Group provides colleague trainingGroup’s business areas and sub-groups are each exposed to different types and levels of climate-related risk in their operations. For example, the general insurance function regularly uses weather, climate and environmental models and data to assess its insurance risk managementfrom covered perils such as partwindstorm and flood. A team of specialist scientists are employed within underwriting to do this work and they also regularly monitor the state of climate science to assess the need to include its potential impacts within pricing and solvency.

In 2018 we developed an implementation plan to address key recommendations of the standard suite of credit risk courses. Supporting this training, a range of online resourceTask Force on Climate-related Financial Disclosure (TCFD). Further detail on planned activities is availableprovided in the Sustainability Strategy and Task Force on Climate-related Financial Disclosure Statement (see pages 6 to colleagues and includes environmental risk theory, procedural guidance, and information on environmental legislation and sector-specific environmental impacts.7).

 

The Group has been a signatory to the Equator Principles since 20062008 and has adopted and applied the expanded scope of Equator Principles III. The Equator Principles support the Group’s approach to assessing and managing environmental and social issues in Project Finance, Project-Related Corporate loans and Bridge loans. Further informationThe Group has also been a signatory to the UN Principles for Responsible Investment (UNPRI) since 2012, which incorporate ESG (environmental, social and governance risk) considerations in asset management. Scottish Widows is contained withinresponsible for the annual UNPRI reporting process.

Within Commercial Banking, an electronic Environmental Risk Screening Tool is the primary mechanism for assessing environmental risk for lending transactions. This system provides screening of location specific and sector based risks that may be present in a transaction. Where a risk is identified, the transaction is referred to the Group’s Responsible Business Review (http://www.lloydsbankinggroup. com/our-group/responsible-business/our-approach/managing-risk/).expert in-house environmental risk team for further review and assessment. Where required, the Group’s panel of environmental consultants provide additional expert support.

 

We provide colleague training on environmental risk management as part of the standard suite of Commercial Banking credit risk courses. To support this training, a range of online resource is available to colleagues and includes environmental risk theory, procedural guidance, and information on environmental legislation and sector-specific environmental impacts.

Table 1.35:1.25: Environmental risk management approach

 

Group credit principles Environmental risk Credit policies Business unit processes Supporting tools Sector briefings Legislation briefings Initial transaction screening Relationship teams Detailed review In-house team, retained consultancy Environmental due diligence Panel consultants Environmental risk approval (including any conditions)

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

LOAN PORTFOLIO

 

In the following tables, where lending and the related impairment allowances are analysed between domestic and international, the classification as domestic or international is based on the location of the office recording the transaction, except for certain lending of the international business booked in London including the Group’s lending in Ireland which, following the merger of Bank of Scotland (Ireland) Limited into Bank of Scotland plc, is held on the balance sheet of Bank of Scotland plc in the UK but is reported as international.

ANALYSIS OF LOANS AND ADVANCES TO BANKS AND CUSTOMERS

 

The following table analyses loans and advances to banks and customers by category of loan at 31 December for each of the five years listed.

 

 2015 2014 2013 2012 2011 
 £m £m £m £m £m   2018
£m		   2017
£m		   2016
£m		   2015
£m		   2014
£m		 
Loans and advances to banks 25,117  26,155 25,365 32,760 32,620   6,285   6,611   26,902   25,117   26,155 
Loans and advances to customers:                                        
Mortgages  312,877   333,318   335,611   337,879   348,210   297,498   304,665   306,682   312,877   333,318 
Other personal lending  20,579   23,123   23,230   28,334   30,014   28,699   28,757   20,761   20,579   23,123 
Agriculture, forestry and fishing  6,924   6,586   6,051   5,531   5,198   7,314   7,461   7,269   6,924   6,586 
Energy and water supply  3,247   3,853   4,414   3,321   4,013   1,517   1,609   2,320   3,247   3,853 
Manufacturing  5,953   6,000   7,650   8,530   10,061   8,260   7,886   7,285   5,953   6,000 
Construction  4,952   6,425   7,024   7,526   9,722   4,684   4,428   4,535   4,952   6,425 
Transport, distribution and hotels  13,526   15,112   22,294   26,568   32,882   14,113   14,074   13,320   13,526   15,112 
Postal and telecommunications  2,563   2,624   2,364   1,397   1,896   2,711   2,148   2,564   2,563   2,624 
Financial, business and other services  43,072   44,979   42,478   48,729   64,046   77,505   57,006   49,197   43,072   44,979 
Property companies  32,228   36,682   44,277   52,388   64,752   28,451   30,980   32,192   32,228   36,682 
Lease financing  2,751   3,013   4,435   6,477   7,800   1,822   2,094   2,628   2,751   3,013 
Hire purchase  9,536   7,403   5,090   5,334   5,776   15,434   13,591   11,617   9,536   7,403 
Total loans  483,325��  515,273   530,283   564,774   616,990   494,293   481,310   487,272   483,325   515,273 
Allowance for impairment losses  (3,033)  (6,414)  (11,966)  (15,253)  (18,746)
Allowance for impairment losses1  (3,152)  (2,201)  (2,412)  (3,033)  (6,414)
Total loans and advances net of allowance for impairment losses  480,292   508,859   518,317   549,521   598,244   491,141   479,109   484,860   480,292   508,859 

1The allowance for loan losses at 31 December 2018 is measured in accordance with IFRS 9; for earlier years, it was determined in accordance with IAS 39.

 

Following the reduction in the Group’s non-UK activities, an analysis between domestic and foreign operations is not provided for 2013 or later years. The analysis of loans and advances at 31 December 2012 and 2011 between domestic and international offices is as follows:provided.

  2012  2011 
  £m  £m 
Domestic        
Loans and advances to banks  32,073   31,852 
Loans and advances to customers:        
Mortgages  322,687   331,715 
Other personal lending  26,119   28,244 
Agriculture, forestry and fishing  5,482   5,010 
Energy and water supply  1,773   1,689 
Manufacturing  7,246   8,055 
Construction  6,481   7,885 
Transport, distribution and hotels  22,205   27,232 
Postal and telecommunications  1,239   1,491 
Financial, business and other services  44,155   56,721 
Property companies  43,683   49,561 
Lease financing  5,306   6,792 
Hire purchase  4,970   5,237 
Total loans  523,419   561,484 
Allowance for impairment losses  (7,076)  (8,025)
Total loans and advances net of allowance for impairment losses  516,343   553,459 
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

  2012  2011 
  £m  £m 
Foreign        
Loans and advances to banks  687   768 
Loans and advances to customers:        
Mortgages  15,192   16,495 
Other personal lending  2,215   1,770 
Agriculture, forestry and fishing  49   188 
Energy and water supply  1,548   2,324 
Manufacturing  1,284   2,006 
Construction  1,045   1,837 
Transport, distribution and hotels  4,363   5,650 
Postal and telecommunications  158   405 
Financial, business and other services  4,574   7,325 
Property companies  8,705   15,191 
Lease financing  1,171   1,008 
Hire purchase  364   539 
Total loans  41,355   55,506 
Allowance for impairment losses  (8,177)  (10,721)
Total loans and advances net of allowance for impairment losses  33,178   44,785 

  2012  2011 
  £m  £m 
Total        
Loans and advances to banks  32,760   32,620 
Loans and advances to customers:        
Mortgages  337,879   348,210 
Other personal lending  28,334   30,014 
Agriculture, forestry and fishing  5,531   5,198 
Energy and water supply  3,321   4,013 
Manufacturing  8,530   10,061 
Construction  7,526   9,722 
Transport, distribution and hotels  26,568   32,882 
Postal and telecommunications  1,397   1,896 
Financial, business and other services  48,729   64,046 
Property companies  52,388   64,752 
Lease financing  6,477   7,800 
Hire purchase  5,334   5,776 
Total loans  564,774   616,990 
Allowance for impairment losses  (15,253)  (18,746)
Total loans and advances net of allowance for impairment losses  549,521   598,244 
8166

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

SUMMARY OF LOAN LOSS EXPERIENCE

 

The following table analyses the movements in the allowance for impairment losses on loans and advances to banks and customers (drawn balances) for each of the five years listed.

 

 2015 2014 2013 2012 2011   2018
£m		   2017
£m		   2016
£m		   2015
£m		   2014
£m		 
 £m £m £m £m £m 
Balance at beginning of year  6,414   11,966   15,253   18,746   18,393 
Balance at end of preceding year  2,201   2,412   3,033   6,414   11,966 
Adjustment on adoption of IFRS 9  1,023                 
Balance at 1 January 2018  3,224                 
Exchange and other adjustments  (246)  (410)  291   (380)  (369)  126   132   69   (246)  (410)
Disposal of businesses  (82)  –   (176)  –   –   (181)  –   –   (82)  – 
Advances written off:                                        
Loans and advances to customers:                                        
Mortgages  (71)  (87)  (601)  (133)  (86)  (12)  (42)  (42)  (71)  (87)
Other personal lending  (853)  (1,329)  (1,437)  (2,267)  (2,617)  (988)  (925)  (728)  (853)  (1,329)
Agriculture, forestry and fishing  (1)  (8)  (11)  (45)  (11)  (4)  (1)  (1)  (1)  (8)
Energy and water supply  (73)  –   (102)  (77)  (48)  –   –   (9)  (73)  – 
Manufacturing  (126)  (59)  (130)  (226)  (137)  (11)  (40)  (19)  (126)  (59)
Construction  (21)  (157)  (84)  (654)  (92)  (82)  (65)  (96)  (21)  (157)
Transport, distribution and hotels  (728)  (1,119)  (798)  (458)  (329)  (42)  (65)  (64)  (728)  (1,119)
Postal and telecommunications  (11)  –   (14)  (7)  (1)  (2)  –   (189)  (11)  – 
Financial, business and other services  (604)  (946)  (1,030)  (1,071)  (1,120)  (244)  (158)  (712)  (604)  (946)
Property companies  (1,648)  (2,669)  (1,891)  (3,554)  (2,630)  (134)  (136)  (215)  (1,648)  (2,669)
Lease financing  (31)  (4)  (10)  (75)  (224)  –   (2)  –   (31)  (4)
Hire purchase  (37)  (54)  (121)  (130)  (192)  (57)  (65)  (36)  (37)  (54)
Loans and advances to banks  –   –   (3)  (10)  (6)  –   –   –   –   – 
Total advances written off  (4,204)  (6,432)  (6,232)  (8,707)  (7,493)  (1,576)  (1,499)  (2,111)  (4,204)  (6,432)
Recoveries of advances written off:                                        
Loans and advances to customers:                                        
Mortgages  35   18   28   53   26   20   17   44   35   18 
Other personal lending  366   600   408   757   326   333   419   329   366   600 
Energy and water supply  5   –   –   –   –   84   –   3   5   – 
Manufacturing  –   –   –   –   –   10   –   80   –   – 
Construction  –   –   –   –   –   65   4   78   –   – 
Transport, distribution and hotels  63   –   –   1   1   9   15   50   63   – 
Postal and telecommunications  1   –   –   –   – 
Financial, business and other services  193   –   –   –   –   42   6   241   193   – 
Property companies  101   –   –   4   –   16   –   34   101   – 
Lease financing  –   –   –   2   –   –   19   –   –   – 
Hire purchase  1   63   20   26   68   –   2   2   1   63 
Total recoveries of advances written off  764   681   456   843   421   580   482   861   764   681 
Total net advances written off  (3,440)  (5,751)  (5,776)  (7,864)  (7,072)  (996)  (1,017)  (1,250)  (3,440)  (5,751)
8267

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

  2015  2014  2013  2012  2011 
  £m  £m  £m  £m  £m 
Effect of unwinding of discount recognised through interest income  (56)  (126)  (351)  (374)  (226)
Allowances for impairment losses charged against income for the year:                    
Loans and advances to customers:                    
Mortgages  33   (138)  224   278   444 
Other personal lending  437   536   920   881   1,669 
Agriculture, forestry and fishing  1   2   –   54   27 
Energy and water supply  35   28   95   71   105 
Manufacturing  23   (4)  31   236   206 
Construction  13   (81)  66   326   350 
Transport, distribution and hotels  (88)  198   421   649   884 
Postal and telecommunications  (2)  6   (3)  8   15 
Financial, business and other services  77   179   552   824   1,464 
Property companies  (140)  40   457   1,725   2,776 
Lease financing  31   (1)  (26)  26   60 
Hire purchase  23   (30)  (12)  47   20 
Loans and advances to banks  –   –   –   –   – 
Total allowances for impairment losses charged against income for the year  443   735   2,725   5,125   8,020 
Total balance at end of year  3,033   6,414   11,966   15,253   18,746 
Ratio of net write-offs during the year to average loans outstanding during the year  0.8%   1.1%   1.1%   1.4%   1.2% 

The Group’s impairment allowances in respect of loans and advances to banks and customers decreased by £3,381 million, or 53 per cent, from £6,414 million at 31 December 2014 to £3,033 million at 31 December 2015. This decrease resulted from a charge to the income statement of £443 million being more than offset by net advances written off of £3,440 million (advances written off of £4,204 million less recoveries £764 million). A further decrease of £82 million followed the disposal of the Group’s interest in TSB Banking Group plc. The reduction in the charge to the income statement of £292 million, or 40 per cent, from £735 million in 2014 to £443 million in 2015 reflects lower charges in all Divisions, particularly in Retail and in respect of the portfolio of assets which are outside of the Group’s risk appetite, reflecting the continuing run-off of such assets, in particular exposures in Ireland. By category of lending, the most significant elements of the charge to the income statement were a charge of £437 million in respect of other personal lending and a charge of £77 million in respect of financial business and other services, together with credits of £88 million in relation to transport, distribution and hotels and £140 million in respect of property companies. Of the net advances written off of £3,440 million, £487 million related to other personal lending, £665 million related to transport, distribution and hotels and £1,547 million to property companies.

83

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

   2018
£m		   2017
£m		   2016
£m		   2015
£m		   2014
£m		 
Effect of unwinding of discount recognised through interest income  (44)  (23)  (32)  (56)  (126)
Allowances for impairment losses charged against income for the year:                    
Loans and advances to customers:                    
Mortgages  29   (119)  (23)  33   (138)
Other personal lending  699   596   438   437   536 
Agriculture, forestry and fishing  10   2   3   1   2 
Energy and water supply  (8)  –   (4)  35   28 
Manufacturing  9   5   (48)  23   (4)
Construction  15   85   143   13   (81)
Transport, distribution and hotels  47   (19)  (35)  (88)  198 
Postal and telecommunications  (2)  1   191   (2)  6 
Financial, business and other services  79   42   6   77   179 
Property companies  56   (7)  (166)  (140)  40 
Lease financing  –   –   15   31   (1)
Hire purchase  88   111   72   23   (30)
Loans and advances to banks  1   –   –   –   – 
Total allowances for impairment losses charged against income for the year  1,023   697   592   443   735 
Total balance at end of year  3,152   2,201   2,412   3,033   6,414 
Ratio of net write-offs during the year to average loans outstanding during the year  0.2%   0.2%   0.3%   0.8%   1.1% 

 

Following the reduction in the Group’s non-UK activities, an analysis between domestic and foreign operations is not provided for 2013 or later years. provided.

The analysisGroup’s impairment allowances in respect of movements in the allowance for impairment losses on loans and advances to banks and customers for the years endedincreased by £951 million, or 9 per cent, from £2,201 million at 31 December 20122017 to £3,152 million at 31 December 2018. However, an increase of £1,023 million arose on transition to IFRS 9 on 1 January 2018; adjusting for this the Group’s impairment allowance in respect of loans and 2011 between domesticadvances to banks and international offices is as follows:customers decreased by £72 million from £3,224 million at 1 January 2018 to £3,152 million at 31 December 2018. This decrease resulted from a charge to the income statement of £1,023 million being more than offset by net advances written off of £996 million (advances written off of £1,576 million less recoveries £580 million) together with a reduction of £181 million on sale of the Group’s Irish mortgage portfolio. The increase in the charge to the income statement from £697 million in 2017 to £1,023 million in 2018 reflects lower levels of releases and write-backs and the impact of a full year’s ownership of MBNA. By category of lending, the most significant elements of the charge to the income statement were charges of £699 million in respect of other personal lending, £79 million in respect of financial, business and other services and £88 million in respect of hire purchase. Of the net advances written off of £996 million, £655 million related to other personal lending, £202 million related to financial, business and other services and £118 million to property companies.

Domestic 2012  2011 
  £m   £m 
Balance at beginning of year  8,025   9,786 
Exchange and other adjustments  (24)  68 
Advances written off:        
Loans and advances to customers:        
Mortgages  (96)  (56)
Other personal lending  (2,258)  (2,605)
Agriculture, forestry and fishing  (11)  (8)
Energy and water supply  (68)  (48)
Manufacturing  (75)  (105)
Construction  (477)  (38)
Transport, distribution and hotels  (140)  (247)
Postal and telecommunications  (1)  (1)
Financial, business and other services  (919)  (894)
Property companies  (528)  (1,594)
Lease financing  (74)  (120)
Hire purchase  (129)  (57)
Loans and advances to banks  (10)  (6)
Total advances written off  (4,786)  (5,779)
Recoveries of advances written off:        
Loans and advances to customers:        
Mortgages  53   26 
Other personal lending  751   326 
Agriculture, forestry and fishing  –   – 
Energy and water supply  –   – 
Manufacturing  –   – 
Construction  –   – 
Transport, distribution and hotels  1   1 
Postal and telecommunications  –   – 
Financial, business and other services  –   – 
Property companies  –   – 
Lease financing  2   – 
Hire purchase  26   68 
Total recoveries of advances written off  833   421 
Total net advances written off  (3,953)  (5,358)
8468

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Domestic 2012  2011 
 £m  £m 
Effect of unwinding of discount recognised through interest income  (405)  (406)
Allowances for impairment losses charged against income for the year:        
Loans and advances to customers:        
Mortgages  32   24 
Other personal lending  1,121   1,670 
Agriculture, forestry and fishing  15   19 
Energy and water supply  77   130 
Manufacturing  81   110 
Construction  221   168 
Transport, distribution and hotels  289   298 
Postal and telecommunications  –   (8)
Financial, business and other services  734   1,188 
Property companies  776   287 
Lease financing  37   48 
Hire purchase  50   1 
Loans and advances to banks  –   – 
Total allowances for impairment losses charged against income for the year  3,433   3,935 
Total balance at end of year – Domestic  7,076   8,025 
         
Foreign  2012   2011 
  £m   £m 
Balance at beginning of year  10,721   8,607 
Exchange and other adjustments  (356)  (437)
Advances written off:        
Loans and advances to customers:        
Mortgages  (37)  (30)
Other personal lending  (9)  (12)
Agriculture, forestry and fishing  (34)  (3)
Energy and water supply  (9)  – 
Manufacturing  (151)  (32)
Construction  (177)  (54)
Transport, distribution and hotels  (318)  (82)
Postal and telecommunications  (6)  – 
Financial, business and other services  (152)  (226)
Property companies  (3,026)  (1,036)
Lease financing  (1)  (104)
Hire purchase  (1)  (135)
Loans and advances to banks  –   – 
Total advances written off  (3,921) ��(1,714)
Recoveries of advances written off:        
Loans and advances to customers:        
Mortgages  –   – 
Other personal lending  6   – 
Agriculture, forestry and fishing  –   – 
Energy and water supply  –   – 
Manufacturing  –   – 
Construction  –   – 
Transport, distribution and hotels  –   – 
Postal and telecommunications  –   – 
Financial, business and other services  –   – 
Property companies  4   – 
Hire purchase  –   – 
Total recoveries of advances written off  10   – 
Total net advances written off  (3,911)  (1,714)
85

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Foreign 2012  2011 
 £m  £m 
Effect of unwinding of discount recognised through interest income  31   180 
Allowances for impairment losses charged against income for the year:        
Loans and advances to customers:        
Mortgages  246   420 
Other personal lending  (240)  (1)
Agriculture, forestry and fishing  39   8 
Energy and water supply  (6)  (25)
Manufacturing  155   96 
Construction  105   182 
Transport, distribution and hotels  360   586 
Postal and telecommunications  8   23 
Financial, business and other services  90   276 
Property companies  949   2,489 
Lease financing  (11)  12 
Hire purchase  (3)  19 
Loans and advances to banks  –   – 
Total allowances for impairment losses charged against income for the year  1,692   4,085 
Total balance at end of year – Foreign  8,177   10,721 
         
Total  2012   2011 
  £m   £m 
Balance at beginning of year  18,746   18,393 
Exchange and other adjustments  (380)  (369)
Advances written off:        
Loans and advances to customers:        
Mortgages  (133)  (86)
Other personal lending  (2,267)  (2,617)
Agriculture, forestry and fishing  (45)  (11)
Energy and water supply  (77)  (48)
Manufacturing  (226)  (137)
Construction  (654)  (92)
Transport, distribution and hotels  (458)  (329)
Postal and telecommunications  (7)  (1)
Financial, business and other services  (1,071)  (1,120)
Property companies  (3,554)  (2,630)
Lease financing  (75)  (224)
Hire purchase  (130)  (192)
Loans and advances to banks  (10)  (6)
Total advances written off  (8,707)  (7,493)
Recoveries of advances written off:        
Loans and advances to customers:        
Mortgages  53   26 
Other personal lending  757   326 
Energy and water supply  –   – 
Manufacturing  –   – 
Construction  –   – 
Transport, distribution and hotels  1   1 
Financial, business and other services  –   – 
Property companies  4   – 
Lease financing  2   – 
Hire purchase  26   68 
Total recoveries of advances written off  843   421 
Total net advances written off  (7,864)  (7,072)
86

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Total 2012
£m		  2011
£m		 
Effect of unwinding of discount recognised through interest income  (374)  (226)
Allowances for impairment losses charged against income for the year:        
Loans and advances to customers:        
Mortgages  278   444 
Other personal lending  881   1,669 
Agriculture, forestry and fishing  54   27 
Energy and water supply  71   105 
Manufacturing  236   206 
Construction  326   350 
Transport, distribution and hotels  649   884 
Postal and telecommunications  8   15 
Financial, business and other services  824   1,464 
Property companies  1,725   2,776 
Lease financing  26   60 
Hire purchase  47   20 
Loans and advances to banks  –   – 
Total allowances for impairment losses charged against income for the year  5,125   8,020 
Total balance at end of year – Total  15,253   18,746 

 

The following table analyses the coverage of the allowance for loan losses by category of loans.

 

 2015
Allowance
£m		 2015
Percentage
of loans
in each
category to
total loans
%		 2014
Allowance
£m		 2014
Percentage of
loans
in each
category to
total loans
%		 2013
Allowance
£m		 2013
Percentage of
loans
in each
category to
total loans
%		 2012
Allowance
£m		 2012
Percentage of
loans
in each
category to
total loans
%		 2011
Allowance
£m		 2011
Percentage of
loans
in each
category to
total loans
%		  2018
Allowance1
£m		   2018
Percentage
of loans
in each
category to
total loans
%		   2017
Allowance1
£m		  2017
Percentage of
loans
in each
category to
total loans
%		   2016
Allowance1
£m		  2016
Percentage of
loans
in each
category to
total loans
%		   2015
Allowance1
£m		  2015
Percentage of
loans
in each
category to
total loans
%		   2014
Allowance1
£m		  2014
Percentage of
loans
in each
category to
total loans
%		 
Balance at year end applicable to:                                         
Loans and advances to banks – 5.2 – 5.1 – 4.8 3 5.8 14 5.3  2   1.3   –   1.4   –   5.5   –   5.2   –   5.1 
Loans and advances to customers:                                         
Mortgages 479 64.7 460 64.7 657 63.5 1,113 60.0 948 56.4  509   60.1   485   63.4   576   63.0   479   64.7   460   64.7 
Other personal lending 388 4.3 607 4.5 919 4.4 1,147 5.0 1,895 4.9  823   5.8   381   6.0   356   4.3   388   4.3   607   4.5 
Agriculture, forestry and fishing 15 1.4 18 1.3 38 1.1 67 1.0 51 0.8  19   1.5   8   1.6   13   1.5   15   1.4   18   1.3 
Energy and water supply 20 0.7 61 0.7 149 0.8 191 0.6 165 0.7  11   0.3   5   0.3   6   0.5   20   0.7   61   0.7 
Manufacturing 70 1.2 179 1.2 296 1.4 337 1.5 475 1.6  65   1.7   35   1.6   84   1.5   70   1.2   179   1.2 
Construction 165 1.0 158 1.3 395 1.3 504 1.3 898 1.6  514   0.9   410   0.9   319   0.9   165   1.0   158   1.3 
Transport, distribution and hotels 219 2.8 1,051 2.9 1,954 4.2 2,162 4.7 2,117 5.3  161   2.9   57   2.9   161   2.7   219   2.8   1,051   2.9 
Postal and telecommunications 4 0.5 17 0.5 11 0.4 40 0.2 62 0.3  10   0.5   5   0.4   5   0.5   4   0.5   17   0.5 
Financial, business and other services 811 8.9 1,225 8.7 2,293 8.0 2,764 8.6 3,075 10.4  476   15.7   312   11.9   312   10.1   811   8.9   1,225   8.7 
Property companies 790 6.7 2,553 7.1 5,145 8.3 6,664 9.3 8,710 10.5  294   5.8   343   6.4   470   6.6   790   6.7   2,553   7.1 
Lease financing – 0.6 1 0.6 6 0.8 33 1.1 92 1.3  –   0.4   –   0.4   –   0.5   –   0.6   1   0.6 
Hire purchase 72 2.0 84 1.4 103 1.0 228 0.9 244 0.9  268   3.1   160   2.8   110   2.4   72   2.0   84   1.4 
Total balance at year end 3,033 100.0 6,414 100.0 11,966 100.0 15,253 100.0 18,746 100.0  3,152   100.0   2,201   100.0   2,412   100.0   3,033   100.0   6,414   100.0 

871The allowance for loan losses at 31 December 2018 is measured in accordance with IFRS 9; for earlier years, it was determined in accordance with IAS 39.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Following the reduction in the Group’s non-UK activities, an analysis between domestic and foreign operations is not provided for 2013 or later years. The analysis of the coverage of the allowance for loan losses at 31 December 2012 and 2011 between domestic and international offices is as follows:provided.

  Domestic Foreign Total
    Percentage of   Percentage of   Percentage of
    loans in each   loans in each   loans in each
    category to   category to   category to
2012 Allowance
£m		 total loans
%		 Allowance
£m		 total loans
%		 Allowance
£m		 total loans
%
Balance at year end applicable to:            
Loans and advances to banks 3 6.1 – 1.7 3 5.8
Loans and advances to customers:            
Mortgages 106 62.0 1,007 36.8 1,113 60.0
Other personal lending 1,064 5.0 83 5.4 1,147 5.0
Agriculture, forestry and fishing 57 1.0 10 0.1 67 1.0
Energy and water supply 177 0.3 14 3.7 191 0.6
Manufacturing 194 1.4 143 3.1 337 1.5
Construction 215 1.2 289 2.5 504 1.3
Transport, distribution and hotels 715 4.2 1,447 10.6 2,162 4.7
Postal and telecommunications 10 0.2 30 0.4 40 0.2
Financial, business and other services 2,008 8.4 756 11.1 2,764 8.6
Property companies 2,307 8.3 4,357 21.0 6,664 9.3
Lease financing 14 1.0 19 2.8 33 1.1
Hire purchase 206 0.9 22 0.8 228 0.9
Total 7,076 100.0 8,177 100.0 15,253 100.0

  Domestic Foreign Total
    Percentage of   Percentage of   Percentage of
    loans in each   loans in each   loans in each
    category to   category to   category to
2011 Allowance
£m		 total loans
%		 Allowance
£m		 total loans
%		 Allowance
£m		 total loans
%
Balance at year end applicable to:            
Loans and advances to banks 14 5.7 – 1.4 14 5.3
Loans and advances to customers:            
Mortgages 123 59.1 825 29.7 948 56.4
Other personal lending 1,555 5.0 340 3.2 1,895 4.9
Agriculture, forestry and fishing 39 0.9 12 0.3 51 0.8
Energy and water supply 137 0.3 28 4.2 165 0.7
Manufacturing 318 1.4 157 3.6 475 1.6
Construction 531 1.4 367 3.3 898 1.6
Transport, distribution and hotels 668 4.9 1,449 10.2 2,117 5.3
Postal and telecommunications 35 0.3 27 0.7 62 0.3
Financial, business and other services 2,172 10.1 903 13.2 3,075 10.4
Property companies 2,153 8.8 6,557 27.4 8,710 10.5
Lease financing 63 1.2 29 1.8 92 1.3
Hire purchase 217 0.9 27 1.0 244 0.9
Total 8,025 100.0 10,721 100.0 18,746 100.0
8869

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

RISK ELEMENTS IN THE LOAN PORTFOLIO AND POTENTIAL PROBLEM LOANS

 

The Group’s credit risk elements analysedIFRS 9, which was adopted by categories reflecting US lendingthe Group on 1 January 2018, requires that:

– interest is recognised on all loans and advances and, as a result, no loan is classified as non-accrual; and
–an allowance for expected credit losses is recognised on all loans and advances irrespective of whether any payments are past due.

As a result, the Group no longer analyses its loans between those that are neither past due nor impaired, past due but not impaired, impaired with no provision held and accounting practices, which differ from those employed in the UK, are detailed below:impaired with a provision.

 

NON-PERFORMING LENDING

In the US, it is the normal practice to stop accruing interest when payments are 90 days or more past due or when recovery of both principal and interest is doubtful. When the loans are transferred to non-accrual status, accrued interest is reversed from income and no further interest is recognised until it becomes probable that the principal will be repaid in full. Loans on which interestWhilst IFRS 7 has been accrued but suspended would be included in risk elements as loans accounted for on a non-accrual basis.

Inamended to recognise the US non-performing loans and advances are typically written off more quickly than in the UK. Consequently a UK bank may appear to have a higher levelimpact of non-performing loans and advances than a comparable US bank although the reported income may be similar in both the US and the UK.

The Group complies with IFRS 7, which9, it still requires more detailed qualitative and quantitative disclosures about its loan portfolios. Accordingly,The Group has revised its disclosures accordingly; the following tables are presented in respect of the Group’s credit risk elements and potential problem loans.

20182017 and
earlier years
Analysis of impairment and provision statusü
Days past due for loans and advances that are considered to have experienced a significant increase in credit risk, but are not credit-impairedü
Days past due for loans past due but not impairedü
Credit quality of all loans and advancesü
Credit quality of loans neither past due nor impairedü
Interest foregone on non-performing lendingüü

ANALYSIS OF IMPAIRMENT AND PROVISION STATUS

31 December 2017 and earlier years

The table below shows separately those loans that are (i) neither past due nor impaired, (ii) past due but not impaired, (iii) impaired, but not requiring a provision and (iv) impaired with a provision.

 

            Loans and 
 Loans and            advances 
 advances      designated 
   designated Loans and  Loans and advances to customers at fair value 
 Loans and Loans and advances to customers at fair value advances Retail – Retail –       through 
 advances Retail – Retail – through to banks mortgages other Commercial Total profit or loss 
(audited) to banks
£m		 mortgages
£m		 other
£m		 Commercial
£m		 Total
£m		 profit or loss
£m		 £m £m £m £m £m £m 
31 December 2017                        
Neither past due nor impaired  6,577   295,765   48,897   116,396   461,058   31,590 
Past due but not impaired  6   5,934   585   336   6,855   – 
Impaired – no provision required  28   640   306   700   1,646   – 
– provision held  –   3,529   1,053   1,613   6,195   – 
Gross  6,611   305,868   50,841   119,045   475,754   31,590 
31 December 2016                        
Neither past due nor impaired  26,888   296,303   39,478   109,364   445,145   33,079 
Past due but not impaired  14   7,340   386   305   8,031   – 
Impaired – no provision required  –   784   392   689   1,865   – 
– provision held�� –   3,536   1,038   2,056   6,630   – 
Gross  26,902   307,963   41,294   112,414   461,671   33,079 
31 December 2015                         
Neither past due nor impaired 25,006 302,063 38,886 100,001 440,950 33,174  25,006   302,063   38,886   100,001   440,950   33,174 
Past due but not impaired 111 8,233 393 463 9,089 –  111   8,233   393   463   9,089   – 
Impaired – no provision required – 732 690 1,092 2,514 –  –   732   690   1,092   2,514   – 
– provision held – 3,269 911 2,896 7,076 –  –   3,269   911   2,896   7,076   – 
Gross 25,117 314,297 40,880 104,452 459,629 33,174  25,117   314,297   40,880   104,452   459,629   33,174 
31 December 2014                         
Neither past due nor impaired 26,003 320,324 37,886 106,768 464,978 36,725  26,003   320,324   37,886   106,768   464,978   36,725 
Past due but not impaired 152 10,311 674 488 11,473 –  152   10,311   674   488   11,473   – 
Impaired – no provision required – 578 938 847 2,363 –  –   578   938   847   2,363   – 
– provision held – 3,766 1,109 7,070 11,945 –  –   3,766   1,109   7,070   11,945   – 
Gross 26,155 334,979 40,607 115,173 490,759 36,725  26,155   334,979   40,607   115,173   490,759   36,725 
31 December 2013 
Neither past due nor impaired 25,219 318,668 36,789 107,764 463,221 29,443
Past due but not impaired 146 12,329 580 786 13,695 –
Impaired – no provision required – 637 1,284 1,824 3,745 –
– provision held – 6,229 1,456 20,829 28,514 –
Gross 25,365 337,863 40,109 131,203 509,175 29,443
31 December 2012 
Neither past due nor impaired 32,726 319,613 41,223 117,152 477,988 14,551
Past due but not impaired 31 12,880 922 1,527 15,329 –
Impaired – no provision required – 741 1,530 1,504 3,775 –
– provision held 3 7,391 2,124 33,003 42,518 –
Gross 32,760 340,625 45,799 153,186 539,610 14,551
31 December 2011 
Neither past due nor impaired 32,494 330,727 41,448 146,655 518,830 11,121
Past due but not impaired 15 12,742 1,093 2,509 16,344 –
Impaired – no provision required 6 1,364 1,604 3,544 6,512 –
– provision held 105 6,701 2,940 44,116 53,757 –
Gross 32,620 351,534 47,085 196,824 595,443 11,121

 

The analysis of lending between retail and commercial has been prepared based upon the type of exposure and not the business segment in which the exposure is recorded. Included within retail are exposures to personal customers and small businesses, whilst included within commercial are exposures to corporate customers and other large institutions.

8970

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

31 December 2018

The table below analyses the Group’s loans and advances to customers and banks that are considered to have experienced a significant increase in credit risk, but are not credit-impaired, according to the number of days that have elapsed since the last payment received by the Group was due from the borrower; the analysis of lending has been prepared based on the division in which the asset is held.

       
  Loans and  Loans and advances to customers
  advances  Retail –  Retail –          
  to banks  mortgages  other  Commercial  Other  Total 
  £m  £m  £m  £m  £m  £m 
31 December 2018                        
Up to date  3   10,118   4,387   6,020   10   20,535 
1-30 days past due  –   1,955   486   455   –   2,896 
Over 30 days past due  –   1,581   214   117   2   1,914 
Total  3   13,654   5,087   6,592   12   25,345 

A financial asset is “past due” if a counterparty has failed to make a payment when contractually due.

31 December 2017 and earlier years

The loans that are past due but not impaired are further analysed in the table below according to the number of days that have elapsed since the last payment received by the Group was due from the borrower. The analysis of lending between retail and commercial has been prepared based upon the type of exposure and not the business segment in which the exposure is recorded. Included within retail are exposures to personal customers and small businesses, whilst included within commercial are exposures to corporate customers and other large institutions.

 

            Loans and 
 Loans and            advances 
 advances     designated 
   designated Loans and  Loans and advances to customers at fair value 
 Loans and Loans and advances to customers at fair value advances Retail – Retail –       through 
 advances Retail – Retail – through to banks mortgages other Commercial Total profit or loss 
(audited) to banks
£m		 mortgages
£m		 other
£m		 Commercial
£m		 Total
£m		 profit or loss
£m		 £m £m £m £m £m £m 
31 December 2017                        
0-30 days  6   3,057   458   246   3,761   – 
30-60 days  –   1,115   111   10   1,236   – 
60-90 days  –   785   3   13   801   – 
90-180 days  –   977   3   8   988   – 
Over 180 days  –   –   10   59   69   – 
Total  6   5,934   585   336   6,855   – 
31 December 2016                        
0-30 days  14   3,547   285   157   3,989   – 
30-60 days  –   1,573   75   37   1,685   – 
60-90 days  –   985   2   74   1,061   – 
90-180 days  –   1,235   6   14   1,255   – 
Over 180 days  –   –   18   23   41   – 
Total  14   7,340   386   305   8,031   – 
31 December 2015                         
0-30 days 111 4,066 276 248 4,590 –  111   4,066   276   248   4,590   – 
30-60 days – 1,732 81 100 1,913 –  –   1,732   81   100   1,913   – 
60-90 days – 1,065 9 52 1,126 –  –   1,065   9   52   1,126   – 
90-180 days – 1,370 8 19 1,397 –  –   1,370   8   19   1,397   – 
Over 180 days – – 19 44 63 –  –   –   19   44   63   �� 
Total 111 8,233 393 463 9,089 –  111   8,233   393   463   9,089   – 
31 December 2014                         
0-30 days 152 4,854 453 198 5,505 –  152   4,854   453   198   5,505   – 
30-60 days – 2,309 110 51 2,470 –  –   2,309   110   51   2,470   – 
60-90 days – 1,427 90 139 1,656 –  –   1,427   90   139   1,656   – 
90-180 days – 1,721 5 38 1,764 –  –   1,721   5   38   1,764   – 
Over 180 days – – 16 62 78 –  –   –   16   62   78   – 
Total 152 10,311 674 488 11,473 –  152   10,311   674   488   11,473   – 
31 December 2013 
0-30 days 146 5,596 489 347 6,432 –
30-60 days – 2,639 87 102 2,828 –
60-90 days – 1,734 4 57 1,795 –
90-180 days – 2,360 – 41 2,401 –
Over 180 days – – – 239 239 –
Total 146 12,329 580 786 13,695 –
31 December 2012 
0-30 days – 5,996 744 860 7,600 –
30-60 days 3 2,667 138 131 2,936 –
60-90 days 2 1,750 29 328 2,107 –
90-180 days 6 2,467 5 56 2,528 –
Over 180 days 20 – 6 152 158 –
Total 31 12,880 922 1,527 15,329 –
31 December 2011 
0-30 days 1 5,989 868 1,163 8,020 –
30-60 days 9 2,618 195 481 3,294 –
60-90 days 4 1,833 25 260 2,118 –
90-180 days – 2,302 4 159 2,465 –
Over 180 days 1 – 1 446 447 –
Total 15 12,742 1,093 2,509 16,344 –

 

A financial asset is ‘past due’“past due” if a counterparty has failed to make a payment when contractually due.an amount outstanding beyond its contractual due date.

9071

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

POTENTIAL PROBLEM LOANS

 

Potential problem loans are loans where known information about possible credit problems causes management to have concern as to the borrower’s ability to comply with the present loan repayment terms.

 

31 December 2018

IFRS 7 requires the disclosure of information about the credit quality of loans and advances. The Group’s disclosures analyse its loans between those that the Group believes are of good quality, satisfactory quality, lower quality and those that are below standard but not credit-impaired. The below standard but not credit-impaired balances represent potential problem loans; the analysis of lending has been prepared based on the division in which the asset is held.

       
  Loans and  Loans and advances to customers
  advances  Retail –  Retail –          
  to banks  mortgages  other  Commercial  Other  Total 
  £m  £m  £m  £m  £m  £m 
31 December 2018                        
Good quality  6,180   268,524   47,051   65,189   44,375   425,139 
Satisfactory quality  105   1,766   3,720   28,922   6   34,414 
Lower quality  –   262   357   4,429   –   5,048 
Below standard, but not credit-impaired  –   899   1,322   54   –   2,275 
Total  6,285   271,451   52,450   98,594   44,381   466,876 

31 December 2017 and earlier years

IFRS 7 required the disclosure of information about the credit quality of loans and advances that arewere neither past due nor impaired. The Group’s disclosures analyse these loans between those that the Group believes arebelieved were of good quality, satisfactory quality, and lower quality and those that arewere below standard but not impaired. The below standard but not impaired balances representrepresented potential problem loans. The analysis of lending between retail and commercial has been prepared based upon the type of exposure and not the business segment in which the exposure is recorded. Included within retail are exposures to personal customers and small businesses, whilst included within commercial are exposures to corporate customers and other large institutions.

 

            Loans and 
  Loans and            advances 
  advances     designated 
   designated Loans and  Loans and advances to customers at fair value 
 Loans and Loans and advances to customers at fair value advances Retail – Retail –       through 
 advances Retail – Retail –  through to banks mortgages other Commercial Total profit or loss 
(audited) to banks
£m		 mortgages
£m		 other
£m		 Commercial
£m		 Total
£m		 profit or loss
£m		 £m £m £m £m £m £m 
31 December 2017                        
Good quality  6,351   294,748   43,145   81,121       31,548 
Satisfactory quality  198   790   4,770   30,154       42 
Lower quality  28   32   286   4,807       – 
Below standard, but not impaired  –   195   696   314       – 
Total  6,577   295,765   48,897   116,396   461,058   31,590 
31 December 2016                        
Good quality  26,745   295,286   34,195   72,083       33,049 
Satisfactory quality  87   814   4,479   30,433       30 
Lower quality  3   39   387   6,433       – 
Below standard, but not impaired  53   164   417   415       – 
Total  26,888   296,303   39,478   109,364   445,145   33,079 
31 December 2015                         
Good quality 24,670 301,403 33,589 63,453   33,156  24,670   301,403   33,589   63,453       33,156 
Satisfactory quality 311 527 4,448 28,899   15  311   527   4,448   28,899       15 
Lower quality 4 27 476 7,210   3  4   27   476   7,210       3 
Below standard, but not impaired 21 106 373 439   –  21   106   373   439       – 
Total 25,006 302,063 38,886 100,001 440,950 33,174  25,006   302,063   38,886   100,001   440,950   33,174 
31 December 2014                         
Good quality 25,654 318,967 30,993 65,106   36,482  25,654   318,967   30,993   65,106       36,482 
Satisfactory quality 263 1,159 5,675 28,800   238  263   1,159   5,675   28,800       238 
Lower quality 49 72 623 11,204   5  49   72   623   11,204       5 
Below standard, but not impaired 37 126 595 1,658   –  37   126   595   1,658       – 
Total 26,003 320,324 37,886 106,768 464,978 36,725  26,003   320,324   37,886   106,768   464,978   36,725 
31 December 2013 
Good quality 25,044 314,749 29,129 66,345   29,432
Satisfactory quality 171 2,948 6,414 29,038   7
Lower quality 2 308 501 9,991   3
Below standard, but not impaired 2 663 745 2,390   1
Total 25,219 318,668 36,789 107,764 463,221 29,443
31 December 2012 
Good quality 32,173 313,372 30,924 60,049   14,514
Satisfactory quality 174 4,532 8,579 33,477   28
Lower quality 10 552 862 18,153   6
Below standard, but not impaired 369 1,157 858 5,473   3
Total 32,726 319,613 41,223 117,152 477,988 14,551
31 December 2011 
Good quality 32,141 323,060 29,123 71,907   11,065
Satisfactory quality 171 5,432 9,747 42,311   45
Lower quality 9 970 1,127 24,676   11
Below standard, but not impaired 173 1,265 1,451 7,761   –
Total 32,494 330,727 41,448 146,655 518,830 11,121

 

For further details see note 5352 on page F-90.F-91.                                                

72

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

INTEREST FOREGONE ON NON-PERFORMING LENDING

 

The table below summarises the interest foregone on impaired lending.

 

 20152018
 £m
Interest income that would have been recognised under original contract terms504324
Interest income included in profit(248)(227)
Interest foregone25697

TROUBLED DEBT RESTRUCTURINGS

The Company’s accounting policy for loans that are renegotiated is set out in note 2(H) to the financial statements. In accordance with IFRS 9, an impairment provision is recognised on all loans; as a result, the Company has amended these disclosures in 2018. Loans modified by the Group during the year as a result of a customer’s financial difficulties were credit-impaired at 31 December 2018 and are included within the forborne balances set out in the table below.

    Purchased       
    or originated       
 Credit-impaired  credit-impaired  Other  Total 
 forborne  forborne  forborne  forborne 
 loans and  loans and  loans and  loans and 
 advances  advances  advances  advances 
 £m  £m  £m  £m 
At 31 December 2018               
Retail:               
Secured 642   4,241   1,206   6,089 
Unsecured 200   –   235   435 
UK Motor Finance 25   –   31   56 
Total Retail 867   4,241   1,472   6,580 
Commercial 2,978   –   894   3,872 
            
          Impairment 
 Total forborne loans  Total forborne loans  Total loans and  allowance as a % of 
 and advances which  and advances which  advances which are  loans and advances 
 are not impaired  are impaired  forborne  which are forborne 
 £m  £m  £m  % 
At 31 December 2017           
UK secured retail 1,291   137   1,428   4.3 
UK unsecured retail 55   139   194   38.6 
Consumer credit cards 105   190   295   36.0 
Asset Finance UK Retail 15   19   34   36.6 
Run off: Ireland secured retail 213   25   238   21.0 
Commercial Banking 447   1,927   2,374   35.0 
Run off: Corporate Real Estate, other Corporate and Specialist Finance –   715   715   44.1 
At 31 December 2016               
UK secured retail 1,879   217   2,096   4.7 
UK unsecured retail 20   107   127   40.5 
Consumer credit cards 93   119   212   29.0 
Asset Finance UK Retail 55   62   117   27.0 
Run off: Ireland secured retail 137   19   156   16.6 
Commercial Banking 466   2,197   2,663   31.1 
Run off: Corporate Real Estate, other Corporate and Specialist Finance 3   995   998   51.1 
At 31 December 2015               
UK secured retail 2,929   173   3,102   4.2 
UK unsecured retail 28   119   147   40.0 
Consumer credit cards 105   120   225   26.8 
Asset Finance UK Retail 49   51   100   25.5 
Run off: Ireland secured retail 143   26   169   13.3 
Commercial Banking 986   2,543   3,529   30.9 
Run off: Corporate Real Estate, other Corporate and Specialist Finance 9   1,771   1,780   52.5 
Run-off Ireland: Commercial real estate and corporate 32   5   37   0.0 
9173

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

TROUBLED DEBT RESTRUCTURINGS

In the US, loans whose terms have been modified due to problems with the borrower are required to be separately disclosed. If the new terms were in line with market conditions at the time of the restructuring and the restructured loan remains current as to repayment of principal and interest then the disclosure is discontinued at the end of the first year. The Company’s accounting policy for loans that are renegotiated is set out in note 2(H)(l) to the financial statements. The table below sets out loans that are forborne at 31 December 2015 and 2014, separately identifying those loans that are also impaired:

  ImpairmentTotal forborne loans
and advances which
are not impaired
£m		 Total forborne loans
and advances which
are impaired
£m		 Total loans and
advances which are
forborne
£m		 Impairment
allowance as a % of
loans and advances
which are forborne
%		 
 Total forborne Total forborne  allowance as a
 loans and loans and Total loans and % of loans and
 advances which advances which advances which advances which
 are not impaired are impaired are forborne are forborne
 £m £m £m %
At 31 December 2015 
UK secured retail 2,929 173 3,102 4.2
UK unsecured retail 28 119 147 40.0
Consumer credit cards 105 120 225 26.8
Asset Finance UK Retail 49 51 100 25.5
Run off: Ireland secured retail 143 26 169 13.3
Commercial Banking 986 2,528 3,514 30.9
Run off: Corporate Real Estate, other Corporate and Specialist Finance 9 1,771 1,780 52.5
Run-off Ireland: Commercial real estate and corporate 32 5 37 0.0
At 31 December 2014                
UK secured retail 4,128 266 4,394 3.5 4,128   266   4,394   3.5 
UK unsecured retail 23 139 162 39.4 23   139   162   39.4 
Consumer credit cards 94 140 234 29.1 94   140   234   29.1 
Asset Finance UK Retail 56 53 109 20.5 56   53   109   20.5 
Run off: Ireland secured retail 239 41 280 12.7 239   41   280   12.7 
Commercial Banking 1,896 3,241 5,137 31.0 1,896   3,241   5,137   31.0 
Run off: Corporate Real Estate, other Corporate and Specialist Finance 86 1,912 1,998 58.3 86   1,912   1,998   58.3 
Run-off Ireland: Commercial real estate and corporate 384 3,052 3,436 72.2 384   3,052   3,436   72.2 

 

The Group assesses whether a loan benefiting from a UK Government-sponsored programme is impaired or a troubled debt restructuring using the same accounting policies and practices as it does for loans not benefiting from such a programme.

 

Further information on the schemes operated by the Group to assist borrowers who are experiencing financial stress and on the Group’s forborne loans is set out on pages 5953 to 6154 and pages 6960 to 78.64.

 

ASSETS ACQUIRED IN EXCHANGE FOR ADVANCES

 

In most circumstances in the US, title to property securing residential real estate transfers to the lender upon foreclosure. The loan is written off and the property acquired in this way is reported in a separate balance sheet category with any recoveries recorded as an offset to the provision for loan losses recorded in the year. Upon sale of the acquired property, gains or losses are recorded in the income statement as a gain or loss on acquired property.

 

In the UK, although a bank is entitled to enforce a first charge on a property held as security, it typically does so only to the extent of enforcing its power of sale. In accordance with IFRS and industry practice, Lloyds Banking Group usually takes control of a property held as collateral on a loan at repossession without transfer of title. Loans subject to repossession continue to be reported as loans in the balance sheet. AnyThe Group’s gains or losses on sale of the acquired property are recorded within the provision for loan losses during the reporting period.

 

The difference in practices has no effect on net income reported in the UK compared to that reported in the US but it does result in a difference in classification of losses and recoveries in the income statement. It also has the effect of causing UK banks to report an increased level of non-performing loans compared with US banks.

 

In certain circumstances the Group takes physical possession of assets held as collateral against wholesale lending. In such cases, the assets are carried on the Group’s balance sheet and are classified according to the Group’s accounting policies.

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CROSS BORDER OUTSTANDINGS

 

The business of Lloyds Banking Group involves exposures in non-local currencies. These cross-bordercross border outstandings comprise loans (including accrued interest), acceptances, interest-bearing deposits with other banks, other interest-bearing investments and any other monetary assets which are denominated in non-local currency. The following table analyses, by type of borrower, foreign outstandings which individually represent in excess of 1 per cent of Lloyds Banking Group’s total assets.

 

      Governments Banks and other Commercial,
      and official financial industrial
    Total institutions institutions and other
  % of assets £m £m £m £m
At 31 December 2015:          
United States of America 1.5 11,748 6,349 952 4,447
At 31 December 2014:          
United States of America 1.3 11,437 7,838 1,177 2,422
At 31 December 2013:          
United States of America 1.3 10,679 7,156 1,626 1,897
Republic of Ireland 1.1 8,990 2 119 8,869
  % of assets  Total
£m		  Governments
and official
institutions
£m		  Banks and other
financial
institutions
£m		  Commercial,
industrial
and other
£m		 
At 31 December 2018:                    
United States of America  1.6   12,502   4,045   5,091   3,366 
At 31 December 2017:                    
United States of America  1.6   12,963   6,760   3,205   2,998 
At 31 December 2016:                    
United States of America  1.6   13,224   7,564   1,718   3,942 

 

At 31 December 2015,2018, United States of America had commitments of £1,096£1,212 million.

 

At 31 December 2015,2018, no countries had cross-border outstandings of between 0.75 per cent and 1 per cent of assets.

 

At 31 December 2014,2017, no countries had cross-bordercross border outstandings of between 0.75 per cent and 1 per cent of assets.

 

At 31 December 20132016, no countries had cross-bordercross border outstandings of between 0.75 per cent and 1 per cent of assets.

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REGULATORY AND LEGAL RISK

DEFINITION

Regulatory and legal risk is defined as the risk that the Group is exposed to financial loss, fines, censure, or legal or enforcement action; or to civil or criminal proceedings in the courts (or equivalent) and/or the Group is unable to enforce its rights due to failing to comply with applicable laws (including codes of practice which could have legal implications), regulations, codes of conduct, legal obligations, or a failure to adequately manage actual or threatened litigation, including criminal proceedings.

EXPOSURES

Whilst the Group has a zero risk appetite for material regulatory breaches or material legal incidents, the Group remains exposed to them, driven by significant ongoing and new legislation, regulation and court proceedings in the UK and overseas which in each case needs to be interpreted, implemented and embedded into day-to-day operational and business practices across the Group.

MEASUREMENT

Regulatory and legal risks are measured against a defined risk appetite metric, which is an assessment of material regulatory breaches and material legal incidents.

MITIGATION

The Group undertakes a range of key mitigating actions to manage regulatory and legal risk. These include the following:

– The Board establishes a Group-wide risk appetite and metric for regulatory and legal risk.
– Group policies and procedures set out the principles and key controls that should apply across the business which are aligned to the Group risk appetite. Mandated policies and processes require appropriate control frameworks, management information, standards and colleague training to be implemented to identify and manage regulatory and legal risk.
– Business units identify, assess and implement policy and regulatory requirements and establish local controls, processes, procedures and resources to ensure appropriate governance and compliance.
– Business units regularly produce management information to assist in the identification of issues and test management controls are working effectively.
– Risk and Legal provide oversight, proactive support and constructive challenge to the business in identifying and managing regulatory and legal issues.
– Risk conducts thematic reviews of regulatory compliance and provides oversight of regulatory compliance assessments across businesses and divisions where appropriate.
– Business units, with the support of divisional and Group-level bodies, conduct ongoing horizon scanning to identify changes in regulatory and legal requirements.
– The Group engages with regulatory authorities and industry bodies on forthcoming regulatory changes, market reviews and investigations, ensuring programmes are established to deliver new regulation and legislation.

MONITORING

Material risks are managed through the relevant divisional level committees, with review and escalation through Group level committees where appropriate, including the escalation of any material regulatory breaches or material legal incidents.

 

CONDUCT RISK

 

DEFINITION

 

Conduct risk is defined as theThe risk of customer detriment due to poor design, distribution and execution of products and services or other activities which could undermine the integrity of the market or distort competition, leading to unfair customer outcomes, regulatory censure and/or a reduction in earnings/value, throughand financial orand reputational loss, from inappropriate or poor customer treatment or business conduct.

RISK APPETITE

The Group’s conduct risk appetite is designed to safeguard customers from systemic unfair outcomes and is monitored through a number of key metrics with defined limits and triggers which are reviewed and approved by the Board annually. The metrics and their outputs are regularly assessed by Executive and Board Risk committees to ensure that the Group operates within appetite policies, processes and standards. These are in place to provide a framework for businesses and colleagues to operate in accordance with the laws, regulations and voluntary codes, which apply to the Group and its activities.

For further information on risk appetite refer to page 46.loss.

 

EXPOSURES

 

Conduct risk affectsThe Group faces significant conduct risks, which affect all aspects of the Group’s operations and all types of customers.

Conduct risks can impact directly or indirectly on the Group’s customers and other stakeholders.can materialise from a number of areas across the Group, including: business and strategic planning that does not sufficiently consider customer needs; ineffective management and monitoring of products and their distribution (including the sales process); unclear, unfair, misleading or untimely customer communications; a culture that is not sufficiently customer-centric; poor governance of colleagues’ incentives and rewards and approval of schemes which drive unfair customer outcomes; ineffective management and oversight of legacy conduct issues; ineffective management of customers’ complaints or claims; and outsourcing of customer service and product delivery via third-parties that do not have the same level of control, oversight and culture as the Group. The Group faces significant conduct risks, for example, through products or services not meeting the needs of its customers; sales processes resulting in poor advice; failure to deal with a customer’s complaint effectively where the Group has not met customer expectations, which may lead to a referralis also exposed to the Financial Ombudsman Service; orrisk of engaging in or failing to manage conduct which disruptscould constitute market abuse, undermine the fair and effective operationintegrity of a market in which it is active. Given theactive, distort competition or create conflicts of interest.

There is a high level of scrutiny regarding financial institutions’ treatment of customers, and business conductincluding those in vulnerable circumstances, from regulatory bodies, the media, politicians and consumer groups,groups.

There continues to be a significant focus on market misconduct, resulting from previous issues relating to London Inter-bank Offered Rate (LIBOR) and foreign exchange (FX).

Due to the level of enhanced focus relating to conduct, there is a risk that certain aspects of the Group’s current or legacy business may be determined by the Financial Conduct Authority, and other regulatory bodies or the courts as not being conducted in accordance with applicable laws or regulations, or in a manner that fails to deliver fair and reasonable customer treatment. The Group may also be liable for damages to third parties harmed by the conduct of its business.

 

MEASUREMENT

 

To articulate its conduct risk appetite, the Group has sought more granularity through the use of suitable conduct risk metricsConduct Risk Appetite Metrics (CRAMs) and tolerances that indicate where it may potentially be operating outside its conduct risk appetite. Conduct Risk Appetite Metrics (CRAMs)These include Board-level conduct risk metrics covering an assessment of overall CRAMs performance, out of appetite CRAMs, Financial Ombudsman Service (FoS) change rates and complaints.

CRAMs have been designed for allservices and product families offered by the Group;Group and are measured by a consistent set of common metrics have been agreed for all products to support a consistent approach.metrics. These contain a range of product design, sales and post-salesprocess metrics to provide a more holistic view of conduct risks; each productsome products also hashave a suite of additional bespoke metrics. The common metrics are sales volume, product governance adherence, target market, outcome testing: meets customer needs, outcome testing: information disclosure, outcome testing: regulatory compliance, retention, usage, claims (decline rates), complaints, Financial Ombudsman Service uphold rate and complaints outcome testing.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Each of the tolerances for the metrics are agreed for the individual product or service and are tracked month by month.regularly tracked. At a consolidated level these metrics are part of the Board approved risk appetite. The Group also continues to measure how effectively the overall Conduct Strategy is embedded across all divisionsevolve its approach to measurements supporting customer vulnerability, process delivery and functions and its impact on customer outcomes through the Group Customer First Committee (GCFC). In relation to market conduct, metrics have also been generated, covering, for example, the way in which confidential information and potential conflicts of interest are managed.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTSjourneys.

 

MITIGATION

 

The Group takes a range of mitigating actions with respect to this risk; it has implemented a customer-focused, UK-centric strategy, strengthened itsconduct risk. The Group’s ongoing commitment to good customer outcomes sets the tone from the top and supports the development of the right customer-centric culture –  strengthening links between actions to support conduct, culture and values, improved systemscustomer and processes, and implementedenabling more effective controls. These actions are being further embedded throughout the Group (across all business areas and all supporting functional areas) as part of the transition of the Group’s Conduct Strategy from a programmecontrol management. Actions to business as usual supported by the GCFC, including:enable good conduct include:

 

–Conduct risk appetite established at Group and business area level;level, with metrics included in the Group risk appetite to ensure ongoing focus.
  
–Conduct policies and procedures in place to ensure appropriate controls and processes that deliver fair customer outcomes.
– Customer needs explicitly considered within business and product level planning and strategy;strategy, through divisional customer plans, with integral conduct lens, reviewed and challenged by Group Customer First Committee (GCFC).
  
–Cultural transformation, supported by strong direction and tone from senior executives and the Board. This is underpinned by the Group’s values, behaviours and Codescode of Responsibility,responsibility, to deliver the best bank for customers;customers.
  
–Continued embedding of the customer vulnerability framework. The Customer Vulnerability Cross Divisional Committee continues to operate at a senior level to prioritise change, drive implementation and ensure consistency across the Group. Significant partnership with Macmillan to support customers with cancer continues, alongside ongoing activities to support all vulnerable customers, including those experiencing financial and domestic abuse.
– Continued embedding and evolving of the Group’s customer journey strategy and framework to support the Group’s focus on conduct from an end-to-end customer perspective.
– Enhanced product governance framework to ensure products continue to offer customers fair value, and consistently meet thetheir needs of the relevant target market throughout their product life cycle; reviewed and challenged by Group Product Governance Committee (GPGC).
  
–Sales processes and governance framework to deliver consistently fair outcomes;
–Enhanced complaints management through effectively responding to, and learning from, root causes to reduceof complaint volumes and the Financial Ombudsman ServiceFoS change rate;rates.
  
–Review and oversight of thematic conduct agenda items at GPGC, ensuring holistic consideration of key Group-wide conduct risks.
– Enhanced recruitment and training, andwith a focus on how the Group manages colleagues’ performance with clearer customer accountabilities; andaccountabilities.
  
–Application of the Conduct Strategy to third partiesOngoing engagement with third-parties involved in serving the Group’s customers.customers to ensure consistent delivery.
– Monitoring and testing of customer outcomes to ensure the Group delivers fair outcomes for customers whilst making continuous improvements to products, services and processes.
– Continued focus on market conduct through training and enhancements of procedures and controls, governed by the Market Steering Committee which also provides read-across for the Group on industry issues.
– Implementation of enhanced change delivery methodology to enable prioritisation and delivery of initiatives to address conduct challenges.
– Focus on proactive identification and mitigation of conduct risk in the Group Strategic Review 3.
– Active engagement with regulatory bodies and other stakeholders to develop understanding of concerns related to customer treatment, effective competition and market integrity, to ensure that the Group’s strategic conduct focus continues to meet evolving stakeholder expectations.

The Group has also prioritised activity designed to reinforce good conduct in its engagement with the markets in which it operates, together with the development of preventative and detective controls in order to be able to demonstrate this.

The Group’s leadership team is committed to embedding the Conduct Strategy within the business following its approved transition into business as usual to support the development of the right customer centric culture. The Board and Group Risk Committee receive regular reports and metrics to track progress on how the Group is meeting customer needs and minimising conduct risk.

All Group business areas have continued to apply significant resources to the Conduct Strategy to achieve the target of transition to business as usual and to continue delivering improved outcomes for customers.

The Group actively engages with regulatory bodies and other stakeholders in developing its understanding of current customer treatment concerns, and those relating to the fairness and effectiveness of markets, to ensure that the implementation of the Group’s conduct strategy meets evolving stakeholder expectations.

 

MONITORING

 

Monitoring and reporting is undertaken at Board, Group and business area committees. As part of the reporting of CRAMs, a robust outcomes testing regime is in place to test performancedetermine whether the Group is delivering fair outcomes for customers.

GCFC acts as the guardian of customer critical activities. The GCFCexperience and has responsibility for monitoring and reviewing integrated measurement of enhanced outcomes, customer viewsplans and cultural transformation,actions to improve it, including challenging Divisionsdivisions to make changes based on key learnings to support the delivery of the Group’s vision and foster a customer-centric culture.

OPERATIONAL RISK

DEFINITION

Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events, which can lead to adverse customer centric culture. Thereimpact, reputational damage or financial loss.

EXPOSURES

The principal operational risks to the Group which could result in customer detriment, unfair customer outcomes, financial loss, disruption and/or reputational damage are:

– A cyber-attack;
– Change and execution risk in delivering the Group’s change agenda;
– Failure in IT systems, due to volume of change, and/or aged infrastructure;
– Failure to protect and manage the Group’s and customers’ data;
– Internal and/or external fraud or financial crime;
– Failure to ensure compliance with increasingly complex and detailed regulation including anti-money laundering, anti-bribery, counter-terrorist financing, and financial sanctions and prohibitions laws and regulations; and
– Operational resilience and damage to physical assets including: terrorist acts, other acts of war or hostility, geopolitical, pandemic or other such events.

A number of these risks could increase where there is a reliance on third-party suppliers to provide services to the Group or its customers.

MEASUREMENT

Operational risk is managed across the Group through an operational risk framework and operational risk policies. The operational risk framework includes a risk and control self-assessment process, risk impact likelihood matrix, key risk and control indicators, risk appetite, a robust operational event management and escalation process, scenario analysis and an operational losses process.

Table 1.26 below shows high level loss and event trends for the Group using Basel II categories. Based on data captured on the Group’s Operational Risk System, in 2018 the highest frequency of events occurred in external fraud (59.83 per cent) and execution, delivery and process management (25.52 per cent). Clients, products and business practices accounted for 63.18 per cent of losses by value, driven by legacy issues where impacts materialised in 2018 (excluding PPI).

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.26:Operational risk events by risk category (losses greater than or equal to £10,000), excluding PPI1

  % of total volume % of total losses
  2018  2017  2018  2017 
Business disruption and system failures  1.10   1.43   2.80   1.31 
Clients, products and business practices  11.61   10.84   63.18   86.23 
Damage to physical assets  1.47   1.78   0.20   0.17 
Employee practices and workplace safety  –   0.05   –   0.06 
Execution, delivery and process management  25.52   24.26   30.03   8.91 
External fraud  59.83   61.29   3.68   3.38 
Internal fraud  0.47   0.35   0.11   (0.06)
Total  100.00   100.00   100.00   100.00 

12017 breakdowns have been restated to reflect a number of events that have been reclassified following an internal review.

Operational risk losses and scenario analysis is used to inform the Internal Capital Adequacy Assessment Process (ICAAP). The Group calculates its minimum (Pillar I) operational risk capital requirements using The Standardised Approach (TSA). Pillar II is calculated using internal and external loss data and extreme but plausible scenarios that may occur in the next 12 months.

MITIGATION

The Group’s strategic review considers the changing risk management requirements, adapting the change delivery model to be more agile and develop the people skills and capabilities needed to be a ‘Bank of the Future’. The Group continues to review and invest in its control environment to ensure it addresses the inherent risks faced. Risks are reported and discussed at local governance forums and escalated to executive management and Board as appropriate to ensure the correct level of visibility and engagement. The Group employs a range of risk management strategies, including: avoidance, mitigation, transfer (including insurance) and acceptance. Where there is a reliance on third-party suppliers to provide services, the Group’s sourcing policy ensures that outsourcing initiatives follow a defined process including due diligence, risk evaluation and ongoing assurance.

Mitigating actions to the principal operational risks are:

– The threat landscape associated with cyber risk continues to evolve and there is significant regulatory attention on this subject. The Board has defined a cyber risk appetite and continues to invest heavily to protect the Group from malicious cyber-attacks. Most recent investment has focused on improving the Group’s approach to identity and access management, improving capability to detect and respond to cyber-attacks and improved ability to manage vulnerabilities across the estate.
– The Group acknowledges the challenges faced with delivering new strategic initiatives and programmes alongside the extensive agenda of regulatory and legal changes whilst enhancing systems and controls. To address this, impacts of change are assessed in terms of the ability of the business to execute effectively and the potential impact on its risk profile. Key elements are monitored, including identifying resources and skills required to deliver change, critical dependencies and change readiness, while controls are also put in place to manage change activity and are monitored in line with the Group Change Policy. Execution and change risks and controls are reported through Group Transformation governance up to Board Risk Committee, and are recorded on key risk systems to allow for consolidation and aggregation. To supplement this, the Group takes a risk-based approach to change oversight across the three lines of defence, encompassing delivery assurance, risk oversight and audit reviews focused on a combination of specific change activity and broad overarching themes.
– The Group continues to optimise its approach to IT and operational resilience by investing in technology improvements and enhancing the resilience of systems that support the Group’s critical business processes, primarily through the Technology Resilience Programme, with independent verification of progress on an annual basis. The Board recognises the role that resilient technology plays in achieving the Group’s strategy of becoming the best bank for customers and in maintaining banking services across the wider industry. As such, the Board dedicates considerable time and focus to this subject at both the Board and the Board Risk Committee, and continues to sponsor key investment programmes that enhance resilience.
– The Group is making a significant investment to improve data, including the security of data and oversight of third-parties. The Group’s strategy is to introduce advanced data management practices, based on Group-wide standards, data-first culture and modern enterprise data platforms, supported by a simplified modern IT architecture.
– The Group adopts a risk-based approach to mitigate the internal and external fraud risks it faces, reflecting the current and emerging fraud risks within the market. Fraud risk appetite metrics have been defined, holistically covering the impacts of fraud in terms of losses to the Group, costs of fraud systems and operations, and customer experience of actual and attempted fraud. Oversight of the appropriateness and performance of these metrics is undertaken regularly through business area and Group-level committees. This approach drives a continual programme of prioritised enhancements to the Group’s technology, process and people related controls, with an emphasis on preventative controls supported by real time detective controls wherever feasible. Group-wide policies and operational control frameworks are maintained and designed to provide customer confidence, protect the Group’s commercial interests and reputation, comply with legal requirements and meet regulatory expectations. The Group’s fraud awareness programme remains a key component of its fraud control environment, and awareness of fraud risk is supported by mandatory training for all colleagues. The Group also plays an active role with other financial institutions, industry bodies, and enforcement agencies in identifying and combatting fraud.
– The Group has adopted policies and procedures designed to detect and prevent the use of its banking network for money laundering, terrorist financing, bribery, tax evasion, human trafficking, and modern-day slavery, and activities prohibited by legal and regulatory sanctions. Against a background of increasingly complex and detailed laws and regulations, and of increased criminal and terrorist activity, the Group regularly reviews and assesses its policies, procedures and organisational arrangements to keep them current, effective and consistent across markets and jurisdictions. The Group requires mandatory training on these topics for all employees. Specifically, the anti-money laundering procedures include ‘know-your-customer’ requirements, transaction monitoring technologies, reporting of suspicions of money laundering or terrorist financing to the applicable regulatory authorities, and interaction between the Group’s Financial Intelligence Unit and external agencies and other financial institutions. The Anti-Bribery Policy prohibits the payment, offer, acceptance or request of a bribe, including ‘facilitation payments’ by any employee or agent and provides a confidential reporting service for anonymous reporting of suspected or actual bribery activity. The Sanctions and the Related Prohibitions Policy sets out a framework of controls for compliance with legal and regulatory sanctions.
– The Group has increased its focus on operational resilience and has updated its operational resilience strategy to reflect changing priorities of both customers and regulators. At the core of its approach to operational resilience are the Group’s Critical business processes which drive all activity, including further mapping of the processes to identify any additional resilience requirements such as impact tolerances in the event of a service outage. The Group continues to develop playbooks that address a range of interruptions from internal and external threats and tests these through scenario-based testing and exercising.
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

MONITORING

Monitoring and reporting of operational risk is undertaken at Board, Group and divisional risk committees. Each committee monitors key risks, control effectiveness, key risk and control indicators, events, operational losses, risk appetite metrics and the results of independent testing conducted by Risk and/or Internal Audit.

The Group maintains a formal approach to operational risk event escalation, whereby material events are identified, captured and escalated. Root causes of events are determined, where possible, and action plans put in place to ensure an optimum level of control to keep customers and the business safe, reduce costs, and improve efficiency.

The insurance programme is monitored and reviewed regularly, with recommendations being made to the Group’s senior management annually prior to each renewal. Insurers are monitored on an ongoing basis, to ensure counterparty risk is minimised. A process is in place to manage any insurer rating changes or insolvencies.

PEOPLE RISK

DEFINITION

The risk that the Group fails to provide an appropriate colleague and customer-centric culture, supported by robust reward and wellbeing policies and processes; effective leadership to manage colleague resources; effective talent and succession management; and robust control to ensure all colleague-related requirements are met.

EXPOSURES

The Group’s management of material people risks is critical to its capacity to deliver against its strategic objectives and to be the best bank for customers. The Group is exposed to the following key people risks:

– Maintaining organisational skills, capability, resilience and capacity levels in response to increasing volumes of organisational, political and external market change;
– Senior Managers and Certification Regime (SM&CR) and additional regulatory constraints on remuneration structures may impact the Group’s ability to attract and retain talent;
– The increasing digitisation of the business is changing the capability mix required and may impact the Group’s ability to attract and retain talent;
– The increasing demands on colleagues and consequential impact colleague wellbeing may impact on the Group’s ability to enhance colleague skills to achieve capability uplift for a digital era; and
– Colleague engagement may continue to be challenged by ongoing media attention on banking sector culture, conduct and ethical considerations.

MEASUREMENT

People risk is measured through a series of quantitative and qualitative indicators, aligned to key sources of people risk for the Group such as succession, retention, colleague engagement, wellbeing and performance management. In addition to risk appetite measures and limits, people risks and controls are monitored on a monthly basis via the Group’s risk governance framework and reporting structures.

MITIGATION

The Group takes many mitigating actions with respect to people risk. Key areas of focus include:

– Focusing on leadership and colleague engagement, through delivery of strategies to attract, retain and develop high calibre people together with implementation of rigorous succession planning;
– Continued focus on the Group’s culture by developing and delivering initiatives that reinforce the appropriate behaviours which generate the best possible long-term outcomes for customers and colleagues;
– Managing organisational capability and capacity through divisional people strategies to ensure there are the right skills and resources to meet the Group’s customers’ needs and deliver the Group’s strategic plan;
– Maintain effective remuneration arrangements to ensure they promote an appropriate culture and colleague behaviours that meet customer needs and regulatory expectations;
– Ensuring colleague wellbeing strategies and support are in place to meet colleague needs, and that the skills and capability growth required to build a workforce for the ‘Bank of the Future’ are achieved;
– Ensuring compliance with legal and regulatory requirements related to SM&CR, embedding compliant and appropriate colleague behaviours in line with Group policies, values and its people risk priorities; and
– Ongoing consultation with the Group’s recognised unions on changes which impact their members.

MONITORING

People risks from across the Group are monitored and reported through Board and Group Governance Committees in accordance with the Group’s Risk Management Framework. Risk exposures are discussed monthly via the Group People Risk Committee with upwards reporting to Group Risk and Executive Committees. In addition, oversight, challenge and reporting are completed at Risk division level to assess the effectiveness of controls, recommending follow up remedial action if required. All material people risk events are escalated in accordance with the formal Group Operational Risk Policy and People Policies to the respective divisional Managing Directors and the Group Director, Conduct, Compliance and Operational Risk.

INSURANCE UNDERWRITING RISK

DEFINITION

Insurance underwriting risk is defined as the risk of adverse developments in longevity, mortality, persistency, General Insurance underwriting and policyholder behaviour, leading to reductions in earnings and/or value.

EXPOSURES

The major source of insurance underwriting risk within the Group is the Insurance business.

Longevity and persistency are key risks within the life and pensions business. Longevity risk arises from the annuity portfolios where policyholders’ future cash flows are guaranteed at retirement and increases in life expectancy, beyond current assumptions, will increase the cost of annuities. Longevity risk exposures are expected to increase with the Insurance business growth in the annuity market. Persistency assumptions are set to give a best estimate; however customer behaviour may result in increased cancellations or cessation of contributions.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Property insurance risk is a key risk within the General Insurance business, through Home Insurance. Exposures can arise, for example, in extreme weather conditions such as flooding, when property damage claims are higher than expected.

The Group’s defined benefit pension schemes also expose the Group to longevity risk. For further information please refer to the defined benefit pension schemes component of the market risk section and note 35 to the financial statements.

MEASUREMENT

Insurance underwriting risks are measured using a variety of techniques including stress, reverse stress and scenario testing, as well as stochastic modelling. Current and potential future insurance underwriting risk exposures are assessed and aggregated on a range of stresses including risk measures based on 1-in-200 year stresses for Insurance’s regulatory capital assessments and other supporting measures where appropriate, including those set out in note 32 to the financial statements.

MITIGATION

Insurance underwriting risk in the Insurance business is mitigated in a number of ways:

– Strategic decisions made consider the maintenance of the current well-diversified portfolio of insurance risks;
– Processes for underwriting, claims management, pricing and product design seek to control exposure. Experts in demographic risk (for example longevity) support the propositions;
– General Insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements broadly spread over different reinsurers. Detailed modelling, including that of the potential losses under various catastrophe scenarios, supports the choice of reinsurance arrangements;
– Longevity risk transfer and hedging solutions are considered on a regular basis and since 2017 Insurance has reinsured £2.7 billion of annuitant longevity;
– Exposure limits by risk type are assessed through the business planning process and used as a control mechanism to ensure risks are taken within risk appetite.

MONITORING

Insurance underwriting risks in the Insurance business are monitored by Insurance senior executive committees and ultimately the Insurance Board. Significant risks from the Insurance business and the defined benefit pension schemes are reviewed by the Group Executive and Group Risk Committees and/or Board.

Insurance underwriting risk exposures within the Insurance business are monitored against risk appetite. The Insurance business monitors experiences against expectations, for example business volumes and mix, claims and persistency experience. The effectiveness of controls put in place to manage insurance underwriting risk is evaluated and significant divergences from experience or movements in risk exposures are investigated and remedial action taken.

CAPITAL RISK

DEFINITION

Capital risk is defined as the risk that the Group has a sub-optimal quantity or quality of capital or that capital is inefficiently deployed across the Group.

EXPOSURES

A capital risk exposure arises when the Group has insufficient capital resources to support its strategic objectives and plans, and to meet external stakeholder requirements and expectations. This could arise due to a depletion of the Group’s capital resources as a result of the crystallisation of any of the risks to which it is exposed. Alternatively a shortage of capital could arise from an increase in the amount of capital that needs to be held either at Group level or at regulated entity or sub-group levels under the Group’s post ring-fence structure. The Group’s capital management approach is focused on maintaining sufficient capital resources to prevent such exposures while optimising value for shareholders.

MEASUREMENT

The Group measures the amount of capital it requires and holds through applying the regulatory framework defined by the Capital Requirements Directive and Regulation (CRD IV) as implemented in the UK by the Prudential Regulation Authority (PRA) and supplemented through additional regulation under the PRA Rulebook.

The minimum amount of total capital, under Pillar 1 of the regulatory framework, is determined as 8 per cent of aggregate risk-weighted assets. At least 4.5 per cent of risk-weighted assets are required to be covered by common equity tier 1 (CET1) capital and at least 6 per cent of risk-weighted assets are required to be covered by tier 1 capital. These minimum Pillar 1 requirements are supplemented by additional minimum requirements under Pillar 2A of the regulatory framework, the aggregate of which is referred to as the Group’s Total Capital Requirement (TCR), and a number of regulatory capital buffers as described below.

Additional minimum requirements under Pillar 2A are set by the PRA as a firm-specific Individual Capital Requirement (ICR) reflecting a point in time estimate, which may change over time, of the minimum amount of capital that is needed by the bank to cover risks that are not fully covered by Pillar 1, such as credit concentration and operational risk, and those risks not covered at all by Pillar 1, such as pensions and interest rate risk in the banking book (IRRBB).

The Group is also focusrequired to maintain a number of regulatory capital buffers, which are required to be met with CET1 capital.

Systemic buffers are designed to hold systemically important banks to higher capital standards, so that they can withstand a greater level of stress before requiring resolution.

– Although the Group is not currently classified as a global systemically important institution (G-SII) under the Capital Requirements Directive, it has been classified as an ‘other’ systemically important institution (O-SII) by the PRA. The O-SII buffer is set to zero in the UK.
– The systemic risk buffer (SRB) will come into force for UK ring-fenced banks during 2019, with the PRA expected to announce both the SRB rate and date of application for the Group’s Ring-Fenced Bank (RFB) sub-group in the first half of 2019. The size of buffer applied to the RFB sub-group will be dependent upon its total assets. Although the SRB will apply at a sub-consolidated level within the Group’s structure, the PRA has indicated that they will include in the Group’s PRA Buffer an amount equivalent to the RFB sub-group’s SRB. The amount included in the PRA Buffer is expected to be lower as a percentage of Group risk-weighted assets reflecting the assets of the Group that are not held in the RFB sub-group and for which the SRB will not apply.

The capital conservation buffer (CCB) is a standard buffer of 2.5 per cent of risk-weighted assets designed to provide for losses in the event of stress. The CCB has been phased in over a number of years –  during 2018 it was 1.875 per cent and it increased to the full 2.5 per cent on 1 January 2019.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The countercyclical capital buffer (CCYB) is time-varying and is designed to require banks to hold additional capital to remove or reduce the enhancementbuild-up of preventativesystemic risk in times of credit boom, providing additional loss absorbing capacity and detective controlsacting as an incentive for banks to encourageconstrain further credit growth. The amount of the buffer is determined by reference to buffer rates set by the FPC for the individual countries where the Group has relevant credit exposures. The CCYB rate for the UK is currently set at 1.0 per cent. The FPC regularly considers the adequacy of the UK CCYB rate in light of the evolution of the overall risk environment. As at 31 December 2018 non-zero buffer rates also currently apply for Norway, Sweden, Hong Kong, Iceland, Slovakia, Czech Republic, and demonstrateLithuania. During 2019 France, Bulgaria, Denmark and Ireland will implement non-zero buffer rates. The Group’s overall countercyclical capital buffer at 31 December 2018 was 0.9 per cent of risk-weighted assets, having increased significantly during the year (from 0.002 per cent at 31 December 2017) as a result of the increase in the UK rate from nil to 1.0 per cent, the Group’s supportrelevant credit exposures being predominantly UK based.

As part of the capital planning process, forecast capital positions are subjected to extensive internal stress testing to determine the adequacy of the Group’s capital resources against the minimum requirements, including the ICR. The PRA considers outputs from both the Group’s internal stress tests and the annual Bank of England stress test, in conjunction with the Group’s other regulatory capital buffers, as part of the process for informing the setting of a bank-specific capital buffer for the Group, known as the PRA Buffer. The PRA requires the PRA Buffer to remain confidential between the Group and the PRA.

All buffers are required to be met with CET1 capital. A breach of the PRA buffer would trigger a dialogue between the Group and the PRA to agree what action is required whereas a breach of the CRD IV combined buffer (all regulatory buffers excluding the PRA buffer) would give rise to automatic constraints upon any discretionary capital distributions by the Group.

In addition to the risk-based capital framework outlined above, the Group is also subject to minimum capital requirements under the UK Leverage Ratio Framework. The leverage ratio is calculated by dividing fully loaded tier 1 capital resources by a defined measure of on-balance sheet assets and off-balance sheet items.

The minimum leverage ratio requirement under the UK Leverage Ratio Framework is 3.25 per cent. This is supplemented by a time-varying countercyclical leverage buffer (CCLB) which is determined by multiplying the leverage exposure measure by 35 per cent of the countercyclical capital buffer (CCYB) rate. As at 31 December 2018 the CCLB was 0.3 per cent (31 December 2017: nil). An additional leverage ratio buffer (ALRB) will apply from 2019 to the Group’s ring-fenced bank (RFB) sub-group, to be determined by multiplying the RFB leverage exposure measure by 35 per cent of the SRB. An equivalent amount of capital, referred to as the Leverage Ratio Group Add-on, will be required to be held at Group level under the UK leverage framework to cover the RFB’s additional leverage ratio buffer.

At least 75 per cent of the 3.25 per cent minimum leverage ratio requirement and the entirety of any buffers that may apply must be met by CET1 capital.

The leverage ratio framework does not currently give rise to higher capital requirements for the Group than the risk-based capital framework.

MITIGATION

The Group has a capital management framework including policies and procedures that are designed to ensure that it operates within its risk appetite, uses its capital resources efficiently and continues to comply with regulatory requirements.

The Group is able to accumulate additional capital through the retention of profits over time, which can be enhanced through cutting costs and reducing or cancelling dividend payments and share buybacks, by raising new equity via, for example, a rights issue or debt exchange and by raising additional tier 1 or tier 2 capital through issuing tier 1 instruments or subordinated liabilities. The cost and availability of additional capital is dependent upon market conditions and perceptions at the time. The Group is also able to manage the demand for capital through management actions including adjusting its lending strategy, risk hedging strategies and through business disposals.

Additional measures to manage the Group’s capital position include seeking to optimise the generation of capital demand within the Group’s businesses to strike an appropriate balance of capital held within the Group’s ring-fenced bank (RFB) sub-group and non-ring-fenced insurance and banking subsidiaries and through improving the quality of its capital through liability management exercises.

MONITORING

Capital is actively managed and monitoring capital ratios is a key factor in the Group’s planning processes and stress testing, which separately cover the RFB sub-group and key individual banking entities. Multi-year forecasts of the Group’s capital position, based upon the Group’s operating plan, are produced at least annually to inform the Group’s capital plan whilst shorter term forecasts are more frequently undertaken to understand and respond to variations of the Group’s actual performance against the plan. The capital plans are tested for capital adequacy using a range of stress scenarios covering adverse economic conditions as well as other adverse factors that could impact the Group and the Group maintains a recovery plan which sets out a range of potential mitigating actions that could be taken in response to a stress.

The capital plans also consider the impact of IFRS 9 which has the potential to increase bank capital volatility. Under stress this is primarily a result of provisioning for assets that are not in default at an earlier stage than would have been the case under IAS 39. In addition it currently remains unclear as to how the IFRS 9 requirement to reflect the outcome of multiple future economic scenarios within the calculation of the expected credit losses allowance (ECL) should be reflected in capital stress tests.

The Group notes that the UK regulatory authorities have previously announced, via the Financial Policy Committee (FPC), that the change in accounting standard will not change the cumulative losses banks incur during any given stress period (the losses will however be provided for at an earlier point in the stress) and that the FPC will take steps to ensure that the interaction of IFRS 9 accounting with its annual stress test does not result in de facto increases in capital requirements. In the short term the IFRS 9 transitional arrangements for capital, which the Group has adopted, will provide some stability in capital requirements against increased provisioning, measurement uncertainty and volatility, introduced in the accounting by the adoption of IFRS 9.

Regular reporting of actual and projected ratios for Group, the RFB sub-group and key legal entities, including those in stressed scenarios, is undertaken, including submissions to the Group Capital Risk Committee (GCRC), Group Financial Risk Committee (GFRC), Group Asset and Liability Committee (GALCO), Group Risk Committee (GRC), Board Risk Committee (BRC) and the Board. Capital policies and procedures are well established and subject to independent oversight.

The regulatory framework within which the Group operates continues to evolve and further detail on this will be provided in the Group’s Pillar 3 report. The Group continues to monitor these developments very closely, analysing the potential capital impacts to ensure that, through organic capital

generation, the Group continues to maintain a strong capital position that exceeds both minimum regulatory requirements and the Group’s risk appetite and is consistent with market expectations.

Target capital ratios

The Board’s view of the current level of CET1 capital required remains at around 13 per cent. In addition to this amount the Group intends to hold a management buffer of around 1 per cent to provide capacity for growth, meet regulatory requirements and cover uncertainties.

This takes into account, amongst other things:

– the minimum Pillar 1 CET1 capital requirement of 4.5 per cent of risk-weighted assets.
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– the Group’s Pillar 2A ICR set by the PRA, reflecting their point in time estimate, which may change over time, of the amount of capital that is needed in relation to risks not covered by Pillar 1. During the year the PRA updated the Group’s ICR representing a reduction from 5.4 per cent to 4.6 per cent of risk-weighted assets at 31 December 2018, of which 2.6 per cent must be met by CET1 capital. The requirement has increased to 4.7 per cent of risk-weighted assets, of which 2.7 per cent must be met by CET1 capital, from 1 January 2019 to reflect the commencement of the UK’s ring-fencing regime.
– the capital conservation buffer (CCB) requirement of 1.875 per cent of risk-weighted assets, increasing to 2.5 per cent of risk-weighted assets from 1 January 2019.
– the Group’s current countercyclical capital buffer (CCYB) requirement of 0.9 per cent of risk-weighted assets.
– the introduction of the SRB during 2019 for the RFB sub-group, which will require the Group to hold an equivalent monetary amount of capital.
– the Group’s PRA Buffer, which the PRA sets after taking account of the results of the PRA stress tests and other information, as well as outputs from the Group’s internal stress tests. The PRA requires the PRA Buffer itself to remain confidential between the Group and the PRA.

Dividend policy

The Group has established an ordinary dividend policy that is both progressive and sustainable, based on growing the ordinary dividend per share over time. The rate of growth of the ordinary dividend will be decided by the Board in light of the circumstances at the time.

The Board also gives due consideration to the return of surplus capital through the use of special dividends or share buybacks. Surplus capital represents capital over and above the amount management wish to retain to grow the business, meet regulatory requirements and cover uncertainties. The amount of required capital may vary from time to time depending on circumstances and by its nature there can be no guarantee that any return of surplus capital will be appropriate in future years.

The ability of the Group to pay a dividend is also subject to constraints including the availability of distributable reserves, legal and regulatory restrictions and the financial and operating performance of the entity.

Distributable reserves are determined as required by the Companies Act 2006 by reference to a company’s individual financial statements. At 31 December 2018 Lloyds Banking Group plc (‘the Company’) had accumulated distributable reserves of approximately £8.5 billion. Substantially all of the Company’s merger reserve is available for distribution under UK company law as a result of transactions undertaken to recapitalise the Company in 2009.

Lloyds Banking Group plc acts as a holding company which also issues capital and other securities to capitalise and fund the activities of the Group. The profitability of the holding company, and consequently its ability to sustain dividend payments, is therefore dependent upon the continued receipt of dividends from its main operating subsidiaries, including Lloyds Bank plc (the ring-fenced bank), Lloyds Bank Corporate Markets plc (the non-ring-fenced bank), LBG Equity Investments Limited (the non-ring-fenced investments business) and Scottish Widows Group Limited (the insurance business). A number of Group subsidiaries, principally those with banking and insurance activities, are subject to regulatory capital requirements which require minimum amounts of capital to be maintained relative to their size and risk. The principal operating subsidiary is Lloyds Bank plc which, at 31 December 2018, had a consolidated CET1 capital ratio of 14.9 per cent (31 December 2017: 15.8 per cent). The Group actively manages the capital of its subsidiaries, which includes monitoring the regulatory capital ratios for its banking and insurance subsidiaries and, on a consolidated basis, the RFB sub-group against approved internal risk appetite limits. The Group operates a formal capital management policy which requires all subsidiary entities to remit any surplus capital to their parent companies.

Minimum requirement for own funds and eligible liabilities (MREL)

The purpose of the minimum requirement for own funds and eligible liabilities (MREL) is to require firms to maintain sufficient equity and liabilities that are capable of credibly bearing losses in resolution. MREL can be satisfied by a combination of regulatory capital and certain unsecured debt resources (which must be subordinate to a firm’s operating liabilities).

In November 2016 the Bank of England published a statement of policy on its approach for setting MREL in line with EU requirements.

Applying the Bank of England’s MREL policy to minimum capital requirements from 1 January 2019, the Group’s indicative MREL requirement, excluding regulatory capital buffers, is as follows:

– From 2020, 2 times Pillar 1 plus Pillar 2A, equivalent to 20.7 per cent of risk-weighted assets
– From 2022, 2 times Pillar 1 plus 2 times Pillar 2A, equivalent to 25.4 per cent of risk-weighted assets

The Bank of England will review the calibration of MREL in 2020 before setting final end-state requirements to be met from 2022. This review will take into consideration any changes to the capital framework, including the finalisation of Basel III.

During 2018, the Group issued £8.8 billion (sterling equivalent) of senior unsecured securities from Lloyds Banking Group plc which, while not included in total capital, are eligible to meet MREL. Combined with previous issuances made over the last two years the Group remains comfortably positioned to meet MREL requirements from 2020 and, as at 31 December 2018, had a transitional MREL ratio of 32.4 per cent of risk-weighted assets.

Analysis of capital position

The Group’s CET1 capital ratio increased by 2.10 per cent on an adjusted basis before ordinary dividends and the share buyback, primarily as a result of:

– Strong underlying capital build, net of remediation costs, of 1.95 per cent, largely driven by underlying profits
– Dividends paid by the Insurance business in July 2018 and in February 2019, in relation to 2018 earnings generating an increase of 0.25 per cent
– The completion of the sale of the Irish mortgage portfolio in the second half of the year which resulted in a 0.25 per cent increase
– Other movements, resulting in a net increase of 0.03 per cent, included the impact of structural changes arising from transfer between Insurance and the ring-fenced bank, risk-weighted asset reductions, market movements and additional pension contributions
– Offset by a reduction of 0.38 per cent relating to PPI charges

The implementation of IFRS 9 on 1 January 2018 resulted in an initial reduction in CET1 capital of 0.30 per cent which, following the application of transitional relief, reduced to 0.01 per cent. No additional relief has been recognised at 31 December 2018 as Stage 1 and Stage 2 expected credit losses (ECLs), net of regulatory expected losses, have not increased beyond the position at 1 January 2018.

Overall the Group’s CET1 ratio has strengthened to 16.0 per cent on an adjusted basis before ordinary dividends and the share buyback. After ordinary dividends the Group’s CET1 ratio reduces to 14.8 per cent on an adjusted basis. In addition the Board intends to implement a share buyback programme of up to £1.75 billion, equivalent to 2.46 pence per share. The buyback will impact the Group’s capital position in 2019 and is expected to reduce CET1 capital by c. 0.9 per cent. Allowing for this at 31 December 2018 the adjusted CET1 ratio would be 13.9 per cent after ordinary dividends (31 December 2017: 13.9 per cent adjusted, after ordinary dividends and the share buyback).

Excluding the Insurance dividend paid in February 2019 the Group’s CET1 ratio has strengthened to 15.8 per cent before ordinary dividends and the share buyback and 14.6 per cent after ordinary dividends (31 December 2017: 14.1 per cent).

The accrual for foreseeable dividends reflects the recommended final ordinary dividend of 2.14 pence per share.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The transitional total capital ratio, after ordinary dividends, increased by 1.7 per cent to 22.9 per cent, largely reflecting the issuance of new AT1 and dated subordinated debt instruments, foreign exchange movements on subordinated debt instruments, the reduction in the significant investments deduction from tier 2 capital, the increase in CET1 capital and the reduction in risk-weighted assets, partially offset by the amortisation of dated tier 2 instruments and the annual reduction in the transitional limit applied to grandfathered AT1 capital instruments.

Total capital requirement

The Group’s total capital requirement (TCR) as at 31 December 2018, being the aggregate of the Group’s Pillar 1 and current Pillar 2A capital requirements, was £26,124 million (31 December 2017: £28,180 million).

Capital resources

An analysis of the Group’s capital position as at 31 December 2018 is presented in the following section on both a CRD IV transitional arrangements basis and a CRD IV fully loaded basis. In addition the Group’s capital position reflects the application of the transitional arrangements for IFRS 9.

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Table 1.27:Capital resources (audited)

The table below summarises the consolidated capital position of the Group. The Group’s Pillar 3 Report will provide a comprehensive analysis of the own funds of the Group.

  Transitional Fully loaded
  At 31 Dec
2018
£m		  At 31 Dec
2017
£m		  At 31 Dec
2018
£m		  At 31 Dec
2017
£m		 
Common equity tier 1                
Shareholders’ equity per balance sheet  43,434   43,551   43,434   43,551 
Adjustment to retained earnings for foreseeable dividends  (1,523)  (1,475)  (1,523)  (1,475)
Deconsolidation adjustments1  2,273   1,301   2,273   1,301 
Adjustment for own credit  (280)  109   (280)  109 
Cash flow hedging reserve  (1,051)  (1,405)  (1,051)  (1,405)
Other adjustments  (19)  (177)  (19)  (177)
   42,834   41,904   42,834   41,904 
less: deductions from common equity tier 1                
Goodwill and other intangible assets  (3,667)  (2,966)  (3,667)  (2,966)
Prudent valuation adjustment  (529)  (556)  (529)  (556)
Excess of expected losses over impairment provisions and value adjustments  (27)  (498)  (27)  (498)
Removal of defined benefit pension surplus  (994)  (541)  (994)  (541)
Securitisation deductions  (191)  (191)  (191)  (191)
Significant investments1  (4,222)  (4,250)  (4,222)  (4,250)
Deferred tax assets  (3,037)  (3,255)  (3,037)  (3,255)
Common equity tier 1 capital  30,167   29,647   30,167   29,647 
Additional tier 1                
Other equity instruments  6,466   5,330   6,466   5,330 
Preference shares and preferred securities2  4,008   4,503   –   – 
Transitional limit and other adjustments  (1,804)  (1,748)  –   – 
   8,670   8,085   6,466   5,330 
less: deductions from tier 1                
Significant investments1  (1,298)  (1,403)  –   – 
Total tier 1 capital  37,539   36,329   36,633   34,977 
Tier 2                
Other subordinated liabilities2  13,648   13,419   13,648   13,419 
Deconsolidation of instruments issued by insurance entities1  (1,767)  (1,786)  (1,767)  (1,786)
Adjustments for transitional limit and non-eligible instruments  1,504   1,617   (1,266)  (1,252)
Amortisation and other adjustments  (2,717)  (3,524)  (2,717)  (3,565)
Eligible provisions  –   120   –   120 
   10,668   9,846   7,898   6,936 
less: deductions from tier 2                
Significant investments1  (973)  (1,516)  (2,271)  (2,919)
Total capital resources  47,234   44,659   42,260   38,994 
 
Risk-weighted assets (unaudited)  206,366   210,919   206,366   210,919 
 
Common equity tier 1 capital ratio3  14.6%  14.1%  14.6%  14.1%
Tier 1 capital ratio  18.2%  17.2%  17.8%  16.6%
Total capital ratio  22.9%  21.2%  20.5%  18.5%

1For regulatory capital purposes, the Group’s Insurance business is deconsolidated and replaced by the amount of the Group’s investment in the business. A part of this amount is deducted from capital (shown as ‘significant investments’ in the table above) and the remaining amount is risk-weighted, forming part of threshold risk-weighted assets.
2Preference shares, preferred securities and other subordinated liabilities are categorised as subordinated liabilities in the balance sheet.
3The Group's common equity tier 1 ratio is 14.8 per cent reflecting the dividend paid by the Insurance business in February 2019 in relation to its 2018 earnings. The post share buyback common equity tier 1 ratio is 13.9 per cent on an adjusted basis (31 December 2017: 13.9 per cent).
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Movements in capital resources

The key difference between the transitional capital calculation as at 31 December 2018 and the fully loaded equivalent is primarily related to capital securities that previously qualified as tier 1 or tier 2 capital, but that do not fully qualify under CRD IV, which can be included in additional tier 1 (AT1) or tier 2 capital (as applicable) up to specified limits which reduce by 10 per cent per annum until 2022. The key movements on a transitional basis are set out in the table below.

Table 1.28:Movements in capital resources

  Common
Equity tier 1
£m		  Additional
Tier 1
£m		  Tier 2
£m		  Total
capital
£m		 
At 31 December 2017  29,647   6,682   8,330   44,659 
Banking profit attributable to ordinary shareholders1  3,759   –   –   3,759 
Movement in foreseeable dividends2  (48)  –   –   (48)
Dividends paid out on ordinary shares during the year  (2,240)  –   –   (2,240)
Dividends received from the Insurance business1  750   –   –   750 
Share buyback completed  (1,005)  –   –   (1,005)
Restatement of retained earnings on adoption of IFRS 9  (929)  –   –   (929)
IFRS 9 transitional adjustment to retained earnings  478   –   –   478 
Movement in treasury shares and employee share schemes  300   –   –   300 
Pension movements:                
Removal of defined benefit pension surplus  (453)  –   –   (453)
Movement through other comprehensive income  90   –   –   90 
Fair value through other comprehensive income reserve  (401)  –   –   (401)
Prudent valuation adjustment  27   –   –   27 
Deferred tax asset  218   –   –   218 
Goodwill and other intangible assets  (701)  –   –   (701)
Excess of expected losses over impairment provisions and value adjustments  471   –   –   471 
Significant investments  28   105   543   676 
Eligible provisions3  –   –   (120)  (120)
Movements in subordinated debt:                
Repurchases, redemptions and other  –   (551)  (824)  (1,375)
Issuances  –   1,136   1,766   2,902 
Other movements  176   –   –   176 
At 31 December 2018  30,167   7,372   9,695   47,234 

1Under the regulatory framework, profits made by Insurance are removed from CET1 capital. However, when dividends are paid to the Group by Insurance these are recognised through CET1 capital. The £750 million of dividends received from Insurance during the year include £600 million in respect of their 2017 full year ordinary dividend and £150 million in respect of their 2018 interim ordinary dividend.
2Includes the accrual for the 2018 full year ordinary dividend and the reversal of the accrual for the 2017 full year ordinary dividend which was paid during the year.
3The movement in eligible provisions reflects the adjustment made in respect of the application of the IFRS 9 transitional arrangements.

CET1 capital resources have increased by £520 million over the year, primarily reflecting:

–profit generation during the year
–receipt of the dividends paid by the Insurance business in February 2018 and July 2018
–movements in treasury shares and the employee share schemes
–a reduction in the deferred tax asset deduction
–a reduction in excess expected losses resulting from the partial absorption of the increase in impairment provisions following the adoption of IFRS 9 on 1 January 2018 (remaining expected losses deducted from capital relate specifically to equity exposures), offset by the impact on retained earnings (net of transitional relief)
–largely offset by the interim dividend paid in September 2018, the accrual for the 2018 full year ordinary dividend, the completion of the share buyback programme during the year, the increase in the defined benefit pension scheme surplus deduction, movements through the fair value through other comprehensive income (FVOCI) reserve and an increase in intangible assets which are deducted from capital

AT1 capital resources have increased by £690 million in the period, primarily reflecting the issuance of a new AT1 capital instrument during the year, partially offset by the annual reduction in the transitional limit applied to grandfathered AT1 capital instruments.

Tier 2 capital resources have increased by £1,365 million in the period largely reflecting the issuance of new dated subordinated debt instruments, foreign exchange movements and a reduction in the significant investments deduction following the redemption by Scottish Widows of a subordinated debt instrument issued to the Group, partially offset by the amortisation of dated instruments.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.29:Minimum requirement for own funds and eligible liabilities

An analysis of the Group’s current transitional MREL position is provided below.

  Transitional
  At 31 Dec
2018
£m		  At 31 Dec
2017
£m		 
Total capital resources (transitional basis)  47,234   44,659 
Ineligible AT1 and tier 2 instruments1  (613)  (1,350)
Senior unsecured securities issued by Lloyds Banking Group plc  20,213   10,815 
Total MREL2  66,834   54,124 
Risk-weighted assets  206,366   210,919 
MREL ratio3  32.4%   25.7% 

1Instruments with less than one year to maturity or governed under non-EEA law without a contractual bail-in clause.
2Until 2022, externally issued regulatory capital in operating entities can count towards the Group’s MREL to the extent that such capital would count towards the Group’s consolidated capital resources.
3The MREL ratio is 32.6 per cent on an adjusted basis upon recognition of the dividend paid by the Insurance business in February 2019 in relation to its 2018 earnings (31 December 2017: 26.0 per cent adjusted).

Table 1.30:Risk-weighted assets

  At 31 Dec
2018
£m		  At 31 Dec
2017
£m		 
Foundation Internal Ratings Based (IRB) Approach  60,555   60,207 
Retail IRB Approach  59,522   61,588 
Other IRB Approach  15,666   17,191 
IRB Approach  135,743   138,986 
Standardised (STA) Approach  25,757   25,503 
Credit risk  161,500   164,489 
Counterparty credit risk  5,718   6,055 
Contributions to the default funds of central counterparties  830   428 
Credit valuation adjustment risk  702   1,402 
Operational risk  25,505   25,326 
Market risk  2,085   3,051 
Underlying risk-weighted assets  196,340   200,751 
Threshold risk-weighted assets1  10,026   10,168 
Total risk-weighted assets  206,366   210,919 

1Threshold risk-weighted assets reflect the element of significant investments and deferred tax assets that are permitted to be risk-weighted instead of being deducted from CET1 capital. Significant investments primarily arise from investment in the Group’s Insurance business.

Table 1.31:Risk-weighted assets movement by key driver

  Credit risk
IRB
£m		  Credit risk
STA
£m		  Credit risk
total2
£m		  Counterparty
credit risk3
£m		  Market risk
£m		  Operational
risk
£m		  Total
£m		 
Total risk-weighted assets as at 31 December 2017                          210,919 
Less threshold risk-weighted assets1                          10,168 
Risk-weighted assets as at 31 December 2017  138,986   25,503   164,489   7,885   3,051   25,326   200,751 
Asset size  (271)  591   320   75   –   –   395 
Asset quality  759   354   1,113   (348)  –   –   765 
Model updates  1,472   –   1,472   –   (708)  –   764 
Methodology and policy  (1,002)  182   (820)  (136)  –   –   (956)
Acquisitions and disposals  (4,892)  (984)  (5,876)  –   –   –   (5,876)
Movements in risk levels (market risk only)  –   –   –   –   (901)  –   (901)
Foreign exchange movements  639   (21)  618   (220)  –   –   398 
Other  52   132   184   (6)  643   179   1,000 
Risk-weighted assets as at 31 December 2018  135,743   25,757   161,500   7,250   2,085   25,505   196,340 
Threshold risk-weighted assets1                          10,026 
Total risk-weighted assets as at 31 December 2018                          206,366 

1Threshold risk-weighted assets reflect the element of significant investments and deferred tax assets that are permitted to be risk-weighted instead of being deducted from CET1 capital. Significant investments primarily arise from investments in the Group’s Insurance business.
2Credit risk includes securitisation risk-weighted assets.
3Counterparty credit risk includes movements in contributions to the default funds of central counterparties and movements in credit valuation adjustment risk.
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The risk-weighted assets movement table provides analysis of the movement in risk-weighted assets in the period by risk type and an insight into the key drivers of the movements. The key driver analysis is compiled on a monthly basis through the identification and categorisation of risk-weighted asset movements and is subject to management judgment.

Credit risk, risk-weighted assets:

–Asset size net increase of £0.3 billion includes targeted growth in some key customer segments
–Asset quality increase of £1.1 billion captures movements due to changes in borrower risk, including moves in and out of default, and changes in the economic environment
–Model update increases of £1.5 billion were driven by model refinements, principally within retail portfolios
–Methodology and policy reductions of £0.8 billion were driven by further capital efficient securitisation activity
–Acquisitions and disposals reduction of £5.9 billion reflects the sale of the Irish mortgage portfolio and certain strategic equity holdings
–Sterling foreign exchange movements, principally with Euro and US Dollar, contributed to an increase of £0.6 billion in credit risk-weighted assets

Counterparty credit risk, risk-weighted assets reduction of £0.6 billion was mainly driven by lower CVA risk-weighted assets, foreign exchange movements and yield movement.

Market risk, risk-weighted assets reductions of £1.0 billion were largely due to a reduction in underlying positions and refinements to internal models, partly offset by migrations to Lloyds Bank Corporate Markets.

Operational risk, risk-weighted assets increased following the annual update of the income based Standardised Approach operational risk calculation.

LEVERAGE RATIO

Analysis of leverage movements

The Group’s fully loaded UK leverage ratio increased to 5.5 per cent reflecting the increase in tier 1 capital, partially offset by the £6.0 billion increase in the exposure measure. The latter largely reflects increases in both the derivatives exposure measure and securities financing transactions (SFT) exposure measure, offset in part by the reduction in financial assets at fair value through other comprehensive income and effective operationthe reduction in off-balance sheet items.

On an adjusted basis the UK leverage ratio increased to 5.6 per cent from 5.4 per cent adjusted at 31 December 2017, reflecting the increase in the adjusted fully loaded tier 1 capital position, partially offset by the increase in the exposure measure.

The derivatives exposure measure, representing derivative financial instruments per the balance sheet net of relevant markets.deconsolidation and derivatives adjustment, increased by £5.0 billion during the period, predominantly reflecting a reduction in the regulatory netting benefit and a higher volume of trades through central counterparties, including longer dated trades, which has contributed to the increase in the regulatory potential future exposure. The movements in part reflect the impact of the separation of derivative portfolios between the ring-fenced and non-ring-fenced banks and the establishment of the latter through Lloyds Bank Corporate Markets.

The SFT exposure measure, representing SFT assets per the balance sheet net of deconsolidation and other SFT adjustments, increased by £21.8 billion during the period, largely reflecting a continued increase in customer volumes, partially offset by a small reduction in trading volumes.

Off-balance sheet items reduced by £2.0 billion during the period, primarily reflecting a net reduction in securitisation financing facility commitments, including drawdowns, and a small reduction in new residential mortgage offers placed.

The average UK leverage ratio of 5.5 per cent over the quarter, compared to 5.3 per cent at the start of the quarter, primarily reflected the issuance of a new AT1 capital instrument in October 2018, partially offset by a marginally higher average exposure measure over the quarter when compared to the position at the end of the quarter.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The table below summarises the component parts of the Group’s leverage ratio. Further analysis will be provided in the Group’s Pillar 3 Report.

 

 

Table 1.32: Leverage ratio

  Fully loaded
  At 31 Dec  At 31 Dec 
  2018  2017 
  £m  £m 
Total tier 1 capital for leverage ratio        
Common equity tier 1 capital  30,167   29,647 
Additional tier 1 capital  6,466   5,330 
Total tier 1 capital  36,633   34,977 
Exposure measure        
Statutory balance sheet assets        
Derivative financial instruments  23,595   25,834 
Securities financing transactions  69,301   49,193 
Loans and advances and other assets  704,702   737,082 
Total assets  797,598   812,109 
Qualifying central bank claims  (50,105)  (53,842)
Deconsolidation adjustments1        
Derivative financial instruments  (1,376)  (2,043)
Securities financing transactions  (487)  (85)
Loans and advances and other assets  (130,048)  (140,387)
Total deconsolidation adjustments  (131,911)  (142,515)
Derivatives adjustments        
Adjustments for regulatory netting  (8,828)  (13,031)
Adjustments for cash collateral  (10,536)  (7,380)
Net written credit protection  539   881 
Regulatory potential future exposure  18,250   12,335 
Total derivatives adjustments  (575)  (7,195)
Securities financing transactions adjustments  40   (2,022)
Off-balance sheet items  56,393   58,357 
Regulatory deductions and other adjustments  (8,163)  (7,658)
Total exposure measure2  663,277   657,234 
Average exposure measure3  669,896     
UK Leverage ratio2,5  5.5%  5.3%
Average UK leverage ratio3  5.5%    
CRD IV exposure measure4  713,382   711,076 
CRD IV leverage ratio4  5.1%  4.9%

1Deconsolidation adjustments relate to the deconsolidation of certain Group entities that fall outside the scope of the Group’s regulatory capital consolidation, being primarily the Group’s Insurance business.
2Calculated in accordance with the UK Leverage Ratio Framework which requires qualifying central bank claims to be excluded from the leverage exposure measure.
3The average UK leverage ratio is based on the average of the month end tier 1 capital position and average exposure measure over the quarter (1 October 2018 to 31 December 2018). The average of 5.5 per cent compares to 5.3 per cent at the start and 5.5 per cent at the end of the quarter.
4Calculated in accordance with CRD IV rules which include central bank claims within the leverage exposure measure.
5The UK leverage ratio is 5.6 per cent on an adjusted basis upon recognition of the dividend paid by the Insurance business in February 2019 in relation to its 2018 earnings (31 December 2017: 5.4 per cent adjusted).

Table 1.33:Application of IFRS 9 on a full impact basis for capital and leverage

  IFRS 9 full impact   
  At 31 Dec  At 1 Jan  At 31 Dec 
  2018  2018  2017 
Common equity tier 1 (£m)  29,592   29,060   29,647 
Transitional tier 1 (£m)  36,964   35,742   36,329 
Transitional total capital (£m)  47,195   44,636   44,659 
Total risk-weighted assets (£m)  206,614   211,200   210,919 
Common equity tier 1 ratio (%)  14.3%  13.8%  14.1%
Transitional tier 1 ratio (%)  17.9%  16.9%  17.2%
Transitional total capital ratio (%)  22.8%  21.1%  21.2%
UK leverage ratio exposure measure (£m)  663,182   656,886   657,234 
UK leverage ratio (%)  5.4%  5.2%  5.3%
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Further details on the Group’s adoption of the transitional arrangements for IFRS 9 can be found in the Group publication entitled ‘IFRS 9 “Financial Instruments” Transition’, published in March 2018 and located on the Group’s website at http://www.lloydsbankinggroup.com/investors/financial-performance/.

The Group has opted to apply paragraph 4 of CRR Article 473a (the ‘transitional rules’) which allows for additional capital relief in respect of any post 1 January 2018 increase in Stage 1 and Stage 2 IFRS 9 expected credit loss provisions (net of regulatory expected losses) during the transition period. As at 31 December 2018 no additional capital relief has been recognised.

Stress testing

The Group undertakes a wide ranging programme of stress testing providing a comprehensive view of the potential impacts arising from the risks to which the Group and its key legal entities are exposed. One of the most important uses of stress testing is to assess the resilience of the operational and strategic plans of the Group and its legal entities to adverse economic conditions and other key vulnerabilities. As part of this programme the Group conducts macroeconomic stress tests of the operating plans.

In 2018 the Group participated in both the concurrent UK stress test run by the Bank of England (BoE) and in the European Banking Authority’s (EBA) bi-annual EU-wide stress test. The EBA stress test did not contain a pass/fail threshold and as announced in November, the Group demonstrated its ability to meet applicable capital requirements under stressed conditions. In the case of the BoE stress test, despite the severity of the scenario, the Group exceeded the capital and leverage hurdles after the application of management actions, and as a consequence was not required to take any capital actions.

G-SIB indicators

Although the Group is not currently classified as a Global Systemically Important Bank (G-SIB), by virtue of the Group’s leverage exposure measure exceeding €200 billion the Group is required to report G-SIB indicator metrics to the PRA. The Group’s indicator metrics used within the 2018 Basel G-SIBs annual exercise will be disclosed from April 2019 and the results are expected to be made available by the Basel Committee later this year.

Insurance businesses

The business transacted by the insurance companies within the Group comprises both life insurance business and General Insurance business. Life insurance business comprises unit-linked business, non-profit business and with-profits business.

Scottish Widows Limited (SW Ltd) holds the only with-profit funds managed by the Group. Each insurance company within the Group is regulated by the PRA.

The Solvency II regime for insurers and insurance groups came into force from 1 January 2016. The insurance businesses are required to calculate solvency capital requirements and available capital on a risk-based approach. The Insurance business of the Group calculates regulatory capital on the basis of an internal model, which was approved by the PRA on 5 December 2015, with the latest major change to the model approved in November 2018.

The minimum required capital must be maintained at all times throughout the year. These capital requirements and the capital available to meet them are regularly estimated in order to ensure that capital maintenance requirements are being met.

All minimum regulatory requirements of the insurance companies have been met during the year.

FUNDING AND LIQUIDITY RISK

DEFINITION

Funding risk is defined as the risk that the Group does not have sufficiently stable and diverse sources of funding. Liquidity risk is defined as the risk that the Group has insufficient financial resources to meet its commitments as they fall due.

EXPOSURE

Liquidity exposure represents the potential stressed outflows in any future period less expected inflows. The Group considers liquidity exposure from both an internal and a regulatory perspective.

MEASUREMENT

Liquidity risk is managed through a series of measures, tests and reports that are primarily based on contractual maturities with behavioural overlays as appropriate. Note 52 on page F-88 sets out an analysis of assets and liabilities by relevant maturity grouping. The Group undertakes quantitative and qualitative analysis of the behavioural aspects of its assets and liabilities in order to reflect their expected behaviour.

MITIGATION

The Group manages and monitors liquidity risks and ensures that liquidity risk management systems and arrangements are adequate with regard to the internal risk appetite, Group strategy and regulatory requirements. Liquidity policies and procedures are subject to independent internal oversight by Risk. Overseas branches and subsidiaries of the Group may also be required to meet the liquidity requirements of the entity’s domestic country. Management of liquidity requirements is performed by the overseas branch or subsidiary in line with Group Policy. Liquidity risk of the Insurance business is actively managed and monitored within the Insurance business. The Group plans funding requirements over the life of the funding plan, combining business as usual and stressed conditions. The Group manages its liquidity position with regard to its internal risk appetite and the Liquidity Coverage Ratio (LCR) required by the PRA and Capital Requirements Directive and Regulation (CRD IV) liquidity requirements.

The Group’s funding and liquidity position is underpinned by its significant customer deposit base, and is supported by strong relationships across customer segments. The Group has consistently observed that in aggregate the retail deposit base provides a stable source of funding. Funding concentration by counterparty, currency and tenor is monitored on an ongoing basis and where concentrations do exist, these are managed as part of the planning process and limited by internal risk appetite, with analysis regularly provided to senior management.

To assist in managing the balance sheet, the Group operates a Liquidity Transfer Pricing (LTP) process which: allocates relevant interest expenses from the centre to the Group’s banking businesses within the internal management accounts; helps drive the correct inputs to customer pricing; and is consistent with regulatory requirements. LTP makes extensive use of behavioural maturity profiles, taking account of expected customer loan prepayments and stability of customer deposits, modelled on historic data.

The Group can monetise liquid assets quickly, either through the repurchase agreements (repo) market or through outright sale. In addition, the Group has pre-positioned a substantial amount of assets at the Bank of England’s Discount Window Facility which can be used to access additional liquidity in a time of stress. The Group considers diversification across geography, currency, markets and tenor when assessing appropriate holdings of liquid assets. The Group’s liquid asset buffer is available for deployment at immediate notice, subject to complying with regulatory requirements.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Liquidity risk within the Insurance business may result from: the inability to sell financial assets quickly at their fair values; an insurance liability falling due for payment earlier than expected; the inability to generate cash inflows as anticipated; an unexpected large operational event; or from a general insurance catastrophe e.g. a significant weather event. Liquidity risk is actively managed and monitored within the Insurance business to ensure that it remains within approved risk appetite, so that even under stress conditions, there is sufficient liquidity to meet obligations.

MONITORING

Daily monitoring and control processes are in place to address internal and regulatory liquidity requirements. In order to meet ring-fencing requirements from 1 January 2019, the shape and scale of liquidity reporting has increased with additional monitoring and reporting requirements for the Ring-Fenced Bank (RFB) sub-group and non-ring-fenced banking entities. The Group monitors a range of market and internal early warning indicators on a daily basis for early signs of liquidity risk in the market or specific to the Group. This captures regulatory metrics as well as metrics the Group considers relevant for its liquidity profile. These are a mixture of quantitative and qualitative measures, including: daily variation of customer balances; changes in maturity profiles; funding concentrations; changes in LCR outflows; credit default swap (CDS) spreads; and basis risks.

The Group carries out internal stress testing of its liquidity and potential cash flow mismatch position over both short (up to one month) and longer-term horizons against a range of scenarios forming an important part of the internal risk appetite. The scenarios and assumptions are reviewed at least annually to ensure that they continue to be relevant to the nature of the business including reflecting emerging horizon risks to the Group, such as a further sovereign downgrade. For further information on the Group’s 2018 liquidity stress testing results refer to page 92.

The Group maintains a Contingency Funding Plan which is designed to identify emerging liquidity concerns at an early stage, so that mitigating actions can be taken to avoid a more serious crisis developing. Contingency Funding Plan invocation and escalation processes are based on analysis of five major quantitative and qualitative components, comprising assessment of: early warning indicators; prudential and regulatory liquidity risk limits and triggers; stress testing results; event and systemic indicators; and market intelligence.

Funding and liquidity management in 2018

The Group has maintained its strong funding and liquidity position with a stable loan to deposit ratio of 107 per cent.

During the year, the Group took advantage of favourable funding markets to raise £21.4 billion of new term wholesale funding in order to refinance maturities in the year including the Bank of England’s Funding for Lending Scheme (FLS) and increase liquidity buffers. As a result wholesale funding increased from £101.1 billion to £123.3 billion.

During 2018, the Group repaid £12 billion of its FLS drawings, which has reduced the amount outstanding to £13.1 billion at 31 December 2018. The balance of Term Funding Scheme drawings remains at £19.9 billion as at 31 December 2018.

The Group’s liquidity position remains strong and in excess of the regulatory minimum and internal risk appetite, with a LCR of 130 per cent as at 31 December 2018 based on the EU Delegated Act. Total LCR eligible liquid assets as at 31 December 2018 were £129.4 billion, up £8.5 billion in the year.

The Group’s strong ratings continue to reflect its robust balance sheet, improved profitability and bail-in capital position. During 2018, S&P upgraded Lloyds Bank plc’s long-term rating by one notch to ‘A+’ and S&P, Moody’s and Fitch assigned definitive ratings to Lloyds Bank Corporate Markets (LBCM) of A/ A1/A respectively.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.34:Group funding position

     At 1 Jan     At 31 Dec    
  At 31 Dec  2018     2017    
  2018  (adjusted)1  Change  (reported)  Change 
  £bn  £bn  (%)  £bn  (%) 
Funding requirement                    
Loans and advances to customers2  444.4   444.2   –   455.7   (2)
Loans and advances to banks3  5.9   1.7       4.1   44 
Debt securities at amortised cost  4.0   3.3   21   3.6   11 
Reverse repurchase agreements  –   0.7       0.7     
Financial assets at fair value through other comprehensive income – non-LCR eligible4  0.8   1.7   (53)        
Available-for-sale financial assets – non-LCR eligible4              0.9     
Cash and balances at central bank – non-LCR eligible5  5.8   4.8   21   4.8   21 
Funded assets  460.9   456.4   1   469.8   (2)
Other assets6  212.9   247.2   (14)  234.7   (9)
   673.8   703.6   (4)  704.5   (4)
On balance sheet LCR eligible liquid assets                    
Reverse repurchase agreements  40.9   16.9       16.9     
Cash and balances at central banks5  48.9   53.7   (9)  53.7   (9)
Debt securities at amortised cost  1.2               �� 
Financial assets at fair value through other comprehensive income  24.0   41.2   (42)        
Available-for-sale financial assets              41.2     
Trading and fair value through profit and loss  11.9   1.7       1.7     
Repurchase agreements  (3.1)  (5.9)  (47)  (5.9)  (47)
   123.8   107.6   15   107.6   15 
Total Group assets  797.6   811.2   (2)  812.1   (2)
Less: other liabilities6  (187.9)  (226.8)  (17)  (226.5)  (17)
Funding requirement  609.7   584.4   4   585.6   4 
Funded by                    
Customer deposits7  416.3   415.5       415.5   – 
Wholesale funding8  123.3   101.1   22   101.1   22 
   539.6   516.6   4   516.6   4 
Term funding scheme  19.9   19.9   –   19.9     
Total equity  50.2   47.9   5   49.1   2 
Total funding  609.7   584.4   4   585.6   4 

1Adjusted to reflect the implementation of IFRS 9 and IFRS 15.
2Excludes reverse repos of £40.5 billion (1 January 2018: £16.8 billion; 31 December 2017: £16.8 billion).
3Excludes nil (31 December 2017: £1.7 billion) of loans and advances to banks within the Insurance business and £0.4 billion (1 January 2018: £0.8 billion; 31 December 2017: £0.8 billion) of reverse repurchase agreements.
4Non-LCR eligible liquid assets comprise a diversified pool of highly rated unencumbered collateral (including retained issuance).
5Cash and balances at central banks are combined in the Group’s balance sheet.
6Other assets and other liabilities primarily include balances in the Group’s Insurance business and the fair value of derivative assets and liabilities.
7Excludes repos of £1.8 billion (1 January 2018: £2.6 billion; 31 December 2017: £2.6 billion).
8The Group’s definition of wholesale funding aligns with that used by other international market participants; including interbank deposits, debt securities in issue and subordinated liabilities.
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.35:Reconciliation of Group funding to the balance sheet (audited)

  Included in
funding
analysis
£bn		  Repos
and cash
collateral
received by
Insurance
£bn		  Fair value
and other
accounting
methods
£bn		  Balance
sheet
£bn		 
At 31 December 2018                
Deposits from banks  8.3   22.1   (0.1)  30.3 
Debt securities in issue  97.1   –   (5.9)  91.2 
Subordinated liabilities  17.9   –   (0.2)  17.7 
Total wholesale funding  123.3   22.1         
Customer deposits  416.3   1.8   –   418.1 
Total  539.6   23.9         
At 31 December 2017                
Deposits from banks  5.1   24.1   0.6   29.8 
Debt securities in issue  78.1   –   (5.6)  72.5 
Subordinated liabilities  17.9   –   –   17.9 
Total wholesale funding  101.1   24.1         
Customer deposits  415.5   2.6   –   418.1 
Total  516.6   26.7         

Table 1.36:Analysis of 2018 total wholesale funding by residual maturity

  Less
than one
month
£bn		  One to
three
months
£bn		  Three to
six months
£bn		  Six to nine
months
£bn		  Nine
months
to one year
£bn		  One to
two years
£bn		  Two to
five years
£bn		  More than
five years
£bn		  Total at
31 Dec
2018
£bn		  Total at
31 Dec
2017
£bn		 
Deposit from banks  5.3   0.9   0.7   0.1   0.1   0.5   0.7   –   8.3   5.1 
Debt securities in issue:                                        
Certificates of deposit  1.7   2.4   4.1   1.3   1.3   1.2   –   –   12.0   10.0 
Commercial paper  1.1   2.7   3.8   0.3   0.1   –   –   –   8.0   3.2 
Medium-term notes  0.5   –   0.1   2.2   0.3   4.5   16.0   21.8   45.4   37.4 
Covered bonds  0.7   –   1.1   1.0   –   5.5   12.6   6.2   27.1   24.7 
Securitisation  –   0.6   –   0.1   –   2.8   –   1.1   4.6   2.8 
   4.0   5.7   9.1   4.9   1.7   14.0   28.6   29.1   97.1   78.1 
Subordinated liabilities  0.1   0.1   –   0.3   0.1   2.4   2.7   12.2   17.9   17.9 
Total wholesale funding1  9.4   6.7   9.8   5.3   1.9   16.9   32.0   41.3   123.3   101.1 
Of which issued by Lloyds Banking Group plc2  –   –   –   –   –   –   9.9   10.4   20.3   15.4 

1The Group’s definition of wholesale funding aligns with that used by other international market participants; including interbank deposits, debt securities and subordinated liabilities.
2Consists of medium-term notes only.

Table 1.37:Total wholesale funding by currency (audited)

  Sterling
£bn		  US Dollar
£bn		  Euro
£bn		  Other
currencies
£bn		  Total
£bn		 
At 31 December 2018  25.8   45.2   42.8   9.5   123.3 
At 31 December 2017  25.8   32.1   37.0   6.2   101.1 

Table 1.38:Analysis of 2018 term issuance (audited)

  Sterling
£bn		  US Dollar
£bn		  Euro
£bn		  Other
currencies
£bn		  Total
£bn		 
Securitisation  0.8   1.5   –   –   2.3 
Medium-term notes  –   6.2   1.3   3.0   10.5 
Covered bonds  3.0   0.6   0.9   –   4.5 
Private placements1  0.1   0.7   0.1   0.2   1.1 
Subordinated liabilities  –   2.3   0.7   –   3.0 
Total issuance  3.9   11.3   3.0   3.2   21.4 
Of which issued by Lloyds Banking Group plc2  –   4.9   1.3   2.6   8.8 
                     
1Private placements include structured bonds and term repurchase agreements (repos).
2Consists of medium-term notes only.
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The Group continues to access wholesale funding markets across a wide range of products, currencies and investors to maintain a stable and diverse source of funds. In 2019, the Group will continue with this approach to funding, including capital and funding from the holding company, Lloyds Banking Group plc, as needed to transition towards final UK Minimum Requirements for Own Funds and Eligible Liabilities (MREL). The Group will continue to issue funding trades from Lloyds Bank plc, operating company, across senior unsecured, covered bonds, ABS and RMBS. Over the course of 2019, the Group expects to launch an operating company funding programme for LBCM. The maturity of the Funding for Lending and Term Funding Schemes are fully factored into the Group’s funding plans, and in the expected ‘steady state’ wholesale funding requirements of £15-20 billion per annum.

Liquidity Portfolio

At 31 December 2018, the banking business had £129.4 billion of highly liquid unencumbered LCR eligible assets (31 December 2017: £120.9 billion), of which £128.6 billion is LCR level 1 eligible (31 December 2017: £120.2 billion) and £0.8 billion is LCR level 2 eligible (31 December 2017: £0.7 billion). These assets are available to meet cash and collateral outflows and PRA regulatory requirements. The Insurance business manages a separate liquidity portfolio to mitigate insurance liquidity risk. Total LCR eligible liquid assets represent just under 6.2 times the Group’s money market funding less than one year to maturity (excluding derivative collateral margins and settlement accounts) and exceed total wholesale funding, and thus provide a substantial buffer in the event of market dislocation.

Table 1.39:LCR eligible assets

  At 31 Dec
2018
£bn		  At 31 Dec
2017
£bn		  Change
%		  Average
2018
£bn		  Average
2017
£bn		 
Level 1                    
Cash and central bank reserves  48.9   53.7   (9)  58.1   51.0 
High quality government/MDB/agency bonds1  78.7   65.8   20   66.2   72.0 
High quality covered bonds  1.0   0.7   43   0.8   1.1 
Total  128.6   120.2   7   125.1   124.1 
Level 22  0.8   0.7   14   0.8   0.6 
Total LCR eligible assets  129.4   120.9   7   125.9   124.7 

1Designated multilateral development bank (MDB).
2Includes Level 2A and Level 2B.

Table 1.40:LCR eligible assets by currency

  Sterling
£bn		  US Dollar
£bn		  Euro
£bn		  Other
currencies
£bn		  Total
£bn		 
At 31 December 2018                    
Level 1  98.2   19.8   10.6   –   128.6 
Level 2  0.4   0.4   –   –   0.8 
Total  98.6   20.2   10.6   –   129.4 
At 31 December 2017                    
Level 1  90.8   16.3   13.1   –   120.2 
Level 2  0.2   0.5   –   –   0.7 
Total  91.0   16.8   13.1   –   120.9 

The banking business also has a significant amount of non-LCR eligible liquid assets which are eligible for use in a range of central bank or similar facilities. Future use of such facilities will be based on prudent liquidity management and economic considerations, having regard for external market conditions.

Stress testing results

Internal liquidity stress testing results at 31 December 2018 showed that the banking business had liquidity resources representing 167 per cent of modelled outflows from all wholesale funding sources, retail and corporate deposits, intraday requirements and rating dependent contracts under the Group’s most severe liquidity stress scenario.

The above scenario considers a two notch downgrade of the Group’s current long-term debt rating and accompanying one notch short-term downgrade implemented instantaneously by all major rating agencies, which could result in a contractual outflow of £1.3 billion of cash over a period of up to one year, £2.2 billion of collateral posting related to customer financial contracts and £6.1 billion of collateral posting associated with secured funding.

Encumbered assets

This disclosure provides further detail on the availability of assets that could be used to support potential future funding requirements of the Group. The disclosure is not designed to identify assets that would be available in the event of a resolution or bankruptcy.

The Board and the Group Asset and Liability Committee (GALCO) monitor and manage total balance sheet encumbrance using a number of risk appetite metrics. At 31 December 2018, the Group had £53.4 billion (31 December 2017: £64.6 billion) of externally encumbered on-balance sheet assets with counterparties other than central banks. The decrease in encumbered assets was primarily driven by a decrease in repo encumbrance. The Group also had £584.3 billion (31 December 2017: £587.5 billion) of unencumbered on-balance sheet assets, and £159.8 billion (31 December 2017: £160.1 billion) of pre-positioned and encumbered assets held with central banks. Primarily, the Group encumbers mortgages, unsecured lending and credit card receivables through the issuance programmes and tradable securities through securities financing activity. The Group mainly positions mortgage assets at central banks.

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Table 1.41:On balance sheet encumbered and unencumbered assets

  Encumbered with Pre-  Unencumbered assets   
  counterparties other positioned  not pre-positioned   
  than central banks and  with central banks   
              encumbered                
              assets     Other          
     Covered        held with  Readily  realisable  Cannot be       
  Securitisations  bond  Other  Total  central banks  realisable1  assets2  used3  Total  Total 
  £m  £m  £m  £m  £m  £m  £m  £m  £m  £m 
At 31 December 2018                                        
Cash and balances at central banks  –   –   –   –   –   49,645   –   5,018   54,663   54,663 
Financial assets at fair value through profit or loss  54   –   2,646   2,700   –   5,190   –   150,639   155,829   158,529 
Derivative financial instruments  –   –   –   –   –   –   –   23,595   23,595   23,595 
Financial assets at amortised cost:                                        
Loans and advances to banks  –   –   12   12   –   1,223   2,555   2,493   6,271   6,283 
Loans and advances to customers  5,774   29,041   6,012   40,827   159,822   12,098   155,278   116,833   284,209   484,858 
Debt securities  –   –   2,627   2,627   –   2,581   4   26   2,611   5,238 
   5,774   29,041   8,651   43,466   159,822   15,902   157,837   119,352   293,091   496,379 
Financial assets at fair value through other comprehensive income  –   –   7,278   7,278   –   17,114   –   423   17,537   24,815 
Other4  –   –   –   –   –   56   612   38,949   39,617   39,617 
Total assets  5,828   29,041   18,575   53,444   159,822   87,907   158,449   337,976   584,332   797,598 
At 31 December 2017                                        
Cash and balances at central banks  –   –   –   –   –   53,887   –   4,634   58,521   58,521 
Trading and other financial assets at fair value through profit or loss  –   –   4,642   4,642   –   7,378   –   150,858   158,236   162,878 
Derivative financial instruments  –   –   –   –   –   –   –   25,834   25,834   25,834 
Loans and receivables:                                        
Loans and advances to banks  –   –   –   –   –   213   1,417   4,981   6,611   6,611 
Loans and advances to customers  5,023   26,414   6,610   38,047   160,060   13,927   170,771   89,693   274,391   472,498 
Debt securities  –   –   2,374   2,374   –   919   4   346   1,269   3,643 
   5,023   26,414   8,984   40,421   160,060   15,059   172,192   95,020   282,271   482,752 
Available-for-sale financial assets  –   –   19,526   19,526   –   21,514   –   1,058   22,572   42,098 
Other4  –   –   –   –   –   16   1,175   38,835   40,026   40,026 
Total assets  5,023   26,414   33,152   64,589   160,060   97,854   173,367   316,239   587,460   812,109 

1Assets regarded by the Group to be readily realisable in the normal course of business, to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, and are not subject to any restrictions on their use for these purposes.
2Assets where there are no restrictions on their use to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, but are not readily realisable in the normal course of business in their current form.
3The following assets are classified as unencumbered – cannot be used: assets held within the Group’s Insurance businesses which are generally held to either back liabilities to policyholders or to support the solvency of the Insurance subsidiaries; assets held within consolidated limited liability partnerships which provide security for the Group’s obligations to its pension schemes; assets segregated in order to meet the Financial Resilience requirements of the PRA’s Supervisory Statement 9/16 ‘Operational Continuity in Resolution’; assets pledged to facilitate the use of intra-day payment and settlement systems; and reverse repos and derivatives balance sheet ledger items.
4Other comprises: items in the course of collection from banks; investment properties; goodwill; value in-force business; other intangible assets; tangible fixed assets; current tax recoverable; deferred tax assets; retirement benefit assets and other assets.

The above table sets out the carrying value of the Group’s encumbered and unencumbered assets, separately identifying those that are available to support the Group’s funding needs. The table does not include collateral received by the Group (i.e. from reverse repos) that is not recognised on its balance sheet, the vast majority of which the Group is permitted to repledge.

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FUNDING AND LIQUIDITY RISK – CONTRACTUAL CASH OBLIGATIONS

The following table sets out the amounts and maturities of Lloyds Banking Group’s contractual cash obligations at 31 December 2018.

  Within
one year
£m		  One to three
years
£m		  Three to
five years
£m		  Over five
years
£m		  Total
£m		 
Long-term debt – dated  576   3,323   2,291   6,870   13,060 
Debt securities in issue  25,392   26,244   16,301   30,316   98,253 
Finance leases  10   16   8   12   46 
Operating leases  259   458   349   977   2,043 
Capital commitments  378   –   –   –   378 
Other purchase obligations  1,337   2,340   1,346   987   6,010 
   27,952   32,381   20,295   39,162   119,790 

Other purchase obligations include amounts expected to be payable in respect of material contracts entered into by Lloyds Banking Group, in the ordinary course of business, for the provision of outsourced and other services. The cost of these services will be charged to the income statement as it is incurred. Lloyds Banking Group also has a constructive obligation to ensure that its defined post-retirement benefit schemes remain adequately funded. The amount and timing of Lloyds Banking Group’s cash contributions to these schemes is uncertain and will be affected by factors such as future investment returns and demographic changes. Lloyds Banking Group expects to make cash contributions of at least £1,050 million to these schemes in 2019.

At 31 December 2018, Lloyds Banking Group also had £4,596 million of preference shares, preferred securities and undated subordinated liabilities outstanding.

At 31 December 2018, the principal sources of potential liquidity for Lloyds Banking Group plc were dividends received from its directly owned subsidiary companies, particularly Lloyds Bank plc and Scottish Widows Group Limited, and loans from this and other Lloyds Banking Group companies. The ability of Lloyds Bank to pay dividends going forward, or for Lloyds Bank or other Lloyds Banking Group companies to make loans to Lloyds Banking Group plc, depends on a number of factors, including their own regulatory capital requirements, distributable reserves and financial performance.

OFF-BALANCE SHEET ARRANGEMENTS

A table setting out the amounts and maturities of Lloyds Banking Group’s other commercial commitments and guarantees at 31 December 2018 is included in note 52 to the financial statements. These commitments and guarantees are not included in Lloyds Banking Group’s consolidated balance sheet.

Lending commitments are agreements to lend to customers in accordance with contractual provisions; these are either for a specified period or, as in the case of credit cards and overdrafts, represent a revolving credit facility which can be drawn down at any time, provided that the agreement has not been terminated. The total amounts of unused commitments do not necessarily represent future cash requirements, in that commitments often expire without being drawn upon.

Lloyds Banking Group’s banking businesses are also exposed to liquidity risk through the provision of securitisation facilities to certain corporate customers. At 31 December 2018, Lloyds Banking Group offered securitisation facilities to its corporate and financial institution client base through its conduit securitisation vehicles, Argento, Cancara and Grampian. These are funded in the global asset-backed commercial paper market. The assets and obligations of these conduits are included in Lloyds Banking Group’s consolidated balance sheet. Lloyds Banking Group provides short-term asset-backed commercial paper liquidity support facilities on commercial terms to the issuers of the commercial paper, for use in the event of a market disturbance should they be unable to roll over maturing commercial paper or obtain alternative sources of funding.

Details of securitisations and other special purpose entity arrangements entered into by Lloyds Banking Group are provided in notes 30 and 48 to the financial statements. The successful development of Lloyds Banking Group’s ability to securitise its own assets has provided a mechanism to tap a well established market, thereby diversifying Lloyds Banking Group’s funding base.

Within Lloyds Banking Group’s insurance businesses, the principal sources of liquidity are premiums received from policyholders, charges levied upon policyholders, investment income and the proceeds from the sale and maturity of investments. The investment policies followed by Lloyds Banking Group’s life assurance companies take account of anticipated cash flow requirements including by matching the cash inflows with projected liabilities where appropriate. Cash deposits and highly liquid government securities are available to provide liquidity to cover any higher than expected cash outflows.

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GOVERNANCE RISK

DEFINITION

Governance risk is defined as the risk that the Group’s organisational infrastructure fails to provide robust oversight of decision-making and the control mechanisms to ensure strategies and management instructions are implemented effectively.

EXPOSURES

The internal and corporate governance arrangements of major financial institutions continue to be subject to a high level of regulatory and public scrutiny. The Group’s exposure to governance risk is also reflective of the significant volume of existing and proposed legislation and regulation, both within the UK and across the multiple jurisdictions within which it operates, with which it must comply.

MEASUREMENT

The Group’s governance arrangements are assessed against new or proposed legislation and regulation and best practice among peer organisations in order to identify any areas of enhancement required.

MITIGATION

The Group’s Risk Management Framework (RMF) establishes robust arrangements for risk governance, in particular by:

– Defining individual and collective accountabilities for risk management, risk oversight and risk assurance through a three lines of defence model which supports the discharge of responsibilities to customers, shareholders and regulators;
– Outlining governance arrangements which articulate the enterprise-wide approach to risk management; and
– Supporting a consistent approach to Group-wide behaviour and risk decision-making through a Group policy framework which helps everyone understand their responsibilities by clearly articulating and communicating rules, standards, boundaries and risk appetite measures which can be controlled, enforced and monitored.

Under the banner of the RMF, training modules are in place to support all colleagues in understanding and fulfilling their risk responsibilities.

The Group’s code of responsibility embodies its values and reflect its commitment to operating responsibly and ethically both at a business and an individual level. All colleagues are required to adhere to the code in all aspects of their roles.

Effective implementation of the RMF mutually reinforces and is reinforced by the Group’s risk culture, which is embedded in its approach to recruitment, selection, training, performance management and reward.

MONITORING

A review of the Group’s RMF, which includes the status of the Group’s principles and policy framework, and the design and operational effectiveness of key governance committees, is undertaken on an annual basis and the findings are reported to the Group Risk Committee, Board Risk Committee and the Board.

For further information on Corporate Governance see pages 131 to 156.

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MARKET RISK

 

DEFINITION

 

Market risk is defined as the risk that unfavourable market moves (including changes in and increased volatility of interest rates, market impliedmarket-implied inflation rates, credit spreads and bond prices for bonds, foreign exchange rates, equity, property and commodity prices and other instruments), lead to reductions in earnings and/or value.

RISK APPETITE

Risk appetite is defined within the Group as the amount and type of risk that the Group is prepared to seek, accept or tolerate. The Group’s Risk Management Framework and Market Risk Principle, reviewed and approved annually by the Board, articulate accountabilities for the management of market risk across the Group, and how this is discharged through a robust governance structure with the objective of seeking an optimal risk profile which supports sustainable business growth and minimises losses. The Group Asset and Liability Committee (GALCO), chaired by the Chief Financial Officer, is responsible for approving and monitoring group market risks, management techniques, market risk measures, behavioural assumptions, and the market risk policy.

The market risk policy defines the framework and mandatory requirements for market risk management and oversight adopted by the Group. The policy is owned by Group Corporate Treasury (GCT) and refreshed annually. The policy is underpinned by supplementary market risk procedures, which define specific market risk management and oversight requirements.

For further information on risk appetite refer to page 46.

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BALANCE SHEET LINKAGES

 

The information provided in table 1.36 (below)1.42 aims to facilitate the understanding of linkages between banking, trading, and insurance balance sheet items and the positions disclosed in the Group’s market risk disclosures. This breakdown of financial instruments included and not included in trading book Value at Risk (VaR) provides a linkage with the trading book market risk measures reported later on in the market risk section. It is important to highlight that this table does not reflect how the Group manages trading book market risk, since it does not discriminate between

TABLE 1.42:MARKET RISK LINKAGE TO THE BALANCE SHEET

  Banking  
2018 Total
£m		  Trading
book only
£m		  Non-trading
£m		  Insurance
£m		  Primary market risk factor
Assets              
Cash and balances at central banks  54,663   –   54,663   –  Interest rate
Financial assets at fair value through profit or loss  158,529   35,246   6,380   116,903  Interest rate, foreign exchange, credit spread
Derivative financial instruments  23,595   14,734   6,898   1,963  Interest rate, foreign exchange, credit spread
Financial assets at amortised cost                  
Loans and advances to banks  6,283   –   6,242   41  Interest rate
Loans and advances to customers  484,858   –   484,818   40  Interest rate
Debt securities  5,238   –   5,238   –  Interest rate, credit spread
   496,379   –   496,298   81   
Financial assets at fair value through other comprehensive income  24,815   –   24,815   –  Interest rate, foreign exchange, credit spread
Value of in-force business  4,762   –   –   4,762  Equity
Other assets  34,855   –   19,641   15,214  Interest rate
Total assets  797,598   49,980   608,695   138,923   
                   
Liabilities                  
Deposit from banks  30,320   –   30,320   –  Interest rate
Customer deposits  418,066   –   418,066   –  Interest rate
Financial liabilities at fair value through profit or loss  30,547   23,451   7,085   11  Interest rate, foreign exchange
Derivative financial instruments  21,373   10,827   8,406   2,140  Interest rate, foreign exchange, credit spread
Debt securities in issue  91,168   –   91,168   –  Interest rate, credit spread
Liabilities arising from insurance and investment contracts  112,727   –   –   112,727  Credit spread
Subordinated liabilities  17,656   –   15,889   1,767  Interest rate, foreign exchange
Other liabilities  25,542   –   9,605   15,937  Interest rate
Total liabilities  747,399   34,278   580,539   132,582   

The defined benefit pension schemes’ assets and liabilities are included under Other assets and Other liabilities in its VaR model.this table and note 35 on page F-52 provides further information.

Table 1.36: Market risk linkage to the balance sheet

     Banking      
     Trading book         
2015 Total
£m		  only
£m		  Non-trading
£m		  Insurance
£m		  Primary risk factor
Assets                  
Cash and balances at central banks  58,417   –   58,417   –  Interest rate
Items in the course of collection from banks  697   –   697   –  Interest rate
Trading and other financial assets at fair value through profit or loss  140,536   42,661   2,181   95,694  Interest rate, foreign exchange, credit spread
Derivative financial instruments  29,467   25,305   2,570   1,592  Interest rate, foreign exchange, credit spread
Loans and receivables:                  
Loans and advances to banks  25,117   –   3,385   21,732  Interest rate
Loans and advances to customers  455,175   –   455,175   –  Interest rate
Debt securities  4,191   –   4,191   –  Interest rate, credit spread
   484,483   –   462,751   21,732   
Available-for-sale financial assets  33,032   –   33,030   2  Interest rate, credit spread, foreign exchange
Held-to-maturity investments  19,808   –   19,808   –  Interest rate
Value of in-force business  4,596   –   –   4,596  Equity
Other assets  35,652   –   16,656   18,996  Interest rate
Total assets  806,688   67,966   596,110   142,612   
                   
Liabilities                  
Deposits from banks  16,925   –   16,925   –  Interest rate
Customer deposits  418,326   –   418,326   –  Interest rate
Items in course of transmission to banks  717   –   717   –  Interest rate
Trading and other financial liabilities at fair value through profit or loss  51,863   43,984   7,879   –  Interest rate, foreign exchange
Derivative financial instruments  26,301   22,124   2,413   1,764  Interest rate, foreign exchange, credit spread
Debt securities in issue  82,056   –   82,056   –  Interest rate
Liabilities arising from insurance and investment contracts  103,071   –   –   103,071  Credit spread
Subordinated liabilities  23,312   –   21,638   1,674  Interest rate, foreign exchange
Other liabilities  37,137   –   7,103   30,034  Interest rate
Total liabilities  759,708   66,108   557,057   136,543   

 

The Group’s trading book assets and liabilities are originated by Financial Markets within the Commercial Banking division. Within the Group’s balance sheet these fall under the trading assets and liabilities and derivative financial instruments. The assets and liabilities are classified as trading books if they have been acquired or incurred formeet the purpose of selling or repurchasingrequirements as set out in the near future. These consist of government, corporate and financial institution bonds and loans/deposits and repos.Capital Requirements Regulation, article 104. Further information on these activities can be found under the Trading portfolios section on page 101.

 

Derivative assets and liabilities are held by the Group for three main purposes; to provide risk management solutions for clients, to manage portfolio risks arising from client business and to manage and hedge the Group’s own risks. The majority of derivatives exposure arises within Financial Markets.

Insurance business assets and liabilities relate to policyholder funds, as well as shareholder invested assets, including annuity funds. The Group recognises the value of in-force business in respect of Insurance’s long-term life assurance contracts as an asset in the balance sheet (see note 25,24, page F-42)F-44).

 

The Group ensures that it has adequate cash and balances at central banks and stocks of high quality liquid assets (e.g. Giltsgilts or US Treasury Securities)securities) that can be converted easily into cash to meet liquidity requirements. The majority of these assets are held as available-for-salefinancial assets at fair value through other comprehensive income with the remainder held as financial assets at fair value through profit and loss. Further information on these balances can be found under the Funding and Liquidity Riskliquidity risk on page 103.88. Interest rate risk in the asset portfolios is swapped into floating.a floating rate.

 

The majority of debt issuance originates from the Issuance, Capital Vehiclesissuance, capital vehicles and Medium Term Notesmedium-term notes desks and the interest rate risk of the debt issued is hedged by swapping them into a floating rate.

Table 1.37 shows the key market risks for the Group’s banking, defined benefit pension schemes and trading, banking and Insurance and trading activities.

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The non-trading book primarily consists of customer on-balance sheet activities and the Group’s capital and funding activities, which expose it to the risk of adverse movements in market prices, predominantly interest rates, credit spreads, exchange rates and equity prices, as described in further detail within the Banking activities section (see below).

Table 1.37: Key1.43 (below) shows the key material market risks for the Group by individual business activity (profit before tax impact measured against Group single stress scenarios)Group’s banking, defined benefit pension schemes, insurance and trading activities.

TABLE 1.43:KEY MATERIAL MARKET RISKS FOR THE GROUP BY INDIVIDUAL BUSINESS ACTIVITY (PROFIT BEFORE TAX IMPACT MEASURED AGAINST GROUP SINGLE STRESS SCENARIOS)

            Risk Type 
2018 Interest rate  Basis risk  FX  Credit spread  Equity  Inflation 
Banking activities1  l   ¡   –   l   l   – 
Defined benefit pension schemes1  ¡   –   –   n   –   – 
Insurance portfolios1  o   –   –   l   ¡   o 
Trading portfolios2  –   –   –   –   –   – 
                         
Profit before tax  Loss   Gain                 
> £500m  l   n                 
£250m – £500m  l   n                 
£50m – £250m  ¡   o                 
Immaterial/zero  –   –                 

1Banking activities, Pensions and Insurance stresses; Interest rate -100 bps, Basis Risk type3 month London Interbank Offered Rate (LIBOR) +100bps / bank base rate -25bps, Foreign Exchange (FX) -15 per cent GBP, Credit Spread +100 per cent, Equity -30 per cent, Inflation +50 bps
  
2Trading Portfolios; Interest rateBasis risk -70bps, FX -5 per cent GBP, Credit spreadEquitySpread +20 per cent, Inflation
Banking activitiesllollo
Defined benefit pension schemelonlo
Insurance portfolios¡¡ll¡
Trading portfoliosoo¡o
Key
Profit before tax:LossGain
>£500mln
£250m – £500mln
<£250mln
<£50m¡o +50bps.

 

MEASUREMENT

 

In addition to measuring single factors, Group market risk is managed within a Board approved framework and risk appetite. Board risk appetite is calibrated primarily to five multi-risk Group economic multi-risk scenarios, and is supplemented with sensitivity based measures. The scenarios assess the impact of unlikely, but plausible, adverse stresses on income with the worst case for banking activities, defined benefit pensions, insurance and trading portfolios reported against independently, and across the Group as a whole.

 

The BoardGroup risk appetite is cascaded first to GALCOthe Group Asset and Liability Committee (GALCO), chaired by the Chief Financial Officer, where risk appetite is approved and monitored by risk type, and then to Group Market Risk Committee (GMRC) where risk appetite is sub allocatedsub-allocated by Division.division. These levels of risk appetite comprise scenarios/stress based measures (single factor stresses), percentile based measures (e.g. VaR and Stressed VaR), and sensitivity based measures (e.g. sensitivity to 1 basis point move in interest rates), as well as stochastic measures within the Insurance business. These measuresmetrics are reviewed regularly by senior management to inform effective decision making.decision-making.

 

MITIGATION

 

GALCO is responsible for approving and monitoring group market risks, management techniques, market risk measures, behavioural assumptions, and the market risk policy. Various mitigation activities are assessed and undertaken across the Group to manage portfolios and seek to ensure they remain within approved limits. The mitigation actions will vary dependent on exposure but will, in general, look to reduce risk in a cost effective manner by offsetting balance sheet exposures and externalising through to the financial markets dependent on market liquidity. The market risk policy is owned by Group Corporate Treasury (GCT) and refreshed annually. The policy is underpinned by supplementary market risk procedures, which define specific market risk management and oversight requirements.

 

MONITORING

 

GALCO and the GMRC regularly review high level market risk exposure as part of the wider risk management framework. They also make recommendations to the Group Chief ExecutiveBoard concerning overall market risk appetite and Group Market Risk Policy. Exposures at lower levels of delegation are monitored at various intervals according to their volatility, from daily in the case of trading portfolios to monthly or quarterly in the case of less volatile portfolios. Levels of exposures compared to approved limits and triggers are monitored by Risk Division and where appropriate, escalation procedures are in place.

 

How market risks arise and are managed across the Group’s activities is considered in more detail below.

 

BANKING ACTIVITIES

 

EXPOSURES

Exposures

The Group’s banking activities expose it to the risk of adverse movements in market prices, predominantly interest rates, credit spreads, exchange rates and equity prices, with little or no exposure to commodity risk.prices. The volatility of market values can be affected by both the transparency of prices and the amount of liquidity in the market for the relevant asset, liability or liability.

Interest rate riskinstrument.

 

Interest rate risk

Yield curve risk in the Group’s divisional portfolios, and in the Group’s capital and funding activities arises from the different repricing characteristics of the Group’s non-trading assets, liabilities (see loans and advances to customers and customer deposits in table 1.36)1.42) and off balanceoff-balance sheet positions of the Group. Behavioural assumptions are applied to (i) embedded optionality within products; (ii) the duration of balances that are contractually repayable on demand, such as current accounts and overdrafts, together with net free reserves of the group; and (iii) to the re-pricing behaviour of managed rate liabilities namely variable rate savings.positions.

 

Basis risk arises from the possible changes in spreads, for example where the bank lends with reference to a central bank rate but funds with reference to LIBOR, and the spread between these two rates widens or tightens.

 

PrepaymentOptionality risk arises predominantly infrom embedded optionality within assets, liabilities or off-balance sheet items where either the Retail division, asGroup or the customer can affect the size or timing of cash flows. One example of this is mortgage prepayment risk where the customer owns an option allowing them to prepay when it is economical to do so. This can result in customer balances amortiseamortising more quickly or slowly than anticipated due to economic conditions or customer’scustomers’ response to changes in economic conditions. Pipeline and pre hedge risk arises where new business volumes are higher or lower than forecasted.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Foreign exchange risk

Economic foreign exchange exposure arises from the Group’s investment in its overseas operations (net investment exposures are disclosed in note 5352 on page F-90)F-88). In addition, the Group incurs foreign exchange risk through non-functional currency flows from services provided by customer facingcustomer-facing divisions and the Group’s debt and capital management programmes.

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Equity risk

Equity risk arises primarily from three different sources; (i) the Group’s strategic equity holdings e.g. Visa Europe, now held in Banco Sabadell, Aberdeen, and Visa Europe;the Equities sub-group; (ii) exposure to Lloyds Banking Group share price through deferred shares and deferred options granted to employees as part of their benefits package; and (iii) the Group’s private equity investments held by Lloyds Development Capital.Capital within the Equities sub-group.

 

Credit spread risk

Credit spread risk arises largely from i)(i) the liquid asset portfolio held in the management of Group liquidity, comprising of government supranational and other eligible assets; and ii)(ii) the Credit Valuation Adjustment (CVA) and Debit Valuation Adjustment (DVA) sensitivity to credit spreads.spreads; and (iii) a number of the Group’s structured medium-term notes where the Group has elected to fair value the notes through the profit and loss account.

 

MEASUREMENT

Measurement

Interest rate risk exposure is monitored monthly using, primarily:

 

(i) Market value sensitivity: this methodology considers all repricing mismatches (behaviourally adjusted where appropriate) in the current balance sheet and calculates the change in market value that would result from an instantaneous 25, 100 and 200 basis points parallel rise or fall in the yield curve (subject to an appropriate floor). The market value sensitivities are calculated on a static balance sheet using principal cash flows excluding interest, commercial margins and other spread components and are therefore discounted at the risk free zero-coupon rate.

 

(ii) Interest income sensitivity: this measures the 12 month impact on future net interest income arising from anvarious economic scenarios. These include instantaneous 25, 100 and 200 basis pointspoint parallel rise or fallshifts in all the yield curves over a rolling 12 month basisand the five Group economic scenarios (subject to an appropriate floor). These scenarios are reviewed every year and are designed to replicate severe but plausible economic events, capturing risks that would not be evident through the use of parallel shocks alone such as basis risk and steepening or flattening of the yield curve. An additional negative rates scenario is also used for information purposes where all floors are removed; however this is not measured against the limit framework.

Unlike the market value sensitivities, the interest income sensitivities incorporate additional behavioural assumptions as to how and when individual products would reprice in response to such change.changing rates. In addition a dynamic balance sheet is used which includes the run-off of current assets and liabilities and the addition of planned new business.

Reported sensitivities are not necessarily predictive of future performance as they do not capture additional management actions that would likely be taken in response to an immediate, large, movement in interest rates. These actions could reduce the net interest income sensitivity, help mitigate any adverse impacts or they may result in changes to total income that are not captured in the net interest income.

 

(iii) Market Value notional limit: this caps the amount of conventional and inflation-linked government bonds held by the Group for liquidity purposes.

(iv) Structural hedge limits; theselimits: the structural hedging programme managing interest rate risk in the banking book relies on a number of assumptions made around customer behaviour. A material mismatch between assumptions and reality could lead to a deterioration in earnings. In order to monitor this risk a number of metrics are in place to enhance understanding of assumption and duration risk takenrisks within the behaviouralisation of this portfolio.

 

The Group has an integrated Asset and Liability Management (ALM) system which supports non tradednon-traded asset and liability management of the Group. This provides a single consolidated tool to measure and manage interest rate repricing profiles (including behavioural assumptions), perform stress testing and produce forecast outputs. Interest rate repricing profiles are reported by currency and used to calculate the income and value sensitivities (in GBP equivalent). Repricing assumptions and customer reaction to changes in product pricing is a major determinant of the risk profile. The Group is aware that any assumptions based model is open to challenge. However, aA full behavioural review is performed annually, by Group ALM functionsor in response to changing market conditions, to ensure the assumptions remain appropriate and the model itself is reviewed by Risk Division.

A limit structure existssubject to ensureannual re-validation, as required under the Group Model Governance Policy. The key behavioural assumptions are (i) embedded optionality within products; (ii) the duration of balances that risks stemming from residualare contractually repayable on demand, such as current accounts and temporary positions or from changes in assumptions about customeroverdrafts, together with net free reserves of the Group; and (iii) the re-pricing behaviour remain within the Group’s risk appetite.of managed rate liabilities namely variable rate savings.

 

Table 1.381.44 below shows, split by material currency, the Group’s market value sensitivities to an instantaneous parallel up and down 25 and 100 basis points change to all interest rate.rates.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

TABLE 1.44:GROUP BANKING ACTIVITIES: MARKET VALUE SENSITIVITY

Table 1.38: Banking activities: market value sensitivity

 2015  2014  2018 2017
 Up 25bps
£m		 Down 25bps
£m		 Up 100bps
£m		 Down 100bps
£m		  Up 25bps
£m		 Down 25bps
£m		 Up 100bps
£m		 Down 100bps
£m		   Up
25bps
£m		   Down
25bps
£m		   Up
100bps
£m		   Down
100bps
£m		   Up
25bps
£m		   Down
25bps
£m		   Up
100bps
£m		   Down
100bps
£m		 
Sterling 48.7  (48.8) 194.2  (115.9) (15.7) 15.5  (63.8) 3.9   29.1   (29.5)  113.7   (122.4)  (9.9)  10.1   (38.7)  22.1 
US dollar 1.9  (1.9) 7.5  (5.9) 4.7  (4.9) 17.8  (15.9)
US Dollar  (7.8)  7.8   (30.6)  31.9   (3.6)  3.7   (14.2)  15.3 
Euro 1.7  (2.1) 6.9  (6.8) (7.2) 4.8  (27.3) 15.0   (3.0)  1.7   (11.2)  7.2   2.2   (0.7)  8.9   0.9 
Australian dollar (0.1) 0.1  (0.2) 0.2  (0.4) 0.4  (1.3) 1.8 
Other (0.3) 0.3  (1.4) 0.9  (0.3) 0.3  (1.2) 0.8   (0.1)  0.1   (0.4)  0.5   (0.1)  0.2   (0.5)  0.6 
Total 51.9  (52.4) 207.0  (127.5) (18.9) 16.1  (75.8) 5.6   18.2   (19.9)  71.5   (82.8)  (11.4)  13.3   (44.5)  38.9 

 

This is a risk based disclosure and the amounts shown would be amortised in the income statement over the duration of the portfolio. The measure, however, is simplified in that it assumes all interest rates, for all currencies and maturities, move at the same time and by the same amount.

 

The market value sensitivity is driven by temporary customer flow positions not yet hedged plus other positions occasionally held, within limits, by the Group’s wholesale funding desks in order to minimise overall funding and hedging costs. The level of risk is low relative to the size of the total balance sheet.

 

Table 1.391.45 below shows supplementary value sensitivity to a steepening and flattening (c.100 basis points around the 3 year point) in the yield curve. This ensures there are no unintended consequences to managing risk to parallel shifts in rates.

 

Table 1.39: Banking activities: market value sensitivity to a steepening and flattening of the yield curve

  2015 2014 
  Steepener
£m		  Flattener
£m		  Steepener
£m		  Flattener
£m		 
Sterling (105.7) 97.1  69.3  (85.7)
US dollar (3.4) 4.8  19.5  (6.8)
Euro (0.5) 2.0  (8.6) 3.0 
Australian dollar (0.0) (0.0) 0.5  7.5 
Other 0.2  (0.2) 0.2  (0.2)
Total (109.4) 103.7  80.9  (82.2)
97TABLE 1.45:GROUP BANKING ACTIVITIES: MARKET VALUE SENSITIVITY TO A STEEPENING AND FLATTENING OF THE YIELD CURVE

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

  2018  2017
  Steepener
£m		  Flattener
£m		  Steepener
£m		  Flattener
£m		 
Sterling  38.3   (36.5)  (1.1)  (16.5)
US Dollar  6.5   (5.7)  7.1   (8.9)
Euro  (6.8)  3.6   (3.8)  7.9 
Other  (0.1)  0.1   (0.2)  0.2 
Total  37.9   (38.5)  2.0   (17.3)

 

The table below shows the banking book income sensitivity to an instantaneous parallel up and down 25 and 100 basis points change to all interest rates.

 

TABLE 1.46:GROUP BANKING ACTIVITIES: NET INTEREST INCOME SENSITIVITY

Table 1.40: Banking activities: net interest income sensitivity (audited)

  2015  2014 
  Up 25bps
£m		  Down 25bps
£m		  Up 100bps
£m		  Down 100bps
£m		  Up 25bps
£m		  Down 25bps
£m		  Up 100bps
£m		  Down 100bps
£m		 
Client facing activity and
associated hedges		 152.4  (140.1) 604.7  (464.2) (4.6) (46.0) 176.3  (222.3)
  2018 2017
   Up
25bps
£m		   Down
25bps
£m		   Up
100bps
£m		   Down
100bps
£m		   Up
25bps
£m		   Down
25bps
£m		   Up
100bps
£m		   Down
100bps
£m		 
Client facing activity and associated hedges  76.2   (125.4)  341.6   (538.6)  86.1   (54.0)  370.5   (186.9)

 

Income sensitivity is measured over a rolling 12 month basis.

 

The increase in the net interest income sensitivity continues to reflect structural hedging againsta down 100bps shock reflects the additional margin compression. The increased sensitivity reflects both the timing of margin management, and the level of floors giving rise to increased compression risk in the Group.within retail savings as bank base rate has risen.

 

Basis risk, foreign exchange, equity, and credit spread risks are measured primarily through scenario analysis by assessing the impact on profit before tax over a 12 month horizon arising from a change in market rates, and reported within the Board Risk Appetiterisk appetite on a monthly basis. Supplementary measures such as sensitivity and exposure limits are applied where they provide greater insight into risk positions. Frequency of reporting supplementary measures varies from daily to quarterly appropriate to each asset class.risk type.

 

MITIGATION

Mitigation

The Group’s policy is to optimise reward whilst managing its market risk exposures within the risk appetite defined by the Board. The Group Market Risk policyPolicy and procedures outlines the hedging process, and the centralisation of risk from divisions into GCT, e.g. via Transfer Pricing Framework.the transfer pricing framework. GCT is responsible for managing the centralised risk and does this through natural offsets of matching assets and liabilities, and appropriate hedging activity of the residual exposures, subject to the authorisation and mandate of GALCO within the Board risk appetite. Derivative desks in Financial Markets will then externalise theThe hedges are externalised to the market. market by derivative desks within GCT and Commercial Banking Markets. The Group has hedge accounting solutions in place, which reduce the accounting volatility arising from the Group’s economic hedging activities by utilising both LIBOR and bank base rate assets.

The largest residual risk exposure arises from balances that are deemed to be insensitive to changes in market rates (including current accounts, a portion of variable rate deposits and investable equity), and is managed through the Group’s structural hedge. Consistent with the Group’s strategy to deliver stable returns, GALCO seeks to minimise large reinvestment risk, and to smooth earnings over a range of investment tenors. The structural hedge consists of longer-term fixed rate assets or interest rate swaps and the amount and duration of the hedging activity is reviewed regularly by GALCO, with current target duration of around four years.GALCO.

 

Whilst the bank faces margin compression in the current low rate environment,environments, its exposure to pipeline and prepayment risk are not considered material, and are hedged in line with expected customer behaviour. These are appropriately monitored and controlled through Divisional ALCOs.divisional Asset and Liability Committees (ALCOs).

99

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Net investment foreign exchange exposures are managed centrally by GCT, by hedging non GBPnon-sterling asset values with currency borrowing. Economic foreign exchange exposures arising from non-functional currency flows are identified by divisions and transferred and managed centrally. The Group also has a policy of forward hedging its forecasted currency profit and loss to year end.

 

MONITORINGMonitoring

The Risk Management Framework, Policy and Procedures document articulate the monitoring of Banking book market risk through the committee structure. The Group’s Three Lines of Defence ensure risk is identified, and appropriately measured, reported and understood. The appropriate limits and triggers are monitored by senior executive Committeescommittees within the Bankingbanking divisions. Banking assets, liabilities and associated hedging are actively monitored and if necessary rebalanced to be within agreed tolerances.

 

DEFINED BENEFIT PENSION SCHEMESEXPOSURE

 

EXPOSURESLiquidity exposure represents the potential stressed outflows in any future period less expected inflows. The Group considers liquidity exposure from both an internal and a regulatory perspective.

MEASUREMENT

Liquidity risk is managed through a series of measures, tests and reports that are primarily based on contractual maturities with behavioural overlays as appropriate. Note 52 on page F-88 sets out an analysis of assets and liabilities by relevant maturity grouping. The Group undertakes quantitative and qualitative analysis of the behavioural aspects of its assets and liabilities in order to reflect their expected behaviour.

MITIGATION

The Group manages and monitors liquidity risks and ensures that liquidity risk management systems and arrangements are adequate with regard to the internal risk appetite, Group strategy and regulatory requirements. Liquidity policies and procedures are subject to independent internal oversight by Risk. Overseas branches and subsidiaries of the Group may also be required to meet the liquidity requirements of the entity’s domestic country. Management of liquidity requirements is performed by the overseas branch or subsidiary in line with Group Policy. Liquidity risk of the Insurance business is actively managed and monitored within the Insurance business. The Group plans funding requirements over the life of the funding plan, combining business as usual and stressed conditions. The Group manages its liquidity position with regard to its internal risk appetite and the Liquidity Coverage Ratio (LCR) required by the PRA and Capital Requirements Directive and Regulation (CRD IV) liquidity requirements.

 

The Group’s funding and liquidity position is underpinned by its significant customer deposit base, and is supported by strong relationships across customer segments. The Group has consistently observed that in aggregate the retail deposit base provides a stable source of funding. Funding concentration by counterparty, currency and tenor is monitored on an ongoing basis and where concentrations do exist, these are managed as part of the planning process and limited by internal risk appetite, with analysis regularly provided to senior management.

To assist in managing the balance sheet, the Group operates a Liquidity Transfer Pricing (LTP) process which: allocates relevant interest expenses from the centre to the Group’s banking businesses within the internal management accounts; helps drive the correct inputs to customer pricing; and is consistent with regulatory requirements. LTP makes extensive use of behavioural maturity profiles, taking account of expected customer loan prepayments and stability of customer deposits, modelled on historic data.

The Group can monetise liquid assets quickly, either through the repurchase agreements (repo) market or through outright sale. In addition, the Group has pre-positioned a substantial amount of assets at the Bank of England’s Discount Window Facility which can be used to access additional liquidity in a time of stress. The Group considers diversification across geography, currency, markets and tenor when assessing appropriate holdings of liquid assets. The Group’s liquid asset buffer is available for deployment at immediate notice, subject to complying with regulatory requirements.

88

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Liquidity risk within the Insurance business may result from: the inability to sell financial assets quickly at their fair values; an insurance liability falling due for payment earlier than expected; the inability to generate cash inflows as anticipated; an unexpected large operational event; or from a general insurance catastrophe e.g. a significant weather event. Liquidity risk is actively managed and monitored within the Insurance business to ensure that it remains within approved risk appetite, so that even under stress conditions, there is sufficient liquidity to meet obligations.

MONITORING

Daily monitoring and control processes are in place to address internal and regulatory liquidity requirements. In order to meet ring-fencing requirements from 1 January 2019, the shape and scale of liquidity reporting has increased with additional monitoring and reporting requirements for the Ring-Fenced Bank (RFB) sub-group and non-ring-fenced banking entities. The Group monitors a range of market and internal early warning indicators on a daily basis for early signs of liquidity risk in the market or specific to the Group. This captures regulatory metrics as well as metrics the Group considers relevant for its liquidity profile. These are a mixture of quantitative and qualitative measures, including: daily variation of customer balances; changes in maturity profiles; funding concentrations; changes in LCR outflows; credit default swap (CDS) spreads; and basis risks.

The Group carries out internal stress testing of its liquidity and potential cash flow mismatch position over both short (up to one month) and longer-term horizons against a range of scenarios forming an important part of the internal risk appetite. The scenarios and assumptions are reviewed at least annually to ensure that they continue to be relevant to the nature of the business including reflecting emerging horizon risks to the Group, such as a further sovereign downgrade. For further information on the Group’s 2018 liquidity stress testing results refer to page 92.

The Group maintains a Contingency Funding Plan which is designed to identify emerging liquidity concerns at an early stage, so that mitigating actions can be taken to avoid a more serious crisis developing. Contingency Funding Plan invocation and escalation processes are based on analysis of five major quantitative and qualitative components, comprising assessment of: early warning indicators; prudential and regulatory liquidity risk limits and triggers; stress testing results; event and systemic indicators; and market intelligence.

Funding and liquidity management in 2018

The Group has maintained its strong funding and liquidity position with a stable loan to deposit ratio of 107 per cent.

During the year, the Group took advantage of favourable funding markets to raise £21.4 billion of new term wholesale funding in order to refinance maturities in the year including the Bank of England’s Funding for Lending Scheme (FLS) and increase liquidity buffers. As a result wholesale funding increased from £101.1 billion to £123.3 billion.

During 2018, the Group repaid £12 billion of its FLS drawings, which has reduced the amount outstanding to £13.1 billion at 31 December 2018. The balance of Term Funding Scheme drawings remains at £19.9 billion as at 31 December 2018.

The Group’s liquidity position remains strong and in excess of the regulatory minimum and internal risk appetite, with a LCR of 130 per cent as at 31 December 2018 based on the EU Delegated Act. Total LCR eligible liquid assets as at 31 December 2018 were £129.4 billion, up £8.5 billion in the year.

The Group’s strong ratings continue to reflect its robust balance sheet, improved profitability and bail-in capital position. During 2018, S&P upgraded Lloyds Bank plc’s long-term rating by one notch to ‘A+’ and S&P, Moody’s and Fitch assigned definitive ratings to Lloyds Bank Corporate Markets (LBCM) of A/ A1/A respectively.

89

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.34:Group funding position

     At 1 Jan     At 31 Dec    
  At 31 Dec  2018     2017    
  2018  (adjusted)1  Change  (reported)  Change 
  £bn  £bn  (%)  £bn  (%) 
Funding requirement                    
Loans and advances to customers2  444.4   444.2   –   455.7   (2)
Loans and advances to banks3  5.9   1.7       4.1   44 
Debt securities at amortised cost  4.0   3.3   21   3.6   11 
Reverse repurchase agreements  –   0.7       0.7     
Financial assets at fair value through other comprehensive income – non-LCR eligible4  0.8   1.7   (53)        
Available-for-sale financial assets – non-LCR eligible4              0.9     
Cash and balances at central bank – non-LCR eligible5  5.8   4.8   21   4.8   21 
Funded assets  460.9   456.4   1   469.8   (2)
Other assets6  212.9   247.2   (14)  234.7   (9)
   673.8   703.6   (4)  704.5   (4)
On balance sheet LCR eligible liquid assets                    
Reverse repurchase agreements  40.9   16.9       16.9     
Cash and balances at central banks5  48.9   53.7   (9)  53.7   (9)
Debt securities at amortised cost  1.2               �� 
Financial assets at fair value through other comprehensive income  24.0   41.2   (42)        
Available-for-sale financial assets              41.2     
Trading and fair value through profit and loss  11.9   1.7       1.7     
Repurchase agreements  (3.1)  (5.9)  (47)  (5.9)  (47)
   123.8   107.6   15   107.6   15 
Total Group assets  797.6   811.2   (2)  812.1   (2)
Less: other liabilities6  (187.9)  (226.8)  (17)  (226.5)  (17)
Funding requirement  609.7   584.4   4   585.6   4 
Funded by                    
Customer deposits7  416.3   415.5       415.5   – 
Wholesale funding8  123.3   101.1   22   101.1   22 
   539.6   516.6   4   516.6   4 
Term funding scheme  19.9   19.9   –   19.9     
Total equity  50.2   47.9   5   49.1   2 
Total funding  609.7   584.4   4   585.6   4 

1Adjusted to reflect the implementation of IFRS 9 and IFRS 15.
2Excludes reverse repos of £40.5 billion (1 January 2018: £16.8 billion; 31 December 2017: £16.8 billion).
3Excludes nil (31 December 2017: £1.7 billion) of loans and advances to banks within the Insurance business and £0.4 billion (1 January 2018: £0.8 billion; 31 December 2017: £0.8 billion) of reverse repurchase agreements.
4Non-LCR eligible liquid assets comprise a diversified pool of highly rated unencumbered collateral (including retained issuance).
5Cash and balances at central banks are combined in the Group’s balance sheet.
6Other assets and other liabilities primarily include balances in the Group’s Insurance business and the fair value of derivative assets and liabilities.
7Excludes repos of £1.8 billion (1 January 2018: £2.6 billion; 31 December 2017: £2.6 billion).
8The Group’s definition of wholesale funding aligns with that used by other international market participants; including interbank deposits, debt securities in issue and subordinated liabilities.
90

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Table 1.35:Reconciliation of Group funding to the balance sheet (audited)

  Included in
funding
analysis
£bn		  Repos
and cash
collateral
received by
Insurance
£bn		  Fair value
and other
accounting
methods
£bn		  Balance
sheet
£bn		 
At 31 December 2018                
Deposits from banks  8.3   22.1   (0.1)  30.3 
Debt securities in issue  97.1   –   (5.9)  91.2 
Subordinated liabilities  17.9   –   (0.2)  17.7 
Total wholesale funding  123.3   22.1         
Customer deposits  416.3   1.8   –   418.1 
Total  539.6   23.9         
At 31 December 2017                
Deposits from banks  5.1   24.1   0.6   29.8 
Debt securities in issue  78.1   –   (5.6)  72.5 
Subordinated liabilities  17.9   –   –   17.9 
Total wholesale funding  101.1   24.1         
Customer deposits  415.5   2.6   –   418.1 
Total  516.6   26.7         

Table 1.36:Analysis of 2018 total wholesale funding by residual maturity

  Less
than one
month
£bn		  One to
three
months
£bn		  Three to
six months
£bn		  Six to nine
months
£bn		  Nine
months
to one year
£bn		  One to
two years
£bn		  Two to
five years
£bn		  More than
five years
£bn		  Total at
31 Dec
2018
£bn		  Total at
31 Dec
2017
£bn		 
Deposit from banks  5.3   0.9   0.7   0.1   0.1   0.5   0.7   –   8.3   5.1 
Debt securities in issue:                                        
Certificates of deposit  1.7   2.4   4.1   1.3   1.3   1.2   –   –   12.0   10.0 
Commercial paper  1.1   2.7   3.8   0.3   0.1   –   –   –   8.0   3.2 
Medium-term notes  0.5   –   0.1   2.2   0.3   4.5   16.0   21.8   45.4   37.4 
Covered bonds  0.7   –   1.1   1.0   –   5.5   12.6   6.2   27.1   24.7 
Securitisation  –   0.6   –   0.1   –   2.8   –   1.1   4.6   2.8 
   4.0   5.7   9.1   4.9   1.7   14.0   28.6   29.1   97.1   78.1 
Subordinated liabilities  0.1   0.1   –   0.3   0.1   2.4   2.7   12.2   17.9   17.9 
Total wholesale funding1  9.4   6.7   9.8   5.3   1.9   16.9   32.0   41.3   123.3   101.1 
Of which issued by Lloyds Banking Group plc2  –   –   –   –   –   –   9.9   10.4   20.3   15.4 

1The Group’s definition of wholesale funding aligns with that used by other international market participants; including interbank deposits, debt securities and subordinated liabilities.
2Consists of medium-term notes only.

Table 1.37:Total wholesale funding by currency (audited)

  Sterling
£bn		  US Dollar
£bn		  Euro
£bn		  Other
currencies
£bn		  Total
£bn		 
At 31 December 2018  25.8   45.2   42.8   9.5   123.3 
At 31 December 2017  25.8   32.1   37.0   6.2   101.1 

Table 1.38:Analysis of 2018 term issuance (audited)

  Sterling
£bn		  US Dollar
£bn		  Euro
£bn		  Other
currencies
£bn		  Total
£bn		 
Securitisation  0.8   1.5   –   –   2.3 
Medium-term notes  –   6.2   1.3   3.0   10.5 
Covered bonds  3.0   0.6   0.9   –   4.5 
Private placements1  0.1   0.7   0.1   0.2   1.1 
Subordinated liabilities  –   2.3   0.7   –   3.0 
Total issuance  3.9   11.3   3.0   3.2   21.4 
Of which issued by Lloyds Banking Group plc2  –   4.9   1.3   2.6   8.8 
                     
1Private placements include structured bonds and term repurchase agreements (repos).
2Consists of medium-term notes only.
91

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The Group continues to access wholesale funding markets across a wide range of products, currencies and investors to maintain a stable and diverse source of funds. In 2019, the Group will continue with this approach to funding, including capital and funding from the holding company, Lloyds Banking Group plc, as needed to transition towards final UK Minimum Requirements for Own Funds and Eligible Liabilities (MREL). The Group will continue to issue funding trades from Lloyds Bank plc, operating company, across senior unsecured, covered bonds, ABS and RMBS. Over the course of 2019, the Group expects to launch an operating company funding programme for LBCM. The maturity of the Funding for Lending and Term Funding Schemes are fully factored into the Group’s funding plans, and in the expected ‘steady state’ wholesale funding requirements of £15-20 billion per annum.

Liquidity Portfolio

At 31 December 2018, the banking business had £129.4 billion of highly liquid unencumbered LCR eligible assets (31 December 2017: £120.9 billion), of which £128.6 billion is LCR level 1 eligible (31 December 2017: £120.2 billion) and £0.8 billion is LCR level 2 eligible (31 December 2017: £0.7 billion). These assets are available to meet cash and collateral outflows and PRA regulatory requirements. The Insurance business manages a separate liquidity portfolio to mitigate insurance liquidity risk. Total LCR eligible liquid assets represent just under 6.2 times the Group’s money market funding less than one year to maturity (excluding derivative collateral margins and settlement accounts) and exceed total wholesale funding, and thus provide a substantial buffer in the event of market dislocation.

Table 1.39:LCR eligible assets

  At 31 Dec
2018
£bn		  At 31 Dec
2017
£bn		  Change
%		  Average
2018
£bn		  Average
2017
£bn		 
Level 1                    
Cash and central bank reserves  48.9   53.7   (9)  58.1   51.0 
High quality government/MDB/agency bonds1  78.7   65.8   20   66.2   72.0 
High quality covered bonds  1.0   0.7   43   0.8   1.1 
Total  128.6   120.2   7   125.1   124.1 
Level 22  0.8   0.7   14   0.8   0.6 
Total LCR eligible assets  129.4   120.9   7   125.9   124.7 

1Designated multilateral development bank (MDB).
2Includes Level 2A and Level 2B.

Table 1.40:LCR eligible assets by currency

  Sterling
£bn		  US Dollar
£bn		  Euro
£bn		  Other
currencies
£bn		  Total
£bn		 
At 31 December 2018                    
Level 1  98.2   19.8   10.6   –   128.6 
Level 2  0.4   0.4   –   –   0.8 
Total  98.6   20.2   10.6   –   129.4 
At 31 December 2017                    
Level 1  90.8   16.3   13.1   –   120.2 
Level 2  0.2   0.5   –   –   0.7 
Total  91.0   16.8   13.1   –   120.9 

The banking business also has a significant amount of non-LCR eligible liquid assets which are eligible for use in a range of central bank or similar facilities. Future use of such facilities will be based on prudent liquidity management and economic considerations, having regard for external market conditions.

Stress testing results

Internal liquidity stress testing results at 31 December 2018 showed that the banking business had liquidity resources representing 167 per cent of modelled outflows from all wholesale funding sources, retail and corporate deposits, intraday requirements and rating dependent contracts under the Group’s most severe liquidity stress scenario.

The above scenario considers a two notch downgrade of the Group’s current long-term debt rating and accompanying one notch short-term downgrade implemented instantaneously by all major rating agencies, which could result in a contractual outflow of £1.3 billion of cash over a period of up to one year, £2.2 billion of collateral posting related to customer financial contracts and £6.1 billion of collateral posting associated with secured funding.

Encumbered assets

This disclosure provides further detail on the availability of assets that could be used to support potential future funding requirements of the Group. The disclosure is not designed to identify assets that would be available in the event of a resolution or bankruptcy.

The Board and the Group Asset and Liability Committee (GALCO) monitor and manage total balance sheet encumbrance using a number of risk appetite metrics. At 31 December 2018, the Group had £53.4 billion (31 December 2017: £64.6 billion) of externally encumbered on-balance sheet assets with counterparties other than central banks. The decrease in encumbered assets was primarily driven by a decrease in repo encumbrance. The Group also had £584.3 billion (31 December 2017: £587.5 billion) of unencumbered on-balance sheet assets, and £159.8 billion (31 December 2017: £160.1 billion) of pre-positioned and encumbered assets held with central banks. Primarily, the Group encumbers mortgages, unsecured lending and credit card receivables through the issuance programmes and tradable securities through securities financing activity. The Group mainly positions mortgage assets at central banks.

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Table 1.41:On balance sheet encumbered and unencumbered assets

  Encumbered with Pre-  Unencumbered assets   
  counterparties other positioned  not pre-positioned   
  than central banks and  with central banks   
              encumbered                
              assets     Other          
     Covered        held with  Readily  realisable  Cannot be       
  Securitisations  bond  Other  Total  central banks  realisable1  assets2  used3  Total  Total 
  £m  £m  £m  £m  £m  £m  £m  £m  £m  £m 
At 31 December 2018                                        
Cash and balances at central banks  –   –   –   –   –   49,645   –   5,018   54,663   54,663 
Financial assets at fair value through profit or loss  54   –   2,646   2,700   –   5,190   –   150,639   155,829   158,529 
Derivative financial instruments  –   –   –   –   –   –   –   23,595   23,595   23,595 
Financial assets at amortised cost:                                        
Loans and advances to banks  –   –   12   12   –   1,223   2,555   2,493   6,271   6,283 
Loans and advances to customers  5,774   29,041   6,012   40,827   159,822   12,098   155,278   116,833   284,209   484,858 
Debt securities  –   –   2,627   2,627   –   2,581   4   26   2,611   5,238 
   5,774   29,041   8,651   43,466   159,822   15,902   157,837   119,352   293,091   496,379 
Financial assets at fair value through other comprehensive income  –   –   7,278   7,278   –   17,114   –   423   17,537   24,815 
Other4  –   –   –   –   –   56   612   38,949   39,617   39,617 
Total assets  5,828   29,041   18,575   53,444   159,822   87,907   158,449   337,976   584,332   797,598 
At 31 December 2017                                        
Cash and balances at central banks  –   –   –   –   –   53,887   –   4,634   58,521   58,521 
Trading and other financial assets at fair value through profit or loss  –   –   4,642   4,642   –   7,378   –   150,858   158,236   162,878 
Derivative financial instruments  –   –   –   –   –   –   –   25,834   25,834   25,834 
Loans and receivables:                                        
Loans and advances to banks  –   –   –   –   –   213   1,417   4,981   6,611   6,611 
Loans and advances to customers  5,023   26,414   6,610   38,047   160,060   13,927   170,771   89,693   274,391   472,498 
Debt securities  –   –   2,374   2,374   –   919   4   346   1,269   3,643 
   5,023   26,414   8,984   40,421   160,060   15,059   172,192   95,020   282,271   482,752 
Available-for-sale financial assets  –   –   19,526   19,526   –   21,514   –   1,058   22,572   42,098 
Other4  –   –   –   –   –   16   1,175   38,835   40,026   40,026 
Total assets  5,023   26,414   33,152   64,589   160,060   97,854   173,367   316,239   587,460   812,109 

1Assets regarded by the Group to be readily realisable in the normal course of business, to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, and are not subject to any restrictions on their use for these purposes.
2Assets where there are no restrictions on their use to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, but are not readily realisable in the normal course of business in their current form.
3The following assets are classified as unencumbered – cannot be used: assets held within the Group’s Insurance businesses which are generally held to either back liabilities to policyholders or to support the solvency of the Insurance subsidiaries; assets held within consolidated limited liability partnerships which provide security for the Group’s obligations to its pension schemes; assets segregated in order to meet the Financial Resilience requirements of the PRA’s Supervisory Statement 9/16 ‘Operational Continuity in Resolution’; assets pledged to facilitate the use of intra-day payment and settlement systems; and reverse repos and derivatives balance sheet ledger items.
4Other comprises: items in the course of collection from banks; investment properties; goodwill; value in-force business; other intangible assets; tangible fixed assets; current tax recoverable; deferred tax assets; retirement benefit assets and other assets.

The above table sets out the carrying value of the Group’s encumbered and unencumbered assets, separately identifying those that are available to support the Group’s funding needs. The table does not include collateral received by the Group (i.e. from reverse repos) that is not recognised on its balance sheet, the vast majority of which the Group is permitted to repledge.

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FUNDING AND LIQUIDITY RISK – CONTRACTUAL CASH OBLIGATIONS

The following table sets out the amounts and maturities of Lloyds Banking Group’s contractual cash obligations at 31 December 2018.

  Within
one year
£m		  One to three
years
£m		  Three to
five years
£m		  Over five
years
£m		  Total
£m		 
Long-term debt – dated  576   3,323   2,291   6,870   13,060 
Debt securities in issue  25,392   26,244   16,301   30,316   98,253 
Finance leases  10   16   8   12   46 
Operating leases  259   458   349   977   2,043 
Capital commitments  378   –   –   –   378 
Other purchase obligations  1,337   2,340   1,346   987   6,010 
   27,952   32,381   20,295   39,162   119,790 

Other purchase obligations include amounts expected to be payable in respect of material contracts entered into by Lloyds Banking Group, in the ordinary course of business, for the provision of outsourced and other services. The cost of these services will be charged to the income statement as it is incurred. Lloyds Banking Group also has a constructive obligation to ensure that its defined post-retirement benefit pension schemes remain adequately funded. The amount and timing of Lloyds Banking Group’s cash contributions to these schemes is uncertain and will be affected by factors such as future investment returns and demographic changes. Lloyds Banking Group expects to make cash contributions of at least £1,050 million to these schemes in 2019.

At 31 December 2018, Lloyds Banking Group also had £4,596 million of preference shares, preferred securities and undated subordinated liabilities outstanding.

At 31 December 2018, the principal sources of potential liquidity for Lloyds Banking Group plc were dividends received from its directly owned subsidiary companies, particularly Lloyds Bank plc and Scottish Widows Group Limited, and loans from this and other Lloyds Banking Group companies. The ability of Lloyds Bank to pay dividends going forward, or for Lloyds Bank or other Lloyds Banking Group companies to make loans to Lloyds Banking Group plc, depends on a number of factors, including their own regulatory capital requirements, distributable reserves and financial performance.

OFF-BALANCE SHEET ARRANGEMENTS

A table setting out the amounts and maturities of Lloyds Banking Group’s other commercial commitments and guarantees at 31 December 2018 is included in note 52 to the financial statements. These commitments and guarantees are not included in Lloyds Banking Group’s consolidated balance sheet.

Lending commitments are agreements to lend to customers in accordance with contractual provisions; these are either for a specified period or, as in the case of credit cards and overdrafts, represent a revolving credit facility which can be drawn down at any time, provided that the agreement has not been terminated. The total amounts of unused commitments do not necessarily represent future cash requirements, in that commitments often expire without being drawn upon.

Lloyds Banking Group’s banking businesses are also exposed to significant risks from both theirliquidity risk through the provision of securitisation facilities to certain corporate customers. At 31 December 2018, Lloyds Banking Group offered securitisation facilities to its corporate and financial institution client base through its conduit securitisation vehicles, Argento, Cancara and Grampian. These are funded in the global asset-backed commercial paper market. The assets and obligations of these conduits are included in Lloyds Banking Group’s consolidated balance sheet. Lloyds Banking Group provides short-term asset-backed commercial paper liquidity support facilities on commercial terms to the issuers of the commercial paper, for use in the event of a market disturbance should they be unable to roll over maturing commercial paper or obtain alternative sources of funding.

Details of securitisations and other special purpose entity arrangements entered into by Lloyds Banking Group are provided in notes 30 and 48 to the financial statements. The successful development of Lloyds Banking Group’s ability to securitise its own assets has provided a mechanism to tap a well established market, thereby diversifying Lloyds Banking Group’s funding base.

Within Lloyds Banking Group’s insurance businesses, the principal sources of liquidity are premiums received from policyholders, charges levied upon policyholders, investment income and the proceeds from the present valuesale and maturity of investments. The investment policies followed by Lloyds Banking Group’s life assurance companies take account of anticipated cash flow requirements including by matching the cash inflows with projected liabilities where appropriate. Cash deposits and highly liquid government securities are available to provide liquidity to cover any higher than expected cash outflows.

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GOVERNANCE RISK

DEFINITION

Governance risk is defined as the risk that the Group’s organisational infrastructure fails to provide robust oversight of decision-making and the control mechanisms to ensure strategies and management instructions are implemented effectively.

EXPOSURES

The internal and corporate governance arrangements of major financial institutions continue to be subject to a high level of regulatory and public scrutiny. The Group’s exposure to governance risk is also reflective of the significant volume of existing and proposed legislation and regulation, both within the UK and across the multiple jurisdictions within which it operates, with which it must comply.

MEASUREMENT

The Group’s governance arrangements are assessed against new or proposed legislation and regulation and best practice among peer organisations in order to identify any areas of enhancement required.

MITIGATION

The Group’s Risk Management Framework (RMF) establishes robust arrangements for risk governance, in particular by:

– Defining individual and collective accountabilities for risk management, risk oversight and risk assurance through a three lines of defence model which supports the discharge of responsibilities to customers, shareholders and regulators;
– Outlining governance arrangements which articulate the enterprise-wide approach to risk management; and
– Supporting a consistent approach to Group-wide behaviour and risk decision-making through a Group policy framework which helps everyone understand their responsibilities by clearly articulating and communicating rules, standards, boundaries and risk appetite measures which can be controlled, enforced and monitored.

Under the banner of the RMF, training modules are in place to support all colleagues in understanding and fulfilling their risk responsibilities.

The Group’s code of responsibility embodies its values and reflect its commitment to operating responsibly and ethically both at a business and an individual level. All colleagues are required to adhere to the code in all aspects of their liabilities, primarily real interest rate, credit spread, equity,roles.

Effective implementation of the RMF mutually reinforces and alternative asset risks. The liability discount rate provides exposureis reinforced by the Group’s risk culture, which is embedded in its approach to interest rate riskrecruitment, selection, training, performance management and credit spread risk,reward.

MONITORING

A review of the Group’s RMF, which includes the status of the Group’s principles and policy framework, and the design and operational effectiveness of key governance committees, is undertaken on an annual basis and the findings are partially offset by fixed interest assets (such as giltsreported to the Group Risk Committee, Board Risk Committee and corporate bonds) and swaps. Equity and alternative asset risk arises from direct asset holdings.the Board.

 

For further information on Corporate Governance see pages 131 to 156.

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MARKET RISK

DEFINITION

Market risk is defined as the risk that unfavourable market moves (including changes in and increased volatility of interest rates, market-implied inflation rates, credit spreads and prices for bonds, foreign exchange rates, equity, property and commodity prices and other instruments) lead to reductions in earnings and/or value.

BALANCE SHEET LINKAGES

The information provided in table 1.42 aims to facilitate the understanding of linkages between banking, trading, and insurance balance sheet items and the positions disclosed in the Group’s market risk disclosures.

TABLE 1.42:MARKET RISK LINKAGE TO THE BALANCE SHEET

  Banking  
2018 Total
£m		  Trading
book only
£m		  Non-trading
£m		  Insurance
£m		  Primary market risk factor
Assets              
Cash and balances at central banks  54,663   –   54,663   –  Interest rate
Financial assets at fair value through profit or loss  158,529   35,246   6,380   116,903  Interest rate, foreign exchange, credit spread
Derivative financial instruments  23,595   14,734   6,898   1,963  Interest rate, foreign exchange, credit spread
Financial assets at amortised cost                  
Loans and advances to banks  6,283   –   6,242   41  Interest rate
Loans and advances to customers  484,858   –   484,818   40  Interest rate
Debt securities  5,238   –   5,238   –  Interest rate, credit spread
   496,379   –   496,298   81   
Financial assets at fair value through other comprehensive income  24,815   –   24,815   –  Interest rate, foreign exchange, credit spread
Value of in-force business  4,762   –   –   4,762  Equity
Other assets  34,855   –   19,641   15,214  Interest rate
Total assets  797,598   49,980   608,695   138,923   
                   
Liabilities                  
Deposit from banks  30,320   –   30,320   –  Interest rate
Customer deposits  418,066   –   418,066   –  Interest rate
Financial liabilities at fair value through profit or loss  30,547   23,451   7,085   11  Interest rate, foreign exchange
Derivative financial instruments  21,373   10,827   8,406   2,140  Interest rate, foreign exchange, credit spread
Debt securities in issue  91,168   –   91,168   –  Interest rate, credit spread
Liabilities arising from insurance and investment contracts  112,727   –   –   112,727  Credit spread
Subordinated liabilities  17,656   –   15,889   1,767  Interest rate, foreign exchange
Other liabilities  25,542   –   9,605   15,937  Interest rate
Total liabilities  747,399   34,278   580,539   132,582   

The defined benefit pension schemeschemes’ assets and liabilities please refer toare included under Other assets and Other liabilities in this table and note 3735 on page F-51.F-52 provides further information.

 

MEASUREMENT

Management of the assets is the responsibility of the Trustees of the schemes who are responsible for setting the investment strategy and for agreeing funding requirements with the Group. The difference betweenGroup’s trading book assets and liabilities determines whether there is a surplus or deficit. Any deficit mustare originated within the Commercial Banking division. Within the Group’s balance sheet these fall under the trading assets and liabilities and derivative financial instruments. The assets and liabilities are classified as trading books if they meet the requirements as set out in the Capital Requirements Regulation, article 104. Further information on these activities can be metfound under the Trading portfolios section on page 101.

Derivative assets and liabilities are held by the Group with additional funding agreed withfor three main purposes; to provide risk management solutions for clients, to manage portfolio risks arising from client business and to manage and hedge the TrusteesGroup’s own risks. Insurance business assets and liabilities relate to policyholder funds, as partwell as shareholder invested assets, including annuity funds. The Group recognises the value of a triennial valuation process.

MITIGATIONin-force business in respect of Insurance’s long-term life assurance contracts as an asset in the balance sheet (see note 24, page F-44).

 

The Group takes an active involvement in agreeing risk managementensures that it has adequate cash and mitigation strategiesbalances at central banks and stocks of high quality liquid assets (e.g. gilts or US Treasury securities) that can be converted easily into cash to meet liquidity requirements. The majority of these assets are held as financial assets at fair value through other comprehensive income with the Trusteesremainder held as financial assets at fair value through profit and loss. Further information on these balances can be found under Funding and liquidity risk on page 88. Interest rate risk in the asset portfolios is swapped into a floating rate.

The majority of debt issuance originates from the issuance, capital vehicles and medium-term notes desks and the interest rate risk of the schemes through whom any such activity must be conducted. An interest rate and inflation hedging programmedebt issued is in place to reduce liability risk. The schemes have also reduced equity allocation and are investing the proceeds in credit assets as part ofhedged by swapping them into a programme to de-risk the portfolio.floating rate.

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MONITORINGThe non-trading book primarily consists of customer on-balance sheet activities and the Group’s capital and funding activities, which expose it to the risk of adverse movements in market prices, predominantly interest rates, credit spreads, exchange rates and equity prices, as described in further detail within the Banking activities section (see below).

Table 1.43 (below) shows the key material market risks for the Group’s banking, defined benefit pension schemes, insurance and trading activities.

TABLE 1.43:KEY MATERIAL MARKET RISKS FOR THE GROUP BY INDIVIDUAL BUSINESS ACTIVITY (PROFIT BEFORE TAX IMPACT MEASURED AGAINST GROUP SINGLE STRESS SCENARIOS)

            Risk Type 
2018 Interest rate  Basis risk  FX  Credit spread  Equity  Inflation 
Banking activities1  l   ¡   –   l   l   – 
Defined benefit pension schemes1  ¡   –   –   n   –   – 
Insurance portfolios1  o   –   –   l   ¡   o 
Trading portfolios2  –   –   –   –   –   – 
                         
Profit before tax  Loss   Gain                 
> £500m  l   n                 
£250m – £500m  l   n                 
£50m – £250m  ¡   o                 
Immaterial/zero  –   –                 

1Banking activities, Pensions and Insurance stresses; Interest rate -100 bps, Basis Risk 3 month London Interbank Offered Rate (LIBOR) +100bps / bank base rate -25bps, Foreign Exchange (FX) -15 per cent GBP, Credit Spread +100 per cent, Equity -30 per cent, Inflation +50 bps
2Trading Portfolios; Interest rate -70bps, FX -5 per cent GBP, Credit Spread +20 per cent, Inflation +50bps.

MEASUREMENT

 

In addition to measuring single factors, Group risk appetite is calibrated primarily to five multi-risk Group economic scenarios, and is supplemented with sensitivity based measures. The scenarios assess the impact of unlikely, but plausible, adverse stresses on income with the worst case for banking activities, defined benefit pensions, insurance and trading portfolios reported against independently, and across the Group as a whole.

The Group risk appetite is cascaded first to the Group Asset and Liability Committee (GALCO), chaired by the Chief Financial Officer, where risk appetite is approved and monitored by risk type, and then to Group Market Risk Committee (GMRC) where risk appetite is sub-allocated by division. These metrics are reviewed regularly by senior management to inform effective decision-making.

MITIGATION

GALCO is responsible for approving and monitoring group market risks, management techniques, market risk measures, behavioural assumptions, and the market risk policy. Various mitigation activities are assessed and undertaken across the Group to manage portfolios and seek to ensure they remain within approved limits. The mitigation actions will vary dependent on exposure but will, in general, look to reduce risk in a cost effective manner by offsetting balance sheet exposures and externalising through to the financial markets dependent on market liquidity. The market risk policy is owned by Group Corporate Treasury (GCT) and refreshed annually. The policy is underpinned by supplementary market risk procedures, which define specific market risk management and oversight requirements.

MONITORING

GALCO and the GMRC regularly review high level market risk exposure as part of the wider risk management framework, governanceframework. They also make recommendations to the Board concerning overall market risk appetite and Group Market Risk Policy. Exposures at lower levels of delegation are monitored at various intervals according to their volatility, from daily in the case of trading portfolios to monthly or quarterly in the case of less volatile portfolios. Levels of exposures compared to approved limits and triggers are monitored by Risk and where appropriate, escalation procedures are in place.

How market risks arise and are managed across the Group’s activities is considered in more detail below.

BANKING ACTIVITIES

Exposures

The Group’s banking activities expose it to the risk of adverse movements in market prices, predominantly interest rates, credit spreads, exchange rates and equity prices. The volatility of market values can be affected by both the transparency of prices and the amount of liquidity in the market for the relevant asset, liability or instrument.

Interest rate risk

Yield curve risk in the Group’s divisional portfolios, and in the Group’s capital and funding activities arises from the different repricing characteristics of the schemesGroup’s non-trading assets, liabilities (see loans and advances to customers and customer deposits in table 1.42) and off-balance sheet positions.

Basis risk arises from the possible changes in spreads, for example where the bank lends with reference to a central bank rate but funds with reference to LIBOR, and the spread between these two rates widens or tightens.

Optionality risk arises predominantly from embedded optionality within assets, liabilities or off-balance sheet items where either the Group or the customer can affect the size or timing of cash flows. One example of this is mortgage prepayment risk where the customer owns an option allowing them to prepay when it is economical to do so. This can result in customer balances amortising more quickly or slowly than anticipated due to customers’ response to changes in economic conditions.

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Foreign exchange risk

Economic foreign exchange exposure arises from the Group’s investment in its overseas operations (net investment exposures are disclosed in note 52 on page F-88). In addition, the Group incurs foreign exchange risk through non-functional currency flows from services provided by customer-facing divisions and the Group’s debt and capital management programmes.

Equity risk

Equity risk arises primarily from three different sources; (i) the Group’s strategic equity holdings e.g. Visa Europe, now held in the Equities sub-group; (ii) exposure to Lloyds Banking Group share price through deferred shares and deferred options granted to employees as part of their benefits package; and (iii) the Group’s private equity investments held by Lloyds Development Capital within the Equities sub-group.

Credit spread risk

Credit spread risk arises largely from (i) the liquid asset portfolio held in the management of Group liquidity, comprising of government supranational and other eligible assets; (ii) the Credit Valuation Adjustment (CVA) and Debit Valuation Adjustment (DVA) sensitivity to credit spreads; and (iii) a number of the Group’s structured medium-term notes where the Group has elected to fair value the notes through the profit and loss account.

Measurement

Interest rate risk exposure is monitored monthly using, primarily:

(i) Market value sensitivity: this methodology considers all repricing mismatches (behaviourally adjusted where appropriate) in the current balance sheet and calculates the change in market value that would result from an instantaneous 25, 100 and 200 basis points parallel rise or fall in the yield curve (subject to an appropriate floor). The market value sensitivities are calculated on a static balance sheet using principal cash flows excluding interest, commercial margins and other spread components and are therefore discounted at the risk free zero-coupon rate.

(ii) Interest income sensitivity: this measures the 12 month impact on future net interest income arising from various economic scenarios. These include instantaneous 25, 100 and 200 basis point parallel shifts in all yield curves and the five Group economic scenarios (subject to an appropriate floor). These scenarios are reviewed every year and are designed to replicate severe but plausible economic events, capturing risks that would not be evident through the use of parallel shocks alone such as basis risk and steepening or flattening of the yield curve. An additional negative rates scenario is also used for information purposes where all floors are removed; however this is not measured against the limit framework.

Unlike the market value sensitivities, the interest income sensitivities incorporate additional behavioural assumptions as to how and when individual products would reprice in response to changing rates. In addition a dynamic balance sheet is used which includes two specialist pensions committees (one Group executive sub-committeethe run-off of current assets and liabilities and the addition of planned new business.

Reported sensitivities are not necessarily predictive of future performance as they do not capture additional management actions that would likely be taken in response to an immediate, large, movement in interest rates. These actions could reduce the net interest income sensitivity, help mitigate any adverse impacts or they may result in changes to total income that are not captured in the net interest income.

(iii) Structural hedge limits: the structural hedging programme managing interest rate risk in the banking book relies on a supporting management committee).number of assumptions made around customer behaviour. A material mismatch between assumptions and reality could lead to a deterioration in earnings. In order to monitor this risk a number of metrics are in place to enhance understanding of risks within this portfolio.

 

The surplus or deficit in the schemes is tracked on a monthly basis along with various single factorGroup has an integrated Asset and scenario stressesLiability Management (ALM) system which consider the assetssupports non-traded asset and liabilities holistically. The impact on Group capital resourcesliability management of the schemesGroup. This provides a single consolidated tool to measure and manage interest rate repricing profiles (including behavioural assumptions), perform stress testing and produce forecast outputs. The Group is monitored monthly. Performance against risk appetite triggersaware that any assumptions based model is also regularly monitored. Hedgesopen to challenge. A full behavioural review is performed annually, or in response to changing market conditions, to ensure the assumptions remain appropriate and the model itself is subject to annual re-validation, as required under the Group Model Governance Policy. The key behavioural assumptions are in place(i) embedded optionality within products; (ii) the duration of balances that are contractually repayable on demand, such as current accounts and asset/liability matching positions are also actively monitored.overdrafts, together with net free reserves of the Group; and (iii) the re-pricing behaviour of managed rate liabilities namely variable rate savings.

Table 1.44 below shows, split by material currency, the Group’s market value sensitivities to an instantaneous parallel up and down 25 and 100 basis points change to all interest rates.

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TABLE 1.44:GROUP BANKING ACTIVITIES: MARKET VALUE SENSITIVITY

INSURANCE PORTFOLIOS

  2018 2017
   Up
25bps
£m		   Down
25bps
£m		   Up
100bps
£m		   Down
100bps
£m		   Up
25bps
£m		   Down
25bps
£m		   Up
100bps
£m		   Down
100bps
£m		 
Sterling  29.1   (29.5)  113.7   (122.4)  (9.9)  10.1   (38.7)  22.1 
US Dollar  (7.8)  7.8   (30.6)  31.9   (3.6)  3.7   (14.2)  15.3 
Euro  (3.0)  1.7   (11.2)  7.2   2.2   (0.7)  8.9   0.9 
Other  (0.1)  0.1   (0.4)  0.5   (0.1)  0.2   (0.5)  0.6 
Total  18.2   (19.9)  71.5   (82.8)  (11.4)  13.3   (44.5)  38.9 

 

EXPOSURESThis is a risk based disclosure and the amounts shown would be amortised in the income statement over the duration of the portfolio.

 

The main elementsmarket value sensitivity is driven by temporary customer flow positions not yet hedged plus other positions occasionally held, within limits, by the Group’s wholesale funding desks in order to minimise overall funding and hedging costs. The level of marketrisk is low relative to the size of the total balance sheet.

Table 1.45 below shows supplementary value sensitivity to a steepening and flattening (c.100 basis points around the 3 year point) in the yield curve. This ensures there are no unintended consequences to managing risk to which the Group is exposed through the Insurance business are equity, credit spread, interest rate and inflation.parallel shifts in rates.

 

–TABLE 1.45:Equity risk arises indirectly through the value of future management charges on policyholder funds. These management charges form part of the value of in-force business (see note 25 on page F-42). Equity risk also arises in the with-profits funds but is less material.
–Credit spread risk mainly arises from annuities where policyholders’ future cashflows are guaranteed at retirement. Exposure arises if the assets which are held to back these liabilities, mainly corporate bonds and loans, do not perform in line with expectations. Within the Group accounts a large amount of this exposure is removed as accounting rules require that assets Insurance have acquired from Group are maintained at the original amortised book value.
–Interest rate risk arises through holding credit and interest assets mainly in the annuity book and also to cover general insurance liabilities, capital requirements and risk appetite.
–Inflation exposure is from a combination of inflation linked policyholder benefits and inflation assumptions used to project future expenses.GROUP BANKING ACTIVITIES: MARKET VALUE SENSITIVITY TO A STEEPENING AND FLATTENING OF THE YIELD CURVE

 

  2018  2017
  Steepener
£m		  Flattener
£m		  Steepener
£m		  Flattener
£m		 
Sterling  38.3   (36.5)  (1.1)  (16.5)
US Dollar  6.5   (5.7)  7.1   (8.9)
Euro  (6.8)  3.6   (3.8)  7.9 
Other  (0.1)  0.1   (0.2)  0.2 
Total  37.9   (38.5)  2.0   (17.3)

MEASUREMENT

The table below shows the banking book income sensitivity to an instantaneous parallel up and down 25 and 100 basis points change to all interest rates.

TABLE 1.46:GROUP BANKING ACTIVITIES: NET INTEREST INCOME SENSITIVITY

  2018 2017
   Up
25bps
£m		   Down
25bps
£m		   Up
100bps
£m		   Down
100bps
£m		   Up
25bps
£m		   Down
25bps
£m		   Up
100bps
£m		   Down
100bps
£m		 
Client facing activity and associated hedges  76.2   (125.4)  341.6   (538.6)  86.1   (54.0)  370.5   (186.9)

Income sensitivity is measured over a rolling 12 month basis.

 

Current and potential future marketThe increase in the net interest income sensitivity to a down 100bps shock reflects the additional margin compression risk exposures within Insurance are assessed using a range of stress testing exercises and scenario analyses. Risk measures include 1-in-200 year stresses used for regulatory capital assessments and single factor stresses for profit before tax.retail savings as bank base rate has risen.

 

Table 1.41 demonstrates the impact of the Group’s Fiscal Solvency stress scenario (with no diversification benefit) on Insurance’s portfolio; this is the most onerous scenario for Insurance out of the Group scenarios. The amounts include movements in assets, liabilities and the value of in-force business in respect of insurance contracts and participating investment contracts.

Table 1.41:Insurance business: profit before tax sensitivities

  Increase (reduction) in profit
before tax		 
  2015
£m		  2014
£m		 
Interest rates – increase 100 basis points (43) (124)
Inflation – increase 50 basis points (23) (143)
Credit spreads – 100% widening (864) (582)
Equity – 30% fall (616) (745)
Property – 25% fall (51) (60)

Credit spread exposure increased in 2015 reflecting the Insurance business entry into the bulk annuity market, with a £0.4 billion deal in the fourth quarter, building on the £2.4 billion Scottish Widows with-profits deal earlier in the year.

Further stresses that show the effect of reasonably possible changes in key assumptions, including the risk-free rate,Basis risk, foreign exchange, equity, investment volatility, widening of credit default spreads on corporate bonds and an increase in illiquidity premia, as applied to profit before tax are set out in note 34.

MITIGATION

Equity and credit spread risks are inherent within Insurance products and are closely monitored to ensure they remain within risk appetite. A hedging strategy is in place to reduce exposure frommeasured primarily through scenario analysis by assessing the with-profit funds.

Interest rate risk in the annuity book is mitigated by investing in assets whose cash flows closely match thoseimpact on the projected future liabilities. It is not possible to eliminate risk completely as the timing of insured events is uncertain and bonds are not available at all of the required maturities. As a result, the cash flows cannot be precisely matched and so sensitivity tests are used to test the extent of the mismatch.

Other market risks (e.g. interest rate exposure outside the annuity book and inflation) are also closely monitored and where considered appropriate, hedges are put in place to reduce exposure.

MONITORING

Market risks in the Insurance business are monitored by Insurance senior executive Committees and ultimately the Insurance Board. Monitoring includes the progression of market risk capital against risk appetite limits, as well as the sensitivity of profit before tax over a 12 month horizon arising from a change in market rates, and reported within the Board risk appetite on a monthly basis. Supplementary measures such as sensitivity and exposure limits are applied where they provide greater insight into risk positions. Frequency of reporting supplementary measures varies from daily to combinedquarterly appropriate to each risk type.

Mitigation

The Group’s policy is to optimise reward whilst managing its market risk stress scenariosexposures within the risk appetite defined by the Board. The Group Market Risk Policy and in yearprocedures outlines the hedging process, and the centralisation of risk from divisions into GCT, e.g. via the transfer pricing framework. GCT is responsible for managing the centralised risk and does this through natural offsets of matching assets and liabilities, and appropriate hedging activity of the residual exposures, subject to the authorisation and mandate of GALCO within the Board risk appetite. The hedges are externalised to the market movements. Asset/liability matching positionsby derivative desks within GCT and hedgesCommercial Banking Markets. The Group has hedge accounting solutions in place, are actively monitoredwhich reduce the accounting volatility arising from the Group’s economic hedging activities by utilising both LIBOR and if necessary rebalanced to be within agreed tolerances. In addition market risk is controlled via approved investment policies and mandates.

TRADING PORTFOLIOS

EXPOSURESbank base rate assets.

 

The largest residual risk exposure arises from balances that are deemed to be insensitive to changes in market rates (including current accounts, a portion of variable rate deposits and investable equity), and is managed through the Group’s tradingstructural hedge. Consistent with the Group’s strategy to deliver stable returns, GALCO seeks to minimise large reinvestment risk, and to smooth earnings over a range of investment tenors. The structural hedge consists of longer-term fixed rate assets or interest rate swaps and the amount and duration of the hedging activity is small relative to its peers and the Group does not have a programme of proprietary trading activities. The Group’s trading activity is undertaken solely to meet the financial requirements of commercial and retail customers for foreign exchange, credit and interest rate products. These activities support customer flow and market making activities.reviewed regularly by GALCO.

 

All trading activitiesWhilst the bank faces margin compression in low rate environments, its exposure to pipeline and prepayment risk are performed within the Commercial Banking division. While the trading positions takennot considered material, and are generally small, any extreme moveshedged in the main risk factorsline with expected customer behaviour. These are appropriately monitored and other related risk factors could cause significant losses in the trading book depending on the positions at the time. The average 95 per cent 1-day trading VaR (diversified across risk factors) was £1.5 million for year end 2015 compared to £3.0 million for year end 2014. This decrease was due to the significant de-risking activities that took place at the portfolio level.

Trading market risk measures are applied to all the Group’s regulatory trading bookscontrolled through divisional Asset and they include daily VaR (table 1.42), sensitivity based measures, and stress testing calculations.Liability Committees (ALCOs).

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

MEASUREMENT

Net investment foreign exchange exposures are managed centrally by GCT, by hedging non-sterling asset values with currency borrowing. Economic foreign exchange exposures arising from non-functional currency flows are identified by divisions and transferred and managed centrally. The Group internally uses VaR as the primary risk measure for all trading book positions.

Table 1.42 shows some relevant statistics for the Group’s 1-day 95 per cent confidence level VaR that are based on 300 historical consecutive business days to year end 2015 and year end 2014.

The riskalso has a policy of loss measured by the VaR model is the minimum expected loss in earnings given the 95 per cent confidence. The total and average trading VaR numbers reported below have been obtained after the application of the diversification benefits across the five risk types. The maximum and minimum VaR reported for each risk category did not necessarily occur on the same day as the maximum and minimum VaR reported at Group level.

Table 1.42: Trading portfolios: VaR (1-day 95 per cent confidence level) (audited)

  At 31 December 2015  At 31 December 2014 
  Close
£m		  Average
£m		  Maximum
£m		  Minimum
£m		  Close
£m		  Average
£m		  Maximum
£m		  Minimum
£m		 
Interest rate risk 0.8  1.4  3.5  0.8  1.7  2.8  4.8  1.3 
Foreign exchange risk 0.2  0.3  0.8  0.1  0.2  0.4  1.3  0.0 
Equity risk –  –  –  –  –  –  –  – 
Credit spread risk 0.2  0.4  1.0  0.2  0.6  0.7  1.1  0.5 
Inflation risk 0.1  0.3  1.6  0.1  0.4  0.3  0.8  0.2 
Sub-total                        
Sum of risk factors 1.3  2.3  6.2  1.3  2.8  4.3  6.4  2.5 
Portfolio Diversification (0.4) (0.9)       (0.9) (1.3)      
Total VaR1 0.9  1.4  3.1  0.8  1.9  3.0  4.6  1.6 

1VaR over 2015 is based on diversified VaR across risk factors following the PRA granting the Group permission to calculate VaR on a diversified basis. We have applied the same diversification approach for 2014.

The market risk for the trading book continues to be low with respect to the size of the Group and compared to our peers. This reflects the fact that the Group’s trading operations are customer-centric and focused onforward hedging and recycling client risks.

Although it is an important market standard measure of risk, VaR has limitations. One of them is the use of limited historical data sample which influences the output by the implicit assumption that future market behaviour will not differ greatly from the historically observed period. Another known limitation is the use of defined holding periods which assumes that the risk can be liquidated or hedged within that holding period. Also calculating the VaR at the chosen confidence interval does not give enough information about potential losses which may occur if this level is exceeded. The Group fully recognises these limitations and supplements the use of VaR with a variety of other measurements which reflect the nature of the business activity. These include detailed sensitivity analysis, position reporting and a stress testing programme.

Trading book VaR (1-day 99 per cent) is compared daily against both hypothetical and clean profit and loss. 1-day 99 per cent VaR charts for Lloyds Bank, HBOS and Lloyds Banking Group models can be found in the Group’s Pillar 3 Report.

MITIGATION

Active management of the Group portfolio is necessary such that the level of exposure is strictly controlled and managed within the approved risk limits.

MONITORING

Trading risk appetite is monitored daily with 1-day 95 per cent VaR and Stress Testing limits. These limits are complemented with position level action triggers andits forecasted currency profit and loss referrals. Risk and position limits are set and managed at both desk and overall trading book levels. They are reviewed at least annually and can be changed as required within the overall Group risk appetite framework.

100

OPERATING AND FINANCIAL REVIEW AND PROSPECTSto year end.

 

OPERATIONAL RISK

DEFINITION

Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.

Monitoring

The aim of operational risk management is to manage operational risks in line with defined appetites, and to protect both customers and the Group whilst delivering sustainable growth. The Group Operational Risk Management Framework is the method by which operational risks are managed in terms of setting risk appetite, evaluating key exposures, measuring risk, mitigating risk, and monitoring risks on an ongoing basis, as set out below.

RISK APPETITE

The Group’s operational risk appetite is designed to safeguard the interests of customers, internal and external stakeholders, and shareholders. Appetite is expressed through four high level statements summarised below, each of which are defined withappropriate limits and triggers approved by the Board, and are regularly monitored by senior executive committees within the banking divisions. Banking assets, liabilities and Board Risk Committee (BRC):associated hedging are actively monitored and if necessary rebalanced to be within agreed tolerances.

 

–Customer: The Group builds trust and does not expect its customers to be impacted negatively.
–Reputation: The Group does not expect to suffer events or behaviours that have a material negative impact on its reputation. The Group minimises the impact from cyber attacks that could result in a significant loss of customer confidence or undermine the stability of the Group.
–Financial loss: The Group does not expect to experience cumulative fraud or operational losses above 3 per cent or more of budgeted Group income, or individual losses of more than £100 million.
–Management time and resources: The Group does not expect internal events that divert excessive senior management time from running the business or have extensive impact on colleague time and/or morale.

For further information on risk appetite refer to page 46.

EXPOSURES

The principal operational risks to the Group are:

–The risk that the Group is unable to provide services to customers as a result of an IT systems failure;
–Cyber risks associated with malicious attacks on the confidentiality or integrity of electronic data, or the availability of systems;
–External fraud arising from an act of deception or omission;
–Risks arising from inadequate delivery of services to customers; and
–The risk associated with the ongoing provision of services to TSB and other organisations.

The risks below also have potential to negatively impact customers and the Group’s future results:

–Terrorist acts, other acts of war or hostility, geopolitical, pandemic or other such events and responses to those acts/events may create economic and political uncertainties, which could have a material adverse effect on UK and international macroeconomic conditions generally, and more specifically on the Group’s results of operations, financial condition or prospects in ways that cannot necessarily be predicted.
–Systems and procedures are implemented and maintained by the Group to comply with increasingly complex and detailed anti-money laundering and anti-terrorism laws and regulations. However, these may not always be fully effective in preventing third parties from using the Group as a conduit for money laundering, terrorist financing and other illegal or prohibited activities. Should the Group be associated with money laundering, terrorist financing or breaches of financial crime regulations and prohibitions, its reputation could suffer and/or it could become subject to fines, sanctions and legal enforcement; any one of which could have a material adverse effect upon operating results, financial condition and prospects.

MEASUREMENT

Operational risk is managed within a Board approved framework and risk appetite, as set out above. A variety of measures are used such as: scoring of potential risks, using impact and likelihood, with impact thresholds aligned to the risk appetite statements above; assessment of the effectiveness of controls; monitoring of events and losses by size, business unit and internal risk categories.

Based on data captured on the Group’s Operational Risk System, in 2015, the highest frequency of events occurred in external fraud (71.96 per cent) and execution, delivery and process management (15.81 per cent). Clients, products and business practices accounted for 83.43 per cent of losses by value, driven by legacy issues where impacts materialised in 2015 (excluding PPI).

Table 1.43 below shows high level loss and event trends for the Group using Basel II categories.

Table 1.43: Operational risk events by risk category (losses greater than or equal to £10,000)

  % of total volume  % of total losses 
  2015  20141  2015  20141 
Business disruption and system failures 0.40  1.20  0.13  0.39 
Clients, products and business practices 11.46  14.31  83.43  80.87 
Damage to physical assets 0.06  –  0.04  – 
Employee practices and workplace safety 0.03  0.04  –  – 
Execution, delivery and process management 15.81  20.30  11.08  14.12 
External fraud 71.96  63.69  5.27  4.58 
Internal fraud 0.28  0.46  0.05  0.04 
Total 100.00  100.00  100.00  100.00 

1During the year, the Group undertook a review of the internal classification of operational risk events to improve alignment to the Basel categories. As a result of this review, the Group has changed the classification categories for a number of events. 2014 has been revised to reflect the new categorisations.
101

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Operational risk scenario assessments and actual losses are used by the Group to calculate the appropriate holding of operational risk regulatory capital under the Internal Capital Adequacy Assessment Process (ICAAP). The Group calculates its minimum (Pillar I) operational risk capital requirements using The Standardised Approach (TSA), which the Basel Committee has stated as being appropriate for an ‘internationally active’ bank.

MITIGATION

The Group continues to review and invest in its control environment to ensure it addresses the inherent risks faced. Risks are reported and discussed at local governance forums and escalated to executive management as appropriate. This ensures the correct level of visibility and engagement. The Group employs a range of risk management strategies, including: avoidance, mitigation, transfer (which would also include insurance) and acceptance. Contingency plans are maintained for a range of potential scenarios, with regular disaster recovery and scenario testing scheduled to test and challenge the readiness of the Group to respond in the event of an incident.

–The Group continues to mature its approach to operational resilience. The IT Resilience Programme is making significant progress in addressing the observations and associated resilience risks raised in the Independent IT Resilience Review performed by PwC (2013). The Board recognises the role that resilient technology plays in achieving the Group’s strategy of becoming the best bank for customers and in maintaining banking services across the wider industry. As such, the Board dedicates considerable time and focus to this subject at both the Board and the Board Risk Committee, and continues to sponsor key investment programmes that enhance our resilience.
–The threat landscape associated with cyber risk has continued to evolve alongside increasing Regulatory attention. The Board has defined a Cyber Risk Appetite and is supporting investment to help mitigate this risk.
–In addition to initiatives that protect the Group against a malicious cyber-attack the Group continues to invest in enhanced protection of customer information, including limiting access to key systems and enhancing the security, durability and accessibility of critical information.
–The Group adopts a risk based approach to mitigate the external fraud risks it faces, reflecting the current and emerging external fraud risks within the market. This approach drives an annual programme of enhancements to the Group’s technology, process and people related controls, with an emphasis on preventative controls supported by real time detective controls wherever feasible. Groupwide policies and operational control frameworks are maintained and designed to provide customer confidence, protect the Group’s commercial interests and reputation, comply with legal requirements and meet regulatory expectations. The Group’s fraud awareness programme remains a key component of its fraud control environment.
–The Group remediates issues that are identified in its customer processes, addressing root cause and rectifying customers as required. Enhancing the overall servicing environment remains a focus of dedicated Group programmes such as Simplification.
–Following the successful divestment of TSB the Group retains responsibility for the ongoing provision of key services which are managed via robust change management governance and a consolidated strategic change plan. There are separate governance arrangements in place to oversee the impacts of the divestment on the retained business customers, operations and controls.
–Operational resilience measures and recovery planning defined in the Group’s Business Continuity Management policy ensure an appropriate and consistent approach to the management of continuity risks, including potential interruptions from a range of internal and external incidents or threats including environmental and climatic issues, terrorism, cyber, economic instability, pandemic planning and operational incidents.
–The Group has adopted policies and procedures designed to detect and prevent the use of its banking network for money laundering, terrorist financing, bribery and activities prohibited by legal and regulatory sanctions. The Group regularly reviews and assesses these policies to keep them current, effective and consistent across markets. The Group requires mandatory training on these topics for all employees. Specifically, the anti-money laundering procedures include ‘know-your-customer’ requirements, transaction monitoring technologies and reporting of suspicions of money laundering or terrorist financing to the applicable regulatory authorities and the Anti-Bribery Policy prohibits the payment, offer, acceptance or request of a bribe, including ‘facilitation payments’ by any employee or agent and provides a confidential reporting service for anonymous reporting for suspected or actual bribery activity. The Sanctions and the Related Prohibitions Policy sets out a framework of controls for compliance with legal and regulatory sanctions.

MONITORING

Monitoring and reporting is undertaken at Board, Group and business area committees, in accordance with delegated limits of authority which are regularly reviewed and refreshed. Business unit risk exposure is aggregated and discussed at the Group Conduct, Compliance and Operational Risk Committee, and matters are escalated to the Chief Risk Officer, or higher committees, if appropriate. A combination of: regular management information and reporting from business areas, oversight and challenge from Risk Division, Group Audit and other assurance activities ensures that key risks are regularly presented and debated by executive management.

The Group maintains a formal approach to operational risk event escalation, whereby material events are identified, captured and escalated. Root causes of events are determined, where possible and action plans put in place to ensure an optimum level of control to keep customers and the business safe, reduce costs, and improve efficiency.

The insurance programme is monitored and reviewed regularly, with recommendations being made to the Group’s senior management annually prior to each renewal. Insurers are monitored on an ongoing basis, to ensure counterparty risk is minimised. A process is in place to manage any insurer rating changes or insolvencies.

102

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

FUNDING AND LIQUIDITY RISK

DEFINITION

Funding risk is defined as the risk that the Group does not have sufficiently stable and diverse sources of funding or the funding structure is inefficient. Liquidity risk is defined as the risk that the Group has insufficient financial resources to meet its commitments as they fall due, or can only secure them at excessive cost.

RISK APPETITE

Funding and liquidity risk is managed separately for the Banking and Insurance businesses. Funding and liquidity risk appetite for the Banking business is set with the support of the Group Asset and Liability Committee (GALCO). The liquidity risk appetite for the Insurance business is reviewed and set annually by the Insurance Board.

For the Banking Group, the liquidity risk appetite covers a range of metrics considered key to maintaining a strong liquidity and funding position, including a number of stressed metrics, with regular reporting to GALCO and the Board. Risk appetite is a key element of the annual Group planning process with risk appetite defined over the life of the funding plan. For further information on risk appetite refer to page 46.

EXPOSURE

 

Liquidity exposure represents the amount of potential stressed outflows in any future period less expected inflows. Liquidity is consideredThe Group considers liquidity exposure from both an internal and a regulatory perspective.

 

MEASUREMENT

 

Liquidity risk is managed through a series of measures, tests and reports that are primarily based on contractual maturity.maturities with behavioural overlays as appropriate. Note 5352 on page F-90F-88 sets out an analysis of assets and liabilities by relevant maturity grouping. In order to reflect more accurately the expected behaviour of the Group’s assetsThe Group undertakes quantitative and liabilities, measurement and modellingqualitative analysis of the behavioural aspects of each is constructed. Divisional teams form a view of customer behaviour based on quantitativeits assets and qualitative analysis. The analysis takes into account items such as early repayment, forbearance and impairment for assets; rollover and early withdrawal for liabilities. The assumptions are subjectliabilities in order to governance via divisional asset and liability committees. The behavioural reviews form the foundation of the Group’s Liquidity Transfer Pricing (LTP) and are applied to the contractual profile of the Group for the liquidity risk stress testing framework.reflect their expected behaviour.

 

MITIGATION

 

The Group mitigatesmanages and monitors liquidity risks and ensures that liquidity risk management systems and arrangements are adequate with regard to the internal risk appetite, Group strategy and regulatory requirements. Liquidity policies and procedures are subject to independent internal oversight by Risk. Overseas branches and subsidiaries of the Group may also be required to meet the liquidity requirements of the entity’s domestic country. Management of liquidity requirements is performed by the overseas branch or subsidiary in line with Group Policy. Liquidity risk of a liquidity mismatch in excess of its risk appetite by managing the liquidity profile ofInsurance business is actively managed and monitored within the balance sheet through short term liquidity management andInsurance business. The Group plans funding requirements over the life of the funding plan, combining business as usual and stressed conditions. The Group manages its liquidity position with regard to its internal risk appetite and liquidity position as a coverage ratio (proportion of stressed outflows coveredthe Liquidity Coverage Ratio (LCR) required by eligible liquid assets) corresponding with the PRA and CRD IVCapital Requirements Directive and Regulation (CRD IV) liquidity requirements. Longer term funding is used to manage the Group’s strategic liquidity profile, determined by the Group’s balance sheet structure. Longer term is defined as having an original maturity of more than one year.

 

The Group’s funding and liquidity position is underpinned by its significant customer deposit base, and is supported by strong relationships with corporate customers and certain wholesale marketacross customer segments. A substantial proportion ofThe Group has consistently observed that in aggregate the retail deposit base is made up of customers’ current and savings accounts which, although mostly repayable on demand, have traditionally in aggregate providedprovides a stable source of funding. Funding concentration by counterparty, currency and currencytenor is monitored on an ongoing basis. Wherebasis and where concentrations do exist, (for example, maturity profile), these are managed as part of the planning process and limited by the internal risk appetite, and considered manageable. The abilitywith analysis regularly provided to deploy assets quickly, either through the repo market or through outright sale, is also an important source of liquidity for the Group’s Banking businesses.senior management.

 

To assist in managing the balance sheet, the Group operates an LTPa Liquidity Transfer Pricing (LTP) process which: allocates relevant interest expenses from the centre to the Group’s Bankingbanking businesses within the internal management accounts in a manner consistent with the Group Funding and Liquidity Policy;accounts; helps drive the correct inputs to customer pricing and supports the overall Group balance sheet strategy;pricing; and is consistent with regulatory requirements.

Relevant interest expenses allocated via LTP include term funding spreads incurred over a three month LIBOR benchmark and the cost of funding and holding liquid asset reserves. LTP makes extensive use of behavioural maturity profiles, taking account of expected customer loan prepayments and stability of customer deposits. Such behavioural maturity assumptions aredeposits, modelled on historic data.

The Group can monetise liquid assets quickly, either through the repurchase agreements (repo) market or through outright sale. In addition, the Group has pre-positioned a substantial amount of assets at the Bank of England’s Discount Window Facility which can be used to access additional liquidity in a time of stress. The Group considers diversification across geography, currency, markets and tenor when assessing appropriate holdings of liquid assets. The Group’s liquid asset buffer is available for deployment at immediate notice, subject to formal governance, reviewed at least annually and founded on analysis and evidence of actual customer behaviour using historical data gathered over several years.complying with regulatory requirements.

88

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Liquidity risk within the Insurance business may result from: the inability to sell financial assets quickly at their fair values; an insurance liability falling due for payment earlier than expected; the inability to generate cash inflows as anticipated; an unexpected large operational event; or from a general insurance catastrophe e.g. a significant weather event. Following the implementation of Solvency II, the annuity portfolio is ring-fenced and assets held to match annuity liability cashflows are excluded from shareholder liquidity. In the event a liquidity shortfall arises on the annuity portfolio, shareholder liquidity will be required to support this. As a result, the shareholder’s exposure to liquidity risk is through Insurance’s non-annuity and surplus assets, any shortfall arising in the annuity portfolio and the investment portfolios within the general insurance business. Liquidity risk is actively managed and monitored within the Insurance business to ensure that it remains within approved risk appetite, so that even under stress conditions, there is sufficient liquidity to meet obligations and remain within approved risk appetite. In addition, liquidity risk is controlled via approved funding and liquidity policies.obligations.

 

MONITORING

Liquidity is actively monitored at Group level. Routine reporting is in place to senior management and through the Group’s committee structure, in particular GALCO which meets monthly. In a stress situation the level of monitoring and reporting is increased commensurate with the nature of the stress event. Liquidity policies and procedures are subject to independent internal oversight.

 

Daily monitoring and control processes are in place to address internal and regulatory liquidity requirements. In order to meet ring-fencing requirements from 1 January 2019, the shape and scale of liquidity reporting has increased with additional monitoring and reporting requirements for the Ring-Fenced Bank (RFB) sub-group and non-ring-fenced banking entities. The Group monitors a range of market and internal early warning indicators on a daily basis for early signs of liquidity risk in the market or specific to the Group. This captures regulatory metrics as well as metrics the Group considers relevant for its liquidity profile. These are a mixture of quantitative and qualitative measures, including: daily variation of customer balances,balances; changes in maturity profiles, cash outflows,profiles; funding concentration,concentrations; changes in primary liquidity portfolio,LCR outflows; credit default swap (CDS) spreadsspreads; and changing funding costs.

103

OPERATING AND FINANCIAL REVIEW AND PROSPECTSbasis risks.

 

In addition, the monitoring framework has two other important components. Firstly, theThe Group carries out internal stress testing of its liquidity and potential cash flow mismatch position over both short (up to one month) and longer term (up to three months)longer-term horizons against a range of scenarios reflecting possible future liquidity risks.forming an important part of the internal risk appetite. The scenarios and the assumptions are reviewed at least annually to gain assuranceensure that they continue to be relevant to the nature of the business.business including reflecting emerging horizon risks to the Group, such as a further sovereign downgrade. For further information on the Group’s 20152018 liquidity stress testing results refer to page 108. In addition to the liquidity stress testing framework, the Group funding plan is stressed against a range of macroeconomic scenarios, including those prescribed by the PRA. The Group also applies its own macroeconomic stress scenarios, including a one in 20 year recession. Liquidity Risk Appetite and regulatory metrics are calculated and monitored over the life the plan under base and stress conditions.92.

 

Secondly, theThe Group maintains a Contingency Funding Plan which is designed to identify emerging liquidity concerns at an early stage, so that mitigating actions can be taken to avoid a more serious crisis developing. Contingency Funding Plan invocation and escalation processes are based on analysis of five major quantitative and qualitative components, comprising assessment of: early warning indicators,indicators; prudential and regulatory liquidity risk limits and triggers,triggers; stress testing results,results; event and systemic indicatorsindicators; and market intelligence.

 

Funding and liquidity management in 20152018

During 2015 theThe Group has maintained its strong funding and liquidity position with a stable loan to deposit ratio of 109107 per cent.

During the year, the Group took advantage of favourable funding markets to raise £21.4 billion of new term wholesale funding in order to refinance maturities in the year including the Bank of England’s Funding for Lending Scheme (FLS) and increase liquidity buffers. As a result wholesale funding increased from £101.1 billion to £123.3 billion.

During 2018, the Group repaid £12 billion of its FLS drawings, which has reduced the amount outstanding to £13.1 billion at 31 December 2018. The balance of Term Funding Scheme drawings remains at £19.9 billion as at 31 December 2018.

The Group’s liquidity position remains strong and in excess of the regulatory minimum and internal risk appetite, with a LCR of 130 per cent as at 31 December 2018 based on the EU Delegated Act. Total LCR eligible liquid assets broadly equal to total wholesale funding and over five times money market funding less than one year to maturityas at 31 December 2015. The Group has a diverse funding platform which comprises a strong customer deposit base along with wholesale funding comprising of a range of secured and unsecured funding products.2018 were £129.4 billion, up £8.5 billion in the year.

 

Total funded assets reduced by £22.2 billion to £471.2 billion during 2015. Loans and advances to customers, excluding reverse repos, reduced by £22.4 billion. Mortgage lending increased by 1 per cent, slightly below market growth, reflecting the Group’s focus on protecting margin in a low growth environment. UK loan growth in Consumer Finance was strong at 17 per cent and SME lending growth was 5 per cent, both outperforming the market. The growth was offset by the sale of TSB, the further reduction in run-off and other lending portfolios which are closed to new business.

Total customer deposits fell by £28.8 billion to £418.3 billion at 31 December 2015, largely due to the sale of TSB and the planned reduction in tactical deposits.

Wholesale funding has increased by £3.4 billion to £119.9 billion; the amount with a residual maturity less than one year falling to £37.9 billion (£41.1 billion at 31 December 2014). The Group’s term funding ratio (wholesale funding with a remaining life of overstrong ratings continue to reflect its robust balance sheet, improved profitability and bail-in capital position. During 2018, S&P upgraded Lloyds Bank plc’s long-term rating by one year as a percentage of total wholesale funding) increasednotch to 68 per cent (65 per cent at 31 December 2014). In 2015 the Group’s term issuance costs were lower than 2014‘A+’ and significantly lower than previous years.

In 2015 Standard and Poor’s (S&P),S&P, Moody’s and Fitch completed their exceptional reviews of Lloyds Bank’sassigned definitive ratings following the UK implementation of the EU Bank Recovery and Resolution Directive. In all cases, Lloyds Bank’s ratings were either affirmed or upgraded due to the delivery of our strategy to be a low risk, customer focused UK bank and/or recognition of the protection Lloyds’ sizeable subordinated debt buffer provides to senior creditors. In particular, Fitch upgraded Lloyds Bank to ‘A+’ from ‘A’ and revised the outlook to ’Stable’ from ‘Negative’. Moody’s affirmed Lloyds’ rating at ‘A1’ with a ‘Positive’ outlook. S&P affirmed Lloyds’ rating at ‘A’ with a ’Stable’ outlook. Following these rating actions, Lloyds Bank’s median rating has improved to ‘A+’ (previously ‘A’). The effectsCorporate Markets (LBCM) of a potential downgrade from all three rating agencies are included in the Group liquidity stress testing.A/ A1/A respectively.

The LCR became the Pillar 1 standard for liquidity in the UK in October 2015. The Group comfortably meets the requirements and has a robust and well governed reporting framework in place for both regulatory reporting and internal management information. The Net Stable Funding Ratio (NSFR) is due to become a minimum standard from January 2018. The Group continues to monitor the requirements and expects to meet the minimum requirements once these are confirmed by the PRA.

The combination of a strong balance sheet and access to a wide range of funding markets, including government and central bank schemes, provides the Group with a broad range of options with respect to funding the balance sheet.

Table 1.44: Summary funding and liquidity metrics

  At 31 Dec
2015		  At 31 Dec
2014		  Change
%		 
LCR eligible liquidity buffer (£bn)1 123.4  109.3  13 
Term funding ratio (%) 68.4  64.7  6 
Loan to deposit ratio (%) 108.8  106.8  2 
LCR eligible liquid assets/money market funding less than one year maturity1 5.7  5.8  (2)

1Comparative 2014 data relates to Individual Liquidity Adequacy Standards (ILAS) eligible primary liquid assets.
10489

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Table 1.45:1.34:Group funding position

  At 31 Dec  At 31 Dec    
  2015  2014  Change 
  £bn  £bn  % 
Funding requirement            
Loans and advances to customers1  455.2   477.6   (5)
Loans and advances to banks2  3.4   3.0   13 
Debt securities  4.2   1.2     
Reverse repurchase agreements  1.0   –     
Available-for-sale financial assets – non LCR eligible3  2.7   8.0   (66)
Cash and balances at central banks – non LCR eligible4  4.7   3.6   31 
Funded assets  471.2   493.4   (4)
Other assets5  234.2   265.2   (12)
   705.4   758.6   (7)
On balance sheet LCR eligible liquid assets6            
Reverse repurchase agreements  –   7.0     
Cash and Balances at central banks4  53.7   46.9   14 
Available-for-sale financial assets  30.3   48.5   (38)
Held to maturity financial assets  19.8   –     
Trading and fair value through profit and loss  3.0   (6.1)    
Repurchase agreements  (5.5)  –     
   101.3   96.3   5 
Total Group assets  806.7   854.9   (6)
Less: Other liabilities5  (221.5)  (240.3)  (8)
Funding requirement  585.2   614.6   (5)
Funded by            
Customer deposits  418.3   447.1   (6)
Wholesale funding7  119.9   116.5   3 
   538.2   563.6   (5)
Repurchase agreements  –   1.1     
Total equity  47.0   49.9   (6)
Total funding  585.2   614.6   (5)

     At 1 Jan     At 31 Dec    
  At 31 Dec  2018     2017    
  2018  (adjusted)1  Change  (reported)  Change 
  £bn  £bn  (%)  £bn  (%) 
Funding requirement                    
Loans and advances to customers2  444.4   444.2   –   455.7   (2)
Loans and advances to banks3  5.9   1.7       4.1   44 
Debt securities at amortised cost  4.0   3.3   21   3.6   11 
Reverse repurchase agreements  –   0.7       0.7     
Financial assets at fair value through other comprehensive income – non-LCR eligible4  0.8   1.7   (53)        
Available-for-sale financial assets – non-LCR eligible4              0.9     
Cash and balances at central bank – non-LCR eligible5  5.8   4.8   21   4.8   21 
Funded assets  460.9   456.4   1   469.8   (2)
Other assets6  212.9   247.2   (14)  234.7   (9)
   673.8   703.6   (4)  704.5   (4)
On balance sheet LCR eligible liquid assets                    
Reverse repurchase agreements  40.9   16.9       16.9     
Cash and balances at central banks5  48.9   53.7   (9)  53.7   (9)
Debt securities at amortised cost  1.2               �� 
Financial assets at fair value through other comprehensive income  24.0   41.2   (42)        
Available-for-sale financial assets              41.2     
Trading and fair value through profit and loss  11.9   1.7       1.7     
Repurchase agreements  (3.1)  (5.9)  (47)  (5.9)  (47)
   123.8   107.6   15   107.6   15 
Total Group assets  797.6   811.2   (2)  812.1   (2)
Less: other liabilities6  (187.9)  (226.8)  (17)  (226.5)  (17)
Funding requirement  609.7   584.4   4   585.6   4 
Funded by                    
Customer deposits7  416.3   415.5       415.5   – 
Wholesale funding8  123.3   101.1   22   101.1   22 
   539.6   516.6   4   516.6   4 
Term funding scheme  19.9   19.9   –   19.9     
Total equity  50.2   47.9   5   49.1   2 
Total funding  609.7   584.4   4   585.6   4 

 

1Excludes £nil (31 December 2014: £5.1 billion)Adjusted to reflect the implementation of reverse repurchase agreements.IFRS 9 and IFRS 15.
  
2Excludes £20.8reverse repos of £40.5 billion (1 January 2018: £16.8 billion; 31 December 2017: £16.8 billion).
3Excludes nil (31 December 2014: £21.32017: £1.7 billion) of loans and advances to banks within the Insurance business and £0.9£0.4 billion (31(1 January 2018: £0.8 billion; 31 December 2014: £1.92017: £0.8 billion) of reverse repurchase agreements.
  
34Non LCRNon-LCR eligible liquidityliquid assets comprise a diversified pool of highly rated unencumbered collateral (including retained issuance).
  
45Cash balances and balances at central banks are combined in the Group’s balance sheet.
  
56Other assets and other liabilities primarily include balances in the Group’s Insurance business and the fair value of derivative assets and liabilities.
  
672014 comparators are on an ILAS basis.Excludes repos of £1.8 billion (1 January 2018: £2.6 billion; 31 December 2017: £2.6 billion).
  
78The Group’s definition of wholesale funding aligns with that used by other international market participants; including interbank deposits, debt securities in issue and subordinated liabilities.
10590

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Table 1.46:1.35:Reconciliation of Group funding to the balance sheet (audited)

  At 31 December 2015  At 31 December 2014 
  Included in
funding analysis
£bn		  Repos and
cash collateral
received by
Insurance
£bn		  Fair value
and other
accounting
methods
£bn		  Balance sheet
£bn		  Included in
funding analysis
£bn		  Repos and cash
collateral received
by Insurance
£bn		  Fair value
and other
accounting
methods
£bn		  Balance sheet
£bn		 
Deposits from banks 8.5  8.4  –  16.9  9.8  1.1  –  10.9 
Debt securities in issue 88.1  –  (6.0) 82.1  80.6  –  (4.4) 76.2 
Subordinated liabilities 23.3  –  –  23.3  26.1  –  (0.1) 26.0 
Total wholesale funding 119.9  8.4        116.5  1.1       
Customer deposits 418.3  –  –  418.3  447.1  –  –  447.1 
Total 538.2  8.4        563.6  1.1       
           
Table 1.47: Analysis of 2015 total wholesale funding by residual maturity          
 Less than
one month
£bn		  One to
three
months
£bn		  Three to
six months
£bn		  Six to
nine
months
£bn		  Nine
months to
one year
£bn		  One to
two years
£bn		  Two to
five years
£bn		  More than
five years
£bn		  Total at
31 Dec
2015
£bn		  Total at
31 Dec
2014
£bn		 
Deposit from banks 6.7   0.8   0.5   0.1   0.1   –   –   0.3   8.5   9.8 
Debt securities in issue:                                       
Certificates of deposit 1.0   4.3   2.0   2.5   0.8   –   –   –   10.6   6.8 
Commercial paper 3.7   2.3   0.3   0.2   0.1   –   –   –   6.6   7.3 
Medium-term notes1 0.9   0.6   2.0   0.9   0.5   5.2   13.6   13.9   37.6   29.2 
Covered bonds –   –   1.2   1.1   0.5   5.3   7.4   10.3   25.8   25.2 
Securitisation 0.4   –   0.8   0.2   0.2   3.6   0.9   1.4   7.5   12.1 
  6.0   7.2   6.3   4.9   2.1   14.1   21.9   25.6   88.1   80.6 
Subordinated liabilities –   0.2   0.2   0.5   2.3   0.9   7.6   11.6   23.3   26.1 
Total wholesale funding2 12.7   8.2   7.0   5.5   4.5   15.0   29.5   37.5   119.9   116.5 
Of which is issued by
Lloyds Banking Group plc3		 –   –   –   –   0.3   –   –   3.1   3.4   2.6 

  Included in
funding
analysis
£bn		  Repos
and cash
collateral
received by
Insurance
£bn		  Fair value
and other
accounting
methods
£bn		  Balance
sheet
£bn		 
At 31 December 2018                
Deposits from banks  8.3   22.1   (0.1)  30.3 
Debt securities in issue  97.1   –   (5.9)  91.2 
Subordinated liabilities  17.9   –   (0.2)  17.7 
Total wholesale funding  123.3   22.1         
Customer deposits  416.3   1.8   –   418.1 
Total  539.6   23.9         
At 31 December 2017                
Deposits from banks  5.1   24.1   0.6   29.8 
Debt securities in issue  78.1   –   (5.6)  72.5 
Subordinated liabilities  17.9   –   –   17.9 
Total wholesale funding  101.1   24.1         
Customer deposits  415.5   2.6   –   418.1 
Total  516.6   26.7         

Table 1.36:Analysis of 2018 total wholesale funding by residual maturity

  Less
than one
month
£bn		  One to
three
months
£bn		  Three to
six months
£bn		  Six to nine
months
£bn		  Nine
months
to one year
£bn		  One to
two years
£bn		  Two to
five years
£bn		  More than
five years
£bn		  Total at
31 Dec
2018
£bn		  Total at
31 Dec
2017
£bn		 
Deposit from banks  5.3   0.9   0.7   0.1   0.1   0.5   0.7   –   8.3   5.1 
Debt securities in issue:                                        
Certificates of deposit  1.7   2.4   4.1   1.3   1.3   1.2   –   –   12.0   10.0 
Commercial paper  1.1   2.7   3.8   0.3   0.1   –   –   –   8.0   3.2 
Medium-term notes  0.5   –   0.1   2.2   0.3   4.5   16.0   21.8   45.4   37.4 
Covered bonds  0.7   –   1.1   1.0   –   5.5   12.6   6.2   27.1   24.7 
Securitisation  –   0.6   –   0.1   –   2.8   –   1.1   4.6   2.8 
   4.0   5.7   9.1   4.9   1.7   14.0   28.6   29.1   97.1   78.1 
Subordinated liabilities  0.1   0.1   –   0.3   0.1   2.4   2.7   12.2   17.9   17.9 
Total wholesale funding1  9.4   6.7   9.8   5.3   1.9   16.9   32.0   41.3   123.3   101.1 
Of which issued by Lloyds Banking Group plc2  –   –   –   –   –   –   9.9   10.4   20.3   15.4 

1Medium-term notes include funding from the National Loan Guarantee Scheme (31 December 2015: £1.4 billion; 31 December 2014: £1.4 billion).
2The Group’s definition of wholesale funding aligns with that used by other international market participants; including interbank deposits, debt securities in issue and subordinated liabilities.
  
32Comprises £3.4 billionConsists of subordinated liabilities (31 December 2014: £2.0 billion) and £nil of medium termmedium-term notes (31 December 2014: £0.6 billion) issued by the holding company, Lloyds Banking Group plc.only.

 

Table 1.48: Total wholesale funding by currency (audited)             
  Sterling  US dollar  Euro  Other currencies  Total 
  £bn  £bn  £bn  £bn  £bn 
At 31 December 2015 34.9  37.6  41.3  6.1  119.9 
At 31 December 2014 34.4  35.6  40.1  6.4  116.5 
             
Table 1.49: Analysis of 2015 term issuance (audited)            
           Other    
  Sterling  US dollar  Euro  currencies  Total 
  £bn  £bn  £bn  £bn  £bn 
Securitisation 1.0  1.2  0.3  –  2.5 
Medium-term notes 0.3  4.8  3.3  1.2  9.6 
Covered bonds 1.7  –  2.0  –  3.7 
Private placements1 1.0  2.1  2.3  –  5.4 
Subordinated liabilities –  0.3  –  –  0.3 
Total issuance 4.0  8.4  7.9  1.2  21.5 
Of which is issued by Lloyds Banking Group plc2 –  0.3  –  –  0.3 

Table 1.37:Total wholesale funding by currency (audited)

  Sterling
£bn		  US Dollar
£bn		  Euro
£bn		  Other
currencies
£bn		  Total
£bn		 
At 31 December 2018  25.8   45.2   42.8   9.5   123.3 
At 31 December 2017  25.8   32.1   37.0   6.2   101.1 

Table 1.38:Analysis of 2018 term issuance (audited)

  Sterling
£bn		  US Dollar
£bn		  Euro
£bn		  Other
currencies
£bn		  Total
£bn		 
Securitisation  0.8   1.5   –   –   2.3 
Medium-term notes  –   6.2   1.3   3.0   10.5 
Covered bonds  3.0   0.6   0.9   –   4.5 
Private placements1  0.1   0.7   0.1   0.2   1.1 
Subordinated liabilities  –   2.3   0.7   –   3.0 
Total issuance  3.9   11.3   3.0   3.2   21.4 
Of which issued by Lloyds Banking Group plc2  –   4.9   1.3   2.6   8.8 
                     
1Private placements include structured bonds and term repurchase agreements (repos).
  
2Comprises £0.3 billionConsists of subordinated liabilities issued by the holding company, Lloyds Banking Group plc. In addition Lloyds Banking Group plc issued c£1.2 billion of subordinated liabilities as part of an exchange of outstanding operating company securities for new holding company securities.medium-term notes only.
91

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Term issuance for 2015 totalled £21.5 billion. The Group continuedcontinues to maintain a diversified approach toaccess wholesale funding markets with trades in public and private format, secured and unsecured products andacross a wide range of products, currencies and markets. For 2016,investors to maintain a stable and diverse source of funds. In 2019, the Group will continue to maintainwith this diversified approach to funding, including capital and funding from the holding company, Lloyds Banking Group plc, as needed to optimise the capital and funding position to transition towards final UK Minimum Requirements for Own Funds and Eligible Liabilities (MREL) which is still being consulted on in. The Group will continue to issue funding trades from Lloyds Bank plc, operating company, across senior unsecured, covered bonds, ABS and RMBS. Over the UK. Continued usecourse of 2019, the UK government’sGroup expects to launch an operating company funding programme for LBCM. The maturity of the Funding for Lending Scheme (FLS) has further underlined the Group’s support to the UK economic recovery and the Group remains committed to passing the benefits of this low cost funding on to its customers. In 2015 the Group drew down £12.1 billion under the FLS, bringing total drawings under the FLS to £32.1 billion. The maturities for the FLSTerm Funding Schemes are fully factored into the Group’s funding plan.

106

OPERATING AND FINANCIAL REVIEW AND PROSPECTSplans, and in the expected ‘steady state’ wholesale funding requirements of £15-20 billion per annum.

 

LIQUIDITY PORTFOLIO

The UK regulator adopted the EU delegated Act on 1 October 2015. Prior to this, liquidity was managed on an Individual Liquidity Adequacy Standards (ILAS) basis where liquid assets were divided into Primary and Secondary categories. Post 1 October 2015, liquid assets are classed as LCR eligible or non-LCR eligible.

Portfolio

At 31 December 2015,2018, the Bankingbanking business had £123.4£129.4 billion of highly liquid unencumbered LCR eligible assets (31 December 2017: £120.9 billion), of which £122.9£128.6 billion is LCR level 1 eligible (31 December 2017: £120.2 billion) and £0.5£0.8 billion is LCR level 2 eligible.eligible (31 December 2017: £0.7 billion). These assets are available to meet cash and collateral outflows and PRA regulatory requirements. AThe Insurance business manages a separate liquidity portfolio to mitigate any insurance liquidity risk is managed within the Insurance business.risk. Total LCR eligible liquid assets represent 5.7just under 6.2 times the Group’s money market funding less than one year to maturity (excluding derivative collateral margins and settlement accounts) and is broadly equivalent toexceed total wholesale funding, and thus providesprovide a substantial buffer in the event of continued market dislocation. During 2015 the Group has increased regulatory liquidity to strengthen the overall liquidity position.

 

Table 1.50: LCR eligible assets      
  At 31 Dec
2015
£bn		  Average
20151
£bn		 
Level 1      
Cash and central bank reserves  53.7   57.2 
High quality government/MDB/agency bonds2  65.8   63.0 
High quality covered bonds  3.4   3.3 
Total Level 1  122.9   123.5 
         
Level 23  0.5   0.7 
Total LCR eligible assets  123.4   124.2 

Table 1.39:LCR eligible assets

  At 31 Dec
2018
£bn		  At 31 Dec
2017
£bn		  Change
%		  Average
2018
£bn		  Average
2017
£bn		 
Level 1                    
Cash and central bank reserves  48.9   53.7   (9)  58.1   51.0 
High quality government/MDB/agency bonds1  78.7   65.8   20   66.2   72.0 
High quality covered bonds  1.0   0.7   43   0.8   1.1 
Total  128.6   120.2   7   125.1   124.1 
Level 22  0.8   0.7   14   0.8   0.6 
Total LCR eligible assets  129.4   120.9   7   125.9   124.7 

 

1Average for fourth quarter 2015 only.
2Designated multilateral development bank (MDB). Includes eligible government guaranteed bonds.
3
2Includes Level 2A and Level 2B.

 

Table 1.51: LCR eligible assets by currency            
  At 31 December 2015
   Sterling
£bn		   US Dollar
£bn		   Euro
£bn		   Total
£bn		 
Level 1  90.9   15.8   16.2   122.9 
Level 2  0.1   –   0.4   0.5 
Total  91.0   15.8   16.6   123.4 
Table 1.52: ILAS eligible assets            
  At 31 Dec  At 31 Dec  Average  Average 
  2015  2014  2015  2014 
  £bn  £bn  £bn  £bn 
Primary liquidity1            
Cash and balances at central bank  52.6   46.9   65.1   62.3 
Government/MDB bonds2  64.4   62.4   51.3   47.9 
Total  117.0   109.3   116.4   110.2 
Secondary liquidity1                
High-quality ABS/covered bonds3  3.3   3.9   3.6   3.6 
Credit institution bonds3  0.2   0.9   0.5   1.4 
Corporate bonds3  0.3   0.6   0.4   0.3 
Own securities (retained insurance)  14.7   20.6   15.9   22.2 
Other securities  9.1   5.7   6.5   5.5 
Other4  76.6   67.5   65.2   74.1 
Total  104.2   99.2   92.1   107.1 
Total liquidity  221.2   208.5         

1Primary and secondary liquidity as defined under the ILAS regulatory system.
2Designated multilateral development bank (MDB).
3Assets rated A- or above.
4Includes other central banks eligible assets.
107

OPERATING AND FINANCIAL REVIEW AND PROSPECTSTable 1.40:LCR eligible assets by currency

 

Table 1.53: ILAS eligible assets by currency
  At 31 December 2015 At 31 December 2014
  Sterling
£bn		 US Dollar
£bn		 Euro
£bn		 Total
£bn		 Sterling
£bn		 US Dollar
£bn		 Euro
£bn		 Total
£bn
At 31 December 2015                
Primary liquidity1 88.6 14.8 13.6 117.0 81.1 14.5 13.7 109.3
Secondary liquidity1 97.0 2.2 5.0 104.2 91.3 1.2 6.7 99.2
Total 185.6 17.0 18.6 221.2 172.4 15.7 20.4 208.5

1Primary and secondary liquidity as defined under the ILAS regulatory system.
  Sterling
£bn		  US Dollar
£bn		  Euro
£bn		  Other
currencies
£bn		  Total
£bn		 
At 31 December 2018                    
Level 1  98.2   19.8   10.6   –   128.6 
Level 2  0.4   0.4   –   –   0.8 
Total  98.6   20.2   10.6   –   129.4 
At 31 December 2017                    
Level 1  90.8   16.3   13.1   –   120.2 
Level 2  0.2   0.5   –   –   0.7 
Total  91.0   16.8   13.1   –   120.9 

 

The Bankingbanking business also had £98.9 billionhas a significant amount of secondary, non-LCR eligible liquidity, the vast majority ofliquid assets which however, isare eligible for use in a range of central bank or similar facilities and the Group routinely makes use of as part of its normal liquidity management practices.facilities. Future use of such facilities will be based on prudent liquidity management and economic considerations, having regard for external market conditions.

 

The Group considers diversification across geography, currency, markets and tenor when assessing appropriate holdings of primary and secondary liquid assets. This liquidity is managed as a single pool in the centre and is under the control of the function charged with managing the liquidity of the Group. It is available for deployment at immediate notice, subject to complying with regulatory requirements, and is a key component of the Group’s liquidity management process.

STRESS TESTING RESULTS

Stress testing results

Internal liquidity stress testing results at 31 December 20152018 showed that the Bankingbanking business had liquidity resources representing 163167 per cent of modelled outflows from all wholesale funding sources, retail and corporate deposits, intraday requirements and rating dependent contracts under the Group’s most severe liquidity stress scenario (the three month PRA combined scenario).scenario.

 

The liquidity stress testing assumes that further credit rating downgrades may reduce investor appetite for some of the Group’s liability classes and therefore funding capacity. A hypothetical idiosyncraticabove scenario considers a two notch downgrade of the Group’s current long-term debt rating and accompanying one notch short-term downgrade implemented instantaneously by all major rating agencies, which could result in ana contractual outflow of £1.5£1.3 billion of cash over a period of up to one year, £2.1£2.2 billion of collateral posting related to customer financial contracts and £5.6£6.1 billion of collateral posting associated with secured funding. The Group’s internal liquidity risk appetite includes such a stress scenario. The stress scenario modelling demonstrates the Group has available liquidity resources to manage such an event.

 

ENCUMBERED ASSETS

Encumbered assets

This disclosure provides further detail on the availability of assets that could be used to support potential future funding requirements of the Group. The disclosure is not designed to identify assets that would be available in the event of a resolution or bankruptcy.

 

The Group’s analysis separately identifies thoseBoard and the Group Asset and Liability Committee (GALCO) monitor and manage total balance sheet encumbrance using a number of risk appetite metrics. At 31 December 2018, the Group had £53.4 billion (31 December 2017: £64.6 billion) of externally encumbered on-balance sheet assets with counterparties other than central banks. The decrease in encumbered assets was primarily driven by a decrease in repo encumbrance. The Group also had £584.3 billion (31 December 2017: £587.5 billion) of unencumbered on-balance sheet assets, and £159.8 billion (31 December 2017: £160.1 billion) of pre-positioned and encumbered assets held with central banks. Primarily, the Group encumbers mortgages, unsecured lending and credit card receivables through the issuance programmes and tradable securities through securities financing activity. The Group mainly positions mortgage assets at central banks;banks.

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Table 1.41:On balance sheet encumbered and unencumbered assets not held at central banks are classified as either encumbered or unencumbered.

  Encumbered with Pre-  Unencumbered assets   
  counterparties other positioned  not pre-positioned   
  than central banks and  with central banks   
              encumbered                
              assets     Other          
     Covered        held with  Readily  realisable  Cannot be       
  Securitisations  bond  Other  Total  central banks  realisable1  assets2  used3  Total  Total 
  £m  £m  £m  £m  £m  £m  £m  £m  £m  £m 
At 31 December 2018                                        
Cash and balances at central banks  –   –   –   –   –   49,645   –   5,018   54,663   54,663 
Financial assets at fair value through profit or loss  54   –   2,646   2,700   –   5,190   –   150,639   155,829   158,529 
Derivative financial instruments  –   –   –   –   –   –   –   23,595   23,595   23,595 
Financial assets at amortised cost:                                        
Loans and advances to banks  –   –   12   12   –   1,223   2,555   2,493   6,271   6,283 
Loans and advances to customers  5,774   29,041   6,012   40,827   159,822   12,098   155,278   116,833   284,209   484,858 
Debt securities  –   –   2,627   2,627   –   2,581   4   26   2,611   5,238 
   5,774   29,041   8,651   43,466   159,822   15,902   157,837   119,352   293,091   496,379 
Financial assets at fair value through other comprehensive income  –   –   7,278   7,278   –   17,114   –   423   17,537   24,815 
Other4  –   –   –   –   –   56   612   38,949   39,617   39,617 
Total assets  5,828   29,041   18,575   53,444   159,822   87,907   158,449   337,976   584,332   797,598 
At 31 December 2017                                        
Cash and balances at central banks  –   –   –   –   –   53,887   –   4,634   58,521   58,521 
Trading and other financial assets at fair value through profit or loss  –   –   4,642   4,642   –   7,378   –   150,858   158,236   162,878 
Derivative financial instruments  –   –   –   –   –   –   –   25,834   25,834   25,834 
Loans and receivables:                                        
Loans and advances to banks  –   –   –   –   –   213   1,417   4,981   6,611   6,611 
Loans and advances to customers  5,023   26,414   6,610   38,047   160,060   13,927   170,771   89,693   274,391   472,498 
Debt securities  –   –   2,374   2,374   –   919   4   346   1,269   3,643 
   5,023   26,414   8,984   40,421   160,060   15,059   172,192   95,020   282,271   482,752 
Available-for-sale financial assets  –   –   19,526   19,526   –   21,514   –   1,058   22,572   42,098 
Other4  –   –   –   –   –   16   1,175   38,835   40,026   40,026 
Total assets  5,023   26,414   33,152   64,589   160,060   97,854   173,367   316,239   587,460   812,109 

 

–1Encumbered assets: Assets recognised on the Group’s balance sheet which have been pledged as collateral against an existing liability, and as a result are assets which are unavailable to the Group to secure funding, satisfy collateral needs or be sold to reduce potential future funding requirements.
–Pre-positioned and encumbered assets held with central banks: Assets which have been delivered to central banks to facilitate future drawdowns under central bank funding schemes and assets which are encumbered under such schemes.
The following sub analyses have been provided for unencumbered assets not pre-positioned at central banks:
–Unencumbered – Readily realisable: Assets regarded by the Group to be readily realisable in the normal course of business, to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, and are not subject to any restrictions on their use for these purposes.
  
–2Unencumbered – Other realisable: Assets where there are no restrictions on their use to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, but are not readily realisable in the normal course of business in their current form.
  
–3UnencumberedThe following assets are classified as unencumbered – Cannotcannot be used: Assets that have not beenassets held within the Group’s Insurance businesses which are generally held to either back liabilities to policyholders or to support the solvency of the Insurance subsidiaries; assets held within consolidated limited liability partnerships which provide security for the Group’s obligations to its pension schemes; assets segregated in order to meet the Financial Resilience requirements of the PRA’s Supervisory Statement 9/16 ‘Operational Continuity in Resolution’; assets pledged but whichto facilitate the Group has assessed could not be pledgeduse of intra-day payment and therefore could not be used to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements.settlement systems; and reverse repos and derivatives balance sheet ledger items.

The following assets are classified as unencumbered – cannot be used: assets held within the Group’s Insurance businesses which are generally held to either back liabilities to policyholders or to support the solvency of the Insurance subsidiaries; assets held within consolidated limited liability partnerships which provide security for the Group’s obligations to its pension schemes; assets pledged to facilitate the use of intra-day payment and settlement systems; and reverse repos and derivatives balance sheet ledger items.

The Board and GALCO monitor and manage total balance sheet encumbrance via a number of risk appetite metrics. At 31 December 2015, the Group had £77.4 billion (31 December 2014: £105.2 billion) of externally encumbered on balance sheet assets with counterparties other than central banks. The reduction in encumbered assets was driven by securitisation and covered bond maturities. The Group also had £573.7 billion (31 December 2014: £641.8 billion) of unencumbered on balance sheet assets, and £155.6 billion (31 December 2014: £107.8 billion) of pre-positioned and encumbered assets held with central banks. Primarily the Group encumbers mortgages, unsecured lending and credit card receivables through the issuance programmes and tradable securities through securities financing activity. The Group mainly positions mortgage assets at central banks.

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Table 1.54: On balance sheet encumbered and unencumbered assets

  Encumbered with counterparties other than
central banks		 Pre-
positioned
and
encumbered
assets held
with central
banks		 Unencumbered assets not pre-positioned with central banks Total 
  Securitisations
£m		 Covered
bonds
£m		 Other
£m		 Total
£m		 £m Readily
realisable
£m		 Other
realisable
assets
£m		 Cannot be
used
£m		 Total
£m		 £m 
At 31 December 2015                   
Cash and balances at central banks – – – – – 56,323 – 2,094 58,417 58,417 
Trading and other financial assets at fair value through profit or loss – – 6,922 6,922 – 7,459 17 126,138 133,614 140,536 
Derivative financial instruments – – – – – – – 29,467 29,467 29,467 
Loans and receivables:                    
Loans and advances to banks – – 37 37 – 431 910 23,739 25,080 25,117 
Loans and advances to customers 13,668 32,641 7,418 53,727 150,086 7,678 159,510 84,174 251,362 455,175 
Debt securities – – 855 855 – 3,150 62 124 3,336 4,191 
  13,668 32,641 8,310 54,619 150,086 11,259 160,482 108,037 279,778 484,483 
Available-for-sale financial assets – – 15,810 15,810 5,548 11,048 31 595 11,674 33,032 
Held-to-maturity investments – – – – – 19,808 – – 19,808 19,808 
Other1 – – – – – 10 2,716 38,219 40,945 40,945 
Total assets 13,668 32,641 31,042 77,351 155,634 105,907 163,246 304,550 573,703 806,688 
At 31 December 2014                     
Cash and balances at centralbanks – – – – – 48,302 – 2,190 50,492 50,492 
Trading and other financial assets at fair value through profit or loss – – 13,389 13,389 – 5,149 2,259 131,134 138,542 151,931 
Derivative financialinstruments – – – – – – – 36,128 36,128 36,128 
Loans and receivables:                     
Loans and advances to banks – – 26 26 – 424 712 24,993 26,129 26,155 
Loans and advances to customers 25,534 39,280 7,850 72,664 107,803 16,086 161,458 124,693 302,237 482,704 
Debt securities – – 728 728 – 281 100 104 485 1,213 
  25,534 39,280 8,604 73,418 107,803 16,791 162,270 149,790 328,851 510,072 
Available-for-sale financial assets 119 – 18,321 18,440 – 37,711 30 312 38,053 56,493 
Held-to-maturity investments – – – – – – – – – – 
Other1 – – – – – 2,054 2,598 45,128 49,780 49,780 
Total assets 25,653 39,280 40,314 105,247 107,803 110,007 167,157 364,682 641,846 854,896 

14Other comprises: items in the course of collection from banks,banks; investment properties, goodwill,properties; goodwill; value of in-force business,business; other intangible assets,assets; tangible fixed assets,assets; current tax recoverable,recoverable; deferred tax assets,assets; retirement benefit assets and other assets.

 

The above table sets out the carrying value of the Group’s encumbered and unencumbered assets, separately identifying those that are available to support the Group’s funding needs. It should be noted that theThe table does not include collateral received by the Group (i.e. from reverse repos) that is not recognised on its balance sheet, the vast majority of which the Group is permitted to repledge. The Group provides collateralised security financing services to its clients, providing them with cash financing or specific securities. Collateralised security financing is also used to manage the Group’s own short-term cash and collateral needs. For securities accepted as collateral mandates are credit rating driven with appropriate notional limits per rating, asset and individual bond concentration. The vast majority of collateral the Group uses in repo/reverse repo and stock lending/stock borrowing transactions is investment grade government issued, primarily UK government debt. The majority of repo/reverse repo and stock lending/stock borrowing transactions are short-term, having a residual maturity of less than three months.

10993

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

FUNDING AND LIQUIDITY RISK – CONTRACTUAL CASH OBLIGATIONS

The following table sets out the amounts and maturities of Lloyds Banking Group’s contractual cash obligations at 31 December 2015.2018.

 

 Within
one year
£m		 One to three
years
£m		 Three to
five years
£m		 Over five
years
£m		 Total
£m		  Within
one year
£m		 One to three
years
£m		 Three to
five years
£m		 Over five
years
£m		 Total
£m		 
Enhanced capital notes – – 3,211 399 3,610 
Long-term debt – dated 584 580 – 12,845 14,009   576   3,323   2,291   6,870   13,060 
Debt securities in issue 25,759 21,258 14,522 28,395 89,934   25,392   26,244   16,301   30,316   98,253 
Finance leases 13 16 – 12 41   10   16   8   12   46 
Operating leases 267 451 434 1,049 2,201   259   458   349   977   2,043 
Capital commitments 388 – – – 388   378   –   –   –   378 
Other purchase obligations 1,308 2,056 1,275 660 5,299   1,337   2,340   1,346   987   6,010 
 28,319 24,361 19,442 43,360 115,482   27,952   32,381   20,295   39,162   119,790 

 

Other purchase obligations include amounts expected to be payable in respect of material contracts entered into by the Lloyds Banking Group, in the ordinary course of business, for the provision of outsourced and other services. The cost of these services will be charged to the income statement as it is incurred. The Lloyds Banking Group also has a constructive obligation to ensure that its defined post-retirement benefit schemes remain adequately funded. The amount and timing of the Lloyds Banking Group’s cash contributions to these schemes is uncertain and will be affected by factors such as future investment returns and demographic changes. Lloyds Banking Group expects to make cash contributions of at least £600£1,050 million to these schemes in 2016.2019.

 

At 31 December 2015,2018, Lloyds Banking Group also had £5,693£4,596 million of preference shares, preferred securities and undated subordinated liabilities outstanding.

 

At 31 December 2015,2018, the principal sources of potential liquidity for Lloyds Banking Group plc were dividends received from its directly owned subsidiary company,companies, particularly Lloyds Bank plc and Scottish Widows Group Limited, and loans from this and other Lloyds Banking Group companies. The ability of Lloyds Bank and HBOS to pay dividends going forward, or for Lloyds Bank or other Lloyds Banking Group companies to make loans to Lloyds Banking Group plc, depends on a number of factors, including their own regulatory capital requirements, distributable reserves and financial performance.

 

OFF-BALANCE SHEET ARRANGEMENTS

A table setting out the amounts and maturities of Lloyds Banking Group’s other commercial commitments and guarantees at 31 December 20152018 is included in note 5352 to the financial statements. These commitments and guarantees are not included in Lloyds Banking Group’s consolidated balance sheet.

 

Lending commitments are agreements to lend to customers in accordance with contractual provisions; these are either for a specified period or, as in the case of credit cards and overdrafts, represent a revolving credit facility which can be drawn down at any time, provided that the agreement has not been terminated. The total amounts of unused commitments do not necessarily represent future cash requirements, in that commitments often expire without being drawn upon.

 

Lloyds Banking Group’s financial guarantee contracts are accounted for as financial instruments and measured at fair value on the balance sheet. The contractual nominal amounts of these guarantees totalled £7,165 million at 31 December 2015 (with £4,014 million expiring within one year; £942 million between one and three years; £1,182 million between three and five years; and £1,027 million over five years).

Lloyds Banking Group’s banking businesses are also exposed to liquidity risk through the provision of securitisation facilities to certain corporate customers. At 31 December 2015,2018, Lloyds Banking Group offered securitisation facilities to its corporate and financial institution client base through its conduit securitisation vehicles, Argento, Cancara and Grampian. These are funded in the global asset-backed commercial paper market. The assets and obligations of these conduits are included in Lloyds Banking Group’s consolidated balance sheet. Lloyds Banking Group provides short-term asset-backed commercial paper liquidity support facilities on commercial terms to the issuers of the commercial paper, for use in the event of a market disturbance should they be unable to roll over maturing commercial paper or obtain alternative sources of funding.

 

Details of securitisations and other special purpose entity arrangements entered into by theLloyds Banking Group are provided in notes 1930 and 2048 to the financial statements. The successful development of Lloyds Banking Group’s ability to securitise its own assets has provided a mechanism to tap a well established market, thereby diversifying Lloyds Banking Group’s funding base.

As indicated on page F-35, the Group’s securitisations include a number of synthetic securitisation arrangements. Synthetic securitisations use credit default swaps to transfer the credit risk of the underlying assets to a third party without transferring the funding requirement. As the prices of the underlying assets fall, this creates a credit risk on the third party which typically is not collateralised. The total notional amount of credit default swaps used for synthetic securitisation transactions at 31 December 2015 was £83 million.

 

Within Lloyds Banking Group’s insurance businesses, the principal sources of liquidity are premiums received from policyholders, charges levied upon policyholders, investment income and the proceeds from the sale and maturity of investments. The investment policies followed by Lloyds Banking Group’s life assurance companies take account of anticipated cash flow requirements including by matching the cash inflows with projected liabilities where appropriate. Cash deposits and highly liquid government securities are available to provide liquidity to cover any higher than expected cash outflows.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

CAPITAL RISK

DEFINITION

Capital risk is defined as the risk that the Group has a sub-optimal amount or quality of capital or that capital is inefficiently deployed across the Group.

RISK APPETITE

Capital risk appetite is set by the Group Board, reflecting the Group’s strategic plans, regulatory capital constraints and market expectations. It is defined by a number of minimum capital ratios, a minimum leverage ratio and a minimum buffer over regulatory solvency requirements for the Insurance business set by the Insurance Board. The Group monitors its actual and forecast capital positions aiming to remain within its appetite at all times.

For further information on risk appetite refer to page 46.

EXPOSURES

A capital risk exposure arises when the Group has insufficient capital resources to support its strategic objectives and plans, and to meet external stakeholder requirements and expectations. This could arise due to a depletion of the Group’s capital resources as a result of the crystallisation of any of the risks to which it is exposed. Alternatively a shortage of capital could arise from an increase in the amount of capital that is needed to be held. The Group’s capital management approach is focused on maintaining sufficient capital resources to prevent such exposures while optimising value for shareholders.

MEASUREMENT

The Group measures the amount of capital it holds using the regulatory framework defined by the Capital Requirements Directive and Regulation (CRD IV) as implemented in the UK by the Prudential Regulation Authority (PRA). Full details of the Group’s regulatory capital framework are provided on page 14 of the Pillar 3 Report.

The minimum amount of total capital, under Pillar 1 of the regulatory framework, is determined as 8 per cent of aggregate risk-weighted assets. At least 4.5 per cent of risk-weighted assets are required to be covered by common equity tier 1 (CET1) capital and at least 6 per cent of risk-weighted assets are required to be covered by tier 1 capital. These minimum Pillar 1 requirements are supplemented by additional minimum requirements under Pillar 2 of the regulatory framework and a number of regulatory capital buffers as described below.

Additional minimum requirements are set by the PRA by the issuance of bank specific Individual Capital Guidance (ICG). This reflects a point in time estimate by the PRA, which may change over time, of the total amount of capital that is needed by the bank. It includes the assessment of risks that are not fully covered by Pillar 1, such as credit concentration and operational risk, and those risks not covered at all by Pillar 1 such as pensions and interest rate risk. During 2015 the PRA increased the Group’s ICG such that at 31 December 2015 it represented 4.6 per cent of risk-weighted assets of which 2.6 per cent had to be covered by CET1 capital. The Group believes that the increase reflects the impact of market and economic factors and the reduction in risk-weighted assets rather than any fundamental changes to the nature of the underlying risks. However the Group is not permitted by the PRA to give any further details of the quantum of the individual components.

The Group is also required to maintain a number of regulatory capital buffers which are required to be met with CET1 capital.

Systemic risk buffers are designed to hold systemically important banks to higher capital standards. The Group is not currently categorised as a global systemically important bank (G-SIB) for which the Financial Stability Board (FSB) has set buffer rates. The Financial Policy Committee (FPC) has recently issued a consultation on the UK systemic risk buffer requirements for ring-fenced banks and large building societies proposing a rate of up to 2.5 per cent. The requirements will come into force from 2019 and the Group awaits finalisation of these later in 2016.

The capital conservation buffer is a general buffer of 2.5 per cent of risk-weighted assets designed to provide for losses in the event of stress and is being phased in over the period from 1 January 2016 to 1 January 2019.

The countercyclical capital buffer is time-varying and is designed to require banks to hold additional capital to remove or reduce the build up of systemic risk in times of credit boom, providing additional loss absorbing capacity and acting as an incentive for banks to constrain further credit growth. The amount of the buffer is determined by reference to buffer rates set by the FPC for the individual countries where the Group has credit risk exposures. The current requirement for the Group is negligible.

The FPC can also set sectoral capital requirements which are temporary increases to banks’ capital requirements on exposures to specific sectors, if the FPC judges that exuberant lending to those sectors poses risks to financial stability. No sectoral capital requirements currently apply to the Group.

As part of the capital planning process, forecast capital positions are subjected to extensive stress analyses to determine the adequacy of the Group’s capital resources against the minimum requirements, including ICG. The PRA uses the outputs from some of these stress analyses to inform the setting of a minimum level of capital buffer for the Group. Prior to 2016 this was known as the Capital Planning Buffer but has now been replaced by the PRA Buffer which is set taking account of the capital conservation buffer, countercyclical capital buffer and any sectoral capital requirements that already apply to the Group. The PRA requires the PRA Buffer to remain confidential between the Group and the PRA.

In addition to the risk-based capital framework outlined above, the Group is also subject to minimum capital requirements under the UK’s leverage ratio framework. The leverage ratio is calculated by dividing ‘fully loaded’ tier 1 capital resources by a defined measure of on-balance sheet assets and off-balance sheet items.

The minimum leverage ratio is 3 per cent, in line with current Basel Committee proposals. In addition the UK framework requires two buffers to be maintained: The Additional Leverage Ratio Buffer (ALRB), which it is proposed should be up to 0.9 per cent, and a time-varying Countercyclical Leverage Buffer (CCLB) of up to 0.9 per cent (currently negligible for the Group). At least 75 per cent of the minimum 3 per cent requirement and the entirety of any buffers that may apply must be met by CET1 capital. The ALRB applies from 1 January 2016 but only for G-SIBs and as the Group is not categorised as a G-SIB it is not currently subject to the ALRB. Final rules are awaited on the wider application of the ALRB to ring-fenced banks and large building societies within the UK from 2019.

The proposed leverage ratio framework does not currently give rise to higher capital requirements for the Group than the risk-based capital framework.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

MITIGATION

The Group has a capital management framework including policies and procedures that are designed to ensure that it operates within its risk appetite, uses its capital resources efficiently and continues to comply with regulatory requirements.

The Group is able to accumulate additional capital through the retention of profits over time, which can be enhanced through cutting costs and reducing or cancelling dividend payments, by raising new equity via, for example, a rights issue or debt exchange and by raising additional tier 1 or tier 2 capital through issuing tier 1 instruments or subordinated liabilities. The cost and availability of additional capital is dependent upon market conditions and perceptions at the time. The Group is also able to manage the demand for capital through management actions including adjusting its lending strategy, risk hedging strategies and through business disposals.

Additional measures to manage the Group’s capital position include seeking to optimise the generation of capital demand within the Group’s businesses to strike an appropriate balance of capital held within the Group’s Insurance and banking subsidiaries and through improving the quality of its capital through liability management exercises.

MONITORING

Capital is actively managed and regulatory ratios are a key factor in the Group’s planning processes and stress analyses. Forecasts of the Group’s capital position, based upon the Group’s operating plan, are produced at least annually to inform the Group’s capital strategy whilst shorter term forecasts are more frequently undertaken to understand and respond to variations of the Group’s actual performance against the plan. The capital plans are tested for capital adequacy using a range of stress scenarios covering adverse economic conditions as well as other adverse factors that could impact the Group and the Group maintains a Recovery Plan which sets out a range of potential mitigating actions that could be taken in response to a stress.

Regular reporting of actual and projected ratios, including those in stressed scenarios, is undertaken, including submissions to the Group Asset and Liability Committee (GALCO), Group Risk Committee (GRC), Board Risk Committee (BRC) and the Board. Capital policies and procedures are subject to independent oversight.

The regulatory framework within which the Group operates continues to evolve. In particular, the Basel Committee is continuing to review the treatment of the standardised risk-weighted asset frameworks for credit risk and operational risk and the credit valuation adjustment risk framework. It is also to finalise recommendations for the capital treatment of interest rate risk in the banking book (IRRBB), the calibration of leverage ratio requirements and continues to consider the treatment of sovereign risk and the setting of additional constraints on the use of internally modelled approaches including the design of a new capital floors framework. In addition the Bank of England is consulting on proposals for the application of the European Commission’s MREL (minimum requirements for own funds and eligible liabilities).

In December 2015, the FPC published a document alongside its Financial Stability Report in which it expressed its views on the overall calibration of the capital requirements framework for the UK banking system together with a description of how it expected the framework to transition from its current state to its end point in 2019 as well as ongoing work to refine capital requirements during that transitional period.

The Group continues to monitor these developments very closely, analysing the potential capital impacts to ensure that, through organic capital generation, the Group continues to maintain a strong capital position that exceeds the minimum regulatory requirements and the Group’s risk appetite and is consistent with market expectations.

Stress testing

In addition to the internal stress testing activity undertaken in 2015, the Group participated in the UK-wide concurrent stress testing run by the Bank of England, comfortably exceeding both the capital and leverage minimum thresholds.

Capital management in 2015

The continued strengthening of the Group’s capital position during 2015, through a combination of increased underlying profits, net of PPI and other conduct charges, and a reduction in risk-weighted assets, provided the Group with the ability to pay both an interim dividend at half year and to recommend the payment of both a full year ordinary dividend and a special dividend whilst maintaining strong capital ratios.

–The CET1 ratio before dividends in respect of 2015 increased 0.9 percentage points from 12.8 per cent to 13.7 per cent.
–The CET1 ratio after dividends in respect of 2015 was unchanged at 12.8 per cent, increasing to 13.0 per cent on an adjusted basis upon recognition of the dividend paid by the Insurance business in February 2016 in relation to its 2015 earnings.
–The leverage ratio after dividends in respect of 2015 reduced from 4.9 per cent to 4.8 per cent.
–The transitional total capital ratio after dividends in respect of 2015 reduced 0.5 percentage points from 22.0 per cent to 21.5 per cent.

Dividends

The Group has established a dividend policy that is both progressive and sustainable. We expect ordinary dividends to increase over the medium term to a dividend payout ratio of at least 50 per cent of sustainable earnings. The Board interprets progressive to indicate a dividend per share that is expected to increase over the medium term. Sustainable earnings represents the long term earnings generation of the business. Sustainable earnings are defined as earnings after tax attributable to ordinary shareholders adjusted to remove the effects of market volatility, exceptional conduct or litigation events, major liability management or restructuring and other one off items such as the sale of businesses, and exceptional underlying business performance.

The Board also gives due consideration to the distribution of surplus capital through the use of special dividends or share buy-backs. Surplus capital represents capital over and above the amount management wish to retain to grow the business, meet regulatory requirements and cover uncertainties. The amount of required capital may vary from time to time depending on circumstances and the Board will continue to give due consideration, at the time, to the distribution of any surplus capital. By its nature, there can be no guarantee that this level of special dividends or any surplus capital distribution will be appropriate in future years.

The ability of the Group to pay a dividend is also subject to constraints including the availability of distributable reserves, legal and regulatory restrictions and the financial and operating performance of the entity.

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Distributable reserves are determined as required by the Companies Act 2006 by reference to a company’s individual financial statements. At 31 December 2015 Lloyds Banking Group plc (‘the Company’) had accumulated distributable reserves of approximately £7,500 million. Substantially all of the Company’s merger reserve is available for distribution under UK company law as a result of transactions undertaken to recapitalise the Company in 2009.

Lloyds Banking Group plc acts as a holding company which also issues capital and other securities to capitalise and fund the activities of the Group. The profitability of the holding company, and consequently its ability to sustain dividend payments, is therefore dependent upon the continued receipt of dividends from its subsidiaries (representing both banking and Insurance). A number of Group subsidiaries, principally those with banking and insurance activities, are also subject to regulatory capital requirements. These require entities to maintain minimum amounts of capital related to their size and risk. The principal operating subsidiary is Lloyds Bank plc which, at 31 December 2015, had a consolidated CET1 capital ratio of 15.2 per cent (31 December 2014: 15.1 per cent). The Group actively manages the capital of its subsidiaries, which includes monitoring the regulatory capital ratios for its banking and insurance subsidiaries against approved risk appetite limits. It operates a formal capital management policy which requires all subsidiary entities to remit any surplus capital to their parent companies.

During 2014 and 2015 the Group has undertaken significant capital management actions in order to simplify the Group’s internal capital structure and to ensure that profits generated by subsidiary entities can be more easily remitted to the Company. These activities relate to a number of subsidiary entities, and include the court approved capital reductions by HBOS plc and Bank of Scotland plc, the part VII transfers within insurance businesses and obtaining PRA approval for our internal model, which will support the Solvency II capital regime for the Insurance subsidiaries with effect from 1 January 2016.

The Group remains strongly capitalised, increasing its CET1 capital ratio from 12.8 per cent at 31 December 2014 to 13.7 per cent (pre 2015 dividends) at 31 December 2015. The interim and recommended final dividends totalling 2.25 pence per ordinary share and the special dividend of 0.5 pence per ordinary share reduce the Group’s CET1 ratio to 12.8 per cent. Recognising the 2015 insurance dividend, paid in February 2016 following the implementation of Solvency II, this rises to13.0 per cent on an adjusted basis.

CAPITAL POSITION AT 31 DECEMBER 2015

The Group’s capital position as at 31 December 2015 is presented in the following section applying CRD IV transitional arrangements, as implemented in the UK by the PRA, and also on a fully loaded CRD IV basis. The table below summarises the consolidated capital position of the Group. The Group’s Pillar 3 Report provides a comprehensive analysis of the own funds of the Group.

Table 1.55: Capital resources (audited)

  Transitional Fully loaded
  At 31 Dec
2015
£m		  At 31 Dec
20142
£m		  At 31 Dec
2015
£m		  At 31 Dec
20142
£m		 
Capital resources            
Common equity tier 1            
Shareholders’ equity per balance sheet  41,234   43,335   41,234   43,335 
Adjustment to retained earnings for foreseeable dividends  (1,427)  (535)  (1,427)  (535)
Deconsolidation of insurance entities1  (1,199)  (623)  (1,199)  (623)
Adjustment for own credit  67   158   67   158 
Cash flow hedging reserve  (727)  (1,139)  (727)  (1,139)
Other adjustments  72   132   72   132 
   38,020   41,328   38,020   41,328 
Deductions from common equity tier 1                
Goodwill and other intangible assets  (1,719)  (1,875)  (1,719)  (1,875)
Significant investments1  (2,723)  (2,546)  (2,752)  (2,546)
Deferred tax assets  (3,874)  (4,533)  (3,884)  (4,533)
Other deductions  (1,160)  (1,685)  (1,160)  (1,685)
Common equity tier 1 capital  28,544   30,689   28,505   30,689 
Additional tier 1 instruments  9,177   9,728   5,355   5,355 
Deductions from tier 11  (1,177)  (859)  –   – 
Total tier 1 capital  36,544   39,558   33,860   36,044 
Tier 2 instruments and eligible provisions  13,208   14,530   9,189   11,169 
Deductions from tier 21  (1,756)  (1,288)  (2,933)  (2,146)
Total capital resources  47,996   52,800   40,116   45,067 
Risk-weighted assets (unaudited)  222,845   239,734   222,747   239,734 
Common equity tier 1 capital ratio  12.8%   12.8%   12.8%   12.8% 
Tier 1 capital ratio  16.4%   16.5%   15.2%   15.0% 
Total capital ratio  21.5%   22.0%   18.0%   18.8% 

1For regulatory capital purposes, the Group’s Insurance business is deconsolidated and replaced by the amount of the Group’s investment in the business. A part of this amount is deducted from capital and the remaining amount is risk weighted, forming part of threshold risk-weighted assets.
2Other comprehensive income related to the Group’s Insurance business defined benefit pension scheme has been reclassified from common equity tier 1 other adjustments to deconsolidation of insurance entities.
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The key differences between the transitional capital calculation as at 31 December 2015 and the fully loaded equivalent are as follows:

–Capital securities that previously qualified as tier 1 or tier 2 capital, but do not fully qualify under CRD IV, can be included in tier 1 or tier 2 capital (as applicable) up to specified limits which reduce by 10 per cent per annum until 2022.
–The significant investment deduction from additional tier 1 (AT1) will gradually transition to tier 2.

The movements in the transitional CET1, AT1, tier 2 and total capital positions in the period are provided below.

Table 1.56: Movements in capital resources            
  Common equity
tier 1
£m		  Additional
tier 1
£m		  Tier 2
£m		  Total capital
£m		 
At 31 December 2014  30,689   8,869   13,242   52,800 
Profit attributable to ordinary shareholders1  434           434 
Eligible minority interest  (470)          (470)
Movement in foreseeable dividends  (892)          (892)
Dividends paid out on ordinary shares during the year  (1,070)          (1,070)
Movement in treasury shares and employee share schemes  (537)          (537)
Available-for-sale reserves  (371)          (371)
Deferred tax assets  659           659 
Movements in subordinated debt      (551)  (1,210)  (1,761)
Significant investments  (177)  (318)  (468)  (963)
Other movements  279       (112)  167 
At 31 December 2015  28,544   8,000   11,452   47,996 

1Under the regulatory framework, profits made by Insurance are removed from CET1 capital. However, when dividends are paid to the Group by Insurance these can then be recognised as CET1 capital.

CET1 capital resources have reduced by £2,145 million in the year largely as a result of dividends paid out during the year and the accrual of the full year ordinary dividend and special dividend, representing returns to ordinary shareholders following strong underlying profit generation. Other reductions to CET1 capital primarily reflected the removal of eligible minority interest related to TSB and movements in treasury shares, employee share schemes and the AFS reserve. These reductions in CET 1 capital were partially offset by reductions in both the deferred tax asset deduction and the excess of expected losses over impairment provisions and value adjustments.

AT1 capital resources have reduced by £869 million in the year, primarily reflecting the annual reduction in the transitional limit applied to grandfathered AT1 capital instruments and an increase in the significant investments deduction.

Tier 2 capital resources have reduced by £1,790 million in the year largely reflecting calls and redemptions, amortisation of dated instruments, foreign exchange movements and an increase in the significant investments deduction, partly offset by the issuance of new tier 2 instruments.

Table 1.57: Risk-weighted assets     
  At 31 December
2015
£m		 At 31 December
2014
£m		 
IRB Approach 151,563 160,603 
Standardised Approach 20,443 25,444 
Contributions to the default fund of a central counterparty 488 515 
Credit risk 172,494 186,562 
Counterparty credit risk 7,981 9,108 
Credit valuation adjustment risk 1,684 2,215 
Operational risk 26,123 26,279 
Market risk 3,775 4,746 
Underlying risk-weighted assets 212,057 228,910 
Threshold risk-weighted assets1 10,788 10,824 
Total risk-weighted assets 222,845 239,734 
Movement to fully loaded risk-weighted assets2 (98)– 
Fully loaded risk-weighted assets 222,747 239,734 

1Threshold risk-weighted assets reflect the element of significant investments and deferred tax assets that are permitted to be risk-weighted instead of deducted from CET1 capital. Significant investments primarily arise from the investment in the Group’s Insurance business.
2Differences may arise between transitional and fully loaded threshold risk-weighted assets where deferred tax assets reliant on future profitability and arising from temporary timing differences and significant investments exceed the fully loaded threshold limit, resulting in an increase in amounts deducted from CET1 capital rather than being risk-weighted. At 31 December 2014 the fully loaded threshold was not exceeded and therefore no further adjustment was applied to the transitional threshold risk-weighted assets.
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Table 1.58:Risk-weighted assets movement by key driver
  Credit risk1
£m		  Counter party
credit risk1
£m		  Market risk
£m		  Operational
risk
£m		  Total
£m		 
Risk-weighted assets at 31 December 2014 186,562  11,323  4,746  26,279  228,910 
Management of the balance sheet 1,772  (474) (838) –  460 
Disposals (8,582) (115) –  –  (8,697)
External economic factors (6,370) (518) 80  –  (6,808)
Model and methodology changes (888) (551) (213) –  (1,652)
Other –  –  –  (156) (156)
Risk-weighted assets 172,494  9,665  3,775  26,123  212,057 
Threshold risk-weighted assets2             10,788 
Total risk-weighted assets             222,845 
Movement to fully loaded risk-weighted assets3             (98)
Fully loaded risk-weighted assets             222,747 

1Credit risk includes movements in contributions to the default fund of central counterparties and counterparty credit risk includes the movements in credit valuation adjustment risk.
2Threshold risk-weighted assets reflect the element of significant investments and deferred tax assets that are permitted to be risk-weighted instead of deducted from CET1 capital. Significant investments primarily arise from the investment in the Group’s Insurance business.
3Differences may arise between transitional and fully loaded threshold risk-weighted assets where deferred tax assets reliant on future profitability and arising from temporary timing differences and significant investments exceed the fully loaded threshold limit, resulting in an increase in amounts deducted from CET1 capital rather than being risk-weighted. At 31 December 2014 the fully loaded threshold was not exceeded and therefore no further adjustment was applied to the transitional threshold risk-weighted assets.

The risk-weighted assets movement tables provide analyses of the reduction in risk-weighted assets in the period by risk type and an insight into the key drivers of the movements. The key driver analysis is compiled on a monthly basis through the identification and categorisation of risk-weighted asset movements and is subject to management judgment.

Credit risk-weighted assets reductions of £14.1 billion were driven by the following key movements:

–Management of the balance sheet includes risk-weighted asset movements arising from new lending and asset run-off. During 2015, credit risk-weighted assets increased by £1.8 billion, primarily as a result of targeted net lending growth in core businesses, as well as an increase in risk-weighted assets for the Group’s strategic equity investments.
–Disposals include risk-weighted asset reductions arising from the sale of assets, portfolios and businesses. Disposals reduced credit risk-weighted assets by £8.6 billion, primarily driven by the completion of the sale of TSB as well as disposals in the run-off business.
–External economic factors capture movements driven by changes in the economic environment. The reduction in credit risk-weighted assets of £6.4 billion is mainly due to improvements in credit quality, which primarily impacted the Retail and Consumer Finance businesses, and favourable movements in HPI that benefited retail mortgage portfolios.
–Model and methodology reductions of £0.9 billion include the movement in credit risk-weighted assets arising from model and methodology refinements and changes in credit risk approach applied to certain portfolios.

Counterparty credit risk and CVA risk reductions of £1.7 billion are principally driven by trading activity and compressions, hedging and yield curve movements.

Risk-weighted assets related to market risk reduced by £1.0 billion primarily due to active portfolio management and model and methodology refinements.

Leverage ratio

In January 2015 the existing CRD IV rules on the calculation of the leverage ratio were amended to align with the European Commission’s interpretation of the revised Basel III leverage ratio framework. The Group’s leverage ratio has been calculated in accordance with the amended CRD IV rules on leverage.

The table on the next page summarises the component parts of the Group’s leverage ratio. Further analysis is provided in the Group’s Pillar 3 Report.

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Table 1.59: Leverage ratio  
  Fully loaded
  At 31 Dec 2015
£m		  At 31 Dec 20141
£m		 
Total tier 1 capital 33,860  36,044 
Exposure measure      
Derivative financial instruments 29,467  36,128 
Securities financing transactions (SFTs) 34,136  43,772 
Loans and advances and other assets 743,085  774,996 
Total statutory balance sheet assets 806,688  854,896 
Deconsolidation and other adjustments2 (135,926) (144,122)
Derivatives adjustments (9,235) (12,064)
Counterparty credit risk add-on for SFTs 3,361  1,364 
Off-balance sheet items 56,424  50,980 
Regulatory deductions and other adjustments (9,112) (10,362)
Total exposure 712,200  740,692 
Leverage ratio 4.8%  4.9% 

1Restated to align with the amended CRD IV rules on leverage implemented in January 2015.
2

Deconsolidation adjustments predominantly reflect the deconsolidation of assets related to Group subsidiaries that fall outside the scope of the Group’s regulatory consolidation (primarily the Group’s insurance entities).

KEY MOVEMENTS

The Group’s fully loaded leverage ratio reduced by 0.1 per cent to 4.8 per cent reflecting the impact of the reduction in tier 1 capital offset by the £28.5 billion reduction in the exposure measure, the latter largely reflecting the reduction in balance sheet assets arising, in part, from the disposal of TSB.

The derivatives exposure measure, representing derivative financial instruments per the balance sheet net of deconsolidation and derivatives adjustments, reduced by £3.7 billion reflecting a combination of market movements, trading activity and trade compressions and the recognition and subsequent deduction of receivable assets for eligible cash variation margin provided in derivative transactions.

The SFT exposure measure, representing SFTs per the balance sheet inclusive of deconsolidation adjustments and counterparty credit risk add-on, reduced by £9.7 billion primarily reflecting active balance sheet management and reduced trading volumes.

Off-balance sheet items increased by £5.4 billion, primarily reflecting an increase in new corporate lending facilities and corporate customer limits and an increase in new residential mortgage offers placed.

G-SIB REQUIREMENTS

Although the Group is not currently classified as a Global Systemically Important Bank (G-SIB), by virtue of the leverage exposure exceeding €200 billion, the Group is required to report G-SIB metrics to the PRA. The Group’s metrics used within the 2015 Basel G-SIBs annual exercise will be disclosed from April 2016, and the results are expected to be made available by the Basel Committee later this year.

INSURANCE BUSINESSES

The business transacted by the insurance companies within the Group comprises both life insurance business and general insurance business. Life insurance business comprises unit-linked business, non-profit business and with-profits business.

On 31 December 2015, the long-term insurance business of seven life insurance companies within the Group were transferred to Clerical Medical Investment Group Limited (CMIG) pursuant to an insurance business transfer scheme, under Part VII of the Financial Services and Markets Act 2000. Scottish Widows plc and CMIG hold the only with-profit funds managed by the Group, and the Scottish Widows plc with-profit fund was transferred to a new with-profit fund within CMIG. On 31 December 2015, CMIG changed its name to Scottish Widows Limited (SW Ltd), and Scottish Widows plc changed its name to SW Funding plc.

Each life insurance company within the Group is regulated by the PRA. The PRA specifies the minimum amount of capital that must be held by each life insurance company within the Group. Under the PRA rules, applying during the year, each life insurance company within the Group must hold assets in excess of the higher of:

(i)the Pillar 1 amount, which is calculated by applying fixed percentages of mathematical reserves and capital at risk; and
(ii)the Pillar 2 amount, which is derived from an economic capital assessment undertaken by each regulated life insurance company, which is reviewed by the PRA.

The minimum required capital must be maintained at all times throughout the year. These capital requirements and the capital available to meet them are regularly estimated in order to ensure that capital maintenance requirements are being met.

During the year Scottish Widows Group Limited (SWG) was also subject to the capital adequacy requirements of the Insurance Group Directive (IGD), which comprises the consolidated surplus of the Group’s regulated insurance subsidiaries.

All minimum regulatory requirements of the life insurance companies are expected to be met during the year.

The new Solvency II regime for insurers and insurance groups is in force from 1 January 2016. The insurance businesses are required to calculate capital requirements and available capital on a revised risk-based approach. The insurance business of the Group will calculate regulatory capital from 1 January 2016 on the basis of an internal model, which was approved by the PRA on 5 December 2015. The estimated solvency II capital ratio of SWG at 1 January 2016 was 148 per cent before allowing for dividends.

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REGULATORY AND LEGAL RISK

DEFINITION

Regulatory and legal risk is defined as the risk that the Group is exposed to fines, censure, legal or enforcement action, civil or criminal proceedings in the courts (or equivalent) and risk that the Group is unable to enforce its rights as anticipated.

RISK APPETITE

The Group has a zero risk appetite for material regulatory breaches or material legal incidents. This appetite is reviewed and approved annually by the Board. To achieve this, the Group has policies, processes and standards which provide the framework for businesses and colleagues to operate in accordance with applicable laws (including Codes of Practice), regulations, codes of conduct and legal obligations.

For further information on risk appetite refer to page 46.

EXPOSURES

The Group periodically experiences material regulatory breaches and material legal incidents outside its risk appetite. Exposure is also driven by significant ongoing and new legislation, regulation and court proceedings within the UK and overseas with which the Group has to comply, which in each case needs to be interpreted, implemented and embedded into day-to-day operational and business practices across the Group. The industry continues to witness increased levels of government and regulatory intervention in the financial sector with increasing regulatory rules and laws from both the UK and overseas affecting the Group’s operations.

MEASUREMENT

Regulatory and legal risks are measured against a set of risk appetite metrics, with appropriate thresholds, which are approved annually by the Board and which are regularly reviewed and monitored. Metrics include assessments of control and material regulatory rule breaches.

MITIGATION

Mitigation is undertaken across the Group and comprises the following key components:

–The Board establishes a group wide risk appetite and metrics for Regulatory and Legal Risk.
–Group policies and procedures set out the principles and key controls that should apply across the business which are aligned to the group risk appetite. Mandated policies and processes require appropriate control frameworks, management information, standards and colleague training to be implemented to identify and manage regulatory and legal risk.
–Business units assess and implement policy and regulatory requirements and establish local controls to assure compliance.
–Material risks and issues are escalated to divisional and then Group-level bodies which challenge and support the business on its management of them.
–Business units produce regularly management information to assist in the identification of issues and test management controls are working effectively.
–Risk Division and Legal provide oversight and proactive support and constructive challenge to the business in identifying and managing regulatory and legal issues.
–When appropriate Risk Division will conduct thematic reviews of regulatory compliance across businesses and divisions.
–Business units with the support of divisional and Group-Level bodies conduct ongoing horizon scanning to identify and address changes in regulatory and legal requirements.

MONITORING

Business unit risk exposure is reported to Risk Division where it is aggregated at Group level and a report prepared. The report forms the basis of challenge to the business at the monthly Group Conduct, Compliance and Operational Risk Committee. This committee may escalate matters to the Chief Risk Officer, or higher committees. The report also forms the basis of the regulatory and legal sections in the Group’s consolidated risk reporting.

INSURANCE RISK

DEFINITION

Insurance risk is defined as the risk of adverse developments in the timing, frequency or severity of claims for insured/underwritten events and in customer behaviour, leading to reductions or volatility in earnings and/or value.

RISK APPETITE

Insurance risk appetite in the Insurance business is set by the Insurance Board and includes capital and earnings limits on insurance risk drivers.

Insurance risk appetite for longevity in the defined benefit pension schemes is set by the Board using two key metrics: a one year increase to life expectancy, and a combined market and longevity stress.

For further information on risk appetite, refer to page 46.

EXPOSURES

The major sources of insurance risk within the Group are the Insurance business and the Group’s defined benefit pension schemes.

Longevity and persistency are key risks within the life and pensions business. Longevity risk arises from the annuity portfolios where policyholders’ future cashflows are guaranteed at retirement and increases in life expectancy, beyond current assumptions, will increase the cost of annuities. Longevity risk exposures are expected to increase following the 2015 entry into the bulk annuity market. Persistency assumptions are set to give a best estimate however, customer behaviour may result in increased cancellations or cessation of contributions.

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Property insurance risk is a key risk within the general insurance business, through Home Insurance, and exposures can arise, for example, in extreme weather conditions, such as floodings, when property damage claims are higher than expected.

The prime insurance risk of the Group’s defined benefit pension schemes is longevity.

MEASUREMENT

Insurance risks are measured using a variety of techniques including stress, reverse stress and scenario testing, as well as stochastic modelling. Current and potential future insurance risk exposures are assessed and aggregated on a range of stresses including risk measures based on 1-in-200 year stresses for Insurance’s regulatory capital assessments (Group defined benefit pension schemes utilise 1-in-20 year stresses) and other supporting measures where appropriate, including those set out in note 34 to the financial statements.

MITIGATION

Insurance risk in the Insurance business is mitigated in a number of ways:

–Longevity risk transfer and hedging solutions are considered on a regular basis. A team of longevity and bulk pricing experts has been built to support the new bulk annuity proposition.
–General insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements broadly spread over different reinsurers. Detailed modelling, including that of the potential losses under various catastrophe scenarios, supports the choice of reinsurance arrangements.
–Insurance processes on underwriting, claims management, pricing and product design.
–Exposure limits by risk type are assessed through the business planning process and used as a control mechanism to ensure risks are taken within risk appetite.

The most significant insurance risk in the defined benefit pension schemes is longevity risk. The merits of longevity risk transfer and hedging solutions are regularly reviewed.

MONITORING

Insurance risks in the Insurance business are monitored by Insurance senior executive Committees and ultimately the Insurance Board. Governance of the Group’s defined benefit pension schemes includes two specialist pension committees (one Group executive sub-committee and a supporting management committee). Significant risks from the Insurance business and the defined benefit pension schemes are reviewed by the Group executive and Group Risk Committees and/or Board.

Insurance risk exposures within the Insurance business are monitored against risk appetite. The Insurance business monitors experiences against expectations, for example business volumes and mix, claims and persistency experience. The effectiveness of controls put in place to manage insurance risk is evaluated and significant divergences from experience or movements in risk exposures are investigated and remedial action taken.

Progress against risk appetite metrics in respect of longevity risk in the Group’s defined benefit pension schemes is regularly reported and reviewed by the relevant committees.

PEOPLE RISK

DEFINITION

People risk is defined as the risk that the Group fails to lead, manage and enable colleagues to deliver to customers, shareholders and regulators leading to an inability to deliver the Group’s strategy.

RISK APPETITE

The Group’s people risk appetite and corresponding measures enable the Group to lead responsibly and proficiently, manage people resources effectively, support and develop colleague talent, and meet legal and regulatory obligations related to its people.

The appetite is reviewed and approved annually by the Board. To stay within appetite, the Group has policies, processes and standards which provide the framework for business and colleagues to operate in accordance with the laws, regulations and voluntary codes which apply to the Group and its activities.

For further information on risk appetite, refer to page 46.

EXPOSURES

The Group’s management of material people risks is critical to its capacity to deliver against its strategic objectives and to be the best bank for customers. Over the coming year the Group anticipates the following key people risk exposures:

–The new Senior Managers and Certification Regime (SM&CR), which brings a statutory duty of responsibility and increased accountability may impact the Group’s ability to attract and retain talent;
–Attracting and retaining talent may be impacted by a more active external market alongside increasing regulatory constraints around remuneration structures;
–The increasing digitisation of the business is changing the capability mix required and may impact our ability to attract and retain talent;
–Colleague engagement may continue to be challenged by ongoing media attention on banking sector culture, sales practices and ethical conduct; and
–Maintaining organisational people capability and capacity levels in response to increasing volumes of organisational and external market change.
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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

MEASUREMENT

People risk is measured through a series of quantitative and qualitative indicators, aligned to key sources of people risk for the Group such as succession, retention, colleague engagement and performance management. In addition to risk appetite measures and limits, people risks and controls are monitored on a monthly basis via the Group’s risk governance framework and reporting structures.

MITIGATION

The Group takes many mitigating actions with respect to people risk. Key areas of focus include:

–Working with the regulators to ensure their guidance on increased accountability in the new SM&CR strengthens remuneration governance to balance implementation costs with the benefits gained from enhanced governance;
–Continued focus on the Group’s culture by developing and delivering initiatives that reinforce the appropriate conduct behaviours which generate the best possible long-term outcomes for customers and colleagues;
–Maintain effective remuneration arrangements to ensure they promote an appropriate culture and colleague behaviours that meet customer needs and regulatory expectations;
–Focusing on leadership and colleague engagement, through delivery of strategies to attract, retain and develop high calibre people together with implementation of rigorous succession planning;
–Ensuring compliance with legal and regulatory requirements related to SM&CR, embedding compliant and appropriate colleague behaviours in line with Group policies, values and its people risk priorities; and
–Ongoing consultation with the Group’s recognised unions on changes which impact their members.

MONITORING

People risks from across the Group are monitored and reported through Board and Group Governance Committees in accordance with the Group’s Risk Management Framework and People Risk sub-framework. Risk exposures are discussed monthly via the Group HR & People Risk Committee with upwards reporting to Group Risk and Executive Committees. In addition oversight, challenge and reporting is completed at Risk Division level and combined with Risk Assurance reviews, is intended to assess the effectiveness of controls, recommending follow up remedial action if relevant. All material People Risk events are escalated in accordance with the formal Group Operational Risk Policy and People Policies to the respective Divisional Managing Directors and the Group Director, Compliance, Conduct and Operational Risk.

FINANCIAL REPORTING RISK

DEFINITION

Financial reporting risk is defined as the risk that the Group suffers reputational damage, loss of investor confidence and/or financial loss arising from the adoption of inappropriate accounting policies, ineffective controls over financial and regulatory reporting, failure to manage the associated risks of changes in taxation rates, law, ownership or corporate structure and the failure to disclose accurate and timely information.

RISK APPETITE

The risk appetite is set by the Board and reviewed on an annual basis or more frequently. It includes complying with statutory and regulatory reporting requirements and compliance with tax legislation in the jurisdictions in which the Group operates.

For further information on risk appetite refer to page 46.

EXPOSURES

Exposure represents the sufficiency of the Group’s policies and procedures to maintain adequate systems, processes and controls to support statutory, prudential regulatory and tax reporting, to prevent and detect financial reporting fraud, to manage the Group’s tax position and to support market disclosures.

MEASUREMENT

Financial reporting risk is measured by the adequacy of, and compliance with, a number of key controls. Identification of potential financial reporting risk also forms a part of the Group’s Operational Risk management framework.

MITIGATION

The Group maintains a system of internal controls, which is designed to:

–Ensure that accounting policies are consistently applied, transactions are recorded and undertaken in accordance with delegated authorities, that assets are safeguarded and liabilities are properly recorded;
–Enable the calculation, preparation and reporting of financial, prudential regulatory and tax outcomes in accordance with applicable International Financial Reporting Standards, statutory and regulatory requirements; and
–Ensure that disclosures are made on a timely basis in accordance with statutory and regulatory requirements and as far as possible are consistent with best practice and in compliance with the British Bankers’ Association Code for Financial Reporting Disclosure.

MONITORING

Financial reporting risk is actively monitored at business unit and Group levels. There are specific programmes of work undertaken across the Group to support:

–Annual assessments of (i) the effectiveness of internal controls over financial reporting; and (ii) the effectiveness of the Group’s disclosure controls and procedures, both in accordance with the requirements of the US Sarbanes Oxley Act; and
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–Annual certifications by the Senior Accounting Officer with respect to the maintenance of appropriate tax accounting arrangements, in accordance with the requirements of the 2009 Finance Act.

The Group also has in place an assurance process to support its prudential regulatory reporting and monitoring activities designed to identify and review tax exposures on a regular basis. There is ongoing monitoring to assess the impact of emerging regulation and legislation on financial, prudential regulatory and tax reporting.

The Group has a Disclosure Committee which assists the Group Chief Executive and Chief Financial Officer in fulfilling their disclosure responsibilities under relevant listing and other regulatory and legal requirements. In addition, the Audit Committee reviews the quality and acceptability of the Group’s financial disclosures. For further information on the Audit Committee’s responsibilities relating to financial reporting see pages 174 to 177.

GOVERNANCE RISK

 

DEFINITION

 

Governance risk is defined as the risk that the Group’s organisational infrastructure fails to provide robust oversight of decision makingdecision-making and the control mechanisms to ensure strategies and management instructions are implemented effectively.

RISK APPETITE

Governance risk appetite is defined and embedded through the Group’s Governance Principle and Policy Framework which are reviewed and approved by the Board on an annual basis. The Group has governance arrangements that support the effective long-term operation of the business and the vision of being the best bank for customers, maximise shareholder value and meet regulatory and social expectations.

For further information on risk appetite refer to page 46.

 

EXPOSURES

 

The internal and corporate governance arrangements of major financial institutions continue to be subject to a high level of regulatory and public scrutiny. The Group’s exposure to governance risk is also reflective of the significant volume of existing and proposed legislation and regulation, both within the UK and overseasacross the multiple jurisdictions within which it operates, with which it must comply. Risk governance and risk culture are mutually reinforcing.

 

MEASUREMENT

 

The Group’s governance arrangements are assessed against new or proposed legislation and regulation and best practice among peer organisations in order to identify any areas of enhancement required.

 

MITIGATION

 

The Group’s Risk Management Framework (RMF) establishes robust arrangements for risk governance, in particular by:

 

–Defining individual and collective accountabilities for risk management, risk oversight and risk assurance through a Three Linesthree lines of Defencedefence model which supports the discharge of responsibilities to customers, shareholders and regulators;
  
–Outlining governance arrangements which articulate the enterprise-wide approach to risk management; and
  
–Supporting a consistent approach to GroupwideGroup-wide behaviour and risk decision makingdecision-making through a Group Policy Frameworkpolicy framework which helps everyone understand their responsibilities by clearly articulating and communicating rules, standards, boundaries and risk appetite measures which can be controlled, enforced and monitored.

 

Under the banner of the RMF, training modules are in place to support all colleagues in understanding and fulfilling their risk responsibilities.

 

The Ethics and Responsible Business Policy and supporting CodesGroup’s code of Personal Responsibility and Business Responsibility embody the Group’sresponsibility embodies its values and reflect its commitment to operating responsibly and ethically both at a business and an individual level. All colleagues are required to adhere to the Codescode in all aspects of their roles.

 

Driving adherence toEffective implementation of the Group’s RMF goes ‘hand in glove’ with its approach tomutually reinforces and is reinforced by the Group’s risk culture, which is embedded in the Group’sits approach to recruitment, selection, training, performance management and reward.

 

MONITORING

 

A review of the Group’s RMF, which includes the status of the Group’s Principlesprinciples and Policy Framework,policy framework, and the design and operational effectiveness of key governance committees, is undertaken on an annual basis and the findings are reported to the Group Risk Committee, Board Risk Committee and the Board.

 

This includes a review of the Group’s current approach to governance and ongoing initiatives in light of the latest regulatory guidance, including in 2015 evolution of frameworks to address Senior Managers and Certification Regime (SM&CR) requirements and the recommendations from a third party review of the Three Lines of Defence.

For further information on Corporate Governance see pages 156131 to 182.156.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

MARKET RISK

DEFINITION

Market risk is defined as the risk that unfavourable market moves (including changes in and increased volatility of interest rates, market-implied inflation rates, credit spreads and prices for bonds, foreign exchange rates, equity, property and commodity prices and other instruments) lead to reductions in earnings and/or value.

BALANCE SHEET LINKAGES

The information provided in table 1.42 aims to facilitate the understanding of linkages between banking, trading, and insurance balance sheet items and the positions disclosed in the Group’s market risk disclosures.

TABLE 1.42:MARKET RISK LINKAGE TO THE BALANCE SHEET

  Banking  
2018 Total
£m		  Trading
book only
£m		  Non-trading
£m		  Insurance
£m		  Primary market risk factor
Assets              
Cash and balances at central banks  54,663   –   54,663   –  Interest rate
Financial assets at fair value through profit or loss  158,529   35,246   6,380   116,903  Interest rate, foreign exchange, credit spread
Derivative financial instruments  23,595   14,734   6,898   1,963  Interest rate, foreign exchange, credit spread
Financial assets at amortised cost                  
Loans and advances to banks  6,283   –   6,242   41  Interest rate
Loans and advances to customers  484,858   –   484,818   40  Interest rate
Debt securities  5,238   –   5,238   –  Interest rate, credit spread
   496,379   –   496,298   81   
Financial assets at fair value through other comprehensive income  24,815   –   24,815   –  Interest rate, foreign exchange, credit spread
Value of in-force business  4,762   –   –   4,762  Equity
Other assets  34,855   –   19,641   15,214  Interest rate
Total assets  797,598   49,980   608,695   138,923   
                   
Liabilities                  
Deposit from banks  30,320   –   30,320   –  Interest rate
Customer deposits  418,066   –   418,066   –  Interest rate
Financial liabilities at fair value through profit or loss  30,547   23,451   7,085   11  Interest rate, foreign exchange
Derivative financial instruments  21,373   10,827   8,406   2,140  Interest rate, foreign exchange, credit spread
Debt securities in issue  91,168   –   91,168   –  Interest rate, credit spread
Liabilities arising from insurance and investment contracts  112,727   –   –   112,727  Credit spread
Subordinated liabilities  17,656   –   15,889   1,767  Interest rate, foreign exchange
Other liabilities  25,542   –   9,605   15,937  Interest rate
Total liabilities  747,399   34,278   580,539   132,582   

The defined benefit pension schemes’ assets and liabilities are included under Other assets and Other liabilities in this table and note 35 on page F-52 provides further information.

The Group’s trading book assets and liabilities are originated within the Commercial Banking division. Within the Group’s balance sheet these fall under the trading assets and liabilities and derivative financial instruments. The assets and liabilities are classified as trading books if they meet the requirements as set out in the Capital Requirements Regulation, article 104. Further information on these activities can be found under the Trading portfolios section on page 101.

Derivative assets and liabilities are held by the Group for three main purposes; to provide risk management solutions for clients, to manage portfolio risks arising from client business and to manage and hedge the Group’s own risks. Insurance business assets and liabilities relate to policyholder funds, as well as shareholder invested assets, including annuity funds. The Group recognises the value of in-force business in respect of Insurance’s long-term life assurance contracts as an asset in the balance sheet (see note 24, page F-44).

The Group ensures that it has adequate cash and balances at central banks and stocks of high quality liquid assets (e.g. gilts or US Treasury securities) that can be converted easily into cash to meet liquidity requirements. The majority of these assets are held as financial assets at fair value through other comprehensive income with the remainder held as financial assets at fair value through profit and loss. Further information on these balances can be found under Funding and liquidity risk on page 88. Interest rate risk in the asset portfolios is swapped into a floating rate.

The majority of debt issuance originates from the issuance, capital vehicles and medium-term notes desks and the interest rate risk of the debt issued is hedged by swapping them into a floating rate.

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The non-trading book primarily consists of customer on-balance sheet activities and the Group’s capital and funding activities, which expose it to the risk of adverse movements in market prices, predominantly interest rates, credit spreads, exchange rates and equity prices, as described in further detail within the Banking activities section (see below).

Table 1.43 (below) shows the key material market risks for the Group’s banking, defined benefit pension schemes, insurance and trading activities.

TABLE 1.43:KEY MATERIAL MARKET RISKS FOR THE GROUP BY INDIVIDUAL BUSINESS ACTIVITY (PROFIT BEFORE TAX IMPACT MEASURED AGAINST GROUP SINGLE STRESS SCENARIOS)

            Risk Type 
2018 Interest rate  Basis risk  FX  Credit spread  Equity  Inflation 
Banking activities1  l   ¡   –   l   l   – 
Defined benefit pension schemes1  ¡   –   –   n   –   – 
Insurance portfolios1  o   –   –   l   ¡   o 
Trading portfolios2  –   –   –   –   –   – 
                         
Profit before tax  Loss   Gain                 
> £500m  l   n                 
£250m – £500m  l   n                 
£50m – £250m  ¡   o                 
Immaterial/zero  –   –                 

1Banking activities, Pensions and Insurance stresses; Interest rate -100 bps, Basis Risk 3 month London Interbank Offered Rate (LIBOR) +100bps / bank base rate -25bps, Foreign Exchange (FX) -15 per cent GBP, Credit Spread +100 per cent, Equity -30 per cent, Inflation +50 bps
2Trading Portfolios; Interest rate -70bps, FX -5 per cent GBP, Credit Spread +20 per cent, Inflation +50bps.

MEASUREMENT

In addition to measuring single factors, Group risk appetite is calibrated primarily to five multi-risk Group economic scenarios, and is supplemented with sensitivity based measures. The scenarios assess the impact of unlikely, but plausible, adverse stresses on income with the worst case for banking activities, defined benefit pensions, insurance and trading portfolios reported against independently, and across the Group as a whole.

The Group risk appetite is cascaded first to the Group Asset and Liability Committee (GALCO), chaired by the Chief Financial Officer, where risk appetite is approved and monitored by risk type, and then to Group Market Risk Committee (GMRC) where risk appetite is sub-allocated by division. These metrics are reviewed regularly by senior management to inform effective decision-making.

MITIGATION

GALCO is responsible for approving and monitoring group market risks, management techniques, market risk measures, behavioural assumptions, and the market risk policy. Various mitigation activities are assessed and undertaken across the Group to manage portfolios and seek to ensure they remain within approved limits. The mitigation actions will vary dependent on exposure but will, in general, look to reduce risk in a cost effective manner by offsetting balance sheet exposures and externalising through to the financial markets dependent on market liquidity. The market risk policy is owned by Group Corporate Treasury (GCT) and refreshed annually. The policy is underpinned by supplementary market risk procedures, which define specific market risk management and oversight requirements.

MONITORING

GALCO and the GMRC regularly review high level market risk exposure as part of the wider risk management framework. They also make recommendations to the Board concerning overall market risk appetite and Group Market Risk Policy. Exposures at lower levels of delegation are monitored at various intervals according to their volatility, from daily in the case of trading portfolios to monthly or quarterly in the case of less volatile portfolios. Levels of exposures compared to approved limits and triggers are monitored by Risk and where appropriate, escalation procedures are in place.

How market risks arise and are managed across the Group’s activities is considered in more detail below.

BANKING ACTIVITIES

Exposures

The Group’s banking activities expose it to the risk of adverse movements in market prices, predominantly interest rates, credit spreads, exchange rates and equity prices. The volatility of market values can be affected by both the transparency of prices and the amount of liquidity in the market for the relevant asset, liability or instrument.

Interest rate risk

Yield curve risk in the Group’s divisional portfolios, and in the Group’s capital and funding activities arises from the different repricing characteristics of the Group’s non-trading assets, liabilities (see loans and advances to customers and customer deposits in table 1.42) and off-balance sheet positions.

Basis risk arises from the possible changes in spreads, for example where the bank lends with reference to a central bank rate but funds with reference to LIBOR, and the spread between these two rates widens or tightens.

Optionality risk arises predominantly from embedded optionality within assets, liabilities or off-balance sheet items where either the Group or the customer can affect the size or timing of cash flows. One example of this is mortgage prepayment risk where the customer owns an option allowing them to prepay when it is economical to do so. This can result in customer balances amortising more quickly or slowly than anticipated due to customers’ response to changes in economic conditions.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Foreign exchange risk

Economic foreign exchange exposure arises from the Group’s investment in its overseas operations (net investment exposures are disclosed in note 52 on page F-88). In addition, the Group incurs foreign exchange risk through non-functional currency flows from services provided by customer-facing divisions and the Group’s debt and capital management programmes.

Equity risk

Equity risk arises primarily from three different sources; (i) the Group’s strategic equity holdings e.g. Visa Europe, now held in the Equities sub-group; (ii) exposure to Lloyds Banking Group share price through deferred shares and deferred options granted to employees as part of their benefits package; and (iii) the Group’s private equity investments held by Lloyds Development Capital within the Equities sub-group.

Credit spread risk

Credit spread risk arises largely from (i) the liquid asset portfolio held in the management of Group liquidity, comprising of government supranational and other eligible assets; (ii) the Credit Valuation Adjustment (CVA) and Debit Valuation Adjustment (DVA) sensitivity to credit spreads; and (iii) a number of the Group’s structured medium-term notes where the Group has elected to fair value the notes through the profit and loss account.

Measurement

Interest rate risk exposure is monitored monthly using, primarily:

(i) Market value sensitivity: this methodology considers all repricing mismatches (behaviourally adjusted where appropriate) in the current balance sheet and calculates the change in market value that would result from an instantaneous 25, 100 and 200 basis points parallel rise or fall in the yield curve (subject to an appropriate floor). The market value sensitivities are calculated on a static balance sheet using principal cash flows excluding interest, commercial margins and other spread components and are therefore discounted at the risk free zero-coupon rate.

(ii) Interest income sensitivity: this measures the 12 month impact on future net interest income arising from various economic scenarios. These include instantaneous 25, 100 and 200 basis point parallel shifts in all yield curves and the five Group economic scenarios (subject to an appropriate floor). These scenarios are reviewed every year and are designed to replicate severe but plausible economic events, capturing risks that would not be evident through the use of parallel shocks alone such as basis risk and steepening or flattening of the yield curve. An additional negative rates scenario is also used for information purposes where all floors are removed; however this is not measured against the limit framework.

Unlike the market value sensitivities, the interest income sensitivities incorporate additional behavioural assumptions as to how and when individual products would reprice in response to changing rates. In addition a dynamic balance sheet is used which includes the run-off of current assets and liabilities and the addition of planned new business.

Reported sensitivities are not necessarily predictive of future performance as they do not capture additional management actions that would likely be taken in response to an immediate, large, movement in interest rates. These actions could reduce the net interest income sensitivity, help mitigate any adverse impacts or they may result in changes to total income that are not captured in the net interest income.

(iii) Structural hedge limits: the structural hedging programme managing interest rate risk in the banking book relies on a number of assumptions made around customer behaviour. A material mismatch between assumptions and reality could lead to a deterioration in earnings. In order to monitor this risk a number of metrics are in place to enhance understanding of risks within this portfolio.

The Group has an integrated Asset and Liability Management (ALM) system which supports non-traded asset and liability management of the Group. This provides a single consolidated tool to measure and manage interest rate repricing profiles (including behavioural assumptions), perform stress testing and produce forecast outputs. The Group is aware that any assumptions based model is open to challenge. A full behavioural review is performed annually, or in response to changing market conditions, to ensure the assumptions remain appropriate and the model itself is subject to annual re-validation, as required under the Group Model Governance Policy. The key behavioural assumptions are (i) embedded optionality within products; (ii) the duration of balances that are contractually repayable on demand, such as current accounts and overdrafts, together with net free reserves of the Group; and (iii) the re-pricing behaviour of managed rate liabilities namely variable rate savings.

Table 1.44 below shows, split by material currency, the Group’s market value sensitivities to an instantaneous parallel up and down 25 and 100 basis points change to all interest rates.

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TABLE 1.44:GROUP BANKING ACTIVITIES: MARKET VALUE SENSITIVITY

  2018 2017
   Up
25bps
£m		   Down
25bps
£m		   Up
100bps
£m		   Down
100bps
£m		   Up
25bps
£m		   Down
25bps
£m		   Up
100bps
£m		   Down
100bps
£m		 
Sterling  29.1   (29.5)  113.7   (122.4)  (9.9)  10.1   (38.7)  22.1 
US Dollar  (7.8)  7.8   (30.6)  31.9   (3.6)  3.7   (14.2)  15.3 
Euro  (3.0)  1.7   (11.2)  7.2   2.2   (0.7)  8.9   0.9 
Other  (0.1)  0.1   (0.4)  0.5   (0.1)  0.2   (0.5)  0.6 
Total  18.2   (19.9)  71.5   (82.8)  (11.4)  13.3   (44.5)  38.9 

This is a risk based disclosure and the amounts shown would be amortised in the income statement over the duration of the portfolio.

The market value sensitivity is driven by temporary customer flow positions not yet hedged plus other positions occasionally held, within limits, by the Group’s wholesale funding desks in order to minimise overall funding and hedging costs. The level of risk is low relative to the size of the total balance sheet.

Table 1.45 below shows supplementary value sensitivity to a steepening and flattening (c.100 basis points around the 3 year point) in the yield curve. This ensures there are no unintended consequences to managing risk to parallel shifts in rates.

TABLE 1.45:GROUP BANKING ACTIVITIES: MARKET VALUE SENSITIVITY TO A STEEPENING AND FLATTENING OF THE YIELD CURVE

  2018  2017
  Steepener
£m		  Flattener
£m		  Steepener
£m		  Flattener
£m		 
Sterling  38.3   (36.5)  (1.1)  (16.5)
US Dollar  6.5   (5.7)  7.1   (8.9)
Euro  (6.8)  3.6   (3.8)  7.9 
Other  (0.1)  0.1   (0.2)  0.2 
Total  37.9   (38.5)  2.0   (17.3)

The table below shows the banking book income sensitivity to an instantaneous parallel up and down 25 and 100 basis points change to all interest rates.

TABLE 1.46:GROUP BANKING ACTIVITIES: NET INTEREST INCOME SENSITIVITY

  2018 2017
   Up
25bps
£m		   Down
25bps
£m		   Up
100bps
£m		   Down
100bps
£m		   Up
25bps
£m		   Down
25bps
£m		   Up
100bps
£m		   Down
100bps
£m		 
Client facing activity and associated hedges  76.2   (125.4)  341.6   (538.6)  86.1   (54.0)  370.5   (186.9)

Income sensitivity is measured over a rolling 12 month basis.

The increase in the net interest income sensitivity to a down 100bps shock reflects the additional margin compression risk within retail savings as bank base rate has risen.

Basis risk, foreign exchange, equity, and credit spread risks are measured primarily through scenario analysis by assessing the impact on profit before tax over a 12 month horizon arising from a change in market rates, and reported within the Board risk appetite on a monthly basis. Supplementary measures such as sensitivity and exposure limits are applied where they provide greater insight into risk positions. Frequency of reporting supplementary measures varies from daily to quarterly appropriate to each risk type.

Mitigation

The Group’s policy is to optimise reward whilst managing its market risk exposures within the risk appetite defined by the Board. The Group Market Risk Policy and procedures outlines the hedging process, and the centralisation of risk from divisions into GCT, e.g. via the transfer pricing framework. GCT is responsible for managing the centralised risk and does this through natural offsets of matching assets and liabilities, and appropriate hedging activity of the residual exposures, subject to the authorisation and mandate of GALCO within the Board risk appetite. The hedges are externalised to the market by derivative desks within GCT and Commercial Banking Markets. The Group has hedge accounting solutions in place, which reduce the accounting volatility arising from the Group’s economic hedging activities by utilising both LIBOR and bank base rate assets.

The largest residual risk exposure arises from balances that are deemed to be insensitive to changes in market rates (including current accounts, a portion of variable rate deposits and investable equity), and is managed through the Group’s structural hedge. Consistent with the Group’s strategy to deliver stable returns, GALCO seeks to minimise large reinvestment risk, and to smooth earnings over a range of investment tenors. The structural hedge consists of longer-term fixed rate assets or interest rate swaps and the amount and duration of the hedging activity is reviewed regularly by GALCO.

Whilst the bank faces margin compression in low rate environments, its exposure to pipeline and prepayment risk are not considered material, and are hedged in line with expected customer behaviour. These are appropriately monitored and controlled through divisional Asset and Liability Committees (ALCOs).

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Net investment foreign exchange exposures are managed centrally by GCT, by hedging non-sterling asset values with currency borrowing. Economic foreign exchange exposures arising from non-functional currency flows are identified by divisions and transferred and managed centrally. The Group also has a policy of forward hedging its forecasted currency profit and loss to year end.

Monitoring

The appropriate limits and triggers are monitored by senior executive committees within the banking divisions. Banking assets, liabilities and associated hedging are actively monitored and if necessary rebalanced to be within agreed tolerances.

DEFINED BENEFIT PENSION SCHEMES

Exposures

The Group’s defined benefit pension schemes are exposed to significant risks from their assets and liabilities. The liability discount rate provides exposure to interest rate risk and credit spread risk, which are partially offset by fixed interest assets (such as gilts and corporate bonds) and swaps. Equity and alternative asset risk arises from direct asset holdings. Scheme membership provides exposure to longevity risk.

For further information on defined benefit pension scheme assets and liabilities please refer to note 35 on page F-52.

Measurement

Management of the schemes’ assets is the responsibility of the Trustees of the schemes who are responsible for setting the investment strategy and for agreeing funding requirements with the Group. The Group is liable for meeting the funding deficit, and as part of a triennial valuation process will agree with the Trustees a funding strategy to eliminate the deficit over an appropriate period.

Longevity risk is measured using both 1-in-20 year stresses (risk appetite) and 1-in-200 year stresses (regulatory capital).

Mitigation

The Group takes an active involvement in agreeing mitigation strategies with the schemes’ Trustees. An interest rate and inflation hedging programme is in place to reduce liability risk. The schemes have also reduced equity allocation and invested the proceeds in credit assets as part of a programme to de-risk the portfolio. The merits of longevity risk transfer and hedging solutions are regularly reviewed.

Monitoring

In addition to the wider risk management framework, governance of the schemes includes two specialist pensions committees.

The surplus or deficit in the schemes is tracked on a monthly basis along with various single factor and scenario stresses which consider the assets and liabilities holistically. Key metrics are monitored monthly including the Group’s capital resources of the scheme, the performance against risk appetite triggers, and the performance of the hedged asset and liability matching positions.

INSURANCE PORTFOLIOS

Exposures

The main elements of market risk to which the Group is exposed through the Insurance business are equity, credit spread, interest rate and inflation.

Equity risk arises indirectly through the value of future management charges on policyholder funds. These management charges form part of the value of in-force business (see note 24 on page F-43). Equity risk also arises in the with-profits funds but is less material.

Credit spread risk mainly arises from annuities where policyholders’ future cash flows are guaranteed at retirement. Exposure arises if the market value of the assets which are held to back these liabilities, mainly corporate bonds and loans, do not perform in line with expectations.

Interest rate risk arises through holding credit and interest assets mainly in the annuity book and also to cover general insurance liabilities, capital requirements and risk appetite.

Inflation exposure arises from a combination of inflation linked policyholder benefits and inflation assumptions used to project future expenses.

Measurement

Current and potential future market risk exposures within Insurance are assessed using a range of techniques including stress, reverse stress and scenario testing, as well as stochastic modelling.

Risk measures include 1-in-200 year stresses used for regulatory capital assessments and single factor stresses for profit before tax.

Table 1.47 demonstrates the impact of the Group’s UK Recession scenario on Insurance’s portfolio (with no diversification benefit, but after the impact of Group consolidation on interest rate and spread widening). For Insurance, this impact of this scenario is identical to Eurozone Credit Crunch so no restatement of 2017 figures is required. The amounts include movements in assets, liabilities and the value of in-force business in respect of Insurance contracts and participating investment contracts. The impact of equity movements at 2018 has been mitigated by hedging actions in the year. The impact of interest rate and credit spread movements at 2018 has been impacted by the adoption of IFRS9.

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OPERATING AND FINANCIAL REVIEW AND PROSPECTS

TABLE 1.47: INSURANCE BUSINESS: PROFIT BEFORE TAX SENSITIVITIES

  Increase (reduction)
in profit before tax
  2018  2017 
  £m  £m 
Interest rates – decrease 100 basis points  297   (202)
Inflation – increase 50 basis points  93   24 
Credit spreads – 100% widening  (823)  140 
Equity – 30% fall  (38)  (1,001)
Property – 25% fall  (50)  (67)
Total  (521)  (1,106)

Further stresses that show the effect of reasonably possible changes in key assumptions, including the risk-free rate, equity investment volatility, widening of credit default spreads on corporate bonds and an increase in illiquidity premia, as applied to profit before tax are set out in note 32 on page F-51.

One of the consequences of preparations for the formation of the Ring-Fenced Bank was to reduce the impact of some stresses within the Insurance business, though Group exposures may not have materially changed. Examples of this include centralisation of defined benefit pension schemes, and the transfer of specific hedging programmes from the corporate centre to the business unit where the exposure emanated.

Mitigation

Equity and credit spread risks are closely monitored and, where appropriate, asset liability matching is undertaken to mitigate risk. Hedging strategies are in place to reduce exposure from unit-linked funds and the with-profit funds.

Interest rate risk in the annuity book is mitigated by investing in assets whose cash flows closely match those on the projected future liabilities. It is not possible to eliminate risk completely as the timing of insured events is uncertain and bonds are not available at all of the required maturities. As a result, the cash flows cannot be precisely matched and so sensitivity tests are used to test the extent of the mismatch.

Other market risks (e.g. interest rate exposure outside the annuity book and inflation) are also closely monitored and where considered appropriate, hedges are put in place to reduce exposure.

Monitoring

Market risks in the Insurance business are monitored by Insurance Senior Executive Committees and ultimately the Insurance Board. Monitoring includes the progression of market risk capital against risk appetite limits, as well as the sensitivity of profit before tax to combined market risk stress scenarios and in year market movements. Asset and liability matching positions and hedges in place are actively monitored and if necessary rebalanced to be within agreed tolerances. In addition market risk is controlled via approved investment policies and mandates.

TRADING PORTFOLIOS

Exposures

The Group’s trading activity is small relative to its peers and does not engage in any proprietary trading activities. The Group’s trading activity is undertaken solely to meet the financial requirements of commercial and retail customers for foreign exchange, credit and interest rate products. These activities support customer flow and market making activities.

All trading activities are performed within the Commercial Banking division. While the trading positions taken are generally small, any extreme moves in the main risk factors and other related risk factors could cause significant losses in the trading book depending on the positions at the time. The average 95 per cent 1-day trading VaR (Value at Risk; diversified across risk factors) was £0.8 million for 31 December 2018 compared to £0.6 million for 31 December 2017.

Trading market risk measures are applied to all of the Group’s regulatory trading books and they include daily VaR (table 1.48), sensitivity based measures, and stress testing calculations.

Measurement

The Group internally uses VaR as the primary risk measure for all trading book positions.

Table 1.48 shows some relevant statistics for the Group’s 1-day 95 per cent confidence level VaR that are based on 300 historical consecutive business days to year end 2018 and year end 2017.

The risk of loss measured by the VaR model is the minimum expected loss in earnings given the 95 per cent confidence. The total and average trading VaR numbers reported below have been obtained after the application of the diversification benefits across the five risk types, but does not reflect any diversification between Lloyds Bank Corporate Markets and any other entities. The maximum and minimum VaR reported for each risk category did not necessarily occur on the same day as the maximum and minimum VaR reported at Group level.

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TABLE 1.48: TRADING PORTFOLIOS: VAR (1-DAY 95 PER CENT CONFIDENCE LEVEL) (AUDITED)

  At 31 December 2018  At 31 December 2017 
  Close  Average  Maximum  Minimum  Close  Average  Maximum  Minimum 
  £m  £m  £m  £m  £m  £m  £m  £m 
Interest rate risk  0.6   0.7   1.8   0.4   0.5   0.6   2.1   0.2 
Foreign exchange risk  0.1   0.1   2.1   –   0.1   0.1   0.4   0.0 
Equity risk  –   –   –   –   –   –   –   – 
Credit spread risk  0.2   0.2   0.7   0.1   0.3   0.3   0.5   0.2 
Inflation risk  0.3   0.3   0.7   0.2   0.2   0.3   0.9   0.2 
All risk factors before diversification  1.2   1.3   3.0   0.9   1.1   1.3   2.9   0.9 
Portfolio diversification  (0.4)  (0.5)          (0.4)  (0.7)        
Total VaR  0.8   0.8   2.1   0.4   0.7   0.6   2.2   0.3 

The market risk for the trading book continues to be low with respect to the size of the Group and compared to its peers. This reflects the fact that the Group’s trading operations are customer-centric and focused on hedging and recycling client risks.

Although it is an important market standard measure of risk, VaR has limitations. One of them is the use of limited historical data sample which influences the output by the implicit assumption that future market behaviour will not differ greatly from the historically observed period. Another known limitation is the use of defined holding periods which assumes that the risk can be liquidated or hedged within that holding period. Also, calculating the VaR at the chosen confidence interval does not give enough information about potential losses which may occur if this level is exceeded. The Group fully recognises these limitations and supplements the use of VaR with a variety of other measurements which reflect the nature of the business activity. These include detailed sensitivity analysis, position reporting and a stress testing programme.

Trading book VaR (1-day 99 per cent) is compared daily against both hypothetical and actual profit and loss. The 1-day 99 per cent VaR chart for Lloyds Banking Group can be found in the Group’s Pillar 3 Report

Mitigation

The level of exposure is controlled by establishing and communicating the approved risk limits and controls through policies and procedures that define the responsibility and authority for risk taking. Market risk limits are clearly and consistently communicated to the business. Any new or emerging risks are brought within risk reporting and defined limits.

Monitoring

Trading risk appetite is monitored daily with 1-day 95 per cent VaR and stress testing limits. These limits are complemented with position level action triggers and profit and loss referrals. Risk and position limits are set and managed at both desk and overall trading book levels. They are reviewed at least annually and can be changed as required within the overall Group risk appetite framework.

MODEL RISK

DEFINITION

Model risk is defined as the risk of financial loss, regulatory censure, reputational damage or customer detriment, as a result of deficiencies in the development, application or ongoing operation of models and rating systems.

Models are defined as quantitative methods that process input data into quantitative outputs, or qualitative outputs (including ordinal letter output) which have a quantitative measure associated with them. Model Governance Policy is restricted to specific categories of application of models, principally financial risk, treasury and valuation, with certain exclusions, such as prescribed calculations and project appraisal calculations.

EXPOSURES

There are over 300 models in the Group performing a variety of functions including:

– capital calculation;
–credit decisioning, including fraud;
–pricing models;
–impairment calculation;
–stress testing and forecasting; and
–market risk measurement.

As a result of the wide scope and breadth of coverage, there is exposure to model risk across a number of the Group’s primary risk categories.

MEASUREMENT

The Group risk appetite framework is the key component for measuring the Group’s model risk. Reported monthly to the Group Risk Committee and Board, focus is placed on the performance of the Group’s most material models.

MITIGATION

The model risk management framework, established by and with continued oversight from an independent team in the Risk division, provides the foundation for managing and mitigating model risk within the Group. Accountability is cascaded from the Board and senior management via the Group Risk Management Framework.

This provides the basis for the Group Model Governance Policy, which defines the mandatory requirements for models across the Group, including:

102

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

– the scope of models covered by the policy;
–model materiality;
–roles and responsibilities, including ownership, independent oversight and approval; and
– key principles and controls regarding data integrity, development, validation, implementation, ongoing maintenance and revalidation, monitoring, and the process for non-compliance.

The model owner takes responsibility for ensuring the fitness for purpose of the models and rating systems, supported and challenged by the independent specialist Group function.

The above ensures all models in scope of policy, including those involved in regulatory capital calculation, are developed consistently and are of sufficient quality to support business decisions and meet regulatory requirements.

MONITORING

The Group Model Governance Committee is the primary body for overseeing model risk. Policy requires that Key Performance Indicators are monitored for every model to ensure they remain fit for purpose and all issues are escalated appropriately. Material model issues are reported to Group and Board Risk Committees monthly with more detailed papers as necessary to focus on key issues.

103

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

INVESTMENT PORTFOLIO, MATURITIES, DEPOSITS, SHORT-TERM BORROWINGS

 

Trading securities and other financialFinancial assets at fair value through profit or loss; financial assets at fair value through other comprehensive income (2017 and 2016: available-for-sale financial assets; held-to-maturity investments;assets); and debt securities classified as loans and receivablesheld at amortised cost

 

The following table sets out the book values and valuationsvaluation (fair value) of the Group’s debt securities, treasury and other bills and equity shares at 31 December for each of the three years indicated.

 

 2018 2018 2017 2017 2016 2016 
 Book value Valuation Book value Valuation Book value Valuation 
 2015
Book value
£m		  2015
Valuation
£m		  2014
Book value
£m		  2014
Valuation
£m		  2013
Book value
£m		  2013
Valuation
£m		  £m £m £m £m £m £m 
Trading securities and other financial assets at fair value through profit or loss                               
US treasury and US government agencies 663  663  658  658  922  922   474   474   1,458   1,458   1,607   1,607 
Other government securities 21,454  21,454  24,815  24,815  19,767  19,767   17,621   17,621   20,562   20,562   25,125   25,125 
Other public sector securities 2,039  2,039  2,170  2,170  2,197  2,197   2,064   2,064   1,527   1,527   1,325   1,325 
Bank and building society certificates of deposit 135  135  554  554  1,491  1,491   1,105   1,105   222   222   244   244 
Mortgage-backed securities 1,358  1,358  1,034  1,034  798  798   225   225   400   400   707   707 
Other asset-backed securities 847  847  850  850  927  927   349   349   1,021   1,021   1,538   1,538 
Corporate and other debt securities 20,316  20,316  22,090  22,090  20,620  20,620   18,310   18,310   19,990   19,990   19,832   19,832 
Treasury bills and other bills 74  74  1,459  1,459  115  115   20   20   18   18   20   20 
Equity shares 60,476  60,476  61,576  61,576  66,403  66,403   77,485   77,485   86,090   86,090   67,697   67,697 
 107,362  107,362  115,206  115,206  113,240  113,240   117,653   117,653   131,288   131,288   118,095   118,095 
Financial assets at fair value through other comprehensive income                        
US treasury and US government agencies  3,963   3,963                 
Other government securities  15,008   15,008                 
Bank and building society certificates of deposit  118   118                 
Mortgage-backed securities  120   120                 
Other asset-backed securities  131   131                 
Corporate and other debt securities  5,151   5,151                 
Treasury and other bills  303   303                 
Equity shares  21   21                 
  24,815   24,815                 
Available-for-sale financial assets                                          
US treasury and US government agencies 6,349  6,349  7,226  7,226  6,594  6,594           6,760   6,760   7,564   7,564 
Other government securities 18,980  18,980  40,176  40,176  31,696  31,696           27,948   27,948   41,150   41,150 
Bank and building society certificates of deposit 186  186  298  298  208  208           167   167   142   142 
Mortgage-backed securities 197  197  674  674  1,263  1,263           1,156   1,156   108   108 
Other asset-backed securities 319  319  685  685  915  915           255   255   317   317 
Corporate and other debt securities 5,808  5,808  5,529  5,529  1,855  1,855           4,615   4,615   6,030   6,030 
Treasury bills and other bills –  –  863  863  875  875 
Equity shares 1,193  1,193  1,042  1,042  570  570           1,197   1,197   1,213   1,213 
 33,032  33,032  56,493  56,493  43,976  43,976           42,098   42,098   56,524   56,524 
Held-to-maturity investments                  
UK government 19,808  19,851  –  –  –  – 
Debt securities classified as loans and receivables                  
Debt securities held at amortised cost                        
Mortgage-backed securities 2,528  2,493  190  155  333  285   3,272   3,396   2,366   2,351   2,089   2,065 
Other asset-backed securities 1,234  1,173  985  900  740  668   780   642   1,260   1,225   1,290   1,227 
Corporate and other debt securities 526  441  164  45  407  298   1,192   1,206   43   10   94   11 
 4,288  4,107  1,339  1,100  1,480  1,251   5,244   5,244   3,669   3,586   3,473   3,303 
Allowance for impairment losses (97) –  (126) –  (125) –   (6)  –   (26)  –   (76)  – 
 4,191  4,107  1,213  1,100  1,355  1,251   5,238   5,244   3,643   3,586   3,397   3,303 
121104

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

MATURITIES AND WEIGHTED AVERAGE YIELDS OF INTEREST-BEARING SECURITIES

 

The weighted average yield for each range of maturities is calculated by dividing the annualised interest income prevailing at 31 December 20152018 by the book value of securities held at that date.

 

 Maturing within
one year		 Maturing after one but
within five years		 Maturing after five but
within ten years		 Maturing after
ten years		 Maturing within
one year		  Maturing after one but
within five years		  Maturing after five but
within ten years		  Maturing after
ten years		 
 Amount
£m		  Yield
%		  Amount
£m		  Yield
%		  Amount
£m		  Yield
%		  Amount
£m		  Yield
%		  Amount
£m		 Yield
%		 Amount
£m		 Yield
%		 Amount
£m		 Yield
%		 Amount
£m		 Yield
%		 
Trading securities and other financial assets at fair value through profit or loss                        
Financial assets at fair value through profit or loss                                
US treasury and US government agencies 12  1.3  417  1.0  107  1.7  127  3.0   –   –   238   1.96   133   2.92   103   3.72 
Other government securities 655  4.5  3,456  2.3  2,856  2.5  14,487  2.7   1,509   2.22   1,958   2.12   2,398   2.26   11,756   2.24 
Other public sector securities 34  3.7  18  5.6  48  4.4  1,939  1.7   10   3.70   569   1.83   346   3.81   1,139   2.92 
Bank and building society certificates of deposit 135  0.3  –  –  –  –  –  –   1,105   0.80   –   –   –   –   –   – 
Mortgage-backed securities –  –  11  1.5  136  2.1  1,211  1.7   –   –   10   2.00   80   4.59   135   3.61 
Other asset-backed securities –  –  107  3.5  393  3.2  347  2.4   4   1.00   47   2.98   1   0.00   297   2.53 
Corporate and other debt securities 14,703  3.2  3,897  5.4  602  4.7  1,114  4.7   968   1.86   3,112   3.61   4,155   4.30   10,075   3.76 
Treasury bills and other bills 74  0.2  –  –  –  –  –  –   20   –   –   –   –   –   –   – 
 15,613     7,906     4,142     19,225      3,616       5,934       7,113       23,505     
Available-for-sale financial assets                        
Financial assets at fair value through other comprehensive income                                
US treasury and US government agencies –  –  3,077  2.3  1,676  4.9  1,596  5.9   1,045   1.09   1,070   3.24   1,695   5.19   153   2.49 
Other government securities 335  7.5  1,509  4.2  1,771  2.0  15,365  4.0   1,139   1.96   8,893   3.48   4,534   2.10   442   1.23 
Bank and building society certificates of deposit 186  –  –  –  –  –  –  –   118   0.32   –   –   –   –   –   – 
Mortgage-backed securities 60  1.8  23  1.4  –  –  114  1.6   –   –   120   0.08   –   –   –   – 
Other asset-backed securities –  –  –  –  37  0.5  282  0.9   –   –   73   4.89   –   –   58   3.93 
Corporate and other debt securities 508  2.3  3,569  0.9  1,731  1.3  –  –   958   1.85   3,666   1.77   527   2.22   –   – 
Treasury and other bills  93   0.14   210   1.85   –   –   –   – 
 1,089     8,178     5,215     17,357      3,353       14,032       6,756       653     
Held-to-maturity investments                        
Other government securities –  –  3,654  3.0  16,154  3.7  –  – 
Debt securities classified as loans and receivables                        
Debt securities held at amortised cost                                
Mortgage-backed securities –  –  –  –  30  2.0  2,498  1.1   –   –   2,024   1.81   –   –   1,248   1.51 
Other asset-backed securities 75  0.9  223  0.4  739  1.2  197  2.1   528   0.19   –   –   93   2.55   159   0.12 
Corporate and other debt securities 33  –  13  –  410  5.4  70  0.4   –   –   238   2.79   937   2.99   17   3.41 
 108     236     1,179     2,765      528       2,262       1,030       1,424     

 

The Group’s investment holdings at 31 December 20152018 include £57,599£31,043 million due from the UK government and its agencies and £7,011 million due from the US government and its agencies.

122105

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

MATURITY ANALYSIS AND INTEREST RATE SENSITIVITY OF LOANS AND ADVANCES TO CUSTOMERS AND BANKS AT 31 DECEMBER 20152018

 

The following table analyses the maturity profile and interest rate sensitivity of loans by type on a contractual repayment basis at 31 December 2015.2018. Following the reduction in the Group’s non-UK activities, an analysis between domestic and foreign operations is not provided.

 

All amounts are before deduction of impairment allowances. Demand loans are included in the ‘maturing in one year or less’ category.

 

 Maturing in one
year or less
£m		  Maturing after
one but within
five years
£m		  Maturing after
five years
£m		  Total
£m		  Maturing in one
year or less
£m		 Maturing after
one but within
five years
£m		 Maturing after
five years
£m		 Total
£m		 
Loans and advances to banks 20,645  3,860  612  25,117   4,073   160   2,052   6,285 
Loans and advances to customers:                            
Mortgages 11,357  47,944  253,576  312,877   13,659   51,070   232,769   297,498 
Other personal lending 6,072  4,562  9,945  20,579   4,835   5,043   18,821   28,699 
Property companies 4,835  10,567  16,826  32,228   4,221   11,759   12,471   28,451 
Financial, business and other services 16,893  17,122  9,057  43,072   56,555   11,910   9,040   77,505 
Transport, distribution and hotels 6,088  4,762  2,676  13,526   6,851   4,491   2,771   14,113 
Manufacturing 3,122  2,069  762  5,953   5,053   2,304   903   8,260 
Other 9,744  11,993  8,236  29,973   9,593   16,333   7,556   33,482 
Total loans 78,756  102,879  301,690  483,325   104,840   103,070   286,383   494,293 
Of which:                           
Fixed interest rate 23,673  46,054  113,697  183,424   60,703   45,154   146,080   251,937 
Variable interest rate 55,083  56,825  187,993  299,901   44,137   57,916   140,303   242,356 
 78,756  102,879  301,690  483,325   104,840   103,070   286,383   494,293 

 

DEPOSITS

 

The following tables show the details of the Group’s average customer deposits in each of the past three years.

 

 2015
Average
balance
£m		  2015
Average
rate
%		  2014
Average
balance
£m		  2014
Average
rate
%		  2013
Average
balance
£m		  2013
Average
rate
%		  2018
Average
balance
£m		 2018
Average
rate
%		 2017
Average
balance
£m		 2017
Average
rate
%		 2016
Average
balance
£m		 2016
Average
rate
%		 
Non-interest bearing demand deposits 45,294  –  42,049  –  35,994  –   72,913   –   66,276   –   54,379   – 
Interest-bearing demand deposits 83,756  0.47  82,545  0.80  75,704  0.55   92,190   0.41   94,627   0.33   90,272   0.48 
Savings deposits 174,239  1.00  201,046  1.18  266,122  1.93   152,304   0.38   168,013   0.23   164,155   0.57 
Time deposits 122,142  0.99  133,060  1.32  56,055  1.02   98,476   0.86   86,043   1.15   111,751   1.05 
Total average deposits 425,431  0.79  458,700  1.04  433,875  1.41   415,883   0.44   414,959   0.41   420,557   0.60 

 

Following the reduction in the Group’s non-UK activities, an analysis between domestic and foreign operations is not provided.

 

CERTIFICATES OF DEPOSIT AND OTHER TIME DEPOSITS

 

The following table gives details of the Group’s certificates of deposit issued and other time deposits at 31 December 20152018 individually in excess of US $100,000 (or equivalent in another currency) by time remaining to maturity. Following the continuing reduction in the Group’s non-UK activities, an analysis between domestic and foreign operations is not provided.

 

   3 months
or less
£m		  Over 3 months
but within
6 months
£m		  Over 6 months
but within
12 months
£m		    Over
12 months
£m		      Total
£m		  3 months
or less
£m		 Over 3 months
but within
6 months
£m		 Over 6 months
but within
12 months
£m		 Over
12 months
£m		 Total
£m		 
Certificates of deposit 5,827  1,781  3,452  37  11,097   3,469   4,806   2,542   1,201   12,018 
Time deposits 28,879  8,074  7,023  5,148  49,124   26,004   3,576   4,987   2,454   37,021 
Total 34,706  9,855  10,475  5,185  60,221   29,473   8,382   7,529   3,655   49,039 
123

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

SHORT-TERM BORROWINGS

Short-term borrowings are included within the balance sheet captions ‘Deposits by banks’, ‘Customer accounts’ and ‘Debt securities in issue’ and are not identified separately on the balance sheet. The short-term borrowings of the Group consist of overdrafts from banks, securities sold under agreements to repurchase, notes issued as part of lending securitisations, certificates of deposit issued, commercial paper and promissory notes issued and other marketable paper. Securities sold under agreements to repurchase, certificates of deposit issued, commercial paper, securitisation notes and covered bonds are the only significant short-term borrowings of the Group.

The following tables give details of these significant short-term borrowings of the Group for each of the past three years.

  2015
£m		  2014
£m		  2013
£m		 
Liabilities in respect of securities sold under repurchase agreements         
Balance at the year end 7,061  1,075  4,852 
Average balance for the year 5,960  2,104  6,515 
Maximum balance during the year 9,467  9,971  27,801 
Average interest rate during the year 0.6%  1.1%  1.2% 
Interest rate at the year end 0.6%  1.2%  0.6% 
Certificates of deposit issued         
Balance at the year end 11,101  7,033  8,866 
Average balance for the year 11,708  9,912  13,145 
Maximum balance during the year 13,925  11,376  14,343 
Average interest rate during the year 0.4%  0.4%  0.9% 
Interest rate at the year end 0.2%  0.3%  0.6% 
Commercial paper         
Balance at the year end 6,663  7,373  5,035 
Average balance for the year 5,286  8,432  10,878 
Maximum balance during the year 12,700  14,768  18,313 
Average interest rate during the year 0.6%  0.3%  0.5% 
Interest rate at the year end 0.0%  0.1%  0.5% 
Securitisation notes         
Balance at the year end 7,763  11,908  18,613 
Average balance for the year 10,362  13,836  22,246 
Maximum balance during the year 12,155  15,787  28,059 
Average interest rate during the year 2.4%  2.1%  2.4% 
Interest rate at the year end 2.7%  2.0%  2.0% 
Covered bonds         
Balance at the year end 27,200  27,191  30,667 
Average balance for the year 26,503  29,754  37,138 
Maximum balance during the year 27,200  31,684  40,673 
Average interest rate during the year 4.2%  4.5%  3.7% 
Interest rate at the year end 3.7%  4.3%  4.2% 
124106

MANAGEMENT AND EMPLOYEES

 

DIRECTORS AND SENIOR MANAGEMENT

 

The Group is led by the Board comprising a Chairman (who was independent on appointment), independent Non-Executive Directors and Executive Directors with a wide range of experience. The appointment of directors is considered by the Nomination &and Governance Committee and approved by the Board. Following the provisions in the articles of association, directors must stand for election by the shareholders at the first annual general meeting following their appointment. In line with UK Corporate Governance best practice, all Directors are subject to annual re-election by shareholders at each annual general meeting thereafter. Independent Non-Executive Directors are appointed for an initial term of three years after which their appointment may continue subject to an annual review. Their appointment may be terminated, in accordance with statute and the articles of association, at any time with immediate effect and without compensation.

 

The Board meets regularly. In 2015,2018, a total of 108 Board meetings were held, 8 of which were scheduled at the start of the year.

 

The roles of the Chairman, the Group Chief Executive and the Board and its governance arrangements, including the schedule of matters specifically reserved to the Board for decision, are reviewed annually. The matters reserved to the Board for decision include the approval of the annual report and accounts and any other financial statements; the payment of dividends; the long-term objectives of the Group; the strategies necessary to achieve these objectives; the Group’s budgets and plans; significant capital expenditure items; significant investments and disposals; the basis of allocation of capital within the Group; the organisational structure of the Group; the arrangements for ensuring that the Group manages risks effectively; any significant change in accounting policies or practices; the appointment of the Company’s main professional advisers (other than the auditors) and their fees;fees (where significant); and the determination of Board and Committee structures, together with their size and composition.

 

According to the articles of association, the business and affairs of the Company are managed by the Directors, who have delegated to management the power to make decisions on operational matters, including those relating to credit, liquidity and market risk, within an agreed framework.

 

All Directors have access to the services of the Company Secretary, and independent professional advice is available to the Directors at the Group’s expense, where they judge it necessary to discharge their duties as directors.

 

The Chairman has a private discussion at least once a year with each Director on a wide range of issues affecting the Group, including any matters which the Directors, individually, wish to raise.

 

There is an induction programme for all Directors, which is tailored to their specific requirements having regard to their specific role on the Board and their skills and experience to date. Major shareholders are also offered the opportunity to meet new Non-Executive Directors.

 

The Directors and senior management of Lloyds Banking Group plc are:

 

NON-EXECUTIVE DIRECTORS

1. Lord Blackwell Chairman

LORD BLACKWELL

Chairman
Age: 63

66

Chairman of the Nomination &and Governance Committee, Membermember of the Risk Committee, the Remuneration Committee, and the Responsible Business Committee.Committee and the Board Risk Committee

Appointed: June 2012 (Board), April 2014 (Chairman)

Skills and experience: Lord Blackwell has deep

Deep financial services knowledge as well as extensiveincluding insurance and banking regulatory

Significant experience with strategic planning and implementation

Regulatory and public policy experience gained from senior positions in Downing Street, Regulators and a wide range of industries. His breadth of experience, credibilityindustries

Credibility with key stakeholders

Strong leadership qualities

Lord Blackwell is an experienced Chairman and strong leadership qualities make him an effective Chairman. He wasNon-Executive Director within the financial services sector having previously thebeen Chairman of Scottish Widows Group and Interserve plc, a formerGroup. He was previously Senior Independent Director and Chairman of the UK Board for Standard Life and also chaired their UK Life and Pensions Board. His other former Non-Executive Directorships have included Halma plc, Dixons Group and SEGRO. He was also a member of the Board of the Centre for Policy Studies, a Non-Executive Board Member of Ofcom and of the Office of Fair Trading, a Partner of McKinsey & Co. and a Director of Group Development at NatWest Group. His past Board roles have also included Chairman of Interserve plc, and Non-Executive Director of Halma plc, Dixons Group, SEGRO and Ofcom. He was Head of the Prime Minister’s Policy Unit from 1995 to 1997 and was appointed a Life Peer in 1997.

External appointments: None. Governor of the Yehudi Menuhin School and a member of the Governing Body of the Royal Academy of Music.

ANITA FREW

2. Anita FrewDeputy Chairman and Senior Independent Director
Age: 58

Age: 61

Chairman of the Remuneration Committee, Member of the Audit Committee, the RiskNomination and Governance Committee, the Nomination & GovernanceRemuneration Committee, the Responsible Business Committee and the Responsible Business Committee.Board Risk Committee

Appointed: December 2010 (Board), May 2014 (Deputy Chairman)

, May 2017 (Senior Independent Director)

Skills and experience: Anita has significant

Significant board, financial and general management experience

Experience across a range of sectors, including banking, asset and investment management, manufacturing and utilities. Her extensiveutilities

Extensive experience as chairman in a range of industries

Strong board levelgovernance experience, makes her an effective Deputy Chairman. including investor relations and remuneration

Anita was previously Chairman of Victrex plc, having previously been its Senior Independent Director. She was also the Senior Independent Director of Aberdeen Asset Management and IMI plc, an Executive Director of Abbott Mead Vickers, Director of Corporate Development at WPP Group and a Non-Executive Director of Northumbrian Water. SheWater and has held various investment and marketing roles at Scottish Provident and the Royal Bank of Scotland.

External appointments: Chairman of Croda International Plc and a Non-Executive Director of BHP Billiton.

3. Alan Dickinson Independent Director

Age: 68

Chairman of the Board Risk Committee, Member of the Audit Committee, Nomination and Governance Committee and the Remuneration Committee

Appointed: September 2014

Skills and experience:

Highly regarded retail and commercial banker

Strong strategic, risk and core banking experience

125107

MANAGEMENT AND EMPLOYEES

 

ALAN DICKINSONRegulatory and public policy experience

Independent Director
Age: 65

Chairman of the Risk Committee, Member of the Audit Committee, the Remuneration Committee and the Nomination & Governance Committee.

Appointed: September 2014

Skills and experience: Alan is a highly regarded retail and commercial banker having spenthas 37 yearsyears’ experience with the Royal Bank of Scotland, most notably as Chief Executive of RBS UK. Alan’s strategic focus and core banking experience complements the balance of skills on the Board. More recently, heAlan was a Non-Executive Director of Willis Limited and Chairman of its Risk Committee. He was formerly Chairman of Brown, Shipley & Co. Limited, a Non-Executive Director of Nationwide Building Society andwhere he was Chairman of its Risk Committee and a Non-Executive Director of Carpetright plc.

External appointments: Non-Executive Director of Willis Limited and Chairman of its Risk Committee, Senior Independent Director of Urban & Civic plc and a Governor of Motability.

External appointments: Chairman of Urban&Civic plc.

SIMON HENRY

4. Simon HenryIndependent Director
Age: 54

Age: 57

MemberChairman of the Audit Committee and member of the Board Risk Committee.Committee

Appointed: June 2014

Skills and experience: Simon has deep

Deep international experience in board level strategy and execution. His extensiveexecution

Extensive knowledge of financial markets, treasury and risk management and his qualification

Qualification as an Audit Committee Financial Expert is of particular value in the Board Risk

Strong board governance experience, including investor relations and Audit Committees. Heremuneration

Simon was previously Shell’sformerly Chief Financial Officer for Exploration & Production and prior to that Head of Group Investor Relations.

External appointments: Chief Financial Officer and an Executive Director of Royal Dutch Shell plc with responsibility for Shell’s Finance, IT, Strategy and Planning functions.plc. He was also previously Chair of the European Round Table CFO Taskforce and a Member of the Main Committee of the 100 Group of UK FTSE CFOs,CFOs.

External appointments: Non-Executive Director of Rio Tinto plc and Rio Tinto Limited, Independent Director of PetroChina Company Limited, Member of the Defence Board and Chair of the Defence Audit Committee, UK Government, Member of the Advisory Panel of CIMA and of the Advisory Board of the Centre for European Reform.

DYFRIG JOHN5. Lord Lupton CBE

Independent Director
Age: 65

Member of the Risk Committee and the Remuneration Committee.

Appointed: January 2014

Skills and experience: Dyfrig has spent his career in banking, principally at HSBC where he worked for 37 years. During that time he held a number of senior management and Board positions in the UK and overseas including Chief Executive Officer of HSBC Bank PLC. He has the knowledge and experience to provide valuable insight and contribute effectively as a Non-Executive Director and Member of the Remuneration Committee and Risk Committee. He was formerly Chairman of Principality Building Society and a Board member of the Wales Millennium Centre.Lloyds Bank Corporate Markets plc

External appointments: Member of the Welsh Rugby Union’s Audit Committee.

NICK LUFF

Independent Director

Age: 48

Chairman of the Audit Committee, Member of the Risk Committee and the Nomination & Governance Committee.

Appointed: March 2013

Skills and experience: Nick has significant financial experience in the UK listed environment having served in a number of senior finance positions within a range of sectors. His background and experience enables him to fulfil the role of Audit Committee Chair and, for SEC purposes, the role of Audit Committee Financial Expert. Nick was previously the Group Finance Director of Centrica plc, Finance Director of The Peninsular & Oriental Steam Navigation Company and Chief Financial Officer of P&O Princess Cruises plc. He previously served as a Non-Executive Director and was the Audit Committee Chair of QinetiQ Group plc.

External appointments: Executive Director and Chief Financial Officer of RELX Group.

DEBORAH MCWHINNEY

Independent Director
Age: 60

63

Member of the Audit Committee and the Board Risk Committee.Committee

Appointed: December 2015

June 2017

Skills and experience: Deborah has an extensive executive background

Extensive international corporate experience, especially in managing technology, operationsfinancial markets

Strong board governance experience, including investor relations and new digital innovations across banking, paymentsremuneration

Regulatory and institutional investment. She broadenspublic policy experience

Significant experience in strategic planning and implementation

Lord Lupton was Deputy Chairman of Baring Brothers, co-founded the Board’s diversity from a global market perspective. Deborah is a former Chief Executive Officer, Global Enterprise PaymentsLondon office of Greenhill & Co., and President, Personal Banking and Wealth Management at Citibank. Shewas Chairman of Greenhill Europe. He was previously PresidentChairman of Institutional Services at Charles Schwab Corporation and held executive roles at Engage Media Services Group, Visa International and BankTrustees of America, where she held senior roles in Consumer Banking.

External appointments: Independent Director of Fluor Corporation and IHS Corporation,Dulwich Picture Gallery, a Trustee of the California InstituteBritish Museum, Governor of TechnologyDowne House School and a member of the InstituteInternational Advisory Board of Global Leadership Foundation. He became a Life Peer in October 2015 and is a former Treasurer of the Conservative Party. He served on the House of Lords Select Committee on Charities.

External appointments: Senior Advisor to Greenhill Europe and Chairman of the Trustees of the Lovington Foundation.

6. Amanda Mackenzie OBE Independent Director

Age: 55

Member of the Remuneration Committee, the Responsible Business Committee and the Board Risk Committee (see note 2 below)

Appointed: October 2018

Skills and experience:

Extensive experience in responsible business

Considerable customer engagement experience

Strong digital technology experience

Significant marketing and brand background

Amanda was a member of Aviva’s Group Executive for Defense Analyses.

126

MANAGEMENT AND EMPLOYEESseven years and Chief Marketing and Communications Officer. Prior to her current role, Amanda was seconded from Aviva as Executive Adviser to Project Everyone, to help launch the United Nations Sustainable Development Goals. She has over 25 years’ of commercial business practice, including director roles at British Airways AirMiles, BT, Hewlett Packard Inc, British Gas and Mothercare plc.

External appointments: Chief Executive of Business in the Community – The Prince’s Responsible Business Network, a Life Fellow of the Royal Society of Arts and Fellow of the Marketing Society.

NICK PRETTEJOHN

7. Nick PrettejohnIndependent Director and Chairman of Scottish Widows Group
Age: 55

Age: 58

Member of the Audit Committee, the Nomination and Governance Committee and the Board Risk Committee.Committee (see note 3 below)

Appointed: June 2014

Skills and experience: Nick has significant

Deep financial services experience, particularly in insurance where he

In-depth regulatory knowledge and experience

Governance experience and strong leadership qualities

Significant experience in strategic planning and implementation

Nick has served as Chief Executive of Lloyd’s of London, and Prudential UK and Europe as well asand Chairman of Brit Insurance. He has the knowledge and experience to provide valuable insight and contribute effectively as a Non-Executive Director and Member of the Audit Committee and Risk Committee. He is a former Non-Executive Director of the Prudential Regulation Authority and of Legal and& General Group Plc as well as Chairman of the Financial Services Practitioner Panel.

External appointments:Panel and the Financial Conduct Authority’s Financial Advice Working Group. He was previously a Member of the BBC Trust and Chairman of the Britten-Pears FoundationFoundation.

External appointments: Chairman of Reach plc (formerly Trinity Mirror plc) and of their Nomination Committee. He is also Chairman of the Royal Northern College of Music.Music and a member of the Board of Opera Ventures.

STUART SINCLAIR

8. Stuart SinclairIndependent Director
Age: 62

Age: 65

Chairman of the Remuneration Committee, Member of the RiskResponsible Business Committee and the Remuneration Committee.Board Risk Committee

Appointed: January 2016

Skills and experience: Stuart has extensive

Extensive experience in retail banking, and insurance and also brings to the Board widerconsumer finance

Governance and regulatory experience

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MANAGEMENT AND EMPLOYEES

Significant experience in strategic planning and implementation

Experience in consumer financeanalysis, marketing and asset finance. Hedistribution

Stuart is a former Non-Executive Director of TSB Banking Group plc, and TSB Bank plc, LV Group, Virgin Direct and Vitality Health (formerly Prudential Health). Until recently he was the Interim Chairman of Provident Financial plc. StuartHe was previouslyalso a Non-Executiveformer Senior Independent Director of LVSwinton Group Limited. In his executive career, he was President and Chief Operating Officer of Aspen Insurance heldafter spending nine years with General Electric as Chief Executive Officer roles at GE Capital’sof the UK Consumer Finance division both in the UK and China, and Directorbusiness then President of UK Retail Banking thenGE Capital China. Before that he was Chief Executive Officer of Tesco Personal Finance and Director of UK Retail Banking at the Royal Bank of Scotland. He was also a Council Membermember of The Royal Institute for International Affairs. His early career included Managing Consultant at Braxton Associates and Partner at Mercer Managing Consultant (now Oliver Wyman)Affairs (Chatham House).

External appointments: Non-Executive Senior Independent Director and Chair of the Risk Committees& Capital Committee at Provident Financial Plc, Vitality Life and Vitality Health. Senior Independent Director atQBE UK Limited (formerly QBE Insurance (Europe) Limited and Swinton Group Limited.Limited).

ANTHONY WATSON9. Sara Weller CBE

Senior Independent Director
Age: 70

Member of the Audit Committee, the Risk Committee, the Remuneration Committee and the Nomination & Governance Committee.

Appointed: April 2009 (Board), May 2012 (Senior Independent Director)

Skills and experience: Tony is our Senior Independent Director and with over 40 years of experience in the investment management industry and related sectors, he is well placed to carry out this role. His former positions include Chief Executive of Hermes Pensions Management and Chairman of the Asian Infrastructure Fund, MEPC, the Marks & Spencer Pension Trustees and of the Strategic Investment Board (Northern Ireland). He is also a former Member of the Financial Reporting Council, a Senior Independent Director of Hammerson and a Non-Executive Director of the Shareholder Executive and Vodafone Group.

External appointments: Senior Independent Director of Witan Investment Trust, Chairman of the Lincoln’s Inn Investment Committee and a member of the Norges Bank Investment Management Corporate Governance Advisory Board.

SARA WELLER CBE

Independent Director
Age: 54

57

Chairman of the Responsible Business Committee, Member of the RiskNomination and Governance Committee, the Remuneration Committee and the Remuneration Committee.Board Risk Committee

Appointed: February 2012

Skills and experience: With a background

Background in retail and associated sectors, including financial services Sara brings a broad perspective to the Board. She is a strong

Strong board governance experience, including investor relations and remuneration

Passionate advocate of customers, the community, financial inclusion and the development of the application of new technology, both of which directly support Lloyds Banking Group’s strategy. Sara has considerabledigital skills

Considerable experience of boards at both executive and non-executive level. Herlevel

Sara’s previous appointments include Managing Director of Argos, various senior positions at J Sainsbury including Deputy Managing Director, Chairman of the Planning Inspectorate, Lead Non-Executive Director at the Department of Communities and Local Government, a Board member at the Higher Education Funding Council, a Non-Executive Director of Mitchells & ButlerButlers as well as a number of senior management roles for Abbey National and Mars Confectionery.

External appointments: Non-Executive Director of United Utilities Group and Chair of their Remuneration Committee and a member of their Nomination Committee, Lead Non-Executive Director at the Department for Work and Pensions, a Governing Council Member of Cambridge University Chairmanand Trustee of the Planning InspectorateLloyds Bank Foundation for England and Board member at the Higher Education Funding Council.

127

MANAGEMENT AND EMPLOYEESWales.

 

EXECUTIVE DIRECTORS

ANTÓNIO HORTA-OSÓRIO

10. António Horta-OsórioExecutive Director and Group Chief Executive
Age: 52

Age: 55

Appointed: January 2011 (Board), March 2011 (Group Chief Executive)

Skills and experience: António brings extensive

Extensive experience in, and understanding of, both retail and commercial banking. This has beenbanking built over a period of more than 2530 years, working both internationally as well asand in the UK. António’s drive,UK

Drive, enthusiasm and commitment to customers along with his proven

Proven ability to build and lead strong management teams brings significant value to all stakeholders of Lloyds Banking Group. Previously he

António previously worked for Citibank, Goldman Sachs Citibank and held various senior management positions at Grupo Santander before becoming its Executive Vice President.President and member of the Group’s Management Committee. He was a Non-Executive Director of Santander UK and subsequently its Chief Executive. He is also a former Non-Executive Director of the Court of the Bank of England and Governor of the London Business School.England.

External appointments: Non-Executive Director of EXOR S.p.A.N.V., Fundação Champalimaud and Sociedade Francisco Manuel dos Santos in Portugal, a member of the Board of Stichting INPAR Management/Enable and Chairman of the Wallace Collection.

GEORGE CULMER

11. George CulmerExecutive Director and Chief Financial Officer
Age: 53

Age: 56

Appointed: May 2012 (Board)

Skills and experience: George is a chartered accountant with extensive

Extensive operational and financial expertise including strategic and financial planning and control. He has workedcontrol

Worked in financial services in the UK and overseas for over 20 years. 25 years

George was an Executive Director and Chief Financial Officer of RSA Insurance Group, the former Head of Capital Management of Zurich Financial Services and Chief Financial Officer of its UK operations as well as holding various senior management positions at Prudential. He is a Non-Executive Director of Scottish Widows.

External appointments: None.

JUAN COLOMBÁS

12. Juan ColombásExecutive Director and Chief RiskOperating Officer
Age: 53

Age: 56

Appointed: November 2013 (Board), January 20112011- September 2017 (Chief Risk Officer), November 2013 (Board)

September 2017 (Chief Operating Officer)

Skills and experience: Juan has significant

Significant banking and risk management experience having spent 30 years working in these fields both internationally

International business and in the UK. management experience

Juan is responsible for developingleading a number of critical Group functions and driving the Group’s risk framework, recommending its risk appetite and ensuring that all risks generated bytransformation activities across the business are measured, reviewed and monitored on an ongoing basis.Group in order to build the Bank of the Future. He was previously the Chief Risk Officer and an Executive Director of Santander’s UK business. Prior to this, position, he held a number of senior risk, control and business management roles across the Corporate, Investment, Retail and Risk Divisions of the Santander Group. He has served aswas previously the Group’s Chief Risk Officer and as a member of the Group Executive Committee since January 2011.

External appointments: Vice Chairman of the International Financial Risk Institute.

External appointments: None.

Notes

1Deborah McWhinney served as a Director throughout the year and retired from the Board on 31 December 2018
2Amanda Mackenzie to be appointed to the Remuneration Committee with effect from 1 March 2019
3Nick Prettejohn to be appointed to the Nomination and Governance Committee with effect from 1 March 2019
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MANAGEMENT AND EMPLOYEES

EMPLOYEES

 

As at 31 December 2015,2018, the Group employed 75,30664,928 people (on a full-time equivalent basis), compared with 84,49067,905 at 31 December 20142017 and 88,97770,433 at 31 December 2013.2016. At 31 December 2015, 74,5532018, 64,222 employees were located in the UK, 376355 in continental Europe, 346288 in the Americas, and 3163 in the rest of the world. At the same date, 32,84933,966 people were employed in Retail, 6,3026,767 in Commercial Banking, 3,426 in Consumer Finance, 1,8445,353 in Insurance 20,198 in Group Operations, and 10,687Wealth, and 18,842 in other functions.

 

The Group has Codes of Responsibility which apply to all employees. The Codes of Responsibility can be found at: www.lloydsbankinggroup.com/RB.Responsible-Business.

128110

COMPENSATION

 

REMUNERATION COMMITTEE
CHAIRMAN’S STATEMENT

 

INTRODUCTION

The Committee is particularly mindful of its obligation to ensure that reward for Executive Directors is clear and transparent, is encouraging strong and sustainable performance, and that the variable components of remuneration are truly variable.

KEY MESSAGES
Underlying profit increased 6 per cent to £8,066 million
Executive Director single figure remuneration outcomes are approximately 2 per cent lower than prior year
Gender pay gap reduced 1.3 per cent to 31.5 per cent – better than the average for Financial Services
Pay budget increase of 2.6 per cent for all colleagues – increases for Executive Directors and other senior colleagues set lower at 2 per cent
Minimum full time salary for all colleagues now exceeds National Living Wage by 7 per cent
Financial and strategic performance in 2018 delivered a Group Balanced Scorecard outcome of 83 per cent of maximum
Group Performance Share outcome is down 3 per cent year-on-year when adjusted for changes to eligible population. The total pool for 2018 is £464.5 million.
2016 Long Term Incentive Plan is vesting at 68.7 per cent

Composition of Executive Director Remuneration 30% c.70% 70% Fixed Salary, Fixed Share Award, Pension, Benefits Variable Group Performance Share, Group Ownership Share Variable Reward Components c.70% c.30% Long-term Short-term 3+ years 1 year 95% 5% Shares Cash

DEAR SHAREHOLDER

 

On behalf of the Board, and as Chair of the Group’s Remuneration Committee, I am pleased to present theour Directors’ remuneration report for the year ended 31 December 2015.2018. This is my first report to you, and on behalf of the Board I am extremely gratefulwould like to thank Anita Frew for her chairmanship of the overall strong supportCommittee in the period to September 2018, when I took over. I hope to continue the excellent work Anita did in ensuring that remuneration is actively debated and positive feedback received from shareholders during 2015. I look forwardtransparent to working together during 2016.all relevant stakeholders.

 

This report is split into three parts:

–Remuneration at a glance - a summary of the key aspects of remuneration outcomes for 2015.
–Directors’ remuneration policy
–Annual report on remuneration - how the policy was implemented in 2015 and is intended to apply in 2016.

A summary ofcovers the information required to meet the Group’s regulatory disclosures, but also provides additional context and detail on the Group’s broader remuneration policy approved atframework, its alignment with our strategy and other factors considered relevant by the 2014 Annual General Meeting (AGM) is included for information only. No changes have been made to the policy this year. My introductory statement and the annual report on remuneration will be subject to an advisory vote at the 2016 AGM.Committee.

 

I took over as Chair of the Remuneration Committee from Tony Watson in October 2015. On behalf of the Group, I would like to take the opportunity to thank Tony for the significant contribution he has made in his chairmanship of the Committee since 2011, a period that has seen profound change both for the Group and the wider UK economy.RESPONDING TO FEEDBACK

 

ALIGNMENT TO STRATEGY

The Committee continues toWe were disappointed that our report for 2017 did not receive the high level of support from shareholders at the 2018 AGM that we had previously experienced. We place great importance on ensuring there isthe opinions of our shareholders and other stakeholders when considering our remuneration policy and its implementation.

During 2018, I took the opportunity to meet a broad selection of shareholders and other key stakeholders, to obtain feedback on our approach. This included shareholders who

opposed the 2017 remuneration report. It became clear link between remunerationin these discussions that, while disclosure levels were generally considered good, the way we determined bonus awards for Executive Directors was perceived to be too complex, and deliverywe could make clearer both how the annual awards were calculated and where judgement or discretion had been applied by the Committee. This report has been designed in part to respond to that feedback and I believe we have listened to, and addressed, the concerns raised. I have summarised the key changes below.

We are not seeking to make any changes to the Directors’ Remuneration Policy for 2019, however we will consult widely on policy changes ahead of the Group’s key strategic objectives. For 2015, the Group’s priorities have been creating the best customer experience, becoming simpler and more efficient and delivering sustainable growth. These support our continued aim of becoming the best bank for customers and our ‘helping Britain prosper’ plan.Annual General Meeting in 2020.

 

Underpinning the Group’s strategic focus is the ‘building the best team’ agenda, a key component of which is the Group’s desire to offer fair reward toOUR PERFORMANCE AND REMUNERATION PHILOSOPHY

WE CONTINUE TO OPERATE FOUR CORE ‘REWARD PRINCIPLES’:
1. Customer alignment
2.Simple, affordable and motivating
3.Shareholder alignment
4.Competitive, performance-driven and fair

These principles underpin all colleagues. In considering employee reward, the Committee seeks to balance the importance of dealing with legacy conduct-related matters, investment for our customers, returning value to shareholdersdecisions and providing support to the communities in which we operate. The Committee has placed a great deal of emphasis on ensuringensure that rewardour remuneration approach and outcomes are aligned to the long term sustainable success of the business, the Group’s commitment to rebuilding trustpurpose and changing our culture to ensure that colleagues are empowered, inspired and incentivised to do the right thing for customers, particularly when it comes to dealing with, and learning from, mistakes of the past.priorities.

REMUNERATION OUTCOMES FOR 2015

As set out in detail in the annual report on remuneration, both the financial and strategic measures set by the Committee for the 2015 bonus were exceeded, with underlying profit of £8,112 million and dividends in respect of 2015 of £1.6 billion and a total capital distribution of £2.0 billion, demonstrating the Group’s return to financial health. In addition, the Group has completed the sale of the remaining holding in TSB (at a premium of around £200 million), whilst the strong financial performance has enabled the Government to make further substantial progress in returning the Group to full private ownership and has resulted in rating agency upgrades and improved feedback from the regulators.

The Group has continued to embed the revised methodology for calculating the risk-adjusted bonus outcome implemented in 2014. The Committee believes it is important that all colleagues are rewarded in a way that recognises the very highest of expectations in respect of conduct and customer treatment and the links between performance, risk management and reward are clear in the way that the Group sets expectations and communicates them with colleagues. When there are failures in risk management, or when material errors occur, it is equally important that accountability is taken collectively for those issues and, where appropriate, at an individual level as well. During 2015, a number of risk and conduct-related matters had an impact on both the Group’s financial performance and its reputation with the public, shareholders and regulatory bodies, such as PPI, as well as the risk management failure which led to regulatory settlement on PPI complaint handling.

Taking into consideration all relevant factors, the Committee has applied collective adjustments of 26 percent to the Group’s 2015 bonus outcome, reducing the total to £353.7 million. As a percentage of pre-bonus underlying profit, the bonus outcome is 4.2 per cent for 2015, down from 4.5 per cent in 2014.

The approach to determine bonus awards for the Executive Directors is consistent with other colleagues across the Group. The Committee determined that bonus awards of between 57 per cent and 63 per cent of maximum opportunity should be made to Executive Directors. In addition, we applied reductions to the 2012 and 2013 deferred bonus awards for each of the Executive Directors, in line with other senior managers, to reflect the Group’s handling of PPI complaints.

The long-term incentive plan (LTIP) awards made in 2013 are proposed to vest at 94.18 per cent, reflecting performance in the period to 31 December 2015. This vesting outcome reflects the significant shareholder value created over the period. Awards were granted at 49.29 pence.

Overall, the total remuneration for the Executive Directors is down by around 20 per cent compared to 2014. Further details on the reward outcomes for Executive Directors are outlined in the annual report on remuneration.

REWARDING COLLEAGUES

During 2015, the Group has continued to invest in the broader remuneration package for colleagues, with improvements made to pay, benefits and colleague share plans. It also undertook a detailed review of the variable pay arrangements used to incentivise customer-facing colleagues, primarily in the Retail division. These arrangements do not contain sales output measures, so colleagues are incentivised purely by reference to customer service or Balanced Scorecard performance measures. In some parts of our business, variable pay arrangements have been removed and have either been replaced with fixed base salary or eligible colleagues have transitioned to the discretionary annual bonus plan. From 2016, a single variable pay arrangement will be introduced for all customer-facing colleagues in the Retail division, using a Balanced Scorecard approach with clearly identified performance descriptors, measuring whole job contribution.

Average discretionary bonus awards across all colleagues are approximately £4,600, with only 3 per cent of our colleagues receiving a bonus in excess of £25,000. In line with previous years, the first £2,000 of any bonus award is paid in cash with the balance being deferred in shares which are released periodically over subsequent months and years.

129WHAT WE HAVE CHANGED IN RESPONSE TO YOUR FEEDBACK

To provide greater clarity on the process for determining variable remuneration for Executive Directors, on page 116 we have provided a step-by-step walk-through of the approach to bonus awards. This shows how we determine the proportion of profit allocated to variable pay for on target performance, which remained at 5.1 per cent for 2018, and the mechanical approach to determining individual awards.

The Committee is also mindful of the changes to corporate governance and reporting regulations which take effect from next year and has begun to prepare for their formal introduction and reporting.

In this report we have published details of our CEO pay ratio, which can be found on page 124. We have also provided an overview of activity that the Board will undertake with regard to understanding the views of the wider workforce on page 141. We anticipate that the role of the Committee will evolve and develop during 2019 and intend to provide full details in 2020. Other aspects the Committee intends to focus on in 2019 include post employment shareholding and pension contributions of Executive Directors relative to the majority of the workforce.


111

COMPENSATION

 

EXECUTIVE SALARY AWARDS FOR 2016As in previous years, we believe any remuneration awarded to Executive Directors must be supported by strong performance achieved with the interests of all our stakeholders in mind.

 

The Committee’s continuing aimremuneration awarded to Executive Directors is heavily weighted towards the delivery of long-term, sustainable performance that aligns with shareholder experience. For the variable awards made under the Group Performance Share and Group Ownership Share plans in respect of performance in 2018, over 95 per cent is awarded in shares, and 70 per cent is subject to position Executive Director remuneration conservatively, but competitively, againstperformance conditions applying over three years.

DELIVERY THROUGH COLLECTIVE SUCCESS

We believe it is important that all our colleagues share in the market.collective success of the Group when we deliver at our best. Therefore for 2019, significant changes are being made to the Group’s performance management framework. Our new approach, which we are calling Your Best, is a simpler approach to performance management, with a stronger emphasis on teamwork and a greater focus on personal growth, skills and development. This is highly relevant to all colleagues in this fast changing economy.

Our colleagues are the stewards of the Group’s future. We are also very mindfultherefore investing significantly in transforming ways of working to enhance our colleagues’ skills and capabilities. All eligible colleagues in the average awardsGroup will receive a Colleague Group Ownership Share award in 2019, continuing our practice of promoting long-term ownership and alignment to shareholder interests. 99 per cent of colleagues hold shares in the Group.

To ensure that the Committee understands the views of a broad range of stakeholders, I have consulted with the Group’s recognised unions who represent the interests of around 30,000 colleagues. I am pleased to confirm that the unions have agreed our pay approach for 2019 receiving overwhelming support from their members. The total pay budget of 2.6 per cent for 2018 for all colleagues has been allocated such that higher pay increases are made to colleagues acrosswho are positioned lower in the Group, which in 2016 will be 2pay range for their role, supporting a policy of real wage growth and pay progression. Increases range from 0.25 per cent to 9.9 per cent. The Group is therefore proposing to increase the base salaries of theproposed salary increases for Executive Directors. For the Chief Financial Officer and Chief Risk Officer, it is proposed that base salaries will increase byDirectors for 2019 have been set at 2 per cent, in line with other senior colleagues but lower than the overall colleague population.

From April 2019, all full-time colleagues in the Group will be paid a minimum salary of £17,510, 7 per cent above the National Living Wage, and where eligible will receive a minimum pay increase of £600 in 2019. This reflects the Group’s commitment to offering colleagues a competitive reward package, which aims to reward all colleagues fairly for their contribution. The Group has been recognised as a Living Wage employer since 2015.

The Group has also made progress in reducing the Gender Pay Gap by 1.3 per cent, with the median gap reducing from 32.8 per cent to 31.5 per cent, lower than the average for Financial Services, through a combination of targeting our salary increases and our efforts to increase female representation at senior levels in the Group.

2018 REMUNERATION IN THE CONTEXT OF BUSINESS PERFORMANCE AND THE PERSPECTIVE OF OUR WIDER STAKEHOLDERS

We have taken on board feedback received in 2018 that suggests our approach to measurement of Group performance was overly complex. For 2018, we operated a scorecard with 20 measures across five ‘blocks’ (as set out in full on page 115), but have reduced this to 15 measures and four ‘blocks’ for 2019. We have weighted the scorecard measures to provide a balance of performance expectations across financial, customer and colleague related outcomes. We will disclose details of the 2019 targets in 2020, but the revised balance of measures is summarised as follows:

33% Financial 33% Customer 33% Colleague and Conduct

The ‘Remuneration Overview’ section on the following pages provides a summary of the 2018 remuneration outcomes and policy for Executive Directors.

The Committee places great importance on ensuring there are clear links between remuneration and delivery of both financial and strategic objectives aligned to the long-term sustainable success of the Group.

 

ForIn 2018, the first time since 2011,Group made significant business progress, providing a base salary increase is also proposedstrong platform for the Group’s strategic development and delivery of key priorities. The Group delivered strong financial performance in a period of political and economic uncertainty. This uncertainty weighed heavily on the Group’s share price during 2018; however, the Group’s resilient and low risk business model enabled strong underlying performance. Underlying Profit increased by 6 per cent and the Group’s capital position strengthened. The Group’s cost:income ratio remains market leading at 49.3 per cent.

Reflecting the Group’s performance in 2018, the Committee determined that the total Group Performance Share funding should be 3 per cent down year-on-year (adjusted for changes in eligible population). Individual awards for Executive Directors reduced on average by 12 per cent year-on-year. Awards for Executive Directors were determined at 67.6 per cent of maximum.

The value of the 2016 Long Term Incentive Plan awards has vested at 68.7 per cent in respect of the three-year performance period ending 31 December 2018. This reflects the significant progress made by the Group towards its strategic and financial goals, while reflecting the fall in share price over the performance period.

How we determine remuneration for Executive Directors and our wider colleague population

The Committee seeks to be transparent in its approach to setting and delivering remuneration. Our policy for 2019 and the implementation report for 2019 can be found on pages 126 and 122.

As a result of taking on the role of Chief Executive. TheExecutive of the Ring-Fenced Bank from 1 January 2019 in addition to his existing responsibility as Group Chief Executive, was hired onit has been determined that the basis that uponFixed Share Award for António Horta-Osório should be increased to £1.05 million. At the Government shareholding falling insame time, the range of 15-20 per cent or less, the Committee would consider his remuneration being increased in line with market conditions. With the Government’s shareholding now being around 9 per cent and given the recovery of the Group’s financial strength, the Committee has decided it should now begin to adjust the Group Chief Executive’s salary towards the Reference Salary. After discussion with shareholders, the Committee has decided to stage this adjustment over two years. For 2016, this will consist of an increase in base salary of 2 per cent, in line with the other Executive Directors, and an additional increase of 4 per cent to reflect the arrangements above, taking his total salary to £1,125,000. The Group Chief Executive has suggested, andagreed to reduce his Pension Allowance to bring this closer to that of the Board has approved, that for 2016majority of the 4colleagues. His Pension Allowance will reduce from its current contractual level of 46 per cent increase beof base salary to 33 per cent of base salary. This results in a decrease in total remuneration and greater value delivered in shares and held until the Government has sold its shareholding in the Group. After this increase, the Group Chief Executive’s salary remains conservative comparedsubject to peers.a longer-term release schedule. Details are provided on page 122.

 

IMPACT OF REGULATORY CHANGE

2015 has been another year in which significant regulatory change has dominated theVariable remuneration agenda. This has included the publication of revised PRA and FCA rules on remuneration under CRD IV and a significant consultation on changes to the EBA Guidelines that overlay the UK rulebook.

In addition, during 2015, the remuneration requirements of the AIFMD Remuneration Code took effect. Alongside the specific remuneration rules, the Committee has also considered the impact of the introduction of the Senior Manager and Certification Regimes from March 2016 and other significant regulatory changes.

In particular, from 2016, there will be a regulatory requirement to extend deferral from three years to seven years. At least 60 per cent of total variable pay must be deferred. Currently the Group defers all bonuses awarded to the Executive Directors entirely in shares, an approach which is significantly more conservative than the market practice and current regulations require. In order to implement longer deferral of variable remuneration, the Group will make modest changes to the delivery of variable remuneration for the 2016 performance period. In addition to these changes for the 2016 performance period, the Committee is conducting a full review of the Group’s approach to variable remuneration and is considering making changes to deliver a simpler and more efficient structure. Any changes would apply from the 2017 performance period and it is intended that the Group will consult on these changes during 2016.

CONSIDERATION OF STAKEHOLDER VIEWS

The Group is committed to consulting key stakeholders to ensure their view is taken into consideration when determining remuneration. During 2015, the Group has consulted with major shareholders to gather their feedback and views on the Group’s approach to remuneration, in particular the proposed changes to base salary for Executive Directors and the Group’s forward-looking approach to variable remunerationother senior colleagues is weighted heavily toward long-term performance, ensuring our colleagues build an ownership interest in 2016. The Group has also met regularly with its main regulators, the PRA and FCA. The Group is grateful for the support and ongoing dialogue with key stakeholders.

The Committee reviews an annual report from the Group HR Director on the operation of the Group’s remuneration policy and its effectiveness. In 2015, the report concluded that effective systems and controls are in place for all requirements of the Policy and that it continues to deliver outcomes in line with the Group’s values, reward principles and the requirements of the PRA and FCA remuneration rules and guidance issuedmotivated by the European Banking Authority.

The Board places great emphasis on ensuring that remuneration policy and practices align to the Group’s strategy and the continued focus on delivering superior and sustainable shareholder returns.returns for shareholders.

All colleagues, including Executive Directors, participate in the Group Performance Share plan. This single approach to bonus awards ensures there is a fair and transparent link between individual remuneration outcomes and Group performance.

The approach to determining awards for Executive Directors is as follows:

 Evaluation of performance: The Committee reviews financial and non-financial performance against the Balanced Scorecard objectives. Judgement may then be used to ensure that mechanical scorecard outcomes are aligned to individual contribution, including ‘how’ Executive Directors have performed.
Full details are provided on page 115.
Determination of Group Performance Share award: The performance assessment determines the maximum opportunity and the range that judgement can be applied within.
Full details are provided on page 116.
Final awards: To ensure fairness with all other colleagues, awards are adjusted to reflect the final pool funding.
Full details are provided on page 116.

In 2018, the Committee did not exercise any discretion over remuneration outcomes. Further details on how the use of discretion was considered can be found on page 118 in respect of the 2016 LTIP vesting outcome and page 116 in respect of the 2018 Group Performance Share awards.

I hope you find the additional explanation in this report helpful in clarifying our approach.

2019 ANNUAL GENERAL MEETING

Together with my Committee members, I look forward to hearing your views on the remuneration arrangements outlined in this report, and to welcoming you to the 2019 AGM where I hope you will support the resolutionsresolution relating to remuneration at the 2016 AGM.remuneration.

 

Stuart Sinclair

Chairman, Remuneration Committee


130112

COMPENSATION

 

REMUNERATION AT A GLANCE

HOW LLOYDS BANKING GROUP PERFORMEDOVERVIEW

 

The Group has had a successful 2015 with a number of strategic milestones achieved, notably improved dividend returns, increase in underlying profit and completion of the sale of TSB at a premium to market value.HOW WE PAY IN LINE WITH PERFORMANCE AND OUR STRATEGIC GOALS

 

The Group’s approach to reward is to provide a clear link between remuneration and delivery of the Group’s strategy and the aim of becoming the best bank for customers. The Group believes in offering fair reward. It is embedding a performance-driven and meritocratic culture where colleagues are rewarded for behaviours aligned to the long-term sustainable success of the business, the commitment to rebuilding trust and changing the culture of the Group.

KEY PERFORMANCE MEASURES

The table below illustrates outcomes against the Group’s key performance measures relevant to remuneration. The annual bonus outcome is driven by a combination of Group underlying profit and Balanced Scorecard performance. The LTIP measures Group performance over a three year period, using a range of financial and strategic measures.


Measure20152014
Underlying profit before tax£8,112m1£7,756m
Group Balanced ScorecardStrongStrong
Economic profit£2,233m£2,094m
Total Shareholder Return (TSR)  
Per annum for the three years ended 31 December16.6%30.2%
Cost:income ratio49.3%49.8%
Net promoter score59.3%59.2%
Digital active customer base11.5m10.4m
Colleague engagement score71%60%

1The underlying profit result used for remuneration purposes is £7,994 million (excluding TSB).

ANNUAL BONUS PLAN OUTCOME

Despite the better results in 2015, the decision has been taken to reduce the Group’s total bonus outcome by approximately 26 per cent. Material adjustments have been made to the outcome in 2015 (as in 2014) to reflect the impacts of legacy items

Discretionary annual bonus awards of £353.7 million will be made for 2015 (4 per cent down from £369.5 million in 2014). The total bonus awards as a percentage of pre-bonus underlying profit before tax declined from 4.5 per cent in 2014 to 4.2 per cent in 2015. This compares favourably to shareholder return from dividend payments over the same period.

 


131

COMPENSATION

TOTAL REMUNERATION FOR EXECUTIVE DIRECTOR REMUNERATION OUTCOMESDIRECTORS 2017 VS 2018

 

The charts below summarise the Executive Directors’ remuneration for the years ended 31 December 20142017 and 2015.

 2018 performance years. Full details are provided on page 117.

 

Notes

Fixed pay Group Performance Share Long term incentive/Group Ownership Share António Horta-Osório Group Chief Executive (GCE) 2,876 1,178 67.6% of max 68.7% of max 2,216 6,270 46% 19% 35% £000 2018 2,842 1,323 77% of max 66.3% of max 2,269 6,434 44% 21% 35% £000 2017 1 2 George Culmer Chief Financial Officer (CFO) 1,524 527 67.6% of max 68.7% of max 1,223 3,274 47% 16% 37% £000 2018 1,501 599 78% of max 66.3% of max 1,228 3,328 45% 18% 37% £000 2017 1 2 Juan Colombás Chief Operating Officer (COO) 1,540 527 67.6% of max 68.7% of max 1,206 3,273 47% 16% 37% £000 2018 1,510 599 80% of max 66.3% of max 1,211 3,320 46% 18% 36% £000 2017

 

1In June 2015, the2018 Group reached a settlement with the Financial Conduct Authority (FCA) with regard to aspects of its Payment Protection Insurance (PPI) complaint handling process during the period March 2012 to May 2013. As a result, the Committee decided to make adjustments in respect of bonusesPerformance Share, awarded in 2012 and 2013 to the Group Executive Committee and some other senior executives given their ultimate oversight of the PPI operations. The number of shares adjusted was 409,039 for the GCE, 109,464 for the CFO and 376,055 for the CRO.March 2019.
  
22015 bonus, awarded in March 2016.
32013The 2016 LTIP vesting and dividend equivalents awarded in shares were confirmed by the Remuneration Committee at its meeting on 1614 February 2016.2019. The average share price between 1 October 20152018 and 31 December 2015 (73.722018 (56.04 pence) has been used to calculateindicate the value. The shares were awarded in 20132016 based on a share price of 49.2972.978 pence.

 

DIRECTORS’ REMUNERATION: POLICY IMPLEMENTATION OVERVIEW FOR 2016HOW EXECUTIVE DIRECTOR REMUNERATION IS COMPOSED1

FIXED 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 Implementation Base Salary For 2019: Award The Group has applied a total pay budget of 2.6 per cent for the wider colleague population. GCE: £1,269,288 (1 January 2019) (2 per cent) CFO: £779,351 COO: £794,938 (1 January 2019) (2 per cent). Fixed share award Award 20% 20% 20% 20% 20% For 2019: GCE: £1,050,000 CFO: £504,000 COO: £497,000 Awards are released in shares in equal tranches over a five year period. Pension Award For 2019: GCE: 33 per cent of base salary CFO: 25 per cent of base salary COO: 25 per cent of base salary Benefits Award Benefits remain unchanged from 2018. Executive Directors receive a flexible benefits allowance in line with colleagues, (4 per cent of salary). This can be used to select benefits including life assurance and critical illness cover. Other benefits include car allowance, transportation and private medical cover. VARIABLE 2018 Group Performance Share Performance period 40% 40% 20% 1 yr hold 1 yr hold 1 yr hold For 2018, the following awards were made: GCE: £1,177,700 CFO: £526,841 COO: £526,841 £2,000 is paid in cash in March 2019, with the balance of the upfront 40 per cent delivered in shares. Half of this is delivered in June 2019 and the remainder subject to holding until March 2020. The remaining 60 per cent is deferred into shares with 40 per cent vesting in 2020 and 20 per cent in 2021. Half of each deferral is also subject to holding for one year.2 See page 122. 2019 Group Ownership Share Individual performance determines 2019 award Performance period 20% 2 yr hold 20% 1 yr hold 20% 1 yr hold 20% 1 yr hold 20% 1 yr hold For 2019 the following awards are being made: GCE: 300 per cent of base salary. CFO: No award COO: 275 per cent of base salary. Awards will be subject to a three year performance period with vesting between the third and seventh anniversary of award. Any shares released are subject to a further holding period in line with regulatory requirements and market practices.2 See page 122.

1All references to CFO refer to George Culmer in role on 1 January 2019.
2Variable remuneration is subject to malus and clawback. See page 123.
113

COMPENSATION

HOW OUR REWARD EMPHASISES LONG TERM PERFORMANCE AND IS ALIGNED TO OUR STRATEGIC PRIORITIES

Financial targets that form the basis of the outcomes for both short term and long term awards are directly linked to the Group’s Four Year Operating Plan.

Variable remuneration awards are subject to a balance of financial and strategic measures as summarised below.

Performance Assessment Short Term Variable Remuneration Year 1 Year 2 Year 3 c. 30% Group Performance Share Financial Performance measures Underlying Profit Strategic Performance measures Group Balanced Scorecard Long Term Variable Remuneration c. 70% Group Ownership Share Financial Performance measures Cost: income ratio / Total Shareholder return / Economic profit Strategic Performance measures Customer satisfaction / Digital active customer growth / Customer complaints Colleague engagement

Shareholding requirements are in line with FTSE 100 practice and actual Executive Director shareholdings are significantly above the required levels as can be seen on page 120.

HOW WE PERFORMED AGAINST THE KEY PERFORMANCE INDICATORS WHICH DIRECTLY IMPACT REMUNERATION OUTCOMES AND SUPPORT THE DELIVERY OF OUR REWARD PRINCIPLES

How we have performed over one year Financial performance &pound;8,066m +6% Underlying profit How we have performed over three years (2016 LTIP measures) &ndash; see page 118. Cost:income ratio1 (10% weighting) Actual: 44.7% 100% 47.3% or less 25% payout 46.1% or less 100% payout Customer satisfaction (10% weighting) Actual: 1st 3rd place 25% payout 1st place 100% payout Colleague engagement (7.5% weighting) Actual: 73 100% 66 25% payout 72 100% payout Total shareholder return (2016–2018) (30% weighting) Actual: (4.8%) 0% 8% p.a. or more 25% payout 16% p.a. or more 100% payout Digital active customer growth2 (7.5% weighting) Actual: 14.1m 100% 13.4m 25% payout 14.0m 100% payout Economic profit (25% weighting) Actual: £3,291m 94.8% £2,507m 25% payout £3,308m or more 100% payout Customer complaints per 1,000 (5% weighting) Actual: 3.04 100% 4.18 25% payout 3.78 100% payout Customer complaints FOS change rate (5% weighting) Actual: 18% 100% =<29% 25% payout =<25% 100% payout

1Adjusted total costs, excluding remediation.
2Excludes MBNA.

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COMPENSATION

ANNUAL REPORT ON REMUNERATION

2018 GROUP BALANCED SCORECARD

A balanced scorecard approach is used to assess Group performance and divisional performance. The Group Balanced Scorecard is made up of 20 measures with clearly defined performance targets agreed by the Committee in Q1 2018. Each receives a mechanical score of 1 to 5 depending on performance against those targets, resulting in an overall score and performance rating, see table on page 116. The Group Chief Executive’s individual performance is measured through the Group Balanced Scorecard.

 

The detailed2018 Group Balanced Scorecard is as follows:

Non-Financial Performance Range/Outcome Objective Measure Minimum: 1 Maximum: 5 Score Customer Satisfying our customers Customer Dashboard (score relating to c. 120 customer specific measures) 0-29 85-100 4 Retaining and growing customers Customer Index (Reviewing customer experience and customer value) <4 ≥9 Making business with us easier Improvement of customer journeys 50% standardised / 50% optimised The Group has standardised the majority of its customer journeys with little progress to optimise. The Group has optimised the majority of its customer journeys with the remainder being standardised. 4 Fewer complaints, better handled, driving better outcomes Total FCA Complaints per ’000 3.04 >3.25 <3.00 4 FOS Change Rate 18% >30% ≥25% 5 People More engaged colleagues Banking Standards1 Board Colleague Survey results Score movement (absolute) -2 >-6 ≥1 Change vs BSB median (relative) >-2 ≥1 3 Building a better culture Colleague and cultural engagement scores 70.1 <63≥73 4 Building skills for the future Colleague upskilling/ retraining completion 13,548 10% red metrics .4% red metrics Change delivered safely Change Execution Risk 92.9% Green / 4.7% Red Less than 75% of change indicators rated Green, over 15% rated Red Over 92.5% of change indicators rated Green, less than 5% rated Red Major programmes delivered as planned Successful delivery of Major Group Core Programmes (based on time, cost and quality approach) 11 2.9 Helping Britain Prosper Deliver Helping Britain Prosper targets 90.9% rated Green 52.9% 200bps 4 5 5 Financial 1. Banking Standards Board measure combines the absolute and relative movement in one metric.

115

COMPENSATION

CALCULATING THE 2018 GROUP PERFORMANCE SHARE OUTCOME

The Annual Group Performance Share outcome is calculated using the following steps.

Timeline Process Calculation step Funding inputs Q1. 2018 Group underlying profit target determined. Threshold set 20 per cent below target, below which no bonus payable. 8,616m1 The Committee set a funding level to award at target which is 30 per cent of max opportunity for EDs, as per policy, implementation table containingand 50 per cent for all elementsother colleagues. 447.5m2 Percentage of remuneration canunderlying profit used to fund Group Performance Share determined. 447.5m / 8,616m = 5.1% Funding calculation Q4. 2018 Group underlying profit reported (adjusted). 9,154m3 Application of funding percentage. 9,154m x 5.1% = 466.9m Balanced Scorecard Outcome 1.00 1.59 Threshold 1.60 2.59 2.60 2.79 2.80 3.19 3.20 3.59 3.60 3.79 3.80 4.19 4.20 4.59 4.60 4.79 4.80 5.00 Group Scorecard Rating Under Developing Good Minus Good Good Plus Strong Minus Strong Strong Plus Top Minus Top Group Balanced Scorecard Modifier 0 0.55 0.80 0.90 1.00 1.05 1.10 1.15 1.20 1.25 1.30 Maximum Assessment of performance against Group Balanced Scorecard objectives agreed in Q1 2018. Balanced Scorecard Outcome 4.15/5 Group Balanced Scorecard Modifier. 466.9m x 1.15 = 536.9m Reduction for conduct, and other factors. 536.9m 72.4m = 464.5m Overall pool 464.5m Final approved GPS funding for the Group was 4 per cent greater than the original target. 464.5m / 447.5m = 104% (Group Funding Modifier) GPS Funding Underlying profit m Pool Funding % Funding (mechanical) m Performance Adjustment m Conduct, risk and other factors m Overall Pool m Final % of Underlying Profit % 2017 Target 7,846 400.0 Actual 8,567 436.9 87.4 (109.6) 414.7 4.8 5.1% 2018 Target 8,6161 447.52 Actual 9,1543 466.9 70 (72.4) 464.5 5.1

1Target full year underlying profit agreed by Board, adjusted for conduct and target GPS expense.
2On target increased year-on-year due to population change, including colleagues moving from incentives to Group Performance Share in 2018.
3Underlying profit of £8,066m adjusted by £600m for conduct provision, £27m for year-on-year Prudential Value Adjustment in line with regulatory requirement and £461m for Group performance share expense in 2018.

EXECUTIVE DIRECTORS’ GROUP PERFORMANCE SHARE OUTCOME FOR 2018 (AUDITED)

Individual awards for Executive Directors are determined through the assessment of individual performance using the Group or their divisional balanced scorecard. Personal contribution may be foundconsidered where it diverges from scorecard outcomes. Awards will not be made if the Group does not meet threshold financial performance or if an individual is rated Developing or below.

Awards are based on page 152.pre-determined formulaic pay out ranges commensurate with performance as follows:

Individual Under – Good Good Good Strong Strong Strong Top Top Performance Developing Minus   Plus Minus   Plus Minus Opportunity No award Threshold 12.5% – 24.16% – 35.84% – 47.5% – 59.16% – 70.83% – 82.5% – 94.16% – Maximum (% of maximum) 24.15% 35.83% 47.49% 59.15% 70.82% 82.49% 94.15% 100%

 

BASE SALARYBased on the mechanical outturn of individual scorecards, a recommendation is made on the award level within the pre-determined pay out range. This was the mid point of the range and no discretion was applied.

 

Base salary reflectsThe Group modifier is applied to all colleague awards to take into account Group Performance against target. For 2018 an adjustment of 4 per cent.

Executive     Balanced Final Award Group Final GPS Maximum Final Award Director     Scorecard Individual (% of max) Funding Award Opportunity (% of salary) rating Modifier (% of max) (% of salary) António Horta-Osório     Group Strong 65%   67.6% 140% 94.60% George Culmer     Finance Strong 65% 104% 67.6% 100% 67.60% Juan Colombás     Chief Operating Office Strong 65%   67.6% 100% 67.60% Read more page 117

116

COMPENSATION

Individual performance ratings are determined on the basis of whole job contribution taking account of both (i) what has been achieved against the balanced scorecard objectives for the area for which they have responsibility and (ii) personal performance that considers how performance has been achieved through their leadership approach. For the Group Chief Executive the relevant Balanced Scorecard is the Group Balanced Scorecard, for the Chief Financial Officer the Finance Division Scorecard, and for the Chief Operating Officer the Chief Operating Office Scorecard. Discretion may be applied in deciding whether personal performance rating should vary from the mechanical outcome provided by the Balanced Scorecard metrics. No discretion has been exercised for 2018.

António Horta-Osório Group Chief Executive George Culmer Chief Financial Officer Juan Colombás Chief Operating Officer The Group Chief Executive&rsquo;s performance assessment for 2018 reflected the Group&rsquo;s objectives, assessed as Strong. For Group Balanced scorecard please see page 115 Finance Balanced Scorecard rating BSC category Assessment Rating Customer 4.00 Strong People 3.75 Strong minus Control environment 4.00 Strong Building the business 3.67 Strong minus Finance 4.60 Top minus The Chief Financial Officer&rsquo;s individual performance assessment for 2018 reflected the Finance division&rsquo;s objectives, assessed as Strong. The individual block ratings and assessment are shown above. COO Balanced Scorecard rating BSC category Assessment Rating Customer 4.20 Strong Plus People 3.50 Good Plus Control environment 4.25 Strong Plus Building the business 4.00 Strong Finance 4.50 Strong Plus The Chief Operating Officer&rsquo;s individual performance assessment for 2018 reflected the Chief Operating Office objectives, assessed as Strong. The individual block ratings and assessment are shown above.

Key considerations factored into assessing performance and overall rating include, but are not limited to, the following:

Other performance considerations Launched the third stage of the Group’s strategic plan with strategic investment of more than £3 billion over three years. Increased customer ‘net promoter’ score, with reduction in compliants, set against continuing legacy conduct issues and remediation. Further progress in building market leading savings and wealth proposition with agreed Schroders JV. Maintained colleague engagement above UK high-performing norm, with significant increase in skills training. Continued progress against Helping Britain Prosper targets. Financial performance above plan, allowing for increased return of capital to shareholders. Overall rating Strong Other performance considerations Strong financial performance delivered in a continuing challenging low interest rate environment. Continued improvement in the Group’s cost:income ratio to 46 per cent (49.3 per cent including remediation). CET1 capital generation of 210 bps, comfortably exceeding market guidance of 200 bps. Effective management of the establishment of the non-ring fenced bank, Lloyds Bank Corporate Markets plc. V ery strong leadership of the Finance, Legal and Strategy division with excellent colleague engagement. Other performance considerations Maintained a strong operational environment including developing and implementation of Change, Information and Cyber Security risk control, reporting and insight. Delivered customer complaint reductions which saw an 8.2 per cent year-on-year reduction to a close of 3.04 FCA complaints per thousand. Exemplary leadership of delivery of the latest strategic plan, transforming the Group for success in a digital world. Fully supported the People transformation activities across the Group, delivering in excess of 1 million training and development hours for colleagues. Maintained colleague engagement at levels in excess of the UK high performing norm. Overall rating Strong

SINGLE TOTAL FIGURE OF REMUNERATION (AUDITED)

  António Horta-Osório George Culmer Juan Colombás Total
£000 2018 2017 2018 2017 2018 2017 2018 2017
Base salary 1,244 1,220 776 760 779 753 2,799 2,733
Fixed share award 900 900 504 504 497 497 1,901 1,901
Benefits 157 156 49 46 68 71 274 273
Group Performance Share 1,178 1,323 527 599 527 599 2,232 2,521
2016 Long-term incentive (LTIP)1 2,216 2,269 1,223 1,228 1,206 1,211 4,645 4,708
Pension allowance 573 565 194 190 195 188 962 943
Other remuneration2 2 1 1 1 1 1 4 3
Total remuneration 6,270 6,434 3,274 3,328 3,273 3,320 12,817 13,082

1The 2016 LTIP vesting (see page 118) at 68.7 per cent and dividend equivalents awarded in shares were confirmed by the roleRemuneration Committee at its meeting on 14 February 2019. The total number of shares vesting were 3,445,449 and 509,271 shares delivered in respect of dividend equivalents for António Horta-Osório, 1,901,209 shares vesting and 281,017 shares delivered in respect of dividend equivalents for George Culmer and 1,874,804 shares vesting and 277,114 shares delivered in respect of dividend equivalents for Juan Colombás. The average share price between 1 October 2018 and 31 December 2018 (56.04 pence) has been used to indicate the value. The shares were awarded in 2016 based on a share price of 72.978 pence and as such no part of the individual taking accountreported value is attributable to share price appreciation. LTIP and dividend equivalent figures for 2017 have been adjusted to reflect the share price on the date of responsibilities and experience, and payvesting (67.1043 pence) instead of the average price (66.75 pence) reported in the Group as a whole. It helps to recruit and retain Executive Directors and forms the basis2017 report.
2Other remuneration payments comprise income from all employee share plans, which arises through employer matching or discounting of a competitive remuneration package.employee purchases.
117

COMPENSATION

 

PENSION AND BENEFITS (AUDITED)

Pension/Benefits £ António Horta-Osório George Culmer Juan Colombás
Cash allowance in lieu of pension contribution 573,400 193,883 194,838
Car or car allowance 12,000 17,943 12,000
Flexible benefits payments 48,800 30,563 30,138
Private medical insurance 38,151 760 17,342
Tax preparation 24,000 – 5,881
Transportation 34,265 – 2,542

DEFINED BENEFIT PENSION ARRANGEMENTS (AUDITED)

António Horta-Osório has a conditional unfunded pension commitment. This was a partial buy-out of a pension forfeited on joining from Santander Group. It is an Employer-Financed Retirement Benefits Scheme (EFRBS). The EFRBS provides benefits on a defined benefit basis at a normal retirement age of 65. The benefit in the EFRBS accrued during the six years following commencement of employment, therefore ceasing to accrue as of 31 December 2016.

The EFRBS was subject to performance conditions. It provides a percentage of the GCE’s base salary or reference salary in the 12 months before retirement or leaving. No additional benefit is due in the event of early retirement. The rate of pension accrued in each year depended on share price conditions being met and the total pension due is 6 per cent of his base salary of £1,244,400 or £74,664.

There are no other Executive Directors with defined benefit pension entitlements.

Under terms agreed when joining the Group, Juan Colombás is entitled to a conditional lump sum benefit of £718,996 either (i) on reaching normal retirement age of 65 unless he voluntarily resigns or is dismissed for cause, or (ii) on leaving due to long-term sickness or death.

2016 LTIP VESTING (AUDITED)

Awards in the form of conditional rights to free shares in 2016 were made over shares with a value of 300 per cent of reference salary for the GCE and 275 per cent of salary for the CFO and COO. These LTIP awards are vesting at 68.7 per cent, as detailed in the table below. This reflects the Group’s strong financial and strategic performance over the three financial years ended 31 December 2018, balanced against significant uncertainty in the economic and political environment impacting negatively on share price performance, resulting in no vesting for the Total Shareholder Return component.

The Committee has an overarching discretion to reduce the level of award that will vest, regardless of whether the performance condition for partial or full vesting has been met. This qualitative judgement ensures that vesting is not simply driven by a formula that may give an unexpected or unintended remuneration outcome compared to Group performance. The Committee considers this discretion carefully, taking into account circumstances that are relevant to the performance measures and the period under consideration. No discretion has been applied in respect of the vesting outcome for the 2016 LTIP. This was discussed, but it was agreed that the formulaic outcomes were fair and reflective against the original targets set in 2016. Executive Directors are required to retain any vested shares for a further two years after vesting.

Weighting Measure Threshold Maximum Actual Vesting
30% Absolute total shareholder return (TSR) 8% p.a. 16% p.a. (4.8%) 0%
25% Economic profit £2,507m £3,308m £3,291m 23.7%
10% Cost:income ratio1 47.3% 46.1% 44.7% 10%
10% Customer complaint handling2 4.18 3.78 3.04 5%
  (FCA reportable complaints/FOS change rate) =<29% =<25% 18% 5%
10% Customer Satisfaction 3rd 1st 1st 10%
7.5% Digital active customer growth 13.4m 14.0m 14.1m 7.5%
7.5% 

Colleague engagement score

 66 72 73 7.5%
    LTIP (% maximum) vesting 68.7%

1Adjusted total costs.
2The FCA changed the approach to complaint classification and reporting from 30 June 2016. The Committee determined that the original target should be translated on a like-for-like basis into the new reporting requirement. The Committee was satisfied that the revised targets, set on a mechanical basis, were no less stretching.

CHAIRMAN AND NON-EXECUTIVE DIRECTORS (AUDITED)

  Fees £000 Total £000
  2018 2017 2018 2017
Chairman and current Non-Executive Directors        
Lord Blackwell1 743 728 755 740
Alan Dickinson 230 248 230 248
Anita Frew 380 364 380 364
Simon Henry 182 166 182 166
Lord Lupton 318 161 318 161
Amanda Mackenzie2 31 – 31 –
Deborah McWhinney 174 142 174 142
Nick Prettejohn 449 441 449 441
Stuart Sinclair 172 152 172 152
Sara Weller 199 190 199 190
Former Non-Executive Directors        
Anthony Watson (retired May 2017) – 91 – 91
Nick Luff (retired May 2017) – 69 – 69
Total 2,878 2,752 2,890 2,764

1Benefits: car allowance (£12,000).
2Appointed 1 October 2018.
118

COMPENSATION

LOSS OF OFFICE PAYMENTS AND PAYMENTS WITHIN THE REPORTING YEAR TO PAST DIRECTORS (AUDITED)

There were no payments for the loss of office during 2018. In April 2018, following a Court judgment in relation to Integration Awards granted under the Group’s Long-Term Incentive Plan (the LTIP) in 2009, 2,063,640 shares were released and £271,169 paid to John Eric Daniels, former Group Chief Executive and 1,424,778 shares were released and £386,167 paid to Truett Tate, former Executive Director.

EXTERNAL APPOINTMENTS

António Horta-Osório – During the year ended 31 December 2018, the GCE served as a Non-Executive Director of Exor, Fundação Champalimaud, Stichting INPAR Management/Enable and Sociedade Francisco Manuel dos Santos. The Group Chief Executive is entitled to retain the fees, which were £380,569 in total.

RELATIVE IMPORTANCE OFDividend and share buyback1£m  Salaries and performance-based  
SPEND ON PAY (£M)   compensation £m  
The graphs illustrate the total remuneration of      
all Group employees compared with returns2018+26+%4,0392018-5.2%2,991
of capital to shareholders in the form of2017 3,1952017 3,152
dividends and share buyback.      
 1 2018: Ordinary dividend in respect of the financial year     
 ended 31 December 2018, partly paid in 2018 and partly to     
 be paid in 2019 and intended share buyback.     
 2017: Ordinary dividend in respect of the financial year     
 ended 31 December 2017, partly paid in 2017 and partly to     
 be paid in 2018 and intended share buyback.     

COMPARISON OF RETURNS TO SHAREHOLDERS AND GCE TOTAL REMUNERATION

The chart below shows the historical total shareholder return (TSR) of Lloyds Banking Group plc compared with the FTSE 100 as required by the regulations.

The FTSE 100 index has been chosen as it is a widely recognised equity index of which Lloyds Banking Group plc has been a constituent throughout this period.

TSR INDICES – LLOYDS BANKING GROUP AND FTSE 100

 

  CEO 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
GCE single figure of remuneration £000 J E Daniels 1,121 2,572 855 – – – – – – –
 António
Horta-Osório		 – – 1,765 3,398 7,475 11,540 8,704 5,791 6,434 6,270
                       
Annual bonus/ GPS payout (% of maximum opportunity) J E Daniels Waived 62% 0% – – – – – – –
 António
Horta-Osório		 – – Waived 62% 71% 54% 57% 77% 77% 67.6%
                       
Long-term incentive vesting (% of maximum opportunity) J E Daniels 0% 0% 0% – – – – – – –
 António
Horta-Osório		 – – 0% 0% 54% 97% 94.18% 55% 66.3% 68.7%
                       
TSR component vesting (% of maximum) J E Daniels 0% 0% – – – – – – – –
 António
Horta-Osório		 – – 0% 0% 25.3% 30% 30% 0% 0% 0%

Notes: J E Daniels served as GCE until 28 February 2011; António Horta-Osório was appointed GCE from 1 March 2011. António Horta-Osório declined to take a bonus in 2011.

119

COMPENSATION

DIRECTORS’ SHARE INTERESTS AND SHARE AWARDS

DIRECTORS’ INTERESTS (AUDITED)

  Number of shares Number of options Total shareholding1 Value
  Owned outright Unvested
subject to
continued
employment		 Unvested
subject to
performance		 Unvested
subject to
continued
employment		 Vested
unexercised		 Total at
31 December
2018		 Total at
20 February
2019		 Expected value
at 31 December
2018 (£000s)2
Executive Directors         
António Horta-Osório 25,751,860 1,520,915 17,059,116 36,282 – 44,368,173 44,368,8787 18,582
George Culmer 14,754,666 695,245 9,621,899 14,554 – 25,086,364 25,086,9787 10,512
Juan Colombás 9,679,888 696,217 9,488,262 29,109 – 19,893,476 19,894,0917 7,854
Non-Executive Directors3         
Lord Blackwell 150,000 – – – – 150,000 n/a7 n/a
Alan Dickinson 200,000 – – – – 200,000 n/a7 n/a
Anita Frew 450,000 – – – – 450,000 n/a7 n/a
Simon Henry 250,000 – – – – 250,000 n/a7 n/a
Lord Lupton 1,000,000 – – – – 1,000,000 n/a7 n/a
Amanda Mackenzie OBE4 – – – – – – n/a7 n/a
Deborah McWhinney5 250,000 – – – – 250,000 n/a7 n/a
Nick Prettejohn6 69,280 – – – – 69,280 n/a7 n/a
Stuart Sinclair – – – – – – n/a7 n/a
Sara Weller CBE 340,000 – – – – 340,000 n/a7 n/a

1Including holdings of connected persons.
2Awards subject to performance under the LTIP had an expected value of 50 per cent of face value at grant (in line with the Remuneration Policy). Values are based on the 31 December 2018 closing price of 51.85 pence. Full face value of awards are £23,004,897 for António Horta-Osório, £13,007,279 for George Culmer and £10,314,767 for Juan Colombás.
3Deborah McWhinney resigned 31 December 2018. Shares held as at date of resignation.
4Appointed 1 October 2018.
5Shareholdings held by Deborah McWhinney are either wholly or partially in the form of ADRs.
6In addition, Nick Prettejohn held 400 6.475 per cent preference shares at 1 January 2018 and 31 December 2018.
7The changes in beneficial interests for António Horta-Osório (705 shares), George Culmer (614 shares) and Juan Colombás (615 shares) relate to ‘partnership’ and ‘matching’ shares acquired under the Lloyds Banking Group Share Incentive Plan between 31 December 2018 and 20 February 2019. There have been no other changes up to 20 February 2019.

SHAREHOLDING REQUIREMENT (AUDITED)

Executives are expected to build and maintain a company shareholding in direct proportion to their remuneration in order to align their interests to those of shareholders. The minimum shareholding requirements Executive Directors are expected to meet are as follow: 350 per cent of base salary for the GCE and 250 per cent of base salary for other Executive Directors. Newly appointed individuals will have three years from appointment to achieve the shareholding requirement.

There is no appetite for non-compliance with the Shareholding Policy. In the event that exceptional individual circumstances exist resulting in an Executive not being able to comply with the Policy, the Remuneration Committee will consider whether an exception should apply.

In addition to the Group’s shareholding requirements, shares vesting are subject to holding periods in line with regulatory requirements.

António Horta-Osório Shareholding requirement 350% Actual shareholding1 1,294% George Culmer Shareholding requirement 250% Actual shareholding1 1,184% Juan Colombás Shareholding requirement 250%   Actual shareholding1777%

1Calculated using the average share price for the period 1 January 2018 to 31 December 2018 (62.554 pence). Includes ordinary shares acquired through the vesting of the deferred Group Performance Share plan, Fixed Share Awards as the shares have no performance conditions; American Deposit Receipts (ADRs) with each one ADR equating to four shares, Executive Share Awards which have vested but have not been exercised; shares held in the Share Incentive Plan (SIP) Trust, i.e. Free, Partnership, Matching and Dividend shares which are no longer subject to forfeiture, as defined in the SIP Rules. Shares held by Connected Persons, as defined by the Companies Act, but broadly meaning spouse or partner and children, may also be included.

The current Shareholding Policy does not take into account post-employment requirements. Consideration of how post-employment shareholding will be incorporated into the Policy will be undertaken in 2019, ahead of a revised policy being implemented in 2020.

As per the diagram on page 113 illustrating how share based remuneration is delivered to our Executive Directors, shares are deferred for up to seven years and clawback provisions can be implemented for up to ten years. Deferred bonus awards and long term incentive awards that are yet to vest are not currently included within the total shareholding for Executive Directors. Based on the number of outstanding bonus deferrals and number of in-flight long term incentive awards granted to each Executive Director, a post-employment shareholding requirement could be achieved until a formal policy is implemented.

None of those who were Directors at the end of the year had any other interest in the capital of Lloyds Banking Group plc or its subsidiaries.

120

COMPENSATION

OUTSTANDING SHARE PLAN INTERESTS (AUDITED)

        Vested /   At 31   Exercise periods  
  At 1 January
2018		 Granted/
awarded		 Dividends
awarded		 released /
exercised		 Lapsed December
2018		 Exercise price From To Notes
António Horta-Osório                    
LTIP 2015-2017 4,579,006 – 346,087 3,035,880 1,543,126 –       1, 2, 3
LTIP 2016-2018 5,015,210 – – – – 5,015,210       3
GOS 2017-2019 5,318,685 – – – – 5,318,685       3
GOS 2018-2020   6,725,221 – – – 6,725,221       3, 4
Deferred GPS awarded in 2018   1,555,288 – 388,822 – 1,166,466       5
2014 Sharesave 14,995 – – 14,995 –   60.02p     6
2016 Sharesave 14,554 – – – – 14,554 47.49p 01/01/2020 30/06/2020  
2017 Sharesave 21,728 – – – – 21,728 51.03p 01/01/2021 30/06/2021  
George Culmer                    
LTIP 2015-2017 2,477,167 – 187,227 1,642,361 834,806 –       1, 2, 3
LTIP 2016-2018 2,767,409 – – – – 2,767,409       3
GOS 2017-2019 2,993,565   – – – 2,993,565       3
GOS 2018-2020   3,860,925 – – – 3,860,925       3, 4
Deferred GPS awarded in 2018   704,426 – 176,106 – 528,320       5
2014 Sharesave 14,995 – – 14,995 –   60.02p     6
2016 Sharesave 14,554 – – – – 14,554 47.49p 01/01/2020 30/06/2020  
Juan Colombás                    
LTIP 2015-2017 2,442,762 – 184,627 1,619,551 823,211 –       1, 2, 3
LTIP2016-2018 2,728,973 – – – – 2,728,973       3
GOS 2017-2019 2,951,987   – – – 2,951,987       3
GOS 2018-2020   3,807,302 – – – 3,807,302       3, 4
Deferred GPS awarded in 2018   704,426 – 176,106 – 528,320       5
2016 Sharesave 29,109 – – – – 29,109 47.49p 01/01/2020 30/06/2020  

1The shares awarded in March 2015 vested on 12 March 2018. The closing market price of the Group’s ordinary shares on that date was 67.50 pence. Shares vested are subject to a further two-year holding period.
22015 LTIP award was eligible to receive an amount equal in value to any dividends paid during the performance period. Dividend equivalents have been paid based on the number of shares vested and have been paid in shares. The dividend equivalent shares were paid on 12 March 2018. The closing market price of the Group’s ordinary shares on that date was 67.50 pence. The dividend equivalent shares are not subject to any holding period.
3All LTIPs /GOS have performance periods ending 31 December at the end of the three-year period. Awards were made in the form of conditional rights to free shares.
4Awards (in the form of conditional rights to free shares) in 2018 were made over shares with a value of 300 per cent of reference salary for António Horta-Osório (6,725,221 shares with a face value of £3,660,000); 275 per cent for George Culmer (3,860,925 shares with a face value of £2,101,193); and 275 per cent for Juan Colombás (3,807,302 shares with a face value of £2,072,010). The share price used to calculate face value is the average price over the five days prior to grant (27 February to 5 March 2018), which was 68.027 pence. As regulations prohibit the payment of dividend equivalents on awards in 2018 and subsequenet years, the number of shares awarded has been determined by applying a discount factor to the share price on award. An adjustment of 25 per cent was applied. Performance conditions for this award are set out in the table below.
5GPS is deferred into shares. The face value of the share awards in respect of GPS granted in March 2018 was £1,058,016 (1,555,288 shares) for António Horta-Osório; £479,200 (704,426 shares) for George Culmer; and £479,200 (704,426 shares) for Juan Colombás. The share price used to calculate the face value is the average price over the five days prior to grant (27 February to 5 March 2018), which was 68.027 pence.
6Options exercised on 14 June 2018. The closing market price of the Group’s ordinary shares on that date was 63.13 pence.

2018 GROUP OWNERSHIP SHARE PERFORMANCE MEASURES (FOR AWARDS MADE IN MARCH 2018)

As requested in the 2017 Directors’ Remuneration report, (see implementation of the policy in 2018), the following awards were granted in March 2018.

25 per cent of the proportion of the award attributable to each performance measure will vest at threshold performance.

Strategic prioritiesMeasureBasis of payout rangeMetricWeighting
Creating the best customer experienceCustomer satisfactionMajor Group average ranking over 2020Threshold: 3rd
Maximum: 1st		10%
Digital net promoter scoreSet relative to 2020 targetsThreshold: 64
Maximum: 67		7.5%
FCA total reportable complaints and Financial Ombudsman Service (FOS) change rateSet relative to 2020 targets Average rates over 2020Threshold: 2.97
Maximum: 2.69
Threshold: =<29%
Maximum: =<25%		10%
Becoming simpler and more efficientStatutory economic profit1Set relative to 2020 targetsThreshold: £2,300m
Maximum: £3,451m		25%
Cost:income ratioSet relative to 2020 targetsThreshold: 46.4%
Maximum: 43.9%		10%
Delivering sustainable growthAbsolute total shareholder return (TSR)Growth in share price including dividends over 3-year periodThreshold: 8% p.a.
Maximum: 16% p.a.		30%
Building the best teamEmployee engagement indexSet relative to 2020 markets normsThreshold: +5% vs UK Norm Maximum: +2% vs UK High Performing Norm7.5%

1A measure of profit taking into account Expected Losses, tax and a charge for equity utilisation.
121

COMPENSATION

IMPLEMENTATION OF THE POLICY IN 2019

It is proposed to operate the policy in the following way in 2019:


Base Salary		The Group has applied a total pay budget of 2.6 per cent including a minimum pay award of £600 for eligible colleagues. This is considered an appropriate and competitive budget in the current economic and business climate. Salary increases for the Group Chief Executive (GCE) and Chief Operating Officer (COO) are set below the budget for the wider colleague population at 2 per cent. Following confirmation that the Chief Financial Officer (CFO) is due to retire in 2019, his salary is due to remain in line with 2018. 

Salaries will therefore be as follows, effective date shown below:

Group Chief Executive (GCE): £1,125,000 (1 January 2016)

Chief Financial Officer (CFO): £749,088 (1 April 2016)

Chief Risk Officer (CRO): £738,684 (1 January 2016)

FIXED SHARE AWARD

To ensure that total fixed remuneration is commensurate with role and to provide a competitive reward package for Executive Directors with an appropriate balance of fixed and variable remuneration, in line with regulatory requirements.

The levels of award set for 2016 remain unchanged and are as follows:

GCE: £900,000£1,269,288 (with effect from 1 January 2019)

CFO: £779,351

COO: £794,938 (with effect from 1 January 2019)

CFO Designate1: £794,938


Fixed share award

GCE: £1,050,000

CFO: £504,000

CRO:COO: £497,000

CFO Designate1: £504,000

Shares will be released in equal tranches over a five year period.


Pension

The level of pension allowances for 2019 are:

GCE: 33 per cent of base salary

CFO: 25 per cent of base salary

COO: 25 per cent of base salary

CFO Designate1: 25 per cent of base salary

 

Any new Executive Director appointments in 2019 will attract a maximum allowance of 25 per cent of base salary.

ANNUAL BONUS

Incentivise
Benefits

Benefits remain unchanged from 2018. Executive Directors receive a flexible benefit allowance in line with colleagues, (4 per cent of salary). This can be used to select benefits including life assurance and rewardcritical illness cover. Other benefits include car allowance, transportation tax preparation and private medical cover.

Group Performance Share

The approach to determining the achievementGroup Performance Share outcome for 2019 will remain unchanged from 2018. It will be based on a percentage of the Group’s annual financialunderlying profit, adjusted by a scorecard modifier commensurate with Group Balanced Scorecard performance. Adjustments for conduct and strategic targets.risk factors will also be considered.

 

A financial performance threshold will be set at 20 per cent below the Group’s underlying profit target, at which no award will be payable. The maximum annual bonus opportunity isGroup Balanced Scorecard must also exceed a threshold score of 1.6, below which no award will be payable.

Individual award maxima for Executive Directors will remain unchanged from 2018 at 140 per cent of base salary for the GCE and 100 per cent of base salary for other Executive Directors.

LONG-TERM INCENTIVE PLAN No award will be payable if an individual is rated below an expected level from a performance, regulatory or risk perspective.

 

IncentiviseIndividual awards will be based on pre-determined formulaic pay out ranges commensurate with performance and rewardwill be determined by the achievementRemuneration Committee through the assessment of individual performance via a balanced scorecard and personal performance considerations. The Group Chief Executive’s individual performance will be measured through the Group Balanced Scorecard, the Chief Financial Officer will be measured through the Finance Division scorecard and the Chief Operating Officer will be measured through the Chief Operating Office scorecard.

The 2019 scorecard will provide a balanced view across financial, operational and strategic measures. This will be equally weighted between financial, customer and conduct measures. Each measure will be assigned a target assessed against a rating scale of 1 to 5.

The Committee considers the specific measures and targets that apply to 2019 to be commercially sensitive but will provide information on the level of payout relative to the performance achieved in next year’s annual report on remuneration.

For the 2019 performance year, any Group Performance Share opportunity will be awarded in March 2020 in a combination of cash (up to 50 per cent) and shares. 40 per cent will be released in the first year following the award with £2,000 paid in cash, and the balance of the Group’s longer-term objectives,upfront 40 per cent delivered in shares; 50 per cent of which will be subject to align executive interestsholding until March 2020. The remaining 60 per cent is deferred into shares with those40 per cent vesting in 2020 and 20 per cent in 2021. 50 per cent of shareholders andeach release will be subject to retain key individuals.a further 12-month holding in line with regulatory requirements.

 

The Committee may consider the application of malus and clawback as outlined in the performance adjustment section.


Group Ownership Share		 

The maximum annual long-term incentiveGroup Ownership Share award for Executive Directors is 300 per cent of salary.

salary (unchanged from 2018). Awards in 2016, based on individual performance in 2015,2019 are being made as follows:

GCE: 300 per cent of referencebase salary

CFO: No award

COO: 275 per cent of base salary

CRO: 275

As regulations prohibit the payment of dividend equivalents on awards in 2019 and subsequent years, the number of shares subject to the award has been determined by applying a discount factor to the share price on grant, as previously disclosed. The Committee approved an adjustment of 29.8 per cent for colleagues who are senior managers, including the Executive Directors.

Awards will be subject to a three-year performance period with vesting between the third and seventh anniversary of base salaryaward, on a pro-rata basis. Any shares released are subject to a further holding period in line with regulatory requirements and market practice.

Awards made in 2019 will vest based on the Group’s performance against the financial and strategic measures, set out in the table opposite. In line with the Directors’ remuneration policy, the Committee has full discretion to amend payout levels should the award not reflect business and/or individual performance. Business performance includes, but is not limited to, consideration of returns to shareholders.

There are no changes to proposed financial and strategic measures to provide consistency with the 2018 plan, while aligning to the key strategic priorities as set out in the third Group Strategic Review.

The Committee may consider the application of malus and clawback as outlined in the performance adjustment section.

1Remuneration for the CFO Designate will take effect from commencement of employment.
132122

COMPENSATION


Group Ownership Sharecontinued		Strategic prioritiesMeasureBasis of payout rangeMetricWeighting
Creating the best
customer experience		Customer satisfactionMajor Group average ranking over 2021Threshold: 3rd10%
Maximum: 1st 
Digital net promoter scoreSet relative to 2021 targetsThreshold: 65.37.5%
Maximum: 68.3
FCA total reportable complaints and Financial Ombudsman Service (FOS) change rateSet relative to 2021 targetsThreshold: 2.8810%
Maximum: 2.60
Average rates over 2021Threshold: =<29%
Maximum: =<25%
Becoming simpler and more efficientStatutory economic profit1Set relative to 2021 targetsThreshold: £2,210m25%
Maximum: £3,315m
Cost:income ratioSet relative to 2021 targetsThreshold: 45.9%10%
Maximum: 43.4%
Delivering sustainable growthAbsolute total shareholder return (TSR)Growth in share price including dividends over
3-year period		Threshold: 8% p.a.30%
Maximum: 16% p.a.
Building the best teamEmployee engagement indexSet relative to 2021 markets normsThreshold: +5% vs. UK norm7.5%
Maximum: +2% vs. UK high
Performing norm
1A measure of profit taking into account expected losses, tax and a charge for equity utilisation.


Performance adjustment

Performance adjustment is determined by the Remuneration Committee and/or Board Risk Committee and may result in a reduction of up to 100 per cent of the GPS and/or GOS opportunity for the relevant period. It can be applied on a collective or individual basis. When considering collective adjustment, the Senior Independent Performance Adjustment and Conduct Committee (SIPACC) submits a report to the Remuneration Committee and Board Risk Committee regarding any adjustments required to balanced scorecards or the overall GPS and/or GOS outcome to reflect in-year or prior year risk matters.

The application of malus will generally be considered when:

there is reasonable evidence of employee misbehaviour or material error or that they participated in conduct which resulted in losses for the Group or failed to meet appropriate standards of fitness and propriety;

there is material failure of risk management at a Group, business area, division and/or business unit level;

the Committee determines that the financial results for a given year do not support the level of variable remuneration awarded; and/or

any other circumstances where the Committee consider adjustments should be made.

Judgement on individual performance adjustment is informed by taking into account the severity of the issue, the individual’s proximity to the issue and the individual’s behaviour in relation to the issue. Individual adjustment may be applied through adjustments to balanced scorecard assessments and/or through reducing the GPS and/or GOS outcome.

Awards are subject to clawback for a period of up to seven years after the date of award which may be extended to 10 years where there is an ongoing internal or regulatory investigation.

The application of clawback will generally be considered when:

there is reasonable evidence of employee misbehaviour or material error; or

there is material failure of risk management at a Group, business area, division and/or business unit level.

CHAIRMAN AND NON-EXECUTIVE DIRECTOR FEES IN 2019

The annual fee for the Chairman was increased by 2 per cent to £757,700, in line with the overall salary budget for the executive population.

The annual Non-Executive Director fees were increased by 2 per cent, in line with the base salary increase awarded to the senior management of the Group. These changes took effect from 1 January 2019.

  2019 2018
Basic Non-Executive Director fee £79,600 £78,000
Deputy Chairman £104,000 £102,000
Senior Independent Director £62,400 £61,200
Audit Committee Chairmanship £72,800 £71,400
Remuneration Committee Chairmanship £72,800 £71,400
Board Risk Committee Chairmanship £72,800 £71,400
Responsible Business Committee Chairmanship £41,600 £40,800
Audit Committee membership £33,300 £32,650
Remuneration Committee membership £33,300 £32,650
Board Risk Committee membership £33,300 £32,650
Responsible Business Committee membership1 £15,600 £15,300
Nomination and Governance Committee membership2 £15,600 £15,300

1New members only.
2Including payments to Chairmen of other Committees who are members.

Non-Executive Directors may receive more than one of the above fees.

123

COMPENSATION

PERCENTAGE CHANGE IN REMUNERATION LEVELS

Figures for ‘All employees’ are calculated using figures for UK-based colleagues subject to the GPS plan. This population is considered to be the most appropriate group of employees for these purposes because its remuneration structure is consistent with that of the GCE. For 2018, 65,537 colleagues were included in this category.

  % change in base salary
(2017 – 2018)		 % change in GPS
(2017 – 2018)		 % change in benefits
(2017 – 2018)
GCE (salary increase effective 1 January 2019) 2 (11)1 2
All employees 2.62 1.42 2.62

1Reflects the increase in base salary from 1 January 2018 against which the award is determined.
2Adjusted for movements in staff numbers and other impacts to ensure a like-for-like comparison. Salary increases effective 1 April 2019.

ADDITIONAL DISCLOSURES

CEO PAY RATIO

The Group is committed to ensuring remuneration is competitive, performance-driven and fair. The Group has decided to publish the CEO pay ratio in advance of the formal disclosure requirement using the prescribed Methodology A, as shown in the table below together with an alternative view based on fixed pay.

In assessing the pay ratio for 2018, the Committee has considered likely ratios at industry and sector peers, and companies with a similar employee profile. The Remuneration Committee views pay ratios as a useful reference point to inform policy-setting, but also takes into consideration a number of other factors when considering remuneration levels, including direct engagement on pay with the Group’s recognised unions and shareholders. The Committee is confident that the Group’s policy on pay is fair and that improvements to pay progression will continue to ensure that lower paid colleagues receive a greater share of pay awards.

 Total remuneration (Methodology A)  Fixed pay 
YearP25
(Lower Quartile)		P50
(Median)		P75
(Upper Quartile)		 P25
(Lower Quartile)		P50
(Median)		P75
(Upper Quartile)
2018237:1169:193:1 113:181:148:1
2017245:1177:197:1 113:182:148:1
Y-o-Y (4%)   (1%) 

The median ratio has decreased 4 per cent year-on-year. The median ratio provides a fair reflection of the Group’s approach to pay as colleagues at this level make up approximately 70 per cent of the Group’s employee base, however, these colleagues do not receive long-term incentive plan awards which are more volatile. For the majority of colleagues, year-on-year changes in remuneration are principally driven by pay awards, which the Group directs to the lowest grades. For example, the P25 colleague in 2017 received a 5 per cent pay increase in 2018, meaning this colleague moved up in the percentile ranking to P25.5. The colleague who is now at P25 for 2018 received a 3 per cent pay increase which brought them up from P24.5 to that level. For 2019, the pay budget has been set at 2.6 per cent, but only 2 per cent for senior colleagues, including the Group Chief Executive. To support the Group’s policy of real wage growth and commitment to pay progression, there is a focus on ensuring higher pay awards for colleagues who are lower paid, or paid lower within their pay range. From April 2019, all full-time colleagues will be paid a minimum salary of £17,510. For some colleagues, this will result in an increase of up to 9.9 per cent. This salary level is 7 per cent above the National Living Wage.

NOTES TO THE CALCULATION:

The P25, P50 and P75 colleagues were determined based on calculating total remuneration for all UK employees as at 31 December 2018. This methodology was selected on the basis that it provided the most accurate means of identifying the median, lower and upper quartile colleagues.
The 2018 total remuneration for the colleagues identified at P25, P50 and P75 are as follows: £26,490, £37,058, £67,225.
The 2018 base salary for the colleagues identified at P25, P50 and P75 are as follows: £21,560, £30,364, £45,230.
The colleague identified at P50 is not eligible to receive a car benefit unless required for role and does not participate in the long term incentive plan, therefore the ratio does not provide a like-for-like comparison to the total remuneration of the Group Chief Executive. Each of the three individuals identified was a full-time employee during the year.
The single total figure of remuneration calculated for each of the 65,537 UK colleagues includes full time equivalent base pay, Group Performance Share awards for the 2018 performance year, long term incentive plan payments (for eligible colleagues), core benefits, pension, overtime and shift payments, travel/relocation payments and private medical benefit.
Due to operational constraints, the calculation of the colleague Pension Input Figure excludes the adjustment to uprate the opening value for defined benefit plans specified in section 229 of the Finance Act 2004. The omission of this factor does not materially affect the outcome of the ratio and/or distort the validity of the valuation. All other data has been calculated in line with the methodology for the single total figure of remuneration for the Group Chief Executive.
124

COMPENSATION

GENDER PAY

WE REDUCED OUR GENDER PAY GAP BY 1.3 PER CENT IN 2018

The Group is committed to offering all colleagues a reward package that is competitive, performance-driven and fair.

We recognise that supporting gender equality and diversity more broadly supports the success of the UK as a whole. We regularly review our pay levels to ensure that men and women are paid equally for doing equivalent roles across the Group and the Group is committed to increasing the number of women in senior roles. As a result of progress made in

REMUNERATION COMMITTEE

The Committee comprises Non-Executive Directors from a wide background to provide a balanced and independent view on remuneration matters. During the year Anita Frew stepped down as Chair of the Committee and was replaced by Stuart Sinclair with effect from 1 September 2018. Stuart has been a member of the Committee since January 2016 and Anita remains a member of the Committee.

For details of membership and attendance at meetings, please see page 133.

The purpose of the Committee is to set the remuneration for all Executive Directors and the Chairman, including pension rights and any compensation payments. It recommends and monitors the level and structure of remuneration for senior management and material risk takers. It also considers, agrees and recommends to the Board an overall remuneration policy and philosophy for the Group that is aligned with its long-term business strategy, its business objectives, its risk appetite, values and the long-term interests of the Group that recognises the interests of relevant stakeholders, including the wider workforce.

ANNUAL EFFECTIVENESS REVIEW

During 2018, the Committee met its key objectives and carried out its responsibilities effectively, as confirmed by the annual effectiveness review.

HOW THE REMUNERATION COMMITTEE SPENT ITS TIME IN 2018

The Committee held five scheduled meetings during 2018 where the following key matters were considered.

Committee:

Approval of terms of reference
Results of the effectiveness review and suggestions for improvement

Group wide remuneration approach:

Determination of the overall 2017 Group Performance Share outcome
Approval of the 2015 LTIP vesting
Approval of the 2018 Group Performance

hiring female talent into senior positions and targeting greater pay awards for lower graded colleagues (where there is a majority of female colleagues), we have reduced our gender pay gap by 1.3 per cent. An increase in part time working at lower grades and a reduction in the number of female colleagues at the most senior grades, offset the progress made in female colleagues taking on more senior positions in the Group. As a result the mean bonus gap increased by 1.2 per cent from 2017 to 2018. Further information is available at: https:///www.lloydsbankinggroup.com/globalassets/our-group/responsible-business/reporting-centre/gender-pay-gap-report-2017-18-final.pdf.

Share methodology including performance measures included within the Group Balanced Scorecard
2018 Colleague Group Ownership Share
2018 Sharesave offer
Approval of a simplified 2019 Balanced Scorecard approach following stakeholder feedback
Review of the Group’s new approach to performance, ‘Your Best’
Senior Executives and Executive Directors:
Review of performance and remuneration arrangements for Executive Directors and key senior management
Key Stakeholders:
Shareholder feedback following the 2018 AGM in May
Feedback sessions following engagement with the PRA/FCA
Consideration of the revised UK Corporate Governance Code and how the Committee intends to ensure compliance moving into 2019 and beyond
Consideration for ensuring a clear link between pay and performance following the launch of the Group’s new approach to performance, ‘Your Best’
Review and approval of MBNA integration remuneration approach
Review and approval of LDC bonus award approach

Key Priorities for 2019

We are not seeking to make any changes to our Directors Remuneration Policy for 2019 but the Committee will undertake a full review of the Policy in 2019 ahead of the 2020 AGM. During 2019, the Committee will increase its level of oversight on remuneration matters for the wider workforce to support with key decision making when setting the policy. This will include implementation of changes supporting the Group’s new performance management approach.

In light of the recent enhancements in corporate governance, the Committee will

Mean Pay Gap % 2018 31.5% 2017 32.8% Mean Bonus Gap % 2018 66.4% 2017 65.2%

continue to focus on implementing the revised principles of the UK Corporate Governance Code. In addition to continuous engagement with stakeholders, the Committee intends to increase the level of engagement it has with the wider workforce on remuneration matters.

ADVICE PROVIDED TO THE COMMITTEE:

Mercer is the appointed advisor to the Committee, following a competitive tender process in 2016 and was retained during the year. The Committee is of the view that Mercer provides independent remuneration advice to the Committee and does not have any connections with the Group that may impair its independence. The broader Mercer company provides unrelated advice on accounting and investments. Mercer is a founding member and signatory to the UK Remuneration Consultants Code of Conduct which governs standards in the areas of transparency, integrity, objectivity, confidentiality, competence and due care, details of which can be found at www.remunerationconsultantsgroup.com.

During the year, Mercer attended Committee meetings upon invitation and provided advice and support in areas such as market and best practice, regulatory and governance developments, drafting the remuneration report, and benchmarking pay and performance.

Fees payable for the provision of Remuneration Committee services in 2018 were £89,870, based on time and materials.

António Horta-Osório (Group Chief Executive), Juan Colombás (Chief Operating Officer), Jen Tippin (Group People and Productivity Director), Matt Sinnott (Group Reward Director), Stuart Woodward (Reward Regulation, Governance and Variable Reward Director) and Letitia Smith (Group Director, Conduct, Compliance & Operational Risk) provided guidance to the Committee (other than for their own remuneration).

Stephen Shelley (Chief Risk Officer) and George Culmer (Chief Financial Officer) also attended the Committee to advise as and when necessary on risk, financial and other operational matters.


Statement of voting at Annual General Meeting

The table below sets out the voting outcome at the Annual General Meeting in May 2018.

  Votes cast in favour Votes cast against Votes withheld
  Number of shares
(millions)		 Percentage of
votes cast		 Number of shares
(millions)		 Percentage of
votes cast		 Number of shares
(millions)
Directors’ remuneration policy (binding vote in 2017) 47,673 98.03% 959 1.97% 535
2018 annual report on remuneration (advisory vote) 39,664 79.22% 10,405 20.78% 645
125

COMPENSATION

 

DIRECTORS’ REMUNERATION POLICY

 

The Group’s remuneration policy set out in the 2013 Directors’ remuneration report was formally approved by shareholders at the AGM on 1511 May 2014.

2017 and took effect from that date. It is intended that approval of the remuneration policy will be sought at three yearthree-year intervals, unless amendments to the policy are required, in which case further shareholder approval will be sought. Nosought; no changes are proposed for 2016, therefore shareholders will not be asked to vote on the remuneration policy at the AGM this year.

The remuneration policy tables for Executive and Non-Executive Directors are included below for ease of reference. They have been reproduced as approved in 2014 with minor changes due to regulatory requirements under the latest PRA Rulebook which take effect in 2016 and changes in the operation of the all-employee share plans in 2015. Information on how the Policy will be implemented in 2016 is included in the annual report on remuneration.2019. The full policy is set out on pages 102 to 109 ofin the 2016 annual report and accounts for the year ended 31 December 2013(pages 90 to 98) which is available at: https://www.lloydsbankinggroup.com/globalassets/documents/investors/2013/2013_lbg_annual_report.pdf

As outlined in the 2013 Directors’ remuneration report, the Group’s policy is intended to ensure that the remuneration proposition is both cost effective and enables the Group to attract and retain executives of the highest calibre. The objective is to align individual reward with the Group’s performance, the interests of its shareholders and a prudent approach to risk management. In this way, the requirements of the major stakeholders are balanced: customers, shareholders, employees, and regulators.annual-reports/download-centre/.

 

The policy is based on principles which are applicable to all employees within the Group andtables in particular the principle that the reward package should support the deliverythis section provide a summary of the strategic aim of becoming the ‘best bank for customers’. It embeds a performance-driven and meritocratic culture, encourages effective risk disciplines and is in line with relevant regulations and codes of best practice.Directors’ remuneration policy. There is no significant difference between the policy for Executive Directors and that for other senior employees. If a significant differencecolleagues. Further information about the remuneration policy for any individual were proposed, this would be subject to approval by the Remuneration Committee (within regulatory requirements)other colleagues is set out in section ‘Other remuneration disclosures’.

 

REMUNERATION POLICY TABLE FOR EXECUTIVE DIRECTORS

 

BASE SALARY


Basesalary

Purpose and link to strategy

To support the recruitment and retention of Executive Directors of the calibre required to develop and deliver the Group’s strategic priorities. Base salary reflects the role of the individual, taking account of market competitiveness, responsibilities and experience, and pay in the Group as a whole. It helps to recruit and retain Executive Directors and forms the basis of a competitive remuneration package.

Operation

Base salaries are typically reviewed annually with any increases normally taking effect from 1 January. When determining and reviewing base salary levels, the Committee takes into account base salary increases for employees throughout the Group and ensures that decisions are made within the following two parameters:

 

– An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective job-sizing methodologies.

 

– Pay for comparable roles in comparable publicly listed financial services groups of a similar size.

 

The Committee also takes into account base salary increases for employees throughoutSalary may be paid in sterling or other currency and at an exchange rate determined by the Group.Committee.

 

As disclosed in previous reports, since his appointment, the Group Chief Executive (GCE) has a reference salary of £1.22 million which is used to calculate certain elements of long-term remuneration and the pension allowance.

Maximum potential

The Committee will make no increase which it believes is inconsistent with the two parameters above. Increases will normally be in line with the increase awarded to the overall employee population. However, a greater salary increase may be appropriate in certain circumstances, such as a new appointment made on a salary below a market competitive level, where phased increases are planned, or where there has been an increase in the responsibilities of an individual. Where increases are awarded in excess of the wider employee population, the Committee will provide an explanation in the relevant annual report on remuneration.

Performance measures

N/A


Fixedshareaward		 
Performance measuresN/A
FIXED SHARE AWARD

Purpose and link to strategy

To ensure that total fixed remuneration is commensurate with role and to provide a competitive reward package for Executive Directors with an appropriate balance of fixed and variable remuneration, in line with regulatory requirements.

Operation

The fixed share award will initially be delivered entirely in Lloyds Banking Group shares, released over five years with 20 per cent being released each year following the year of award. The Committee can, however, decide to deliver some or all of it in the form of cash.

 

Maximum potential

The maximum award is 100 per cent of base salary.

Performance measures

N/A


Pension		 
Performance measuresN/A
133

COMPENSATION

PENSION
Purpose and link to strategyThe pension policy aims to support

To provide cost effective and market competitive retirement benefits, supporting Executive Directors in building long-term retirement savings.

Operation

Executive Directors are entitled to participate in the Group’s defined contribution scheme with company contributions set as a percentage of salary.

 

An individual may elect to receive some or all of their pension allowance as cash in lieu of pension contribution.

Maximum potential

The maximum allowance for the GCE is 50 per cent of referencebase salary less any flexible benefitbenefits allowance.

 

The maximum allowance for other Executive Directors is 25 per cent of base salary.

 

All future appointments as Executive Directors will attract a maximum allowance of 25 per cent of base salary.

Performance measures

N/A

Performance measuresN/A
BENEFITS
Benefits		 

Purpose and link to strategy

To provide suitableflexible benefits as part of a competitive remuneration package.

Operation

Benefits may include those currently provided and disclosed in the annual report on remuneration.

Core benefits include a company car or car allowance, private medical insurance, life insurance and other benefits that may be selected through the Group’s flexible benefits plan.

 

Additional benefits may be provided to individuals in certain circumstances such as relocation. This may include benefits such as accommodation, relocation, and travel. The Committee retains the right to provide additional benefits depending on individual circumstances.

 

When determining and reviewing the level of benefits provided, the Committee ensures that decisions are made within the following two parameters:

 

An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective job-sizing methodologies.

 

Benefits for comparable roles in comparable publicly listed financial services groups of a similar size.

 

Maximum potential

The Committee will make no increaseonly increases in the benefits currently provided which it believes is inconsistentare consistent with the two parameters above. The Group’sExecutive Directors receive a flexible benefits allowance, is capped atin line with all other employees. The flexible benefits allowance does not currently exceed 4 per cent of base salary.

Performance measures

N/A

126

COMPENSATION


All-employee plans		 
Performance measuresN/A
ALL-EMPLOYEE PLANS

Purpose and link to strategy

Executive Directors are eligible to participate in HMRC approved all-employee schemesHMRC-approved share plans which encouragepromote share ownership.

ownership by giving employees an opportunity to invest in Group shares.

Operation

Executive Directors may participate in these plans in line with HMRC guidelines currently prevailing (where relevant), on the same basis as other eligible employees.

 

Maximum potential

Participation levels may be increased up to HMRC limits as amended from time to time. With effect from April 2014, theThe monthly savings limits for Save As You Earn (SAYE) is currently £500. The maximum value of shares that may be purchased under the Share Incentive Plan (SIP) in any year is currently £1,800 with a two for onetwo-for-one match. Currently a three for twothree-for-two match is operated up to a maximum employee investment of £30 per month.

The maximum value of free shares that may be awarded in any year is £3,600.

Performance measures

N/A


Group Performance Share plan		 
Performance measuresN/A, following HMRC rules.
134

COMPENSATION

ANNUAL BONUS
Purpose and link to strategyIncentivise

To incentivise and reward the achievement of the Group’s annual financial and strategic targets.

targets whilst supporting the delivery of long-term superior and sustainable returns.

Operation

Measures and targets are set annually and awards are determined by the Committee after the year end based on performance against the targets set. The annual bonusGroup Performance Share may be delivered partly in cash and partly deferred into cash, shares, notes or other debt instruments including contingent convertible bonds. TheWhere all or part of any award is deferred, the Committee may adjust these deferred awards in the event of any variation of share capital, demerger, special dividend or distribution or amend the terms of the plan in accordance with the plan rules.

At the time of the release, Executive Directors receive

Where an amount (in cashaward or shares) equal to the interest that would have accrued on thea deferred component, if deferralaward is made in notes or debt instruments, or dividends paid or payable if deferred in shares between the date of grant and the vesting of the award onor other share-linked instrument, the number of shares which have vested.

to be awarded may be calculated using a fair value or based on discount to market value, as appropriate.

The Committee applies its judgement to determine the payout level commensurate with business and/or individual performance. The Committee may reduce the level of deferred award (including to zero), apply additional conditions to the vesting, or delay the vesting of deferred awards to a specified date or until conditions set by the Committee are satisfied, where it considers it appropriate as a result of an event occurringa risk matter coming to light before vesting. Bonus awardsAwards may be subject to malus and clawback for a period of up to seven years after the date of award. This periodaward which may be extended to ten10 years where there is an ongoing internal or regulatory investigation.

 

Maximum potential

The maximum annual bonusGroup Performance Share opportunities are 140 per cent of base salary for the GCE and 100 per cent of base salary for other Executive Directors.

Performance measures

Measures and targets are set annually by the Committee in line with the Group’s strategic business plan and further details are set out in the annual report on remuneration for the relevant year.

At least 50 per cent

Measures consist of both financial and non-financial measures and the awards are weighted towards financialweighting of these measures withwill be determined annually by the balance on strategic objectives.Committee. All assessments of performance are ultimately subject to the Committee’s judgement, but no award will be made if threshold performance (as determined by the Committee) is not met for financial measures or the individual is rated ‘Developing performer’ or below. The expected value of the bonusGroup Performance Share is 30 per cent of maximum opportunity.

The Committee retains the right to change the measures and weighting of those measures, including following feedback from regulators, shareholders and/or other stakeholders.

The Committee is however, committed to providing transparency in its decision making in respect of bonusGroup Performance Share awards and will disclose historic targetmeasures and measuretarget information together with information relating to how the Group has performed against those targets in the annual report on remuneration for the relevant year unlessexcept to the extent that this information is deemed to be commercially sensitive, in which case it will be disclosed once it is deemed not to be sensitive.

135

Group Ownership Share plan		 

COMPENSATION

LONG-TERM INCENTIVE PLAN (LTIP)
Purpose and link to strategyIncentivise

To incentivise and reward Executive Directors and senior management to deliver against strategic objectives designed to support the achievementlong-term success of the Group’s longer-term objectives, to align executive interests with thoseGroup and encourage working as a team. It ensures executives build an ownership interest in the Group and are motivated by delivering long-term superior and sustainable returns for shareholders.

Operation

Awards are granted under the rules of shareholders and to retain key individuals.

Operationthe 2016 Long-Term Incentive Plan approved at the AGM on 12 May 2016. Awards are made in the form of conditional shares or nil cost options. Award levels are set at the time of grant, in compliance with regulatory requirements, and may be subject to a discount in determining total variable remuneration under the rules set by the European Banking Authority.

The number of shares to be awarded may be calculated using a fair value or based on a discount to market value, as appropriate.

Vesting will be subject to the achievement of performance conditions measured over a period of three years, or such longer period, as determined by the Committee.

On vesting, Executive Directors receive an amount (in cash or shares) equal to the dividends which would have been paid during the vesting period on shares vesting.

The Committee retains full discretion to amend the payout levels should the award not reflect business and/or individual performance. The Committee may reduce (including to zero) the level of the award, apply additional conditions to the vesting, or delay the vesting of awards to a specified date or until conditions set by the Committee are satisfied, where it considers it appropriate as a result of an event occurringa risk matter coming to light before vesting. Executive Directors are required to hold the shares which vest for a further two years. LTIP awardsAwards may be subject to malus and clawback for a period of up to seven years after the date of award. This periodaward which may be extended to ten10 years where there is an ongoing internal or regulatory investigation.

 

Maximum potential

The maximum annual award for Executive Directors will normally be 300 per cent of salary excluding dividend equivalents (this being the reference salary in the case of the GCE).salary. Under the plan rules, awards can be made up to 400 per cent of salary in exceptional circumstances excluding dividend equivalents.

circumstances.

Performance measures

Measures and targets are set by the Committee annually and are set out in the annual report on remuneration each year.

At least 60 per cent of awards are weighted towards typical market (e.g. Total Shareholder Return) and/or financial measures (e.g. economic profit), with the balance on strategic measures.

25 per cent will vest for threshold performance, and 50 per cent for on-target performance and 100 per cent for maximum performance.

The measures are chosen to support the ‘bestbest bank for customers’customers strategy and to align management and shareholder interests. Targets are set by the Committee to be stretching within the context of the strategic business plan. Measures are selected to balance profitability, achievement of strategic goals and to ensure the incentive does not encourage inappropriate risk taking.

Measures and targets are set annually byrisk-taking.

Following the Committee and limited details can therefore be provided inend of the remuneration policy.

For future awards,relevant performance period, the Committee will disclose in the annual report on remuneration for the relevant year historic measure and target information, together with how the Group has performed against those targets, unless this information is deemed to be commercially sensitive, in which case it will be disclosed once it is deemed not to be sensitive.

127

COMPENSATION


Deferral of variable remuneration and holding periods		 
Shareholding guidelinesExecutive Directors are required to build up a holding of a value of 200 per cent of base salary

Operation

The Group Performance Share and fixed share award for the GCE and 150 per cent for other Executive Directors. Details of holdings are shown in the annual report on remuneration.

DEFERRAL OF VARIABLE REMUNERATION
OperationThe annual bonus and long-term incentiveGroup Ownership Share plans are both considered variable remuneration for the purpose of regulatory payment and deferral requirements. The payment of variable remuneration and deferral levels are determined at the time of award and in compliance with regulatory requirements (which currently require that at least 60 per cent of total variable remuneration is deferred for seven years with pro-rata vesting between the third and seventh year, and at least 50 per cent of total variable remuneration is paid in shares or other equity linked instruments)instruments subject to a holding period in line with current regulatory requirements).

 
From 2016,

A proportion of the aggregate variable remuneration may vest immediately on award. The remaining proportion of the variable remuneration is then deferred awards normally vest over a period of seven yearsin line with vesting betweenregulatory requirements.

Further information on which performance measures were chosen and how performance targets are set are disclosed in the third and seventh anniversary of award, on a pro-rata basis.relevant sections throughout the report.

136

COMPENSATION

 

REMUNERATION POLICY TABLE FOR CHAIRMAN AND NON-EXECUTIVE DIRECTORS

 

The table below sets out the remuneration policy that has been applied to Non-Executive Directors (NEDs) from the date of the AGM in 2014.
Chairman and Non-Executive Director fees

PURPOSE AND LINK TO STRATEGY

 

CHAIRMAN AND NON-EXECUTIVE DIRECTOR FEES
Purpose and link to strategy

To provide an appropriate reward to attract and retain a high-calibre individual with the relevant skills, knowledge and experience.

Operation

OPERATION

The Committee is responsible for evaluating and making recommendations to the Board with regards to the Chairman’s fees. The Chairman does not participate in these discussions.

The GCE and the Chairman are responsible for evaluating and making recommendations to the Board in relation to the fees of the NEDs.

When determining and reviewing fee and benefit levels, the Committee ensures that decisions are made within the following are considered:

–parameters:

The individual’s skills and experience.

–  Comparable fees at FTSE companies

An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective sizing methodologies.

Fees and benefits for comparable roles in comparable publicly listed financial services groups of a similar size to Lloyds Banking Group, including the major UK banks.

size.

The Chairman receives an all inclusiveall-inclusive fee, which is reviewed periodically plus benefits including life insurance, car allowance, medical insurance and transportation. The Committee retains the right to provide additional benefits depending on individual circumstances.

NEDs are paid a basic fee plus additional fees for the chairmanship/membership of committees and for membership of Group companies/boards/non-board level committees.

 

Additional fees are also paid to the senior independent director and to the deputy chairman to reflect additional responsibilities.

Any increases normally take effect from 1 January of a given year.

When determining and reviewing fee and benefit levels, the Committee ensures that decisions are made within the following two parameters:
–  An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective sizing methodologies.
–  Pay for comparable roles in comparable publicly listed financial services groups of a similar size.

The Chairman and the NEDs are not entitled to receive any payment for loss of office (other than in the case of the Chairman’s fees for the six month notice period) and are not entitled to participate in the Group’s bonus, share plan or pension arrangements.

NEDs are reimbursed for expenses incurred in the course of their duties, such as travel and any tax arising from these expenses. Where appropriate, the Group will also meet the costs and any tax arising from travel for business purposes.

Maximum potential  accommodation expenses, on a grossed-up basis (where applicable).

MAXIMUM POTENTIAL

The Committee will make no increase in fees or benefits currently provided which it believes is inconsistent with the two parameters above.

PERFORMANCE METRICS

N/A

  
Performance metricsN/A

SERVICE AGREEMENTS

 

The service contracts of all current Executive Directors are terminable on 12 months’ notice from the Group and six months’ notice from the individual. The Chairman also has a letter of appointment. His engagement may be terminated on six months’ notice by either the Group or him.

LETTERS OF APPOINTMENT

The Non-Executive Directors all have letters of appointment and are appointed for an initial term of three years after which their appointment may continue subject to an annual review. Non-Executive Directors may have their appointment terminated, in accordance with statute and the articles of association, at any time with immediate effect and without compensation.

All Directors are subject to annual re-election by shareholders.

The service contracts and letters of appointments are available for inspection at the Company’s registered office.

On behalf of the Board

Stuart Sinclair

Chairman, Remuneration Committee

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COMPENSATION

 

Termination paymentsTERMINATION PAYMENTS

It is the Group’s policy that where compensation on termination is due, it should be paid on a phased basis, mitigated in the event that alternative employment is secured. Where it is appropriate to make a bonus payment (now known as Group Performance Share) to the individual, this should relate to the period of actual service, rather than the full notice period. Any bonusGroup Performance Share payment will be determined on the basis of performance as for all continuing employees and will remain subject to performance adjustment (malus).(malus and clawback) and deferral. Generally, on termination of employment, bonusGroup Performance Share awards, long-term incentive awards (now known as Group Ownership Share) and other rights to payments will lapse except where termination falls within one of the reasons set out below. In the event of redundancy, the individual may receive a payment in line with statutory entitlements at that time. If an Executive Director is dismissed for gross misconduct, the Executive Director will receive normal contractual entitlements until the date of termination and all deferred bonus awardsGroup Performance Share and long-term incentiveGroup Ownership Share awards will lapse.

 

  Base salary Fixed Share Awardshare award Pension, benefits and
other fixed
remuneration
Resignation In the case of resignation to take up new employment, paid until date of termination (including any period of leave required by the Group). In the case of resignation for other reasons, base salary will be paid in monthly instalments for the notice period (or any balance of it), offset by earnings from new employment during this period. Awards continue and are released at the normal time and the number of shares subject to the award in the current year will be reduced to reflect the fact that the Executive Director has left early.date of termination. Paid until date of termination including any period of leave required by the Group (subject to individual benefit scheme rules).
Redundancy or termination by mutual agreement Paid until date of termination (including any period of leave required by the Group). In respect of the balance of any notice period, base salary will be paid in monthly instalments, offset by earnings from new employment during this period. Awards will normally continue and be released at the normal time and the number of shares subject to the award in the current year will be reduced to reflect the fact that the Executive Director has left earlydate of termination unless, in the case of mutual agreement, the Committee determines that exceptional circumstances apply in which case shares may be released on termination. Paid until date of termination including any period of leave required by the Group (subject to individual benefit scheme rules).
Retirement/ill health, injury, permanent disability/death Paid until date of retirement/death. For ill health, injury or permanent disability which results in the loss of employment, paid for the applicable notice period (including any period of leave required by the Group). Awards will normally continue and be released at the normal time and the number of shares subject to the award in the current year will be reduced to reflect the fact that the Executive Director has left earlydate of termination except for (i) death where shares are released on termination,the date of termination; or unless,(ii) in the case of permanent disability the Committee determines that exceptional circumstances apply, in which case shares may be released on the date of termination. Paid until date of death/retirement (subject to individual benefit scheme rules). For ill health, injury, permanent disability, paid for the notice period including any period of leave required by the Group (subject to individual benefit scheme rules).
Change of control or merger N/A Unless the Committee decides otherwise, awardsAwards will be releasedpayable on the date of the corporate eventChange of Control and the number of shares subject to the award in the current year will be reduced to reflect the factshorter accrual period. The Committee may decide that the Executive Director has left early unless the Committee determines thatvested awards will be exchanged for (and future awards overmade over) shares in the acquiring company or such other company as the Committee determines.relevant company. N/A
Other reason where the Committee determines that the executive should be treated as a good leaver Paid until date of termination (including any period of leave required by the Group). In respect of the balance of any notice period, base salary will be paid in monthly instalments, offset by earnings from new employment during this period. Awards continue and are released at the normal time and the number of shares subject to the award in the current year will be reduced to reflect the fact that the Executive Director has left early.date of termination. Paid until date of termination including any period of leave required by the Group (subject to individual benefit scheme rules).
138129

COMPENSATION

 

  Annual bonus (now known as Group Performance
Share)1(1)		 Long-term incentive (now known as Group
Ownership Share)2(2)		 Chairman and non-executiveNon-Executive
directorsDirector fees3(3)
Resignation Forfeited, including unvestedUnvested deferred elements (2010 deferred bonus not subject to forfeiture but continues to be subject to performance adjustment)Group Performance Share awards are forfeited and in-year Group Performance Share awards are accrued until the date of termination (or the commencement of garden leave if earlier), unless the Committee determines otherwise in exceptional circumstances. Unvested award lapsesAwards lapse on date of leaving (or on notice of leaving) unless the Committee determines otherwise in exceptional circumstances.circumstances that they will vest on the original vesting date (or exceptionally on the date of leaving). Where award is to vest it will be subject to the performance conditions and time pro-rating (for months worked in performance period). Malus and clawback will apply. Paid until date of leaving Board.
Redundancy or termination by mutual agreement Accrued upFor cases of redundancy, unvested deferred Group Performance Share awards are retained and in-year Group Performance Share awards are accrued until the date of termination (current year)(or the commencement of garden leave if earlier). Deferred bonus paid in line with normal timeframes andSuch awards would be subject to performance adjustment. The Committee may allow awards to vest early if it considers it appropriate.deferral, malus and clawback. For termination by mutual agreement, the same approach as for resignation would apply. Pro-rated awardAwards vest on the original vesting date (or exceptionally on the date of leaving). Vesting is subject to the performance conditions and time pro-rating (for months worked in performance period) released at end of period, subject to performance objectives being met. The Committee may allow awards to vest early if it considers it appropriate.. Malus and clawback will apply. Paid until date of leaving Board.
Retirement/ill health/health, injury, permanent disability Accrued upUnvested deferred Group Performance Share awards are retained and in-year Group Performance Share awards are accrued until the date of termination (current year)(or the commencement of garden leave if earlier). Deferred bonus paid in line with normal timeframes andSuch awards would be subject to performance adjustment. The Committee may allow awards to vest early if it considers it appropriate.deferral, malus and clawback. Pro-rated awardAwards vest on the original vesting date (or exceptionally on the date of leaving). Vesting is subject to the performance conditions and time pro-rating (for months worked in performance period) released at end of period, subject to performance objectives being met. The Committee may allow awards to vest early if it considers it appropriate.. Malus and clawback will apply. Paid until date of leaving Board.
Death Accrued upUnvested deferred Group Performance Share awards are retained and in-year Group Performance Share awards are accrued until the date of termination (current year).termination. Deferred bonus paidGroup Performance Share awards vest on death in cash, unless the Committee determines otherwise. Pro-rated awardAwards vest on death subject to the performance conditions and time pro-rating (for months worked) released to Estate as soon as practicable after date of death. Performance conditionsworked in performance period unless determined otherwise). Malus and clawback will not apply. Paid until date of leaving Board.
Change of control or merger2 
Change in control2AccruedIn-year Group Performance Share accrued up until date of terminationchange of control or merger (current year). Deferred bonus vestsWhere there is a Corporate Event, deferred Group Performance Share awards vest to the extent and timing determined by the Committee.Committee in its absolute discretion. Pro-rated awardAwards vest on date of event. Vesting is subject to the performance conditions and time pro-rating (for months worked in performance period) released on date of change in control, subject to performance objectives being met at the time of the transaction.period unless determined otherwise). Malus and clawback will normally apply. Instead of vesting, awards may be exchanged for equivalent awards over the shares orof the acquiring company or another company. Paid until date of leaving Board.
Other reason where the Committee determines that the executive should be treated as a good leaver Accrued upUnvested deferred Group Performance Share awards are retained and in-year Group Performance Share awards are accrued until the date of termination (current year)(or the commencement of garden leave if earlier). Deferred bonus paidGroup Performance Share awards vest in line with normal timeframes and are subject to performance adjustment.malus and clawback. The Committee may allow awards to vest early if it considers it appropriate. Pro-rated awardAwards vest on the original vesting date (or exceptionally on the date of leaving). Vesting is subject to the performance conditions and time pro-rating (for months worked in performance period) released at end of period, subject to performance objectives being met. The Committee may allow awards to vest early if it considers it appropriate.. Malus and clawback will apply. Paid until date of leaving Board.

 

1If any annual bonusGroup Performance Share is to be paid to the Executive Director for the current year, this will be determined on the basis of performance for the period of actual service, rather than the full notice period (and so excluding any period of leave required by the Group).
  
2Reference to change of control or merger includes a compromise or arrangementsarrangement under section 899 of the Companies Act 2006 or equivalent,equivalent. Fixed share awards may also be released/exchanged in the event of a resolution for the voluntary winding up of the Company; a demerger, delisting, distribution (other than an ordinary dividend) or other transaction, which, in the opinion of the Committee, might affect the current or future value of any award; or a reverse takeover, merger by way of a dual listed company or other significant corporate event, as determined by the Committee. In the event of a demerger, special dividend or other transaction which would in the Committee’s opinion affect the value of awards, the Committee may allow a long termlong-term incentive award to vest to the extent relevant performance conditions are met to that date and if the Committee so determined, on a time pro ratedpro-rated basis (unless determined otherwise) to reflect the number of months of the performance period worked.
  
3The Chairman is entitled to six monthsmonths’ notice.

On termination, the Executive Director will be entitled to payment for any accrued but untaken holiday calculated by reference to base salary and fixed share award.

The cost of legal, tax or other advice incurred by an Executive Director in connection with the termination of their employment and/or the cost of support in seeking alternative employment may be met up to a maximum of £100,000.

Additional payments may be made where required to settle legal disputes, or as consideration for new or amended post-employment restrictions.

Where an Executive Director is in receipt of expatriate or relocation expenses at the time of termination (as at the date of the 2014 AGM no current Executive Directors are in receipt of such expenses), the cost of actual expenses incurred may continue to be reimbursed for up to 12 months after termination or, at the Group’s discretion, a one-off payment may be made to cover the costs of premature cancellation. The cost of repatriation may also be covered.

139130

COMPENSATION

ANNUAL REPORT ON REMUNERATION

REMUNERATION COMMITTEE

COMMITTEE PURPOSE AND RESPONSIBILITES

The Remuneration Committee has responsibility for setting remuneration for all Executive Directors and the Chairman, including pension rights and any compensation payments. The Committee also recommends and monitors the level and structure of remuneration for senior management and material risk takers.

The Committee’s purpose is to consider, agree and recommend to the Board an overall remuneration policy and philosophy for the Group that is aligned with its long-term business strategy, its business objectives, its risk appetite, values and the long-term interests of the Group that recognises the interests of relevant stakeholders. The Committee’s Terms of Reference can be found on the Company’s website at www.lloydsbankinggroup.com/ our-group/corporate-governance

The Directors who served on the Committee during the year and their attendance at Committee meetings is set out in the table below.

 Remuneration
 Committee meetings1
 Eligible to 
 attendAttended
Committee Chairman  
Anthony Watson (until 30 September 2015 and member thereafter)1111
Anita Frew (member to 30 September 2015 and Chairman thereafter)11102
Committee members who served during 2015  
Lord Blackwell1111
Alan Dickinson322
Dyfrig John1111
Sara Weller1111
Former members who served during 2015  
Carolyn Fairbairn41010

1The number of meetings includes ad hoc meetings.
2Ad hoc meeting arranged at short notice.
3Appointed as member of the Committee on 17 July 2015.
4Retired on 31 October 2015.

COMMITTEE COMPOSITION, SKILLS AND EXPERIENCE

The Committee comprises Non-Executive Directors from a wide background to provide a balanced and independent view on remuneration matters. From 1 October 2015, Anita Frew succeeded Anthony Watson as Chairman, with Anthony Watson remaining as a member of the Committee. The change was made to bring about the separation of the roles of Senior Independent Director – also held by Anthony Watson – and Chairman of the Remuneration Committee in line with best practice. Carolyn Fairbairn retired as a Director of the Board and as a member of the Committee with effect from 31 October 2015. Dyfrig John has notified the Board that he wishes to reduce his workload and therefore does not intend to seek re-election at the 2016 Annual General Meeting. Stuart Sinclair was appointed as an independent Non-Executive Director and as a member of the Committee on 4 January 2016.

HOW COMMITTEE MEETINGS ARE RUN

The management of the Committee is in keeping with the basis on which meetings of the Board are managed, as detailed on page 157, with a structure which facilitates open discussion and debate, with steps taken to ensure adequate time for members of the Committee to consider proposals which are put forward.

During 2015, the Committee met its key objectives and carried out its responsibilities effectively, as confirmed by the annual effectiveness review. Building on improvements made in the previous year, the review identified a number of actions relating to agenda planning, the timeliness and content of Committee papers and induction of new Committee members that will continue to maintain and improve the Committee’s effectiveness.

MATTERS CONSIDERED BY THE COMMITTEE

The Committee met 11 times during 2015, including four ad hoc meetings called at short notice, to consider the following principal matters:

– Review of remuneration arrangements for senior executives;

– Determination of bonus outcome based on divisional and functional performance and adjustment for risk;

– Review of the use of new balanced scorecards for the determination of bonuses in divisions and functions;

– Performance conditions for the long-term incentive plan (LTIP) and the deferred bonus plan, including a review of clawback provisions;

– Bonus and salary awards for Executive Directors and key senior managers;

– Performance adjustments in respect of staff, and in particular in relation to staff accountable for PPI or LIBOR infractions;

– Feedback from the Committee Chairman on his/her meetings respectively with the PRA and shareholders;

– Results of the Remuneration Committee effectiveness review and the suggestions for improvement;

– Approval of the 2014 and 2015 Directors’ remuneration report for publication within the annual report and Form 20-F; and

– Remuneration governance in the light of regulatory changes.

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COMPENSATION

The Committee appoints independent consultants to provide advice on specific matters according to their particular expertise. During the year, Deloitte LLP advised the Committee. Deloitte was appointed as remuneration consultant by the Committee following a competitive tendering process. Deloitte has voluntarily signed up to the Remuneration Consultants’ Code of Conduct. The Committee has evaluated Deloitte’s performance during 2015. The process of the review consisted of a detailed questionnaire completed by members of the Committee. The results were discussed by the Committee and it was concluded that Deloitte were effective in providing objective and independent advice to the Committee. In particular, it was recognised that Deloitte had sufficient knowledge and experience of all appropriate remuneration-related areas to provide adequate contributions to enable the Committee to fulfil its responsibilities. Deloitte LLP is not connected with the Group.

Deloitte’s fees for services to the Committee in 2015 were on a time and materials basis and amounted to £426,700. In addition, Deloitte LLP provided the Group with advice on taxation and other consulting services, and assurance services.

António Horta-Osório (Group Chief Executive), Rupert McNeil (Group HR Director until 16 October 2015), Paul Hucknall (HR Director, Performance & Reward), Chris Evans (Director, Performance and Variable Reward) and Matthew Elderfield (Group Director, Conduct, Compliance and Organisational Risk) provided guidance to the Committee (other than for their own remuneration).

Juan Colombás (Chief Risk Officer) and George Culmer (Chief Financial Officer) also attended the Committee to advise as and when necessary on risk and financial matters.

The Committee is satisfied that its processes are robust and diligent and that the Group’s remuneration and incentive plans conform to best practice standards.

STATEMENT OF VOTING AT ANNUAL GENERAL MEETING

The Group’s remuneration policy was detailed within the Directors’ remuneration report for 2013 and voted on at the 2014 AGM. The remuneration offered to the Executive Directors in 2015 was disclosed in last year’s remuneration implementation report and was voted on at the 2015 AGM. The shareholder votes submitted at the meetings, either directly, by mail or by proxy, were as follows:

  Votes cast in favour  Votes cast against  Votes
withheld		 
  Number of
shares
(millions)		  Percentage of
votes cast		  Number of
shares
(millions)		  Percentage of
votes cast		  Number of
shares
(millions)		 
Remuneration policy (2014 vote)  48,261   97.97%   999   2.03%   1,391 
Remuneration implementation report (2015 vote)  51,131   97.67%   1,220   2.33%   410 

REMUNERATION OUTCOME FOR 2015
EXECUTIVE DIRECTORS (AUDITED)

The following table summarises the total remuneration delivered during 2015 in relation to service as an Executive Director.

  António Horta-Osório  George Culmer  Juan Colombás6  Totals 
£000 2015  2014  2015  2014  2015  2014  2015  2014 
Base salary  1,061   1,061   731   720   724   710   2,516   2,491 
Fixed share award  900   900   504   504   497   497   1,901   1,901 
Benefits  140   119   41   40   73   60   254   219 
Pension allowance1  568   568   182   180   181   173   931   921 
Other remuneration2  2   1   2   301   2   –   6   302 
Annual bonus3  850   800   462   496   455   468   1,767   1,764 
Long-term incentive4  5,252   7,379   2,841   3,563   2,529   3,172   10,622   14,114 
Conditional pension buy-out5  –   712   –   –   –   –   –   712 
Total remuneration  8,773   11,540   4,763   5,804   4,461   5,080   17,997   22,424 
Less: Buy-out amounts  –   (712)  –   (300)  –   –   –   (1,012)
Less: performance adjustment7  (234)  –   (65)  –   (3)  –   (302)  – 
Total remuneration less buy-outs and performance adjustment  8,539   10,828   4,698   5,504   4,458   5,080   17,695   21,412 

–As disclosed last year, the 2014 annual bonus awarded to the Group Chief Executive (GCE) was subject to a discretionary adjustment to reflect the external environment. The 2014 mechanical bonus outcome, before any discretionary adjustment would have been £978,882, but was reduced by approximately 18 per cent to £800,000. This year the mechanical bonus outcome is £849,649.
–In June 2015, the Group reached a settlement with the Financial Conduct Authority (FCA) with regard to aspects of its Payment Protection Insurance (PPI) complaint handling process during the period March 2012 to May 2013. As a result, the Committee decided to make performance adjustments in respect of bonuses awarded in 2012 and 2013 to the Group Executive Committee and some other senior executives given their ultimate oversight of the PPI operations. The number of shares adjusted was 409,039 for the GCE, 109,464 for the Chief Financial Officer (CFO) and 376,055 for the Chief Risk Officer (CRO) (pro-rated in the above table to reflect his appointment to Executive Director).

1Following changes to the amount of tax relief available on pension contributions in each year, Executive Directors may elect to receive some or all of their allowances as cash. The breakdown of payments made in cash and contributions into the pension scheme are shown below.
2Other remuneration payments comprise contractual cash payments to George Culmer as part of the buyout of benefits from his previous employer and income from all employee share plans, which arises through employer matching or discounting of employee purchases.
3In addition to deferral and performance adjustment, the GCE’s bonus will only vest if the Group’s share price remains above 75.5 pence on average for any 126 consecutive trading days in the five years following grant or the UK government sells 100 per cent of its shareholding in the Group at any time during the three years following grant. 50 per cent of the award will vest and be released, at the earliest, on the second anniversary of the award if either of the conditions has been met by that date, with the remaining 50 per cent vesting no less than six months later. If neither of the conditions has been met by the fifth anniversary of the award, the award will lapse entirely.
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COMPENSATION

4The LTIP vesting and dividend equivalents awarded in shares were confirmed by the Remuneration Committee at its meeting on 16 February 2016. The average share price between 1 October 2015 and 31 December 2015 (73.72 pence) has been used to indicate the value. The shares were awarded in 2013 based on a share price of 49.29 pence. LTIP figures for 2014 have been adjusted for the share price on the date of vesting (79.2 pence).
5The GCE has a conditional unfunded pension commitment, subject to share price performance. This was a partial buyout of a pension forfeited on joining from Santander Group. It is an Employer-Financed Retirement Benefits Scheme (EFRBS). The EFRBS provides benefits on a defined benefit basis at a normal retirement age of 65. The EFRBS applies for a maximum of six years following the commencement of employment and the maximum allowance over that period is 26.5 per cent of the higher of the GCE’s base salary and reference salary in the 12 months before retirement or leaving, subject to performance conditions. No additional benefit is due in the event of early retirement. The rate of pension accrual in each year depends on share price conditions being met. Accrual at 31 December 2015 is a pension of 6 per cent of the reference salary or £73,200. No new pension entitlement was accrued in 2015.
There are no other Executive Directors with defined benefit pension commitments.
6Under terms agreed when joining the Group, the CRO is entitled to a conditional lump sum benefit of £718,996 either (i) on reaching normal retirement age unless the CRO voluntarily resigns or is dismissed for cause, or (ii) on leaving due to long term sickness or death.
7Performance adjustment: the share price used for the valuation was the market price for a share in the Group at the award dates, 49.29 pence and 78.878 pence, respectively. For the CRO, the total number of shares (376,055) has been pro-rated to reflect his appointment to Executive Director on 29 November 2013.

PENSION AND BENEFITS (AUDITED)

Pension/Benefit £ António
Horta-Osório		  George
Culmer		  Juan
Colombás		 
Employer contribution to pension scheme  10,670   18,076   20,774 
Cash allowance in lieu of pension contribution  556,890   164,624   160,276 
Car or car allowance  12,000   11,168   12,000 
Flexible benefits payments  42,440   28,800   28,400 
Private medical insurance  28,928   760   13,149 
Tax preparation  24,829   –   15,766 
Transportation  32,440   –   3,598 

2013 LTIP VESTING (AUDITED)

  Number of shares
awarded		 Vesting
%		 Number of shares
vesting		 Indicative
share price
at vesting		 Indicative
value of award
at vesting		 Indicative
dividend
equivalent		 Indicative
total value		 
António Horta-Osório 7,425,441 94.18% 6,993,280 73.72 pence £5,155,446 £96,308 £5,251,754 
George Culmer 4,017,041 94.18% 3,783.249 73.72 pence £2,789,011 £52,100 £2,841,111 
Juan Colombás 3,576,283 94.18% 3,368,143 73.72 pence £2,482,995 £46,384 £2,529,379 

ANNUAL BONUS (AUDITED)

In line with 2014, the Group’s total bonus outcome is the sum of the divisional and functional bonus outcomes. The bonus outcome for each division and function is driven by two performance indicators of equal weighting: Group underlying profit and division/function Balanced Scorecard (BSC) performance. Each performance indicator is used as a modifier to increase or decrease the target bonus outcome in the range of 0 per cent – 145 per cent, subject to an overall funding limit as outlined below.

The 2015 annual bonus outcome for the Group (excluding TSB) was determined by adjusting the Group’s target bonus outcome (£415.4 million in 2015) according to:

–Group underlying profit performance: a target of £7,536 million was approved by the Board, with threshold and maximum set at 20 per cent above and below target. The outcome for 2015 was as follows:

This resulted in a modifier of 1.14.

–Balanced Scorecard performance: stretching objectives for each division were approved by the Committee around the start of the performance year. The objectives were aligned to the Group’s strategy and split across five categories:
–Customer
–People
–Risk
–Building the business
–Financial

BSC ratings are based on a scale ranging from ‘Under’ (at the lowest level), through ‘Developing’, ‘Good’, ‘Strong’ and up to ‘Top’ which is the highest rating. Each of these ratings may be further differentiated by the addition of ‘minus’ or ‘plus’.

For 2015, the Group adopted a new approach whereby each measure in the BSC is assigned targets aligned to the five-point rating scale. Performance against these targets has been subject to detailed review and calibration by Management and the Committee advisor (Deloitte LLP). This detailed review is intended to support the Committee in exercising judgement.

The Committee reviewed performance in depth to determine ratings for the Group and each division, including consideration of risk matters arising in 2015.

142

COMPENSATION

The ratings for each division and function are communicated to colleagues within the business area to ensure bonus outcomes are transparent. The ratings are considered commercially sensitive; however, as an indication of performance, the overall rating for the Group (as determined by the Committee) was Strong and the average modifier applied was 1.21.

Key performance factors considered by the Committee in arriving at the performance assessment for the Group included:

–Improvements in financial results – net interest income increased by 5 per cent to £11,482 million, underlying profit increased by 5 per cent in the year to £8,112 million and there was a 48 per cent improvement in impairments.
–The Group successfully completed the sale of TSB.
–Growth in the key customer segments – net lending to SMEs increased by 5 per cent and there has been continued development of the Group’s digital capability.
–Low risk – the continued reduction in risk-weighted assets resulted in an improvement in the Group’s common equity tier 1 ratio and the asset quality ratio continued to improve, demonstrating the Group’s low risk position.
–Effective cost leadership – the ongoing Simplification programme has delivered £373 million of annual run-rate savings to date and is ahead of target in achieving £1 billion of savings by the end of 2017. The Group has increased investment in IT, with a focus on ensuring that systems and processes are both efficient and resilient.
–An increased ordinary dividend of 2.25 pence per share in 2015, in line with its progressive and sustainable dividend policy.
–The resilience of our capital position was demonstrated again in 2015 when we comfortably exceeded the threshold for the latest PRA stress test.
–Building the best team – employee engagement up 11 points and best bank for customers index up 6 points highlighting increased customer focus in the business.
–Delivering a consistent and relentless approach under the Group conduct strategy to ensure we deliver customer needs with an open and transparent culture.

–Collective performance adjustment: consideration was given to items not factored into the Group underlying profit or divisional balanced scorecards. These included the provisions for legacy conduct-related matters relevant to the year and regulatory settlements in relation to PPI handling. It also considered positive factors, such as the sale of the remaining holding in TSB (at a premium of c.£200 million). As a result of these items, the Committee approved an overall adjustment of approximately 26 per cent, resulting in a final bonus outcome of £353.7 million as shown in the table below.

TOTAL BONUS OUTCOME

2015 final position
On-target bonus£415.4m
Group underlying profit modifier1.14
Divisional/functional performance modifier (weighted average of all divisions/functions)1.21
Modified total outcome£479.5m
Collective performance adjustment (approx.)26%
Total bonus outcome£353.7m

To ensure fairness for the Group’s shareholders, the total bonus outcome is subject to a limit of 10 per cent of pre-bonus underlying profit. For 2015, the bonus outcome of £353.7 million is significantly below the limit of £835 million.

INDIVIDUAL OUTCOMES FOR EXECUTIVE DIRECTORS

The individual bonus awards for Executive Directors are determined in the same way as for colleagues across the Group, with outcomes based on:

–Group underlying profit performance
–Balanced Scorecard performance
–Collective performance adjustment
–Individual performance
–On-target award

Awards are approved by the Committee, which has discretion to adjust outcomes for any reason.

António Horta-Osório

The Group Chief Executive’s (GCE) individual performance assessment for 2015, as confirmed by the Committee, reflected a number of considerations including:

–Underlying profit increased by 5 per cent to £8,112 million, leading to an improvement in underlying return on required equity to 15 per cent.
–Improved financial strength with the adjusted common equity tier 1 (CET1) ratio at 13.0 per cent after dividend payments and improved credit rating.
–Strong performance on 2015 stress tests, comfortably exceeding the PRA capital threshold.
–Continued support for ‘helping Britain prosper’ plan, maintaining record of above market growth in SME lending.
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COMPENSATION

–Continued growth in digital channels and service capabilities for personal customers.
–Further improvement in employee engagement survey results.
–Successful completion of the TSB sale.
–Gained shareholder support for credible and sustainable dividend policy. 2015 ordinary dividends 2.25 pence per share, with an additional special dividend of 0.5 pence per share recommended.
–Maintained conditions that allowed UKFI to effect a significant reduction in the government shareholding. The UKFI shareholding is now around 9 per cent compared to around 25 per cent before the trading plan commenced in December 2014.

Based on a full assessment of performance, the Committee agreed an individual rating for 2015 of Strong for the GCE.

Expected outcomes are based on individual performance before taking into account a modifier based on underlying profit and the Group BSC, as follows:

RatingUnderDevelopingGoodStrongTop
Expected outcome as % of salary0%0%42%91%140%

Following the Committee’s assessment of performance against the underlying profit target and Group BSC objectives, and taking into account the collective performance adjustment of 26 per cent and the individual rating of Strong, the Committee determined a 2015 bonus award to the GCE of £849,649 (57 per cent of maximum). As disclosed previously, the mechanical bonus outcome for the GCE’s bonus in 2014 was £978,882. This award was reduced to £800,000 to reflect the external environment at the time. The GCE’s 2015 bonus of £849,649 is 13 per cent lower than the 2014 mechanical bonus outcome.

George Culmer

The Chief Financial Officer’s (CFO) personal performance assessment for 2015, as confirmed by the Committee, reflected a number of considerations including:

–Maintaining a sound performance of the Finance Division, continuing to improve key risk metrics in liquidity, funding and capital.
–Playing a key role in the continued improvement in the Group’s common equity tier 1 ratio (13 per cent compared to 12.8 per cent for 2014), whilst increasing ordinary dividend payments to 2.25 pence per share, with an additional special dividend of 0.5 pence per share.
–Cost leadership, with continued reductions in cost:income ratio to 49.3 per cent.
–Rating upgrade from a median of A to A+ following positive engagement with the Credit Risk Agencies (CRAs).
–Stress testing within appetite.
–Delivering the completion of the TSB sale.
–Well managed relationships with key risk external stakeholders, e.g. investors, regulators and CRAs.

Based on a full assessment of performance, the Committee agreed an individual rating for 2015 of Strong Plus for the CFO.

Expected outcomes are based on individual performance before taking into account a modifier based on underlying profit and the Finance division’s BSC, as follows:

RatingUnderDevelopingGoodStrongTop
Expected outcome as % of salary0%0%30%65%100%

Following the Committee’s assessment of performance against the underlying profit target and the Finance division’s bsc objectives, and taking into account the collective performance adjustment of 26 per cent and the individual rating of Strong Plus, the Committee determined a 2015 bonus award to the CFO of £461,846 (63 per cent of maximum).

Juan Colombás

The Chief Risk Officer’s (CRO) personal performance assessment for 2015, as confirmed by the Committee, reflected a number of considerations including:

–Significant progress in the Group’s Risk Management, delivering important steps forward in the governance of the business.
–Prudent lending criteria, leading to improved credit quality across all portfolios.
–Effective risk management leading to a reduction in the impairment charge to £568 million.
–Further improved RWA/Capital management and further reductions in the run-off portfolio.
–Continued good progress in conduct strategy.
–Continued strengthening and enhancement of the Group’s policy, standards and control framework.

Based on a full assessment of performance, the Committee agreed an individual rating for 2015 of Strong Plus for the CRO.

Expected outcomes are based on individual performance, before taking into account a modifier based on underlying profit and the Risk division’s BSC, as follows:

RatingUnderDevelopingGoodStrongTop
Expected outcome as % of salary0%0%30%65%100%
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COMPENSATION

Following the Committee’s assessment of performance against the underlying profit target and the Risk division’s BSC objectives, and taking into account the collective performance adjustment of 26 per cent and the individual rating of Strong Plus, the Committee determined a 2015 bonus award to the CRO of £455,431 (63 per cent of maximum).

DEFERRAL

Consistent with the aim of ensuring that short-term financial results are only rewarded if they promote sustainable growth, the 2015 bonus awards for all Executive Directors are deferred into shares until at least March 2018 and subject to malus, clawback and a further holding period following vesting. They are also subject to remaining in the Group’s employment.

The Group Chief Executive’s 2015 bonus award is subject to an additional condition that the share price must remain above 75.5 pence on average for any 126 consecutive trading days in the five years following grant or the UK government sells 100 per cent of its shareholding during the three years following grant. 50 per cent of the award will vest and be released, at the earliest, on the second anniversary of the award if either of the conditions has been met by that date, with the remaining 50 per cent vesting no less than six months later. If neither of the conditions has been met by the fifth anniversary of the award, the award will lapse entirely.

The Group has implemented clawback, covering all material risk takers, in line with PRA requirements. Vested variable remuneration can be recovered from employees for a period of up to seven years after the date of award in the case of a material or severe risk event.

The Committee reserves the right to exercise its discretion in reducing any payment that otherwise would have been earned, if it deems appropriate.

LONG-TERM AWARDS MADE IN MARCH 2013 VESTING FOR THE PERIOD ENDED ON 31 DECEMBER 2015 (AUDITED)

The Group has performed strongly over the performance period of the 2013 Long Term Incentive Plan (LTIP) awards, continuing to transform the business for the benefit of its shareholders. During the performance period of the plan (from 1 January 2013 to 31 December 2015), the Group’s share price increased by 47 per cent from 49.69 pence to 73.07 pence.

At the end of the performance period, it has been assessed that awards will vest at 94.18 per cent of maximum.

  Threshold Maximum Vesting at
threshold		 Vesting at
maximum		 Actual
performance		 Vesting % of
maximum		 
Economic profit 35% of award £1,254m £1,881m 25% 100% £2,233m 35% 
Absolute total shareholder return 30% of award 
 		8% per
annum		 
 		16% per
annum		 
 		 
25%		 
 		 
100%		 
 		 
16.6%		 
 		 
30%		 
Customer satisfaction (FCA reportable  complaints per 1,000 accounts over 3 years)110% of award 1.05 0.95 25% 100% 1.02 4.18% 
Total costs 10% of award <=£9,323m <=£8,973m 25% 100% £8,691m 10% 
Non-core assets at end of 2015 (excluding UK Retail) 10% of award £37.2bn £28.4bn 25% 100% £10.3bn 10% 
SME lending 5% of award at market 4% 25% 100% 8.1% 5% 

1Excluding CMC-led complaints and PPI complaints.

PERCENTAGE CHANGE IN REMUNERATION OF THE GROUP CHIEF EXECUTIVE VERSUS THE WIDER EMPLOYEE POPULATION

Figures for ‘All Employees’ are calculated using figures for UK-based colleagues subject to the Group Annual Bonus Plan. This population is considered to be the most appropriate group of employees for these purposes because its remuneration structure is consistent with that of the GCE. For 2015, 46,474 colleagues were included in this category.

  % change in
base salary
(2014 – 2015)		 % change
in bonus
(2014 – 2015)		 % change
in benefits
(2014 – 2015)		 
GCE 6% 6% 18% 
All employees 2%1 (14.1)%1 2%1 

1Adjusted for movements in staff numbers and other impacts to ensure a like-for-like comparison.

RELATIVE SPEND ON PAY (£M)

The graph below illustrates the relative importance of spend on pay (total remuneration of all Group employees) compared with distributions to shareholders. Distributions to shareholders are ordinary and special dividends.

12015: Ordinary and special dividend in respect of the financial year ended 31 December 2015, partly paid in 2015 and partly to be paid in 2016. 2014: ordinary dividend in respect of the financial year ended 31 December 2014, paid in 2015.
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COMPENSATION

PAYMENTS WITHIN THE REPORTING YEAR TO PAST DIRECTORS (AUDITED)

As part of arrangements on leaving the Group, a deferred bonus was released to Tim Tookey (£68,713).

LOSS OF OFFICE PAYMENTS (AUDITED)

There were no payments for the loss of office made to former Directors during 2015.

EXTERNAL APPOINTMENTS HELD BY THE EXECUTIVE DIRECTORS

António Horta-Osório – During the year ended 31 December 2015, the Group Chief Executive served as a Non-Executive Director of Exor, Fundação Champalimaud, Stichting INPAR and Sociedade Francisco Manuel dos Santos for which he received fees of £216,054 in total.

CHAIRMAN AND NON-EXECUTIVE DIRECTORS (AUDITED)

  Fees £000 Taxable benefits £000 Total £000 
  2015 2014 2015 2014 2015 2014 
Current Non-Executive Directors             
Lord Blackwell 700 5801 122 92 712 589 
Alan Dickinson 144 333 – – 144 33 
Anita Frew 236 2023 – – 236 202 
Simon Henry 105 533 – – 105 53 
Dyfrig John 105 105 – – 105 105 
Nick Luff 135 135 – – 135 135 
Deborah McWhinney 9 – – – 9 – 
Nick Prettejohn 350 1823 – – 350 182 
Anthony Watson 209 215 – – 209 215 
Sara Weller 135 123 – – 135 123 
Former Non-Executive Directors             
Sir Winfried Bischoff (retired April 2014) – 183 – 104 – 193 
Carolyn Fairbairn (retired October 2015) 88 105 – – 88 105 
David Roberts (retired May 2014) – 95 – – – 95 
Total 2,216 2,011 12 19 2,228 2,030 

1Fees reflect the period of service prior to becoming Chairman of the Board.
2Car allowance (£8,909 and £12,000).
3Fees reflect the period in role on a pro-rata basis.
42014 taxable benefits are made up of car allowance of £3,136, private medical benefit of £608, and transportation of £6,693.
146

COMPENSATION

BREAKDOWN OF NON-EXECUTIVE DIRECTORS’ FEES (£000S)

  Board fee Deputy
Chairman		 Senior
Independent
Director		 Audit
Committee		 Remuneration
Committee		 Board Risk
Committee		 SWG
Board fees1		 Other fees 2015
Total		 
Alan Dickinson 65     20 9 50     144 
Carolyn Fairbairn 54     17 17       88 
Anita Frew 65 100   20 27 20   42 236 
Simon Henry 65     20   20     105 
Dyfrig John 65     20 20       105 
Nick Luff 65     50   20     135 
Deborah McWhinney 5     2   2     9 
Nick Prettejohn 65     20   20 245   350 
Anthony Watson 65   60 20 43 20   12 209 
Sara Weller 65       20 20   302 135 

1Scottish Widows Group Ltd.
2Fees for membership of Nomination Committee.

HISTORICAL TOTAL SHAREHOLDER RETURN (TSR) PERFORMANCE

The chart below shows the historical TSR of Lloyds Banking Group plc compared with the FTSE 100 as required by the regulations, rebased as at 31 December 2008. The FTSE 100 index has been chosen as it is a widely recognised equity index of which Lloyds Banking Group plc has been a constituent throughout this period.

TOTAL SHAREHOLDER RETURN INDICES – LLOYDS BANKING GROUP AND FTSE 100

HISTORICAL GROUP CHIEF EXECUTIVE (GCE) REMUNERATION OUTCOMES

 GCE 2009 2010 2011 2012 2013 2014 2015 
GCE single figure ofJ E Daniels 1,121 2,572 855 – – – – 
remuneration £000António Horta-Osório – – 1,765 3,398 7,475 11,540 8,773 
Annual bonus payoutJ E Daniels Waived 62% 0% – – – – 
(% of maximum opportunity)António Horta-Osório – – Waived 62% 71% 54% 57% 
Long-term incentive vestingJ E Daniels 0% 0% 0% – – – – 
(% of maximum opportunity)António Horta-Osório – – 0% 0% 54% 97% 94.18% 

Notes: J E Daniels served as GCE until 28 February 2011; António Horta-Osório was appointed GCE from 1 March 2011. J E Daniels declined to take a bonus in 2009 and António Horta-Osório declined to take a bonus in 2011.

147

COMPENSATION

OUTSTANDING SHARE AWARDS

DIRECTORS’ INTERESTS (AUDITED)

Shareholding guidelines

Executive Directors were required to build up a holding in Lloyds Banking Group plc shares of value equal to 150 per cent of base salary (200 per cent for the GCE) within three years from the later of 1 January 2012 or their date of joining the Board. With the introduction of the fixed share award in 2014, the gross annual value of this award was added to salary to determine the personal shareholding requirement. For the purposes of assessing the additional shareholding requirement, Executive Directors have up to three years from 1 January 2014 to build up the additional shareholding created by the addition of the fixed share award. As at 31 December 2015, all Executive Directors significantly exceeded the requirements.

Executive Directors are required to retain any shares vesting from 2013 LTIP awards onwards for a further two years post vesting (although vested shares would count towards the shareholding requirement).

  Number of shares Number of options Total shareholding4 Value 
  Owned
outright		 Unvested
subject to
continued
employment		 Unvested
subject to
performance		 Unvested
subject to
continued
employment		 Vested
unexercised		 Totals at
31 December
2015		 Totals at
3 March
2016		 Expected
value at
31 December
2015
(£000s)2		 
Executive Directors                 
António Horta-Osório1 11,761,072 5,759,844 16,644,524 37,151 – 34,202,591 34,203,2043 18,911 
George Culmer 7,090,093 1,735,766 9,004,413 37,151 – 17,867,423 17,867,9573 9,766 
Juan Colombás 3,145,458 1,801,742 8,253,825 29,990 535,231 13,766,246 13,766,7803 7,043 
Non-Executive Directors                 
Lord Blackwell 50,000 – – – – 50,000 n/a n/a 
Alan Dickinson 100,000 – – – – 100,000 n/a n/a 
Anita Frew 300,000 – – – – 300,000 n/a n/a 
Simon Henry 100,000 – – – – 100,000 n/a n/a 
Dyfrig John 27,385 – – – – 27,385 n/a n/a 
Nick Luff 300,000 – – – – 300,000 n/a n/a 
Deborah McWhinney1 200,000 – – – – 200,000 n/a n/a 
Nick Prettejohn – – – – – – 69,280 n/a 
Stuart Sinclair – – – – – – n/a n/a 
Anthony Watson 476,357 – – – – 476,357 n/a n/a 
Sara Weller 200,000 – – – – 200,000 n/a n/a 

1Shareholdings held by António Horta-Osório and Deborah McWhinney are either wholly or partially in the form of ADRs.
2Awards subject to performance under the LTIP had an expected value of 50 per cent of face value at grant (using current accounting assumptions). Values are based on the 31 December 2015 closing price of 73.07 pence. Full face value of awards are £24,991,833 for António Horta-Osório, £13,055,725 for George Culmer and £10,058,995 for Juan Colombás.
3The changes in beneficial interests for António Horta-Osório (613 shares), George Culmer (534 shares) and Juan Colombás (534 shares) relate to ‘partnership’ and ‘matching’ shares acquired under the Lloyds Banking Group Share Incentive Plan between 31 December 2015 and 3 March 2016. There have been no other changes up to 3 March 2016.
4Including holdings of connected persons.

A summary of transactions undertaken in the year, including share plan awards vested plus open market purchases and sales made by Directors, is shown on page 151.

As a result of the above shareholdings, the position for each Executive Director is as follows:

    Shareholding requirement Current shareholding   
Executive Directors Base salary plus
fixed share award
(£000s)		 % of base
salary plus
fixed share award		 Number of
shares1		 % of base
salary plus
fixed share
award1		 Number of shares
as at
31/12/152		 Requirement
met		 
António Horta-Osório 1,961 200% 5,155,439 456% 11,759,547 Yes 
George Culmer 1,238 150% 2,441,801 435% 7,088,568 Yes 
Juan Colombás 1,221 150% 2,407,887 214% 3,428,561 Yes 

1Number of shares required and current shareholding percentage of base salary plus fixed share award figures are calculated using the average share price for the period 1 April 2014 to 31 March 2015 (76.075 pence).
2Includes shares owned outright reduced by forfeitable ‘matching’ shares under the Share Incentive Plan, plus the estimated net number of vested unexercised options.

None of those who were Directors at the end of the year had any other interest in the capital of Lloyds Banking Group plc or its subsidiaries.

148

COMPENSATION

BREAKDOWN OF SHARES INTERESTS (AUDITED)

Long-term incentive plan awarded in 2015

Awards (in the form of conditional rights to free shares) in 2015 were made over shares with a value of 300 per cent of reference salary for the GCE (4,579,006 shares with a face value of £3,660,000); 275 per cent for the CFO (2,477,167 shares with a face value of £1,980,000); and 275 per cent for the CRO (2,442,762 shares with a face value of £1,952,500). The share price used to calculate face value is the average price over the five days prior to grant (6 March to 11 March 2015), which was 79.93 pence. This was the average share price used to determine the number of shares awarded.

The performance conditions attached to these awards are set out in the table below. The performance period ends on 31 December 2017.

CategoryMeasureBasis of payout rangeMetricWeighting
Delivering
sustainable growth		Absolute TSRGrowth in share price
including dividends over
3-year period		Threshold: 8% pa
Maximum: 16% pa		30%
Becoming simpler
and more efficient		Economic profitSet relative to 2017 targetsThreshold: £2,870m
Maximum: £3,587m		25%
Cost:income ratioSet relative to 2017 targetsThreshold: 45.6%
Maximum: 44.5%		10%
Creating the best
customer experience		Customer complaint
handling (total FCA
reportable complaints
per 1,000 accounts)1
and
Financial Ombudsman
Service (FOS) uphold rate		Average performance over
3-year period		Threshold: 1.15 complaints
per 1,000 accounts and 32%
FOS uphold rate
Maximum: 1.05 complaints
per 1,000 accounts and 28%
FOS uphold rate		10%
Net promoter scoreMajor Group average
ranking over 2017		Threshold: 3rd
Maximum: 1st		10%
Digital active customer
base		Set relative to 2017 targetsThreshold: 12.7m active users
Maximum: 13.3m active users		7.5%
Colleague engagement
score		Set relative to 2017 targetsThreshold: 62%
Maximum: 70%		7.5%

1Measure excludes PPI complaints and any complaints received via Claims Management Companies (CMC), but includes Banking, Home Finance, General Insurance, Life, Pensions and Investment complaints. The Group’s performance is heavily influenced by CMC volumes which are automatically reportable if defended. However, only 2 per cent of complaints received via CMCs are currently upheld by the Financial Ombudsman Service (FOS). Accordingly, the Committee has determined that complaints received via CMCs should be excluded from this measure.

The targets referred to in the table relate to the Group’s strategic plan, as approved by the Board. Further details have not been provided for reasons of commercial sensitivity, but will be disclosed after vesting.

For each measure, 25 per cent will vest for threshold performance, 50 per cent for on-target performance and 100 per cent for maximum performance.

Deferred bonus awarded in 2015

Bonus is deferred into shares. The face value of the share awards in respect of bonuses granted in March 2015 was £800,000 (1,000,875 shares) for the GCE; £496,000 (620,542 shares) for the CFO; and £467,892 (585,376 shares) for the CRO. The share price used to calculate the face value is the average price over the five days prior to grant (6 March to 11 March 2015), which was 79.93 pence.

149

COMPENSATION

INTERESTS IN SHARE OPTIONS (AUDITED)              
              Exercise periods  
  At
1 January
2015		 Granted
during
the year		 Exercised
during  
the year		 Lapsed during
the year		 At
31 December
2015		 Exercise
price		 From To Notes
António Horta-Osório 22,156 – – – 22,156 40.62p 1/6/2016 30/11/2016 1
  14,995   – – 14,995 60.02p 1/1/2018 30/6/2018 1
George Culmer 2,216,187 – 2,216,187 – – –     2,3
  2,243,816 – 2,243,816 – – –     2,3
  22,156 – – – 22,156 40.62p 1/6/2016 30/11/2016 1
  14,995 – – – 14,995 60.02p 1/1/2018 30/6/2018 1
Juan Colombás 235,499 – – – 235,499 – 15/6/2011 30/3/2021 4
  299,732 – – – 299,732 – 15/6/2012 30/3/2021 4
  29,990 – – – 29,990 60.02p 1/1/2018 30/6/2018 1
Former Directors who served during 2015              
None                  

1Sharesave.
2Executive share award granted on 6 August 2012 for the loss of deferred share awards forfeited on leaving RSA Insurance Group plc.
3Options exercised on 31 March 2015. The closing market price of the Group’s ordinary shares on that date was 78.28 pence.
4Share buy-out award granted on 30 March 2011 for the loss of deferred share awards forfeited on leaving the Santander Group. Awards are consistent with those forfeited and have a nil option price.

The aggregate amount of gains made by Directors on the exercise of share options was £3,491,290.

None of the other Directors at 31 December 2015 had options to acquire shares in Lloyds Banking Group plc or its subsidiaries.

The market price for a share in the Group at 1 January 2015 and 31 December 2015 was 75.82 pence and 73.07 pence, respectively. The range of prices between 1 January 2015 and 31 December 2015 was 68.68 pence to 89.00 pence.

LLOYDS BANKING GROUP LONG-TERM INCENTIVE PLAN (AUDITED)

The following table shows conditional shares awarded under the plan. Further information regarding this plan can be found on pages 149 and 154.

  At
1 January
2015		 Awarded
during the
year		 Vested
during the
year		 Lapsed
during the
year		 At
31 December
2015		 End of
performance
period		 Expected
value
(£000s)		 Notes
António Horta-Osório 9,644,684 – 9,316,764 327,920 – 31/12/2014 – 1
  7,425,441 – – – 7,425,441 31/12/2015 5,426  
  4,640,077   – – 4,640,077 31/12/2016 3,391  
    4,579,006 – – 4,579,006 31/12/2017 3,346 2
George Culmer 4,657,045 – 4,498,705 158,340 – 31/12/2014 – 1
  4,017,041 – – – 4,017,041 31/12/2015 2,935  
  2,510,205 - – – 2,510,205 31/12/2016 1,834  
    2,477,167     2,477,167 31/12/2017 1,810 2
Juan Colombás 4,146,064 – 4,005,097 140,967 – 31/12/2014 – 1
  3,576,283 – – – 3,576,283 31/12/2015 2,613  
  2,234,780 – –   2,234,780 31/12/2016 1,633  
    2,442,762 – – 2,442,762 31/12/2017 1,785 2

1The shares awarded in March 2012 vested on 12 March 2015. The closing market price of the Group’s ordinary shares on that date was 79.2 pence.
2Award price 79.93 pence.

Values are based on the 31 December 2015 closing price of 73.07 pence.

150

COMPENSATION

DIRECTORS’ INTERESTS – SUMMARY OF AWARDS VESTED, PURCHASES AND SALES MADE BY DIRECTORS IN 2015 (UNAUDITED)

  Holding at
1 January 2015
(or appointment
Date)		 Transactions
during
the year		 Number of
shares		 Notes Holding at
31 December
2015
Executive Directors          
António Horta-Osório 6,204,884 12/03/15 4,937,883 Release of 2012 LTIP  
    27/03/15 149,642 Fixed Share Award  
    19/05/15 56 Dividend reinvestment  
    25/06/15 136,880 Fixed Share Award  
    29/09/15 162,262 Fixed Share Award  
    21/12/15 166,993 Fixed Share Award  
    Monthly 2,472 Share Incentive Plan purchase and matching shares 11,761,072
George Culmer 1,232,436 12/03/15 2,384,313 Release of 2012 LTIP  
    27/03/15 83,799 Fixed Share Award  
    31/03/15 2,358,546 Exercise of Share Buy out Award  
    19/05/15 11,151 Dividend reinvestment  
    25/06/15 76,652 Fixed Share Award  
    25/06/15 357,526 Release of 2012 Deferred Bonus  
    02/09/15 357,526 Release of 2012 Deferred Bonus  
    28/09/15 41,358 Dividend reinvestment  
    29/09/15 90,867 Fixed Share Award  
    21/12/15 93,516 Fixed Share Award  
    Monthly 2,403 Share Incentive Plan purchase and matching shares 7,090,093
Juan Colombás 3,101,794 12/03/15 2,122,701 Release of 2012 LTIP  
    12/03/15 118,078 Release of 2011 Deferred Bonus  
    27/03/15 82,635 Fixed Share Award  
    20/05/15 3,647 Dividend reinvestment  
    12/06/15 (2,750,000) Sale  
    25/06/15 75,588 Fixed Share Award  
    25/06/15 44,355 Release of 2012 Deferred Bonus  
    02/09/15 162,436 Release of 2011 and 2012 Deferred Bonus  
    29/09/15 89,604 Fixed Share Award  
    21/12/15 92,217 Fixed Share Award  
    Monthly 2,403 Share Incentive Plan purchase and matching shares 3,145,458
Non-Executive Directors          
Lord Blackwell 50,000       50,000
Alan Dickinson 50,000 30/10/2015 50,000 Purchase 100,000
Anita Frew 300,000       300,000
Simon Henry – 30/06/2015 100,000 Purchase 100,000
Dyfrig John 27,385       27,385
Nick Luff 200,000 20/03/2015 100,000 Purchase 300,000
Deborah McWhinney1 200,000       200,000
Nick Prettejohn –       –
Anthony Watson 476,357       476,357
Sara Weller 200,000       200,000

1Held in 50,000 ADRs with one ADR being equivalent to four ordinary shares.
151

COMPENSATION

IMPLEMENTATION OF THE POLICY IN 2016

It is proposed to operate the policy in the following way in 2016:

Base salaryIn line with the policy, when determining and reviewing base salary levels, the Committee ensures that decisions are made within the following two parameters:
– An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective job-sizing methodologies.
–Pay for comparable roles in comparable publicly listed financial services groups of a similar size.
The Committee also takes into account base salary increases for employees throughout the Group. The Group has applied a 2 per cent overall salary budget increase for the general population differentiated by performance and market position (with increases of around 5 per cent for strongly performing colleagues). Salary increases of 2 per cent are proposed for the Chief Financial Officer (CFO) and the Chief Risk Officer (CRO).
When the Group Chief Executive Officer (GCE), António Horta-Osório, was appointed to the Board at the start of 2011 it was agreed that, reflecting the weak financial position of the Group at that time, his salary would initially be held at £1,061,000, a level below the prevailing market rate. To recognise this fact, the agreement with the GCE also contained a market related ‘reference salary’ of £1.22 million, to be used in setting long term remuneration such as pension and LTIP. Since 2011 the Group has achieved a successful transformation of its financial strength under his leadership and the government has reduced its shareholding from over 40 per cent to around 9 per cent. Until now, however, the GCE has received no increase in his base salary since joining the Board in January 2011, despite overall pay settlements in the Group, including the proposed 2 per cent for 2016, amounting to 13.8 per cent since 2011.
For the first time since 2011, a base salary increase is proposed for the GCE. The GCE was hired on the basis that upon the Government shareholding falling in the range of 15-20 per cent or less, the Committee would consider his remuneration being increased in line with market conditions. With the Government’s shareholding now being around 9 per cent and given the recovery of the Group’s financial strength, the Committee has decided it should now begin to adjust the GCE’s salary towards the reference salary. After discussion with shareholders, the Committee has decided to stage this adjustment over two years. For 2016, this will consist of an increase in base salary of 2 per cent, in line with the other Executive Directors, and an additional increase of 4 per cent to reflect the arrangements above, taking his total salary to £1,125,000. The GCE has suggested, and the Board has approved, that for 2016 the 4 per cent increase be delivered in shares and held until the Government has sold its shareholding in the Group. After this increase, the GCE’s salary remains conservative compared to peers.
Salaries will therefore be as follows, effective dates shown below:
GCE: £1,125,000 (1 January 2016)
CFO: £749,088 (1 April 2016)
CRO: £738,684 (1 January 2016)
There is no change to the GCE’s reference salary of £1.22 million which is used to calculate certain elements of long-term remuneration and the pension allowance.
Fixed share awardFixed share awards were introduced in 2014 in order to ensure that total fixed remuneration is commensurate with role and to provide a competitive reward package for Executive Directors, with an appropriate balance of fixed and variable remuneration, in line with regulatory requirements.
The actual levels of award set for 2016 are as follows:
GCE: £900,000
CFO: £504,000
CRO: £497,000
Shares will be released in equal tranches over a five year period.
PensionIn line with the remuneration policy, Executive Directors are entitled to a pension allowance which they may choose to take as cash in lieu of pension contributions. The level of allowances has not been increased for 2016.
GCE: 50 per cent of reference salary less flexible benefits allowance
CFO: 25 per cent of base salary
CRO: 25 per cent of base salary
The GCE is also entitled to the provision of an Employer-Financed Retirement Benefits Scheme (EFRBS),
subject to performance conditions, as described further in the annual report on remuneration.
BenefitsFor 2016, the benefits provided to Executive Directors include a car allowance, transportation, private medical insurance, life assurance and other benefits selected through the flexible benefits allowance which is capped at 4 per cent of base salary.
All employee plansExecutive Directors are eligible to participate in the Group’s Sharesave and Sharematch plans on the same basis as other employees.

152

COMPENSATION

ANNUAL BONUS
OpportunityThe maximum annual bonus opportunity is 140 per cent of base salary for the GCE and 100 per cent of base salary for other Executive Directors. All assessments of performance are ultimately subject to the Committee’s judgement, but no award will be made if threshold performance for the financial measure is not met and/or the individual is rated ‘Developing performer’ or below. The expected value of the bonus is 30 per cent of the maximum opportunity.
DeferralFor the 2016 performance year, the annual bonus will be awarded in a combination of cash (up to 50 per cent) and shares. 40 per cent of the annual bonus will be released immediately on award, 40 per cent will be released on the first anniversary of award and the remaining 20 per cent will be released on the second anniversary of award. These deferral arangements will apply to the GCE and the other Executive Directors.
Performance measures
and targets		For 2016 the annual bonus will be based on:
– Underlying profit – 50 per cent
–Balanced scorecard (BSC) objectives comprising five categories (customer, people, control environment, building the business, finance) – 50 per cent
The Committee considers the targets that apply to these measures to be commercially sensitive but will provide information on the level of payout relative to the performance achieved in next year’s annual report on remuneration.
The Committee applies its judgement to determine the payout level commensurate with business and/or individual performance in determining the final BSC rating.
Performance adjustment is determined by the Remuneration Committee and Board Risk Committee and may result in a reduction of up to 100 per cent of the bonus opportunity. The Independent Performance Adjustment Committee (IPAC) reviews the BSC outcomes and submits a report to the Remuneration Committee and Board Risk Committee to assist in this process.
The application of malus will generally be considered when:
–there is reasonable evidence of employee misbehaviour, misconduct or material error or that they participated in conduct which resulted in losses for the Group or failed to meet appropriate standards of fitness and propriety;
–there is material failure of risk management at a Group, business area, division and/or business unit level;
–the financial results at a Group, division or business unit level are re-stated or consideration is given to restatement;
–the Committee determines that the financial results for a given year do not support the level of variable remuneration awarded; and/or
–any other circumstances where the Committee consider adjustments should be made.
Individual performance adjustment is informed using a matrix-based approach taking into account the severity of the issue, the individual’s proximity to the issue and the individual’s behaviour in relation to the issue.
In addition, the annual bonus may be subject to clawback for a period of up to seven years after the date of award. This period may be extended to ten years where there is an ongoing internal or regulatory investigation.
The application of clawback will generally be considered when:
–there is reasonable evidence of employee misbehaviour or material error; or
–there is material failure of risk management at a Group, business area, division and/or business unit level.
153

COMPENSATION

LONG-TERM INCENTIVE PLAN
OpportunityThe maximum annual long-term incentive award for Executive Directors is 300 per cent of salary. Awards in 2016 are being made as follows:
GCE: 300 per cent of reference salary
CFO: 275 per cent of base salary
CRO: 275 per cent of base salary
Performance measures
and targets		2016 awards will be subject to a three-year performance period, and a two-year holding period following vesting.
During 2015 and early 2016, the Committee consulted widely with various shareholders on appropriate performance measures and, in particular, on how management can be incentivised through the LTIP to successfully deliver the objectives set out in the Group Strategic Review.
The awards made in 2016 will vest based on the Group’s performance against the following key measures:
– Absolute Total Shareholder Return (30 per cent)
–Economic profit (25 per cent)
–Cost:income ratio (10 per cent)
–Strategic measures (35 per cent)
The following table provides a breakdown of these measures and the targets applicable.
The Committee believes these measures capture risk management and profit growth and appropriately align management and shareholder interests.
LTIP awards may be subject to clawback for a period of up to seven years after the date of award. This period may be extended to ten years where there is an ongoing internal or regulatory investigation.
The Committee may consider the application of malus and clawback as outlined in the annual bonus section above.
Strategic focusMeasureBasis of payout rangeMetricWeighting
DeliveringAbsolute TotalGrowth in share price includingThreshold: 8%30%
sustainable growthShareholderdividends overMaximum: 16%
Return (TSR)3-year period
Becoming simplerEconomic profit1Set relative toThreshold: £2,507m25%
and more efficient2018 targetsMaximum: £3,308m
Cost: income ratioSet relative toThreshold: 47.3%10%
2018 targetsMaximum: 46.1%
Creating the bestTotal reportable complaints2,3Set relative toSee note 2 below10%
customer experienceand2018 targets=<35%
Financial Ombudsman Service=<25%
(FOS) uphold rate3
Net promoter scoreMajor Group average rankingThreshold: 3rd10%
over 2018Maximum: 1st
Digital activeSet relative toThreshold: 13.4m
customer base2018 targetsMaximum: 14m7.5%
ColleagueSet relative toThreshold: 66%
engagement score2018 targetsMaximum: 72%7.5%

1The reduction in economic profit compared to the 2015 LTIP (for 2017 performance) reflects the introduction of the corporation tax surcharge for banks of 8 per cent.
2Measure excludes PPI complaints and any complaints received via Claims Management Companies, but includes Banking, Home Finance, General Insurance, Life, Pensions and Investment complaints. The FCA has issued guidance which applies from 2016. The threshold and maximum for total reportable complaints are subject to validation, based on experience in H1 2016 and will be disclosed to shareholders later in the year.
3The Board will continue to review its risk appetite and to the extent that this results in changes to the acceptable level of uphold, consideration will be given to bringing the metric in line with revised appetite. The metric will be no easier to achieve.
154

COMPENSATION

CHAIRMAN AND NON-EXECUTIVE DIRECTOR FEES IN 2016

The annual fee for the Chairman was increased by 2 per cent to £714,000, in line with the overall salary budget for the general colleague population.

The annual Non-Executive Director fees were reviewed in November 2015. As a result of this review and following consultation with shareholders, for the first time since 2008, the fees were increased, as follows, to reflect market practice in financial services groups of a similar size. These changes took effect from 1 January 2016.

 20162015
Basic fee£75,000£65,000
Deputy Chairman£100,000£100,000
Senior Independent Director£60,000£60,000
Audit Committee Chairmanship£60,000£50,000
Remuneration Committee Chairmanship£60,000£50,000
Board Risk Committee Chairmanship£60,000£50,000
Responsible Business Committee Chairmanship£30,000£30,000
Audit Committee membership£30,000£20,000
Remuneration Committee membership£30,000£20,000
Board Risk Committee membership£30,000£20,000
Responsible Business Committee members1£10,000N/A
Nomination & Governance Committee membership2£5,000£5,000

1New members only.
2Where individual is not already Chairman of another Committee.

Non-Executive Directors may receive more than one of the above fees.

The following pages contain information that is required to be audited in compliance with the Directors’ remuneration requirements of the Companies Act 2006. All narrative and quantitative tables are unaudited unless otherwise stated.

ADDITIONAL DISCLOSURES

Emoluments of the eight highest paid senior executives1

The following table sets out the emoluments of the eight highest paid senior executives (excluding Executive Directors) in respect of the 2015 performance year.

 Executive
 87654321
 £000£000£000£000£000£000£000£000
Fixed        
Cash based585406330420580508711682
Share based410280740650406350490467
Total fixed9956861,0701,0709868581,2011,149
Variable        
Upfront cash22222222
Deferred cash00000000
Upfront shares1356729823890177137238
Deferred shares2054645036061269209360
Long-term incentive plan9511,5788611,0762,0711,9732,7632,588
Total variable pay1,2931,6931,6111,6762,2242,4213,1113,188
Pension cost1461016684145127178169
Total remuneration2,4342,4802,7472,8303,3553,4064,4904,506

1Includes members of the Group Executive Committee and Senior Executive level colleagues.

Variable remuneration in respect of performance year 2015. LTIP values shown reflect awards for which the performance period ended on 31 December 2015 and include dividend equivalents. Pension costs based on a percentage of salary according to level.

155

CORPORATE GOVERNANCE

 

STATEMENT ON US CORPORATE GOVERNANCE STANDARDS

 

The Board is committed to achieving long termthe delivery of the Group’s strategy which will transform the Group for success for the Company by being the best bank for customers and generating superior and sustainable returns for shareholders.in a digital world. The Board’s strategy is underpinned by high standards of corporate governance designed to ensure consistency and rigour in its decision making. This report explains how those standards, in particular, those laid down in the Financial Reporting Council’s 2014 UK Corporate Governance Code 2016 (the UK Code), apply in practice to ensure that the Board and management work together for the long termlong-term benefit of the Company and its shareholders. The UK Code can be accessed at www.frc.org.uk.

 

To assist the Board in carrying out its functions and to provide independent oversight of internal control and risk management, certain responsibilities are delegated to the Board’s Committees. The Board is kept up to date on the activities of the Committees through reports from each of the Committee Chairmen. Terms of referenceReference for each of the Committees are available on the website at www.lloydsbankinggroup.com. Information on the membership, role and activities of the Nomination &and Governance Committee, the Audit Committee, the Board Risk Committee and the Responsible Business Committee can be found on pages 171144 to 181.155.

 

Further information about the work of the Remuneration Committee is included on pages 129111 to 155.112 and 125.

 

As a non-US company listed on the New York Stock Exchange (NYSE) Lloyds Banking Group plc is required to disclose any significant ways in which its corporate governance practices differ from those followed by domestic US companies listed on the NYSE. As Lloyds Banking Group plc’s main listing is on the London Stock Exchange, it follows the principles contained in the 2014 UK Corporate Governance Code issued by the UK Financial Reporting Council (the UK Code).Code. The Group has complied with the provisions of the UK Code and has done so throughout 20152018 regarding the provisions where the requirements are of a continuing nature. Key differences are set out below.

 

The NYSE corporate governance listing standards require domestic US companies to adopt and disclose corporate governance policies. For Lloyds Banking Group plc, consistent with the principles of the UK Code, the Nomination &and Governance Committee sets the corporate governance principles applicable to the Company and oversees the annual evaluation of the performance of the Board, its Committees and its individual members.

 

Under the NYSE corporate governance listing standards, the remuneration, nomination &and governance committees of domestic US companies must be comprised of entirely independent directors. However for Lloyds Banking Group plc, again consistent with the principles of the UK Code, the Remuneration Committee and the Nomination &and Governance Committee include the Chairman, with all other members being independent non-executive directors.

156131

CORPORATE GOVERNANCE

 

LEADERSHIPA LETTER FROM OUR CHAIRMAN

 

TheBUILDING ROBUST STAKEHOLDER RELATIONSHIPS

During the year, the Board continued to ensure corporate governance was embedded into the thinking and processes of the business.
Lord Blackwell
Chairman

CHAIRMAN’S LETTER

This Corporate Governance Report details our approach to governance in practice, how the Board

The Group is led by an effective, committed operates and unitary Board, which is collectively responsible for the long-term successkey activities of the Company.Board during the year, together with information on the annual Board evaluation process. It also includes the reports from each of the Board’s principal Committees.

Strong Board oversight is vitally important alongside the executive governance framework. A major focus over the last year has been the implementation of our strategic transformation programme, following extensive Board engagement in the conception and design of the strategy to deliver the ‘Bank of the Future’.

This transformation programme is managed through multiple workstreams and initiatives, and the scale and pace of change is highly demanding. It has involved a significant shift in organisational decision-making and controls from business and functional lines to cross divisional workstreams. It has also required a substantial investment in colleague skills and culture to support the re-shaping of roles around the new ways of working. The Board comprises a Chairman (who was independent on appointment), independent Non-Executive Directorshas devoted considerable time to reviewing the way this is being implemented, with particular attention to the management of the risks arising from the implementation of new technologies, the new ways of working and Executive Directors. The names and biographiesthe overall pace of current Directors are set out on pages 125 to 127.change.

BOARD AND COMMITTEE CHANGES

 

There ishave been a clear divisionnumber of responsibility atchanges to the headBoard and Committees during the year. Amanda Mackenzie was appointed to the Board in October, and became a member of the Company, whichBoard Risk Committee and the Responsible Business Committee. She is documentedalso joining the Remuneration Committee with effect from 1 March 2019. Also, Nick Prettejohn is joining the Nomination and Governance Committee with effect from 1 March 2019. After three years on the Board, Deborah McWhinney decided to leave the Group, for personal reasons, with effect from 31 December 2018. Deborah provided valuable insight to the Board during her tenure, especially in respect of

IT infrastructure and cyber security. She left with our thanks and best wishes for the future. Anita Frew stepped down as Chairman of the Remuneration Committee in September and was replaced by Stuart Sinclair. Anita will continue to be a member of the Committee, and remains as the Group’s Deputy Chairman and Senior Independent Director. Further to the announcement in October that George Culmer would be retiring from the Group in the third quarter of 2019, the Group announced in February 2019, that, subject to regulatory approvals, William Chalmers will succeed George as Executive Director and Chief Financial Officer.

GOVERNANCE AND THE RING-FENCED BANK STRUCTURE

Building on the work carried out last year to create our non-ring fenced bank, Lloyds Bank Corporate Markets plc, the Group has now completed the new regulatory requirements by establishing new governance around its ring-fenced banking activities – Lloyds Bank plc and Bank of Scotland plc (together the ‘Ring-Fenced Banks’). These companies serve the Group’s personal and business clients in the UK and contain the vast majority of the Group’s UK banking activities. Further information on the governance structure for the Ring-Fenced Banks can be found on page 135.

Group Directors are also Directors of the Ring-Fenced Banks and, in addition, we have appointed three Non-Executive Directors to the Ring-Fenced Banks, who are independent of the Group (the ‘Ring-Fenced Bank only Directors’). These three Ring-Fenced Bank only Directors were recruited during 2018 and took up their formal roles on 1 January 2019. They are Nigel Hinshelwood and Brendan Gilligan, who both have extensive experience of the financial sector, and Sarah Bentley, who has significant experience in consumer-focused industries as well as in digital technology. More information is provided in the Nomination and Governance Committee report on pages 144 to 146. Nigel Hinshelwood has been appointed as the Senior Independent Director of the Ring-Fenced Bank Boards.

BOARD EVALUATION

In accordance with the UK Corporate Governance Framework. The Chairman has overall responsibility forCode the leadershipBoard engaged Egon Zehnder to facilitate the annual review of the Board and for ensuring its effectiveness whileCommittees, following two years in which we had undertaken internal reviews of board effectiveness. This process ran between August 2018 and January 2019, and was overseen by the Nomination and Governance Committee. The process which was undertaken and the findings of the review can be found on pages 139 to 140, together with information about our progress against the 2017 review actions.

CORPORATE GOVERNANCE CODE

During the year under review, the Group Chief Executive managesapplied and leadswas fully compliant with the business.UK Corporate Governance Code 2016. Additionally, in preparation for our adoption of the UK Corporate Governance Code 2018 from 1 January this year, the Group undertook a review of its Corporate Governance Framework. We also considered our approach to workforce engagement. Further information on workforce engagement can be found on page 141. We will report on our application of the UK Corporate Governance Code 2018 in next year’s annual report.

 

Lord Blackwell

Chairman

STRATEGY
The Board has been engaged with the Group’s strategy through multiple touchpoints throughout the year. These have included:
the annual cycle of two offsite meetings to debate priorities and agree implementation plans;
a suite of formal Board metrics and qualitative reporting to monitor progress and risks;
‘Deep dive’ sessions on key areas (see page 133 for more information);
‘Gallery Walk’ sessions with workstream teams in the Lab environment; and
a wide range of informal interactions to ‘feel the pulse’.


132

CORPORATE GOVERNANCE

Corporate Governance Framework setsgovernance report

OUR BOARD IN 2018*

Gender diversity A. B. A. Male: 9 B. Female: 4 Skills and experience (Non-Executive Directors only) Retail/Commercial Banking Financial markets/wholesale banking/ corporate clients Insurance Prudential and conduct risk in financial institutions Core technology operations Government/regulatory Consumer/marketing/distribution Strategic thinking 7 out a number of key decisions10 8 out of 10 5 out of 10 10 out of 10 5 out of 10 10 out of 10 8 out of 10 10 out of 10 Board tenure A. B. C. D. E. A. 0-2 years: 2 B. 2-4 years: 2 C. 4-6 years: 4 D. 6-8 years: 4 E. 8+ years: 1 Age A. B. C. A. 46-55: 2 B. 56-65: 9 C. 66-75: 2

*Data as at 31 December 2018. Amanda Mackenzie joined the Board on 1 October 2018, and matters that are reserved forDeborah McWhinney retired from the Board’s approval. Board on 31 December 2018.

BOARD AND COMMITTEE COMPOSITION AND ATTENDANCE IN 20184

Board memberBoard meetingsNomination and
Governance Committee		Audit
Committee		Board Risk
Committee		Remuneration
Committee		Responsible
Business Committee
Lord Blackwell (C)8/87/7–8/86/64/4
António Horta-Osório8/8–––––
Juan Colombás8/8–––––
George Culmer8/8–––––
Alan Dickinson8/87/77/78/86/6–
Anita Frew8/86/77/78/86/634/4
Simon Henry7/8–7/78/8––
Lord Lupton8/8–6/78/8––
Amanda Mackenzie11/1––2/2–1/1
Deborah McWhinney28/8–6/78/8––
Nick Prettejohn8/8–7/78/8––
Stuart Sinclair7/8––7/86/634/4
Sara Weller8/87/7–8/86/64/4

1 Amanda Mackenzie joined the Board and respective Committees on 1 October 2018.
2Deborah McWhinney retired from the Board on 31 December 2018.
3Stuart Sinclair succeeded Anita Frew as the Chair of the Remuneration Committee on 1 September 2018.
4Where a Director is unable to attend a meeting s/he receives papers in advance and has the opportunity to provide comments to the Chair of the Board, or to the relevant Committee Chair.
Chairman

‘DEEP DIVE’ SESSIONS
The Board regularly takes the opportunity to hold ‘deep dive’ sessions with senior management outside formal Board meetings. The purpose of the sessions is to provide the Board with deeper insight into key areas of strategic focus, whilst providing Directors with a greater understanding and appreciation for the subject matter to help drive better quality of debate and enhance knowledge. The sessions are structured to allow plenty of opportunity for discussion and include presentations and videos.
In 2018 deep dive sessions were held on the following topics:
IT Architecture Strategy
People and ways of working (initial deep dive in April, and update meeting in October)
Open Banking
Lloyds Bank Corporate Markets plc update
Scottish Widows strategy
Governance of GSR3 and value streams
133

CORPORATE GOVERNANCE

KEY FOCUS AREAS

The Board sets the strategy, oversees its delivery and establishes the culture, values and standards of the Group. The Board ensures that the Group manages risk effectively, monitors financial performance and reporting and ensures that appropriate and effective succession planning arrangements and remuneration policies are in place. It provides and encourages entrepreneurial leadership across the Group within this framework.

 

Below are details of the main topics discussed by the Board during the year.

LEADING CUSTOMER EXPERIENCE MAXIMISE TRANSFORM DIGITISE

DISCUSSIONS AND DECISIONS

Regular updates
Group Performance Report 
Finance report, including budgets, forecast and capital positions
Risk reports
2018 customer performance dashboard 
Chairman’s report
Reports from Chairmen of Committees and principal subsidiaries

Financial
2018 budget
Dividend approval
Update on structural hedging strategy
Pension scheme valuations
Group Corporate Treasury Management information pack
GSR3 and four year operating plan
Draft results and presentations to analysts
Funding and liquidity plans
Capital plan
Basel Pillar 3 disclosures
Annual report and Form 20-F
Unconsolidated income statement
Group treasury plan 2019
Strategy
Two strategy away days to review the progress in implementing the Group’s strategy
‘Deep dive’ on IT Architecture Strategy 
‘Deep dive’ on Open Banking 
Consideration and approval of large transactions 
Cloud strategy, which supports the transformation of the Group’s IT architecture 

Customers
Annual review of customer conduct framework and risks
Performance reviews against customer dashboard
Deep dives on customer propositions, including mortgage offerings and transforming customer journeys 
Processes and outcomes for fair treatment of customer complaints and remediation
Progress in providing a ’single customer view’ of Group products and supporting Open Banking developments 
Supporting vulnerable customers and customers in financial difficulty
Updates on our support for financial inclusion

Culture and values
‘Deep dive’ on people and ways of working in April, and an additional deep dive in October 
Helping Britain Prosper Plan 
Conduct, culture and values – Culture dashboard 
Responsible business report
Governance and stakeholders
Establishment of the operational, organisational and governance structure for the Ring-Fenced Banks.
Board effectiveness and Chairman’s performance reviews
AGM documentation approval and subsequent voting results briefing
Review and approval of the Corporate Governance Framework
Review and approval of various Group policies including Signing Authorities, Group Statement on Modern Slavery, and Board and GEC Members’ Dealing Policy
Investor Relations updates
Revised principal Committee responsibilities
Chairman’s fee review
(without Chairman present)
Non-Executive Directors’ fees review
(with Non-Executive Directors’ abstaining)
Going concern statement
Banking Standards Board update
Board appointments and Executive succession plans

Regulatory
Ring-Fenced Banking updates
Whistleblowing updates
Regulatory updates
Senior Manager and Certification Regime updates

Risk management
Approval of Group risk appetite
Cyber security briefings
Review and approval of conduct risk
Review and approval of PRA and EBA stress testing results
Review and approval of the Risk Management Framework


134

CORPORATE GOVERNANCE

Governance in action

Schroders joint venture

On 23 October 2018, the Group announced a strategic partnership with Schroders plc to create a market-leading wealth management proposition. The three key components of the partnership are:

(i) the establishment of a new financial planning joint venture (the ‘JV’);

(ii) the Group taking a 19.9 per cent stake in Schroders high net worth UK wealth management business; and

(iii) the appointment of Schroders as the active investment manager of approximately £80 billion of the Scottish Widows and Lloyds Banking Group insurance and wealth related assets.

This strategic partnership will combine the Group’s significant client base, multi-channel distribution and digital capabilities with Schroders’ investment and wealth management expertise and technology capabilities.

As part of the structure of the partnership, the Board considered two primary elements:

The management of the insurance and wealth related assets; and
The establishment of the JV

Management of the assets was largely the responsibility of the Insurance Business. In July 2018, a recommendation was made to the Insurance Board (and the Boards of all the other entities that were to be parties to the arrangements) proposing that Schroders be appointed as core investment management and investment advisory partner

following a structured Request for Proposal process, involving two rounds of bidding, due diligence, site visits, client references and joint implementation workshops. An evaluation process indicated that Schroders would be the preferred bidder, with Schroders standing out on strategic alignment as well as investment performance, which was seen as key to building a successful long-term relationship. The recommendation included the proposed strategic partnership with the Wealth business, which would benefit the Insurance business. The recommendation to appoint Schroders to manage the funds was accepted in principle by the Insurance Board, subject to approval of the proposed JV arrangements by the Group Board. Group Board approval of the JV proposals was obtained on 2 October 2018.

The JV element of the partnership was considered by the main Group Board. Initially papers were presented at scheduled Board meetings, but as the proposal progressed, a Committee of the Board considered and approved the project to provide flexibility, to better respond to the needs of the business and engage in governance of the project, which was important for the implementation of the Group’s strategy in the area of insurance and wealth, and for the Group as a whole. The Board scrutinised the proposal to satisfy itself that the establishment of the JV was in the best interests of the Group’s customers. The Board considered, amongst other things, the process for referring Group customers to the JV and that the standards of customer service would meet the Group’s values and standards, ensuring that customers were at the heart of the decision being made.


Revised Group governance arrangements and Group restructure to comply with ring-fencing

Following the financial crisis, UK legislation was passed to better protect customers and the day-to-day banking services they rely on. The new rules mean large UK banks must separate personal banking services such as current and savings accounts from risks in other parts of the business, like investment banking. This is called ring-fencing. Banks have taken different approaches on how they implement these rules with effect from 1 January 2019.

The Group, led by the Nomination and Governance Committee, has worked closely with the Regulators to ensure that there is in place a Group structure and governance arrangements which are appropriate for the Group, and meet regulatory requirements. Lloyds Bank plc and Bank of Scotland plc have been identified as the banks which have been included within the ring-fence (together, the ‘Ring-Fenced Banks’). Broadly, there are three key PRA principles that underpin the governance structure for the Ring-Fenced Banks.

Independent decision making by the Ring-Fenced Bank Boards – on any matters where there might be a conflict between the interests of the Ring-Fenced Banks and the interests of another part of the Group, ensuring that the Ring-Fenced Bank Boards act in the interests of the Ring-Fenced Banks.

Risks considered and managed from the Ring-Fenced Banks’ perspective – this includes maintenance of the capital adequacy and liquidity of the Ring-Fenced Banks.

Clear and effective governance at both Ring-Fenced Bank and Lloyds Banking Group plc level – including second and third lines of defence in respect of risk management.

In order to meet ring-fencing requirements a major governance and legal entity programme has been implemented across the Group, which has included the following aspects:

REORGANISATION

The reorganisation of the subsidiaries of the Group, which have now been restructured into four sub-groups under Lloyds Banking Group plc:

the ‘Ring-Fenced Bank sub-group’ containing Lloyds Bank plc and Bank of Scotland plc (which includes the Halifax business and MBNA);

the ‘LBCM sub-group’ under Lloyds Bank Corporate Markets plc, which now holds the Group’s subsidiaries and branches in the Crown Dependencies, Singapore and the US. A number of client agreements were also transferred from Lloyds Bank plc and Bank of Scotland plc to Lloyds Bank Corporate Markets plc in order to comply with the ring-fencing regulatory requirements which took effect on 1 January 2019;

the ‘Insurance sub-group’ under Scottish Widows Group Limited (including Scottish Widows Limited); and

the ‘Equity sub-group’ under a new equity holding company, LBG Equity Investments Limited, under which the principal subsidiary is Lloyds Development Capital Limited.

Lloyds Banking Group plc Aligned Boards Lloyds Bank plc* HBOS plc Bank of Scotland plc* Lloyds Bank Corporate Markets plc Scottish Widows Group Limited LBG Equity Investments Limited Ring-Fenced Banks* Non Ring-Fenced Bank Insurance Equity Investments

THE BOARD STRUCTURE

To facilitate effective governance, the boards of Lloyds Banking Group plc, Lloyds Bank plc, Bank of Scotland plc and HBOS plc are run on an aligned basis as the business of the Ring-Fenced Banks accounts for the majority of the Group’s operations. This involves the Directors of Lloyds Banking Group plc also sitting on the Boards of the other three companies. To provide further support to the fulfilment of the three key principles of governance of the Ring-Fenced Banks outlined above, three additional independent Non-Executive Directors have been appointed to the Ring-Fenced Bank Boards.

Consistent with the existing independent Scottish Widows Limited Board, Lloyds Bank Corporate Markets plc also has an independent Board. Further detail on the risk management framework of the Group and of each sub-group is set out on page 35.

NEW DIRECTORS OF THE RING-FENCED BANKS

During the first quarter of the year the Nomination and Governance Committee oversaw the selection process and recommendation for appointment of three new Non-Executive Directors to the Boards of Lloyds Bank plc and Bank of Scotland plc. As described in the Chairman’s introduction on page 132, Sarah Bentley, Brendan Gilligan and Nigel Hinshelwood were recruited during the year, and took office with effect from 1 January 2019. All the Ring-Fenced Bank only Directors sit on the Board Risk Committees of each of the Ring-Fenced Banks and two are members of the relevant Audit and Remuneration Committees. Nigel Hinshelwood, who is the Senior Independent Director of each of the Ring-Fenced Banks with effect from 1 January 2019, is also a member of the Nomination Committee of each of the Ring-Fenced Banks.

135

CORPORATE GOVERNANCE

Q&A WITH ALAN DICKINSON, CHAIR OF THE BOARD RISK COMMITTEE

Q: What is the Group’s risk appetite and risk tolerance?

A: Taking risk is a critical part of what any bank must do. How well it does that determines how well it meets the needs of its customers and how successful it will be as an organisation.

The Board Risk Committee has three key responsibilities.

The first is to review the environment in which the Group is operating – factors such as the economic and geopolitical climate for example – and recommend for Board approval how much risk the Group should take – the ‘Risk Appetite’. This will usually be a maximum level of risk in any one area – such as how large a proportion of new mortgage loans should be represented by high loan to value loans, typically to first time buyers.

The second is to ensure that the ways in which the risk that is taken are effective and efficient, for example setting out policies and procedures to be followed and checks and balances to make sure that the right actions happen. This is the Risk Management Framework which is reviewed regularly by the Board Risk Committee to give comfort that it is still guiding the Group to do those things right.

The third responsibility is to continually assess the ways in which Group colleagues have risk in mind when doing their jobs – what I would call the ‘Risk Culture’. The role of the Board and its Risk Committee is to set the ‘tone from the top’ – to set an example as to what risks to take and how to manage those risks.

Q: How do we remain focused on resolving legacy conduct, litigation and regulatory matters?

A: The Committee pays a great deal of attention to these issues. Whilst PPI mis-selling is by far the most costly and well known issue, there remain many smaller issues which have been identified over the years since the financial crisis. The Group has established very considerable resources to address these potential redress requirements and has made material progress over the last 12 months in resolving these matters. In very many cases our customers may have been unaware of their potential claim. The Board Risk Committee has placed great emphasis on clearing up these issues and achieving resolution as rapidly as possible and reviews progress at each and every meeting.

Q: What are the biggest risk factors to our industry and what steps are we taking to address them?

A: Even in the best of times, it is essential for banks to be aware of both inherent and emerging risks of which there are many. The inherent risks receive regular scrutiny, but emerging risks require special attention particularly with a banking group the size of Lloyds Banking Group.

The sheer scale of our balance sheet and the nature of banking in taking deposits and lending those deposits on to other customers means that we are mindful of the risks in the UK economy at any time and indeed in the global economy given that, as a trading nation, what goes on in the world will very rapidly impact the UK. The geopolitical situation and, closer to home, EU exit are very important risk factors to be considered when assessing the Group’s Risk Appetite.

As economic cycles mature, it is important to be mindful of the impact of the money supply upon asset prices and to gauge the impact of a sudden reversal of asset price growth on investor sentiment, markets and the real economy. We are always wary of asset price bubbles and the potential impact upon an ever more closely linked global economy of a sudden reversal.

Aside from the balance sheet impacts of such events, operational resilience has become ever more important as the processes and systems by which banks provide their services become ever more technologically reliant and dependent upon continued smooth running of services provided in-house and through expert third parties. The demand for change and more sophisticated services in itself brings operational risk as platforms are changed. Add on the increasing risk of cyber attacks and operational resilience is receiving a very considerable amount of attention from the Board Risk Committee.

Change also brings other risks. It is important to provide the ever more user friendly and sophisticated services that the banking customers of tomorrow increasingly require, and will obtain from other suppliers if we do not. Changing processes and systems that have been established over decades if not more and making the organisation agile and able to respond to demand, is a very material risk and will take up a great deal of the Board Risk Committee’s time for many years ahead.

Q: What keeps you awake at night?

A: Fortunately, I sleep pretty well. The comprehensive work programme undertaken by the Board Risk Committee means that most issues have been reviewed in detail and actions taken or accelerated where appropriate.

The greater concerns lie where it is simply impossible to be in control of events be they geopolitical or, say, operational such as cyber-security. It is much easier to predict with accuracy potential losses from lending on mortgage or credit card than the reputational and financial losses that might arise from a successful cyber-attack.

Ensuring that the Group is as prepared as it possibly can be with the strongest defences and tools at its disposal is the only prudent course to take and is one we have pursued vigorously in recent years to protect the Group and all of its customers from whatever might happen in the future.


Beyond Board meetings

Non-Executive Directors regularly meet with senior management and spend time increasing their understanding of the business through site visits, formal briefing sessions or more informal events including breakfast meetings with senior staff. These informal meetings allow Directors greater time to discuss business in an informal setting, ensuring that there is sufficient time for the Board to discuss matters of a material nature at Board meetings.

Non-Executive Directors see attendance at Board and Committee meetings as only one part of their role. In addition to the annual schedule of Board and Committee meetings, the Non-Executive Directors undertake a full programme of activities and engagements each year.

Where further training or awareness is identified, such as new technology, regulations or sector advances, deep dives are held with the relevant field expert to provide overviews, chances to raise questions, and debate the impacts on business in an informal setting. Details of the new mandatory training that has been rolled out to the Non-Executive Directors this year can be seen on page 140.

The Board held joint discussions with Scottish Widows Group Limited in April, and Lloyds Bank Corporate Markets plc in September. These meetings are important in respect of both governance and the sharing of best practice. They also provide the opportunity for in-depth focus on both insurance and corporate markets matters. Performance and business updates are also provided, and, in the case of Lloyds Bank Corporate Markets plc, updates on key milestones in respect of the development of this new bank.


136

CORPORATE GOVERNANCE

How our Board works

MEETINGS, ACTIVITIES AND PROCESSES

The right processes in place to deliver on our strategy

During the year, there were eight scheduled Board meetings, with details of attendance shown on page 133. In addition to formal meetings, the Board meets as necessary to consider matters of a time-sensitive nature. The Chairman and the Chairmen of each Committee ensure Board and Committee meetings are structured to facilitate open discussion, debate and challenge.

The Board is supported by its Committees which make recommendations on matters delegated to them under the Corporate Governance Framework, in particular in relation to Board appointments internal control risk, financial reporting, governance and remuneration matters. This enablesissues.

The management of all Committees is in keeping with the Board to spend a greater proportion of its timebasis on strategic, forward looking agenda items. Each Committee comprises Non-Executive Directors only and is chaired by an experienced Chairman. The Committee Chairmen report to the Board on the activities of the Committee at each Board meeting. A structure chartwhich meetings of the Board Committees can be found on page 158.

A full schedule of all matters reserved to the Board and Terms of Reference for eachare managed. Each of the Board Committees can be found at www.lloydsbankinggroup.com/our-group/corporate-governance

Group Chief Executive

ResponsibilityCommittees’ structures facilitates open discussion and debate, with steps taken to ensure adequate time for day-to-day management of the business is delegated to the Group Chief Executive. The Group Chief Executive delegates aspects of his own authority, as permitted under the Corporate Governance Framework, to members of the Group Executive Committee (GEC). The GEC meets weeklyCommittees to scrutinise the Group’s business. The Group Audit Director, the Group HR Director (until October 2015) and the Company Secretary attend the weekly GEC meetings to ensure that there is appropriate internal audit oversight, that employee interests and people strategy mattersconsider proposals which are considered and that the highest standards of corporate governance are maintained, including the escalation of matters to the Board and its Committees. In January 2016, a new role of Chief People, Legal and Strategy Officer was created to lead the HR, Legal and Strategy functions. The Chief People, Legal and Strategy Officer is a member of the GEC and reports to the Group Chief Executive.put forward.

Company Secretary

All Directors, including Non-Executive Directors, have access to the services of the Company Secretary in relation to the discharge of their duties. Both the appointment and removal of the Company Secretary is a matter for the Board as a whole.

KEY ROLES AND RESPONSIBILITIES

Chairman – Lord Blackwell

– Leads the Board
–Promotes the highest standards of corporate governance
–Sets the Board’s agenda
–Builds an effective and complementary Board
–Leads Board succession planning
–Ensures effective communication with shareholders

Deputy Chairman – Anita Frew

– Ensures continuity of Chairmanship during any change of chairmanship
–Supports the Chairman in representing the Board and acting as a spokesperson
–Deputises for the Chairman
–Available to the Board for consultation and advice
–Represents the Group’s interests to official enquiries and review bodies

Senior Independent Director – Anthony Watson

– Sounding board for the Chairman and Group Chief Executive
–Acts as a conduit for the views of other Non-Executive Directors
–Conducts the Chairman’s annual performance appraisal
–Helps resolve shareholders’ concerns
–Attends meetings with major shareholders and financial analysts to understand issues and concerns

Non-Executive Directors

– Challenge constructively
–Help develop and set the Group’s strategy
–Actively participate in Board decision making
–Scrutinise management performance
–Satisfy themselves on the integrity of financial information
–Review the Group’s risk exposures and controls
–Determine the remuneration of Executive Directors

The Non-Executive Directors are listed on pages 125 to 127.

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Group Chief Executive – António Horta-Osório

– Manages the Group on a day-to-day basis
–Makes decisions on matters affecting the operation, performance and strategy of the Group’s business
–Provides leadership and direction to senior management
–Coordinates all activities to implement the strategy and for managing the business in accordance with the Group’s risk appetite and business plan set by the Board

Executive Directors

– Under the leadership of the Group Chief Executive, make and implement decisions in all matters affecting the operations, performance and strategy of the Group’s business
–Provide specialist knowledge and experience to the Board
–Responsible for the successful leadership and management of the Risk and Finance divisions
–Design, develop and implement strategic plans
–Deal with day-to-day operations of the Group

 

The Executive Directors make decisions within clearly defined parameters which are listed on page 127

Company Secretary – Malcolm Wood

– Advises the Board
–Ensures good information flows and comprehensive practical support are provided to Directors
–Maintains the Group’s corporate governance framework
–Organises Directors’ induction and training
–Communicates with shareholders as appropriate and ensures due regard is paid to their interests

documented within the Corporate Governance Framework. However, where appropriate, any activities outside the ordinary course of business are brought to the full Board and governance structure

Reports fromfor their consideration, even if the Nomination &matters fall within the agreed parameters. The Corporate Governance Committee,Framework helps to ensure that decisions are made by management with the Audit Committee,correct authority.

In the Board Risk Committee andrare event of a Director being unable to attend a meeting, the Responsible Business Committee can be found on pages 171 to 181. Information about the workChairmen of the Remuneration Committee is included inrespective meetings discuss the Directors’ remuneration report on pages 129 to 155. Please see pages 53 to 54 for a list ofmatters proposed with the Group Chief Executive CommitteesDirector concerned wherever possible, seeking their support and their purpose.

Subsidiary governance

feedback accordingly. The Boards ofChairman subsequently represents those views at the four main companies, Lloyds Banking Group plc, Lloyds Bank plc, HBOS plc and Bank of Scotland plc, comprise the same Directors, with Board meetings for these companies being held concurrently. The agenda is split between the companies, allowing decisions to be taken and scrutinised by the appropriate Board.meeting.

 

The Board recognises the need to be adaptable and flexible to respond to changing circumstances and emerging business priorities, whilst ensuring the continuing monitoring and oversight of the Group’s insurance subsidiary, Scottish Widows Group Limited, which also sits as the Board of its major subsidiaries, is chaired by a Non-Executive member of the Lloyds Banking Group Board and contains a balance of independent Non-Executive Directors, Group executives and Insurance Division executives. This composition supports its legal and regulatory requirements for independent decision making within the overall framework of Group policies and controls.core issues.

 

The Group continues to conduct the majority of its business through a number of subsidiary entities. A certification process, at individual entity level, of compliance with the minimum governance standards set out in the Corporate Governance Framework enhances management of any legal, regulatory and reputational risks associated with the Group’s subsidiary entities.

The process provides GEC members with additional oversight of subsidiary entities within their respective business area, including an escalation process for any matters of non-compliance. In addition, the process provides continued focus on simplification of the Group’s legal entity structure through consideration of the lifecycle of each entity.

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Changes in Board Committees

During 2015, the Nomination & Governance Committee continued to keep under review succession planning and the effectiveness of the Board and its Committees. To ensure the Group’s corporate governance is consistent with best practice, in addition to the annual Board Effectiveness Review, a Corporate Governance Review was carried out by the Company Secretary during the year. The following changes to Committees were made:

– The Group established a Responsible Business Committee (RBC) of the Board. The RBC is chaired by Sara Weller CBE and includes as members Lord Blackwell, Chairman, and Anita Frew, Deputy Chairman. The RBC oversees the measurement and communication of the Group’s customer-centric culture and values, as well as the development of the Helping Britain Prosper Plan. The creation of a board-level RBC underlines the Group’s commitment to being a responsible business. A report on the activities of the RBC can be found on page 181;
–Anita Frew, Deputy Chairman, succeeded Anthony Watson, Senior Independent Director, as Chairman of the Remuneration Committee, effective 1 October 2015. The change reflected best governance on the separation of the role of the Senior Independent Director and the Chairman of the Remuneration Committee. Mr Watson served as Chairman of the Remuneration Committee since May 2010 and remains a member of the Remuneration Committee;
–Alan Dickinson, an independent Non-Executive Director and Chairman of the Board Risk Committee, was appointed as a member of the Remuneration and Nomination & Governance Committees, effective 17 July 2015;
–Carolyn Fairbairn, an independent Non-Executive Director, retired from the Board and as a member of the Audit and Remuneration Committees on 31 October 2015;
–Deborah McWhinney joined the Board as an independent Non-Executive Director on 1 December 2015 and was appointed as a member of the Audit and Risk Committees; and
–Stuart Sinclair joined the Board as an independent Non-Executive Director on 4 January 2016 and was appointed as a member of the Risk and Remuneration Committees.
Dyfrig John, an independent Non-Executive Director, has notified the Board that he does not intend to seek re-election at the 2016 AGM. Mr John is currently a member of the Risk and Remuneration Committees.

THE BOARD IN 2015

The Directors who served during the year and their attendance at Board meetings is set out in the table below. The attendance of Directors at Committee meetings is displayed within the individual Committee reports found on pages 171 to 181 and for the Remuneration Committee on page 140. Whilst all Non-Executive Directors are, where appropriate, invited to and regularly attend other Committee meetings, only their attendance at Committees of which they are members is recorded.

A number of other Board Committee meetings were held during the year, including meetings in relation to the disposal of the Group’s remaining interest in TSB Bank, the regulatory par call of Enhanced Capital Notes, stress testing results and PPI complaint handling.

 Board meetings1
 Eligible to 
 attendAttended
Directors who served during 2015  
António Horta-Osório1010
Lord Blackwell1010
Juan Colombás1010
George Culmer1010
Alan Dickinson1010
Anita Frew1010
Simon Henry1092
Dyfrig John1010
Nick Luff1010
Deborah McWhinney311
Nick Prettejohn1010
Anthony Watson1010
Sara Weller1010
Former directors who served during 2015  
Carolyn Fairbairn488
1The number of Board meetings includes two ad hoc meetings, one held in October in relation to the Group’s preparation for the SM&CR and one in December to provide updates on the Court of Appeal decision on the regulatory par call of Enhanced Capital Notes and the 2015 PRA stress test result.
2Mr Henry was unable to join the July Board meeting due to the third quarter 2015 results announcement for Royal Dutch Shell plc, of which he is Chief Financial Officer, being presented on the same day.
3Joined the Board on 1 December 2015.
4Retired on 31 October 2015.

Board tenure (as at 31 December 2015)

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SETTING THE BOARD AGENDA AND BOARD PAPER CONTENT

There is a comprehensive and continuous agenda setting and escalation process in place for ensuringto ensure that the Board has the right information at the right time and in the right format to enable the Directors to make the right decisions. The Chairman setsleads the Board agenda,process, assisted by the Group Chief Executive and Company Secretary. A yearly planner is prepared by the Company Secretary to map out the flow of key items of business to the Board and to ensureThe process ensures that sufficient time is being set aside for strategic discussions and material issues.business critical items.

 

The process of escalating issues and agenda setting was a key focusis reviewed at least annually as part of the 2014 Board Effectiveness Review and the Company Secretary’s end-to-end Corporate Governance Review. Accordingly a number ofwith enhancements were made to the process, during the year. A key recommendation was the introduction of quarterly reviews of topics for Board presentations and ‘deep dives’ as described on pages 165where necessary, to 167.

Draft Board papers are reviewed at the appropriate Group Chief Executive Committee meeting held prior to the Board meeting, along with the draft Board agenda, and there is time allocated at each GEC meeting to consider whether any matters require escalation to the Board. The Group Chief Executive also held separate Board paper review meetings to review individual papers in more detail or those not considered at one of the meetings referred to above. These meetings were held with the Chief Financial Officer, the Chief Risk Officer, the Company Secretary and authors of the main papers, as required.

Prior to each Board meeting the Chairman, Company Secretary and the Chief of Staff, who assists the Group Chief Executive and runs his executive office, review the agenda, the arrangements for the Board meeting and the time allocation for individual agenda items. A similar comprehensive process is in place for each of the Board Committees.

HOW BOARD MEETINGS ARE RUN

The Chairman ensures Board meetings are structured to facilitate open discussion, debate and challenge. Through his opening remarks, the Chairman sets the focus of each meeting.

In the rare event of a Director being unable to attend a meeting, the Chairman discusses the matters proposed with the Director concerned, seeking their support and or feedback accordingly. The Chairman subsequently represents those views at the meeting.

Directors are sent papers for the Board meeting up to seven days in advanceensure it remains effective. Details of the meeting in order that they may haveprocess are provided on the time to consider the proposals put forward and seek clarification or further information as required. The Board makes full use of technology such as video conferencing, teleconferencing, a Board portal and tablets in its meeting arrangements. This leads to greater flexibility, security and efficiency in Board paper distribution.

EFFECTIVE USE OF THE BOARD’S TIME

To ensure that there is sufficient time for the Board to discuss matters of a material nature, Board dinners and/or breakfast meetings are held prior to each scheduled Board meeting. This allows the Directors greater time to discuss their views ahead of the meeting. Some of these pre meetings are for Non-Executive Directors only, some also include the Group Chief Executive and others the full Board. At least once a year, a meeting is held without the Chairman in attendance. Additionally, ‘deep dive’ sessions into specific topics are delivered either at the end of Board meetings or at additional sessions held between Board meetings.

ACCESS TO ADVICE

The Group provides access, at its expense, to the services of independent professional advisers in order to assist Directors in their role. Board Committees are also provided with sufficient resources to undertake their duties.

The return to dividends

The Board met on several occasions during 2015 to consider the appropriate level of dividend payment and to set the dividend policy. The Group’s dividend policy aims to provide a progressive and sustainable dividend whilst distributing surplus capital where appropriate to do so. In reaching the decision to pay a dividend, the Board has to take into account a number of legal, financial and capital considerations. Further information on capital management and the Group’s dividend policy can be found on pages 112 and 113.

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BOARD FOCUS IN 2015

 

BOARD MEETINGS AND ACTIVITY IN 2015

 

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THE BOARD IN ACTION

The Non-Executive Directors see attendance at Board and Committee meetings as only one part of their role. The Non-Executive Directors regularly meet with senior management and spend time increasing their understanding of the business through formal briefing sessions or more informal events such as breakfast briefings, dinners and site visits.next page.

 

The Non-Executive Directors also receive regular updates from the Group Chief Executive’s office including a weekly email which gives context to current issues. In-depth and background materials are regularly provided via a reading roomdesignated area on the secure electronic Board portal.

 

A full schedule of matters reserved for the Board and Terms of Reference for each of the principal Committees can be found at www.lloydsbankinggroup.com


Q&A WITH ANITA FREW, DEPUTY CHAIRMAN AND SENIOR INDEPENDENT DIRECTOR

Q: What is your role as Senior Independent Director?

A: I have a number of different stakeholders to whom I am accountable, being shareholders, the Chairman, the other Directors and the Group as a whole. I make myself available to shareholders when there are concerns that have not or cannot be dealt with through the usual channels of the Chairman or Executive Directors. I also attend regular meetings with major shareholders to ensure that there is a balanced understanding of the issues and concerns that this group of shareholders have. I act as a sounding board for the Chairman and Group Chief Executive on Board and shareholder matters, and have regular meetings with both. In additionmatters relating to the Chairman such as his performance and conduct evaluation, agreeing his objectives and succession planning, I will Chair the Nomination and Governance Committee in his place to ensure independence. I will also conduct his annual scheduleappraisal, and deal with any concerns regarding the Chairman that other members of Board and Committee meetings, the Board held eight ‘deep dives’, a two-day strategy offsite meeting and a strategy meeting at the Group’s Bristol site reviewing the operating plan. Further details are given below.have.

 

TheRegarding the Board meets annually prioras a whole, I act as a trusted intermediary for the other Non-Executive Directors where this is required to help them to challenge and contribute effectively; and take the AGMinitiative in Scotland followed by a joint discussion with the Chairman or other Board of Scottish Widowsmembers if it should seem that the Board is not functioning effectively.

For the Group, Limited allowing in-depth focus on insurance matters.as the Ring-Fenced Bank structure is now in place, I also liaise and collaborate with the Ring-Fenced Bank Senior Independent Director where appropriate.

 

NON-EXECUTIVE DIRECTORS’ OFFICEQ: Where does the Senior Independent Director add value?

 

A:The Non-Executive Directors frequently visitrole of the Group’s offices on Group businessSenior Independent Director has grown enormously in the past few years, and to meetI believe stakeholders really value this alternative contact within the Board, providing a highly versatile intermediary with senior management outside ofthe Board and Committee meetings. To support the Non-Executive Directors in fulfilling their role, the Group provides an office, with administrative support, andsenior management. This is supported by me having a meeting room for the Non-Executive Directors’ use.

CHAIRMAN’S OFFICE

The Chairman maintains an office with support to help manage his programme of activities, obtain briefings and deal with external contacts.

CHAIRMAN’S ACTIVITIES

The Chairman undertakes an extensive engagement programme each year representing the Group at industry events, acting as a spokesperson for the Group and meeting with clients, regulators, investors, the media, the Foundations and their beneficiaries. The programme includes visits to regional offices, branches, IT and operations centres, where the Chairman meets local management and colleagues through meetings, floor walks, team talks and Town Hall sessions. The Town Hall sessions are an opportunity for colleagues to hear from the Chairman on the Group’s performance and strategic direction, and importantly, to ask questions. These events are very popular and are always well attended.

DEEP DIVES

During the year the Board held eight ‘deep dives’ which provided the opportunity for presentations from senior management and an in-depth review of key areas of focus including:

–Customer experience
–Group Digital (two updates)
–IT transformation update and outlook
–Group Operations, including IT strategy
–Retail performance and products
–Commercial Banking
–The changing UK payments landscape

STRATEGY OFFSITE

During the year the Board spent two days offsite focusing on:

–Culture and colleague engagement
–Group strategy implementation
–Retail strategy

The agenda was structured to allow plenty of opportunity for discussion and concluded with a group discussion on strategy, culture and rebuilding trust.

SITE VISIT TO BRISTOL

In November 2015, the Board held an offsite meeting in Bristol, attended by GEC members, at which it reviewed the Group operating plan in detail. The November Committee meetings also took place at the Group’s Bristol offices. During the visit, Board and GEC members took the opportunity to meet colleagues based in Bristol and the South West over dinner and at an informal breakfast hosted by the Chairman and Non-Executive Directors. Some Board members also visited the Bristol City Centre branch to meet the local director and branch based colleagues.

CHAIRMAN’S TOWN HALL SESSIONS

In October 2015, as part of his engagement programme, the Chairman visited two of the Group’s IT sites near Manchester, where he was joined by 275 colleagues.

The Chairman spoke to colleagues on the progress the Group is makingclose relationship with the next stage of its strategystakeholders to become the best bank for customers, how it had strengthened its balance sheet, and the importance of continuing to restorereinforce the trust and confidence needed to perform the role effectively. The majority of customersmy role is undertaken during normal business circumstances, but recognising that I will need to step in when any issues arise. The relationships fostered during times of normal business provide a strong basis to deal with any such issues effectively and other key stakeholders. The visit included a question and answer session, where colleagues asked questions on such topics as howindependently.

Q: As Whistleblowing Champion for the Group, what are the reporting lines to you, and how do matters get escalated to the Board?

A: My role as the Group’s whistleblowing Champion is remediating risk,to oversee the impactintegrity, independence and effectiveness of new challenger banksthe Group’s procedures for whistleblowing. There is a dedicated team within the Group that is responsible for managing whistleblowing concerns and emerging new technologiesas such I delegate much of the day-to-day activity to these trusted colleagues. I retain oversight over the team through regular catch up meetings and have a direct reporting line for matters that require escalation to me. On an annual basis, I am

responsible for presenting to the Board on the landscape.effectiveness of the Group’s arrangements and this includes relevant case updates, industry perspective and whether the internal processes are effective to handle disclosures properly.

Q: Are you satisfied the Company has a robust process in place in respect of whistleblowing?

A: The Group’s whistleblowing arrangements are subject to annual review by Group Internal Audit. This provides an opportunity for an independent party to review the whistleblowing processes and test whether they are effective. The results to date from these reviews have been positive compared to our peers. The Audit Committee and Board also receive regular reports regarding whistleblowing.

In addition, the Group has recently participated in a benchmarking exercise led by Protect. Protect (formerly known as Public Concern at Work) provide external confidential advice. Colleagues can contact the independent UK Whistleblowing charity, Protect who can talk you through your options and help you raise a concern about risk, malpractice or suspected wrongdoing at work. This exercise reviewed the governance, engagement and operational arrangements and compared these to other financial and non-financial companies. The Group scored positively with the results showing a favourable position.


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BOARD MEETINGS 

Start of the year

A yearly planner is prepared by the Company Secretary to map out the flow of key items of business to the Board.

Board venues are agreed and colleagues in the areas that the Board will visit are engaged at both senior management and operational level.

Agenda set

The Chairman holds monthly meetings to review the draft agenda and planner with the Company Secretary and Chief of Staff, as well as quarterly meetings with a wider group of central functions, to identify emerging issues.

The draft Board agenda is discussed between the Chairman and the Group Chief Executive and reviewed at GEC meetings.

Matters may be added to agendas in response to external events, Non-Executive Director requests, regulatory initiatives and the quarterly Board topic review meetings.

Papers compiled and distributed

Templates and guidelines are included within targeted training for authors of papers to ensure consistency and high quality of information.

Meeting packs are uploaded and communicated to all Directors via a secure electronic Board portal typically a week in advance of the meeting to ensure sufficient time to review the matters which are to be discussed and seek clarification or any additional information.

Before the meeting

Executive meetings are held ahead of all Board and Committee meetings to ensure all matters being presented to the Board have been through a thorough discussion and escalation process.

Committee meetings are held prior to Board meetings, with the Chairman of each Committee then reporting matters discussed to the Board.

Non-Executive discussions and informal dinners are held prior to most Board meetings, some of which also include the Group Chief Executive.

Board meeting

Board meetings have certain standing items, such as a report from the Group Chief Executive and Chief Financial Officer on Group performance, reports from the Chairmen of Committees and principal subsidiaries and updates from GEC members.

Topics for deep dives or additional items are discussed when required and include business, governance and regulatory updates.

The Board makes full use of technology such as video conferencing, teleconferencing, a Board portal and tablets/devices in its meeting arrangements. This leads to greater flexibility, security and efficiency in Board paper distribution and meeting arrangements.

After the meeting

The Board meetings offer the Board the chance to meet colleagues within the business, and if any additional meetings are required to provide more details, these are arranged.

Minutes and matters arising from the meeting are produced and circulated to the Directors for review and feedback.

Those responsible for matters arising are asked to provide updates to a subsequent meeting.

LORD BLACKWELL’S VISIT TO CARDIFF

As one of his regular site visits, Lord Blackwell was in Cardiff in September meeting colleagues from St. William House, local branches and Lloyds Bank Foundation charity, Women Connect First.

The Chairman met with a number of teams, including the Group Customer Services Customer Solutions Centre, which is designing and developing a new customer management system which utilises artificial intelligence, and colleagues from Black Horse, including the Complaints team. Lord Blackwell sat with colleagues and went through some live cases with them, discussing the challenges they face in ensuring fair and reasonable outcomes.

This was followed by a networking lunch with the Commercial Banking SME and the Mid Markets Team, who deliver local face-to-face relationships across five geographical areas of Wales.

Lord Blackwell’s visit continued with a Town Hall session, with over 200 colleagues, followed by a visit to two local branches where he discussed the evolution of technology with mortgage advisors, and how their role has changed. Lord Blackwell then met with Women Connect First, which aims to empower black and minority ethnic women in Cardiff, helping them realise their full potential and make an impact on Welsh society.

To end his visit in Cardiff, Lord Blackwell hosted a colleague recognition dinner. The evening recognised the achievements of colleagues who demonstrate the Group values of making a difference together, keeping things simple and putting customers first.


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BOARD OVERSIGHT: IT RESILIENCE AND DIGITAL TRANSFORMATIONHow our Board works

 

The Board remains focused on how the Group delivers solutions that continue to put the customer at the heart of everything it does. The Group’s multi-channel service reflects customers’ changing preferences in how they choose to do business with the Group, providing seamless access through a secure and resilient digital infrastructure.

The Board spends considerable time reviewing the delivery of the three-year IT resilience investment and digital transformation programmes. IT resilience and cyber security are regularly monitored through the risk dashboard in the reports from the Group Chief Executive and Group Risk Officer and through the work of the Board Risk Committee of which all Non-Executive Directors are members. Additionally, the Board received a detailed progress update at its strategy offsite meeting in November and presentations from senior management on the delivery of the programmes at ‘deep dive’ sessions held during the year.

Also, the Board’s approach to succession planning, led by the Chairman, helps ensure the Board is well placed to address future technology and market risks across the full range of business areas in which the Group operates. Read more on succession planning and Board appointments on page 172.

Information on the progress being made on the delivery of digital capability can be found in the Business overview and on IT resilience and cyber security in the report from the Board Risk Committee.

ASSESSING OUR EFFECTIVENESS

 

BOARD SIZE AND COMPOSITIONBoard evaluation

 

The Board should be of sufficient size to reflect a broad range of views and perspectives whilst allowing all Directors to participate effectively in meetings. The Board currently comprises three Executive Directors, ten independent Non-Executive Directors and the Chairman who was independent on appointment. The size of the Board is within the optimal range set by the Nomination & Governance Committee. Further details on the composition of the Board and independence of the Non-Executive Directors are provided in the Nomination & Governance Committee report.

HOW THE BOARD CHANGESPERFORMS AND IS EVALUATED

 

In June 2015, Carolyn Fairbairn, an independent Non-Executive Director, informed the Board of her intention to retire from the Board on 31 October 2015 to take up the position of Director-General of the Confederation of British Industry in November 2015. Ms Fairbairn had been a member of the Board since June 2012. Dyfrig John, an independent Non-Executive Director, has notified the Board that he wishes to reduce his workload and therefore does not intend to seek re-election at the 2016 AGM. Mr John has been a member of the Board since January 2014.

Deborah McWhinney and Stuart Sinclair joined the Board as independent Non-Executive Directors on 1 December 2015 and 4 January 2016 respectively. The Board is not looking actively to appoint any further Non-Executive Directors at this stage.

More about the appointment of new Directors and the Group’s approach to succession planning can be found in the Nomination & Governance Committee report. Changes to Board Committee memberships are set out on page 159.

Directors’ biographies can be found at www.lloydsbankinggroup.com/our-group/directors

DIVERSITY POLICY

The Board places great emphasis on ensuring that its membership reflects diversity in the broadest sense. The combination of personalities and experience on the Board provides a comprehensive range of perspectives and challenge and improves the quality of decision making.

The Board has adopted, and was close to achieving, the recommendations of Lord Davies of 25 per cent female representation by 2015. As at 31 December 2015, female representation on the Board remained at 23 per cent (based on three female directors and ten male directors). During the period between the appointment of Stuart Sinclair on 4 January 2016 and Dyfrig John’s retirement at the 2016 AGM, female representation on the Board will drop to 21.4 per cent, when there will be eleven male directorsaccordance with the number of women onthree-year cycle, the Board remaining at three.

DEVELOPING DIVERSITY

The Board recognises that senior management is a group from which future directors may be selected. To promote diversity the Group has a variety of colleague networks which include: Breakthrough, a women’s network; the Group Ethnic Minority network; the Access network which aims to provide support for colleagues with disabilities;2018 effectiveness review was facilitated externally by Egon Zehnder1, an external board evaluation specialist, between August 2018 and Rainbow, an inclusive Groupwide network for lesbian, gay, bisexual and transgender colleagues.

More information on the Group’s diversity programmes, including details of the Group’s commitment to raise the percentage of women employed in senior management roles to 40 per cent by 2020, is provided in the Responsible Business section of our website at www.lloydsbankinggroup.com/ our-group/responsible-business

BOARD INDUCTION

The Group appreciates the importance of a well-focused induction plan to help a new Director get up to speed as quickly as possible and enable them to contribute fully to Board deliberations.

The Chairman personally ensures that on appointment each Director receives a full, formal and tailored induction. The emphasis is on ensuring the induction brings the business and its issues alive for the new Director, taking account of the specific role they have been appointed to fulfil and their skills/experience of the Director to date.

The plan is informed by the recruitment and resourcing process, with input from other key internal stakeholders and from the Directors themselves. At its core is a comprehensive programme of one-to-one briefings with key senior executives across the Group. Committee Chairmen receive additional dedicated training from relevant business executives to support them in their role and the Chairman of Scottish Widows Group Limited receives further briefings on the insurance business.

Non-Executive Directors are encouraged to identify any further information needs and to request any additional meetings or visits to help familiarise themselves with the business. In practice, some of the areas covered by the induction plan are likely to have been covered as part of the Director’s own research prior to taking on the role. However, the plan aims to provide a more in-depth review of the issues and, facilitated by the Company Secretary, is

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delivered as soon as possible after the date of appointment. Directors who take on or change roles during the year attend induction meetings in respect of those new roles.

INDUCTION PLAN – DEBORAH MCWHINNEY AND STUART SINCLAIR

Core programme

–Strategic and corporate induction
–Governance and Director responsibilities
–Responsibilities of an FCA approved person
–Senior Managers and Certification Regime
–Detailed risk induction programme
–Detailed briefings on each of the Group’s business divisions
–Opportunity to meet with major shareholders as requested

One-to-one briefings

–Chairman
–Company Secretary
–Executive Directors
–GEC members
–Group Audit Director
–Senior executives from across the Group

Bespoke programme

The Chairman personally ensures a new Director receives a tailored induction. In the case of Ms McWhinney, she requested that the risk induction include an overview of the UK regulatory landscape, reflective of her career having been spent in the United States to date.

Branch and site visits form part of the induction and in the case of Mr Sinclair, he requested a visit to the Group’s insurance business, Scottish Widows.

Both Ms McWhinney and Mr Sinclair also received specific briefings on the Committees on which they will serve.

Briefing and reading materials

Briefing and reading materials are made available on the Board portal.

PROFESSIONAL DEVELOPMENT AND TRAINING

Continuing professional development is an important aspect of every professional’s working life, including Directors. Skills and knowledge need to be kept up-to-date to ensure the efficiency of the Board as a whole and the ability of every single Director to contribute to the highest standards.

The Chairman leads the learning and development of Directors and the Board generally and regularly reviews and agrees with each Director their training and development needs.

The Company provides ample opportunities, support and resources for learning. A comprehensive programme, under the leadership of the Chairman, is in place throughout the year and comprises both formal and informal training and information sessions. ‘Deep dive’ sessions into specific topics play an important role and are delivered either at the end of Board meetings or at additional sessions held between Board meetings. The ‘deep dive’ sessions delivered in 2015 are described on page 162.

Site visits and conversations at Board dinners are also recognised as effective ways of learning, since they give Directors an opportunity to consider business areas and experiences outside their direct areas of expertise. Site visits in particular provide ‘shop floor’ experiences and reconnect Directors and senior management alike with the business and with customer service as it is performed throughout the branches. This provides insights into what customers want and need from the Group.

The Board also receives regular refresher training and information sessions throughout the year to address current business or emerging issues such as the SM&CR, ring-fencing and resolution and stress testing.

Management meetings and one-to-one meetings with key executives from across the Group’s operations complete the picture. The Company Secretary maintains a training and development log for each Director.

Development and training programme at a glance

During the year a comprehensive programme, under the leadership of the Chairman, was in place comprising both formal and informal training and information sessions. These included:

–Deep dive’ sessions detailed on page 162
–Site visits, Board dinners and breakfast meetings
–Training and information sessions on the SM&CR, ring-fencing and resolution and stress testing
–Management meetings and one-to-one meetings with key executives from across the Group’s operations
–Briefing material on the Board portal
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BOARD EFFECTIVENESS

The Chairman of the Board leads the rolling review of the Board’s effectiveness and that of its Committees and individual Directors with the support of the Nomination & Governance Committee, which he also chairs.January 2019. The annual evaluation,effectiveness review, which is facilitated externally at least once every three years, provides an opportunity to consider ways of identifying greater efficiencies, maximising strengths and highlighting areas forof further development.

CORPORATE GOVERNANCE REVIEW

In late 2014 the Chairman commissioned the newly appointed Company Secretary to undertake an end-to-end review of the Group’s governance arrangements from a fresh perspective. The Company Secretary’s review was informed by, amongst other matters, the 2014 annual review of Board Effectiveness as well as the work which is being carried out in the Group in preparation for the SM&CR. The Company Secretary completed his review in 2015 and his findings and the Board’s response are set out on page 168.

2014 EVALUATION OF THE BOARD’S PERFORMANCE

The 2014 evaluation was conducted internally between December 2014 and January 2015 by the Company Secretary, and was overseen by the Nomination & Governance Committee. Following the review, a number of changes were introduced and actions implemented which led to improvements in a number of areas including the timeliness and content of papers and the process for escalation of issues to the Board and its Committees. These enhancements have been reflected in improved scores from the 2015 evaluation. A summary of the Board’s progress against the actions arising from the 2014 effectiveness review are set out on page 166.

2015 EVALUATION OF THE BOARD’S PERFORMANCE

In accordance with the three year cycle, the 2015 evaluation was facilitated externally by JCA Group between October 2015 and January 2016. The review was commissioned by the Chairman,Board, assisted by the Company Secretary and overseen by the Nomination &and Governance Committee. JCA Group hasDetails of this effectiveness review are provided certain Board and senior management level recruitment services to the Group from time to time but not in relation to the searches for the Group Board Non-Executive Directors during 2015. Otherwise, JCA Group has no other connection with the Group.below.

 

The 2015Board conducted internal effectiveness reviews in 2016 and 2017. These were led by the Chairman of the Board, and included a review considered broadlyof effectiveness of the same areas asBoard, its Committees and individual Directors with the 2014support of the Nomination and Governance Committee. Performance evaluation of the Chairman is carried out by the Non-Executive Directors, led by the Senior Independent Director, taking into account the views of the Executive Directors.

2018 EVALUATION OF THE BOARD’S PERFORMANCE

The 2018 effectiveness review for comparabilitysought the Directors’ views on a range of topics including: strategy; planning and performance; risk and control; planning and performance; Board composition and size; culture and dynamics; balance of skills and experience; diversity; relationships between managementculture and independent directors; governance;dynamics; the Board’s calendar and agenda; the quality and timeliness of information; and support for Directors and Committees.

 

2015 REVIEW PROCESS

–Meeting between JCA Group and the Senior Independent Director
–Questionnaire completed by each Director broadly in the same format as for the 2014 review for comparability
–Individual meetings between each Director and a representative from JCA Group
–Presentation by JCA Group of the highlights to the Nomination & Governance Committee in November 2015
–Presentation by JCA Group to the Board in January 2016

At the time of the 2016 AGM, Anthony Watson will have beenThe effectiveness review findings focus on the Board for more than seven years. Therefore, in compliance with the Code, his review was particularly rigorous.

Anthony Watson, the Senior Independent Director, carried out theboth evaluation of the Chairman’s performance using a questionnaire and individual meetings with Directors other than the Chairman.

Deborah McWhinney and Stuart Sinclair, who joined the Board in December 2015 and January 2016 respectively, did not participate in the review but attended the presentation by JCA Group to the Board in January 2016.

OUTCOME OF 2015 BOARD EFFECTIVENESS REVIEW

The outcome of the effectiveness review has been discussed by the Board and each of the Committees. The outcome of the evaluation of the Chairman’s performance was discussed by the Directors in the absence of the Chairman.

The reviews concluded that the performance of the Board its Committees, the Chairmanas a whole, and each of the Directors continues to be effective. All Directors demonstrated commitment to their roles. Overall, theindividual Directors.

This is a well functioning Board was considered collegiate, inclusiveunderpinned by a shared purpose, strong team dynamics and hard-working, with shared values of integrity and respect. The Chairman was widely respected and had strong working relationships with the Chief Executive Officer, Executive Directors and Non-Executive Directors and had performed his role to a high standard. The Board had high regard for the Chief Executive Officer and the transformation of the business he had led. The increasing depth of debate at meetings was welcomed but the review identified a number of actions that will continue to maintain and improve the Board’s effectiveness and ensure the effort and time given by the Board translates into creating real impact for the business, shareholders and customers. The review recommendations are summarised on page 167.robust processes.2

 

If Directors have concerns about the Company or a proposed action which cannot be resolved, it is recorded in the Board minutes. Also on resignation, Non-Executive Directors are encouraged to provide a written statement of any concerns to the Chairman, for circulation to the Board. No such concerns were raised in 20152018 and up to the date of the approval of the annualthis report.

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2014 BOARD EFFECTIVENESS REVIEW (INTERNAL)

 

RecommendationsActions taken/progress
The timeliness and content of Board and Committee papers–New Board template and guidelines rolled out
   
 –EXTERNAL EVALUATION PROCESS
Stage 1 – August 2018
Initial meetings with the Chairman took place to build on the existing questionnaire and establish a discussion guide. Analysis of the existing skills matrix was undertaken. This enabled Egon Zehnder to understand the Board’s purpose and scope out the effectiveness review.
Stage 2 – September to November 2018
Questionnaires were sent to the Directors ahead of the one-to-one interviews with each Director. Egon Zehnder also attended the November Board meeting. This enabled Egon Zehnder to witness and evaluate the Board’s processes and behaviours.
Stage 3 – January 2019
Findings were reviewed with the Company Secretary. The summary findings were then shared and discussed with the Chairman and feedback on each of the Committees was shared with the relevant principal Committees. The final summary was presented to the Board in January at a meeting facilitated by Egon Zehnder. Feedback on individual Directors is shared with the Chairman.


HIGHLIGHTS FROM THE 2018 REVIEW

The evaluation concluded that the performance of the Board, its Committees, the Chairman and each of the Directors continues to be effective. All Directors demonstrated commitment to their roles.

The key findings and areas for consideration include the following:

FindingsAreas for consideration
 

 Purpose of creating the conditions for sound governance and renewed stakeholder confidence has been well executed through tight controls and disciplined risk management;

 The strategy is clear and the Directors are aligned on strategic priorities.

 Despite strong engagement in strategy the Board agenda is perceived to be still overly rooted in regulatory compliance and risk mitigation. Looking ahead, there is an opportunity for the Board to become more outwardly-focused.

 Controls and governance are very strong;

 Committees are broadly well chaired;

 The 2018 strategy review process was hailed as a great success in allowing for wide-ranging and free-flowing debate.

 Further targetedstreamlining of meeting papers and agendas to enable more expansive discussion;

 The increase in the number of Directors attending aligned Board meetings may require different disciplines in the conduct of meetings;

 Large attendance of Committee meetings could inhibit debate.

 The Chairman:

– has focused on building an independently-minded, diverse Board, and has laid the foundations for an open Board culture;

– invests considerable one-on-one time with Non-Executive Directors, which provides a platform for timely, two-way feedback, and helps the new Non-Executive Directors build confidence and a sense of belonging.

 Board Directors are committed and suitably inquisitive. They come well-prepared to meetings and show a healthy balance of supporting management and asking pertinent questions.

 Consideration as to whether there is scope for bringing further technology know-how to the Board in due course;

 Non-Executive Directors would like to offer greater support to the Chairman by leveraging their unique skills and experience more fully.

Purpose and StrategyProcessesPeople
1At the time of the 2018 review Egon Zehnder provided certain Board and senior management level services from time to time, including in respect of succession planning as detailed on page 144, otherwise Egon Zehnder has no other connection with the Group.
22018 Board Effectiveness Review.
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CORPORATE GOVERNANCE

PROGRESS AGAINST THE 2017 INTERNAL BOARD EFFECTIVENESS EVALUATION

During the year, work focused particularly on Board papers and presentations. A summary of the Board’s progress against the actions arising from the 2017 evaluation are set out below.

Recommendations from the 2017 evaluationActions taken during 2018

 Reduction in volume of Board papers.

 More concise reports, highlighting important points and avoiding unnecessary volume and repetition.

 Fewer and shorter presentations.

 A review of the schedule of Board and Committee meetings took place, and a number of meetings have been removed after being considered unnecessary.

 Instructions have been given to all those who produce Board papers to avoid repetition between presentations and briefing papers. Bespoke training has also been provided by the Company Secretary.

 In order to allow more time for authorsdiscussion, challenge and debate, certain items of the agenda at Board meetings had no presentations although the responsible executives were available at the meeting to ensurerespond to queries from the Board.

 Enhanced video conferencing facilities have been installed in various Group locations to improve the quality of remote participation in meetings when attendance in person is not possible.

 Increased feedback from stakeholders other than regulators and customers, including shareholders and bondholders.

 The Group’s brokers attended the Board meeting in April to provide investor feedback on the results and strategy announcements.

 The bi-annual presentation to the Board on reputation contained information on shareholder sentiment and was attended by the Group Director of Investor Relations.

 A governance lunch was held in November with key institutional shareholders. This was hosted by the Chairman and the Chairmen of the Board Committees, and feedback was reported to the Board.

 As part of the monthly report to the Board, the CFO now reports on the Bank of England’s ‘minimum requirements for own funds and eligible liabilities’ and will continue to highlight significant developments related to the Group’s debt funding.

 Terms of Reference to be reviewed and updated to avoid duplication of effort in areas covered by other Committees. The Terms of Reference were reviewed, and considered by the Nomination and Governance Committee in April, and approved by the Board in November.
 Major change management; finance; accounting and data experience to be considered for future recruitment of Directors.

 These areas of experience will continue to be considered.

 Amanda Mackenzie, appointed in October 2018 has a substantial amount of experience in respect of change management.

Board papers are delivered in a timely manner, present a balanced viewand presentations to the BoardStakeholder feedbackResponsible Business Committee Terms of all issues and are conciseReferenceNon- Executive Director Recruitment

   
 –Improved 2015 effectiveness review scores
The process for escalation of matters

PROFESSIONAL DEVELOPMENT AND TRAINING PROGRAMME AT A GLANCE

In addition to the existing methods of training for the Directors, the Board agreed in 2017 that the Non-Executive Directors should be provided with a mandatory training programme. This was trialled by members of the Nomination and its Committees

–Corporate Governance Framework amendedCommittee and has since been rolled out to impose clear responsibility on GEC members to escalate matters
–Time allocated at each GEC meeting to consider whether any matters require escalation
–Briefings to other senior executivesthe rest of the Directors.

Training modules were identified from a list of the topics used by Group colleagues, and following discussions between Group Secretariat, Risk and Group Learning, the following themes were identified as being the most relevant for Non-Executive Directors:

 Anti-Bribery

 Competition Law

 Information Security

 Whistleblowing

 Senior Manager and Certification Regime (‘SMCR’) has also been included as an additional theme for all Non-Executive Directors.

DELIVERY OF TRAINING

The training is delivered via an online training platform on the obligation to escalate matters

–Quarterly reviews of topics for Board presentationsGroup’s intranet. The Directors can access this at any time, and deep dives introduced involvingonce the Chairman,training is completed, it is recorded on the Company Secretary, the Chief Risk Officer and the Group Chief Executive or his Chief of Staff, who assists the Group Chief Executive and runs his executive office. The quarterly reviews are also attended by the Group Audit Director and the Group Director, Conduct, Compliance and Operational Risk
–Improved 2015 effectiveness review scores
The creation of a new Board Committeesystem to provide oversight ofa full audit trail. The Directors have completed the strategy and plansmodules for delivering the Group’s aspirations to be a leader in responsible business, as part of the Group’s objective of helping Britain prosper2018.

–Board-level Responsible Business Committee established
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CORPORATE GOVERNANCE

 

RECOMMENDATIONS FROM THE 2015 BOARD EFFECTIVENESS REVIEW (EXTERNAL)

Strategy

– Continue to focus on strategy, with particular attention to the longer term horizon and the impact of the changing technology and competitive landscape

Succession planning

– Maintain a proactive approach to succession planning for Executive and Non-Executive Directors and for senior management

How our Board information

– Continue the progress made in 2015 in ensuring that information provided to the Board and its Committees is clear, concise, relevant and focused
– Review and continue to evolve metrics used to assess business performance to ensure that they provide an appropriate level of detail and insight for the Board

SERVICE CONTRACTS AND LETTERS OF APPOINTMENT

The Executive Directors have service contracts which may be terminated on 12 months’ notice by the Company or six months’ notice by the Executive Director. The Chairman has a letter of appointment which may be terminated on six months’ notice by either the Company or the Chairman. The Non-Executive Directors all have letters of appointment and are appointed for an initial term of three years after which their appointment may continue subject to an annual review. Non-Executive Directors may have their appointment terminated, in accordance with statute and the articles of association, at any time with immediate effect and without compensation. All Directors are subject to annual re-election by shareholders.

The terms and conditions of appointment of the Chairman, Non-Executive Directors and Executive Director are available for inspection at the registered office address.

ELECTION AND RE-ELECTION

All Directors appointed to the Board since the AGM in 2015 will stand for election at the 2016 AGM. All other Directors will retire and those wishing to serve again will submit themselves for re-election at the AGM. Dyfrig John, an independent Non-Executive Director, has notified the Board that he does not intend to seek re-election at the 2016 AGM. Biographies of current Directors are set out on pages 125 to 127. Details of the Directors seeking election or re-election at the AGM are set out in the Notice of Meeting.

DIRECTORS’ AND OFFICERS’ LIABILITY INSURANCE

Throughout 2015 the Group had appropriate insurance cover in place to protect Directors, including the former Director who retired during the year, from liabilities that may arise against them personally in connection with the performance of their role. As well as insurance cover, the Group agrees to indemnify the Directors to the maximum extent permitted by law. No Director or former Director sought to recover costs or expenses under their indemnity in 2015.

TIME COMMITMENTS

Non-Executive Directors are required to devote such time as is necessary for the effective discharge of their duties. The estimated minimum time commitment set out in the terms of appointment is 35-40 days per annum including attendance at Committee meetings. For Committee Chairmen and the Senior Independent Director, this increases to a minimum of 45 to 50 days. The time devoted on the Group’s business by the Non-Executive Directors is in reality considerably more than the minimum requirements. As described elsewhere, the Non-Executive Directors see preparation for and attendance at Board and Committee meetings as only one part of their role. Outside of formal meetings, they meet regularly with senior management and attend briefing sessions and more informal events.

Non-Executive Directors may be expected to relinquish other appointments to ensure that they can meet the time commitments of their role. Fees paid to Non-Executive Directors reflect the time commitment and responsibilities of the role. Non-Executive Directors do not receive share options or other performance related pay. Executive Directors are restricted to taking no more than one non-executive director role in a FTSE 100 company nor the chairmanship of such a company. The Chairman is required to commit to this being his primary role, limiting his other commitments to ensure he can spend as much time as the role requires. The Chairman stepped down as Chairman of Interserve plc on 29 February 2016. The Chairman’s biography can be found on page 125.

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CORPORATE GOVERNANCE

CORPORATE GOVERNANCE REVIEW

In November 2014, the Chairman commissioned the Company Secretary to examine the corporate governance of the Group.

The purpose of the review was to provide the Board with an assessment of the Group’s corporate governance together with recommendations on steps to improve it. The Nomination & Governance Committee considered the review in April 2015 prior to the Chairman and the Company Secretary reporting on the conclusions to the Board.

The review focused on the operation of the Board and its Committees and in particular: agenda setting and the process of escalating issues; the timing and content of information received by the Board and its Committees; how the Board and the Committees used their time; and Secretariat support.

The review found the governance of the Group by the Board and its Committees to be generally effective and the Secretariat and the Insurance Secretariat to be generally effective in supporting the governance of the Group. Recommendations included:

– quarterly reviews of topics for Board presentations and deep dives involving the Chairman, the Company Secretary, the Chief Risk Officer and the Group Chief Executive or his Chief of Staff, who assists the Group Chief Executive and runs his executive office. The quarterly reviews are also attended by the Group Audit Director and the Group Director, Conduct, Compliance and Operational Risk;
–Board and Committee papers to be standardised using the adoption of a new Board template;
–the Board calendar should avoid more than two Board Committee meetings taking place on the same day;
–Chairmen should maintain an appropriate balance between presentations and time allocated to discussion; and
–Secretariat should recruit additional senior capability in order to take a more pro-active role in maintaining high governance standards throughout the Group.

Recruitment for the Secretariat is ongoing. All other recommendations from the governance review have been implemented in full.

SENIOR MANAGERS AND CERTIFICATION REGIME (SM&CR)

The Company Secretary carried out a further review of the Corporate Governance Framework in preparation for the introduction in March 2016 of the SM&CR and, as relevant to the Scottish Widows Group, the Senior Insurance Managers Regime (SIMR).

The review found that the framework was generally aligned with the requirements of the SM&CR and, as relevant to the Scottish Widows Group, the SIMR, but a number of changes were recommended. These included amendments to the statements of responsibilities of the Directors and members of the GEC and minor amendments to the terms of reference of a number of Board and Group Chief Executive Committees.

The Nomination & Governance Committee considered the review in January 2016 prior to a report on the conclusions to the Board. The Board reviewed and approved the proposed changes, which were part of a wider range of initiatives undertaken to prepare the Group for the introduction of SM&CR and SIMR.

CONFLICTS OF INTEREST

All Directors of the Company and its subsidiaries must avoid any situation which might give rise to a conflict between their personal interests and those of the Group. Prior to appointment, potential conflicts of interest are disclosed and assessed to ensure that there are no matters which would prevent that person from taking on the role.

Directors are responsible for notifying the Chairman and Company Secretary as soon as they become aware of actual or potential conflict situations. In addition, conflicts are monitored as follows:

–the Directors are required to complete a conflicts questionnaire on appointment and annually thereafter;
–changes to the commitments of all Directors are reported to the Nomination & Governance Committee and the Board; and
–a register of potential conflicts and time commitments is regularly reviewed and authorised by the Board to ensure the authorisation status remains appropriate.

If any potential conflict arises, the articles of association permit the Board to authorise the conflict, subject to such conditions or limitations as the Board may determine. Decisions regarding these conflicts of interest could be and are only taken by directors who have no interest in the matter. In taking the decision, the Directors act in a way they consider, in good faith, would be most likely to promote the Company’s success. Any authorities given are reviewed periodically, and as considered appropriate, and at least every 15 months. No Director is permitted to vote on any resolution or matter where he or she has an actual or potential conflict of interest. The Board confirms that no material conflicts were reported to it during the year.

Stuart Sinclair is a Non-Executive Director of Provident Financial Plc, a supplier of personal credit products to the non-standard lending market, and Senior Independent Director at both QBE Insurance (Europe) Limited, a general insurance and reinsurance company, and Swinton Group Limited, an insurance broker for home and motor insurance. The Board has recognised that potential conflicts may arise in relation to his position at QBE Insurance and in relation to Swinton Group. The Board has authorised the potential conflicts and requires Mr Sinclair to recuse himself from discussions, should the need arise.

Prior to Carolyn Fairbairn’s retirement from the Board, she was also a Non-Executive Director of the Competition and Markets Authority (CMA). During the period she served on the Board, she recused herself from all discussions at the CMA on their investigation into banking competition.

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CORPORATE GOVERNANCEworks

 

INTERNAL CONTROL

 

BOARD RESPONSIBILITYBoard responsibility

 

The Board is responsible for the Group’s risk management and internal control systems, which are designed to facilitate effective and efficient operations and to ensure the quality of internal and external reporting and compliance with applicable laws and regulations. The Directors and senior management are committed to maintaining a robust control framework as the foundation for the delivery of effective risk management. The Directors acknowledge their responsibilities in relation to the Group’s risk management and internal control systems and for reviewing their effectiveness.

 

In establishing and reviewing during the year the systems of risk management and internal control systems, the Directors confirm that they carried out a robust assessment of the principal risks facing the Company, including those that would threaten its business model, future performance, solvency or liquidity, the likelihood of a risk event occurring and the costs of control. The process for identification, evaluation and management of the principal risks faced by the Group is integrated into the Group’s overall framework for risk governance. The Group is forward-looking in its risk identification processes to ensure emerging risks are identified. The risk identification, evaluation and management process also identifies whether the controls in place result in an acceptable level of risk. At Group level, a consolidated risk report and risk appetite dashboard are reviewed and regularly debated by the executive Group Risk Committee, Board Risk Committee and the Board to ensure that they are satisfied with the overall risk profile, risk accountabilities and mitigating actions. The report and dashboard provide a monthly view of the Group’s overall risk profile, key risks and management actions, together with performance against risk appetite and an assessment of emerging risks which could affect the Group’s performance over the life of the operating plan. Information regarding the main features of the internal control and risk management and internal control systems in relation to the financial reporting process is provided within the risk management report on pages 4048 to 62.106. The Board concluded that the Group’s risk management arrangements are adequate to provide assurance that the risk management systems put in place are suitable with regard to the Group’s profile and strategy.

CONTROL EFFECTIVENESS REVIEWControl Effectiveness Review

 

An annual control effectiveness reviewControl Effectiveness Review (CER) is undertaken to evaluate the effectiveness of the Group’s control framework with regard to its material risks, and to ensure management actions are in place to address key gaps or weaknesses in the control framework. Business areas and head office functions assess the controls in place to address all material risk exposures across all risk types. The CER considers all material controls, including financial, operational and compliance controls. Senior management complete an attestation to confirmapprove the CER findings which are reviewed and independently challenged by the Risk Division and Group Internal Audit and reported to the Board. Action plans are implemented to address any control deficiencies.

 

REVIEWS BY THE BOARDReviews by the Board

 

The effectiveness of the risk management and internal control systems is reviewed regularly by the Board and the Audit Committee, including an annual review. The Audit Committeewhich also receives reports of reviews undertaken by the Risk Division and Group Internal Audit. The Audit Committee receives reports from the Company’s auditor, PricewaterhouseCoopers LLP (which include details of significant internal control matters that they have identified), and has a discussion with the auditor at least once a year without executives present, to ensure that there are no unresolved issues of concern.

 

The Group’s risk management and internal control systems are regularly reviewed by the Board and are consistent with the Guidanceguidance on Risk Management, Internal Control and Related Financial and Business Reporting issued by the Financial Reporting Council and compliant with the requirements of the Capital Requirements Directive IV (CRD IV).CRD IV. They have been in place for the year under review and up to the date of the approval of the annual report.Annual Report. The Group has determined materiala pathway to compliance with BCBS 239 risk data aggregation and risk reporting requirements and continues to actively manage enhancements.


 

CONCLUSION

The Group has enhanced the control environment during the last year in a number of key respects, such as IT, cyber security and Anti-Money Laundering (AML) controls. This is reflected in the 2015 CER assessment which provides reasonable assurance that the Group’s controls are effective or that where control weaknesses are identified, they are subject to management oversight and action plans. This conclusion is consistent with the delivery of previously initiated action plans and an improvement in the operational risk profile of the Group. The Audit Committee, in conjunction with the Board Risk Committee, concluded that the Group’s risk management and internal control systems were effective and adequate having regard to the Group’s risk profile and strategy, and recommended that the Board approve them accordingly.

REMUNERATION

The statement by the Chairman of the Remuneration committee, the Directors’ Remuneration policy and the Directors’ Remuneration Implementaion Report are set out on pages 129 to 155.

SHAREHOLDER RELATIONSHIPS

The Board recognises and values greatly the need to deliver a programme of

Workforce engagement that offers all shareholders the opportunity to receive company communication and to share their views with the Board. Accordingly, the Group has dedicated teams with responsibility for engaging with institutional investors, retail shareholders and the market using a comprehensive communication programme. This includes investor meetings in the UK and overseas, analyst briefings, market announcements and the AGM. The Group’s website is a key tool in ensuring shareholders can access communications and documents as soon as they are published, including a live webcast of the AGM. Recordings of webcasts and other analyst presentations are also available.

KEY FACTS AT 31 DECEMBER 2015

 

– 

During the year, the Nomination and Governance Committee made a recommendation to the Board as to how the Board would engage with the ‘wider workforce’ as a key stakeholder following the Financial Reporting Council’s recent guidelines. The Board has discussed and agreed the approach to engagement during 2019, methods of gathering and documenting workforce views, and considering how feedback provided by the workforce would be presented to and considered by the Board on a timely basis.

The definition of the Group’s ‘workforce’ was considered and agreed as ‘our permanent

The Group has 2.6 million shareholders,

employees, contingent workers and third-party suppliers that work on the largestGroup’s premises delivering services to our customers and supporting key business operations’.

ENGAGEMENT ACTIVITY AND DEVELOPING DIALOGUE

Board members already participate in a number of ordinary shareholders inkey engagement activities such as site visits, Q&A sessions, colleague feedback sessions, Chairman’s breakfasts, and the UK. Retail shareholders represent approximately 99.1 per centHelping Britain Prosper Live events. Enhancements to current engagement activities have been agreed to provide the opportunity for feedback, themes and viewpoints of the total numberwider workforce to be brought to the attention of shareholders.the Board for

discussion and debate to encourage a meaningful dialogue between the Board and the workforce.

From the second quarter of 2019, the Board will receive a report on a quarterly basis to provide further oversight and insight into workforce related activity and support with key decision making.

RAISING CONCERNS IN CONFIDENCE

The Group’s existing whistleblowing channel provides an opportunity for both colleagues and the wider workforce to raise concerns in confidence.

  
–Institutional shareholders hold approximately 95.58 per cent of the issued share capital on the share register including approximately 7 per cent held on behalf of retail shareholders in private nominee arrangements.
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CORPORATE GOVERNANCE

 

RELATIONSHIPS WITH INSTITUTIONAL INVESTORS

Investor Relations has primary responsibility for managing and developing the Group’s external relationships with existing and potential institutional equity investors. Supported by the Group Chief Executive, Chief Financial Officer, other members of the senior management team and Non-Executive Board members where appropriate, they achieve this through a combination of briefings to analysts and institutional investors (both at results briefings and throughout the year), as well as individual discussions with institutional investors.

Investor Relations ensures that the Group’s Board and Executive Committee are informed of key messages, market developments and the perception of the Group in the market. The primary responsibility for managing and developing relationships with existing and potential debt investors restsComplying with the GroupUK Corporate Treasury team with support from Investor Relations.

During 2015, Investor Relations held over 1,250 meetings with and gave presentations to institutional debt and equity investors. Discussions included the Group’s financial and operational performance, the dividend payment and associated policy, the Group’s capital management policy and progress in the Group’s strategy to be the best bank for customers.

Investor Relations is also responsible for delivering the Group’s financial results which includes presentations to the market and publication of formal results and announcements, as well as hosting regular national and international roadshows and meetings for current and potential institutional equity and debt investors in the Company.

GOVERNANCE AND EXECUTIVE REMUNERATION

Lord Blackwell (Chairman), Anthony Watson (Senior Independent Director) and Anita Frew (Deputy Chairman and Chairman of the Remuneration Committee), have participated in numerous meetings and discussions with investors and other stakeholders, including the Group’s regulators, regarding governance and the strategic direction of the Group. They also engaged extensively with proxy advisors, regulators and larger shareholders on issues relating specifically to executive remuneration.

At the Group’s AGM in May 2015, shareholders gave an advisory ‘for’ vote of 97.68 per cent in favour of the implementation during 2014 of the Directors’ Remuneration Policy. Shareholders will be asked to provide an advisory vote on the Directors’ Remuneration Implementation Report for the financial year ended 31 December 2015 at the AGM inGovernance Code 2016 and in 2017 when shareholders will also be asked to consider and approve a new Directors Remuneration Policy.

RELATIONSHIPS WITH RETAIL SHAREHOLDERS

The Company Secretary has a team dedicated to engage with retail shareholders who, with support from the Group’s registrar Equiniti Limited, deliver the Group’s shareholder service strategy, including the AGM.

Shareholders are engaged using a rolling programme of communications. By way of example, when the Group resumed dividend payments in February 2015 a mailing was sent to shareholders informing them of the choices available based on existing payment instructions held.

The Group’s retail shareholders are well informed and knowledgeable and this is demonstrated through much of the correspondence received. Enquiries from retail shareholders range from discussing technical accounting matters and strategy implementation, through to their experiences as customers.

Group Secretariat provides feedback to the Board and appropriate committees to ensure the views of retail shareholders are received and considered.

The Group is committed to helping Britain prosper and since 2012 Group Secretariat has engaged with ProSearch, a tracing agency, to find lost shareholders and reunite them with unclaimed dividends. To date, shareholders have been reunited with over £32 million, with a further £900,000 being donated to charitable causes.

THE ANNUAL GENERAL MEETING

The AGM is an opportunity for shareholders to engage directly with the Board. All Board members attended the Group’s AGM in 2015. The AGM in 2016 will again be held in Scotland in accordance with the articles of association. At the AGM in 2015, over 70 per cent of total voting rights were voted by shareholders. The lowest vote ‘in favour’ across all resolutions was 93.26 per cent. All resolutions are voted on by way of a poll.

STATEMENT OF COMPLIANCE

UK CORPORATE GOVERNANCE CODE

 

The UK Corporate Governance Code 2014 (Code)2016 (the ‘Code’) applied to the 2015Lloyds Banking Group 2018 financial year. The Group confirms that it applied the main principles and complied with all the provisions of the Code throughout the year. The Group has been subject to the provisions of the UK Corporate Governance Code 2018 since January 2019, and will report on this next year. The Code is publicly available at www.frc.org.uk

THE BRITISH BANKERS’ ASSOCIATION CODE FOR FINANCIAL REPORTING DISCLOSUREwww.frc.org.uk. The following two pages explain how we have applied the Main Principles and the provisions of the Code during the year.

 

The Group has adopted the British Bankers’ Association’sUK Finance Code for Financial Reporting Disclosure and its 20152018 financial statements have been prepared in compliance with its principles.

170A. Leadershipü

A1. The Board’s Role The Group is led by an effective, committed unitary Board, which is collectively responsible for the long-term success of the Group. The Group’s Corporate Governance Framework, which is reviewed annually by the Board, sets out a number of key decisions and matters that are reserved for the Board’s approval. Further details can be found online at www.lloydsbankinggroup.com and on page 137.

IndependentResponsibilities
Chairman
Lord Blackwell		Lord Blackwell leads the Board and promotes the highest standards of corporate governance. He sets the Board’s agenda and builds an effective and complementary Board. The Chairman leads Board succession planning and ensures effective communication with shareholders.
Executive Directors
Group Chief Executive
António Horta-Osório		António Horta-Osório manages and leads the Group on a day-to-day basis and makes decisions on matters affecting the operation, performance and strategy of the Group’s business. He delegates aspects of his own authority, as permitted under the Corporate Governance Framework, to other members of the Group Executive Committee.
Chief Financial Officer
George Culmer		Under the leadership of the Group Chief Executive, George Culmer and Juan Colombás make and implement decisions in all matters affecting operations, performance and strategy. They provide specialist knowledge and experience to the Board. Together with António Horta-Osório, George Culmer and Juan Colombás design, develop and implement strategic plans and deal with day-to-day operations of the Group.
Chief Operating Officer
Juan Colombás		 
Non-Executive Directors
Deputy Chairman and Senior Independent Director
Anita Frew		As Deputy Chairman, Anita Frew would ensure continuity of chairmanship during any change of chairmanship. She supports the Chairman in representing the Board and acts as a spokesperson. She deputises for the Chairman and is available to the Board for consultation and advice.
The Deputy Chairman may represent the Group’s interests to official enquiries and review bodies. As Senior Independent Director, Anita Frew is also a sounding board for the Chairman and Chief Executive. She acts as a conduit for the views of other Non-Executive Directors and conducts the Chairman’s annual performance appraisal. She is available to help resolve shareholders’ concerns and attend meetings with major shareholders and financial analysts to understand issues and concerns.
Alan DickinsonThe Non-Executive Directors challenge management constructively and help develop and set the Group’s strategy. They actively participate in Board decision-making and scrutinise management performance. The Non-Executive Directors satisfy themselves on the integrity of financial information and review the Group’s risk exposures and controls. The Non-Executive Directors, through the Remuneration Committee,  determine the remuneration of Executive Directors.
Simon Henry
Lord Lupton
Amanda Mackenzie¹
Deborah McWhinney2
Nick Prettejohn
Stuart Sinclair
Sara Weller
Company Secretary
Malcolm Wood		The Company Secretary advises the Board on various matters including governance and ensures good information flows and comprehensive practical support is provided to Directors. He maintains the Group’s Corporate Governance Framework and organises Directors’ induction and training. The Company Secretary communicates with shareholders as appropriate and ensures due regard is paid to their interests. Both the appointment and removal of the Company Secretary is a matter for the Board as a whole.

CORPORATE GOVERNANCE

NOMINATION & GOVERNANCE COMMITTEE REPORT

Good succession planning contributes to the delivery of the Group’s strategy by ensuring the desired mix of skills and experience of Board members now and in the future.

 Committee meetings
 Eligible to attendAttended
Committee Chairman  
Lord Blackwell77
Committee members who served during 2015  
Alan Dickinson133
Anita Frew77
Nick Luff77
Deborah McWhinney2––
Anthony Watson763

 

1JoinedAmanda Mackenzie joined the Committee on 17 July 2015.Board with effect from 1 October 2018.
  
2JoinedDeborah McWhinney left the Committee on 1Board with effect from 31 December 2015. No Committee meeting was held in December.
3Mr Watson was unable to attend the July Committee meeting due to a prior commitment.2018.

 

Chairman’s overiewA2. Division of responsibilities There is clear division of responsibility at the head of the Company, as noted above. As documented in the Group’s Corporate Governance Framework there is clear separation between the role of the Chairman, who is responsible for the leadership and effectiveness of the Board, and the Chief Executive, who is responsible for the running of the Company’s business.

 

During 2015, succession planningA3. Role of the Chairman The Chairman has overall responsibility for the leadership of the Board and for ensuring its effectiveness. The responsibilities of the Chairman and his fellow Directors are set out above.

Lord Blackwell was independent on appointment.

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CORPORATE GOVERNANCE

A4. Role of the Non-Executive Directors The Senior Independent Director (‘SID’), Anita Frew, acts as a sounding board for the Chairman and Group Chief Executive. She can be contacted by shareholders and other Directors as required.

The Non-Executive Directors challenge management constructively and help develop and set the Group’s strategy.

Meetings are held between the Non-Executive Directors in the absence of the Executive Directors, and at least once a year in the absence of the Chairman.

Further information on meeting arrangements and the responsibilities of the Directors are given on pages 136 to 138 and 142 respectively.

B. Effectivenessü

B1. The Board’s composition The balance of skills, experience, independence, and knowledge on the Board is the responsibility of the Nomination and Governance Committee, and is reviewed annually or whenever appointments are considered. Having the right balance on the Board and its Committees remained a key focus forhelps to ensure that those bodies discharge their respective duties and responsibilities effectively.

In particular, the Nomination &and Governance Committee. OnCommittee monitors whether there are any relationships or circumstances which may affect a Director’s independence. Following the Committee’s recommendation,most recent review of independence the Committee concluded that all Non-Executive Directors are independent in character and judgement as shown on page 142.

More information on the annual Board effectiveness review can be found on pages 139 to 140 and information on the Board appointed Deborah McWhinney and Stuart Sinclair as independent Non-Executive Directors in December 2015 and January 2016 respectively. Details of all Board changes during the year are set outDiversity Policy can be found on page 163. 146.

B2. Board appointments The process for Board appointments is led by the Nomination and Governance Committee, which then makes a recommendation to the Board.

More details about the appointment of Deborah and Stuart and the Group’s approach to succession planning can be found on page 144.

More information about the next page.work and focus of the Nomination and Governance Committee can be found on pages 144 to 146.

B3. Time commitmentsNon-Executive Directors are advised of time commitments prior to their appointment and they are required to devote such time as necessary to discharge their duties effectively. The time commitments of the Directors are considered by the Board on appointment and annually, and following the most recent review, the Board is satisfied that there are no Directors whose time commitments are considered to be a matter for concern. External appointments, which may affect existing time commitments for the Board’s business, must be agreed with the Chairman, and prior Board approval must be obtained before taking on any new external appointments.

No Executive Director has either taken up more than one Non-Executive Director role at a FTSE100 company or taken up the Chairmanship of such a company.

More information on Directors’ attendance at Board and Committee meetings can be found on page 133.

B4. Training and development The Chairman leads the training and development of Directors and the Board generally and regularly reviews and agrees with each Director their individual and combined training and development needs.

Ample opportunities, support and resources for learning are provided through a comprehensive programme, which is in place throughout the year and comprises both formal and informal training and information sessions.

The Chairman personally ensures that on appointment each Director receives a full, formal and tailored induction. The emphasis is on ensuring the induction brings the business and its issues alive for the new Director, taking account of the specific role they have been appointed to fulfil and the skills/experience of the Director to date.

Directors who take on or change roles during the year attend induction meetings in respect of those new roles. The Company Secretary maintains a training and development log for each Director.

B5. Provision of information and support The Chairman, supported by the Company Secretary, ensures that Board members receive appropriate and timely information.

The Group provides access, at its expense, to the services of independent professional advisers in order to assist Directors in their role.

Board Committees are also provided with sufficient resources to discharge their duties.

All Directors have access to the services of the Company Secretary in relation to the discharge of their duties.

B6. Board and Committee performance and evaluation An externally facilitated performance evaluation was completed in 2018, with internally facilitated evaluations having taken place in 2016 and 2017. More information can be found on pages 139 to 140, along with the findings, actions, and progress made during the year.

B7. Re-election of Directors At the 2019 AGM all Directors will seek re-election or election. Being the first AGM following her appointment, Amanda Mackenzie will stand for election, with all other Directors standing for re-election. The Board believes that all Directors continue to be effective and committed to their roles.

C. Accountabilityü

C1. Financial and business reporting The Code requirement that the Annual Report is fair, balanced and understandable is considered throughout the drafting and reviewing process and the Board has concluded that the 2018 Annual Report is fair balanced and understandable. Information on the Company’s business model and strategy can be found on pages 5 to 10.

C2. Risk management and internal control systems The Board is responsible for the Group’s risk management and internal controls systems; see page 141 for more detail regarding internal control. The Audit Committee is responsible for the effectiveness of internal controls and the Risk Management Framework. Further information can be found on pages 147 to 150.

The Board Risk Committee is responsible for the review of the risk culture of the Group, setting the tone from the top in respect of risk management. Further information can be found on pages 151 to 154.

The Directors’ confirmation that the business is a going concern can be found on page 156.

C3. Role and responsibilities of the Audit Committee The Board has delegated a number of responsibilities to the Audit Committee, including oversight of financial reporting processes, the effectiveness of the internal controls and the risk management framework, whistleblowing arrangements and the work undertaken by the external and internal auditors. The Audit Committee Report which can be found on pages 147 to 150, sets out how the Committee has discharged its duties and areas of focus during the year.

D. Remunerationü

D1. Level and elements of remuneration The Group is committed to offering all colleagues a reward package that is competitive, performance-driven and fair and its Remuneration Policy is designed to promote the long term success of the Company. The Directors’ Remuneration Report on pages 111 to 130 provides full details regarding the remuneration of Directors. The Remuneration Policy can be found in the 2016 Annual Report and Accounts and remains unchanged since last approved by shareholders at the 2017 AGM.

D2. Procedure The work of the Remuneration Committee and its focus during the year can be found on page 125.

E. Relations with Shareholdersü

E1. Shareholder engagement The Board actively engages with all stakeholders including shareholders.

E2. Use of General Meetings The Board values the AGM as a key opportunity to meet shareholders. The 2019 AGM will be held on 16 May 2019. The whole Board is expected to attend and will be available to answer shareholders’ questions.

To facilitate shareholder participation, electronic proxy voting and voting through the CREST proxy appointment service are available. All votes are taken by way of a poll to include all shareholder votes cast.

 

A webcast of the AGM is carried out to allow shareholders who cannot attend in person to view the meeting live.

Key

ü  Fully Compliant


143

CORPORATE GOVERNANCE

Nomination and Governance Committee report

The Committee has overseen further development of the Group’s senior management succession planning programme.

Dear Shareholder

Board and GEC changes

As reported in my introduction to the Governance Report on page 132, there have been a number of changes to our Committee structure and composition were recommended to the Board including the establishment of a Responsible Business Committee, underlining the Group’s commitment to being a responsible business. Full details of all Committee changes during the year, are set outall of which have been overseen by the Nomination and Governance Committee (the ‘Committee’). The Committee conducted a rigorous process for identifying and assessing candidates to recruit both the Ring-Fenced Bank only Non-Executive Directors and an additional Group Non-Executive Director. Details of this selection process can be found on page 159.146. The Committee has also overseen the transition from Anita Frew to Stuart Sinclair as the Chair of the Remuneration Committee Chairman, and as part of the succession plan which is in place for senior management, have approved the appointment of Kate Cheetham as Company Secretary to replace Malcolm Wood when he retires from the Group in June 2019.

 

Our CorporateFollowing the announcement in October that George Culmer would be retiring from the Group in the third quarter of 2019, the Nomination and Governance Framework is reviewed at least annually byCommittee conducted a rigorous search process for his successor. This led to the announcement in February 2019 that, subject to customary regulatory approvals, William Chalmers would join the Group in June 2019, becoming an Executive Director and Chief Finance Officer when George steps down.

Board to ensure it remains effective. Theeffectiveness review is

As highlighted in my letter on page 132, an externally facilitated Board effectiveness review was conducted during the year. This was overseen by the Committee, and this year the framework was subjectfull details are provided on pages 139 to an additional end-to-end review by the Company Secretary and a further review in preparation for the Senior Managers and Certification Regime (SM&CR). Full details of the Company Secretary’s findings and the Board’s response are set out on page 168.140.

Succession planning

 

The Committee continued its work on succession planning during the year, focusing on the level below the Group Executive Committee (GEC). This has included working with Egon Zehnder to review the changing role requirements and characteristics for bank leadership in the context of the Bank of the Future.

The outcome of this review provided a comprehensive view of the GEC role characteristics against which the current senior management layer below GEC can be assessed to ensure alignment of

capability, aspiration and adequacy of current development plans. The identified characteristics are designed to represent the particular leadership requirements of those undertaking GEC-level roles within the Group as we build the Bank of the Future. Our ambition is to ensure an Executive team that embraces the diverse strengths of individual leaders and collectively exhibits the characteristics expected of a team leading the Group to succeed in a digital world. The GEC characteristics align to the leadership behaviours: inspire delivery; encourage simplicity; develop confidence; and build trust. Additional emphasis is placed upon key capabilities required to lead cultural transformation, including innovative strategic thinking; agile change management; digital technology; collaborative team working and insightful customer perspectives.

The GEC characteristics will become the benchmark for the assessment of, and development planning for, GEC members and attendees as well as successors into those roles. The characteristics will be considered progressin addition to knowledge and experience criteria around breadth of banking/financial services and governance experience. Work was undertaken in September 2018 to support identified successors in reviewing and refreshing their development plans to ensure that these directly support their succession readiness in line with the characteristics.

During the year GEC members and attendees have been assessed against the actions fromGEC characteristics, with both a desktop assessment and self-assessments by GEC members and attendees. These have been reviewed by the 2014Group Chief Executive and me, and formed the basis for discussion with the Committee and other Board Effectiveness Reviewmembers about executive capabilities and I am pleasedsuccession plans.

Individual assessment scores against the GEC characteristics have been shared with each GEC member and attendee for discussion with their line manager. Additional personal development interventions have been agreed as appropriate, with individual development plans continuing to reportbe owned and driven by each Executive.

Overall, the results of the assessment evidence that the changes introducedGEC collectively exhibit strong capabilities in the leadership characteristics required to deliver the Bank of the Future. As a team, their breadth of banking and actions arisinggovernance experience provides the

knowledge base required to enable robust decision-making. Personal characteristics around values, judgement and drive are aligned with the Group’s target culture.

UK Corporate Governance Code

The Financial Reporting Council published in July an amended UK Corporate Governance Code (the ‘New Code’), which is applicable from 1 January 2019, with requirements relating to the reviewannual report applicable to the report and accounts for the year ending 31 December 2019. The Group will be reporting against this New Code in next year’s annual report, but the requirements have led to concrete improvements in a number of areas. Details of our progress againstbeen considered by the 2014 review actionsCommittee and the findingsBoard during the year under review and recommendations fromwork has been done to implement changes to procedures, governance, culture and practice in line with the externally facilitated 2015 reviewNew Code.

The Group’s Corporate Governance Framework

The Corporate Governance Framework was updated in 2017 to anticipate the governance requirements of ring-fencing on the basis of discussions at that time. During 2018, the Corporate Governance Framework was further updated to include additional amendments to reflect commitments made to the Regulator. These amendments included wording to reflect the role of Risk Officer for the Ring-Fenced Banks, particularly in relation to the Risk Committees, additional detail on the conduct of aligned Board and Committee meetings, and clarification of the management of conflict issues. More information on the aligned meetings can be found on pages 166 and 167. I andpage 135.

The Committee has also overseen amendments to the other Board members findCorporate Governance Framework to reflect the annual review process valuable and insightful.requirements of the New Code ahead of implementation in 2019.

 

Lord Blackwell

Chairman, Nomination &and Governance Committee


144

CORPORATE GOVERNANCE

 

ACTIVITIES DURING THE YEAR
Key issuesCommittee review and conclusion
 Recruitment of a new Non- Executive DirectorThe external search firm Russell Reynolds Associates1provided a shortlist of candidates for consideration. Interviews with various members of the Board were held, and the process resulted in the appointment of Amanda Mackenzie in October.
Change in Chairman of the Remuneration CommitteeFollowing Anita Frew’s decision to step down as the Remuneration Committee Chair, the Committee recommended to the Board that Stuart Sinclair replace her in this role. This recommendation was based on Board succession planning and the fact that Stuart is an experienced Non-Executive Director, has been a member of the Remuneration Committee since he joined the Company in January 2016, and has external experience of chairing Board committees.
Structure and composition of the BoardFrom the ongoing assessment of the Board members, the Chairman creates a skills matrix which the Committee uses to track the Board’s strengths and identify gaps in the desired collective skills profile of the Board, giving due weight to diversity in its broadest sense. Recommendations are made to the Board as appropriate. The skills matrix was considered in the appointment of Amanda Mackenzie, and the appointment of the Ring-Fenced Bank only Directors.
 Establishing the GEC characteristics and identifying and supporting potential successors into GEC-level roles

During the year, the Committee, led by the Chairman, reviewed the succession plans and development plans for key senior management roles, and established the GEC characteristics as described on page 144.

This included updating the ongoing development plans for potential successors into Executive Director roles, including Group Chief Executive.

 Recruitment of the Ring-Fenced Bank only DirectorsRussell Reynolds Associates was engaged to shortlist candidates for the positions of three Ring-Fenced Bank only Non-Executive Directors. The recruitment process, led by the Chairman, included interviews with various members of the Board and resulted in the appointment of Nigel Hinshelwood, Sarah Bentley and Brendan Gilligan with effect from 1 January 2019.
 Annual effectiveness review of the Board and its CommitteesDuring the year the Committee selected Egon Zehnder to facilitate the review by the Board and its Committees of their effectiveness and provided oversight for the process. The Committee also reviewed its own effectiveness and found that it met its key objectives and carried out its responsibilities effectively. Full details of the review can be found on pages 139 to 140.
 The Committee provides oversight for various aspects of corporate governance, and during the year key activities included the following:

Annual review of the Corporate Governance Framework, amendments which took into account the Group’s approach to compliance with the PRA’s Ring Fenced Banks Governance Principles, and the requirements of recent regulatory developments including the terms of the revised UK Corporate Governance Code. Our application of the New Code will be reported upon next year;

Continuing oversight of the governance structure for the Ring-Fenced Banks;

A review of the Board/Committee responsibilities and the matters reserved for the Board to assess any instances of overlap or gaps in coverage or escalation;

In the light of the increasing importance of IT in the Group’s GSR3 strategy, a review of the governance and oversight of the IT Programme;

Considering correspondence with shareholders;

Approval of the appointment of Trustees to the Bank’s Foundations.

 A review of the Diversity Policy was undertakenThe Board considered and approved the adoption of a public goal to increase ethnic diversity in the senior management population, a first for a FTSE-100 company. This has now been incorporated into the Board Diversity Policy which was approved by the Board in January 2019. The Board Diversity Policy is available at www.lloydsbankinggroup.com. Please see page 146 for further information regarding diversity.
The Diversity Policy was a consideration in recruitment during the yearDiversity, in its broadest sense as detailed in the Policy, was taken into consideration as part of the recruitment of Amanda Mackenzie and the Ring-Fenced Bank only Directors during the year.
 Reviewing whether Non-Executive Directors were demonstrably independent and free from relationships and other circumstances that could affect their judgementIn recommending Directors for re-election the Committee reviews the performance of each Non-Executive Director and their ability to continue meeting the time commitments required. It also takes account of any relationships that had been disclosed. A particularly rigorous review of Lord Blackwell, Anita Frew and Sara Weller was undertaken as a result of having held the position of Non-Executive Director for longer than six years. Based on its assessment for 2018, the Committee is satisfied that, throughout the year, all Non-Executive Directors remained independent2as to both character and judgement. All Directors were considered to have appropriate roles, including capabilities and time commitments.
 Overseeing the roll out of training to all Non-Executive DirectorsIn addition to existing methods of training for the Non-Executive Directors, at the end of 2017, members of the Committee trialled an online mandatory training programme. This was subsequently rolled out to the rest of the Board. Full details can be found on page 140.

COMMITTEE PURPOSE AND RESPONSIBILITIES

1Aside from assisting with senior recruitment and benchmarking, Russell Reynolds Associates have no other connection to the Company.
2The Chairman was independent on appointment. Under the Code, thereafter the test of independence is not appropriate in relation to the Chairman.
Board composition
Executive succession planning
Ring-Fenced Bank
Annual Board effectiveness review
Governance
Diversity
Independence and time commitments
Training
145

CORPORATE GOVERNANCE

Committee purpose and responsibilities

 

The purpose of the Committee is to keep the Board’s governance, composition, skills, experience, knowledge, independence and succession arrangements under review and to make appropriate recommendations to the Board to ensure the Company’s arrangements are consistent with the highest corporate governance standards.

 

The Committee reports to the Board on how it discharges its responsibilities and makes recommendations to the Board, all of which have been accepted during the year. The Committee’s terms of reference can be found at www.lloydsbankinggroup.com/our-group/corporate-governancecorporate-governance.

DIVERSITY POLICY

The Board places great emphasis on ensuring that its membership reflects diversity in the broadest sense. For information on the diversity policy, please refer to page 163.

COMMITTEE COMPOSITION, SKILLS AND EXPERIENCECommittee composition, skills and experience

 

To ensure a broad representation of experienced and independent Directors, membership of the Committee comprises the Chairman, the Deputy Chairman, who is also the Senior Independent Director, the Chairman of the AuditBoard Risk Committee and the Chairman of the Remuneration Committee and, from 17 July 2015, the Chairman of the RiskResponsible Business Committee. The Group Chief Executive attends meetings as appropriate.

 

During the year, theDetails of Committee met its key objectivesmemberships and carried out its responsibilities effectively, as confirmed by the annual effectiveness review.meeting attendance can be found on page 133.


 

HOW COMMITTEE MEETINGS ARE RUNThe Board diversity policy

 

The managementBoard Diversity Policy (the ”Policy”) sets out the Board of Lloyds Banking Group’s approach to diversity and provides a high level indication of the CommitteeBoard’s approach to diversity in senior management roles which is governed in keeping withgreater detail, through the basisGroup’s policies, a summary of which is provided below.

The Board places great emphasis on which meetingsensuring that its membership reflects diversity in its broadest sense. A combination of demographics, skills, experience, race, age, gender, educational and professional background and cognitive and personal strengths on the Board is important in providing a range of perspectives, insights and challenge needed to support good decision making.

New appointments are made on merit, taking account of the specific skills and experience, independence and knowledge needed to ensure a rounded Board are managed,and the diversity benefits each candidate can bring to the overall Board composition. Amanda Mackenzie was the only Director to be appointed to Lloyds Banking Group plc during the year, and as detailedpart of her appointment diversity was considered in its broadest sense. Amanda brings experience of customer focus and leadership of Business in the Community, which will be a major asset in supporting our mission of Helping Britain Prosper.

Objectives for achieving Board diversity may be set on a regular basis. On gender diversity the Board has a specific objective to maintain at least three female Board members and, recognising the target referred to in the Hampton-Alexander Review for FTSE companies to move towards 33 per cent female representation by 2020, to take opportunities to increase the number of female Board Members over time where that is consistent with other skills and diversity requirements. Female representation on the Board is currently 25 per cent (based on three female Directors and nine male Directors).

The Board also places high emphasis on ensuring the development of diversity in the senior management roles within the Group and supports and oversees the Group’s objectives of achieving 40 per cent of senior roles held by female executives by 2020, and of 8 per cent of senior roles being held by Black, Asian and Minority Ethnic (BAME) executives by 2020. This is underpinned by a range of policies within the Group to help provide mentoring and development opportunities for female and BAME executives and to ensure unbiased career progression opportunities. Progress on this objective is monitored by the Board and built into its assessment of executive performance. A copy of the Policy is available on our website at www.lloydsbankinggroup.com/responsible-business and information on Board diversity can be found on page 160,133.

PROCESS FOR NEW GROUP AND RING-FENCED BANK NON-EXECUTIVE DIRECTOR APPOINTMENTS

Step 1

Russell Reynolds Associates was appointed by the Committee and provided with a structure which facilitates open discussionremit of what skills and debate, with steps taken to ensure adequate time for members ofexperience the Committee to consider proposals which are put forward.

MATTERS CONSIDERED BY THE COMMITTEE

Duringcandidates should have, based on the year the Committee considered a number of issues relating to the Group’s governance arrangements, both internal and external. It assisted the Chairman in keeping the compositionexisting skills matrix of the Board, and taking into account diversity in its Committees under reviewbroadest sense.

Step 2

Interviews were held between the Chairman and to leada shortlist of candidates.

Step 3

The Committee considered the appointment process for nominationsshortlisted candidates, having been provided with an extensive report from Russell Reynolds Associates which was based on interviews with the candidates and included details of their background, skills, experience and a full evaluation. Interviews took place with various members of the Committee. The Committee recommended the appointments to the Board. These issues are summarised onBoard, which subsequently approved them, subject to regulatory approval where required.

Step 4

Formal offer letters were sent.

Step 5

Regulatory applications were made to the next page.PRA and the FCA in respect of the relevant Directors, and approval was obtained.

Step 6

Formal appointment of the Directors took place.


Q&A WITH AMANDA MACKENZIE OBE, INDEPENDENT DIRECTOR

Q: What did you think of the appointment and induction process?

A: Exceedingly thorough! It gave ample opportunity for Lloyds Banking Group to learn about me and vice versa. A Non-Executive Director role today comes with a much greater amount of obligation and scrutiny, rightly so, but it does mean you have to be assured of the company you are joining and of course they of you. I have to say the Group’s very clear purpose of ‘Helping Britain Prosper’ and the determination of everyone I met to make that a reality was very appealing. The Group is prepared to make some tough decisions to deliver on its purpose. The induction process has been wholehearted, open, thorough and interesting. Given my background there are clearly some areas in which I am not an expert and never will be, but I do need to know enough and the induction process has not made me feel foolish for the need to ask basic questions and by contrast has been very welcoming of my knowledge where it is greatest and can help.

Q: What are your first impressions of how the Board functions and the Group’s governance framework?

A: I left the first Board strategy away day I attended with one overarching thought: the combined Board and Group Executive are an incredible group of people and Lloyds Banking Group is an amazing company. Of course there’s much to be done, but, with the right approach, it will be. And no I wouldn’t say that if I didn’t believe it or if I hadn’t seen some comparisons. So far I feel the Board functions extremely well and the governance framework is clear, as simple as it can be and the various lines of defence operate the way one should expect they do.

Q: What are you looking to bring to the Board / What excites you about your role with Lloyds?

A: I certainly hope I can bring my expertise to the Board. I am very thrilled to be part of it and play my part in ‘Helping Britain Prosper’.


171146

CORPORATE GOVERNANCE

 

SUCCESSION PLANNING – A STRATEGIC APPROACH

APPROACH

TheAudit Committee recognises that good succession planning contributes to the delivery of the Group’s strategy by ensuring the desired mix of skills and experience of Board members now and in the future.

Just as importantly, talent needs to be recognised and nurtured within executive and management levels and across the Group as a whole. The Group’s Annual Talent Review allows the Group to identify talent and have the right succession plans and development programmes in place to ensure the Group creates opportunities for current and future leaders.

PROCESS

The Committee supports the Chairman in keeping the composition of the Board and its Committees under regular review and in leading the appointment process for nominations to the Board.

At the core of the process is an on-going audit led by the Chairman of the collective Board’s technical and governance skill set. This exercise allows the creation of a matrix which the Chairman uses to track the Board’s strengths and identify gaps in the desired collective skills profile of Board members taking into account the Group’s future strategic direction.

Gaps may also be identified through the annual Board evaluation process, where Board composition is a key focus. Underpinning this process is consideration of the personal characteristics that an individual is expected to bring to the Board.

The Committee considers the adequacy of succession arrangements for Executive Directors, members of the GEC and their direct reports. The Chairman is responsible for developing and maintaining a succession plan in relation to the Group Chief Executive who is in turn, primarily responsible for developing and maintaining a succession plan for key leadership positions in the senior executive team.

The Board is kept informed of senior executive succession planning with the leadership approach visible to all Non-Executive Directors.

SUCCESSION PLANNING IN PRACTICE

JUNE 2015report

 

–Search commenced for two Non-Executive DirectorsThe Committee has delivered on its responsibilities of ensuring the integrity of the financial statements and effectiveness of internal and external audit services.
  
–Executive search firm Russell Reynolds, who have no other connection with the Group, appointed to support the search
  
–Role specification drawn up, taking into account the Board skills audit and current and future Board requirements and to give due weight to diversity objectives
  
–Search focused

Dear Shareholder

The past year has been another busy one for the Audit Committee (the ‘Committee’). In addition to continuing focus on candidates who would bringissues relevant to the Company’s financial reporting and its internal control framework, considerable time has been spent on other key areas, including implementation of IFRS 9 and oversight of the process for the selection of a combinationnew external auditor.

A number of core retail and/or commercial banking experiencefirms were invited by the Committee to tender for the external audit mandate. Our current auditor, PwC, did not participate. The process, overseen in the first instance by a Selection Committee comprised of members of the Committee, involved representatives meeting with senior management from across the Group. After careful consideration by the Committee, a recommendation was made to the Board for the appointment of Deloitte LLP, which the Board accepted. Subject to shareholders’ approval at the 2021 AGM, Deloitte LLP will therefore be appointed as external auditor in place of PwC, with effect from the year ending December 2021. Ensuring in the interim the continued effectiveness of the external auditor has also been a focus, with the Committee reviewing the plan for the external audit, and considering reports from the auditor on accounting and control matters.

Whilst the regulator has confirmed a 2019 deadline for claims relating to payment protection insurance (PPI), provisioning for other conduct matters in technology/operationsaddition to PPI has continued to form part of the Committee’s focus. Preparations for the implementation of the ring-fencing regime have also been an important area of consideration, with the Committee reviewing the control and accounting aspects of the establishment of the Group’s non ring-fenced bank, which was successfully made operational during the second half of 2018. The Committee has in addition considered other key areas of judgement and complexity relevant to the financial statements, including review of significant one-off transactions, assisting in determining the appropriate accounting treatment in the sale of the Company’s c.3 per cent stake in Standard Life Aberdeen, and the sale of c.£4 billion of Irish mortgage assets.

The Committee considered the style and format of external disclosure for quarters one and three of 2018, and agreed a significant simplification of information provided. IFRS 9 was successfully implemented during the year, although the

 
–

Committee will continue to pay close attention to how the underlying models perform in potentially volatile economic scenarios.

The wider external environment as we head into 2019 continues to be challenging, with an ongoing focus on regulation in the financial sector, and recent proposals for change in respect of audit practice. I am nonetheless pleased to report that in the opinion of the Committee, the Company continues to meet its obligations in respect of financial reporting and disclosure, and continues to operate an effective internal control framework.

Simon Henry

Chairman, Audit Committee

Committee purpose and responsibilities

The purpose of the Committee is to monitor and review the Group’s financial and narrative reporting arrangements, the effectiveness of the internal controls (including over financial reporting) and the risk management framework, whistleblowing arrangements and each of the internal and external audit processes, including the statutory audit of the consolidated financial statements and the independence of the statutory auditor.

The Committee reports to the Board on how it discharges its responsibilities and makes recommendations to the Board, all of which have been accepted during the year. A full list of responsibilities is detailed in the Committee’s terms of reference, which can be found at www.lloydsbankinggroup.com/our-group/corporate-governance. In satisfying its purpose, the Committee undertakes the functions detailed within Disclosure Guidance and Transparency Rule 7.1.3R.

During the year the Committee considered a number of issues relating to the Group’s financial reporting. These issues are summarised on the next page, including discussion of the conclusions the Committee reached, and the key factors considered by the Committee in reaching its conclusions.

In addition, the Committee considered a number of other significant issues not related directly to financial reporting, including internal controls, internal audit and external audit. These issues are also discussed in detail in the next section, including insight into the key factors considered by the Committee in reaching its conclusions.

Candidates considered from North America

Committee composition, skills and other overseas locations as well asexperience

The Committee acts independently of the executive to ensure that the interests of the shareholders are properly protected in relation to financial reporting and internal control.

All members of the Committee are independent Non-Executive Directors with competence in the financial sector and their biographies can be found on pages 107 to 109. Simon Henry is a Chartered Global Management Accountant and has extensive knowledge of financial markets, treasury, risk management and international accounting standards. He is a member having recent and relevant financial experience for the purposes of the UK

SEPT-OCT 2015 Corporate Governance Code and is the Audit Committee financial expert for SEC purposes.

 

– Long list

During the course of candidatesthe year, the Committee held separate sessions with the internal and external audit teams, without members of the executive management present. For details of how the Committee was run, see page 137.

Annually the Committee undertakes an effectiveness review. The review forms part of the Board evaluation process with Directors being asked to complete parts of the questionnaire relating to the Committees of which they were members. The findings of the review were considered

–Short list by the Committee at its January 2019 meeting. On the basis of potential candidates selected and approached by Russell Reynoldsthe evaluation the feedback was that the performance of the Committee continues to gauge interest
–Potential candidates invited to meetbe effective.

Whilst the Committee’s membership comprises the Non-Executive Directors noted on page 133, all Non-Executive Directors may attend meetings as agreed with the Chairman of the Committee. The Group Financial Controller, Chief Internal Auditor, the external auditor, the Group Chief Executive, the Chief Financial Officer, the Chief Risk Officer and individualthe Chief Operating Officer also attend meetings of the Committee members

NOV 2015

– Recommended to the Board the appointmentas appropriate. Details of two candidates, Deborah McWhinneyCommittee membership and Stuart Sinclair, who had stood out in the recruitment process as having the skills, experience, values and personal characteristics tomeeting attendance can be strong contributors to the Board and to address the Board’s skills requirements

DEC 2015-JAN 2016

– Deborah McWhinney joined the Boardfound on 1 December 2015 and brings an extensive executive background in managing technology, operations and new digital innovations across banking, payments and institutional investment. She also broadens Board diversity with a global market perspective
–

Stuart Sinclair joined the Board on 4 January 2016 and in addition to his retail banking experience, also brings wider experience of consumer and asset finance as well as insurance

page 133.

 

Board well placed to address future technology and market risks across the full range of business areas in which the Group operates

HOW THE NOMINATION & GOVERNANCE COMMITTEE SPENT ITS TIME IN 2015

EFFECTIVENESS

During 2015, the Committee oversaw the annual evaluations of the performance of the Board and its Committees. In January 2015, the Committee reviewed the findings of the 2014 Board Effectiveness Review and recommended actions to the Board to address the areas identified for improvement. Progress against the plan was reviewed during the year. For the 2015 Board Effectiveness Review, the Committee made recommendations to the Board on the process and timing of the review including the appointment of an external facilitator. Full details of the 2015 Board Effectiveness Review together with details of the progress against the 2014 review actions are set out on pages 165 to 167.

CORPORATE GOVERNANCE

The Committee continued its role of overseeing the Board’s governance arrangements to ensure that they paid due regard to best practice principles and remain appropriate. In 2015, in addition to the annual review of the Corporate Governance Framework, the Committee oversaw an additional end-to-end review by the Company Secretary and a further review in preparation for the SM&CR. The Company Secretary’s findings and the Board’s response are set out on page 168.

172147

CORPORATE GOVERNANCE

 

During 2015, the Committee received regular corporate governance updates from the Company Secretary, considered the impact of emerging regulation on the Board and its corporate governance practices, received a report from the Chairman on communications from shareholders and approved the appointment of Trustees to the Bank’s Foundations.

INDEPENDENCE AND TIME COMMITMENTS

The independence of Non-Executive Directors, the election or re-election of Directors and their suitability to continue in office were reviewed. In assessing independence, the Committee did not rely solely on the Code criteria but considered whether, in fact, the Non-Executive Director was demonstrably independent and free of relationships and other circumstances that could affect their judgement. It did this with reference to the individual performance and conduct in reaching decisions. It also took account of any relationships that had been disclosed and authorised by the Board. Based on its assessment for 2015, the Committee is satisfied that, throughout the year, all Non-Executive Directors remained independent as to both character and judgement.

The Committee reviewed the role, including capabilities and time commitment, of the Chairman, Deputy Chairman, Senior Independent Director, Non-Executive Directors, the Group Chief Executive and Executive Directors and found them to be appropriate.

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CORPORATE GOVERNANCE

AUDIT COMMITTEE REPORT

The quality of external and internal audit services continues to be of central importance to the Group, and the Committee has played a key role in safeguarding these essential assurance activities.

 Committee meetings 
 Eligible to attendAttended 
Committee Chairman   
Nick Luff77 
Committee members who served during 2015   
Alan Dickinson77 
Anita Frew77 
Simon Henry751
Deborah McWhinney211 
Nick Prettejohn77 
Anthony Watson77 
Former Committee members who served during 2015   
Carolyn Fairbairn366 

1  Mr Henry was unable to attend both January and July Audit Committee meetings due to prior executive commitments.
2Joined the Committee on 1 December 2015.
3Retired on 31 October 2015.

Chairman’s overview

It has been another busy year for the Committee. We have continued to focus on the issues relevant to the Group’s financialFinancial reporting considering key accounting judgments and ensuring ongoing quality in related disclosures. We have also spent a significant proportion of our time considering other key areas, including monitoring of the Group’s internal control framework, where we continue to work to ensure it remains strong and fit for purpose.

Assessing the appropriate provisioning for the costs of redress relating to Payment Protection Insurance (PPI) remains the most significant area of judgment in the Group’s financial reporting. There have been major developments in this area during 2015, including the consultation by the FCA on a potential time bar for claims.

The Committee has reviewed and challenged management’s assessment of the remaining costs relating to PPI claims and is satisfied that the accounting, and related disclosures, are appropriate. Further detail on PPI and other key financial reporting issues are set out in the report below.

The Committee has overseen continued transformation of the internal audit function under the leadership of the Group Audit Director, Mary Hall, following her appointment in the second half of 2014. Audit planning, supported by the development of an audit risk universe, has been enhanced, and greater rigour has been introduced to the audit methodology. Carefully directed use of external expertise is being used to ensure that appropriate skills are deployed in audits of technical areas, and good progress is being made in developing the skills and experience of the internal audit team.

Ensuring the continued effectiveness of the external audit has also been a focus for the Committee. We reviewed the plan for the external audit, considered the reports from the external auditor on accounting and control matters, and engaged with them on key judgments. We are working with the auditors to ensure a smooth transition to a new lead audit partner for the 2016 audit.

Nick Luff

Chairman, Audit Committee

COMMITTEE PURPOSE AND RESPONSIBILITIES

The purpose of the Committee is to monitor and review the Group’s financial and narrative reporting arrangements, the effectiveness of the internal controls over financial reporting and the risk management framework, whistleblowing arrangements and each of the internal and external audit processes.

The Audit Committee reports to the Board on how it discharges its responsibilities and makes recommendations to the Board, all of which have been accepted during the year. A full list of responsibilities is detailed in the Committee’s terms of reference, which can be found at www.lloydsbankinggroup. com/our-group/corporate-governance

COMMITTEE COMPOSITION, SKILLS AND EXPERIENCE

The Committee acts independently of the executive to ensure that the interests of the shareholders are properly protected in relation to financial reporting and internal control.

All members of the Committee are independent Non-Executive Directors, the majority with recent and relevant experience in finance and/or banking. Nick Luff is a chartered accountant and has significant financial experience in the UK listed environment enabling him to fulfill the role of Audit Committee Chair, and for SEC purposes the role of Audit Committee Financial Expert. In addition, Simon Henry is a certified accountant and has extensive knowledge of financial markets, treasury and risk management, and also qualifies as an Audit Committee Financial Expert under SEC rules.

HOW COMMITTEE MEETINGS ARE RUN

The management of the Committee is in keeping with the basis on which meetings of the Board are managed, as detailed on page 160, with a structure which facilitates open discussion and debate, with steps taken to ensure adequate time for members of the Committee to consider proposals which are put forward.

During the course of the year, the Committee held separate sessions with the internal and external audit teams, without members of the executive management present. During the year, the Committee met its key objectives and carried out its responsibilities effectively, as confirmed by the annual effectiveness review. Based on the outcomes of the annual board effectiveness review further efforts are being made to build upon improvements made in the previous year on the timeliness and quality of Committee papers, and additional opportunities for training for Committee members are being introduced.

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CORPORATE GOVERNANCE

Whilst the Committee’s membership comprises the Non-Executive Directors noted above, all Non-Executive Directors may attend meetings as agreed with the Chairman. The Group Audit Director, the external auditor, the Group Chief Executive, the Chief Financial Officer and the Chief Risk Officer also attend meetings of the Committee as appropriate.

MATTERS CONSIDERED BY THE COMMITTEE

During the year the Committee considered a number of issues relating to the Group’s financial reporting, these issues are summarised below, including discussion of the conclusions the Committee reached, and the key factors considered by the Committee in reaching its conclusions. In addition, the Committee considered a number of other significant issues not related directly to financial reporting, including internal controls, internal audit and external audit. These issues are also discussed in detail in the next section, including insight into the key factors considered by the Committee in reaching its conclusion.

HOW THE AUDIT COMMITTEE SPENT ITS TIME IN 2015

FINANCIAL REPORTING

 

During the year, the Committee considered the following significant financial issues in relation to the Group’s financial statements and disclosures, with input from management, Risk Division, Group Internal Audit and the external auditor:

 

KEY ISSUESActivities for the year
Key issues COMMITTEE REVIEW AND CONCLUSIONCommittee review and conclusion

Payment Protection Insurance (PPI)

DeterminingManagement judgement is used to determine the adequacy ofassumptions used to calculate the provision for redress payments and administration costsGroup’s PPI provision. The principal assumptions used in connection with the mis-selling of PPI is highly judgmental. The Group makes a number of assumptions aboutcalculation are the number of future complaints, thatthe extent to which they will be received including uphold rates for complaints received;upheld, the average redress payments;to be paid and related administrativeexpected future administration costs.

 

InDuring the 2015 full year results, an additional provision of £4,000 million was made for expected PPI costs. To 31 December 2015, the Group has provided a total of £16,025further £750 million in respect of PPI mis-sellingfor further operating costs and redress and administration costs.

as claims volumes were higher than previously expected.

 

The Committee continued to challenge management’s assumptions used to calculate the assumptions made by management to determine theGroup’s provision for PPI redress and associated administration costs. It alsoThe overall cost remains uncertain and the Committee reviewed management’s use of sensitivities used to evaluate this uncertainty.

The Committee reviewed management’s assessment of (i) the scope of the reviews required by the regulator; (ii)future customer claims management company activity; and (iii)volumes considering, inter alia, the potential impact of a consultation paper byregulatory changes; the Financial Conduct Authority on setting a deadline by which consumers would need to make their PPI complaintsFCA media campaign; claims management company and oncustomer activity; and the potential impactadditional remediation arising from the continual improvement of Plevin, all of which have significant impact on redress and administration costs.

The Committee oversaw continued use of sensitivities reflecting the uncertainty that remains around the ultimate cost of PPI.

Group Audit has reviewed the process used by management to calculate the PPI provision and has provided assurance to the Committee that the process uses reasonable, consistent and supportable assumptions and inputs.Group’s operational practices.

 

The Committee concluded that the processes followed by management in determining the provision for PPI redress continued to be appropriate and that the provisions and the Group’s external disclosures were appropriate.

The disclosures relating to PPI are set out in note 39:37: ‘Other provisions’ on page F-58 of the financial statements.

Other conduct provisions

During 2015 the Group has made provisions for a number of other conduct related matters, including potential redress in respect of Packaged Bank Accounts which required assumptions to be made, based on management judgement.

 

For Packaged Bank Accounts,In 2018, the Committee understood the basisGroup made provisions totalling £600 million in respect of other conduct   matters, including £151 million for determining expected complaints levels, the rangesecured and unsecured arrears handling activities; and £45 million in respect of potential redress paymentspackaged bank accounts.

There were relatively few new conduct matters in 2018 and the adequacy of provisions made for operational costs for the expected durationmajority of the programme.provisions raised in 2018 related to issues caused prior to the implementation of the Group’s Conduct Strategy in 2013.

The Committee has monitored developments on the Group’s secured and unsecured arrears handling activities, including the impact of the Group’s enhanced data capabilities and the risks emerging around operational costs.

 

Group AuditThe Committee has undertaken a reviewalso reviewed management’s assessment of the process that has been establishedprovision required for packaged bank accounts, including estimates made in respect of future complaint volumes and maintained by management to calculate the extent of conduct related provisions; and has provided assurance to the Committee that the process uses reasonable, consistent, supportable assumptions and inputs.uphold rates.

 

The Committee was satisfied that the provisions for other conduct matters were appropriate. The disclosures relating to other conduct provisions are set out in note 39:37: ‘Other provisions’ on page F-58 of the financial statements.

Allowance for impairment losses on loans and receivablesadvances

DeterminingThe Group adopted IFRS 9 on 1 January 2018 and issued a   transition document setting out the appropriateness ofimpact on the Group. IFRS 9   differs significantly from the previous impairment standard (IAS 39) as it requires impairment losses to be recognised on an expected loss (rather than incurred loss) basis. As a result, the Group’s impairment provision is judgementaldependent on management’s forward looking judgements on matters such as interest rates, house prices and requires the Group to make assumptions.

unemployment rates, as well as its assessment of a customer’s current financial position and whether it has suffered a significant increase in credit risk.

 

The Committee reviewed the Group’s transition document and was satisfied that it was appropriate.

Throughout 2018, the Committee challenged both the level of provisions madeprovision held by the Group, and the assumptionsjudgements and estimates used to calculate the impairment provisions heldprovision. It reviewed on a regular basis the Group’s analysis by stage of its drawn and undrawn balances and its coverage ratios for the Group.

Group Audit has assessed the effectiveness of impairment governance processes and reported their findings to the Committee.

Group’s lending portfolios. The Committee was satisfied that the impairment provisions, and associated disclosures, were appropriate.

Management has designed its disclosures so that they comply with the requirements of the accounting standard, provide relevant information to users to gain an understanding of the new concepts and include sensitivities of assumptions where appropriate.

The disclosures relating to impairment provisions are set out in note 53:20: ‘Allowance for impairment losses’ and note 52: ‘Financial risk management’ on page F-90 of the financial statements. The allowance for impairment losses on loans and advances to customers at 31 December 2018 was £3,150 million (1 January 2018: £3,223 million).

Ring-fencing

In readiness for the ring-fencing regime, which came into force on 1 January 2019, the Group has transferred certain businesses, and assets and liabilities out of Lloyds Bank plc and Bank of Scotland plc (together, the ring-fenced bank) and their subsidiaries to other parts of the Group, including the Group’s non ring-fenced bank, Lloyds Bank Corporate Markets plc (LBCM). For each transfer, the principal accounting judgement considered by management was whether it involved the transfer of a business or a transfer of assets and liabilities.

The Committee discussed the controls and accounting aspects of the Group’s activities to establish its non ring-fenced bank, including the intra-group transfers made to ensure that the Group’s activities were appropriately separated. Two examples of these transfers included the transfer of Scottish Widows from Lloyds Bank plc to Lloyds Banking Group plc and the migration of a number of businesses and customer assets from Lloyds Bank plc to LBCM.

The Committee was satisfied that the control framework established by management to mitigate the financial control risks associated with the transfers was adequate and that the judgements used to determine the accounting for the transfers were appropriate.

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CORPORATE GOVERNANCE

Key issuesCommittee review and conclusion

Retirement benefit obligations

The value of the Group’s defined benefit pension plan obligations is determined by making financial   and demographic assumptions, both of which are significant estimates made by management.

The Committee considered the most critical assumptions underlying the calculation of the defined benefit liabilities, including those in respect of the discount rate, inflation and mortality.

The Committee was satisfied that management had used appropriate assumptions that reflected the Group’s most recent experience and were consistent with market data and other information.

The Committee was satisfied that the Group’s quantitative and qualitative disclosures made in respect of retirement benefit obligations are appropriate. The relevant disclosures are set out in note 35: ‘Retirement benefit obligations’ of the financial statements. The defined benefit obligation at 31 December 2018 was £41,092 million (31 December 2017: £44,384 million).

Recoverability of the deferred tax asset

A deferred tax asset can be recognised only to the extent that it is more likely than not to be recoverable. Where aThe recoverability of the deferred tax asset arises fromin respect of carry forward losses requires consideration of the future levels of the Group’s taxable profit and the legal entities in which the Group must be assessed.

profit will arise.

 

The Committee considered the recognitionhas reviewed management’s assessment of deferred tax assets, in particular legal entity forecast taxable profits based on the Group’s operating plan, the split of these forecasts by legal entity and the Group’s long-term financial and strategic plans. Management’s forecasts included estimates of the impact of the changes in the Group’s structure made to comply with ring-fencing requirements.

 

The Committee considered the impact on deferred tax assets of changes in tax legislation and the removal of the ability to offset customer redress costs against taxable profits.

The Committee agreed with management’s judgement that the deferred tax assets were appropriately supported by forecast taxable profits, taking into account the Group’s long-term financial and strategic plans. The disclosures relating to deferred tax are set out in note 3: Critical accounting estimates and judgements on page F-21 and note 38:36: ‘Deferred tax’ on page F-56 of the financial statements.
175

CORPORATE GOVERNANCE The Group’s net deferred tax asset at 31 December 2018 was £2,453 million (31 December 2017: £2,284 million).

KEY ISSUESCOMMITTEE REVIEW AND CONCLUSION

Uncertain tax positions

The Group has open tax matters which require it to make judgements about the most likely outcome for the purposes of calculating its tax position.

 

The Committee took account of the respective views of both management and the relevant tax authorities when considering the uncertain tax positions of the Group were considered taking into account the respective views of management and the views of the relevant tax authorities.Group. The Committee also understood the external advice obtained by management to support the views taken.

 

The Committee was satisfied that the provisions and disclosures made in respect of uncertain tax positions were appropriate. The relevant disclosures are set out in note 49:47: ‘Contingent liabilities and commitments’ on page F-70 of the financial statements.

Retirement benefit obligations

The Group must make both financial and demographic assumptions of a judgemental nature to determine the value of the defined benefit obligation.

As in previous years, the Committee considered the assumptions underlying the calculation of the defined benefit liabilities, in particular the discount rate and mortality assumptions which, following the completion of the triennial funding valuation, have been updated to reflect recent experience.

The Committee was also satisfied that the Group’s quantitative and qualitative disclosures made in respect of retirement benefit obligations are appropriate. The relevant disclosures are set out in note 37: ‘Retirement benefit obligations’ on page F-51 of the financial statements.

Value-In-ForceValue-In- Force (VIF) asset and insurance liabilities

Determining the value of the VIF asset and insurance liabilities is judgemental and requires management to make significant estimates for both economic and non-economic actuarial assumptions.

 

The Committee challengedreceived a paper from the Group’s Insurance Audit Committee summarising its activities, which included a review of the economic and non-economic actuarial assumptions made by management to determine the Group’s VIF asset and insurance liabilities. The Committee reviewed this paper and discussed the movements in the key assumptions since 31 December 2014.made by management.

 

The Committee was satisfied that the value and associated disclosures of the VIF asset (2018: £4,762 million; 2017: £4,839 million) and liabilities arising from insurance liabilitiescontracts and participating investment contracts (2018: £98,874 million; 2017: £103,413 million) were appropriate. The disclosures are set out in note 25 on page F-42 and note 33 on page F-47 of the financial statements.

Adjustment to derivative valuations

Determining the credit, debit and funding valuation adjustments for uncollateralised derivative transactions requires management to make appropriate judgements on matters such as the creditworthiness of the derivative counterparty.

The Committee reviewed the methodologies for the Group’s derivative valuation adjustments, including management’s proposal to base future funding valuation adjustments on executed trades, rather than average interbank rates, and to include the adjustment in the valuation of all of the Group’s uncollateralised derivatives.

The Committee is satisfied that the proposed change and the disclosures set out in note 50 to the financial statements on page F-73 are appropriate.

Sale of interests in businesses

One-off transactions

Determining the appropriate accounting for the sale of shares in TSB Banking Group (TSB) requiredcertain one-off transactions requires management to make judgements when assessingassess the facts and circumstances specific to each tranche of the transaction.

 

Judgement was required to assess whenDuring the first half of 2018, the Group ceased to control TSB, at which pointsold its results and balance sheet were no longer consolidated inIrish residential mortgage portfolio for approximately £4 billion of cash consideration. The Committee reviewed the Group’s accounts, andaccounting proposed by management, including the recognition of a £105 million loss on disposal recognised.and the derecognition of the assets from the Group’s balance sheet, and was satisfied that it was appropriate.

During June 2018, the Group sold its 3.3 per cent stake in Standard Life Aberdeen for £344 million. The Committee reviewed management’s proposed accounting, which had no impact on the Group’s income statement as the investment was classified as ‘at fair value through other comprehensive income’. The Committee was satisfied that the accounting was appropriate.

Future accounting standards

The Committee has discussed the requirements of IFRS 16 (Leases), which the Group adopted on 1 January 2019; and IFRS 17 (Insurance Contracts), which is expected to come into force for the year ending 31 December 2022.

The Committee discussed the Group’s approach to the new leasing standard (IFRS 16) noting that the principal impact of the standard on the Group was to bring its property leases ‘on-balance sheet’. The impact on the Group’s balance sheet at 1 January 2019 was to recognise a right of use asset and a corresponding liability of approximately £1.8 billion.

It also discussed the Group’s approach to the changes required by IFRS 17 noting that this standard will fundamentally change the accounting for insurance products, requiring that the profit be recognised over the life of the contract rather than permitting immediate up-front profit recognition.

 

The Committee was satisfied with the Group’s disclosure included in its ‘Future accounting treatmentdevelopments’ note to the financial statements setting out the impact of the various tranches of TSB shares sold.

Following the offer made by Visa Inc to purchase Visa Europe Limited, management judgement was required to determine an appropriate carrying value of the Group’s interest in Visa Europe.The interest in Visa Europe is carried as an available-for-sale financial asset. The Committee reviewed management’s assessment of its valuation having regardaccounting standards that were not effective for the terms of the offer made by Visa Inc and concurred with the view taken by management.

Hedge accounting

Determing the appropriateness of hedge accounting adjustments is a complex process requiring the identification and on-going monitoring of a large number of accounting hedge relationships.

The Committee received periodic reports on the Group’s hedge accounting strategies, and challenged management on the reasons for any proposed change to existing practices and the appropriateness of any new strategy.

The Committee was satisfied that the changes proposed by management to the Group’s hedging strategies were appropriate.Group at 31 December 2018.

OTHER SIGNIFICANT ISSUES

The following matters were also considered by the Committee:

Risk management and internal control systems

Full details of the internal control and risk management systems in relation to the financial reporting process are given within the risk management report on pages 46 to 120. Specific matters that the Committee considered during the year included:

–  the effectiveness of systems for internal control, financial reporting and risk management;

–  the extent of the work undertaken by the Finance teams across the Group and consideration of the resources to ensure that the control environment continued to operate effectively;

–  the major findings of internal investigations into control weaknesses, fraud or misconduct and management’s response along with any control deficiencies identified through the assessment of the effectiveness of the internal controls over financial reporting under the US Sarbanes-Oxley Act; and

– 3 Lines of Defence, where Group Audit led an assessment of the effectiveness of such arrangements during the first half of the year, and reported regularly to the Committee on progress made by management against actions raised as part of this assessment.

The Committee was satisfied that internal controls over financial reporting were appropriately designed and operating effectively.

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CORPORATE GOVERNANCE

 

Group Audit

Other significant issues
The following matters were also considered by the Committee during the year:
RISK MANAGEMENT AND INTERNAL CONTROL SYSTEMS
Full details of the internal control and risk management systems in relation to the financial reporting process are given within the risk management section on pages 41 to 103. Specific matters that the Committee considered for the year included:
the effectiveness of systems for internal control, financial reporting and risk management
the extent of the work undertaken by the Finance teams across the Group to ensure that the control environment continued to operate effectively
the major findings of internal investigations into control weaknesses, fraud or misconduct and management’s response along with any control deficiencies identified through the assessment of the effectiveness of the internal controls over financial reporting under the US Sarbanes-Oxley Act
The Committee was satisfied that internal controls over financial reporting were appropriately designed and operating effectively.
GROUP INTERNAL AUDIT
In monitoring the activity, role and effectiveness of the internal audit function and their audit programme the Committee:
monitored the effectiveness of Group Internal Audit and their audit programme through quarterly reports on the activities undertaken and a report from the Quality Assurance function within Group Internal Audit
approved the annual audit plan and budget, including resource and reviewed progress against the plan through the year
assessed Group Internal Audit’s resources and skills (supplemented by externally sourced subject matter experts as required) as adequate to fulfil its mandate
oversaw Group Internal Audit’s progress against the 2017 External Quality Assessment
considered the major findings of significant internal audits, and management’s response

 

In monitoring the activity, role and effectiveness of the internal audit function and their audit programme the Committee:

–  monitored the effectiveness of Group Audit and their audit programme through quarterly reports on the activities undertaken and a report from the Quality Assurance function within Group Audit;

–  approved the annual audit plan and budget and reviewed progress against the plan through the year;

–  considered the major findings of significant internal audits, and management’s response; and

–  reviewed thematic audits completed during the period which included topics on customer outcomes, operational resilience and embedding of the Risk Management Framework.

Speak Up (the Group’s whistleblowing service)SPEAK UP (THE GROUP’S WHISTLEBLOWING SERVICE)

 

The Committee received and considered reports from management on the Group’s whistleblowing arrangements. The Committee reviewed the reports to ensure there are arrangements including summariesin place which colleagues can use in confidence to report concerns about possible improprieties in financial reporting or other matters, and that there is proportionate and independent investigation of cases and ongoing reviews of the Whistleblowing Governance Structure. On consideration ofsuch matters or appropriate follow up. Of the reports submitted, the Committee was satisfied with the actions which had been taken, the reports first having been considered and approved by the Board’s Whistleblowing Champion, Anita Frew.taken.

Auditor independence and remunerationAUDITOR INDEPENDENCE AND REMUNERATION

 

Both the Board and the external auditor have safeguards in placepolicies and procedures designed to protect the independence and objectivity of the external auditor. TheIn 2018, the Committee has a comprehensiveamended its policy to regulateon business recovery services provided by the useauditor in respect of the Group’s customers to reflect revisions made by the Financial Reporting Council (FRC) to its rules. To ensure that there is an appropriate level of oversight by the Committee, the policy sets a financial threshold above which all non-audit services provided by the external auditor must be approved in advance by the Committee; the policy permits senior management to approve certain engagements with fees for amounts below the threshold. The policy also details those services that the Committee prohibits the external auditor from providing to the Group; these are consistent with the non-audit services.

In some cases, PwC are selected over another service provider dueservices which the FRC considers to their detailed knowledge and understanding of the business. Any allowable non-audit service with a value above a defined fee limit requires prior approval from the Audit Committee Chairman.be prohibited. The total amount of fees paid to the auditor for both audit and non auditnon-audit related services in 20152018 is disclosed in note 1112 to the financial statements on page F-30. The decrease against the prior year largely relates to fees incurred in 2014 in respect of assurance services provided by PwC ahead of the Initial Public Offering of TSB in June 2014.statements.

 

External auditorEXTERNAL AUDITOR

 

The Committee oversees the relationship with the external auditor. During the year, the Committee considered the auditors’auditor (PwC) including its terms of engagement (including remuneration), theirand remuneration, and monitors its independence and objectivity,objectivity. Mark Hannam has been PwC’s senior statutory audit partner for the Group and approved the Company since the beginning of 2016, and attends all meetings of the Committee. During 2018, the Committee reviewed PwC’s audit plan, (includingincluding the underlying methodology, and PwC’s risk identification processes).

Theprocesses. In its assessment of PwC’s performance and effectiveness, the Committee also consideredhas considered: PwC’s interactions with the effectivenessCommittee; the responses to a questionnaire issued to the Group’s businesses, Finance, Risk and performance of the auditorInternal Audit; and the audit process. These assessments considered data and information from a number of sources including:

–  the results of an internal effectiveness survey; and

–  the Financial Reporting Council’s (FRC) 2015FRC’s Audit Quality Inspection Report (AQIR) on PwC published in May 2015.

June 2018. In addition, the FRC’s Audit Quality Review team reviewed PwC’s audit of the Group’s 2017 financial statements as part of its latest annual inspection of audit firms. The Chairman and the Committee received a copy of the findings and discussed them with PwC. Whilst there were no significant findings, some areas of PwC’s audit procedures were identified as needing limited improvements only. The Committee concluded that it was satisfied with the auditor’s performance and recommended to the Board a proposal for the reappointmentre-appointment of the auditor to be approved at the Company’s AGM.

 

Statutory Audit Services complianceSTATUTORY AUDIT SERVICES COMPLIANCE

 

The companyCompany and the Group confirms itsconfirm compliance with the provisions of The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014 (the ‘Order’) for the year to 31 December 2015.

2018. PwC havehas been auditor to the companyCompany and the Group since 1995, having previously been auditor to certain of the Group’s constituent companies.

PwC werewas re-appointed as auditor with effect from 1 January 2016 as part offollowing a tenderingtender process conducted during 2014.in 2014 in respect of the audit contract for the 2016, and subsequent, financial years.

During 2018 the Group carried out a formal review to choose its auditor for the year ended 31 December 2021. In accordance with the Order, PwC was excluded from this review. In October 2018, the Board (following the recommendation of the Audit Committee) approved the proposed appointment of Deloitte LLP. A recommendation for approval of this appointment will be made to the shareholders at the 2021 Annual General Meeting and subject to shareholder approval, Deloitte LLP will undertake the Group audit for the year ending 31 December 2021.


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BOARD RISK COMMITTEE REPORT

TheBoard Risk Committee continues to set the tone from the top on risk management and embedding risk culture.report

 Committee meetings
 Eligible to attendAttended
Committee Chairman   
Alan Dickinson88 
Committee members who served during 2015   
Lord Blackwell88 
Anita Frew88 
Simon Henry871
Deborah McWhinney2–– 
Dyfrig John88 
Nick Luff88 
Nick Prettejohn873
Anthony Watson88 
Sara Weller88 

 

1 Mr Henry was unable
The environment within which the Group operates is increasingly subject to attendconsiderable change.

Dear Shareholder

I am pleased to report on how the MayBoard Risk Committee meeting due to prior executive commitments.

2Joined(the ‘Committee‘) has discharged its responsibilities throughout 2018.

During the year, the Committee gave detailed consideration to a wide range of existing and emerging risks, recognising that the environment within which the Group operates is increasingly subject to considerable change. This is achieved through effective planning of the agenda which ensures specific attention is given to those emerging risks which are considered to be of ongoing importance to the Group and its customers, alongside standing areas of risk management. The Committee continues to make use of dedicated sub-committees to provide additional focus on 1 December 2015. Noparticular areas of significance.

The Committee meetingconsidered delivery of key regulatory change programmes such as ring-fenced banking, together with other areas of regulatory attention such as data governance and operational resilience, where the Group continues to strengthen its control environment. Focus was heldalso given to management of customer rectifications, where good progress continued to be made with reduction of the volume of rectification programmes and customers impacted. Stress testing undertaken by the Group, which included the impacts of IFRS 9 for the first time and considered the potential impacts of severe economic scenarios on the Group’s business model, also continued to be reviewed and challenged by the Committee. Each of these areas will be subject to ongoing focus in December.

32019.

Looking ahead, other areas of focus will include continued improvements in the Group’s treatment of customers in financial difficulty, and consumer indebtedness more generally, operational resilience and ever evolving cyber risks, together with risks associated with delivery of the Group’s overall strategy and change portfolio. Uncertainties, particularly around the EU Exit, inevitably continue to provide challenges and potential impacts for the Group’s risk profile; the Committee continues to closely monitor developments in these areas.

The Committee has concluded that the Group continues to have strong discipline in the management of both emerging and existing risks, and the Committee’s work continues to

Mr Prettejohn was unable to attend

help support the May Risk Committee meeting due to prior executive commitments.

Chairman’s overviewGroup in achieving its core aim of operating as a digitised, simple, low risk financial services provider.

 

I am pleased to have this first opportunity to write to you as Chairman of the Board Risk Committee, with our report on how the Committee discharged its responsibilities in 2015.

We have continued to take a dynamic approach to the review of existing and emerging risks, balancing our agenda to include standing areas of risk management, whilst ensuring key risks which have emerged during the course of year are escalated for the Committee’s consideration. Considerable time has been spent by the Committee in making sure that satisfactory action is taken in the management of risk arising from the Group’s material lending portfolios, notably our Mortgage and Commercial lending. Good progress has been made during the year in further understanding the underlying risks and enhancing risk management.

I would also like to highlight the Committee’s work in helping to achieve the core aim of operating as a safe, low risk bank, where we consider the Group has made good progress. We have seen deeper embedding of a strong risk culture helping to deliver further reduction in overall risk levels compared to 2014.

Considerable time has also been spent in the review of risks relating to the resilience of IT systems and cyber security, an area of major importance to the Group. Management has taken material action to address these issues, a position the Committee will continue to monitor closely in 2016.

As in previous years, the Committee has regularly considered in detail the Consolidated Risk Report, discussed further on page 180, which provides a comprehensive overview of the various categories of risk management, including an assessment of adherence to risk appetite limits set by the Board.

The Committee has concluded that the Group continues to have strong discipline in the management of both emerging and existing risks and has taken further positive steps towards achieving the objective of operating a safe, low risk bank. The environment in which the Group operates continues to change rapidly and the Committee will continue to review emerging and inherent risks with that objective very much in mind.

Alan Dickinson

Chairman, Board Risk Committee

 

COMMITTEE PURPOSE AND RESPONSIBILITIESCommittee purpose and responsibilities

 

The purpose of the Board Risk Committee is to review the risk culture of the Group, setting the tone from the top in respect of risk management. The Committee is also responsible for ensuring the risk culture is fully embedded and supports at all times the Group’s agreed risk appetite, covering the extent and categories of risk which the Board considers as acceptable for the Company.Group.

 

In seeking to achieve this, the Committee assumes responsibility for monitoring the Group’s Risk Management Framework, which embraces risk principles, policies, methodologies, systems, processes, procedures and people. It also includes the review of new, or material amendments to risk principles and polices,policies, and overseeing any action resulting from material breaches of such policy.

 

More details on the Group’s wider approach to risk management can be found in the Risk Managementrisk management section on pages 4641 to 120.103. Full details of the Committee’s responsibilities are set out in its terms of reference, which can be found at www.lloydsbankinggroup.com/our-group/corporate-governance

 

COMMITTEE COMPOSITION, SKILLS AND EXPERIENCECommittee composition, skills, experience and operation

 

Alan Dickinson, became ChairChairman of the Board Risk Committee, on 1 January 2015, taking over responsibility from Anita Frew. Alan is a highly regarded Retailretail and Commercialcommercial banker, having spent 37 years with the Royal Bank of Scotland, most notably as Chief Executive of RBS UK, overseeing the group’s Retail and Commercial operations in the UK. The Committee is composed of independent Non-Executive Directors, who provide core banking and risk knowledge, together with breadth of experience which brings knowledge from other sectors, and a clear awareness of the importance of putting the customer at the centre of all that the Group does.

 

Whilst the Committee is made up of the Non-Executive Directors noted above, the Non-Executive Directors who were not members of the Committee routinely attended meetings during 2015. Stuart Sinclair was appointed as an independent Non-Executive Director and a member of the Committee on

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4 January 2016, and from January 2016, allAll Non-Executive Directors are members of the Board Risk Committee. The Chief Risk Officer has

full access to the Committee and attends all meetings, the Group Audit Directormeetings. The Chief Internal Auditor and members of the Executive also attend meetings, as appropriate.

 

During the yearAnnually the Committee met its key objectives and carried out its responsibilities effectively, as confirmedundertakes an effectiveness review. The review forms part of the Board evaluation process with Directors being asked to complete parts of the questionnaire relating to the Committees of which they were members. The findings of the review were considered by the annual effectiveness review.

HOW COMMITTEE MEETINGS ARE RUN

The managementCommittee at its January 2019 meeting. On the basis of the evaluation, the feedback was that the performance of the Committee is in keeping with the basis on which meetingscontinues to be effective. Details of the Board are managed, as detailedCommittee membership and meeting attendance can be found on page 160, with a structure which facilitates open discussion and debate. Steps are taken to ensure adequate time for members to consider proposals which are put forward.133.

 

As the most senior risk forumcommittee in the Group, the Committee interacts with other related risk forums,committees, including the Executiveexecutive Group Risk Committee. Such interaction assists with the agenda planning process, where in addition to annual agenda planning, matters considered by the Group Risk Committee are reviewed to ensure escalation of all relevant matters to the Board Risk Committee.

 

MATTERS CONSIDERED BY THE COMMITTEEMatters considered by the Committee

 

Over the course of the year the Committee considered a wide range of risks facing the Group, both standing and emerging, across all key areas of risk management, in addition to risk culture and risk appetite, as noted above.

 

As part of this review, certain risks were identified which required further detailed consideration. Set out belowon the following pages is a summary of these risks, with an outline of the material factors considered by the Committee, and the conclusions which were ultimately reached.

 

HOW THE BOARD RISK COMMITTEE SPENT ITS TIME IN 2015

KEY RISKSCOMMITTEE REVIEW AND CONCLUSION

Conduct risk

The Committee continues to focus closely on the Group’s approach to conduct risk.

As highlighted in several of the individual sections below, the Committee seeks to ensure that conduct risk is considered and reviewed to ensure the highest standards are applied. For further detail see the sections on Low Risk Bank, Consolidated Risk Report and Divisional Risk Profiles. In addition the Committee considered reports on complaints, rectifications, conduct risk appetite metrics and product governance.

Conclusion: Whilst a great deal has been achieved as a result of the Group’s conduct strategy initiatives, which continue to transition into business as usual management, improving the Group’s conduct risk profile remains a priority for the Group in 2016 and will continue to be a subject of focus for the Committee.During 2018, the Committee continued to utilise established sub-committees to provide additional focus on areas such as IT resilience and cyber, and stress testing and recovery planning. These sub-committees enable members of the Committee to dedicate additional time and resource to achieving a more in-depth understanding of the topics covered, and enable further review and challenge of the associated risks.

Material lending portfolios

Review was undertaken of the risks associated withthe Group’s material lending portfolios, including the key Retail mortgage portfolio and the Commercial portfolio.

In reviewing the material lending portfolios, consideration was given to the quality and size of the lending books, with additional review of the quality of new lending, potential levels of impairments and overall levels of sector concentration. The performance of these portfolios in ’stressed’ situations was also considered, in order to determine their resilience in a wide range of adverse conditions.

Conclusion: Management continues to take satisfactory action in addressing the risks arising from these key lending portfolios, and the Committee will continue to review these core aspects of the Group’s business during the course of 2016.

Low risk bankConsiderable time was devoted to reviewing progress with the Group’s stated aim of operating asa simple, low risk, customer focused bank, generating stable and sustainable earnings.

In assessing progress during the year in achieving this important objective, a number of factors were considered, including financial, operational and credit risk metrics, with particular attention given to assessing progress in delivering the Group’s conduct strategy. Review of the Group’s progress and risk profile in these areas was also considered relative to its financial services peer group. Delivering greater customer focus is a core requirement of the low risk strategy, and was a further important consideration in the Committee’s assessment of the steps taken during the year.

Conclusion: The Group continues to move further towards achieving its stated aim of operating as a low risk bank, and compares favorably in most related areas of assessment with its peer group, with particularly good progress in lowering levels of risk in respect of conduct, capital management and credit quality. As further management initiatives to deliver the Group’s low risk aims are implemented, the Committee will continue to review progress made during the course of the coming year.

IT resilience and cyber security
The risks posed in respect of cyber security and the overall resilience of the IT systems has been a central area of focus for the Committee, acknowledging the increased threat posed to the Group’s business by online crime.

The adequacy of arrangements for IT operational resilience were considered in detail, including the levels of complexity and automation in the Group’s IT systems, with emphasis on processes which underpinned services critical to day to day operations, in particular those with immediate customer impact. In respect of cyber security, consideration was given to areas including possibilities for malicious access and removal of information from systems, and the ability of the Group to detect such attacks.

A variety of exercises were undertaken to test the resilience of IT and cyber security arrangements, with considerable time spent reviewing the results of these exercises and considering the recommendations of management to provide enhancements to these arrangements. In particular the delivery of the Group’s related Cyber Security and IT Resilience programmes was reviewed. Consideration was also given to the Group’s position in the context of its wider banking sector peers.

Conclusion: Whilst much has been achieved in respect of IT resilience and cyber security initiatives, including enhancements delivered to increase resilience to cyber threats, and evidence of a more unified approach to IT resilience, work in respect IT resilience and cyber security will remain an important area for the Group in 2016, and will continue to be reviewed by the Committee.

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ACTIVITIES DURING THE YEAR 

CORPORATE GOVERNANCE

KEY RISKS
Key issuesCommittee review and conclusion
CONDUCT RISK COMMITTEE REVIEW AND CONCLUSION

Stress testing

The review of stress testing exercises and their results was a key area of focus during the year.

The stress testing scenarios considered by the Committee were diverse, including internally modelled scenarios involving factors such as material economic downturns and large scale cyber-attack, with further consideration of stress testing against a number of external scenarios, including those set by the PRA.

Assessment was made of the impacts in these scenarios on a range of metrics relating to resilience in adverse conditions, including amongst others impacts on the Group’s capital and liquidity positions, in particular the impact on the tier one common capital ratio. Comparison in each scenario of the Group’s position relative to its competitors was also undertaken, with detailed review of the mitigating actions proposed by management in each scenario.

Conclusion: The Group’s capital and liquidity positions remained above required minimums in testing against both internal and external scenarios, with outcomes in most scenarios remaining above the wider risk appetite targets set by the Board. The implementation and assessment of robust and well managed stress testing arrangements will remain a key area of focus for the Committee in the coming year.

Consolidated risk report

Review was undertaken on a regular basis of a consolidated report on key aspects of risk management across the business, both existing and emerging risks, including assessment of adherence to risk appetite limits set by the Board.

The Consolidated Risk Report enables review of all core areas of risk management, including Capital, Credit, Operational, Regulatory and Conduct risk amongst others, providing further analysis of key component areas of risk management under each of these headings. Consideration was given not only to the risk management position on a ‘point in time’ basis, but also on a ‘look forward’ basis, with rolling 12 month forecasts , including review of proposed management action to address key risks as they develop.

Conclusion: The Consolidated Risk Report has assisted the Committee in its assessment of the Group’s management of both existing and emerging risks, with ongoing progress being made to embed policies and practice required to mitigate common areas of risk, and sufficient levels of agility within the organisation to address emerging risks as the Group’s operating plan continues to develop.

Divisional risk profiles

In addition to the Consolidated Risk Report, detailed summaries of risk management across each of the Group’s main operating divisions were also considered.

Focus was given to unique areas of risk management within each division, in addition to review of divisional performance in areas of risk management common across the business, including conduct risk management, portfolio concentrations, market conditions, and the overall quality of both new and existing business.

Detailed comparisons of the approach to the management of risk within each division were also considered, including any significant differences in approach, and any instances of potential best practice which could be implemented across the Group. Common and emerging trends were also highlighted.

Conclusion: Key risks continue to be well managed within each of the Group’s main operating divisions, with action taken within each business to address risks which are specific to that division. Such action is aided by the unified approach taken in addressing risks which are common across all areas of the Group, including improving management of conduct risks.

Emerging risks

Achieving the Group’s ‘low risk’ ambitions requires review of the material risks emerging, in particular in relation to the Group’s operating plan, assessing their likely impact and agreeing appropriate mitigants.

The constantly evolving regulatory and economic landscapes in which the Group operates, both within the UK and overseas, have been important factors in assessing emerging risk, and agreeing mitigating actions where material change is anticipated.

Areas of focus have included the opportunities and risks emerging from developments in technology, in particular in relation to the Group’s ambition of improving its digital and technological capabilities in delivering for customers. Risks arising from the implementation of banking sector ring-fencing legislation have also been an important consideration, ensuring adequate forward planning is undertaken to address anticipated risks as requirements in this area continue to emerge.

Conclusion: The Group has a good understanding and oversight of its emerging risk position, and takes steps to mitigate the impacts of new risks as they appear, ensuring close alignment in its assessment of emerging risks with developments in both the Group’s business model and its external regulatory and economic environment.

Banking reform

Review was undertaken of the Group’s implementation of Banking Reform, including Senior Managers and Certification Regime and Ring Fenced Banking.

A number of initiatives are in course across the organisation to implement the provisions of the Financial Services (Banking Reform) Act (the ‘Act’), including projects to enable the implementation of the Senior Managers and Certification Regime, and also the requirements of ring-fenced banking.

Conclusion: As part of its review of these arrangements the Committee concluded there continues to be action needed to fully implement the requirements of the Act, as detailed provisions continue to emerge, however the Group is well placed to respond to the ongoing requirements and future developments.

Pensions risk

Risks arising from the Group’s various pension arrangements were reviewed, in light of ongoing changes in actuarial profiles.

Factors considered by the Committee in the assessment of pensions risk included levels of risk appetite in relation to overall pension provision, with particular consideration of projected future asset performance in changing economic conditions. The risks posed in respect of certain market events were also assessed, including potential interest rate and inflation changes, and also the impact on Group pension schemes of ongoing improvements in life expectancy.

Conclusion: Despite the impact of wider macro-economic uncertainty, and the potential impact on underlying investments, the levels of risk in relation to the Group’s pension schemes continue to be well managed and remain within risk appetite for the Group

180
 
The Committee continues to focus closely on the Group’s management of customer rectifications.Throughout 2018 the Committee has considered reports on the Group’s rectifications portfolio performance, particularly the initiatives to reduce the number of customers with outstanding remediation. The Committee has noted substantial progress in the pace and quality of remediation in delivering a reduction in the number of customers awaiting redress and expect improvements in the time taken to deliver the right customer outcomes. The Committee has remained close to progress on material rectifications, including HBOS Reading.

Conclusion: Root cause analysis and read-across activities continue to improve and embed across the Group with good progress in reducing the volume of rectification programmes and customers impacted. This will remain a key focus for the Committee.
The Committee continues to focus closely on the Group’s management of conduct risks and issues associated with customers in financial difficulty.In 2018 the Committee considered reports on the progress of resolution of conduct issues affecting customers in financial difficulty. Key focus areas included pace and quality of remediation and analysis of lessons learned to prevent similar issues from arising in the future. The Committee also considered the progress made in transforming our approach to helping customers in financial difficulty and improving customer outcomes.

Conclusion: Whilst good progress had been made, ongoing improvement in the Group’s treatment of customers in financial difficulty will continue to be an area of focus.
FINANCIAL RISK – COVERING CREDIT AND MARKET RISK
Reviews were undertaken of the Commercial Banking credit portfolio with a focus on sectors that have been impacted by slower economic growth.A detailed review of the portfolio was conducted, which considered the quality of the overall portfolio as well as newly originated business. The Committee reviewed sectors that have been impacted by slower economic growth or structural change, notably those that are linked to discretionary consumer spending, for example, retail, as well as areas such as commercial real estate, agriculture and leveraged finance.

Credit exposure and risk levels were monitored with reference to management information and risk appetite limits which included overall portfolio information as well as material individual exposures. The Committee also considered the Group’s approach to credit policies and individual transaction limits, and reviewed summary details of transactions and portfolio reviews that were assessed at the Group’s most senior credit committee.

Conclusion: Overall Commercial Banking credit quality remained stable. Origination quality has been maintained, supported by a consistent through-the-cycle approach to risk appetite. The portfolio continues to be monitored closely with consideration given to the macroeconomic outlook and emerging trends.
The Committee reviewed the risks relating to consumer lending indebtedness, PRA guidance on managing affordability risk, new FCA rules on Persistent Debt for credit cards, and residual value risk in Motor Finance.Consideration was given to regulatory feedback, the Group’s lending controls and risk appetite monitoring, new consumer lending indebtedness risk and the residual value risk profile in the Motor Finance portfolio.

The Committee noted that lending controls and risk appetite metrics for both indebtedness and affordability assessment are in place, and acknowledged the Group’s actions to closely monitor and control higher risk and marginal indebtedness segments and reduce exposure over time. The Committee reviewed progress against implementation of new FCA rules on Persistent Debt in the cards portfolio. Persistent Debt has decreased and further treatments are being tested to encourage higher levels of repayment. The Committee reviewed the progress being made to strengthen risk appetite limits and controls on residual value risk in the Motor Finance portfolio.

Conclusion: The Committee was satisfied that appropriate lending controls and monitoring are in place for affordability and indebtedness and noted progress made to strengthen these and improve visibility of customers’ debt positions, as well as ensure resilience in Motor Finance.
The Committee reviewed risks associated with the Group’s UK mortgage portfolio including interest only and buy-to-let lending.Consideration was given to the appropriateness of the Group’s credit risk appetite for new mortgage lending, risks inherent in the portfolio and comparative benchmarks of business mix and performance.

The Committee noted the credit quality of new business and reductions in the level of arrears across the portfolio. In line with our ‘Helping Britain Prosper Plan’, the Group participates more fully in lending to first time buyers and the buy-to-let market than our peer group. The Committee reviewed the additional credit controls that have been introduced to further reduce exposure to more marginal customers in these segments. The Committee also reviewed plans to address the risks associated with maturing interest only mortgages and noted progress made.

Conclusion: The Committee was satisfied that appropriate credit controls were in place to support continued market participation in line with the Group’s risk appetite limits, and that progress has been made on controls to address the risk of interest only lending.
The Committee continues to consider key economic risks, particularly given the increasingly uncertain outlook.During the year the Committee has increased consideration of macroeconomic risks impacting the Group’s central economics forecast incorporated into the Group’s Four-Year Operating Plan. The Committee has focused on economic and geo-political risks such as EU Exit and wider global economic risks, including US monetary policy, the impact of the US currency on emerging markets, trade wars, UK property markets and UK productivity.

Conclusion: The Committee will continue to closely monitor economic uncertainties, particularly arising from EU Exit. The Committee will also focus on risks emerging from the EU due to slower growth and political challenges, as well as risks from wider global events.

Rectifications CiFD Commercial credit quality Customer indebtedness Retail secured Economic update

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Key issuesCommittee review and conclusion
The Committee continues to review the key vulnerabilities of the Group to adverse changes in the economic environment, ensuring that there are adequate financial resources in the event of a severe yet plausible downturn.The Committee has reviewed the stress testing outputs from both the internal and regulatory exercises. This year, PRA stress testing included the impact of IFRS 9 for the first time, which requires us to recognise expected lifetime losses rather than reflecting incurred losses and accelerates loss recognition. This was a key area of focus and challenge at the Committee, which reviewed the evolution of balances through IFRS 9 stages under stress, and associated impairment impact. In addition the Committee assessed the usage and governance of models in the stress testing process to ensure the results were satisfactorily produced.

Conclusion: The Group continues to review the impact of severe economic scenarios on our business model, whilst the Committee ensures the necessary risk oversight via review and challenge of the internal and regulatory stress tests.
OPERATIONAL RISK
Operational resilience is one of the Group’s most important non-financial risks. Key focus in 2018 has been to enhance the existing approach to operational resilience and strengthen the control environment, to improve the Group’s ability to respond to incidents and continue delivering key services to our customers.Key areas of focus for the Committee have included updates on the Group’s cloud strategy, review of the updated operational resilience strategy and response to the Bank of England’s discussion paper. In addition, the Committee has reviewed papers relating to key risk reduction programmes including Identity and Access Management, insider risk and updates to the Group’s approach to managing its third-party suppliers.

Given the significance of the risk to the Group, the Committee has a sub-committee specifically focused on IT and cyber risks.

Conclusion: The Committee takes the operational resilience of its services very seriously and has taken valuable insight from having independent advice and guidance. It has agreed risk appetite statements for critical services and has strengthened these over the last period to reflect the increased focus on resilience. The Committee considers that governance of operational resilience risk is robust and that activities in plan will ensure the ongoing resilience of key services to the Group’s customers.
The Committee continues to focus on data governance and privacy risks including oversight of the Group’s compliance with the General Data Protection Regulation (GDPR), and the associated risks and controls.Data risk continues to be an area of significant regulatory and media attention and the Committee has overseen the implementation of robust governance, to ensure compliance with GDPR. Clear accountabilities have been established by the creation of Divisional Data Privacy Accountable Persons, driving a culture of compliance. A Group Data Protection Office (GDPO) has been established to independently oversee compliance. The Group continues to drive enhancements to the control environment to ensure value is harnessed from the data that we hold, enabling delivery against key strategic priorities, whilst ensuring transparency and trustworthiness to our customers and colleagues.

Conclusion: The Group continues to heighten the controls required to manage data risk. In 2019 data risk has been classified as a primary risk type.
The Committee recognises the importance of People risk management to ensure the Group has the right capabilities and culture as we build the Bank of the Future.The Committee continued to focus on the People risk profile, recognising the challenges faced in successfully delivering the Group strategic and extensive regulatory change agenda. The Group recognises the increasing demands on colleagues and is monitoring colleague wellbeing and engagement as well as developing colleague skills to achieve capability enhancement for a digital era. Particular consideration is given to critical and high performing individuals. The Group has made significant progress in evolving and refining the compliance control environment for the Senior Manager and Certification Regime (SMCR). The delivery of the SMCR extension will remain a focus for 2019.

Conclusion: The Committee provides oversight of People risk, which will remain a key focus as the Group delivers simplified colleague processes and maximises colleague skills and capability to achieve the workforce of the future.
The Committee continues to recognise risks associated with an extensive strategic change agenda, incorporating both discretionary and regulatory change. Focus areas include new execution risk metrics, effective change oversight and governance.Recognising the extent of our transformation agenda, the Committee has received regular monitoring of key change and execution risk indicators. Metrics have been developed and refined throughout the year, alongside regular reporting.

The effectiveness and model for change oversight has been reviewed and refreshed to ensure that there is risk-based assessment of strategic change activity. Similarly, the risk governance with respect to strategic change has been reviewed.

Conclusion: There is significant work needed to transform how change is delivered, impacting both capacity and required change capability. This reorganisation is happening concurrently with change delivery. Further focus is required to manage dependencies and associated risks alongside refinement of execution risk metrics, and change/execution risk reporting.
Negotiations continue to determine the final terms of the UK’s exit from the EU.

The ongoing uncertainty regarding the options, timing and the process itself could affect the outlook for the UK and global economy.		The key risks for the Group include volatility and possible discontinuities in financial markets, impact on our customers’ trading performance, financial position and credit profile, and ability to operate cross-border. When reviewing the possible impacts of the EU Exit, the Committee has given particular consideration to the Group’s strong UK focus and UK-centric strategy. The Committee continues to closely monitor developments, with specific focus on the trading, financial and operational impacts for the Group, and the continued support of our customers.

Conclusion: The EU exit plans continue to be closely monitored by the Committee via specific regular updates, a suite of early warning indicators and corresponding risk mitigation plans.

Stress testingOperationalresilienceData riskPeople riskChange andexecution riskEU Exitplanning

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Key issuesCommittee review and conclusion
Financial crime is a priority for the UK Government, law enforcement and regulators. The Committee continues to monitor the Group’s management of financial crime risk in light of significant regulatory change.The Committee considered the unprecedented volume of regulatory and legislative change, noting the Group’s response to the updated Money Laundering Regulations and UK Criminal Finances Act. Accordingly, the Committee reviewed the Annual Group Money Laundering Officer’s Report (MLRO report) and was satisfied with the standard of compliance detailed within. Additionally, the Committee acknowledged the strategic plans in place to continually improve the Group’s Financial Crime control framework.

The Committee noted the positive outcome of the FCA Systematic Anti-Money Laundering Programme review, recognising the Group’s ‘largely effective Financial Crime control framework’ and ‘strong tone from the top’. Additionally, the Committee noted the progress in the Group’s money mules strategy which has resulted in a significant improvement in the identification and prevention of illicit funds being laundered through Group accounts.

Conclusion: The Committee noted satisfaction with the standard of compliance documented in the MLRO report, and acknowledged the action plans in place across the Group to further enhance the Group’s position.
The Committee continues to closely monitor the Group’s management of fraud risk, whilst minimising the impact of controls on genuine customer journeys.The Committee considered the challenging and evolving nature of the fraud risk environment influenced by factors such as an increasing sophistication of fraud typologies, third-party data breaches, and an uplift in social engineering fraud. The Group continues to invest in new and innovative controls, as well as working in collaboration with the public sector to prevent, detect, and respond to fraud risks. As such, the Committee was updated on strategic plans which will deliver enhanced controls enabling the Group to continue to manage fraud risk within appetite. Additionally, the Committee acknowledged the leading role the Group has played in the development of an industry code for authorised push payment fraud. The code will be agreed in early 2019 and the Group is well positioned to manage the impact.

Conclusion: The Committee noted the positive work undertaken in the detection and prevention of fraud; acknowledged the need to maintain momentum, and therefore parity, with our peers; and, recognised the continuing efforts of the Group to protect the integrity of genuine customer journeys.
REGULAR REPORTING CATEGORIES
Managing regulatory risk continues to be a key focus within the Group due to the significant amount of highly complex and interdependent regulatory reform that we have managed in 2018, and will continue to manage in 2019.The Committee has continued focus on ensuring effective controls and oversight to comply with existing regulatory obligations, as well as receiving regular updates on emerging legal trends. There have been ongoing significant regulatory change programmes in which the Board has placed increased focus in order to ensure successful execution, including the Basel Committee on Banking Supervision (BCBS 239) and Markets in Financial Instruments Directive II. Due consideration to the governance and compliance of the ring-fenced bank has also been considered by the Committee, including monthly programme reporting until the ring-fencing legislation took effect.

Conclusion: The Group continues to place significant focus on complex regulatory changes, as well as ensuring effective horizon scanning of upcoming trends. Regulatory risk will remain a priority area of focus for the Committee in 2019.
The Committee continues to recognise the importance of the Group Executive and the Board holding a strong understanding of the Group’s models, their associated risks and performance.During the year the Committee discussed the current model risk profile, with specific focus on the new IFRS 9 Impairment models, trends in performance and actions being taken to resolve material model issues. The Committee considered wider model issues such as the increase in automation and analytics required to support the Bank’s strategic aims, regulatory issues and the action being taken by the Group to address these, as well as benchmarking the Group’s approach to model risk management compared to the industry.

Conclusion: Whilst good progress was made in 2018, the demand for models and model related activity is expected to continue to increase, with key drivers being the Group strategy, and the need to meet new regulatory requirements in the longer-term.
The Committee continues to focus on ensuring the Group is resolving customer complaints in a timely manner and eradicating the causes for complaints.The Committee continues to focus on ensuring the Group has an effective framework for managing complaints including root cause analysis to establish lessons learned and help prevent similar issues in the future. Consideration has been given to complaint metric performance and quality as measured by the Financial Ombudsman Service.

Conclusion: The Group continues to make good progress however focus needs to remain on reducing the reasons for customers to complain in 2019 and to learn from root cause analysis.
Vulnerable customers represent a significant proportion of the Group’s customer base and continue to be an area of close focus.The Committee considered progress on implementing the Group’s strategy for vulnerable customers which is aligned to UK Finance Vulnerability Taskforce Principles.

The Committee noted the actions in train, including enhanced guidance, more detailed evidencing of embedding, enhancement of the control framework and developing improved management information.

The Group’s signature actions for 2019 will focus on Mental Health, Critical Illness, Financial Abuse, Age Vulnerability and Access to Service.

Conclusion: The Committee recognise the ongoing activity and the progress made, coupled with the significant focus required to deliver effectively on both the Group’s aspirations and external expectations.

Moneylaundering FraudRegulatoryand legal riskModel riskComplaintsVulnerability

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Responsible Business Committee report

 

RESPONSIBLE BUSINESS COMMITTEE REPORT

The establishment of a Board Committee to oversee our responsible business activities demonstrates our commitment to doing
Doing business in a responsible way is key to the right way as we worksuccessful delivery of our purpose to help Britain prosper.

Prosper

 Committee meetings
 Eligible to attendAttended
Committee Chairman  
Sara Weller33
Committee members who served during 2015  
Lord Blackwell33
Anita Frew33

Chairman’s overviewDear Shareholder

I am delightedpleased to presentreport on the first report fromactivity of the Responsible Business Committee formed(the ‘Committee’) in July 2015, to provide oversight, challenge and guidance on the Group’s approach to becoming a more responsible business.2018.

 

The Committee’s remit includes:

–During the establishment, measurement and review of plans to strengthenyear, as well as overseeing progress against the Group’s culture and values;

–  the Group’s approach to: building trust with customers; communities; environment; employees; ethical business; stakeholder engagement and reputation;

–  the design and development of the Responsible Business plan and Helping Britain Prosper Plan (HBPP)as a whole, the Committee focused on some major and the measurement of performance against these plans.emerging Responsible Business themes.

 

The HBPP provides an overviewfour Lloyds Banking Group charitable Foundations do critical work to tackle disadvantage across the UK. The Committee met with Baroness Fritchie, chair of whatthe Lloyds Bank Foundation for England and Wales, to discuss how we could jointly do more to support activity in key areas such as domestic abuse or homelessness.

The Committee took a comprehensive ‘deep dive’ to review the Company’s emerging sustainability strategy. The Group committed to supporting the country’s transition to a lower carbon economy, in line with the Government’s Clean Growth Plan, and directors from all business areas described how their activity contributed to the overall plan.

I had great pleasure in attending the regional launch of our Digital Academy in Manchester in December. Improving digital skills, is a key plank of Britain’s plan to increase productivity, and the Academy works with local organisations and national partners to deliver a range of training, including basic skills (like preparing a CV) as well as more advanced activity, and is accessible to all members of the community.

Further information on the activities which the Committee keeps under review are set out in the 2019 Helping Britain Prosper Plan. The Plan sets out how the Company seeks to help people, communities and businesses prosper.

In conclusion, I would like to thank the many colleagues across the Group is doingfor their hard work and extraordinary commitment to help Britain’s communities, businesses and individuals address current social and economic issues. The Committee has overseen the development of both thesupporting Responsible Business planactivity in their ‘day jobs’, as well as by volunteering over 235,000 hours of their time and helping to raise £3.8 million for our charity of the HBPP, as they evolve in response to progress we have already made and challenges that lie ahead.year, Mental Health UK.

 

The Committee has made progressreport that follows gives more examples of our activity to Help Britain Prosper in establishing its working patterns2018, and reporting arrangements since its first meeting in July 2015. We look forward to continuing our work in 2016 when our focus will be on: the evolution of the HBPPI hope you find it both interesting and stakeholder reaction to it; tracing the Group’s reputation and trust amongst a wide range of stakeholder groups; measuring our progress on building a culture that puts customers at the heart of what we do; and supporting work to embed responsible business activities with all our colleagues across the business.informative.

 

Sara Weller

Chairman, Responsible Business Committee

How the Committee spent its time in 2018

 

EstablishmentDuring the year, the Committee undertook a detailed exercise to consider how its role and remit would develop to ensure it remained best placed to assist with the delivery of the CommitteeCompany’s strategy by concentrating on overseeing the key initiatives to deliver the responsible business strategy.

An executive level

The Committee agreed that its approach should focus on three material areas aligned to oversee the Group’sBank of the Future with the aim of enabling people, businesses and communities to be ready for the future.

Digital Skills has been a significant area for review and debate during the year, with regular updates provided on the direction of and progress with the establishment of the Lloyds Bank Academy. The Committee has provided input and challenge to the team working on the Academy programme and supported the pilot programmes undertaken in Manchester.

The development of the Company’sSustainability strategy was considered with input from external advisers. The Committee engaged with the leaders of business areas on the application of the approach to helping customers in a sustainable way. These included the assistance provided for customers who are victims of flooding, work to support the transition to a low carbon economy and the development of green loans. The Company’s sustainability strategy was recommended to the Board for approval in September 2018 and published on the Company’s website www.lloydsbankinggroup.com/our-group/responsible-business/sustainability-in-Lloyds-banking-group.

The alignment of the working relationship between the Company and the charitableFoundationswas a key area of focus. The Committee considered and supported the development of plans to work in partnership with the Foundations to support the Charitable Sector through strengthening skills-based volunteering across Foundations-supported charities.

In other activities, the Committee considered reports on: an outline for an assurance process on responsible business activities was establishedwithin business areas; colleague engagement in 2013, chaired by a Non-Executive Director,responsible business activities; the partnership with membership drawn from senior leaders across the Group. The Committee played a keyUniversity of Birmingham’s Centre for Responsible Business; the approach to communicating the

Company’s role in the development of the initial HBPP and the Group’s focus on operating as a responsible business.business; the Company’s policies relating to responsible business including the Code of Responsibility and the Statement on compliance with the Modern Slavery Act.

 

A recommendation to establishAt each meeting, updates have been provided on the Board level Responsible Business Committee (RBC) was accepted byperformance against the Board in April 2015. The Company Secretary worked with colleagues to ensure the RBC’s remit met current good practice standards that aligned with, but did not overlap, the responsibilitiesmetrics of the executive level Group Customer First Committee.Helping Britain Prosper Plan.

Committee purpose and operation

 

The Committee’s role is to support the Board in overseeing the Group’s performance as a responsible business by providing oversight of, and support for, the Group’s strategy and plans for delivering the aspirations to be seen as a trusted, responsible business, as part of the Company’s purpose to Help Britain Prosper. This role is fulfilled by providing oversight and challenge on those activities in 2015

During 2015,which impact on the Committee has:Company’s behaviour and reputation as a trusted, responsible business and by considering and recommending to the Board for approval the Responsible Business Report and Helping Britain Prosper Plan.

 

–  received updates on the development of a framework for assessing and measuring stakeholder trust, including customers and shareholders;

–  worked with the executive team to develop the HBPP with a focused suite of metrics;

–  considered reports from theThe Chairman of the Group Customer First Committee and GEC members onreviews the developmentforward agenda regularly to ensure that the focus of the Group’s culture framework;Committee’s work is on its key priorities and members have sufficient time at meetings to raise issues of concern and to engage in constructive dialogue with colleagues.

 

–  discussed responsible business activities in the Group with colleagues in business areas, including Group Sourcing.Committee composition, attendance at meetings and effectiveness review

 

Responsible Business Committee and external stakeholders

The members of the Committee have an on-going dialogue with key stakeholders with an interest in the Committee’s activities. During 2015, the Committee invited a representative of the Group’s Stakeholder Advisory Panel to provide feedback on the 2015 HBPP and recommendations for areas of focus in the 2016 Plan. Representatives of the Financial Conduct Authority were invited to attend a meeting to observe the Committee at work. In 2016, the Committee will be inviting representatives of the Banking Standards Board and the Competition and Markets Authority, amongst others, to join a meeting to discuss their respective work programmes.

181

CORPORATE GOVERNANCE

DISCLOSURE CONTROLS AND PROCEDURES

As of 31 December 2015, Lloyds Bankingfrom Group under the supervision and with the participation of the Group’s management, including the Group Chief ExecutiveInternal Audit and the Chief Financial Officer, performed an evaluation of the effectiveness of the Group’s disclosure controls and procedures. Based on this evaluation, the Group Chief Executive and Chief Financial Officer concluded that the Company’s disclosure controls and procedures, at 31 December 2015, were effective for gathering, analysing and disclosing with reasonable assurance the information that Lloyds Banking Group is requiredOperating Office are invited to disclose in the reports it files under the Securities Exchange Act of 1934, within the time periods specified in the SEC’s rules and forms. The Lloyds Banking Group’s management necessarily applied its judgement in assessing the costs and benefits of such controls and procedures, which by their nature can provide only reasonable assurance regarding management’s control objectives.meetings as appropriate.

 

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTINGDuring the year, the Committee met its key objectives and carried out its responsibilities effectively, as confirmed by the annual effectiveness review. The Committee will consider the output from the 2018 effectiveness review and whether amendments could be made to its current working arrangements.

 

There have been no changes in the Lloyds Banking Group’s internal control over financial reporting during the year ended 31 December 2015 that have materially affected, or are reasonably likely to materially affect, the Lloyds Banking Group’s internal control over financial reporting.

MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The managementDetails of Lloyds Banking Group plc is responsible for establishingcommittee membership and maintaining adequate internal control over financial reporting. Lloyds Banking Group plc’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS.

The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with IFRS and that receipts and expenditures are being made only in accordance with authorisations of management and directors of Lloyds Banking Group plc; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorised acquisition, use, or disposition of the Company’s assets that could have a material effectmeeting attendance can be found on the financial statements.page 133.

Internal control systems, no matter how well designed, have inherent limitations and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

The management of Lloyds Banking Group plc assessed the effectiveness of the Company’s internal control over financial reporting at 31 December 2015 based on the criteria established in Internal Control – Integrated Framework 2013 issued by the Committee of Sponsoring Organisations of the Treadway Commission (COSO). Based on this assessment, management concluded that, at 31 December 2015, the Company’s internal control over financial reporting was effective.

PricewaterhouseCoopers LLP, an independent registered public accounting firm, has issued an audit report on the Company’s internal control over financial reporting as of 31 December 2015.

155

CORPORATE GOVERNANCE

DISCLOSURE CONTROLS AND PROCEDURES

As of 31 December 2018, Lloyds Banking Group, under the supervision and with the participation of the Group’s management, including the Group Chief Executive and the Chief Financial Officer, performed an evaluation of the effectiveness of the Group’s disclosure controls and procedures. Based on this evaluation, the Group Chief Executive and Chief Financial Officer concluded that the Company’s disclosure controls and procedures, at 31 December 2018, were effective for gathering, analysing and disclosing with reasonable assurance the information that Lloyds Banking Group is required to disclose in the reports it files under the Securities Exchange Act of 1934, within the time periods specified in the SEC’s rules and forms. Lloyds Banking Group’s management necessarily applied its judgement in assessing the costs and benefits of such controls and procedures, which by their nature can provide only reasonable assurance regarding management’s control objectives.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

There have been no changes in the Lloyds Banking Group’s internal control over financial reporting during the year ended 31 December 2018 that have materially affected, or are reasonably likely to materially affect, the Lloyds Banking Group’s internal control over financial reporting.

MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of Lloyds Banking Group plc is responsible for establishing and maintaining adequate internal control over financial reporting. Lloyds Banking Group plc’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS.

The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with IFRS and that receipts and expenditures are being made only in accordance with authorisations of management and directors of Lloyds Banking Group plc; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorised acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Internal control systems, no matter how well designed, have inherent limitations and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

The management of Lloyds Banking Group plc assessed the effectiveness of the Company’s internal control over financial reporting at 31 December 2018 based on the criteria established in Internal Control – Integrated Framework 2013 issued by the Committee of Sponsoring Organisations of the Treadway Commission (COSO). Based on this assessment, management concluded that, at 31 December 2018, the Company’s internal control over financial reporting was effective.

PricewaterhouseCoopers LLP, an independent registered public accounting firm, has issued an audit report on the Company’s internal control over financial reporting as of 31 December 2018. This report appears on page F-2.

 

GOING CONCERN

 

The going concern of the Company and the Group is dependent on successfully funding their respective balance sheets and maintaining adequate levels of capital. In order to satisfy themselves that the Company and the Group have adequate resources to continue to operate for the foreseeable future, the Directors have considered a number of key dependencies which are set out in the risk management section under principal risks and uncertainties: funding and liquidity on page 39 and pages 88 to 94 and capital position on pages 79 to 88. Additionally, the Directors have considered capital and funding projections for the Company and the Group. Accordingly, the Directors conclude that the Company and the Group have adequate resources to continue in operational existence for a period of at least 12 months from the date of approval of the financial statements and therefore it is appropriate to continue to adopt the going concern basis in preparing the accounts.

156

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

MAJOR SHAREHOLDERS

All shareholders within a class of the Company’s shares have the same voting rights. As at 15 February 2019 the Company had received notification under the FCA Disclosure Guidance and Transparency Rules (‘DTR’) of the following holdings in the Company’s issued ordinary share capital.

Interest in shares% of issued share capital
/voting rights4
BlackRock Inc.3,668,756,76515.14%
Harris Associates L.P.3,551,514,5712,34.99%

1The notification of 13 May 2015 provided by BlackRock Inc. under Rule 5 of the DTR identifies (i) an indirect holding of 3,599,451,380 shares in the Company representing 5.04 per cent of the voting rights in the Company, and (ii) a holding of 69,305,385 in other financial instruments in respect of the Company andrepresenting 0.09 per cent of the Group is dependent on successfully funding their respective balance sheets and maintaining adequate levelsvoting rights of capital. In orderthe Company. BlackRock Inc.’s holding most recently notified to satisfy themselves that the Company andunder Rule 5 of the Group have adequate resources to continue to operate forDTR varies from the foreseeable future, the Directors have considered a number of key dependencies which are set outholding disclosed in the risk management section under principal risks and uncertainties: funding and liquidity on page 44 and pages 103 to 110 and capital position on pages 111 to 116 and additionally have considered projections for the Group’s capital and funding position. Accordingly, the Directors conclude that it is appropriate to continue to adopt the going concern basis in preparing the accounts over the next 12 months.

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MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

MAJOR SHAREHOLDERS

As at 31 December 2015, 31 December 2014 and 31 December 2013, the Company had received notification from The Solicitor for the Affairs of Her Majesty’s Treasury (HM Treasury) that it had a direct interest of 9.9 per cent, 24.9 per cent and 32.7 per cent respectively in the Company’s issued ordinary share capital with rights to vote in all circumstances at general meetings. Based solely on theBlackRock Inc.’s Schedule 13-G filed by BlackRock, Inc.filing with the US Securities and Exchange Commission dated 95 February 2016, as at2019, which identifies beneficial ownership of 4,598,344,792 shares in the Company representing 6.5% per cent of the issued share capital in the Company. This variance is attributable to different notification and disclosure requirements between these regulatory regimes. The notifiable holding by BlackRock Inc. in the Company has not changed since 31 December 2015, BlackRock, Inc. beneficially owned 6.8 per cent (representing 4,847,496,882 ordinary shares) of the Company’s issued ordinary share capital.2015. Prior to 31 December 2015, BlackRock Inc.’s ownershipholding in the Company was not required to be disclosed under the US Securities and Exchange Commission rules. As at 26 February 2016 no other notification has been received that anyone has an interest

2An indirect holding.
3On 18 September 2017, Harris Associates L.P. disclosed under the DTR beneficial ownership of 3 per cent or more in the Company’s issued ordinary share capital. Further information on HM Treasury’s shareholding in the Company is provided in –Information about the Lloyds Banking Group’s relationship with the UK GovernmentandBusiness – History and development of Lloyds Banking Group.

All shareholders within a class of the Company’s shares have the same voting rights.

As at 31 December 2015, the Company had 2,562,598 registered ordinary shareholders. The majority of the Company’s ordinary shareholders are registered in the United Kingdom. 1,410,222,7973,607,058,758 ordinary shares, representing 1.98 per cent5.01% of that share class. On 31 October 2018, Harris Associates L.P. made a further disclosure under the Company’s issuedDTR of a decrease in their holding, to 3,551,514,571 ordinary shares, representing 4.99% of that share capital, were held by BNY Mellonclass, the notified percentage remaining below 5% as depositary forat the ordinary share American Depositary Share Programme through which there were 168end of 2018.

4Percentage correct as at the date of notification.

As at 15 February 2019, the Company had 2,398,282 registered ordinary shareholders. The majority of the Company’s ordinary shareholders are registered in the United Kingdom. 2,393,491,489 ordinary shares, representing 3.36 per cent of the Company’s issued share capital, were held by BNY Mellon as depositary for the ordinary share American Depositary Share Programme through which there were 186 record holders.

 

Additionally, the majority of the Company’s preference shareholders are registered in the United Kingdom, with a further one record holder with an address in the United States registered through the Company’s preference share American Depositary Share Programme.

 

RELATED PARTY TRANSACTIONS

 

The Group, as at 31 December 2015,2018, had related party transactions with 20 key management personnel, certain of its pension funds, collective investment schemes and joint ventures and associates and TSB Banking Group plc (TSB) and TSB Bank plc (TSB Bank).associates. See note 4946 to the financial statements. In addition, until the sale of its stake in TSB in June 2015 (further detailed below), the Group was a party to related party transactions with TSB and TSB Bank. Material contracts with TSB and TSB Bank are described in theInformation about the Lloyds Banking Group’s relationship with the TSB Groupsection below and material contracts with HM Treasury are described in theInformation about the Lloyds Banking Group’s relationship with the UK Governmentsection below.

Following the initial public offering in June 2014 TSB and TSB Bank became related parties of the Group. The Group has entered into a number of contracts with TSB and TSB Bank for the provision of a range of banking operations services. In June 2015, the sale of the Group’s remaining stake in TSB was completed.

The UK Government through HM Treasury became a related party of the Group in January 2009, and from 1 January 2011, in accordance with IAS 24, UK Government-controlled entities became related parties of the Group. Prior to 11 May 2015 , HM Treasury held more than 20 per cent of the Company’s ordinary share capital and consequently HM Treasury remained a related party of the Company for IAS 24 purposes until that date. The Group regarded the Bank of England and entities controlled by the UK Government, including The Royal Bank of Scotland Group plc, NRAM plc and Bradford & Bingley plc, as related parties for that period of time also.

Except as described below underInformation about the Lloyds Banking Group’s relationship with the UK Government, there are no transactions to which the Group is a party involving the UK Government or any body controlled by the UK Government which are material to the Group or, to the Group’s knowledge, to the UK Government or any UK Government-controlled body, that were not made in the ordinary course of business, or that are unusual in their nature or conditions. However, considering the nature and scope of the bodies controlled by the UK Government, it may be difficult for the Group to know whether a transaction is material for such a body.

To the best of the Group’s knowledge, any outstanding loans made by the Group to or for the benefit of the UK Government, any body controlled by the UK Government or other related parties, were made (1) in the ordinary course of business, (2) on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions with other persons, (3) did not involve more than the normal risk of collectability or present other unfavourable features, and (4) on an arm’s length basis.

The Group also engages in numerous transactions on arm’s length commercial terms in the ordinary course of its business with the UK Government and its various departments and agencies, as well as with other companies in which the UK Government has invested. This includes financings, lending, banking, asset management and other transactions with UK financial institutions in which the UK Government has invested. Since 2010, the Group made use of these measures in order to maintain and improve a stable funding position.

INFORMATION ABOUT THE LLOYDS BANKING GROUP’S RELATIONSHIP WITH THE TSB GROUP

On 9 June 2014, an initial public offering of ordinary shares of one pence each in the capital of TSB was made (the “Offer”) and such ordinary shares issued were admitted to the premium listing segment of the Official List of the Financial Conduct Authority (FCA) and to trading on the London Stock Exchange plc’s main market for listed securities (together, “Admission”). At the time of the Offer, TSB had one principal subsidiary, TSB Bank, a company incorporated in Scotland which carried on a retail banking business operating in the UK. Until Admission, TSB was a wholly-owned subsidiary of Lloyds Bank which is a wholly owned subsidiary of the Company. Pursuant to the Offer, Lloyds Bank sold 192,500,000 ordinary shares in the capital of TSB, representing 38.5 per cent of the ordinary share capital of TSB. On 26 September 2014, the Group announced that it had sold a further 57.5 million ordinary shares in TSB, representing approximately 11.5 per cent of TSB’s ordinary share capital, reducing the Group’s holding in TSB to approximately 50 per cent of TSB’s ordinary share capital. On 20 March 2015, the Group announced that it had agreed to sell a 9.99 per cent interest in TSB to Banco de Sabadell, S.A. (Sabadell) and that it had entered into an irrevocable undertaking to accept in respect of its entire remaining 40.01 per cent shareholding in TSB the recommended cash offer for TSB by Sabadell pursuant to which Sabadell would acquire the entire issued and to be issued share capital of TSB. On 30 June 2015, the Group announced the completion of the sale of its remaining 40.01 per cent stake in TSB to Sabadell.

Pursuant to the terms of the Offer, certain agreements, discussed below, were entered into by the Company and other parties, which became effective on Admission.

SEPARATION AGREEMENT

TSB, TSB Bank and Lloyds Bank entered into a separation agreement on 9 June 2014 (the “Separation Agreement”). The Separation Agreement governs the separation of the TSB Bank, its consolidated subsidiaries and subsidiary undertakings from time to time (together “TSB Group”) from Lloyds

183157

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

Banking Group and certain aspects of the relationship between the TSB Group and Lloyds Banking Group following Admission, including (amongst other things) the allocation of certain pre-Admission liabilities, including liability for breach of law and regulation and of customer terms and conditions.

Under the terms of the Separation Agreement, Lloyds Bank agreed to provide each member of the TSB Group with indemnity protections in respect of historical, pre-Admission issues (including issues in relation to the period between 9 September 2013, when TSB launched as a stand-alone bank, and Admission). This protection includes a broad and, save in certain limited respects, uncapped indemnity in respect of losses arising from pre-Admission acts or omissions that constitute breaches of law and regulation relating to customer agreements or the relevant security interest securing liability under such agreements (the ‘Conduct Indemnity’). The Conduct Indemnity provides TSB Group with economic protection against a wide range of types of losses resulting from historical conduct issues, including the costs of handling and settling customer claims and managing regulatory actions and investigations, the payment of regulatory or court imposed fines and penalties, the costs of any required customer redress, the costs of implementing required changes to systems and procedures and, subject to certain conditions and limitations, the costs of remedial marketing activity.

The Conduct Indemnity also provided the TSB Group with a limited period of continued protection for actions or omissions between Admission and 31 December 2014. Further indemnities were included in the Separation Agreement in respect of losses arising from certain persistent or systemic breaches and certain liabilities in respect of certain employment related litigation and in relation to Lloyds Banking Group pension schemes.

TRANSITIONAL SERVICES AGREEMENTS

TSB Bank and Lloyds Bank entered into a transitional services agreement (TSA) and a Long Term Services Agreement (the “LTSA”) on 9 June 2014. Under the TSA, Lloyds Bank provides certain IT and operational services to TSB, on a transitional basis, for a term of up to the end of 31 December 2016 with certain services (including the IT services) continuing to be provided by Lloyds Bank to TSB on and from 1 January 2017 for a term of up to seven and a half years under the LTSA.

TSB Bank pays a core monthly service charge that includes an agreed baseline of service volumes. TSB Bank may terminate the TSA or the LTSA (or services thereunder) for cause or for convenience before its expiry date subject to minimum notice requirements. Lloyds Bank may only terminate the TSA or LTSA if required to do so by a regulatory authority or by law, or for non-payment of material charges by TSB Bank.

The LTSA outlines the respective responsibilities of each of TSB Bank and Lloyds Bank in relation to exit and provides a mechanism for the parties to continue to define and agree their respective obligations in detailed technical and commercial exit plans during the 12 months following Admission. Due to the critical nature of the IT services, Lloyds Bank and TSB Bank have defined in advance some specific transfer and migration options for TSB’s IT operations and data to a third party provider or another financial institution with whom TSB enters into a merger or acquisition, as the case may be, to operate on TSB’s behalf. Lloyds Bank would assume the cost of creating and transferring a clone operating system to a third party operator, subject to a £50 million contribution from TSB or, alternatively, if TSB exits the IT services via another migration option, Lloyds Bank has agreed to make a £450 million contribution to TSB’s costs of undertaking the migration, and TSB may elect to spend some or all of the £450 million obtaining exit assistance services from Lloyds Bank. With certain exceptions, Lloyds Bank has agreed to support the exit of the services (including both IT services and non-IT services) on a time and materials at cost basis.

MORTGAGE SALE AND SERVICING AGREEMENTS

On 4 March 2014, TSB Bank and Bank of Scotland plc (BoS) entered into a mortgage sale agreement in relation to the equitable assignment (which took effect from 28 February 2014) of a portfolio of residential mortgages (Additional Mortgages) transferred by BoS to TSB Bank (MSA) as well as a mortgage servicing agreement (Servicing Agreement). Pursuant to the MSA, TSB Bank purchased the equitable interest of BoS in the Additional Mortgages for approximately £3.4 billion (being equal to the fair value of the Additional Mortgages at the time of transfer. Under the terms of the MSA, legal title in the Additional Mortgages has remained and will remain with BoS unless a perfection event occurs (namely an insolvency event in relation to BoS, specified material breach by BoS of its obligations under the MSA or following termination of the appointment of BoS as servicer under the MSA at the option of TSB Bank). Unless and until any such perfection event occurs, the Additional Mortgage customers remain customers of BoS. In the Servicing Agreement, BoS agreed to service the Additional Mortgages, including all aspects of the customer relationship, in return for the payment by TSB Bank of a monthly servicing fee equivalent to 0.12 per cent per annum of the outstanding balance of the Additional Mortgages (subject to a minimum monthly fee of £175,000 from 1 July 2018).

RMBS FUNDING FACILITY AGREEMENTS

On 20 May 2014, TSB Bank and a special purpose vehicle established by TSB Bank (TSB RMBS SPV) and others entered into the RMBS Mortgage Sale Agreement, and the same parties, together with Lloyds Bank and others entered into a variable funding note issuance deed (VFNID) and other ancillary documents in relation to the securitisation structure by which TSB part-funds the Additional Mortgages (the “RMBS Funding Facility”).

Under the terms of the VFNID, senior funding is raised by TSB RMBS SPV through a combination of drawings on a variable funding note (VFN) issued by TSB RMBS SPV to Lloyds Bank (the “Lloyds VFN”), and TSB Bank. Subject to certain conditions, up until 17 December 2018, TSB RMBS SPV has the option to repay and redraw the Lloyds VFN (in whole or in part).

INFORMATION ABOUT THE LLOYDS BANKING GROUP’S RELATIONSHIP WITH THE UK GOVERNMENT

HM TREASURY SHAREHOLDING

On 26 February 2016, the Solicitor for the Affairs of Her Majesty’s Treasury (HM Treasury) formally notified the Company that HM Treasury’s holding had reduced to 9.12 per cent of the Company’s issued share capital with rights to vote in all circumstances at general meetings. HM Treasury’s percentage holding has reduced from 24.9 per cent at 31 December 2014 by way of the pre-arranged trading plan referred to in the section headedBusiness – History and Development of Lloyds Banking Group.

HM Treasury’s shareholding in the Company is a consequence of its subscription for equity securities of the Company and of HBOS (prior to the acquisition of HBOS by the Company) in a placing and open offer and preference share subscription, the concomitant placing and open offer by HBOS, the 2009 Placing and Open Offer and the Company’s 2009 Rights Issue.

HM Treasury’s shareholding in the Company is currently managed by UKFI on behalf of HM Treasury. This relationship falls within the scope of the revised framework document between HM Treasury and UKFI published on 1 October 2010 – for more information seeRisk Factors – Government Related Risks – The Solicitor for the Affairs of Her Majesty’s Treasury is the largest shareholder of the Company. Through its shareholding in, and other relationships with, the Company, HM Treasury is in a position to exert significant influence over the Group and its business.

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MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

The goals of the framework document are consistent with the stated public policy aims of HM Treasury, as articulated in a variety of public announcements. In the publication ‘An Introduction: Who We Are, What We Do and the Framework Document Which Governs the Relationship Between UKFI and HM Treasury’, it is stated that UKFI is to ’develop and execute an investment strategy for disposing of the investments in the banks in an orderly and active way through sale, redemption, buy-back or other means within the context of an overarching objective of protecting and creating value for the taxpayer as shareholder, paying due regard to the maintenance of financial stability and to acting in a way that promotes competition’. It further states that UKFI will manage the shareholdings of UK financial institutions in which HM Treasury holds an interest ‘on a commercial basis and will not intervene in day-to-day management decisions of the Investee Companies (as defined therein) (including with respect to individual lending or remuneration decisions)’.

The Company and HM Treasury in January 2009 entered into a registration rights agreement granting customary demand and ‘piggyback’ registration rights in the United States under the United States Securities Act 1933, as amended, to HM Treasury with respect to any ordinary shares of the Group held by HM Treasury. The agreement was amended in June 2009 to include as registrable securities the new shares subscribed for by HM Treasury in the 2009 Placing and Open Offer, any other securities in the Company called by HM Treasury to be issued by any person and any securities issued by HM Treasury which are exchangeable for, convertible into, give rights over or are referable to any such securities. The Company also in June 2009 entered into a resale rights agreement with HM Treasury in which it agreed to provide its assistance to HM Treasury in connection with any proposed sale by HM Treasury of ordinary shares, other securities held by HM Treasury in the Company or any securities of any description caused by HM Treasury to be issued by any person which are exchangeable for, convertible into, give rights over or are referable to such ordinary shares or other securities issued by the Group, to be sold in such jurisdictions (other than the United States) and in such manner as HM Treasury may determine.

OTHER RELATED PARTY TRANSACTIONS WITH THE UK GOVERNMENT

GOVERNMENT AND CENTRAL BANK FACILITIES

During the year ended 31 December 2015, the Group participated in a number of schemes operated by the UK Government and central banks and made available to eligible banks and building societies.

NATIONAL LOAN GUARANTEE SCHEME

The Group participates in the UK Government’s National Loan Guarantee Scheme, which was launched on 20 March 2012. Through the scheme, the Group is providing eligible UK businesses with discounted funding based on the Group’s existing lending criteria. Eligible businesses who have taken up the funding benefit from a 1 per cent discount on their funding rate for a pre-agreed period of time.

FUNDING FOR LENDING

In August 2012, the Group announced its support for the UK Government’s Funding for Lending Scheme and confirmed its intention to participate in the scheme. The Funding for Lending Scheme represents a further source of cost effective secured term funding available to the Group. The original initiative supported a broad range of UK based customers, providing householders with more affordable housing finance and businesses with cheaper finance to invest and grow. In November 2013, the Group entered into extension letters with the Bank of England to take part in an extension of the Funding for Lending Scheme until the end of January 2015. This extension of the Funding for Lending Scheme focused on providing businesses with cheaper finance to invest and grow. In December 2014, the Bank of England announced a further extension to the Funding for Lending Scheme running to the end of January 2016 with an increased focus on supporting small businesses. In November 2015, the Bank of England announced that the deadline for banks to draw down their borrowing allowance would be extended for two years until 31 January 2018. At 31 December 2015, the Group had drawn down £32 billion (31 December 2014: £20 billion) under the Funding for Lending Scheme, of which £22 billion had been drawn down under the extension to the scheme announced in 2013.

ENTERPRISE FINANCE GUARANTEE

The Group participates in the Enterprise Finance Guarantee Scheme which was launched in January 2009 as a replacement for the Small Firms Loan Guarantee Scheme. The scheme is a UK Government-backed loan guarantee, which supports viable businesses with access to lending where they would otherwise be refused a loan due to a lack of lending security. The Department for Business, Innovation and Skills (formerly the Department for Business, Enterprise and Regulatory Reform) provides the lender with a guarantee of up to 75 per cent of the capital of each loan subject to the eligibility of the customer within the rules of the scheme. As at 31 December 2015, the Group had offered 6,509 loans to customers, worth over £550 million. Under the most recent renewal of the terms of the scheme, Lloyds Bank plc and Bank of Scotland plc, on behalf of the Group, contracted with The Secretary of State for Business, Innovation and Skills.

HELP TO BUY

On 7 October 2013, Bank of Scotland plc entered into an agreement with The Commissioners of Her Majesty’s Treasury by which it agreed that the Halifax Division of Bank of Scotland plc would participate in the Help to Buy Scheme with effect from 11 October 2013 and that Lloyds Bank plc would participate from 3 January 2014. The Help to Buy Scheme is a scheme promoted by the UK Government and is aimed to encourage participating lenders to make mortgage loans available to customers who require higher loan-to-value mortgages. Halifax and Lloyds are currently participating in the Scheme whereby customers borrow between 90 per cent and 95 per cent of the purchase price. In return for the payment of a commercial fee, HM Treasury has agreed to provide a guarantee to the lender to cover a proportion of any loss made by the lender arising from a higher loan-to-value loan being made. £3,133 million of outstanding loans at 31 December 2015 (31 December 2014: £1,950 million) had been advanced under this scheme.

BUSINESS GROWTH FUND

As at 31 December 2015, the Group had invested £176 million (31 December 2014: £118 million) in the Business Growth Fund (under which an agreement was entered into with RBS amongst others) and carried the investment at a fair value of £170 million (31 December 2014: £105 million). Since 31 December 2015, the Group has invested a further £20 million in the Business Growth Fund.

BIG SOCIETY CAPITAL

The Group had invested £36 million (31 December 2014: £31 million) in the Big Society Capital Fund under which an agreement was entered into with RBS amongst others. Since 31 December 2015, the Group has invested a further £1 million in the Big Society Capital Fund.

HOUSING GROWTH PARTNERSHIP

The Group has committed to invest up to £50 million into the Housing Growth Partnership under which an agreement was entered into with the Homes and Communities Agency.

185

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

CENTRAL BANK FACILITIES

In the ordinary course of business, the Group may from time to time access market-wide facilities provided by central banks.

OTHER GOVERNMENT-RELATED ENTITIES

Other than the transactions referred to above, there were no other significant transactions with the UK Government and UK Government-controlled entities (including UK Government-controlled banks) during the period that were not made in the ordinary course of business or that were unusual in their nature or conditions.

OTHER RELATIONSHIPS WITH THE UK GOVERNMENT

The Group, in common with other financial institutions, is also working closely with a number of UK Government departments and agencies on various industry-wide initiatives that are intended to support the UK Government’s objective of economic recovery and greater stability in the wider financial system.

For more detail on industry-wide initiatives seeBusiness Growth FundandBig Society Capitalabove.

OTHER RELATED PARTY TRANSACTIONS

Other related party transactions for the twelve months to 31 December 2015 are similar in nature to those for the year ended 31 December 2014.

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REGULATION

 

APPROACH OF THE FINANCIAL CONDUCT AUTHORITY (FCA)(“FCA”)

 

As per the Financial Services and Markets Act 2000 (FSMA)FSMA (amended by the Financial Services Act 2012), the FCA has a strategic functionobjective to ensure that the relevant markets function well. In support of this, the FCA has three operational objectives: to secure an appropriate degree of protection for consumers; to protect and enhance the integrity of the UK financial system and to promote effective competition in the interests of consumers.

 

The FCA Handbook sets out rules and guidance across a range of conduct issues with which financial institutions are required to comply including high level principles of business and detailed conduct of business standards and reporting standards.

 

REGULATORY APPROACH OF THE PRA

 

As per the Financial Services Act 2012, the PRA has two statutory objectives: to promote the safety and soundness of the firms which it supervises and, with respect to insurers, to contribute to the securing of an appropriate degree of protection for policyholders. The PRA’s regulatory and supervisory approach incorporates three key characteristics: to take a judgement-based approach, a forward-looking approach, and a focused-approach.

 

The PRA has largely inherited the prudential aspects of the former Financial Services Authority FSA Handbook, including regulations and guidance relating to capital adequacy and liquidity among several other things. A PRA Rulebook is also in development which will replace the PRA Handbook and will only apply to PRA-authorised firms.

 

OTHER BODIES IMPACTING THE REGULATORY REGIME

 

THE BANK OF ENGLAND AND HM TREASURY

 

The agreed framework for co-operation in the field of financial stability in the financial markets is detailed in the Memorandum of Understanding published jointly by HM Treasury, the FCA (formerly the FSA) and the Bank of England (now including the PRA) (together, the “Tripartite Authorities”“Tripartite Authorities”). The Bank of England has specific responsibilities in relation to financial stability, including: (i) ensuring the stability of the monetary system; (ii) oversight of the financial system infrastructure, in particular payments systems in the UK and abroad; and (iii) maintaining a broad overview of the financial system through its monetary stability role. The Bank of England also wholly incorporates the PRA.

 

UK FINANCIAL OMBUDSMAN SERVICE (FOS)(“FOS”)

 

The FOS provides consumers with a free and independent service designed to resolve disputes where the customer is not satisfied with the response received from the regulated firm. The FOS resolves disputes for eligible persons that cover most financial products and services provided in (or from) the UK. The jurisdiction of the FOS extends to include firms conducting activities under the Consumer Credit Act (CCA).1974. Although the FOS takes account of relevant regulation and legislation, its guiding principle is to resolve cases individually on merit on the basis of what is fair and reasonable; in this regard, the FOS is not bound by law or even its own precedent. The final decisions made by the FOS are legally binding on regulated firms.firms who also have a requirement under the FCA rules to ensure that lessons learned as a result of determinations by the FOS are effectively applied in future complaint handling.

 

THE FINANCIAL SERVICES COMPENSATION SCHEME (FSCS)(“FSCS”)

 

The FSCS was established under the FSMA and is the UK’s statutory fund of last resort for customers of authorised financial services firms. Companies within the Group are responsible for contributing to compensation schemes in respect of banks and other authorised financial services firms that are unable to meet their obligations to customers. The FSCS can pay compensation to customers if a firm is unable, or likely to be unable, to pay claims against it. The FSCS is funded by levies on firms authorised by the PRA and the FCA, including companies within the Group.

 

LENDING STANDARDS BOARD

 

The Lending Standards Board (formerly the Banking Code Standards Board) is responsible for monitoringoverseeing the Standards of Lending Practice (for both personal and enforcing compliance with the voluntarybusiness customers). The Standards of Lending Code introduced on 1 November 2009 (as last amended in October 2014), which relates to certainPractice for personal customers cover six main areas: Financial promotions and communications; product sales; account maintenance and servicing; money management; financial difficulty; and, customer vulnerability across key lending (current account overdrafts, credit cards, loans and credit cards)chargecards) to consumers micro-enterprises and charities with an income of less than £1 million. The Standards of Lending Practice for business customers apply to business customers, which at the point of lending have a non-complex ownership structure, and an annual turnover of less than £6.5 million. The standards cover eight main areas: product information; product sale; declined applications; product execution; credit monitoring; financial difficulty; portfolio management; and, vulnerability for products including loans, overdrafts, commercial mortgages, credit cards, and chargecards.

 

UK COMPETITION AND MARKETS AUTHORITY (CMA)(“CMA”)

 

The objective of the CMA is to promote competition to ensure that markets work well for consumers, businesses and the economy. Since 1 April 2014 the CMA has, with the FCA, exercised the competition functions previously exercised by the Office of Fair Trading and the Competition Commission have been transferred toCommission. Through its five strategic goals (delivering effective enforcement; extending competition frontiers; refocusing competition protection; achieving professional excellence; and, developing integrated performance) the new CMA or the FCA. The CMA’s regulatory and enforcement powers impactimpacts the banking sector in a number of ways, including powers to investigate and prosecute a number of criminal offences under competition law. In addition, the CMA is now the lead enforcer under the Unfair Terms in Consumer Contracts Regulations 1999.

 

UK INFORMATION COMMISSIONER’S OFFICE

 

The UK Information Commissioner’s Office is responsible for overseeing implementation of the Data Protection Act 1998.2018 which enshrines the General Data Protection Regulation. This Act regulates, among other things, the retention and use of data relating to individual customers. The Freedom of Information Act 2000 (the FOIA)“FOIA”) sets out a scheme under which any person can obtain information held by, or on behalf of, a ‘public authority’“public authority” without needing to justify the request. A public authority will not be required to disclose information if certain exemptions set out in the FOIA apply.

 

THE PAYMENTS SYSTEM REGULATOR (PSR)(“PSR”)

 

The Payment System Regulator (PSR)PSR is a newan independent economic regulator for the £75 trillion payment systems industry, which was launched back in April 2015. Payment systems form a vital part of the UK’s financial system – they underpin the services that enable funds to be transferred between people and institutions. The purpose of PSR is to make payment systems work well for those that use them. The PSR is a subsidiary of the Financial Conduct Authority,FCA, but has its own statutory objectives, Managing Director and Board. In summary theirits objectives are: (i) to ensure that payment systems are operated and developed in a way that considers and promotes the interests of all the businesses and consumers that use them; (ii) to promote effective competition in the markets for payment systems and services -– between operators, PSPspayment services providers and infrastructure providers; and (iii) to promote the development of and innovation in payment systems, in particular the infrastructure used to operate those systems.

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REGULATION

 

COMPETITION REGULATION

The Competition and Markets Authorities commenced a Phase 2 competition investigation into personal and SME banking in November 2014. The CMA’s provisional findings were published in October 2015 in which the CMA provisionally concluded that there are features of the market that prevented, restricted or distorted competition and have proposed a list of possible remedies. The statutory deadline for the CMA’s final report is 5 May 2016, but may be extended by up to six months.

 

The FCA obtained concurrent competition powers with the CMA on 1 April 2015 in relation to the provision of financial services in the UK, in addition to supplementing its already existing competition objective. The FCA has commencedbeen undertaking a programme of work to lookassess markets across financial services markets and assessto ascertain whether or not competition is working effectively in the best interests of consumers.

187

REGULATION

The Payment Systems Regulator (PSR) became operational in April 2015 with concurrent competition powers in respect of UK payment systems, in addition to a statutory objective to promote effective competition. The PSR has commenced market reviews into the provision of indirect access and into the ownership and competitiveness of payments infrastructure. The PSR is also the main competent authority for monitoring and enforcing the European Regulation on interchange fees in the UK.

In addition, the PRA also has a secondary objective under the Financial Services (Banking Reform) Act to, so far as reasonably possible, act in a way which facilitates effective competition.

 

The PSR became operational in April 2015 with concurrent competition powers in respect of UK governmentpayment systems, in addition to a statutory objective to promote effective competition. The PSR has completed two market reviews into the provision of indirect access and into the ownership and competitiveness of payments infrastructure. The final report for indirect access was published in July 2016 noting some concerns with quality of access, limited choice and barriers to switching. The final report for competitiveness of payments infrastructure, also published in July 2016, noted some concerns with competition in payments infrastructure.

The FCA announced on 3 November 2016 that it will take action to improve competition in the current account market, following the CMA’s recommendations in the publication of its competition investigation into PCA and SME Banking (9 August 2016). The FCA have published their final report into the ’Strategic Review of Retail Banking Business Models’ (18 December 2018) recognising that PCAs are an important source of competitive advantage for major banks. The focus on high cost credit continues with further forward work on its proposals to simplify the pricing of all overdrafts and end higher prices for unarranged overdrafts. The FCA continues to act as an observer on the “Open Banking” steering group and be involved in developing and testing “prompts” to encourage customers to consider their banking arrangements.

The UK Government has a continuing interest in competition. In November 2015, the UK Government published a document entitled “A better deal: boosting competition to bring down bills for families and firms”. This document focuses on the competition aspects of the government’sUK Government’s productivity plan and aims to promote competition in various sectors, including financial services.

 

The new regulatory regime may lead to greater UK Government and regulatory scrutiny or intervention in the future, ranging from enforced product and service developments and payment system changes to significant structural changes. This could have a significant effect on the Group’s operations, financial condition or the business of the Group.

 

EU REGULATION

 

A High Level Expert Group, chaired by Erkki Liikanen (the ‘Liikanen Report’), considered whether there is a need for structural reforms of the EU banking sector and to make relevant proposals as appropriate, with the objective of establishing a stable and efficient banking system serving the needs of citizens, the economy and the internal market. The High Level Expert Group presented its recommendations to the EU Commissioner on 2 October 2012. They recommended a set of five measures that augment and complement the set of regulatory reforms already enacted or proposed by the EU, the Basel Committee and national governments. First, proprietary trading and other significant trading activities should be assigned to a separate legal entity if the activities to be separated amount to a significant share of the bank’s business. This would ensure that trading activities beyond the threshold are carried out on a stand-alone basis and separate from the deposit bank. The other measures include: emphasising the need for banks to draw up and maintain effective and realistic recovery and resolution plans; supporting the use of designated bail out instruments; applying more robust weights in the determination of minimum capital standards; and augmenting existing corporate governance reforms such as strengthening boards and management, promoting the risk management function, rein in compensation for bank management and staff, improve risk disclosure, and strengthening sanctioning powers.

On 17 January 2014, the EU Commission published a press release confirming that it intends to make a proposal for the reform of the structure of banking in the EU, which will be based on the Liikanen Report. The objective of the reforms will be to make the financial sector as a whole more robust and resilient, to reduce the impact of potential bank failures, and ensure the financial sector is at the service of the real economy. In doing so, the reforms will aim to eliminate the concept of banks being ‘too big to fail.’ The proposed regulation included a derogation from the separate requirements for banks in member states which had implement equivalent legislation before 29 January 2014 (including the UK). The form of the proposed EU regulation has been subject to much debate within the European institutions, with uncetainty surrounding both the outcome and timeline for conclusion. The main disagreements concern the need for ‘automatic’ separation of trading activities and the level of discretion given to National Competent Authorities.

The UK is subject to the directiveslegislation introduced under the Financial Services Action Plan. However, these directives arethe legislation is regularly reviewed at EU level and could be subject to change. The Group will continue to monitor the progress of these initiatives, provide specialist input on their drafting and assess the likely impact on its business.

 

CRD IV implements the Basel III agreement in the EU, and introduces significant changes in the prudential regulatory regime applicable to banks including: increased minimum capital ratios; changes to the definition of capital and the calculation of risk-weighted assets; and the introduction of new measures relating to leverage, liquidity and funding. CRD IV also makes changes to rules on corporate governance, including remuneration, and introduces standardised EU regulatory reporting requirements which will specify the information that must be reported to supervisors in areas such as own funds, large exposures and financial information.

 

On 29 January 2014 the European Commission published its long-awaited proposals for structural reform of EU banks in the form of a draft regulation. The proposals apply to the largest EU banks and groups – on the basis of historical data the Commission estimates that 29 EU banks may be subject to such proposed regulation. The Commission’s publication is only a proposal at this stage. It may well be amended, perhaps substantially, by the European Parliament and the Council before it is adopted.

USU.S. REGULATION

 

In the United States, until 2018 Lloyds Bank and Bank of Scotland plc maintains a branch(“BoS”) maintained branches in New York, each licensed by the New York State Department of Financial Services (NYDFS)(“NYDFS”) and subject to regulation and examination by the NYDFS and the Federal Reserve Bank of New York (FRBNY)(“FRBNY”). Bank of Scotland plc maintainsBoS also maintained a branchrepresentative office in New York (also licensedHouston, Texas (authorized by the NYDFSTexas Department of Banking (“TXB”), and subject to regulation and examination by TXB and the Federal Reserve Bank of Dallas). On 11 July 2018, the New York branch of BoS was closed and its license surrendered to the NYDFS, and the FRBNY)NYDFS confirmed to BoS in October, 2018 that the voluntary liquidation of the BoS New York branch under the New York State Banking Law was considered concluded. On 31 December 2018, Lloyds Bank advised the NYDFS that the Lloyds Bank New York branch was closed and maintainsLloyds Bank surrendered its New York branch license to the NYDFS on that date. The completion of the voluntary liquidation of the Lloyds Bank New York branch is expected to occur during the first half of 2019. The closure of the New York branches of Lloyds Bank and BoS was a consequence of the need by both banks to comply with the geographic limitations of the Ring-fencing Rules (as defined in the Risk Factors section). The BoS Houston representative offices in Chicago and Houston, licensed respectivelyoffice was also closed by BoS on 31 December 2018. In July, 2018, applications filed on behalf of Lloyds Bank Corporate Markets plc (“LBCM”) with the StatesBoard of Illinois and Texas and subject to regulation and examination by the banking supervisorsGovernors of those States as well as the Federal Reserve BanksSystem (“Federal Reserve Board”) and the NYDFS to permit LBCM to establish a branch in whose districts those offices are located.

The licensing authorityNew York were approved, and on 27 July 2018, LBCM’s New York branch license was issued by the NYDFS. Also in July, 2018, at the request of each US branchLloyds Bank, the NYDFS issued a representative office license to Lloyds Bank. Under the New York State Banking Law, the NYDFS has the authority, in certain circumstances, to take possession of the business and property of Lloyds Bank plc and Bank of Scotland plc located in the stateNew York State of the office it licenses.a bank, such as LBCM, which maintains a licensed branch in New York State. Such circumstances generally include violations of law, unsafe business practices and insolvency.

 

The existence of branches and representative officesa branch of LBCM in the USU.S. subjects Lloyds Banking Group plcthe LBCM, the Company and its subsidiaries doing business or conducting activities in the USU.S. to oversight by the Board of GovernorsFederal Reserve Board.

As of the Federal Reserve System (Federal Reserve Board).

Eachend of Lloyds Banking Group plc,2018, each of the Company, Lloyds Bank, plc, HBOS, plcBoS and Bank of Scotland plc isLBCM was a foreign banking organisation treated as a bank holding company within the meaning of the USU.S. Bank Holding Company Act of 1956 (BHC Act)(“BHC Act”) in accordance with the provisions of the International Banking Act of 1978 and each hashad elected, with the permission of the Federal Reserve Board, to be treated as a financial holding company under the BHC Act. Because, as a result of the Ring-fencing Rules, from and after January 1, 2019, neither Lloyds Bank nor BoS may maintain branches or own substantial equity stakes in entities organized outside of the European Economic Area, each ceased to be treated as a financial holding company under the BHC Act from and after that date. HBOS has no direct or indirect investments or activities in the U.S., and also ceased to be treated as a financial holding company. However, each of the Company and LBCM will continue to be treated as a financial holding company under the BHC Act.

 

Financial holding companies may engage in a broader range of financial and related activities than are permitted to bank holding companies that do not maintain financial holding company status, including underwriting and dealing in all types of securities. To maintainA financial holding company status, Lloyds Banking Group plc, Lloyds Bank plc, HBOS plc and Bank of Scotland plc are required toits depository institution subsidiaries must meet certain capital ratios and be deemed to be ‘well managed’“well managed” for purposes of the Federal Reserve Board’s regulations. The Group’sA financial holding company’s direct and indirect activities and investments in the United States are limited to those that are ‘financial“financial in nature’nature” or ‘incidental’“incidental” or ‘complementary’“complementary” to a financial activity, as determined by the Federal Reserve Board. The

Financial holding companies are also subject to approval requirements in connection with certain acquisitions or investments. For example, the Group is also required to obtain the prior approval of the Federal Reserve Board before acquiring, directly or indirectly, the ownership or control of more than 5 per cent of any class of the voting shares of any USU.S. bank or bank holding company.

188159

REGULATION

 

The Group’s USU.S. broker dealer, Lloyds Securities IncInc. (“LSI”), is subject to regulation and supervision by the US Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority, with respect to its securities activities, including sales methods, trade practices, use of safekeeping of customers’ funds and securities, capital structure, recordkeeping, the financing of customers’ purchases and conduct of directors, officers and employees.employees and other matters pertinent to its securities business. In order to comply with the change to Ring-fencing Rules (as defined in the Risk Factors section), LSI became an indirect, wholly-owned subsidiary of LBCM on July 1, 2018 as a result of the sale of 100% of the shares of LSI’s direct parent (Lloyds America Securities Corporation) by Lloyds Bank to LBCM.

 

A major focus of USU.S. governmental policy relating to financial institutions in recent years has been combating money laundering and terrorist financing and enforcing compliance with USU.S. economic sanctions, with serious legal and reputational consequences for any failures arising in these areas. The Group engages, or has engaged, in a limited amount of business with counterparties in certain countries which the USU.S. State Department currently designates as state sponsors of terrorism, including Iran, Syria, Sudan (and Cuba which was removed from the US State sponsors of terrorism list on 29 May 2015).and North Korea. The Group continues to reduce its outstanding exposures to such states which have arisen through historical business activity. In accordance with this, the Group intends to engage only in new business in such jurisdictions and only in very limited circumstances where the Group is satisfied concerning legal, compliance and reputational issues. At 31 December 2015,2018, the Group does not believe that the Group’s business activities relating to countries designated as state sponsors of terrorism were material to its overall business.

 

The Group estimates that the value of the Group’s business in respect of such states represented less than 0.01 per cent of the Group’s total assets and, for the year ended December 2015,2018, the Group believes that the Group’s revenues from all activities relating to such states were less than 0.001 per cent of its total income, net of insurance claims. This information has been compiled from various sources within the Group, including information manually collected from relevant business units, and this has necessarily involved some degree of estimate and judgement.

 

DODD-FRANK ACT

In JulyThe Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), which was enacted in the United States enacted the Dodd-Frank Act, which provides a broad framework forin 2010, has resulted in significant regulatory changes that extend to almost every area of USin U.S. financial regulation. The Dodd-Frank Act addresses, among other issues,topics, systemic risk oversight, bank capital standards, the resolution of failing systemically significant financial institutions in the US, over-the-counterUnited States, OTC derivatives, restrictions on the ability of banking entities to engage in proprietary trading activities and make investments in and sponsor certain private equity funds and hedge funds (known as the ‘Volcker Rule’“Volcker Rule”), asset securitisation activities and securities market conduct and oversight. US regulators have implemented many provisions ofIn addition, the Dodd-Frank Act through detailed rulemaking. Although the majority of required rulesestablished a regulatory framework for swap dealers and regulations have now been finalised, there remain many still in proposed form or yet to be proposed, the substance and impact of which may not fully be known until the final rules are published.major swap participants.

 

UnderAmong other requirements imposed by this framework, the Dodd-Frank Act required entities that are swap dealers and major swap participants mustto register with the USU.S. Commodity Futures Trading Commission (CFTC), and entities that are security-based swap dealers or major security based swap participants will be required to register with the SEC. The (“CFTC has promulgated its registration rules for swap dealers and major swap participants. The SEC finalised its registration rules for security-based swap dealers and major security-based swap participants; however, the registration requirement will not be effective until certain other regulations applicable to security-based swap dealers are adopted.”). Each of Lloyds Bank plc provisionallyand LBCM is registered as a swap dealer in 2013 and as such, is subject to regulation and supervision by the CFTC and the National Futures Association with respect to certain of its swap activities, including risk management practices, trade documentation and reporting, business conduct and recordkeeping, among others.

The New York branch of Lloyds Bank plc is subject to the swap ‘push-out’ provisions of the Dodd-Frank Act, which will require monitoring to ensure the Group conducts its derivatives activities in conformity with the implementing regulations. In December 2014, the swap “push out” provisions of the Dodd-Frank Act were amended such that fewer swap activities need to be pushed out of covered depository institutions.

Furthermore, the Dodd-Frank Act requires the SEC to cause issuers with listed securities, which may include foreign private issuers such as the Group, to establish a ‘clawback’ policy to recoup previously awarded employee compensation in the event of an accounting restatement. The SEC has proposed implementing regulations which have not yet been finalised. The Dodd-Frank Act also grants the SEC discretionary rule-making authority to impose a new fiduciary standard on brokers, dealers and investment advisers, and expands the extraterritorial jurisdiction of US courts over actions brought by the SEC or the United States with respect to violations of the antifraud provisions of the United States Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940.

In December 2013, US regulators adopted final rules implementing the Volcker Rule. Banking entities, including foreign banking organisations subject to the BHC Act, such as Lloyds Banking Group plc, Lloyds Bank plc, HBOS plc and Bank of Scotland plc, are subject to the final rules which require banking entities to conform to the restrictions on proprietary trading activities, hedge fund and private equity activities and certain other enumerated investment restrictions, subject to a number of exclusions and exemptions that substantially limit their extraterritorial reach. Certain foreign banking entities are permitted to engage in proprietary trading from outside the United States if the trade lacks the requisite US nexus and the foreign banking entity complies with the various conditions of the exemption. Investments in, and sponsorship of certain retail investment funds organised outside the United States and publicly offered predominantly outside the United States, and certain retirement and pension funds organised and administered outside the United States for the benefit of non-US residents are generally permitted under the final rules. Certain foreign banking entities, but not any US branch, agency or subsidiary of a foreign banking entity, nor any non-US affiliate controlled by such a US branch, agency or subsidiary, are also permitted to invest in and sponsor certain funds in which ownership interests are not offered for sale or sold inside the United States or to US residents and subject to other conditions. The final rules impose significant compliance and reporting obligations on banking entities. Banking entities had until 21 July 2015 to bring their activities and investments into conformity with the Volcker Rule, however, on 18 December 2014, the Federal Reserve issued an order extending the Volcker Rule’s conformance period until 21 July 2016 for investments in and relationships with certain covered funds and certain foreign funds that were in place on or prior to 31 December 2013.

In February 2014, pursuant to the Dodd-Frank Act’s systemic risk regulation provisions, the Federal Reserve Board adopted final rules that will apply enhanced prudential standards to the US operations of large foreign banking organisations, including the Group. Under the Federal Reserve Board’s final rules, a number of large foreign banking organisations will be required to establish a separately capitalised top-tier US intermediate holding company (IHC) that will hold all of the large foreign banking organisation’s US bank and non-bank subsidiaries, except its US branches and agencies and specified types of subsidiaries. However, this requirement will not apply to a large foreign banking organisation with combined US assets of less than $50 billion, excluding assets held by its US branches and agencies. The Group does not anticipate that the requirement to form an IHC, will apply to the Group. In addition, under the final rules, effective 1 July 2016, US branches and agencies of foreign banking organisations with $50 billion or more in total global consolidated assets, such as the Group, will be subject to liquidity home country capital certification and, in certain circumstances, asset maintenance requirements. These foreign banking organisations must also maintain a US Risk Committee as of 1 July 2016. However, final rules for single counterparty credit limits and for early remediation have yet to be finalised.

The Dodd-Frank Act and related rules and regulations will result in additional costs and impose certain limitations and restrictions on the way that the Group conducts its business, although uncertainty remains about some of the final details, impact and timing of the implementing regulations.

189

REGULATION

 

DISCLOSURE PURSUANT TO SECTION 219 OF THE IRAN THREAT REDUCTION AND SYRIA HUMAN RIGHTS ACT (ITRA)

 

Since the introduction of an enhanced financial sanctions policy, the Group has been proactive in reducing its dealings with Iran and individuals and entities associated with Iran. There remain a small number of historic Iran-related business activities which the Group has not yet been able to terminate for legal or contractual reasons.

 

Pursuant to ITRA Section 219, the Group notes that during 2015,2018, its non-US affiliates, Lloyds Bank plc and Bank of Scotland plc, received or made payments involving entities owned or controlled by the Government of Iran as defined under section 560.304 of title 31, Code of Federal Regulations, and/or designated under Executive Order 13382.13382 or 13224. In all cases, the payment was permitted under UK and EU sanctions legislation, specific authority was sought from and granted by HM Treasury, the UK’s Competent Authority to provide such authorisations or the payment(s) were credited to a blocked account, held in the name of the entity, in accordance with UK and EC sanctions legislation.

 

Gross revenues from these activities were approximately £10,000.£6,000. Net profits from these activities were approximately £11,000.£6,000.

 

The Group’s businesses, being reported below, are conducted in compliance with applicable laws in respect of Iran and Syria sanctions and, except as noted below, the Group intends to continue these historic activities until it is able to legally terminate the contractual relationships or to maintain/manage them in accordance with prevailing sanctions obligations. The nature of these activities is as follows:

 

1.Receipt in relationLimited and infrequent payments made to repayment of a European Export Credit Agreement loan made priorand received from entities directly or indirectly linked to 2005 with respect to engineering and the supply of equipment and related services for several projects in Iran. The loan is now fully repaid. The borrower and/or guarantor is owned by the Government of Iran. Such payments are only made if they comply with UK regulation and legislation and/or licence from the U.S. Treasury Department’s Office of Foreign Assets Control.
  
2.Payments made to Building and Housing Research Centre in Iran related to a guarantee, entered into by the Group in 2006, in connection with the supply of seismic equipment for free field accelerometers systems for dams and civil building monitoring. The beneficiary of the guarantee is an entity owned by the Government of Iran and the payments were made to a frozen account in a European bank for an entity designated under Executive Order 13382.
3.Payments made to a blocked account in the name of Commercial Bank of Syria related to historic guarantees, entered into by the Group between 1997 and 2008, the majority of which relate to Bail Bonds for vessels. The Commercial Bank of Syria is designated under Executive orderOrder 13382.
  
4.3.Sums paid out from a pension trust fund to UK nationals resident in the UK who were employees of a company indirectly owned or controlled by an entity designated under Executive Order 13382 that is also owned or controlled by the Government of Iran.
  
5.4.Lloyds continues to provide payment clearing services to a UK based and UK authorised bank, one of whose account holders is an entity designated under Executive Order 13224 (although not by the UK or EU authorities). Lloyds concludes from the nature of such payment clearing services that revenue and profit (if any) arising from indirectly providing such services to the designated entity is negligible and not material to the Group’s activities and in any event does not flow directly from the designated entity. To the extent that the activities of the designated entity and its UK authorised bank continue to comply with UK regulation and legislation, Lloyds intends to continue its activities and keep this activitythem under review.
190160

LISTING INFORMATION

TRADING MARKETS

 

The ordinary shares of Lloyds Banking Group plc are listed and traded on the London Stock Exchange under the symbol ‘LLOY.L’‘LLOY’. The prices for shares as quoted in the official list of the London Stock Exchange are in pounds sterling. The following table shows the reported high and low closing prices for the ordinary shares on the London Stock Exchange. This information has been extracted from publicly available documents from various sources, including officially prepared materials from the London Stock Exchange, and has not been prepared or independently verified by the Lloyds Banking Group.

 Price per share
(in pence)
High		Price per share
(in pence)
Low
Annual prices:  
201589.0068.68
201486.3070.94
201380.3746.31
201249.2525.30
201169.6121.84
Quarterly prices:  
2015  
Fourth quarter77.8368.68
Third quarter87.6572.30
Second quarter89.0077.38
First quarter81.4372.87
2014  
Fourth quarter80.8972.27
Third quarter76.8771.92
Second quarter80.1570.94
First quarter86.3074.34
2013  
Fourth quarter80.3772.52
Third quarter78.0062.95
Second quarter63.1646.31
First quarter55.6847.65
Monthly prices:  
January 201671.5763.14
December 201574.7168.68
November 201575.0071.60
October 201577.8373.73
September 201577.0072.30
August 201583.3073.46

On 26 February 2016, the closing price of shares on the London Stock Exchange was 72.13 pence, equivalent to $1.00 per share translated at the Noon Buying Rate of $1.39 per £1.00 on 26 February 2016.

Lloyds Banking Group plc’s American Depositary Receipts (ADRs) were traded on the over-the-counter market in the US under the symbol ‘LLDTY’ between March 2000 and November 2001. Since 27 November 2001 Lloyds Banking Group plc American Depositary Shares (ADSs) have beenare listed on the New York Stock Exchange under the symbol ‘LYG’. Each ADS represents four ordinary shares.

191

LISTING INFORMATION

The following table shows the reported high and low closing prices for ADSs on the New York Stock Exchange.

 Price per ADS
(in US dollars)
High		Price per ADS
(in US dollars)
Low
Annual prices:  
20155.644.25
20145.764.62
20135.362.84
20123.231.53
20114.441.34
Quarterly prices:  
2015  
Fourth quarter4.834.25
Third quarter5.534.47
Second quarter5.644.65
First quarter4.964.38
2014  
Fourth quarter5.024.62
Third quarter5.324.70
Second quarter5.534.83
First quarter5.765.01
2013  
Fourth quarter5.364.67
Third quarter5.003.83
Second quarter3.912.84
First quarter3.582.89
2012  
Fourth quarter3.232.34
Third quarter2.561.75
Second quarter2.121.53
First quarter2.351.58
2011  
Fourth quarter2.391.34
Third quarter3.251.76
Second quarter4.032.73
First quarter4.443.70
Monthly prices:  
January 20164.323.66
December 20154.574.25
November 20154.694.36
October 20154.834.58
September 20154.764.47
August 20155.254.64

On 26 February 2016, the closing price of ADSs on the New York Stock Exchange was $4.03.

192

LISTING INFORMATION

 

ADR FEES

 

The Group’s depositary, The Bank of New York Mellon, collects its fees for delivery and surrender of ADSs directly from investors depositing shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The depositary collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. The depositary may collect its annual fee for depositary services by deductions from cash distributions or by directly billing investors or by charging the book-entry system accounts of participants acting for them. The depositary may generally refuse to provide fee-attracting services until its fees for those services are paid.

 

Persons depositing or withdrawing shares must pay:For:
$5.00 (or less) per 100 ADSs (or portion of 100 ADSs)

Issuance of ADSs, including issuances resulting from a distribution of shares or rights or other property.


Cancellation of ADSs for the purpose of withdrawal, including if the deposit agreement terminates.

$.02 (or less) per ADSAny cash distribution to ADS registered holders.

A fee equivalent to the fee that would be payable if securities distributed had been shares and the shares had been deposited for issuance of ADSs

Distribution of securities distributed to holders of deposited securities which are distributed by the depositary to ADS registered holders.

$.02 (or less) per ADSs per calendar yearDepositary services.
Registration or transfer feesTransfer and registration of shares on the share register to or from the name of the depositary or its agent when you deposit or withdraw shares.
Expenses of the depositary

Cable, telex and facsimile transmissions (when expressly provided in the deposit agreement).


Converting foreign currency to US dollars.

Taxes and other governmental charges the depositary or the custodian have to pay on any ADS or share underlying an ADS, for example, stock transfer taxes, stamp duty or withholding taxesAs necessary.
Any charges incurred by the depositary or its agents for servicing the deposited securitiesAs necessary.

 

FEES RECEIVED TO DATE

 

In 2015,2018, the Company received from the depositary $1,078,357$1,049,224 for continuing annual stock exchange listing fees, standard out-of-pocket maintenance costs for the ADRs (consisting of the expenses of postage and envelopes for mailing annual and interim financial reports, printing and distributing dividend checks, electronic filing of US Federal tax information, mailing required tax forms, stationery, postage, facsimile, and telephone calls), any applicable performance indicators relating to the ADR facility, underwriting fees and legal fees.

 

FEES TO BE PAID IN THE FUTURE

 

The Bank of New York Mellon, as depositary, has agreed to reimburse the Company for maintenance expenses that they incur for the ADS program. The depositary has agreed to reimburse the Company for its continuing annual stock exchange listing fees. The depositary has also agreed to pay the standard out-of-pocket maintenance costs for the ADRs, which consist of the expenses of postage and envelopes for mailing annual and interim financial reports, printing and distributing dividend checks, electronic filing of US Federal tax information, mailing required tax forms, stationery, postage, facsimile, and telephone calls. It has also agreed to reimburse the Company annually for certain investor relationship programs or special investor relations promotional activities. In certain instances, the depositary has agreed to provide additional payments to the Company based on any applicable performance indicators relating to the ADR facility. There are limits on the amount of expenses for which the depositary will reimburse the Company, but the amount of reimbursement available to the Company is not necessarily tied to the amount of fees the depositary collects from investors.

193161

DIVIDENDS

 

Lloyds Banking Group plc’s ability to pay dividends is restricted under UK company law. Dividends may only be paid if distributable profits are available for that purpose. In the case of a public limited company, a dividend may only be paid if the amount of net assets is not less than the aggregate of the called-up share capital and undistributable reserves and if the payment of the dividend will not reduce the amount of the net assets to less than that aggregate. In addition, a company cannot pay a dividend if any of its UK insurance subsidiaries is insolvent on a regulatory valuation basis or, in the case of regulated entities, if the payment of a dividend results in regulatory capital requirements not being met. Similar restrictions exist over the ability of Lloyds Banking Group plc’s subsidiary companies to pay dividends to their immediate parent companies. Furthermore, in the case of Lloyds Banking Group plc, dividends may only be paid if sufficient distributable profits are available for distributions due in the financial year on certain preferred securities. The board has the discretion to decide whether to pay a dividend and the amount of any dividend. In making this decision, the board is mindful of the level of dividend cover and, consequently, profit growth may not necessarily result in increases in the dividend. In the case of American Depositary Shares, dividends are paid through The Bank of New York Mellon which acts as paying and transfer agent.

 

The Group has a progressive and sustainable ordinary dividend policy whilst maintaining the flexibility to return surplus capital through buybacks or special dividends.

Given the strong business performance in 2018 the Board has recommended a final ordinary dividend of 2.14 pence per share. This is in addition to the interim ordinary dividend of 1.07 pence per share that was announced in the 2018 half year results. The total ordinary dividend per share for 20152018 of 2.253.21 pence per share has increased from 0.75 pence in 2014, in line with our progressive and sustainable dividend policy, and we continue to expect ordinary dividends to increase over the medium term with a dividend payout ratio of at least 50by 5 per cent of sustainable earnings.from 3.05 pence per share in 2017.

 

The special dividendGroup is planning on the basis of 0.5 pence peran orderly EU withdrawal and, given the resilience of the UK economy, intends to implement a share representsbuyback of up to £1.75 billion (2017: £1 billion) which will commence in March 2019 and is expected to be completed by 31 December 2019. The Board’s current preference is to return surplus capital by way of a buyback programme given the distributionamount of surplus capital, over and above the Board’s viewnormalisation of the current level of capital required to grow the business, meet regulatory requirements and cover uncertainties. This level is consistent with our capital requirement guidance of around 12 per cent plus an amount broadly equivalent to a further year’s ordinary dividend.

The amount of capital we believe is appropriate to hold is likely to vary from time to time depending on circumstancesdividends, and the Board will give due consideration, subject to the situation at the time, to the distribution of any surplus capital through the use of special dividends or share buy backs. By its nature, there can be no guaranteeflexibility that this level of special dividend or any surplus capital distribution will be appropriate in future years.a buyback programme offers.

 

The table below sets out the interim and final dividends in respect of the ordinary shares for fiscal years 2004 through 2015.2018. The sterling amounts have been converted into US dollars at the Noon Buying Rate in effect on each payment date with the exception of the recommended final dividend for 2015,2018, for which the sterling amount has been converted in US dollars at the Noon Buying Rate on 2615 February 2016.2019.

 

Interim ordinary
dividend
per share
(pence)		Interim ordinary
dividend
per share
(cents)		Final ordinary
dividend
per share
(pence)		Final ordinary
dividend
per share
(cents)		 Interim ordinary
dividend
per share
(pence)		 Interim ordinary
dividend
per share
(cents)		 Final ordinary
dividend
per share
(pence)		 Final ordinary
dividend
per share
(cents)		 
200410.719.023.544.7  10.7   19.0   23.5   44.7 
200510.718.923.543.3  10.7   18.9   23.5   43.3 
200610.720.223.546.8  10.7   20.2   23.5   46.8 
200711.222.824.748.2  11.2   22.8   24.7   48.2 
200811.420.3–  11.4   20.3   –   – 
2009–  –   –   –   – 
2010–  –   –   –   – 
2011–  –   –   –   – 
2012–  –   –   –   – 
2013–  –   –   –   – 
20141–0.751.16  –   –   0.75   1.16 
201520.751.141.52.08  0.75   1.14   1.5   2.17 
20163  0.85   1.10   1.70   2.20 
2017  1.00   1.34   2.05   2.72 
2018  1.07   1.41   2.14   2.75 

 

1The recommended dividend for 2014 was in respect of the full year.
2The
2For 2015, the Board has also recommendedmade a capital distribution in the form of a special dividend of 0.5 pence per share (0.69(0.72 cents per share) for 2015.. This is not listed in the table above.
3For 2016, the Board also made a capital distribution in the form of a special dividend of 0.5 pence per share (0.65 cents per share). This is not listed in the table above.
194162

MEMORANDUM AND ARTICLES OF ASSOCIATION OF
LLOYDS BANKING GROUP PLC

 

Lloyds Banking Group plc is incorporated in Scotland under the UK Companies Act 1985 with registered number SC95000.

 

As resolved at the 20152018 Annual General Meeting, with effect from 14 May 2015, Lloyds Banking Group plc adopted amended its Articles of Association to align the rights of theremove references to limited voting shares with changes to the UK Listing Authority Listing Rules and to delete references to deferredfollowing their conversion into ordinary shares all of which were cancelled in the capital of the Company in November 2010.with effect from 1 July 2017. The amended Articles of Association took effect from 24 May 2018.

 

A summary of the material provisions of Lloyds Banking Group plc’s memorandum and articlesArticles of associationAssociation is set out below.

 

OBJECTS OF LLOYDS BANKING GROUP PLC

 

As permitted under recent changes in UK company law, theThe objects of Lloyds Banking Group plc are unrestricted.

RIGHTS ATTACHING TO SHARES

Any share in Lloyds Banking Group plc may be issued with any preferred, deferred or other special rights (including being denominated in another currency), or subject to such restrictions (whether as regards dividend, returns of capital, voting or otherwise) as Lloyds Banking Group plc may from time to time determine by ordinary resolution or as otherwise provided in the Articles of Association.

Subject to statute, Lloyds Banking Group plc may issue any shares which are, or at Lloyds Banking Group plc’s option are, liable to be redeemed. The directors may determine the terms and conditions and manner of such redemption.

 

VOTING RIGHTS

 

For the purposes of determining which persons are entitled to attend or vote at a meeting and how many votes such persons may cast, Lloyds Banking Group plc may specify in the notice of the meeting a time, not more than 48 hours before the time fixed for the meeting, by which a person must be entered on the register in order to have the right to attend or vote at the meeting.

Every holder of ordinary shares who is entitled to be and is present in person (including any corporation by its duly authorised representative) at a general meeting of Lloyds Banking Group plc and is entitled to vote will have one vote on a show of hands and, on a poll, if present in person or by proxy, will have one vote for every such share held by him, save that a member will not be entitled to exercise the right to vote carried by such shares if he or any person appearing to be interested in the shares held by him has been duly served with a notice under section 793 of the Companies Act (requiring disclosure of interests in shares) and is in default in supplying Lloyds Banking Group plc with information required by such notice. The limited voting shares confer the right to receive notice of and to attend and speak at all general meetings of Lloyds Banking Group plc, but do not confer a right to vote unless the business of the meeting includes the consideration of a resolution:

 

– for the winding-up of Lloyds Banking Group plc; or

– to vary the rights of the limited voting shares.

In any such case, the holder may vote the limited voting shares only in respect of such resolution and will have the same rights with regard to the number and exercise of votes as a holder of ordinary shares but, in the case of a variation in the rights of limited voting shares, shall also have the protection of a requirement for approval of the variation either by way of consent in writing by the holders of three-quarters in nominal value of the issued limited voting shares or by a special resolution at a separate class meeting of the holders of limited voting shares. Preference shares confer such rights as may be determined by the directors on allotment, but unless the directors otherwise determine, fully paid preference shares confer identical rights as to voting, capital, dividends (save as to currency or payment thereof) and otherwise, notwithstanding that they are denominated in different currencies and shall be treated as if they are one single class of shares. There are no limitations imposed by UK law or the Articles of Association of Lloyds Banking Group plc restricting the rights of non-residents of the UK or non-citizens of the UK to hold or vote shares of Lloyds Banking Group plc.

 

GENERAL MEETINGS

 

Annual general meetings of Lloyds Banking Group plc are to be held, in each period of 6six months beginning with the day following Lloyds Banking Group plc’s accounting reference date, in Edinburgh or such other place in Scotland as the directors shall appoint and at a date and time as may be determined by the directors. All other general meetings may be convened whenever the directors think fit and shall be requisitioned in accordance with the requirements of the Articles of Association.

Lloyds Banking Group plc must prepare a notice of meeting in respect of a general meeting in accordance with the requirements of the Articles of Association and the Companies Act. Lloyds Banking Group plc must give at least 21 clear days’ notice in writing of an annual general meeting. All other general meetings may be called by at least 14 clear days’ notice in writing.

The directors may make arrangements to enable attendance or regulate the level of attendance at any place specified in the notice of meeting for the holding of a general meeting and, in any such case, shall direct that the meeting be held at a specified place, where the chairman of the meeting shall preside, and make arrangements for simultaneous attendance and participation by members and proxies at other locations. The chairman of a general meeting has express authority to adjourn the meeting if, in his opinion, it appears impracticable to hold or continue the meeting because of crowding or unruly conduct or because an adjournment is otherwise necessary for the proper conduct of the meeting.

The processes and procedures for the conduct of a general meeting (including adjourning meetings, voting, amending resolutions and appointing proxies) is established under the Articles of Association and the Companies Act. The chairman of a general meeting shall be entitled to take any action he considers appropriate for properly and orderly conduct before and during a general meeting, including askingmeeting. The directors shall be entitled to ask persons wanting to attend to submit to searches or other security arrangements.arrangements as such directors consider appropriate.

The quorum necessary for the transaction of business at a general meeting is three members present in person or by proxy and entitled to vote.

 

DIVIDENDS AND OTHER DISTRIBUTIONS AND RETURN OF CAPITAL

 

Under the Companies Act, before Lloyds Banking Group plc can lawfully make a distribution, it must ensure that it has sufficient distributable reserves (accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital duly made). Under the Articles of Association (and subject to statute) the directors are entitled to set aside out of the profits of Lloyds Banking Group plc any sums as they think proper which, at their discretion, shall be applicable for any purpose to which the profits of Lloyds Banking Group plc may be applied.

 

The shareholders in general meeting may by ordinary resolution declare dividends to be paid to members of Lloyds Banking Group plc, but no dividends shall be declared in excess of the amount recommended by the directors. The directors may pay fixed dividends on any class of shares carrying a fixed dividend and may also from time to time pay dividends, interim or otherwise, on shares of any class.class as they think fit. Except in so far as the rights attaching to any shares otherwise provide, all dividends shall be apportioned and paidpro rataaccording to the amounts paid up thereon. Subject to the rights attaching to any shares, any dividend or other monies payable in respect of a share may be paid in such currency or currencies as the directors may determine using such exchange rates as the directors may select.

163

ARTICLES OF ASSOCIATION OF LLOYDS BANKING GROUP PLC

 

The opportunity to elect to receive new shares instead of any cash dividend recommended by the directors may be offered to shareholders provided that the directors shall have obtained in advance the shareholders’ approval to do so as required by the Articles of Association.Association and the procedure under the Articles of Association is followed for allotting such shares.

 

The limited voting shares do not conferIn addition, Lloyds Banking Group plc may by ordinary resolution direct the payment of a right to participatedividend in anywhole or in part by the distribution of profits by way of dividend. For any other distributions, the limited voting shares shall be deemed to confer rights and interests specific assets (a distributionin the profits equally with the holders of ordinary shares according to the amounts paid up on such limited voting shares and ordinary shares respectively otherwise than in advance of calls.specie).

 

On any distribution by way of capitalisation, the amount to be distributed will be appropriated amongst the holders of ordinary shares and limited voting shares in proportion to their holdings of ordinary shares and limited voting shares (pro rata to the amount paid up thereon). If the amount to be distributed is applied in paying up in full unissued ordinary shares and limited voting shares of Lloyds Banking Group plc, a shareholder will be entitled to receive bonus shares of the same class as the shares giving rise to his entitlement to participate in the capitalisation.

195

MEMORANDUM AND ARTICLES OF ASSOCIATION OF
LLOYDS BANKING GROUP PLC

 

Any dividend unclaimedor other moneys payable to a member that has not been cashed or claimed after a period of 12 years from the date of declaration of such dividend or other moneys payable to a member will be forfeited and revert to Lloyds Banking Group plc. NoLloyds Banking Group plc shall be entitled to use such unclaimed or unclaimed dividend or other moneys payable to a member for its benefit in any manner that the directors may think fit. Lloyds Banking Group plc shall not be a trustee of dividends or other moniesmoneys payable that have not been cashed or claimed and it shall not be liable to pay interest on such dividends or in respect of a share shall bear interest against Lloyds Banking Group plc.other moneys.

 

On a return of capital, whether in a winding-up or otherwise, the ordinary shares and the limited voting shares will rank equally in all respects and the preference shares will be entitled to the rights attaching to them on issue.

 

Lloyds Banking Group plc’s ordinary shares limited voting shares, certain preference shares do not confer any rights of redemption. Rights of redemption in respect of Lloyds Bank Group plc’s preference shares shall be as the directors determine on allotment.

 

Lloyds Banking Group plc may, subject to applicable law and to the Articles of Association, issue redeemable shares and redeem the same. Lloyds Banking Group plc has issued certain preference shares which are redeemable. In general, subject to applicable law and the approval of the UK Prudential Regulation Authority, some of these shares are redeemable by Lloyds Banking Group plc on a specified date and in some cases, thereafter on relevant dividend payment dates. Others are redeemable at any time during a specified period and following the occurrence of specified regulatory events.

 

Under the Articles of Association and the Companies Act, the liability of shareholders is limited to the amount (if any) for the time being unpaid on the shares held by that shareholder.

 

CONVERSION OF LIMITED VOTING SHARES

Each limited voting share will be converted into an ordinary share:

–on the day following the last date on which an amount could become due and payable to a holder of limited voting shares under a deed of covenant. A deed of covenant is a legal document which records the obligation of one person to pay a specified sum to another for a specified number of years; or
–if an offer is made to ordinary shareholders (or to all such shareholders other than the offeror and/or any body corporate controlled by the offeror and/ or any persons acting in concert with the offeror) to acquire the whole or any part of the issued ordinary share capital of Lloyds Banking Group plc and the right to cast more than 50 per cent of the votes which may ordinarily be cast on a poll at a general meeting of Lloyds Banking Group plc becomes or is certain to become vested in the offeror and/or any bodies corporate controlled by the offeror and/or any persons acting in concert with the offeror. The publication of a scheme of arrangement under the statutes providing for the acquisition by any person of the whole or part of the ordinary share capital of Lloyds Banking Group plc shall be deemed to be the making of an offer for this purpose.

The ordinary shares resulting from conversion will carry the right to receive all dividends and other distributions declared, made or paid on the ordinary share capital of Lloyds Banking Group plc by reference to a record date on or after the date of conversion and will rank equally in all other respects and form one class with the ordinary share capital of Lloyds Banking Group plc then in issue and fully paid.

Holders of limited voting shares will be entitled to participate in any offer made by way of rights to holders of ordinary shares as if the limited voting shares had been converted at the relevant record date.

VARIATION OF RIGHTS AND ALTERATION OF CAPITAL

 

Subject to the provisions of the Companies Act, the CREST Regulations and every other statute for the time being in force or any judgment or order of any court of competent jurisdiction concerning companies and affecting Lloyds Banking Group plc (the statutes), the rights attached to any class of shares for the time being in issue may (subject to their terms of issue) be varied or abrogated with the consent in writing of the holders of not less than three-quarters in nominal value of the issued shares of that class or with the sanction of a special resolution passed at a separate meeting of the holders of shares of that class. At any such separate meeting, the provisions of the Articles of Association relating to general meetings will apply, but the necessary quorum at any such meeting will be two persons holding or representing by proxy at least one-third in nominal value of the issued shares of that class (except at an adjourned meeting, at which the quorum shall be any holder of shares of the class, present in person or by proxy) and any such person may demand a poll.poll and every such holder shall on a poll have one vote for every share of the class held by such holder.

 

However, for so long asAny special rights attached to any class of shares having preferential rights will not be deemed to be varied by: (i) the limited votingcreation or issue of further shares haveranking in some or all respects equally to such class (but not been converted (as described above):in priority thereto); or (ii) the creation or redemption by Lloyds Banking Group plc of its own shares.

–Lloyds Banking Group plc is prohibited from consolidating or subdividing any of the ordinary shares without consolidating or subdividing the limited voting shares in a like manner and to a like extent; and
–Lloyds Banking Group plc will not create any new class of equity share capital, other than in connection with or pursuant to an employees’ share scheme approved by Lloyds Banking Group plc in general meeting, provided that the creation of equity share capital which carries (as compared with the Existing Ordinary Shares) only restricted voting or no voting rights and no greater rights as regards dividends or capital shall not be deemed to be the creation of a new class of equity share capital.

 

As a matter of UK law, Lloyds Banking Group plc may, by ordinary resolution, increase its share capital, consolidate and divide all or any of its shares into shares of larger amount, sub-divide all or any of its shares into shares of smaller amount and cancel any shares not taken or agreed to be taken by any person. Where a consolidation or subdivision of shares would result in fractions of a share, the directors may sell the shares representing the fractions for the best price reasonably obtainable, and distribute the net proceeds of such sale to the relevant members entitled to such proceeds. Where a member’s entitlement to a portion of the proceeds of sale amounts to less than a minimum figure (as determined by the directors), such portion may be distributed to a charitable organisation at the directors’ discretion.

 

Subject to the provisions of the statutes, Lloyds Banking Group plc may, by special resolution, reduce its share capital, any capital redemption reserve, share premium account or other undistributable reserve in any way.

 

TRANSFER OF SHARES

 

All transfers of shares which are in certificated form may be effected by transfer in writing in any usual or common form or in any other form acceptable to the directors and must be executed by or on behalf of the transferor and, ifexcept in the shares thereby transferred are notcase of fully paid shares, by or on behalf of the transferee. The transferor will be deemed to remain the holder of the shares transferred until the name of the transferee is entered in the register of members of Lloyds Banking Group plc in respect thereof. All transfers of shares which are in uncertificated form may be effected by means of a relevant system.system, unless the CREST Regulations provide otherwise.

 

The directors may, in the case of shares in certificated form, in their absolute discretion and without assigning any reason therefor, refuse to register any transfer of shares (not being fully paid shares) provided that, where any such shares are admitted to the Official List of the UK Financial Conduct Authority, such discretion may not be exercised in such a way as to prevent dealings in the shares of that class from taking place on an open and proper basis. The directors may also decline to register a transfer unless either:

196

MEMORANDUM AND ARTICLES OF ASSOCIATION OF
LLOYDS BANKING GROUP PLCunless:

 

–the instrument of transfer and the lodging of such instrument complies with the requirements of the Articles of Association and the transfer is in respect of only one class of shares; or
  
–the transfer is in favour of not more than four persons as the transferee.
The directors shall refuse to register the transfer of any share on which Lloyds Banking Group plc has a lien and shall refuse to register the transfer of any limited voting share unless the same is:
–between existing holders of limited voting shares; or
–under a scheme established or order made by the Charity Commissioners or by the Court to a transferee having charitable objects; or
–in the course of a winding-up to an institution having charitable objects which prohibit distributions of income and property to members to at least the same extent as is imposed on the transferor by its Memorandum of Association; or
–at the direction of the crown to another charity having similar objects.

The directors shall refuse to register the transfer of any share on which Lloyds Banking Group plc has a lien.

 

The Articles of Association otherwise contain no restrictions on the free transferability of fully paid shares.

164

ARTICLES OF ASSOCIATION OF LLOYDS BANKING GROUP PLC

 

Subject to the statutes and the rules (as defined in the CREST Regulations), and apart from any class of wholly dematerialised security, the directors may determine that any class of shares may be held in uncertificated form and that title to such shares may be transferred by means of an electronic trading system or that shares of any class should cease to be so held and so transferred.

 

DISCLOSURE OF HOLDINGS EXCEEDING CERTAIN PERCENTAGES

 

TheIn broad terms, the Disclosure and Transparency Rules of the UK Financial Conduct Authority require Lloyds Banking Group plc shareholders to notify Lloyds Banking Group plc if the voting rights held by such Lloyds Banking Group plc shareholders (including by way of a certain financial instrument) reach, exceedreaches, exceeds or fallfalls below 3three per cent, four per cent, five per cent, six per cent, seven per cent, eight per cent, nine per cent, ten per cent and each 1one per cent threshold thereafter up to 100 per centcent. Under the Disclosure and Transparency Rules, certain voting rights in Lloyds Banking Group plc may be disregarded.

 

Pursuant to the Companies Act, Lloyds Banking Group plc may also send a notice to any person whom Lloyds Banking Group plc knows or believeshas reasonably cause to bebelieve that such person is interested in Lloyds Banking Group plc’s shares or at any time during the three years immediately preceding the date on which such notice is issued to have been so interested, requiring that person to confirm whether he has or had such an interest and if so provide details of that interest.interest as required by the notice.

 

Under the Articles of Association and UK law, if a person fails to comply with such a notice or provides information that is false in a material particular in respect of any shares (the default shares), the Lloyds Banking Group plc directors may serve a restriction notice on such a person. Such a restriction notice will state that the default shares and, if the Lloyds Banking Group plc directors determine, any other shares held by that person, shall not confer any right to attend or vote at any general meeting of Lloyds Banking Group plc.

 

In respect of a person with a 0.25 per cent or more interest in the issued shares of the class in question, the Lloyds Banking Group plc directors may direct by notice to such member that, subject to certain exceptions, no transfers of shares held by such person shall be registered andand/or that any dividends or other payments on the default shares shall be retained by Lloyds Banking Group plc pending receipt by Lloyds Banking Group plc of the information requested by the Lloyds Banking Group plc directors. Certain consequences of the issue of a restriction notice are outlined above.

 

MANDATORY TAKEOVER BIDS, SQUEEZE-OUT AND SELL-OUT RULES

 

Other than as provided by the Companies Act and the City Code, there are no rules or provisions relating to mandatory bids and/or squeeze-out and sell-out rules in relation to the ordinary shares.

 

UNTRACED MEMBERS

 

Lloyds Banking Group plc is empoweredentitled to sell, as the agent of a member, at the best price reasonably obtainable, any share registered in the name of a member (or any other person entitled to such shares at law) provided that: (i) such shares remaining untraced for 12 years who fails to communicate with Lloyds Banking Group plc within three months following the publication of an advertisement of an intention to make such a disposal; providedand during that during the 12-year period at least three dividends in respect of such shares have become payable and no dividend in respect of those shares has been claimed.cashed or claimed by the relevant member; (ii) Lloyds Banking Group plc uses reasonable efforts to trace the relevant member and, following the expiry of the 12 year period, sends a notice to the last known physical or email address of such member stating Lloyds Banking Group plc’s intention to sell the shares; and (iii) during the three months following sending such notice, Lloyds Banking Group plc does not receive any communication from such member. Lloyds Banking Group plc can also sell, at the best price reasonably obtainable, any addition shares held by the same member that were issued during such 12 year period provided that no dividend on such additional shares has been cashed or claimed by such member during such period.

 

The proceeds from the sale of untraced shares shall be forfeited by the relevant member and shall belong to Lloyds Banking Group plc. Lloyds Banking Group plc shall not be obligedliable or be required to account to the member for the proceeds of the disposal. However, any net proceeds of sale unclaimed after 12 years from the date of sale shall be forfeited and shall revert tosuch sale. Lloyds Banking Group plc.

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LLOYDS BANKING GROUP PLCplc is entitled to use or invest the proceeds from such sale in any manner that the directors think fit.

 

FORFEITURE AND LIEN

The directors may by resolution make calls upon members in respect of any moneys unpaid on their shares (but subject to the terms of allotment of such shares) in the manner required by the Articles of Association.

 

If a member fails to pay in full any call or instalment of a call on or before the due date for payment, then, following notice by the directors requiring payment of the unpaid amount with any accrued interest and any expenses incurred, such share may be forfeited by a resolution of the directors to that effect (including all dividends declared in respect of the forfeited share and not actually paid before such forfeiture). A member whose shares have been forfeited will cease to be a member in respect of the shares, but will, notwithstanding the forfeiture, remain liable to pay to Lloyds Banking Group plc all monies which at the date of forfeiture were presently payable together with interest. The directors may at their absolute discretion enforce payment without any allowance for the value of the shares at the time of forfeiture or for any consideration received on their disposal or waive payment in whole or part.

 

Lloyds Banking Group plc has a first and paramount lien on every share (not being a fully paid share) for all monies (whether presently payable or not) called or payable at a fixed time in respect of such share, and the directors may waive any lien which has arisen and may resolve that any share shall for some limited period be exempt from such a lien, either wholly or partially.

 

A forfeited share becomes the property of Lloyds Banking Group plc, and it may be sold, re-allotted, otherwise disposed of or cancelled as the directors see fit. Any share on which Lloyds Banking Group plc has a lien may be sold on the terms set out in the Articles of Association. The proceeds of sale shall first be applied towards payment of the amount in respect of the lien insofar as it is still payable and then on surrender of the share certificate for cancellation (in the case of shares in certificated form), to the person entitled to the shares at the time of sale.

 

WINDING-UP

 

The directors have the power, in the name and on behalf of Lloyds Banking Group plc, to present a petition to the court for Lloyds Banking Group plc to be wound up.

If Lloyds Banking Group plc is wound up, the liquidator may, with the authority of aan ordinary resolution, divide amongst the members in specie or kind the whole or any part of the assets of Lloyds Banking Group plc. The liquidator may for such purpose set such value as he deems fair upon any one or

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more class or classes of property and may determine how such division shall be carried out as between the members or different classes of members. The liquidator may vest any part of the assets in trustees upon such trusts for the benefit of members as the liquidator thinks fit, and the liquidation may be closed and Lloyds Banking Group plc dissolved, but so that no contributory shall be compelled to accept any shares or other property in respect of which there is a liability.

 

DIRECTORS

Subject to any other provision of the Articles of Association, the number of directors of Lloyds Banking Group plc shall be no fewer than seven. The minimum/maximum number of directors may be varied by ordinary resolution of Lloyds Banking Group plc. The directors may elect from them a chairman and deputy chairman (or two or more deputy chairman) and determine the period for which each is to hold office.

 

The business and affairs of Lloyds Banking Group plc shall be managed by the directors, who may exercise all such powers of Lloyds Banking Group plc (including its borrowing powers) as are not by the statutes or by the Articles of Association required to be exercised by Lloyds Banking Group plc in general meeting, subject to the Articles of Association, to the provisions of the statutes and to such regulations as may be set by special resolution of Lloyds Banking Group plc, but no regulation so made by Lloyds Banking Group plc will invalidate any prior act of the directors which would have been valid if such regulation had not been made.

 

The directors may confer upon any director holding any executive office any of the powers exercisable by them on such terms and conditions, and with such restrictions, as they think fit. The directors may also delegate any of their powers to committees. Any such committee shall have power to sub-delegate to sub-committees or to any person any of the powers delegated to it. Any such committee or sub-committee shall consist of one or more directors only. The meetings and proceedings of any such committee or sub-committee consisting of two or more persons shall be governed, with such changes as are appropriate, by the provisions of the Articles of Association regulating the meetings and proceedings of the directors. The directors may also grant powers of attorney to appoint a company, firm or person (or body of persons) to be the attorneys for Lloyds Banking Group plc with such powers, authorities and discretions and for such period and subject to such conditions as the directors think fit.

 

The directors may meet to consider this business of Lloyds Banking Group plc as they think fit. Any director may summon a meeting on request. The quorum necessary for the transaction of business of the directors may be fixed from time to time by the directors and unless so fixed at any other number shall be four. Questions arising at any meeting of the directors shall be determined by a majority of votes. In the case of an equality of votes, the chairman of the meeting shall have a second or casting vote.

 

DIRECTORS’ RETIREMENT

 

The Articles of Association provide that a director appointed by the board either to fill a casual vacancy or as an additional director shall retire at the annual general meeting next after his appointment but shall be eligible for election as a director at that meeting. The Articles of Association further provide that each director shall retire at the annual general meeting held in the third calendar year following the year in which he was elected or last re-elected and shall be eligible for re-election as a director at that meeting. No person shall be eligible for election as a director at any general meeting unless he is a director that is retiring or is recommended by the directors for election in the manner required by the Articles of Association.

REMOVAL OF A DIRECTOR AND VACATION FROM OFFICE

Subject to statute, Lloyds Banking Group plc may remove any director from office by ordinary resolution of which special notice has been given.

The officer of a director will be vacated in the following circumstances:

– the director becomes prohibited by law from acting as a director;
–the director resigns in writing to the chairman or deputy chairman or the secretary and the directors resolve to accept such offer of resignation;
–if a bankruptcy order is made against such director or such director applies to the court in connection with a voluntary arrangement under the UK Insolvency Act 1986;
–if an order is made by the court claiming jurisdiction on the ground of mentor disorder for the director’s detention or for the appointment of a guardian or for the appointment of a person to exercise powers in respect of such director’s property or affairs;
–if the director is absent from meetings of directors for six months without leave and the directors resolve that such director’s office be vacated; or
–if a written notice is served on him (signed by no less than three-quarters of the directors) to the effect that such director’s office shall be vacated.

 

DIRECTORS’ SHARE QUALIFICATION

 

A director is not required to hold any shares of Lloyds Banking Group plc by way of qualification.

 

DIRECTORS’ INDEMNITY/INSURANCE

 

So far as may be permitted by the statutes, any person who is or was at any time a director, officer, employee or trustee of Lloyds Banking Group plc (or any associated company) may be indemnified by Lloyds Banking Group plc against any liability incurred by him in connection with any negligence, default, breach of duty or breach of trust by him in relation to Lloyds Banking Group plc (or any associated company) or any other liability incurred in the execution of his duties, the exercise of his powers or otherwise in connection with his duties, powers or offices. The directors of Lloyds Banking Group plc may also purchase and maintain insurance in respect of such liabilities. So far as may be permitted by the statutes, Lloyds Banking Group plc may also provide defence costs in relation to any criminal, civil or regulatory proceedings to which any current or former director, officer, employee or trustee of Lloyds Banking Group plc (or any associated company) is subject and do anything to enable any such a person to avoid incurring such expenditure.

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AUTHORISATION OF DIRECTORS’ INTERESTS

 

Subject to the provisions of the statutes, the directors can authorise any matter which would or might otherwise constitute or cause a breach of the duty of a director to avoid a situation in which he has or can have a direct or indirect interest that conflicts, or possibly may conflict, with the interests of Lloyds Banking Group plc.

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Such authorisation of a matter shall be effective only if the matter in question shall have been proposed in writing for consideration at a meeting of the directors in accordance with the board’s normal procedures or in such other manner as the directors may determine.determine, the quorum requirement for the meeting of directors at which the matter is considered is satisfied and the matter is (or would have been) agreed to without the interested directors voting.

 

Any authorisation of a matter under the Articles of Association shall be subject to such conditions or limitations as the directors may determine, whether at the time such authorisation is given or subsequently, and may be terminated by the directors at any time. A director shall comply with any obligations imposed on him pursuant to any such authorisation.

 

A director shall not, save as otherwise agreed by him, be accountable to Lloyds Banking Group plc for any benefit which he (or a person connected with him) derives from any matter authorised by the directors and any contract, transaction or arrangement relating thereto shall not be liable to be avoided on the grounds of any such benefit.

 

Where a director has an interest which can reasonably be regarded as likely to give rise to a conflict of interest, the director may, and shall if so requested by the directors, take such additional steps as may be necessary or desirable for the purpose of managing such conflict of interest, including compliance with any procedures laid down from time to time by the directors.

 

Lloyds Banking Group plc may by ordinary resolution ratify any contract, transaction or arrangement, or other proposal, not properly authorised under the Articles of Association.

 

MATERIAL INTERESTS

 

In general, the Companies Act requires that a director disclose to Lloyds Banking Group plc any personal interest that he may have and all related material information and documents known to him, in connection with any existing or proposed transaction by Lloyds Banking Group plc. The disclosure is required to be made promptly and in any event, no later than at the board of directors meeting in which the transaction is first discussed.

 

Subject to the provisions of the statutes, the director (or a person connected with him), provided that the director has declared the nature and extent of any interest as required under the Articles of Association:

 

–may be a director or other officer of, or be employed by, or otherwise interested (including by the holding of shares) in Lloyds Banking Group plc, a subsidiary undertaking of Lloyds Banking Group plc, any holding company of Lloyds Banking Group plc, a subsidiary undertaking of any such holding company, or any body corporate promoted by Lloyds Banking Group plc or in which Lloyds Banking Group plc is otherwise interested (a relevant company);
  
–may be a party to, or otherwise interested in, any contract, transaction or arrangement with a relevant company;company (or in which the company is otherwise interested);
  
–may (and any firm of which he is a partner, employee or member may) act in a professional capacity for any relevant company (other than as auditor) and be remunerated therefor;
  
–may have an interest which cannot reasonably be regarded as likely to give rise to a conflict of interest;
  
–may have an interest, or a transaction or arrangement giving rise to such an interest, of which the director is not aware; and
  
–may have any other interest authorised under the Articles of Association or by shareholder resolution.
  
Subject to the provisions of the Companies Act, a director is entitled to vote and be counteredcounted in the quorum in respect of any resolution concerning any contract, transaction or arrangement or any other proposal:
  
–in which he has an interest of which he is not aware;
  
–in which he has an interest which cannot reasonably be regarded as likely to give rise to a conflict of interest;
  
–in which he has an interest only by virtue of interests in shares, debentures or other securities of the company, or by reason of any other interest in or through Lloyds Banking Group plc;
  
–which involves the giving of any security, guarantee or indemnity to the director or any other person in respect of (i) money lent or obligations incurred by him or by any other person at the request of or for the benefit of the company or any of its subsidiary undertakings; or (ii) a debt or other obligation of the company or any of its subsidiary undertakings for which he himself has assumed responsibility in whole or in part under a guarantee or indemnity or by the giving of security;
  
–concerning an offer of shares or debentures or other securities of or by the company or any of its subsidiary undertakings (i) in which offer he is or may be entitled to participate as a holder of securities; or (ii) in the underwriting or subunderwriting of which he is to participate;
  
–concerning any other body corporate in which he is interested, directly or indirectly and whether as an officer, shareholder, creditor, employee or otherwise, provided that he (together with persons connected with him) is not the holder of, or beneficially interested in, one per cent or more of the issued equity share capital of any class of such body corporate or of the voting rights available to members of the relevant body corporate;
  
–relating to an arrangement for the benefit of the employees or former employees of the company or any of its subsidiary undertakings which does not award him any privilege or benefit not generally awarded to the employees or former employees to whom such arrangement relates;
  
–concerning the purchase or maintenance by the company of insurance for any liability for the benefit of directors or for the benefit of persons who include directors;
  
–concerning the giving of indemnities in favour of directors;
  
–concerning the funding of expenditure by any director or directors on (i) defending criminal, civil or regulatory proceedings or actions against him or them, (ii) in connection with an application to the court for relief, or (iii) defending him or them in any regulatory investigations (and doing anything to enable any director or directors to avoid incurring such expenditure); and
  
–in respect of which his interest, or the interest of directors generally, has been authorised by ordinary resolution.
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Except as set out above and subject to the Companies Act, a director shall not be entitled to vote on any resolution in respect of any contract, transaction or arrangement, or any other proposal, in which he (or a person connected with him) is interested. Any vote of a director in respect of a matter where he is not entitled to vote shall be disregarded. A director shall not be counted in the quorum for a meeting of the directors in relation to any resolution on which he is not entitled to vote.

 

If a question arises at any time as to whether any interest of a director prevents him from voting, or being counted in the quorum, and such question is not resolved by his voluntarily agreeing to abstain from voting, such question shall be referred to the chairman of the meeting and his ruling in relation to any director other than himself shall be final and conclusive, provided that the nature or extent of the interest of such director has been fairly disclosed. If any such question shall arise in respect of the chairman of the meeting, the question shall be decided by resolution of the directors and the resolution shall be conclusive provided that the nature or extent of the interest of the chairman of the meeting has been fairly disclosed to the directors.

 

CONFIDENTIAL INFORMATION

 

If a director, otherwise than by virtue of his position as director, receives information in respect of which he owes a duty of confidentiality to a person other than Lloyds Banking Group plc, he shall not be required to disclose such information to Lloyds Banking Group plc or otherwise use or apply such confidential information for the purpose of or in connection with the performance of his duties as a director, provided that such an actual or potential conflict of interest arises from a permitted or authorised interest under the Articles of Association. This is without prejudice to any equitable principle or rule of law which may excuse or release the director from disclosing information, in circumstances where disclosure may otherwise be required under the Articles of Association.

 

REMUNERATION

 

Effective from October 1, 2013, Lloyds Banking Group plc must obtain a binding vote of shareholders on remuneration policy at least once every three years and an advisory vote on an implementation report on how the remuneration policy was implemented in the relevant financial year.

 

The ordinary remuneration of the directors is determined by the directors except that such ordinary remuneration shall not exceed £1,000,000 per annum in aggregate or such higher amount as may from time to time be determined by ordinary resolution of Lloyds Banking Group plc andplc. Such ordinary remuneration is (unless otherwise provided by ordinary resolution of Lloyds Banking Group plc) divisible among the directors as they may agree, or, failing agreement, equally. However, any director who holds office for only part of the period in respect of which remuneration is payable shall be entitled only to rank in such division for a proportion of the remuneration relating to the period during which he has held office.

Any director who holds an executive office, or who serves on any committee of the directors, or who otherwise performs services which in the opinion of the directors are outside the scope of the ordinary duties of a director, may be paid extra remuneration by way of salary, commission or otherwise or may receive such other benefits as the directors may determine. determine in their discretion. Such extra remuneration or other benefits are in addition to, or in substitution for, any or all of a director’s entitlement to ordinary remuneration.

Where proposals are under consideration concerning the appointment (including fixing or varying the terms of appointment) of two or more directors to offices or employments with Lloyds Banking Group plc (or any body corporate in which Lloyds Banking Group plc is interested), the proposals may be divided and considered in relation to each director separately. In such case, each of the directors concerned shall be entitled to vote, and be counted in the quorum, in respect of each resolution except that concerning his own appointment or the fixing or variation of the terms thereof.

 

The directors may repay to any director all such reasonable expenses as he may incur in attending and returning from meetings of the directors or of any committee of the directors or general meetings or otherwise in connection with the business of Lloyds Banking Group plc. The directors have the power to pay and agree to pay gratuities, pensions or other retirement, superannuation, death or disability benefits to, or to any person in respect of, any director or ex-director.

 

ELECTRONIC COMMUNICATIONS

 

Subject to and in accordance with statute, Lloyds Banking Group plc has the right to offer shareholders the opportunity to have documents and information made available to them through Lloyds Banking Group plc’s website and in electronic form.

 

EXCHANGE CONTROLS

 

There are no UK laws, decrees or regulations that restrict Lloyds Banking Group plc’s, exportinterest import or importexport of capital, including the availability of cash and cash equivalents for use by Lloyds Banking Group, or that affect the remittance of dividends or other shareholders’ payments to non-UK holders of Lloyds Banking Group plc shares, except as set out inTaxation.

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UK TAXATION

 

The following discussion is intended only as a general guide to current UK and US federal income tax legislation, whatconsiderations relevant to US holders (as defined below in the section on US federal income tax considerations) of Lloyds Banking Group ordinary shares or ADSs. It is understood to bebased on current UK HM Revenue & Customslaw and tax authority practice and the terms of the current UK/US income tax treaty (the Treaty), all of which are subject to change at any time, possibly with retroactive effect.

 

The Treaty for the avoidance of double taxation with respect to taxes on income entered into force following the exchange of instruments of ratification by the UK Parliament and the US Senate on 31 March 2003.

 

The UK HM Revenue & CustomsThis summary does not consider your personal circumstances, and it is the UK government department responsiblenot a substitute for assessing and collecting UK tax revenues. The discussion is intended as a general guide and only applies to persons who are the beneficial owners of their ordinary shares or ADSs. References below to a US holder are to that term as defined, and subject to the exclusions described in the introduction below underUS federal income tax considerations. It may not apply to certain shareholders or ADS holders, such as dealers in securities.

Tax can be complicated and individual circumstances may need to be considered in more detail.advice. Any person who is in any doubt as to his tax position should consult his own professional adviser.

 

UK TAXATION OF CHARGEABLE GAINS

UK RESIDENTS

A disposal (or deemed disposal) of ordinary shares or ADSs by a shareholder or holder of ADSs resident or (in the case of an individual) ordinarily resident for tax purposes in the UK may, depending on the shareholder’s or ADS holder’s particular circumstances, and subject to any available exemption or relief, give rise to a chargeable gain or an allowable loss for the purposes of UK taxation on chargeable gains.

INDIVIDUALS, OTHER THAN US HOLDERS, TEMPORARILY NON-RESIDENT IN THE UK

A shareholder or ADS holder who is an individual and who has, on or after 17 March 1998, ceased to be resident and ordinarily resident for tax purposes in the UK for a period of five years or less of assessment and who disposes of ordinary shares or ADSs during that period may be liable, on return to the UK, to UK taxation on chargeable gains arising during the period of absence, subject to any available exemption, relief and/or foreign tax credit.

US HOLDERS

 

Subject to the provisions set out in the next paragraph in relation to temporary non-residents, US holders generally will not be liable for UK tax on chargeable gains unless they carry on a trade, profession or vocation in the UK through a branch or agency and the ordinary shares or ADSs are or have been used or held by or for the purposes of the branch or agency, in which case such US holder might, depending on individual circumstances, be liable to UK tax on chargeable gains on any disposition of ordinary shares or ADSs.

 

An individual US holder who is only temporarily not resident in the UK may, under anti-avoidance legislation, still be liable for UK tax on chargeable gains realised, subject to any available exemption, relief and/or foreign tax credit.

 

A US holder who is an individual and who has, on or after 17 March 1998, ceased to be resident or ordinarily resident for tax purposes in the UK for a period of five years or lessfewer years of assessment and who disposes of ordinary shares or ADSs during that period may be liable, on return to the UK, to UK taxation on chargeable gains arising during the period of absence, subject to any available exemption, relief and/or foreign tax credit.

 

OTHER NON-UK RESIDENT PERSONS

Subject to the provisions set out above underIndividuals, other than US holders, temporarily non-resident in the UK, shareholders or ADS holders who are neither resident nor ordinarily resident in the UK generally will not be liable for UK tax on chargeable gains unless they carry on a trade, profession or vocation in the UK through a branch or agency and the ordinary shares or ADSs are or have been used or held by or for the purposes of the branch or agency, in which case such shareholders or ADS holders might, depending on individual circumstances, be liable to UK tax on chargeable gains on any disposition of ordinary shares or ADSs. An individual holder of ordinary shares or ADSs who is only temporarily not resident in the UK may, under anti-avoidance legislation, still be liable for UK tax on chargeable gains realised, subject to any available exemption, relief and/or foreign tax credit.

TAXATION OF DIVIDENDS

UK RESIDENTS

Lloyds Banking Group plc will not be required to withhold tax at source when paying a dividend on the ordinary shares or ADSs.

An individual shareholder or ADS holder who is resident in the UK for tax purposes will be entitled to a tax credit in respect of any dividend received from Lloyds Banking Group plc and will be taxable on the gross dividend, which is the aggregate of the dividend received and related tax credit. The value of the tax credit will be equal to one-ninth of the dividend received (and, therefore, 10 per cent of the gross dividend). The gross dividend will be treated as an individual’s marginal taxable income. The tax credit will, however, be treated as discharging the individual’s liability to income tax in respect of the gross dividend, unless and except to the extent that the gross dividend falls above the threshold for the higher rate of income tax. A UK resident individual shareholder or ADS holder who is liable to income tax at the higher rate or additional rate (higher rate is 40 per cent for the 2014-15 and 2015-16 tax years and additional rate is 45 per cent for the 2014-15 and 2015-16 tax years) will be subject to tax at the rate applicable to dividends for such shareholders or ADS holders (32.5 per cent for higher rate taxpayers for the 2014-15 and 2015-16 tax years, 37.5 per cent for additional rate taxpayers for the 2014-15 and 2015-16 tax years) on the gross dividend. The tax credit will be set against but will not fully discharge such shareholders’ or ADS holders’ tax liability on the gross dividend and they will have to pay additional tax. The additional tax is 22.5 per cent of the gross dividend for higher rate taxpayers and 27.5 per cent for additional rate taxpayers for the 2014-15 and 2015-16 tax years.

There will be no payment of the tax credit or any part of it to an individual whose liability to income tax on the dividend and the related tax credit is less than the tax credit.

UK resident shareholders or ADS holders who are not liable to UK tax on dividends, including pension funds and charities, will not be entitled to the payment of any tax credits in respect of dividends.

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Subject to certain exceptions, such as for dealers in securities and for some insurance companies with overseas business, UK resident corporate shareholders or ADS holders will generally not be subject to corporation tax in respect of dividends received from Lloyds Banking Group plc, but will not be entitled to the payment of any tax credit with respect to the dividends.

Shareholders who are within the charge to corporation tax will be subject to corporation tax on dividends paid by the Company, unless (subject to special rules for such shareholders that are small companies) the dividends fall within an exempt class and certain other conditions are met. It is expected that the dividends paid by the Company would generally be exempt. Such shareholders will not be able to claim repayment of tax credits attaching to dividends.

US HOLDERS

 

Lloyds Banking Group plc will not be required to withhold tax at source when paying a dividend on the ordinary shares or ADSs to a US holder. US holders of ADSs or ordinary shares who receive a dividend from Lloyds Banking Group plc will not have any UK tax to pay in respect of the dividend.

 

OTHER NON-UK RESIDENT PERSONS

Lloyds Banking Group plc will not be required to withhold tax at source when paying a dividend on the ordinary shares or ADSs to a holder, other than a US holder, who is not resident for tax purposes in the UK.

Holders of ordinary shares or ADSs, other than US holders, who are not resident for tax purposes in the UK and who receive a dividend from Lloyds Banking Group plc will not have any UK tax to pay in respect of the dividend, but will not normally be able to claim any additional payment in respect of the dividend from the UK HM Revenue & Customs under any applicable Double Tax Treaty.

STAMP DUTY AND STAMP DUTY RESERVE TAX

UK RESIDENTS, US HOLDERS AND OTHER NON-UK RESIDENT PERSONS

 

Any conveyance or transfer on sale of ordinary shares (whether effected using the CREST settlement system or not) will be subject to UK stamp duty or stamp duty reserve tax (SDRT). The transfer on sale of ordinary shares will be liable to ad valorem UK stamp duty or SDRT, generally at the rate of 0.5 per cent of the consideration paid (rounded up to the next multiple of £5 in the case of stamp duty). Stamp duty is usually the liability of the purchaser or transferee of the ordinary shares. An unconditional agreement to transfer such ordinary shares will be liable to SDRT, generally at the rate of 0.5 per cent of the consideration paid, but such liability will be cancelled, or, if already paid, refunded, if the agreement is completed by a duly stamped transfer within six years of the agreement having become unconditional. SDRT is normally the liability of the purchaser or transferee of the ordinary shares.

 

WhereUK tax law requires that when Lloyds Banking Group plc issues ordinary shares or a holder of ordinary shares transfers such shares to the custodian or nominee for the depositary to facilitate the issue of ADSs to a person representing the ordinary shares or to a person providing clearance services (or their nominee or agent), a liability to UK stamp duty or SDRT at the rate of 1.5 per cent (rounded up to the next multiple of £5 in the case of the stamp duty) of either the issue price or, in the case of transfer, the listed price of the ordinary shares, calculated in sterling, will arise. However, following the case before the European Court of Justice (Case C-569/07 HSBC Holdings plc and Vidacos Nominees v The Commissioners for HM Revenue & Customs)litigation, HMRC now accepts that the charge to SDRT at 1.5 per cent on the issue of shares into clearance services or depository receipt schemes is prohibited.not compatible with EU law, and will not apply the charge. Where a holder of ordinary shares transfers such shares to the custodian or nominee for the depositary or clearance services this charge will apply, and generally be payable by the person receiving the ADSs or transferring the ordinary shares into the clearance service.

 

No liability to stamp duty or SDRT will arise as a result of the cancellation of any ADSs with the ordinary shares that they represent being transferred to the ADS holder.

 

No liability to UK stamp duty or SDRT will arise on a transfer of ADSs provided that any document that effectsgives effect to such transfer is not executed in the UK and that it remains at all subsequent times outside the UK. An agreement to transfer ADSs will not give rise to a liability to SDRT.

 

US FEDERAL INCOME TAX CONSIDERATIONS

 

The following summary describes material US federal income tax consequences of the ownership and disposition of ADSs or ordinary shares to the US holders described below, but it does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a decision to own such securities. The summary applies only to US holders that hold ADSs or ordinary shares as capital assets for US federal income tax purposes.

This discussion does not address any alternative minimum or Medicare Contribution tax consequences, nor does it address US federal tax consequences to US holders that are subject to special rules, such as:

 

–certain financial institutions;
  
–dealers or traders in securities that use a mark-to-market method of tax accounting;
  
–persons holding ADSs or ordinary shares as part of a hedge, straddle, wash sale, conversion or other integrated transaction or holders entering into a constructive sale with respect to ADSs or ordinary shares;
  
–persons whose functional currency for US federal income tax purposes is not the US dollar;
  
–persons who acquired ADSs or ordinary shares pursuant to the exercise of any employee stock option or otherwise as compensation;
  
–tax-exempt entities, including ‘individual retirement accounts’ or ‘Roth IRAs’;
  
–persons holding ADSs or ordinary shares in connection with a trade or business conducted outside of the United States;
  
–partnerships or other entities classified as partnerships for US federal income tax purposes; or
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–persons that own or are deemed to own 10 per cent or more (by vote or value) of the voting shares of Lloyds Banking Group plc.

 

If an entity that is classified as a partnership for US federal income tax purposes holds ADSs or ordinary shares, the US federal income tax treatment of a partner will generally depend on the status of the partner and the activities of the partnership. Partnerships holding ADSs or ordinary shares and partners in such partnerships should consult their tax advisers as to the particular US federal income tax consequences of holding and disposing of the ADSs or ordinary shares.

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This summary is based in part on representations of the depositary and assumes that each obligation provided for in or otherwise contemplated by the Deposit Agreement or any other related document will be performed in accordance with its terms. The US Treasury has expressed concerns that parties to whom American depositary shares are released before shares are delivered to the depositary (‘pre-release’), or intermediaries in the chain of ownership between holders and the issuer of the security underlying the American depositary shares, may be taking actions that are inconsistent with the claiming of foreign tax credits by US holders of American depositary shares. Such actions would also be inconsistent with the claiming of the reduced rate of tax applicable to dividends received by certain non-corporate US holders. Accordingly, the availability of the preferential tax rate for dividends received by certain non-corporate US holders, described below, could be affected by actions taken by such parties or intermediaries.

This summary is based upon tax laws of the US including the Internal Revenue Code of 1986, as amended (the Code), administrative pronouncements, judicial decisions and final, temporary and proposed Treasury Regulations, as well as the Treaty, all as of the date hereof, changes to any of which may affect the tax consequences described herein, possibly with retroactive effect. Owners of ADSs or ordinary shares should consult their tax advisers as to the US, UK or other tax consequencesIt is also based in part on representations of the ownershipdepositary and disposition of such securitiesassumes that each obligation provided for in their particular circumstances, includingor otherwise contemplated by the effect ofDeposit Agreement or any US state or local tax laws.other related document will be performed in accordance with its terms.

 

As used herein, a ‘US holder’ is a beneficial owner of ADSs or ordinary shares that is, for US federal income tax purposes:

 

–a citizen or individual resident of the United States;
  
–a corporation, or other entity taxable as a corporation, created or organised in or under the laws of the United States, any state therein or the District of Columbia; or
  
–an estate or trust the income of which is subject to US federal income taxation regardless of its source.

 

In general, a US holder who owns ADSs should be treated as the owner of the underlying shares represented by those ADSs for US federal income tax purposes. Accordingly, no gain or loss should be recognised if a US holder exchanges ADSs for the underlying shares represented by those ADSs.

The US Treasury has expressed concerns that parties to whom American depositary shares are released before shares are delivered to the depositary (‘pre-release’), or intermediaries in the chain of ownership between holders and the issuer of the security underlying the American depositary shares, may be taking actions that are inconsistent with the claiming of foreign tax credits by US holders of American depositary shares. Such actions would also be inconsistent with the claiming of the reduced rate of tax applicable to dividends received by certain non-corporate US holders. Accordingly, the availability of the preferential tax rate for dividends received by certain non-corporate US holders, described below, could be affected by actions taken by such parties or intermediaries.

Owners of ADSs or ordinary shares should consult their tax advisers as to the US, UK or other tax consequences of the ownership and disposition of such securities in their particular circumstances, including the effect of any US state or local tax laws.

 

TAXATION OF DISTRIBUTIONS

 

Distributions paid on ADSs or ordinary shares, other than certain pro rata distributions of ordinary shares, will generally be treated as dividends to the extent paid out of Lloyds Banking Group plc’s current or accumulated earnings and profits (as determined in accordance with US federal income tax principles). Because Lloyds Banking Group plc does not maintain calculations of its earnings and profits under US federal income tax principles, it is expected that distributions generally will be reported to US holders as dividends. The dividends will generally be foreign-source income to US holders and will not be eligible for the dividends-received deduction generally allowed to US corporations under the Code.

 

Subject to applicable limitations and the discussion above regarding concerns expressed by the US Treasury, dividends paid to certain non-corporate US holders may be taxable at favourable rates. Non-corporate US holders should consult their tax advisers to determine whether the favourable rates will apply to dividends they receive and whether they are subject to any special rules that limit their ability to be taxed at these favourable rates.

 

Dividends will be included in a US Holder’s income on the date of the US Holder’s or, in the case of ADSs, the depositary’s receipt of the dividend. The amount of a dividend will equal the US dollar value of the pounds sterling received, calculated by reference to the exchange rate in effect on the date of receipt regardless of whether the payment is converted into US dollars on the date of receipt. If the pounds sterling received as a dividend are not converted into US dollars on the date of receipt, then the US holder’s tax basis in the pounds sterling received will equal such US dollar value and the US holder may realise a foreign exchange gain or loss on the subsequent conversion into US dollars. Generally, any gains or losses resulting from the conversion of pounds sterling into US dollars will be treated as US-source ordinary income or loss.

 

TAXATION OF CAPITAL GAINS

 

Gain or loss realised by a US holder on a sale or other disposition of ADSs or ordinary shares will generally be subject to US federal income tax as capital gain or loss in an amount equal to the difference between the US holder’s tax basis in the ADSs or ordinary shares disposed of and the amount realised on the disposition, in each case as determined in US dollars. Gains or losses, if any, will generally be US-source and will be long-term if the US Holder held the ADSs or ordinary shares for more than one year. The deductibility of losses is subject to limitations.

 

INFORMATION REPORTING AND BACKUP WITHHOLDING

 

Dividends paid on, and the sale proceeds from, ADSs or ordinary shares that are made within the US or through certain US-related financial intermediaries may be subject to information reporting and backup withholding requirements unless the US holder:

 

–is a corporation or other exempt recipient, or
  
–in the case of backup withholding, the US holder provides a correct taxpayer identification number and certifies that it is not subject to backup withholding.

 

The amount of any backup withholding from a payment to a US holder will be allowed as a credit against the US holder’s US federal income tax liability and may entitle it to a refund, provided that the required information is timely furnished to the Internal Revenue Service.

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WHERE YOU CAN FIND MORE INFORMATION

 

The documents concerning the Lloyds Banking Group which are referred to herein may be inspected at the Securities and Exchange Commission (SEC). You may read and copy any document filed or furnished by the Group at the SEC’s public reference room in Washington D.C., at 100 F Street, N.E., Washington D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the reference rooms. The SEC also maintains a website at www. sec.govwww.sec.gov which contains, in electronic form, each of the reports and other information that the Group has filed electronically with the SEC.

References herein to Lloyds Banking Group websites are textual references only and information on or accessible through such websites does not form part of and is not incorporated into this Form 20-F.

 

ENFORCEABILITY OF CIVIL LIABILITIES

 

Lloyds Banking Group plc is a public limited company incorporated under the laws of Scotland. Most of Lloyds Banking Group plc’s directors and executive officers and certain of the experts named herein are residents of the UK. A substantial portion of the assets of Lloyds Banking Group plc, its subsidiaries and such persons, are located outside the United States. As a result, it may not be possible for investors to effect service of process within the United States upon all such persons or to enforce against them in US courts judgments obtained in such courts, including those predicated upon the civil liability provisions of the federal securities laws of the United States. Furthermore, Lloyds Banking Group plc has been advised by its solicitors that there is doubt as to the enforceability in the UK, in original actions or in actions for enforcement of judgments of US courts, of certain civil liabilities, including those predicated solely upon the federal securities laws of the United States.

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RISK FACTORS

 

Set out below areis a summary of certain risk factors which could affect Lloyds Banking Group’s future results and may cause them to differ from expected results in material respects.materially. The factors discussed below should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties that Lloyds Banking Group’s businesses face. For information on Lloyds Banking Group’s risk management policies and procedures, see ‘Lloyds“Lloyds Banking Group—Operating and financial review and prospects—prospects — Risk ManagementManagement”.’

RISK FACTORS RELATING TO THE COMPANY AND THE GROUP

 

CREDIT RELATED RISKS

 

The Group’s businesses are subject to inherent risks concerning borrower and counterparty credit quality which have affected and may adversely impact the recoverability and value of assets on the Group’s balance sheet.

The Group has exposures (lending,(including, but not limited to, lending, undrawn commitments, derivative, equity, contingent, bonds, securities and/or settlement risks) to many different products, counterparties, obligors and obligorsother contractual relationships and the credit quality of its exposures can have a significant impact on the Group’s earnings. Credit risk exposures are categorised as either “retail”, arising primarily in the Retail, Consumer Finance and parts of the Run-Off divisions, and (including small and medium-sized enterprises (SME) and(“SME”)), or “corporate” (including medium and large corporates, banks, financial institutions and sovereigns), arising primarily in the Commercial Banking, Run-Off and Insurance divisions.. This reflects the risks inherent in the Group’s lending and lending-related activities and in the Insuranceinsurance business primarily in respect of investment holdings (including loan assets)assets and bonds) and exposures to reinsurers. Adverse changes in the credit quality of the Group’s UK and/or international borrowers and counterparties or collateral held in support of exposures, or in their behaviour or businesses, may reduce the value of the Group’s assets and materially increase the Group’s write-downs and allowances for impairment losses. Credit risk can be affected by a range of factors outside the Group’s control, which include but are not limited to an adverse economic environment (in the UK and/or in countries where the Group and/or its customers/counterparties do and do not operate)operate, such as any adverse economic effects that could occur in connection with the UK’s exit from the EU), reduced UK consumer and/or government spending (in light of the Group’s concentration in the UK), cuts to benefits, a slower pace of global economic slowdowngrowth leading to aconstraints on liquidity crunch (given concerns around the Eurozone,possibility of adverse global economic environments in Chinadevelopments and emerging markets and other macro-economic issues)potential market volatility), changes in the credit rating of individual counterparties (including sovereigns), the debt levels of individual contractual counterparties and the economic environment in which they operate, increased unemployment, reduced asset values, increased personal or corporate insolvency levels, adverse sector concerns, falling stock and bond/other financial markets, reduced corporate profits, over indebtednessover-indebtedness (including sovereigns), changes (and the timing, quantum and pace of these changes) in interest rates (including the potential increase in the use of zero or negative interest rates), and any subsequent impact on pension liabilities (particularly given changing longevity rates), volatility of oil and commodity prices, changes in foreign exchange rates, higher tenant defaults, counterparty challenges to the interpretation or validity of contractual arrangements, a sharpan increase in credit spreads, changes to insolvency regimes, both in the UK and/or in other jurisdictions where the Group may seek to pursue recovery, making it harder to enforce against counterparties, the impact of technological disruption or cyber-crime, changes in consumer and customer demands and requirements, negative reputational impact or direct campaigns which adversely impact customers, industries or sectors and any external factors of a political, legislative, environmental or regulatory nature, including for example, the imposition ofrising “living wage” requirements, changes in accounting rules and changes to tax changes relatinglegislation and rates.

The UK’s expected exit from the EU has heightened the probability of some or all of these events happening and adds further uncertainty to buy-to-let investmentscounterparty credit risk and the Group’s financial condition. Key related risks which may impact the Group’s business and/or the Group’s clients’ businesses include, but are not limited to: reduced consumer spending, dampened consumer confidence, weaker sterling, volatility in financial markets, a downgrade of the UK credit rating, inflation risk, prolonged low (including zero or negative interest rates) or rising interest rates, impact on European sovereigns and counterparties, loss and/or postponement of foreign direct investment and domestic direct investment, political uncertainty, delays or increased costs in the UK. movement of goods and/or services, potential wider European political instability, uncertainty around trade negotiations and/or the UK’s ability to retain access to the single market, financial services passporting and free movement and cost of labour, relocation of companies and institutions away from the UK, and the withdrawal and/or reduction of EU funding. For more detail on the EU referendum decision see “Business and Economic Risks — Political, legal, regulatory, constitutional and economic uncertainty arising from the outcome of the referendum on the UK’s membership of the European Union could adversely impact the Group’s business, results of operations, financial condition and prospects” below. For further information on general macroeconomic risks affecting the Group in the UK and the EU see “Business and Economic Risks — The Group’s businesses are subject to inherent and indirect risks arising from general macroeconomic conditions in the UK, the U.S., the Eurozone, Asia and globally, and any resulting instability of financial markets or banking systems”.

There are many other factors that could impact credit risk for exampleincluding fraud, natural disasters, flooding,sustainability of client business models, industrial and strike action, war and acts of terrorism.terrorism, climate change, natural disasters and flooding.

 

The Group has credit exposure both in the UK and internationally, including Europe, the U.S., Asia and Latin America.Asia. The Group’s credit exposure includes residential mortgagesmortgage lending (in the UK and, to a lesser extent, the Netherlands) and commercial real estate lending, including commercial real estate lending secured against secondary and tertiary commercial and residential non-prime assets in the UK. The Group’s retail customer portfolios will remain strongly linked to the UK economic environment, with house price deterioration, unemployment increases, inflationary pressures, consumer over-indebtedness and prolonged low or rising interest rates among the factors that may impact secured and unsecured retail credit exposures. Deterioration in used vehicle prices, including as a result of changing consumer demand, could result in increased provisions and/or losses and/or accelerated depreciation charges. The Group also has significant credit exposure to certain individual counterparties in cyclically weakhigher risk and cyclical asset classes and sectors (such as manufacturing, commercial real estate, leveraged lending, oil and gas commodity traders, automotives,and related sectors, commodities trading, automotive and related sectors, construction, consumer-related sectors (such as retail), housebuilders and retail)outsourcing services) and weakened geographic markets and to counterparties whose businesses may be impacted by material unforeseen events. In addition, the Group has concentrated country exposure in the UK and within certain industry sectors, namely real estate and real estate-related sectors and financial intermediation including providing facilities to funds, predominantly against high quality (investment grade equivalent) investors. Otherfunds. Certain industry sectors have been adversely impacted by recent global economic events;events, volatility and sector-specific issues; for example, the oil and gas sector, automotives and related sectors, commodities trading, manufacturing (including auto manufacturers) and such adverseretail. Adverse developments in these sectors increases the risk of default by the Group’s customers in these sectors. The Group’s retail customer portfolios (including those in the Retail, Consumer Finance and Run-Off divisions) will remain strongly linked to the UK economic environment, with house price deterioration, unemployment increases, consumer over-indebtedness and rising interest rates among the factors that may impact secured and unsecured retail credit exposures.

 

In recent years, a number of factors, such as Eurozone instability (including without limitation, the risk of economic stagnation/deflation in the Eurozone or of a memberone or more members leaving the Eurozone), the deterioration of capital market conditions, thea slower pace of global economic slowdown (once again a concern given recentgrowth (given slowdown in economic growth across China and emerging markets and other macro-economicmacroeconomic issues) and measures adopted by the governments of individual countries, have reduced and could further reduce households’ disposable income and businesses’ profitability. Such volatile conditionsIn the UK, any weakening in sterling has the potential to squeeze households’ real incomes by pushing up inflation. This in turn could also have a negative impact on customers’ ability to honour their obligations, which in turn would result in deterioration of the Group’s credit quality. If political conditions or uncertainty over the Eurozone, or the UK Government and Eurozone austerity measures and public spending cuts, result in a prolonged period of economic stagnation, for the UK or Eurozone, or a slowdown in the rate of economic recovery, or there is a broader economic slowdown, it may lead to further weakening of

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counterparty credit quality and subsequent higher impairment charges or fair value reductions in the Group’s lending and contingent equity and derivative portfolios. This could have a material adverse effect on the Group’s results of operations, financial condition or prospects.

 

The possibility of prolonged economic stagnation in the EU or the risk of a member leavingfurther members seeking to leave the EU, (including potentially the UK), or the risk of a Eurozone member leavingseeking to leave the Eurozone, could impact the UK’s own economic recovery, given the extensive trade links between the UK and the Eurozone/EU. Given the extensive economic and financial links between the UK and the Eurozone,Eurozone/EU and in turn, this could impact upon the Group’s performance. The Group has credit exposure to SMEs and corporates, financial institutions and securities which may have material direct and indirect exposures in the Eurozone countries. Any default on the sovereign debt of these countries and the resulting impact on other Eurozone countries, including the potential that someone or more countries could leave the Eurozone, could have a material adverse effect on the Group’s business.

 

At present, default rates are partly cushioned by low rates of interest which have helped customer affordability butand debt serviceability; however, the risk remains of increased default rates as interest rates start to rise. The timing, quantum and pace of any risechange in interest rates is a key risk factor for the Group’s default rates with expectations on the timing and quantum of any riseschanges set by the Bank of England and also by the relevant central bank when lending in a foreign currency.

 

All new lending isdecisions, and decisions related to other exposures (including, but not limited to, undrawn commitments, derivative, equity, contingent and/ or settlement risks), are dependent on the Group’s assessment of each customer’s ability to repay and the value of any underlying security and theresecurity. There is an inherent risk that the Group has incorrectly assessed the credit quality and/or the ability or willingness of borrowers to repay, possibly as a result of incomplete or inaccurate disclosure by those borrowers or as a result of the inherent uncertainty that is involved in the exercise of constructing and using models to estimate the true risk of lending to counterparties. The Group estimates and establishes reserves for credit risks and potential credit losses inherent in its credit exposure. This process, which is critical to the Group’s results and financial condition, requires difficult, subjective and complex judgements, including forecasts of how macro-economicmacroeconomic conditions might impair the ability of borrowers to repay their loans. As is the case with any such assessments, there is always a risk that the Group will fail to adequately identify the relevant factors or that it will fail to estimate accurately the impact of these identified factors.

205

RISK FACTORS The introduction of the impairment requirements of IFRS 9 – Financial Instruments (“IFRS 9”), an international accounting standard, on 1 January 2018 resulted in higher impairment loss allowances. As a result of IFRS 9, impairment losses are recognised earlier, on a more forward looking basis and on a broader scope of financial instruments than was the case under IAS 39. Under IFRS 9, the measurement of impairments involves increased complexity and judgement and impairment charges tend to be more volatile and could adversely impact the Group’s results of operations, financial condition or prospects. See “Other Risks—The Group’s financial statements are based, in part, on assumptions and estimates”.

 

Concentration of credit and market risk could increase the Group’s potential for significant losses including in an adverse market/environment.

The Group has exposure to concentration risk where its business activities focus particularly on a single obligor or a similar type of customer (borrower, sovereign, financial institution or central counterparty), product, industrial sector or geographic location, including the UK market.UK.

 

The Group has large sectorialsignificant exposure to UK residential mortgages and consumer lending. As detailed in “Credit Related Risks — The Group’s businesses are subject to inherent risks concerning borrower and counterparty credit quality which have affected and may adversely impact the recoverability and value of assets on the Group’s balance sheet”, the Group’s UK mortgage and consumer lending portfolios remain strongly linked to the UK economy with any deterioration in the UK’s economic environment having the potential to adversely affect the credit quality of such portfolios. Any decreases in property values may reduce the collateral values against the mortgage portfolios, which could hinder recovery values in default situations, leading to higher impairment charges.

Additionally, the Group has significant sector concentrations (primarily in gilts, real estate and real estate-related lending, and financial intermediation including providing facilities to financial sponsors and funds, predominantlymainly against high quality (investment grade equivalent) investors, and automotive and related sectors and to a lesser extent, oil and gas automotive,and related sectors, manufacturing, agriculture and leveraged lending and asset-backed securities)lending), as well as significant global credit exposure. Additionally, the Group also has significant exposure to the UK residential mortgage market. Whilst progress has been made to mitigate concentration risk in certain portfolios (for example, commercial real estate and real estate-related lending and asset-backed securities), the Group continues to expect challenges in achieving the required level of sales to manage remaining concentrations. Any downturn in these sectors could increase the risk of defaults by the Group’s customers in these sectors and in turn, adversely impact the Group’s results of operations, financial condition or prospects.

 

The Group has significant real estate and real estate-related exposure, including secondary and tertiary non-prime assets, meaning that decreases in residential or commercial property values and/or increases in tenant defaults are likely to lead to higher impairment charges, which could materially affect the Group’s results of operations, financial condition or prospects.

 

The Group’s corporate lending portfolio also contains substantial exposure to large and mid-sized, public and private companies. Exposures to sectors that have experienced cyclical weakness in recent years, coupled with a historic strategy of taking large single name concentrations to non-listed companies and entrepreneurs, and taking exposure at various levels of the capital structure, may give rise to (albeit reducing) single name and risk capital exposure. Whilst expectation of default for these exposures areis appropriately provided for within the Board’sGroup’s base case assumptions, they remain vulnerable to downside risks. As in the UK, the Group’s lending business overseas is also exposed to a small number of long-term customer relationships and these single name concentrations place the Group at risk of loss should default occur.

 

The Group’s efforts to continue to divest, diversify or manage its credit portfolio against concentration risks may not be successful and any concentration of credit risk could increase the potential for significant losses in its credit portfolio. In addition, any disruption in the liquidity or transparency of the financial markets may result in the Group’s inability to sell or syndicate securities, loans or other instruments or positions held (including underwriters)underwrites), thereby leading to increased concentrations of such positions. These concentrations could expose the Group to losses if the mark-to-market value of the securities, loans or other instruments or positions declines causing the Group to take write-downs. Moreover, the inability to reduce the Group’s positions not only increases the market and credit risks associated with such positions, but also increases the level of risk-weighted assets on the Group’s balance sheet, thereby increasing its capital requirements and funding costs, all of which could materially adversely affect the Group’s operating results of operations, financial condition or prospects.

 

The Group’s corporate portfolios are also susceptible to “fallen angel” risk; whererisk, that is, the possibilityprobability of significant default increases significantly following material unexpected events, resulting in the potential for large losses. These types of events can occur from time to time, and may include for example, major fraud, cyber-crime, poor corporate governance, high profile incidents and collapse in specific sectors or products. Theseproducts, all of which are very difficult to forecast.forecast, and could adversely impact the Group’s results of operations, financial condition or prospects.

 

The Group may be forcedrequired to record further credit valuationvalue adjustments, funding value adjustments and debit value adjustments on securities insured or guaranteed by market counterparties, insurers and credit counterparties,its derivative portfolio, which could have a material adverse effect on the Group’s results of operations, financial condition or prospects.

The Group has limited remaining credit exposure to market counterparties through securities insured or guaranteed by such parties and credit protection bought from such parties with respect to certain over-the-counter (OTC) derivative contracts, mainly credit default swaps (CDS) which are recorded at fair value. The fair value of these CDS and other securities, and the Group’s exposure to the risk of default by the underlying counterparties, depend on the valuation and the perceived credit risk of the instrument insured or guaranteed or against which protection has been bought and the credit quality of the protection provider (e.g. the CDS counterparty). The Groupcontinually seeks to limit and manage directcounterparty credit risk exposure to market counterparties. However, indirect exposure may exist through other financial arrangements and counterparties. Any primary or indirect exposure to the financial condition or creditworthiness of these counterparties may have a material adverse effect on the Group’s results of operations, financial condition or prospects. If the financial condition of market counterparties or their perceived creditworthiness deteriorates, the Group may record credit valuation adjustments on the underlying instruments insured by such parties. Although creditCredit value adjustments, debit value adjustmentsadjustment (“CVA”) and funding value adjustmentsadjustment (“FVA”) reserves are actively managed withinheld against uncollateralised derivative exposures and a risk management framework is in place to mitigate reserve value changes. CVA is an expected loss calculation that incorporates current market factors including counterparty credit spreads. FVA

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reserves are held to capitalise the cost of funding uncollateralised derivative exposures. The Group also calculates a debit value adjustment to reflect own credit spread risk as part of the fair value of derivative liabilities. The Group uses several credit risk mitigation techniques to limit counterparty credit risk exposure including netting agreements, collateral agreements, credit default swaps and other forms of credit enhancement where possible.

However, deterioration in stressedthe creditworthiness of financial counterparties, or large adverse financial market conditions adverse movements, in these could impact the size of CVA and FVA reserves and result in a material charge to the Group’s profit and loss account.

 

CONDUCT RISKS

 

The Group is exposed to various forms of conduct risk in its operations, including the risk of misselling financialcustomer detriment due to poor design, distribution and execution of products mishandlingand services or other activities which could undermine the integrity of complaints, business planning and strategy not being based upon customer need and not supporting fairthe market or distort competition, leading to unfair customer outcomes, regulatory censure and engaging in conduct which disrupts the fairfinancial and effective operation of a market in which it is active, any of which could have a material adverse effect on the Group’s results or its relations with its customers and regulators.reputational loss.

The Group is exposed to various forms of conduct risk in its operations. Such risks are inherent in banking services. These include business and strategic planning that does not sufficiently consider customer need (leading to products being offered beyond target markets and missellingmis-selling of financial products), ineffective management and monitoring of products and their distribution (which could result in customers receiving unfair outcomes), customer communications that are unclear, unfair, misleading or untimely (which could impact customer decision-making and result in customers receiving unfair outcomes), a culture that is not sufficiently customer-centric (potentially driving improper decision makingdecision-making and unfair outcomes for customers), outsourcing of customer service and product delivery via third partiesthird-parties that do not have the same level of control, oversight and culture as the Group (resulting(which could result in potentially unfair or inconsistent customer outcomes which could lead to reputational damage and regulatory investigations)outcomes), the possibility of alleged missellingmis-selling of financial products or the mishandling of complaints related to the sale of such products (which could require amendments to sales processes, withdrawal of products or the provision of restitution to affected customers, all of which may require additional provisions in the Group’s financial accounts), ineffective management of customer complaints or claims (which could result in customers receiving unfair outcomes), ineffective processes or procedures to support customers, including those in potentially vulnerable circumstances (which could result in customers receiving unfair outcomes or treatments which do not support their needs), and poor governance of colleagues’ incentives and rewards and approval of schemes which drive unfair customer outcomes. These can lead to remediation and regulatory intervention/enforcement (including fines) and ineffectiveIneffective management and oversight of legacy conduct issues. Thisissues can also result in customers who are undergoing remediation being unfairly treated and therefore further rectification being required. The Group is also exposed to the risk of engaging in, or failing to manage, conduct which disruptscould constitute market abuse, undermine the fair and effective operationintegrity of a market in which it is active.

Whileactive, distort competition or create conflicts of interest. Each of these risks can lead to regulatory censure, reputational damage, regulatory intervention/enforcement, financial loss for the Group has implementedand/or might have a number of policies in order to help mitigate against these risks, no assurance can be given that the strategy and framework will be effective and will not have anmaterial adverse effect on the Group’s results of operations, financial condition or prospects.

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REGULATORY AND LEGAL RISKS

 

The Group and its businesses are subject to substantial regulation and oversight. Adverse legal or regulatory developments could have a significant material adverse effect on the Group’s business, results of operations, financial condition or prospects.

The Group and its businesses are subject to legislation, regulation, court proceedings, policies and voluntary codes of practice including the effects of any changes in these or the interpretation of them in the UK, the European UnionEU and the other markets in which the Group operates. The Group is therefore subject to associated legal and regulatory risks, including risk in connection with legal and regulatory actions and market reviews. Depending on the specific nature of the requirements and how they are enforced, they could have a significant impact on the Group’s operations, business prospects, structure, costs and/or capital requirements and ability to enforce contractual obligations. See also “Business and Economic Risks — Political, legal, regulatory, constitutional and economic uncertainty arising from the outcome of the referendum on the UK’s membership of the European Union could adversely impact the Group’s business, results of operations, financial condition and prospects” below.

 

These laws and regulations include (i) increased regulatory oversight, particularly in respect of conduct issues,issues; (ii) prudential regulatory developments, including ring-fencing,ring-fencing; and (iii) increased legislative requirements, including the new Senior Managers and Certification Regime (the “SMCR”), and (iv) other industry-wide initiatives.including:

•the Competition and Market Authority Open Banking programme which was implemented in the UK in 2018;
•the Second Payment Services Directive (“PSD2”), which entered into force in January 2016 and applied in the UK from January 2018. Finalised EU-wide technical standards on PSD2 are due to be implemented by September 2019 with the aim of protecting customers and their data by providing higher security standards for online payments; and
•the General Data Protection Regulation (“GDPR”), which entered into force in May 2018. The implementation of the GDPR introduced a number of significant changes.

 

Unfavourable developments across any of these areas discussed in greater detail elsewhere herein, could materially affect the Group’s ability to maintain appropriate liquidity, increase its funding costs, constrain the operation of its business and/or have a material adverse effect on the Group’s business, results of operations and financial condition. Areas where these changes could have an adverse effect on the Group include, but are not limited to:

 

(i)general changes in government, central bank or regulatory policy, or changes in regulatory regimes that may influence investor decisions in particular markets in which the Group operates, any of which may change the structure of those markets and the products offered or may increase the costs of doing business in those markets;
  
(ii)external bodies applying or interpreting standards, laws, regulations or contracts differently to the Group;
  
(iii)an uncertain and rapidly evolving prudential regulatory environment which could materially adversely affect the Group’s ability to maintain liquidity and increase its funding costs;
  
(iv)changes in competitive and pricing environments, including markets investigations, or one or more of the Group’s regulators intervening to mandate the pricing of the Group’s products, as a consumer protection measure;
  
(v)one or more of the Group’s regulators intervening to prevent or delay the launch of a product or service, or prohibiting an existing product or service;
  
(vi)further requirements relating to financial reporting, corporate governance, corporate structure and conduct of business and employee compensation;
  
(vii)expropriation, nationalisation, confiscation of assets and changes in legislation relating to foreign ownership;
  
(viii)changes to regulation and legislation relating to economic and trading sanctions, money laundering and terrorist financing; and
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(ix)regulatory changes which influence business strategy, particularly the rate of growth of the business, or which impose conditions on the sales and servicing of products, which have the effect of making such products unprofitable or unattractive to sell.

 

With respect to the State Aid commitments agreed with the European Commission by the Group under the State Aid regime in 2009, the Group has satisfied all material structural and behavioural commitments following the successful carve-out and disposal of TSB and non-core asset reductions. The Group is therefore no longer subject to restrictive behavioural commitments including the constraint on acquisitions, but the Group continues to be bound by two remaining limited ancillary commitments which means that the Group remains subject to supervision by the European Commission with respect to these commitments until they cease to have effect on or before June 2017.

For more detail on the changing prudential regulatory environment see “—“Regulatory and Legal Risks—TheRisks —The Group faces risks associated with an uncertain and rapidly evolving international prudential, legal and regulatory environment”.environment” below.

 

The Group faces risks associated with an uncertain and rapidly evolving international and national prudential, legal and regulatory environment.

The Group’s borrowing costs and access to capital markets, as well as its ability to lend or carry out certain aspects of its business, could be affected by prudential regulatory developments, including (i) amendments to the Financial Services and Markets Act 2000 (the “FSMA”)FSMA introduced by the Financial Services (Banking Reform) Act 2013 (the “Banking“Banking Reform Act”Act”) along with secondary legislation and Prudential Regulation Authority (PRA)/Financial Conduct Authority (FCA)PRA/FCA rules made under the Banking Reform Act; (ii) amendments to the EU legislation comprising the Capital Requirements Directive IV and the Capital Requirements Regulation (CRD IV), effective from 1 January 2014, or implementation of (together, “CRD IV in the UK;”); (iii) evolving European and global prudential and regulatory changes; and (iv) regulatory changes in the U.S. and (v) the evolving regulatory and legal impacts of the UK’s exit from the EU.

 

BANKING REFORM ACT

 

The Banking Reform Act received Royal Assent on 18 December 2013. The Banking Reform Act’s measures contain provisions with respect to, amongst other things (i) ring-fencing domestic retail banking services of UK banks,banks; and (ii) the newimplementation of the Senior Managers and Certification Regime (SMCR)(the “SMCR”).

 

RING-FENCING

 

The Banking Reform Act, secondary legislation and PRA/FCA rules made under the Banking Reform ActFSMA have enacted amendments to the FSMA and the UK regulatory regime that require UK banking groups (such as the Group) with more than £25 billion (on a Groupwidegroup-wide basis) of core deposits (defined as “ring-fenced bodies”“ring-fenced bodies” or “RFBs”“RFBs”) to separate the retail banking activities of their UK banks – particularly deposit-taking and associated services – from certain prohibited forms of activity, includingincluding: (i) dealing in investments; (ii) incurring exposures to relevant financial institutions (which include, amongst others, credit institutions (other than RFBs), investment firms and alternative investment funds (subject to certain limited exceptions)); (iii) participating in an inter-bank payment system other than as a direct member (subject to certain limited exceptions); and (iv) having non-EEA branches or subsidiaries. RFBs are also subject to regulations governing how pension arrangements can be managed, following the implementation of ring-fencing.

 

The PRA and FCA are required byUnder the Banking Reform Act, to implement Ring-fencingthe PRA and FCA established ring-fencing rules (the “Ring-fencing Rules”“Ring-fencing Rules”) byrequiring implementation of ring-fencing prior to 1 January 2019, with the deadline for implementing changes to the Group’s pension scheme being 1 January 2026. The PRA has published consultation papers covering: (i) the legal structure of an RFB and its wider group; (ii) the governance arrangements for an RFB; (iii) the continuity of services and facilities; (iv) prudential requirements applicable to the RFB sub-group; (v) intra-group arrangements; (vi) the use of financial market infrastructure by RFBs; and (vii) reporting requirements regarding compliance with the Ring-fencing regime, including an RFBs’ reliance on any exemptions to the excluded activities and

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prohibitions under secondary legislation. RFBs are able to apply for waivers of the Ring-fencing Rules in accordance with the statutory procedure for waivers set out in FSMA. In May 2015, the PRA published near-final rules covering items (i) through (iv) above. The PRA and FCA have also been granted powers to impose certain restructuring requirements on RFBs, their parent undertakings and certain other regulated entities within an RFB’s group if, in broad terms, the financial stability of the RFB is deemed to be at risk.

Whilst the Ring-fencing Rules and other guidance are not yet in final form, it is expected that the implementation of the Ring-fencing Rules will have an impacthas impacted on the Group’s structure, governance arrangements, business and reporting models, operations, costs and financing arrangements. The Group expects that dueimplemented its ring-fencing programme, including the establishment of the non ring-fenced bank, Lloyds Bank Corporate Markets plc (LBCM), and met the legal and regulatory requirements prior to 1 January 2019. As a predominantly UK retail and commercial bank, the impact on the Group was relatively limited, with minimal impact for the majority of the Group’s retail and commercial customers.

Over the course of 2018, in order to comply with the ring-fencing legislation, certain businesses were transferred out of Lloyds Bank plc and its subsidiaries to other parts of the Group, by means of statutory or contractual transfers. This included the transfer of certain wholesale and international businesses to LBCM and the transfer of Scottish Widows Group and other insurance subsidiaries to Lloyds Banking Group plc.

Due to the implementationGroup’s UK retail and commercial focus, the vast majority of this legislation, it willthe Group’s business continued to be required to reorganiseheld by Lloyds Bank plc and its business, however,subsidiaries (together, the full extentring-fenced bank) and as a result these transfers did not have a material impact on the financial strength of changes required byLloyds Bank plc.

From 1 January 2019, the Group under the Ring-fencing Rules is not yet known. The Group is actively engaged with Her Majesty’s Treasury (HM Treasury), the PRA and FCA to ensure that it is able to fully implement the restructuring required to implement Ring-fencing by the January 2019 deadline. As required under the PRA’s second consultation paper, the Group submitted its latest implementation plan to the PRA and FCA in early 2016. In addition, the Group will becomebecame subject to the expanded oversight powers granted to Her Majesty’s Treasury (“HM Treasury”), the PRA and the FCA under the Banking Reform Act from 1 January 2019.Act.

 

SENIOR MANAGERS AND CERTIFICATION REGIME (SMCR)

 

The SMCR is a new regime which will replacecame into force on 7 March 2016 and replaced the approved persons regime for deposit takers and other PRA designated firms. The SMCR will come into force on 7 March 2016. The SMCR comprises a number of elements, including the senior managers’ regime, the certification regime and the conduct rules, which could potentiallywere extended to apply to Insurance firms (Solvency II entities) in December 2018 and will be expandedextended to solo-regulated firms in December 2019 by changes proposed by the Bank of England and the Financial Services Bill 2015/16.Act 2016. The Group could be exposed to additional risk or loss if it is unable to comply with the requirements arising from the SMCR and its extension or if doing so imposes significant demands on the attention of management.

 

CAPITAL REQUIREMENTS REGULATION AND CAPITAL REQUIREMENTS DIRECTIVE

 

In 2012,The Group is subject to CRD IV which implemented changes approved by the Basel Committee on Banking Supervision (the “Basel Committee”“Basel Committee”) approved significant changes to the regulatory framework applicable to the Group, including new capital and liquidity requirements intended to reinforce capital standards and to establish minimum liquidity standards for credit institutions in Europe (such changes being commonly referred to as “Basel III”). The “Basel III changes refer to, amongst other things, (i) new requirements for a bank’s capital base, (ii) measures to strengthen capital requirements for counterparty credit exposures arising from certain transactions, (iii) the introduction of a leverage ratio and (iv) short-term and longer-term standards for funding and liquidity.

The Basel III reform package has been implemented in Europe through CRD IV.”). Full implementation began from 1 January 2014, with particularsome elements being phased in over a period of time, to be fully effective by 2024.

 

AsCRD IV includes a European regulation,number of capital buffers to provide capital cushions in addition to minimum capital requirements to which the Capital Requirements Regulation is directly applicablefinancial institutions may be subject. See “Other Risks – The Company may not pay a dividend on its ordinary shares in the UK and the Group is subject to its requirements. In December 2013, the PRA published its principal statement of policy, setting out the PRA rules in order to implement the Capital Requirements Directive in the UK.any given financial/calendar year”.

 

The CRD IV regime is expected to continue to evolve as a result of further changes agreed by EU legislators, binding regulatory technical standards and guidelines to be developed by the European Banking Authority (EBA)(“EBA”) and changes to the way in which the PRA interprets and applies these requirements to UK financial institutions. WhilstThe European Commission put forward significant draft proposals to amend CRD IV in November 2016 (with the Group does not anticipate any material changeamended Capital Requirements Regulation to be known as “CRR 2” and the amended Capital Requirements Directive to be known as “CRD V”). The proposals include a binding leverage ratio, a binding net stable funding ratio and more risk-sensitive capital requirements as a consequencerequirements. Inter-institutional negotiations (trilogues) commenced on CRD V and CRR 2 in July 2018, following agreement by the Council of the EBA regulatory technical standardsEU on its general approach and guidelines there is a risk that this may not be the case.

CRD IV introducedEuropean Parliament on its negotiating position. Political agreement on a number of new capital buffers to provide further capital cushions for additional risks that financial institutions may be subject to. These buffers will be fully phasedkey issues was reached in by 1trilogues in November 2018 and the Council announced its endorsement of the agreement in December 2018. The technical mandate was concluded in January 2019 with the final text approved in February 2019. Adoption of the proposals and comprise: (i) a capital conservation buffer; (ii) a time-varying counter-cyclical capital buffer; (iii) buffers applicable to global systemically important banks (G-SIBs); (iv) buffers applicable to other systematically important banks;publication in the Official Journal is anticipated by mid-2019. CRR 2 and (v) a systemic risk buffer (SRB). The Group is not currently categorised as a G-SIB for whichCRD V are two of the pieces of legislation included in the Financial Stability Board (FSB) has set buffer rates. However, withinServices (Implementation of Legislation) Bill which received its first reading in the House of Lords in November 2018. The Bill provides the UK Government with the Bankpower to choose to implement only those EU files, or parts of England’s Financial Policy Committee (FPC) issued a consultation paper in January 2016 on the domestic SRB framework that will apply to the Group’s RFB sub-group, with a finalised framework to be published in 2016.

Under CRD IV Article 141, institutions that fail to meet their “combined buffer requirements” (consisting of buffers (i), (ii), and the higher of (iii), (iv) and (v)) will be subject to restrictions on making “discretionary payments”. These restrictions are scaled according to the extent of the breach and result in a “maximum distributable amount” in each relevant period.

As there are still aspects of the Group’s capital buffer requirementsthose files, which are stillboth appropriate and beneficial for the UK and adjust and improve the legislation as it is brought into UK law to be determined, investors may not be able to predict accurately the risk of dividends on ordinary shares or distributions on other securities being prohibited or restricted as a result of Article 141.

In December 2015, the FPC released a supplement to its Financial Stability Report on the framework of capital requirementsensure that it works better for UK banks. The supplement outlined the FPC’s final views on the overall calibration of the UK capital framework and described how the framework of capital requirements for UK banks is expected to transition from its current state to its end point in 2019, as well as ongoing work to refine requirements during that transition period. In this supplement, the FPC set out its strategy for the time-varying counter-cyclical buffer which will be applied to a bank’s UK exposures. The rate is currently set at 0 per cent and the FPC have indicated that it expects to set a counter-cyclical capital buffer rate in the region of 1 per cent of risk-weighted assets when risks are judged to be neither subdued nor elevated but the rate can be set in excess of this level. There is a risk that the countercyclical buffer could lead to an increase in capital requirements applicable to the Group.

The FPC supplement also set out how the PRA intends to set a PRA buffer for individual banks which is the minimum level of capital buffer required by the PRA. The PRA buffer is confidential between the Group and the PRA and can be set at a level in excess of the combined buffer requirements and any further sectoral capital measures that the PRA has imposed. As a result, investors may not be able to predict accurately the risk of dividends on ordinary shares or distributions on other securities being restricted as a result of the PRA buffer.markets.

 

In addition, the Basel Committee published a package of further revisions to Basel III in December 2017, including changes to: standardised approach for credit risk; internal ratings based approaches for credit risk; the credit valuation adjustment risk framework; the operational risk framework; the

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leverage ratio framework; and a revised output floor. Although Basel III does not directly apply to the risk based capital framework,Group, or to other firms, the Group is also subjectBasel Committee expects these changes to minimum requirements under the UK leverage framework. Currently, the UK leverage ratio framework does not give rise to higher capital requirementsbe implemented by regulators from January 2022, with transitional arrangements for the Group thanoutput floor up to January 2027. Until such rules are translated into draft European and UK legislation, it would be premature to estimate the risk-based capital framework but there is a risk that it could do so as a result of a change in the Group’s financial positionfull impact or a strengthening of the regulatory requirements (which are expected to be calibrated by 2017).timelines.

 

The Group will continue to monitor the ongoing changes to the capitalglobal, EU and UK prudential framework which may affect the Group’s financial position or require the strengthening of regulatory requirements.

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EVOLVING EUROPEAN AND GLOBAL PRUDENTIAL AND REGULATORY CHANGES

More generally and in the longer term, the Basel Committee is considering revisions to Basel III including: credit risk capital requirements and capital floors; operational risk capital requirements; capital requirements covering credit valuation adjustments and potentially new Pillar 1 requirements for interest rate risk in the banking book. However, it is still too early to understand the full impact of these reforms.

In addition, the EBA issued a consultation paper to implement a Minimum Requirement for Own Funds and Eligible Liabilities (MREL), which will apply to EU financial institutions and cover capital and debt instruments that are capable of being written-down or converted to equity in order to prevent a financial institution from failing in a crisis. In December 2015, ahead of its powers to set MREL coming into force on 1 January 2016, the Bank of England published a consultation on its approach to setting MREL. The Bank of England has stated that it expects to set consolidated MREL in 2016 no higher than institutions’ current regulatory minimum capital requirements. For most institutions, the Bank of England proposes to set a final MREL conformance date of 1 January 2020 with MREL requirements transitioning up to that date. The PRA has also separately stated that financial institutions should expect the PRA to investigate whether any financial institution in breach of its MREL requirement is failing, or likely to fail, to satisfy the threshold conditions for authorisation, with a view to taking further action as necessary. There is a risk that the final MREL requirements and the UK implementation of them may create an unexpected adverse impact upon the amount, mix and associated cost of the Group’s capital and eligible debt of the Group.

Following the report of the European Commission’s high-level expert group on banking structural reform chaired by Erkki Liikanen (the “Liikanen Report”), published in 2012, structural reform measures that are similar to some of those contained in the Banking Reform Act are also under consideration.MARKET INFRASTRUCTURE REGULATION

 

European Regulation 648/2012, known as the European Market Infrastructure Regulation (EMIR)(“EMIR”), introducesintroduced new requirements to improve transparency and reduce the risks associated with the derivatives market. EMIR came into force on 16 August 2012 and when it fully comes into effect, EMIR will require entities that enter into any form of derivative contract, including interest rate, foreign exchange, equity, credit and commodity derivatives, to: (i) report every derivative contract entered into to a trade repository; (ii) implement new risk management standards (including operational processes and margining) for all bilateral over the counter (OTC)(“OTC”) derivative trades that are not cleared by a central counterparty; and (iii) clear, through a central counterparty, OTC derivatives that are subject to a mandatory clearing obligation. Some of the requirements under EMIR (such as some clearing requirements) have yet to come into effect. The first clearing obligations for certain interest rate derivatives will applyhave applied from 21 June 2016 (but are subject to a number of phasing in provisions).2016. Variation margin requirements for uncleared trades are expected to comecame into effect from 1 September 2016on 4 February 2017 for major market participants with a sufficiently large derivative trading volume and on 1 March 2017 for all other counterparties. Initialcounterparties, including the Group. Certain products are exempt from variation margin requirements areat this time. The Group does not expect initial margin requirements to apply to it until September 2019. It is expected to be phased in between 1 September 2016 and 1 September 2020. Although uncertainty remains about some of the final details, impact and timing of these requirements, the Group expects that there will be additional costs and limitations on the Group’s business resulting from these requirements.

Significant regulatory initiatives from the U.S. impacting the Group include the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which provides a broad framework for significant regulatory changes that extend to almost every area of U.S. financial regulation, which could have an adverse effect on the Group’s businesses. For example, final rules implementing the Volcker Rule came into effect from 22 July 2015, including prohibitions on certain types of proprietary trading by the Group, and limiting its ability to make investments in and sponsor certain private equity funds and hedge funds, subject to certain extensions for the Group to bring its activities into full compliance. Although uncertainty remains about some of the final details, impact and timing of the Dodd-Frank Act’s implementing regulations, there will be additional costs and limitations on the Group’s business resulting from both the finalised and pending regulatory initiatives, including the final rules imposing registration and other requirements on entities that engage in derivatives activities.

The full impact of the derivative market regulations on the Group remains unclear, and could have a materially adverse effect on the Group’s results, operations, financial condition or prospects. In particular, the costs of complying with the regulations are expected to be burdensome, giving rise to additional expenses that may have an adverse impact on the Group’s financial condition. Additionally, such regulations could make it more difficult and expensive to conduct hedging and trading activities. As a result of these increased costs, the regulation of the derivative markets may also result in the Group deciding to reduce its activity in these markets.

 

It is difficult to predict how and in what final form many of the regulatory changes described herein will be implemented and what financial obligations may be imposed in relation thereto. While the Group continues to work closely with regulatory authorities and industry associations to ensure that it is able to identify and respond to proposed regulatory changes, the Group could be exposed to additional risk of loss if it is unable to comply with the requirements arising from these regulations or if doing so imposes significant demands on the attention of management. Depending on the specific nature of the requirements and how they are enforced, such changes could have a significant impact on the Group’s operations, business prospects, structure, costs and/or capital requirements including changes to how the Group and its businesses are capitalised and funded, distribution of capital, reducing weighted assets, modifying legal entity structure and changing the Group’s business mix to strengthen the Group’s capital position.

 

The Group and its UK subsidiaries may become subject to the provisions of the Banking Act 2009, as amended, which could have an adverse impact on the Group’s business.

Under the Banking Act 2009, as amended, (the “Banking Act”“Banking Act”), substantial powers have been granted to HM Treasury, the Bank of England and the PRA and FCA (together, the “Authorities”“Authorities”) as part of the special resolution regime (the “SRR”“SRR”). These powers enable the Authorities to deal with and stabilise UK-incorporated institutions with permission to accept deposits pursuant to Part 4A of the FSMA thatif they are failing or are likely to fail to satisfy certain threshold conditions (within the meaning of Section 55B of the FSMA). The SRR consists of five stabilisation options: (i) transfer of all or part of the business of the relevant entity or the shares of the relevant entity to a private sector purchaser; (ii) transfer of all or part of the business of the relevant entity to a “bridge bank” established and wholly owned by the Bank of England; (iii) transfer all or part of the relevant entity or “bridge bank” to an asset management vehicle; (iv) making of one or more resolution instruments by the Bank of England; and (v) temporary public ownership of the relevant entity. HM Treasury may also take a parent company of a relevant entity into temporary public ownership where certain conditions are met. The SRR also provides for two new insolvency and administration procedures for relevant entities. Certain ancillary powers include the power to modify certain contractual arrangements in certain circumstances.

 

In addition, the Group’s costs of doing business may increase by amendments made to the Banking Act in relation to deposits covered by the UK Financial Services Compensation Scheme (the “FSCS”“FSCS”). The Group contributes to compensation schemes such as the FSCS in respect of banks and other authorised financial services firms that are unable to meet their obligations to customers. Further provisions in respect of these costs are likely to be necessary in the future. The ultimate cost to the industry, which will also include the cost of any compensation payments made by the FSCS and, if necessary, the cost of meeting any shortfall after recoveries on the borrowings entered into by the FSCS, remains uncertain but may be significant and may have a material effect on the Group’s business, results of operations or financial condition.

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The final text of the EU Directive 2014/59/EU establishing an EU-wide framework for the recovery and resolution of credit institutions and investment firms (the “BRRD”“BRRD”), entered into force on 2 July 2014 and in the UK, the Banking Reform Act made provision for certain aspects of the “bail-in” power. Under the “bail-in power”, before“bail-in” power, prior to insolvency proceedings, regulators would have the power to impose losses on holders of regulatory capital securities, senior bondholders and/or other creditors while potentially leaving untouched certain other classes of excluded creditors; generally losses are to be taken in accordance with the priority of claims under normal insolvency proceedings. Bail-in is expected to applymay be applied to all of the Group’s unsecured senior and subordinated debt instruments with a remaining maturity of greater than seven days. The stated aim of the BRRD is to provide authorities designated by Member StatesEU member states to apply the resolution tools and exercise the resolution powers set forth in the BRRD (the “resolution authorities”“resolution authorities”) with common tools and powers to address banking crises pre-emptively in order to safeguard financial stability and minimise taxpayers’ exposure to losses. The powers granted to resolution authorities under the BRRD include, but are not limited to: (i) a “write-down and conversion power” relating to Tier 1 and Tier 2 capital instruments and (ii) a “bail-in” power relating to eligible liabilities (including the capital instruments and senior unsecured debt securities issued by the Group). Such powers give resolution authorities the ability to write-down or write-off all or a portion of the claims of certain unsecured creditors of a failing institution or group and/or to convert certain debt claims into another security, including ordinary shares of the surviving group entity, if any. Such resulting ordinary shares may be subject to severe dilution, transfer for no consideration, write-down or write-off. Such powers were implemented in the UK with effect from 1 January 2015.

 

The Minimum Requirement for Own Funds and Eligible Liabilities (“MREL”), which is being implemented in the EU and the UK, will apply to EU and UK financial institutions and cover capital and debt instruments that are capable of being written-down or converted to equity in order to prevent a financial institution from failing in a crisis. The Bank of England has set an interim MREL compliance date of 1 January 2020 and a final MREL conformance date of 1 January 2022.

The conditions for use of the bail-in“bail-in” power are, in summary, that (i) the regulator determines that the bank is failing or likely to fail,fail; (ii) having regard to timing and other relevant circumstances, it is not reasonably likely that (ignoring the stabilisation powers) action will be taken by or in respect of the bank to avoid the failure of the bank,bank; (iii) the relevant UK resolution authority determines that it is necessary having regard to the public interest to exercise the bail-in“bail-in” power in the advancement of one of the statutory objectives of resolutionresolution; and (iv) one or more of those objectives would not be met to the same extent by the winding up of the bank. The Banking Act and secondary legislation made thereunder provides certain other limited safeguards for creditors in specific circumstances. The ‘no“no creditor worse off’off” safeguard contained in the Banking Act may not apply in relation to an application of the write-down and conversion power in circumstances where a stabilisation power is not also used; holders of debt instruments which are subject to the

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power may, however, have ordinary shares transferred to or issued to them by way of compensation. The exercise of mandatory write-down and conversion power under the Banking Act or any suggestion of such exercise could, therefore, materially adversely affect the rights of the holders of equity and debt securities and the price or value of their investment and/or the ability of the Group to satisfy its obligations under such debt securities.

 

Certain amendments to the BRRD will be made as a result of proposals originally published by the European Commission on 23 November 2016 (such proposals being known as “BRRD 2”), including extending the “write-down and conversion power” to cover non-own funds eligible liabilities of entities in a banking group other than the resolution entity. Such “internal” MREL may also contain additional write-down or conversion triggers in order to reflect current Bank of England resolution policy which may result in the Company as investor suffering additional losses on such intra-group investments. Trilogues commenced on BRRD 2 in July 2018, following agreement by the Council of the EU on its general approach and the European Parliament on its negotiating position. Political agreement on a number of key issues was reached in trilogues in November 2018 and the Council announced its endorsement of the agreement in December 2018. The technical mandate was concluded in January 2019 with the final text approved in February 2019. Adoption of the proposals and publication in the Official Journal is anticipated by mid-2019. BRRD 2 is one piece of legislation included in the Financial Services (Implementation of Legislation) Bill which received its first reading in the House of Lords in November 2018. The Bill provides the UK Government with the power to choose to implement only those EU files, or parts of those files, which are both appropriate and beneficial for the UK and adjust and improve the legislation as it is brought into UK law to ensure that it works better for UK markets.

In addition to the provisions described above, it is possible that the exercise of other powers under the Banking Act to resolve failing banks in the UK, andwhich give the authorities powers to amend the terms of contracts (for example, varying the maturity of a debt instrument) and to override events of default or termination rights that might be invoked as a result of the exercise of the resolution powers, could have a material adverse effect on the rights of holders of the equity and debt securities issued by the Group, including through a material adverse effect on the price of such securities. The Banking Act also gives the Bank of England the power to override, vary or impose contractual obligations between a UK bank, its holding company and its group undertakings for reasonable consideration, in order to enable any transferee or successor bank to operate effectively. There is also power for HM Treasury to amend the law (excluding provisions made by or under the Banking Act) for the purpose of enabling it to use the regime powers effectively, potentially with retrospective effect.

 

The determination that securities and other obligations issued by the Group will be subject to write-down, conversion or bail-in“bail-in” is likely to be inherently unpredictable and may depend on a number of factors which may be outside of the Group’s control. This determination will also be made by the relevant UK resolution authority and there may be many factors, including factors not directly related to the bankCompany or the Group, which could result in such a determination. Because of this inherent uncertainty and given that both BRRD and the relevant provisions of the Banking Act remain untested in practice, it will be difficult to predict when, if at all, the exercise of a bail-in“bail-in” power may occur which would result in a principal write-off or conversion to other securities, including the ordinary shares of the Company. Moreover, as the criteria that the relevant UK resolution authority will be obliged to consider in exercising any bail-in“bail-in” power provide it with considerable discretion, holders of the securities issued by the Group may not be able to refer to publicly available criteria in order to anticipate a potential exercise of any such power and consequently its potential effect on the Group and the securities issued by the Group.

Potential investors in the securities issued by the Group should consider the risk that a holder may lose some or all of its investment, including the principal amount plus any accrued interest, if such statutory loss absorption measures are acted upon. The BRRD and applicable state aid rules provide that, other than in certain limited circumstances set out in the BRRD, extraordinary governmental financial support will only be available to the Group as a last resort once the write downwrite-down and conversion powers and resolution tools referred to above have been exploited to the maximum extent possible.

 

Holders of the Group’s securities may have limited rights or no rights to challenge any decision of the relevant UK resolution authority to exercise the UK bail-in“bail-in” power or to have that decision reviewed by a judicial or administrative process or otherwise. Accordingly, trading behaviour in respect of such securities is not necessarily expected to follow the trading behaviour associated with other types of securities that are not subject to such recovery and resolution powers. Potential investors in securities issued by the Group should consider the risk that a holder of such securities may lose all of its investment, including (in the case of debt securities) the principal amount plus any accrued and unpaid interest, if such statutory loss absorption measures are acted upon or if that senior unsecured debt instrumentsinstrument may be converted into Lloyds Banking Group plc ordinary shares. Further, the introduction or amendment of such recovery and resolution powers, and/or any implication or anticipation that they may be used, may have a significant adverse effect on the market price of such securities, even if such powers are not used.

 

The Group faces risks associated with its compliance with a wide range of laws and regulations.

The Group is exposed to various forms of legal and regulatory risk, including:

 

(i)certain aspects of the Group’s activities and business may be determined by the relevant authorities, the Financial Ombudsman Service (the “FOS”“FOS”), or the courts, not to have not been conducted in accordance with applicable laws or regulations, or, in the case of the FOS, with what is fair and reasonable in the Ombudsman’s opinion;
  
(ii)the possibility of alleged missellingmis-selling of financial products or the mishandling of complaints related to the sale of such products by or attributed to a member of the Group, resulting in disciplinary action or requirements to amend sales processes, withdraw products, or provide restitution to affected customers, all of which may require additional provisions;
  
(iii)risks relating to compliance with, or enforcement actions in respect of, existing and/or new regulatory or reporting requirements, including as a new PRAresult of a change in focus of regulation or a transfer of responsibility for regulating certain aspects of the Group’s activities and FCA whistleblowing regime, by 7 September 2016, including rules which require certain deposit-holding entities, including those within the Group,business to appoint a senior manager (under the SMCR) by 7 March 2016 who will be responsible for oversight of whistleblowing policies and an internal annual report on whistleblowing, as well as to implement various policies and procedures related to internal and external reporting, internal awareness, confidentiality and related areas;other regulatory bodies;
  
(iv)contractual and other obligations may either not be enforceable as intended or may be enforced against the Group in an adverse way;
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(v)the intellectual property of the Group (such as trade names) may not be adequately protected;
  
(vi)the Group may be liable for damages to third partiesthird-parties harmed by the conduct of its business;
  
(vii)the risk of regulatory proceedings, andenforcement actions and/or private litigation, arising out of regulatory investigations or otherwise (brought by individuals or groups of plaintiffs) in the UK and other jurisdictions;
  
(viii) risks related to court or UK Government activity leading to a new regulatory and reporting regime under the Modern Slavery Act 2015, which (a) consolidates existing criminal offences for slavery and trafficking and creates two new civil ordersrequirement to allow courts to intervene before a crime has occurred, and (b) will require the Group to prepare and publish a statement each year, startingequalise pension benefits for the 2016 financial year, describingeffect of Guaranteed Minimum Pensions. It is possible that any such requirement could increase liabilities in the steps being undertaken to ensure that slavery and human trafficking are not taking place in any of its supply chains and in any part of its own business;Group’s defined benefit pension schemes; and
  
(ix)the transfercontinued uncertainty around the impact of responsibility for regulating consumer creditthe UK’s expected exit from the OFT toEU on the FCA. The FCA’s approach to date has focused,existing regulatory and is expected to continue to focus, on higher risk groups, and the FCA has the ability to undertake its own enforcement actions. The FCA’s consumer credit sourcebook (CONC) is its basis for compliance and enforcement. Additionally,legal framework that the Group is subject tooperates within, as well as the Consumer Credit Act 1974 (the “CCA”), which regulates a wide rangefuture regulatory and legal landscape. For more detail on the EU referendum decision see “Business and Economic
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Risks — Political, legal, regulatory, constitutional and economic uncertainty arising from the outcome of credit agreements. If requirements under the CCA as to licensingreferendum on the UK’s membership of lenders or brokers or entering intothe European Union could adversely impact the Group’s business, results of operations, financial condition and documenting a credit agreement are not, or have not been met, the relevant agreement may not be enforceable against the borrower.prospects” below.

 

Regulatory and legal actions pose a number of risks to the Group, including substantial monetary damages or fines, the amounts of which are difficult to predict and may exceed the amount of provisions set aside to cover such risks. In addition, the Group may be subject, including as a result of regulatory actions, the Group may be subject to other penalties and injunctive relief, civil or private litigation arising out of a regulatory investigation or otherwise, the potential for criminal prosecution in certain circumstances and regulatory restrictions on the Group’s business, all of which can have a negative effect on the Group’s reputation. Any of these risks could have an adverse impact on the Group’s operations, financial condition, results of operations or prospects and the confidence of customers in the Group, as well as taking a significant amount of management time and resources away from the implementation of the Group’s strategy.

 

The Group’s operations also expose it to various forms of reputational impacts. Negative public opinion can result from the actual or perceived manner in which the Group conducts its business activities, from the Group’s financial performance, the level of direct and indirect government support, actual or perceived practices in the banking and financial industry, or allegations of misconduct. Negative public opinion may adversely affect the Group’s ability to keep and attract customers, which may result in a material adverse effect on the Group’s financial condition, results of operations or prospects.

Negative public opinion referenced in the media as “lack of trust” in banking can be impacted by actions of competitors across the industry as well as actions by the Group. RegainingGaining the trust of customers and the public is a key objective of the Group.

 

The Group may settle litigation or regulatory proceedings prior to a final judgmentjudgement or determination of liability to avoid the cost, management efforts or negative business, regulatory or reputational consequences of continuing to contest liability, even when the Group believes that it has no liability or when the potential consequences of failing to prevail would be disproportionate to the costs of settlement. Furthermore, the Group may, for similar reasons, reimburse counterparties for their losses even in situations where the Group does not believe that it is legally compelled to do so. Failure to manage these risks adequately could materially affect the Group, both financially and reputationally.

 

The Group faces risks associated with the high level of scrutiny of the treatment of customers by financial institutions from regulatory bodies, the media and politicians.

The Group’s operations, in particular related to its treatment of customers, are subject to supervision by the FCA and other regulatory authorities. In recent periods, the UK banking industry has been subject to heightened attention from these regulatory authorities, as well as the pressnews media and the UK Government. The FCA in particular continues to focus on conduct of business issues through its supervision activities and its establishment of a new Payment Systems Regulator. Other regulatory efforts include the implementation of the UK Mortgage Market Review (MMR) in April 2014, which now requires lenders to obtain evidence of borrowers’ income so as to ensure that they can afford a mortgage, including with respect to potential interest rate rises. The Bank of England is currently implementing limitations on the ability of lenders to provide high loan-to-income mortgages. Increased scrutiny or regulatory development in these areas could materially affect the Group’s operation of its business and/or have a material adverse effect on the Group’s business, results of operations or financial condition. Alongside these changes, the FCA may consider various adjustments to the MMR or other legislation in order to align it with the Mortgage Credit Directive (2014/17/EU) (MCD), which comes into force on 21 March 2016, including (i) introducing the European Standardised Information Sheet, which is a new product disclosure document to be provided to customers, (ii) requiring firms to calculate both an annual percentage rate of charge (APRC) according to the method set out in the MCD as well as a second APRC for variable-rate mortgage products, and (iii) widening the scope of UK mortgage regulation to include properties located across the EEA, as well as certain buy-to-let mortgages and second charge lending.

 

Additionally, theThe Group ishas historically been subject to the Markets in Financial Instruments Directive (MiFID)(“MiFID”) and, its various implementing measures,since 3 January 2018, the Group is subject to a revised directive (“MiFID II”) and a new regulation (Markets in Financial Instruments Regulation or “MiFIR”), which togetherwere implemented across the divisions of the Group. MiFID, MiFID II and MiFIR regulate the provision of “investment services and activities” in relation to a range of customer-related areas, including customer classification, conflicts of interest, client order handling, investment research and financial analysis, suitability and appropriateness, transparency obligations and transaction reporting. MiFID is in the process of being replaced by a revised directive (MiFID II) and a new regulation (Markets in Financial Instruments Regulation or “MiFIR”), which entered into force on 2 July 2014. The changes to MiFID include expanded supervisory powers that include the ability to ban specific products, services or practices. While the majority of the provisions of MiFID II and MiFIR and the implementing laws and regulations are currently scheduled to apply from 3 January 2017, the Group has commenced work to meet anticipated requirements. However, it is now anticipated that the deadline for implementation will be pushed back by one year until January 2018. If the Group incurs substantial expenses associated with compliance, ongoing compliance, imposesthis may impose significant demands on the attention of management that result in other areas of the Group’s business not receiving sufficient management attention, or if particular products, services or practices are banned, the Group’s results of operations could be materially adversely affected.

 

The Group is also subject to European regulation on customer deposits. On 12 June 2014, the Deposit Guarantee Schemes Directive (2014/2014/49/EU) (recast DGSD)EU (the “recast DGSD”) was published in the Official Journal of the EU, which replaced Directive 94/19/EC on Deposit Guarantee Schemes (the “EU DGSD”).Schemes. As required by the recast DGSD, the UK introduced a compliant deposit guarantee scheme (DGS)(“DGS”) that:

 

•gives a preference in liquidation or resolution to deposits made by retail customers and SMEs over other senior creditors;
  
•sets out the rights of eligible depositors (typically retail customers) to compensation, and repayment circumstances and procedures by the DGS, covering the unavailability of any deposit, up to aggregate deposits of €100,000;
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•places obligations on credit institutions, in particular, requirements to provide specified information to depositors (and potential depositors) on their rights to compensation under the DGS; and
  
•sets out provisions on the financing of DGSs, including target funding levels and contribution amounts by credit institutions.

 

In addition, increasing regulatory scrutiny under EU Data Protection Regulationthe GDPR requires the Group to afford greater transparency and control to customers over how their personal data is used, stored and shared which may limit the extent to which customer data can be used to support the Group achievingusing its strategic objectives. Failure to comply may erode customer trust and result in regulatory fines.

 

The financial impact of legal proceedings and regulatory risks might be material but is difficult to quantify. Amounts eventually paid may materially exceed the amount of provisions set aside to cover such risks, or existing provisions may need to be materially increased in response to changing circumstances, as has been the case in respect of payment protection insurance (PPI)(“PPI”) redress payments.

Where provisions have already been taken in published financial statements of the Group or results announcements for ongoing legal or regulatory matters, these have been recognised, in accordance with IAS 37 “Provisions,(“Provisions, Contingent Liabilities and Contingent Assets”), as the best estimate of the expenditure required to settle the obligation as at the reporting date. Such estimates are inherently uncertain and it is possible that the eventual outcomes may differ materially from current estimates, resulting in future increases or decreases to the required provisions, or actual losses that exceed or fall short of the provisions taken.

 

TheExcluding MBNA Limited (“MBNA”), the Group increased provisions for expected PPI costs by a further £1.4£0.8 billion in 2018. The increase in 2018 related to a number of factors including higher than expected complaint volumes and associated administration costs, an increase in average redress per complaint, additional operational costs to deal with potential complaint volatility and continued improvements in data interrogation and the first six months of 2015 and by £2.6 billion in the second half of 2015. Group’s ability to identify valid complaints.

This brings the total amount provided for at the end of 20152018 to £16.0£19.4 billion, of which £3.5£1.3 billion remains unutilised with approximately £3.0 billion relating to reactive complaints and associated administration costs. The unutilised

With regard to MBNA, as announced in December 2016, the Group’s exposure is capped at £240 million and is already provided for through an indemnity received from Bank of America. MBNA increased its PPI provision comprises elementsby £100 million in the year ended 31 December 2018 but the Group’s exposure continues to cover the Past Business Review, remediation activity and future reactive complaints. remain capped at £240 million under this indemnity.

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Provisions have not been taken where no obligation (as defined in IAS 37 “Provisions,(“Provisions, Contingent Liabilities and Contingent Assets”)) has been established, whether associated with a known or potential future litigation or regulatory matter. Accordingly, an adverse decision in any such matters could result in significant losses to the Group which have not been provided for. Such losses would have an adverse impact on the Group’s financial condition and operations.

 

In November 2014, the UK Supreme Court ruled inPlevin v Paragon Personal Finance Limited [2014] UKSC 61 (“Plevin”) that failure to disclose to a customer a “high” commission payment on a single premium PPI policy sold with a consumer credit agreement created an unfair relationship between the lender and the borrower under s140 of the Consumer Credit Act 1974. It did not define a tipping point above which commission was deemed “high”. The disclosure of commission was not a requirement of the FSA’s (now FCA’s) Insurance: Conduct of Business sourcebook rules for the sale of general insurance (including PPI). The industry, the FCA and the FOS are considering the broader impacts of this decision but there is no current definitive view. Permission to appeal the redress outcome in the Plevin case was refused by the Court of Appeal in July 2015 and by the President of the Family Division in November 2015.

 

On 2 OctoberIn November 2015 and August 2016, the FCA announced a decision to consultconsulted on the introduction of a two year industry deadline by which consumers would need to make their PPI complaints or lose their right to have them assessed. The deadline would fall two years from the date theassessed, and proposed rules come into force, which is not anticipated to be before spring 2016. The FCA’s announcement also includes a decision to consult on rules and guidance about how firms should handle PPI complaints fairly in light of the Plevin judgementjudgment discussed above. On 2 March 2017, the FCA confirmed an industry deadline of 29 August 2019. The proposedFCA’s rules to address Plevin commenced on 29 August 2017. The industry deadline would also applyapplies to the handling of these complaints. It is anticipated that if the proposed introduction of aupcoming industry deadline takes place, it could encourage eligible consumers to bring their claims early and result in a greater number of potential complaints presented to the Groupearlier than would have otherwise been expected during such period in the absence of aan industry deadline for having complaints assessed, which could result in increased remediation and administrative costs in relation to such claims.assessed. The consultation was published on 26 November 2015 and was open until 26 February 2016. Thereafter the FCA will consider the responses received before making final rules. The deadline proposed by the FCA and the outcome of its consultationFCA’s rules, issued on the impact2 of the Plevin case on the handling of PPI complaints and remediationMarch 2017, could have a material adverse effect on the Group’s reputation, business, financial condition, results of operations and prospects.

 

BUSINESS AND ECONOMIC RISKS

 

The Group’s businesses are subject to inherent and indirect risks arising from general macro-economicmacroeconomic conditions in the UK, the U.S., the Eurozone, Asia and globally, and theany resulting instability of the financial markets.markets or banking systems.

The Group’s businesses are subject to inherent and indirect risks arising from general and sector-specific economic conditions in the markets in which it operates, particularly the UK, where the Group’s earnings are predominantly generated and the Group’s operations are increasingly concentrated following the strategic reduction of its international presence. The Group may have credit exposure in countries outside the UK even if it does not have direct exposure or a presence in such countries. Although economic indicators in the UK have performed steadily in recent quarters, anyAny significant macro-economicmacroeconomic deterioration in the UK and/or other economies in which the Group operates or has legacy business, could have a material adverse effect on the results of operations, financial condition or prospects of the Group, as could continued or increasing political uncertainty within the UK whether caused by the EU referendum, continuing EU membership, or otherwise. Additionally, theand other countries. The profitability of the Group’s businesses could be affected by market factors such as unemployment, which has fallen to pre-crisis levels, however this trend could reverse. Lackthe deterioration of continued growth, or reducedUK economic growth insignificantly below long-term average levels, rising unemployment, reduced corporate profitability, reduced personal income levels (in real terms), inflationary pressures, including those arising from the sterling’s depreciation, reduced UK Government and/or consumer expenditure, changes in interest rates (and the timing, quantum and pace of those changes as well as the possibility of further reductions in interest rates, (includingincluding zero or negative interest rates))rates or of unexpected increases in interest rates which may have a detrimental effect on the Group’s customers and their ability to service interest), reducedincreased corporate, profitability, reducedSME or personal income levels, fluctuations in commodity prices, changes in foreign exchange rates, reduced UK Government and/or consumer expenditure, slowdown in global economic growth (which includes existing concerns over growth and the macroeconomic environment in China and emerging markets) and the general macroeconomic environment, increased personal or corporate and SME insolvency rates, increased tenant defaults or increased interest rates may reduce borrowers’ reduced ability to repay loans and mayincreased tenant defaults which could cause prices of residential or commercial real estate or other asset prices to fall, further, thereby reducing the collateral value on many of the Group’s assets.assets, fluctuations in commodity prices, changes in foreign exchange rates; or a marked deterioration in global economic growth reflecting the high levels of debt that have built up in some emerging economies, most notably China. These, in turn, could cause increased impairments and/or fair value adjustments.

 

In addition to the possibility of macro-economicmacroeconomic deterioration, particularly in the Eurozone, any increase ofin financial market instability including any increase in credit spreads, increase or reduction in interest rates, including negative interest rates, and general illiquidity within the markets that the Group uses for hedging or bond issuances may represent further risk to the Group’s business. The outlook for global growth remains uncertain due to issues such as geopolitical tensions (i.e.(including sanctions, tariffs and increased threats of trade disputes, continued instability in the Syrian crisis, fallout from Ukraine/Russia, Middle Eastern instability, anyEast and in the Korean Peninsula), the impact fromof economic policies of foreign governments, continued divergence in economic performance between countries within the U.S. presidential election),Eurozone, and the slow-down of economic growth rates in Asia, China,both mature and in emerging markets generally.generally and China in particular. The Group has significant exposures, particularly by way of loans, in a number of overseas jurisdictions notably Europe, the U.S and beyond, and is therefore subject to various risks relating to the stability of these financial markets. The global financial system has suffered considerable turbulence and uncertainty in recent years and, despite recent growth in the UKEurozone and U.S.,other advanced economies, the outlook for the global economy over the near to medium term remains challenging.uncertain. See also “Business and Economic Risks — Political, legal, regulatory, constitutional and economic uncertainty arising from the outcome of the referendum on the UK’s membership of the European Union could adversely impact the Group’s business, results of operations, financial condition and prospects” below.

 

In the Eurozone, the pace of economic recovery, remains slowwhich has lagged behind that of other advanced countries following the global recession. Relatively weak growth and deflationary pressures, together with highrecession, has now passed its peak. High levels of private and public debt, outstandingcontinued weaknesses in the financial sector and reform fatigue also remain a concern. The possibilityconcern and the timing and pace of prolonged low growththe European Central Bank’s withdrawal of monetary stimulus, the unwinding of existing monetary stimulus from the European Central Bank’s balance sheet and the timing and pace of any increase in interest rates could cause market volatility. In addition, increased political uncertainty in the Eurozone, and fragmentation risk in the EU and UK, could stallcreate financial instability and have a negative impact on the Eurozone and global economies. Any of these risks could weaken the UK’s own economic recovery,prospects, given the extensive economic and financial linkages

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between the UK and the Eurozone.

The UK’suncertainty around the economic policies of foreign governments could create additional uncertainty for the global economic outlook. For example, in the U.S., whilst it is possible that the current administration’s economic policies might have an adverse effect on U.S. and global growth as well as global trade prospects, it is also possible that expansionary policies could boost U.S. and current account balances withinternational growth temporarily at a time of limited spare capacity resulting in higher U.S. inflation and interest rates which could in turn significantly impact global investor risk appetite and pricing expectations, sparking elevated financial market volatility and a tightening of financial conditions.

Concerns remain around the Eurozone would be likely to deteriorate further, negatively affecting UK growthimpact of increased tariffs on trade between the U.S. and other nations including China, Canada and the possibilityEU. The potential for escalation of trade disputes and any retaliatory actions taken may adversely impact the UK leaving the EU could have a further negative impact. The latest Greek bailout agreement has reduced the risk of Greece’s exit from the Eurozone in the near term but has not solved longer term concerns around debt level sustainability.global economic outlook.

 

In addition, developing macro-economicmacroeconomic uncertainty in emerging markets, in particular the high and growing level of debt in China and throughout Asia,the risk of a sharp slowdown in particularChinese economic growth, which may be exacerbated by attempts to de-risk its highly leveraged economy, or a devaluation of the currency exchange rate intervention and market volatility seen in China, and other emerging marketsRenminbi could pose threats to global economic recovery. Financial markets may experience renewed periods of volatility, especially given the recent instability in oil and other commodity prices impacting corporates and emerging markets dependent on the oil and gas sector and potentially triggering deflation or stagflation, with a return of a risk of contagion, which may place new strains on funding markets. Further, the slowdown in emerging markets could impact corporate debt levels more widely, and externalExternal debt levels are higher now in emerging markets than before the global financial crisis, which could lead to higher levels of defaults and non-performing loans, in particular in an environment of rising interest rates. Financial markets may experience renewed periods of volatility, especially given the recent volatility in oil and other commodity prices impacting corporates and emerging

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markets dependent on the oil and gas sector, creating the potential for a return of contagion between countries and banking systems which may place new strains on funding markets.

 

The Group has credit exposure to SMEs and corporates, financial institutions, sovereigns and securities which may have material direct and indirect exposures in the Eurozone countries, the U.S. and other international countries. With the exception of the Group’s retail lending exposures in the Republic of Ireland, its direct credit exposure to the peripheral Eurozone countries through sovereign and private sector exposure is relatively small and has been managed steadily downward since 2008.

 

Nonetheless, anyAny default on the sovereign debt of these countriesa Eurozone country and the resulting impact on other Eurozone countries, including the potential that some countries could leave the Eurozone, could have a material adverse effect on the Group’s business. The exit of aany member state from the European Monetary Union (the “EMU”“EMU”) could result in deterioration in the economic and financial environment in the UK and the Eurozone that would materially affect the capital and the funding position of participants in the banking industry, including the Group. This could also give rise to operational disruptions to the Group’s business.

 

Examples of indirect risks to the Group associated with the Eurozone which have been identified are:are adverse developments relating to: European banking groups with lending and other exposures to certain Eurozone countries;countries, corporate customers with operations or significant trade in certain European jurisdictions;jurisdictions, major travel operators and airlines known to operate in certain Eurozone countries;countries, and international banks with custodian operations based in certain European locations. Adverse developments relating to these sectors, or banking groups could increase the risk of defaults and negatively impact the Group’s business, results of operations or financial condition, by increasing the risk of defaults.condition.

 

The risk of the UK leaving the EU has risen with the Government’s commitment to holding a referendum by the end of 2017 on continuing EU membership (expected to be held on 23 June 2016). The effects on the UK, and European and global economyeconomies of the exit of one or more European Union Member StatesEU member states from the EMU, or the EU, or the redenomination of financial instruments from the Euro to a different currency, are impossibleextremely uncertain and very difficult to predict and protect fully against in view ofof: (i) the potential for economic and financial instability in the Eurozone and potentiallypossibly in the UK,UK; (ii) the severitylasting impact on governments’ financial positions of the recent global financial crisis,crisis; (iii) difficulties in predicting whether the current signs of recovery will be sustained and at what rate, (iv) the uncertain legal position,position; and (v)(iv) the fact that many of the risks related to the business are totally, or in part, outside the control of the Group. However, if any such events were to occur, they may result inin: (a) significant market dislocation,dislocation; (b) heightened counterparty risk,risk; (c) an adverse effect on the management of market risk and, in particular, asset and liability management due, in part, to redenomination of financial assets and liabilities,liabilities; (d) an indirect risk of counterparty failure; or (e) further political uncertainty in the UK, any of which could have a material adverse effect on the results of operations, financial condition or prospects of the Group, (e) an indirect risk of counterparty failure, or (f) further political uncertainty in the UK. Group.

Any adverse changes affecting the economies of the countries in which the Group has significant direct and indirect credit exposures, including those discussed above and any further deterioration in global macro-economicmacroeconomic conditions, could have a material adverse effect on the Group’s results of operations, financial condition or prospects.

 

Political, legal, regulatory, constitutional and economic uncertainty arising from the outcome of the referendum on the UK’s membership of the European Union could adversely impact the Group’s business, results of operations, financial condition and prospects.

On 23 June 2016, the UK held a referendum on the UK’s continued membership of the EU. A majority of voters voted for the UK to leave the EU. The announcement of the referendum result caused significant volatility in the UK stock market and exchange rate fluctuations that resulted in a significant weakening of sterling against the U.S. dollar, the Euro and other major currencies. The share prices of major UK banks and bank holding companies, including the Company, suffered significant declines in market prices immediately following the result of the referendum and major credit rating agencies downgraded the UK’s sovereign credit rating.

Under Article 50 of the Treaty on European Union (“Article 50”) once the exit process is triggered by the withdrawing member state, a two-year period of negotiation begins to determine the terms of the withdrawing member’s exit from the EU with reference to the planned post-exit relationship, after which period its EU membership ceases unless the European Council, together with the withdrawing member, unanimously decides to extend this period.

Following the UK Government’s decision to invoke Article 50 on 29 March 2017, the UK is due to exit the EU at 11 p.m. (London time) on 29 March 2019, although this deadline could be extended or a transitional arrangement put in place, subject to agreement by all EU member states. Negotiations relating to the terms of the UK’s relationship with the EU are likely to extend beyond the two-year period set forth therein which could create additional volatility in the markets and have an adverse impact on the Group’s profitability. The timing of, and process for, such negotiations and the subsequent terms of the UK’s future economic, trading and legal relationships with the EU are uncertain, and will be impacted by the stance the current UK government and the other EU Member States adopt. In addition, an unfavourable outcome of negotiations relating to the UK’s exit from the EU or its future relationship with the EU is likely to create further volatility in the markets which could in turn adversely impact the Group’s business, results of operations, financial condition and prospects.

The UK general election held on 8 June 2017 resulted in a minority government. The UK political environment remains fragile, heightened by the EU exit negotiations.

The effects on the UK, European and global economies of the uncertainties arising from the results of the referendum and the process of the UK’s exit from the EU are difficult to predict but may include economic and financial instability in the UK, Europe and the global economy and the other types of risks described in “The Group’s businesses are subject to inherent and indirect risks arising from general macroeconomic conditions in the UK, the U.S., the Eurozone, Asia and globally, and any resulting instability of financial markets or banking systems” and “Credit Related Risks – The Group’s businesses are subject to inherent risks concerning borrower and counterparty credit quality which have affected and may adversely impact the recoverability and value of assets on the Group’s balance sheet” above.

Furthermore, any uncertainty in the UK arising from the risk of the UK leaving the European UnionEU could be exacerbated shouldby the re-emergence of the possibility of a further Scottish independence referendum be resurrected. There is no guarantee thator any proposed differential arrangements for Northern Ireland when compared to the EU referendum debate will notrest of the UK. This could cause a follow-up Scottish referendum to be considered, causing further uncertainty and risks to the Group.

The longer term effects of the UK’s expected exit from the EU are difficult to predict but could include further financial instability and slower economic growth, in the UK in particular, but also in Europe and the global economy. In the event of any substantial weakening in economic growth, the possible policy of decreases in interest rates by the Bank of England or sustained low or negative interest rates would put further pressure on the Group’s interest margins and adversely affect the Group’s profitability and prospects. Furthermore, such market conditions may also result in an increase in the Group’s pension deficit.

A challenging macroeconomic environment, reduced profitability and greater market uncertainty could negatively impact the Group’s performance and potentially lead to credit ratings downgrades which could adversely impact the Group’s ability to access funding and the cost of such funding. The Group’s ability to access capital markets on acceptable terms and hence its ability to raise the amount of capital and funding required to meet its regulatory requirements and targets, including those relating to loss-absorbing instruments to be issued by the Group, could be affected.

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The Group is subject to substantial EU-derived laws, regulation and oversight. There continues to be significant uncertainty as to the respective legal and regulatory environments in which the Group and its subsidiaries will operate when the UK is no longer a member of the EU. In particular, the Group and its counterparties may no longer be able to rely on the European passporting framework for financial services, which could result in the loss of customers and/or the requirement for the Group to apply for authorisation in multiple EU jurisdictions if it is to continue its business there, the costs, timing and viability of which are uncertain. This uncertainty, and any actions taken as a result of this uncertainty (such as corporate clients of the Group preferring to transact with European competitors or to relocate from the UK to the EU to avoid a loss of passporting rights), as well as new or amended legislation and regulation, may have a significant impact on the Group’s operations, profitability and business model. For further information on the Group’s regulatory and legal risks see “Regulatory and Legal Risks”.

 

Any tightening of monetary policy in jurisdictions in which the Group operates could affect the financial condition of its customers, clients and counterparties, including governments and other financial institutions, which could in turn adversely affect the Group’s results of operations.

Quantitative easing measures implemented by major central banks, adopted alongside record low interest rates to support recovery from the global financial crisis, have arguably helped loosen financial conditions and reduce borrowing costs. Accommodative policiesThese measures may have led to the emergence ofsupported liquidity and valuations for asset and liquidity bubblesclasses that are vulnerable to deflating rapidlyrapid price corrections as financial conditions tighten, potentially causing losses to investors and increasing the risk of default on the Group’s exposure to these sectors.

 

Whilst the U.SThe U.S. Federal Reserve increasedhas been gradually increasing its policy interest rates insince December 2015, they may seek to keep rates on hold, or even reverse the increase. It remains unclear whether other major central banks, including the2015. The Bank of England will begin to raise their policyraised UK interest rates from 0.25 per cent to 0.5 per cent in the near term. Given the current disinflationary global environmentNovember 2017 and uncertain outlookthen to 0.75 per cent in August 2018 and has signalled that scope remains for emerging market growth, it is possible that policyUK interest rate increases may not occur and somerates to rise further. Some other major central banks, such as the ECB, may seekBank of Canada, are also on a tightening cycle, but the withdrawal of accommodative policies in the Eurozone and in Japan is expected to loosen policy further.be somewhat slower.

 

Although uncertainty remains about the timing of any increases by central banks, it is possible that any increase in interest rates may lead to increasing levels of defaults by the Group’s customers. Monetary policy has been highly accommodative in recent years, includingfurther supported by the Bank of England and HM Treasury “Funding for Lending” scheme, and the “Help to Buy” programmescheme, the “Term Funding Scheme” and the purchase of corporate bonds in the UK, which have helped to support demand at a time of very pronounced fiscal tightening and balance sheet repair. Such a long period of stimulus has increased uncertainty over the impact of its reduction, including the possibility of a withdrawal of such programmes which could lead to a risk of higher borrowing costs in wholesale markets, generally weaker than expected growth, or even contracting gross domestic product (“GDP”), reduced business and consumer confidence, higher levels of unemployment or underemployment, adverse changes to levels of inflation potentially higher interest rates and falling property prices in the markets in which the Group operates, and consequently to an increase in delinquency rates and default rates among its customers. Similar risks result from the exceptionally low level of inflation in developed economies, which in Europe particularly could deteriorate into sustained deflation if policy measures prove ineffective.ineffective and economic growth weakens. Reduced monetary stimulus and the actions and commercial soundness of other financial institutions have the potential to impact market liquidity. The adverse impact on the credit quality of the Group’s customers and counterparties, coupled with a decline in collateral values, could lead to a reduction in recoverability and value of the Group’s assets and higher levels of impairment allowances, which could have an adverse effect on the Group’s operations, financial condition or prospects. The Group has credit exposure to SMEs and corporate, financial institutions, sovereigns and securities which may have material direct and indirect exposures in the Eurozone countries. Any default on the sovereign debt of these countries and the resulting impact on other Eurozone countries, including the potential that some countries could leave the Eurozone, could have a material adverse effect on the Group’s business.

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Accommodative credit conditions in some areas of the world since the global financial crisis have led to a further build-up of debt, with private sector corporate debt in emerging markets growing particularly fast.quickly. Emerging market currency depreciation and the rise inrising U.S. interest rates maycould result in increasing difficulties in servicing this higherincreased debt, especially debt that is denominated in U.S. dollars, possibly leading to debt defaults, which may negatively affect economic growth in emerging markets or globally.

 

The Group’s businesses are inherently subject to the risk of market fluctuations, which could have a material adverse effect on the results of operations, financial condition or prospects of the Group.

The Group’s businesses are inherently subject to risks in financial markets and in the wider economy, including changes in, and increased volatility of, interest rates, inflation rates, credit spreads, foreign exchange rates, commodity, equity, bond and property prices and the risk that its customers act in a manner which is inconsistent with the Group’s business, pricing and hedging assumptions. Movements in these markets will continue to have a significant impact on the Group in a number of key areas.

 

For example, adverse market movements have had and would have an adverse effect, which could be material, upon the financial condition of the defined benefit pension schemes of the Group. The schemes’ main exposures are to real rate risk and credit spread risk. These risks arise from two main sources: the “AA” corporate bond liability discount rate and asset holdings.

 

Banking and trading activities that are undertaken by the Group are also subject to market movements, including interest rate risk, foreign exchange risk, inflation risk and credit spread risk. For example, changes in interest rate levels, interbank margins over official rates, yield curves and spreads affect the interest rate margin realised between lending and borrowing costs. The potential for future volatility and margin changes remains. Competitive pressures on fixed rates or product terms in existing loans and deposits may restrict the Group in its ability to change interest rates applying to customers in response to changes in official and wholesale market rates. The Group has a structural hedge in place to stabilise the net interest margin. There is, however, a risk that in a low rate environment the Group will continue to face margin compression in the prolonged low interest rate environment and the yield on its structural hedge will reduce as the amortising hedge ismaturities are reinvested at lowerprevailing market rates.

 

The insurance business of the Group is exposed indirectly to equity and credit markets through the value of future management charges on policyholder funds. Credit spread risk within insurance primarily arises from bonds and loans used to back annuities. The performance of the investment markets will thus have a direct impact upon the profit from investment contracts and on the Insuranceinsurance value in force (VIF)(“VIF”) and the Group’s operating results of operations, financial condition or prospects.

 

Changes in foreign exchange rates, including with respect to the U.S. dollar and the Euro, affect the Group’s financial position and/or forecasted earnings. Foreign exchange risk is actively managed by the Group within a low risk appetite, minimising the Group’s exposure to exchange rate fluctuations. However, changes in foreign exchange rates could still result in a significant reduction in the profit of the Group.

 

Market conditions have resulted, and are expected to result in the future, in material changes to the estimated fair values of financial assets of the Group. Negative fair value adjustments have had, and may continue to have in the future, an adverse effect on the Group’s results of operations, financial condition or prospects.

The Group has exposures to securities, derivatives and other investments, including asset-backed securities, structured investments and private equity investments that are recorded by the Group at fair value. These have been and may be subject to further negative fair value adjustments, particularly in view of the volatile global markets and challenging economic environment. Although credit value adjustments, debit value adjustments and funding value

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adjustments are actively managed within the Group, in stressed market conditions adverse movements in these could result in a material charge to the Group’s profit and loss account.

 

In addition, in volatile markets, hedging and other risk management strategies (including collateralisation strategies and the purchase of CDS)credit default swaps) may not be as effective as they are in normal market conditions, due in part to the decreasing credit quality of hedge counterparties.counterparties, and general illiquidity in the markets within which transactions are executed. Asset valuations in future periods, reflecting prevailing market conditions, may result in further negative changes in the fair values of the Group’s financial assets and these may also translate into increased impairment charges.

 

In addition, the value ultimately realised by the Group for its securities and other investments may be lower than their current fair value. Any of these factors could require the Group to record further negative fair value adjustments, which may have a material adverse effect on its operating results, financial condition or prospects. Material losses from the fair value of financial assets will also have an adverse impact on the Group’s capital ratios. The Group has, in prior years, made asset redesignations as permitted by amendments to IAS 39 (Financial Instruments: “Recognition and Measurement”).

The effect of such redesignations has been, and would be, that any effect on the income statement of movements in the fair value of such redesignated assets that have occurred since 1 July 2008, in the case of assets redesignated prior to 1 November 2008, or which may occur in the future, may not be recognised until such time as the assets become impaired or are disposed of. In addition, in circumstances where fair values are determined using financial valuation models, the Group’s valuation methodologies may require it to make assumptions, judgements and estimates in order to establish fair value. These valuation models are complex and the assumptions used are difficult to make and are inherently uncertain,uncertain. This is particularly relevant in light of the uncertainty as to the strength of anythe global economic recovery and continuing downside risks and may be amplified during periods of market volatility and illiquidity, and anyilliquidity. Any consequential impairments, write-downs or write-downsadjustments could have a material adverse effect on the Group’s operating results of operations, capital ratios, financial condition or prospects.

The value ultimately realised by the Group for its securities and other investments may be lower than their current fair value. Any of these factors could require the Group to record further negative fair value adjustments, which may have a material adverse effect on its results of operations, financial condition or prospects. Material losses from the fair value of financial assets will also have an adverse impact on the Group’s capital ratios.

 

The Group’s businesses are conducted in competitive environments, with increased competition scrutiny, and the Group’s financial performance depends upon management’s ability to respond effectively to competitive pressures.

The markets for UK financial services, and the other markets within which the Group operates, are competitive, and management expects such competition to continue or intensify in responseintensify. This expectation is due to competitor behaviour, new entrants to the market (including a number of new retail banks as well as non-traditional financial services providers), consumer demand, technological changes such as the growth of digital banking, and the impact of regulatory actions and other factors. The Group’s financial performance and its ability to maintain existing or capture additional market share depends significantly upon the competitive environment and management’s response thereto.

 

Notwithstanding this increase in competition described above,The competitive environment can be, and is, influenced by intervention by the UK Government competition authorities and/or European regulatory bodies and/or governments of other countries in which the Group operates, including in response to any perceived lack of competition within these markets by such regulatory authorities,markets. This may significantly impact the competitive position of the Group relative to its international competitors, which may be subject to different forms of government intervention, thus potentially putting the Group at a competitive disadvantage.intervention.

 

The Competition and Markets Authority (the “CMA”“CMA”) launched a full market investigation into competition in the SME banking and personal current account (PCA)(“PCA”) markets in November 2014. The CMA announced its provisional findings on 22 October 2015, stating that there is a combination of

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features of the markets for PCAs, business current accounts (BCAs)2014 and SME lending that give rise to adverse effects on competition, relating to low levels of customer engagement, barriers to accessing and assessing information, barriers to switching and incumbency advantages, and linkages between PCAs, BCAs and SME lending products. At that time, the CMA announced that it will begin detailed consultations with all interested parties on the findings and possible remedies, with an aim to publishpublished its final report on 9 August 2016, followed by the Retail Banking Market Investigation Order 2017 on 2 February 2017. The key final remedies include: the introduction of “Open Banking”, the publication of service quality information and customer information prompts. Recommendations were also made regarding improvements to current account switching, monthly maximum charges for PCA overdraft users, overdraft notifications and additional measures to assist small business in April 2016comparing the different products available. Compliance costs associated with the implementation of these remedies may be substantial and the implementation of these remedies could have a statutory deadlinematerial adverse effect on the Group’s competitive position.

The FCA launched its Strategic Review of 5Retail Banking Business Models in May 2016. However,2017 to evaluate matters relating to competition and conduct. This review was intended to ensure that the CMA has indicated they wish to extend these deadlines. This process, combined with recentFCA’s regulatory approach remains fit for purpose. The FCA’s Final Report into retail banking business models was published in December 2018 and proposed some further work in this area, including ongoing monitoring by the FCA. The outcomes of the review may have a significant impact on the Group’s current business model.

Recent political debate on the reform of the UK banking markets, other current or potential competition reviews, the new payment systems regulator and the new FCA statutory objective to promote competition, along with concurrent competition powers, from April 2015, may lead to proposals or initiatives to reduce regulators’ competition concerns, and for greater UK governmentGovernment and regulatory scrutiny in the future that may impact the Group.Group further. Additionally, the Group may be affected by changes in regulatory oversight following the pension review recommended by the Department for Work and Pensions. For more information on the Group’s regulatory environment, see “— Regulation—Other Bodies Impacting the Regulatory Regime—The Bank of England and HM TreasuryRegime”.

 

The internet and mobile technologies are changing customer behaviour and the competitive environment. There has been a steep rise in customer use of mobile banking over the last threefour years. The Group faces competition from established providers of financial services as well as the threat of competition from banking business developed by non-financial companies, including technology companies with strong brand recognition.

 

As a result of any restructuring or evolution in the market, there may emerge one or more new viable competitors in the UK banking market or a material strengthening of one or more of the Group’s existing competitors in that market. Any of these factors or a combination thereof could result in a significant reduction in the profit of the Group.

 

The Group is exposed to risks related to the uncertainty surrounding the integrity and continued existence of reference rates.

Reference rates and indices, including interest rate benchmarks, such as the London Interbank Offered Rate (“LIBOR”) and the Euro Interbank Offered Rate (“EURIBOR”), which are used to determine the amounts payable under financial instruments or the value of such financial instruments (“Benchmarks”), have, in recent years, been the subject of political and regulatory scrutiny as to how they are created and operated. This has resulted in regulatory reform and changes to existing Benchmarks, with further changes anticipated. These reforms and changes may cause a Benchmark to perform differently than it has done in the past or to be discontinued.

At this time, it is not possible to predict the effect of any such reforms and changes, any establishment of alternative reference rates or any other reforms to these reference rates that may be enacted, including the potential or actual discontinuance of LIBOR publication and any transition away from LIBOR.

Uncertainty as to the nature of such potential changes, alternative reference rates or other reforms may adversely affect a broad array of financial products, including any LIBOR-based securities, loans and derivatives that are included in the Group’s financial assets and liabilities, that use these reference rates and may impact the availability and cost of hedging instruments and borrowings. If any of these reference rates are no longer available, the Group may incur additional expenses in effecting the transition from such reference rates, and may be subject to disputes, which could have an adverse effect on the Group’s results of operations. In addition, it can have important operational impacts through the Group’s systems and infrastructure as all systems will need to account for the changes in the reference rates. Any of these factors may have a material adverse effect on the Group’s results of operations, financial condition or prospects.

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OPERATIONAL RISKS

 

The Group could fail to attract or retain senior management or other key employees.

The Group’s success depends on its ability to attract, retain and develop high calibre talent. AchievementThe SMCR regime may impact the achievement of this aim may be impacted byas the pending introduction of the SMCR, which will come into force on 7 March 2016. The SMCR will includeregime includes a criminal offence of reckless misconduct, a statutory “duty of responsibility” to take reasonable steps to prevent regulatory breaches occurring or continuing in the area of the firm for which they have responsibility and increasing use of senior management attestations. In addition, the proposed limits on variable pay and “clawback” requirements which were introduced pursuant to CRD IV in the UK may put the Group at a competitive disadvantage as compared to companies who are not subject to such restrictions. In addition, macro-economicrestrictions, with macroeconomic conditions and negative media attention on the financial services industry maypossibly adversely impactimpacting employee retention, colleague sentiment and engagement.

In addition, the uncertainty resulting from the UK’s expected exit from the EU, following the referendum decision, on foreign nationals’ long-term residency permissions in the UK may make it challenging for the Group to retain and recruit colleagues with relevant skills and experience.

 

Failure to attract and retain senior management and key employees could have a material adverse effect on the Group’s results of operations, financial condition or prospects.

 

Operational risks such as weaknesses or failures in the Group’s processes, systems and security and risks due to reliance on third party services and products could materially adversely affect the Group’s operations, results of operations, financial condition or prospects, and could result in the reputational damage of the Group.

Operational risks, through inadequate or failed processes, systems (including financial reporting and risk monitoring processes) or security, or from people-related or external events, including the risk of fraud and other criminal acts carried out against the Group, are present in the Group’s businesses. The Group’s businesses are dependent on processing and reporting accurately and efficiently a high volume of complex transactions across numerous and diverse products and services, in different currencies and subject to a number of different legal and regulatory regimes. Any weakness or errors in these processes, systems or security could have an adverse effect on the Group’s results, reporting of such results, and on the ability to deliver appropriate customer outcomes during the affected period which may lead to an increase in complaints and damage to the reputation of the Group.

 

Specifically, failure to develop, deliver or maintain effective IT solutions in line with the Group’s operating environment could have a material adverse impact on customer service.service and business operations. Any prolonged loss of service availability could damage the Group’s ability to service its customers, could result in compensation costs and could cause long-term damage to the Group’s business and brand. Furthermore, failure to protect the Group’s operations from increasingly sophisticated cyber-attacks could result in the loss and/or corruption of customer data or other sensitive information. This could be exacerbated by the increase in data protection requirements as a result of GDPR. The resilience of the Group’s IT infrastructure is of paramountcritical importance to the Group; accordingly, significant investment has been, and will continue to be, made in IT infrastructure and supporting capabilities to ensure its resilience and subsequently the delivery of services to customers. The Group continues to invest in IT, cyber and information security control environments, including activity on user access management and records managementnetwork security controls to address evolving threats. The Group maintains contingency plans for a range of Group specific and industry wide IT failure and breach of securitycyber-attack scenarios. The Board has defined a “Cyber Risk Appetite” and is supporting investment to help mitigate this risk.

 

The Group adopts a risk based approach to mitigate the internal and external fraud risks it faces, reflecting the current and emerging external fraud risks within the market. This approach drives an annuala continual programme of prioritised enhancements to the Group’s technology, process and people related controls, with an emphasis on preventative controls supported by real time detective controls wherever feasible. GroupwideGroup-wide policies and operational control frameworks are maintained and designed to provide customer confidence, protect the Group’s commercial interests and reputation, comply with legal requirements and meet regulatory expectations. The Group also plays an active role with other financial institutions, industry bodies and enforcement agencies in identifying and combatting fraud. The Group’s fraud awareness programme remains a key component of its fraud control environment.

Although the Group devotes significant resources to maintain and regularly update itsthe processes and systems that are designed to protect the security of the Group’s systems, software, networks and other technology assets, there is no assurance that all of the Group’s security measures will provide absolute security. Any damage to the Group’s reputation (including to customer confidence) arising from actual or perceived inadequacies, weaknesses or failures in Group systems, processes or security could have a material adverse effect on the Group’s results of operations, financial condition or prospects.

 

Third parties upon which the Group relies for important products and services could also be sources of operational risk, specifically with regard to security breaches affecting such parties. Many of the operational risks described above also apply when the Group relies on outside suppliers or vendors to provide key components of its business infrastructure. The Group may be required to take steps to protect the integrity of its operational systems, thereby increasing its operational costs. Additionally, any problems caused by these third parties, including as a result of their not providing the Group their services for any reason, their performing their services poorly, or employee misconduct, could adversely affect the Group’s ability to deliver products and services to customers and otherwise to conduct business. Replacing these third party vendors or moving critical services from one provider to another could also entail significant delays and expense.

 

Notwithstanding anything in this risk factor, this risk factor should not be taken as implying that either the Company or any relevant company within the Group will be unable to comply with its obligations as a company with securities admitted to the Official List or as a supervised firm regulated by the FCA andand/or the PRA.

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The Company’sGroup’s business is subject to risks related to cyber crime.cybercrime.

The Group holds personally identifiable information on its systems aligned to product and services delivered to customers. Protection is delivered in accordance with data protection legislation, including GDPR. The Group relies on the effectiveness of its Group Information and Cyber Security policyPolicy and associated procedures, infrastructure and capabilities to protect the confidentiality integrity and availabilityintegrity of information held on its computer systems, networksIT infrastructure and mobile devices and on the computer systems, networks and mobile devicesinfrastructure of third parties on whom the CompanyGroup relies. The Group also takes protective measures to protect itself fromagainst attacks designed to preventimpact the deliveryavailability of critical business processes to its customers. customers and the Group and Board Risk Committees oversee such measures.

In certain international locations, there are additional regulatory requirements that must be followed for business conducted in that jurisdiction. In the U.S., for example, the Company was required from February 2018 to formally attest that it complies with specific cyber security requirements put forth by the New York State Department of Financial Services in Part 500 of Title 23 of the Official Compilation of Codes, Rules and Regulations of the State of New York.

Despite preventative measures (including ensuring incident management capability to respond to such events, by way of regulatory notification, for example), the Group’s computer systems, software, networksIT infrastructure, and mobile devices, and thosethat of third parties on whom the Group relies, may be vulnerable to cyber-attacks, sabotage,malware, denial of services, unauthorised access computer viruses, worms or other malicious code, and other events that have a security impact. Such an event may impact the confidentiality or integrity of the Group’s or its

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clients’, employees’ or counterparties’ information or the availability of services to customers. As a result of such an event or a failure in the Group’s cyber security policies, the Group could experience material financial loss, loss of competitive position, regulatory actions, breach of client contracts, reputational harm or legal liability, which, in turn, could causehave a decline inmaterial adverse effect on the Group’s earnings.results of operations, financial condition or prospects. The Group may be required to spend additional resources to modify its protective measures or to investigate and remediate vulnerabilities or other exposures, and it may be subject to litigation and financial losses that are either not insured against fully or not fully covered through any insurance that it maintains. Any failure in the Group’s cyber security policies, procedures or capabilities, or cyber-related crime, could lead to the Group suffering reputational damage and a loss of clients and could have a material adverse effect on the Group’s results of operations, financial condition or prospects. The Group is committed to continued participation in industry-wide activity relating to cyber risk. This includes working with relevant regulatory and government departments to evaluate the approach the Group is taking to mitigate this risk.risk and sharing relevant information across the financial services sector.

 

Terrorist acts, other acts of war, geopolitical events, pandemics or other such events could have a material adverse effect on the Group’s results of operations, financial condition or prospects.

Terrorist acts, other acts of war or hostility, geopolitical events, pandemics or other such events and responses to those acts/events may create economic and political uncertainties, which could have a material adverse effect on UK and international macro-economicmacroeconomic conditions generally, and more specifically on the Group’s results of operations, financial condition or prospects in ways that cannot necessarily be predicted.

TSB servicing requirements may adversely impact the Group.

As part of the divestment of TSB, the Group provides certain services to TSB which may result in reputational and financial exposure for the Group. For example, TSB relies on the Group for the provision of its IT systems and supporting infrastructure. The risks associated with provision of services to TSB include managing conflict of interests, the confidentiality of data, and competition risks as a part of providing services to a competitor bank. In addition the Group has made financial commitments to support any planned move by TSB to an alternative provider of IT systems and infrastructure.

 

The Group must comply with anti-money laundering, counter terrorist financing, anti-bribery and sanctions regulations, and a failure to prevent or detect any illegal or improper activities fully or on a timely basis could negatively impact customers and expose itthe Group to liability.

The Group is required to comply with applicable anti-money laundering, anti-terrorism, sanctions, anti-bribery and other laws and regulations in the jurisdictions in which it operates. These laws and regulations require the Group, amongst other things, to adopt and enforce “know-your-customer” policies and procedures and to report suspicions of money laundering and terrorist financing, and in some countries specific transactions to the applicable regulatory authorities. These laws and regulations have become increasingly complex and detailed, require improved systems and sophisticated monitoring and compliance personnel, and have become the subject of enhanced government and regulatory supervision.

 

The Group has adopted policies and enhanced its procedures aimed at detecting and preventing the use of its banking network and services for money laundering, financing terrorism, tax evasion, human trafficking, modern day slavery and related activities, applying systems and controls on a risk-based approach throughout its businesses and operations.operations, including through its Financial Intelligence Unit and its interactions with external agencies and other financial institutions. These controls, however, may not completely eliminate instances where third parties seek to use the Group’s products and services to engage in illegal or improper activities. In addition, while the Group reviews its relevant counterparties’ internal policies and procedures with respect to such matters, the Group, to a large degree, relies upon its relevant counterparties to maintain and properly apply their own appropriate anti-money laundering procedures. Such measures, procedures and compliance may not be completely effective in preventing third parties from using the Group (and its relevant counterparties) as a conduit for money laundering and terrorist financing (including illegal cash operations) without the Group’s (and its relevant counterparties’) knowledge. If the Group is associated with, or even accused of being associated with, or becomes a party to, money laundering or terrorist financing, then the Group’s reputation could suffer and/orand it could become subject to fines, sanctions and/or legal enforcement (including being added to any “black lists” that would prohibit certain parties from engaging in transactions with the Group), any one of which could have a material adverse effect on the Group’s operating results of operations, financial condition and prospects.

 

ToFurthermore, failure to comply with trade and economic sanctions, both primary and secondary, administered by agencies in the jurisdictions in which the Group operates and to the extent that the Group fails to comply fully with other applicable compliance laws and regulations, the relevant government and regulatory agencies to which it reports have the power and authority to impose fines and other penalties on the Group, including the revocation of licences. In addition, the Group’s business and reputation could suffer if customers use its banking network for money laundering, financing terrorism, or other illegal or improper purposes.

 

The Group may fail to execute its ongoing strategic change initiatives, and the expected benefits of such initiatives may not be achieved at the time or to the extent expected, or at all.

In order to maintain and enhance the Group’s strategic position, it continues to invest in new initiatives and programmes. The Group has a numberacknowledges the challenges faced with delivering these initiatives and programmes alongside the extensive agenda of strategic initiatives which it pursues on an ongoing basis. For example,regulatory and legal changes whilst enhancing systems and controls. In the development of the Group’s strategy, the Group hasconsiders these demands against its capacity to ensure successful delivery for both customers and shareholders. The Group’s strategic plan provides flexibility through a programme for reducing costs, improving efficiency and financial performance, and enhancingbroad range of initiatives with priorities frequently reviewed to adapt to the overall customer experience by simplifying and reshaping the Group’s businesses. external environment, where necessary.

As the Group continues to deliver this strategy there is considerable focus on digitisation and ensuring the Group meets customer demands through digital and mobile platforms. This approach will support the Group in achieving its cost targets.

 

The successful completion of the programmethese programmes and the Group’s other strategic initiatives requires ongoing subjective and complex judgements, including forecasts of economic conditions in various parts of the world, and can be subject to significant execution risks. For example, the Group’s ability to execute its strategic initiatives successfully may be adversely impacted by a significant global macroeconomic downturn, legacy issues, limitations in the Group’s management or operational capacity and capability or significant and unexpected regulatory change in countries in which the Group operates.

 

Failure to execute the Group’s strategic initiatives successfully could have an adverse effect on the Group’s ability to achieve the stated targets and other expected benefits of these initiatives, and there is also a risk that the costs associated with implementing such initiatives may be higher than the financial benefits expected to be achieved, which could materially adversely impact the Group’s results of operations, financial condition or prospects.

The Group may be unable to fully capture the expected value from acquisitions, which could materially and adversely affect the Group’s results of operations, financial conditions or prospects.

The Group may from time to time undertake acquisitions as part of its growth strategy, which could subject the Group to a number of risks, such as: (i) the rationale and assumptions underlying the business plans supporting the valuation of a target business may prove inaccurate, in particular with respect to synergies and expected commercial demand; (ii) the Group may fail to successfully integrate any acquired business, including its technologies, products and personnel; (iii) the Group may fail to retain key employees, customers and suppliers of any acquired business; (iv) the Group may be required or wish to terminate pre-existing contractual relationships, which could prove costly and/or be executed at unfavourable terms and conditions; (v) the Group may fail to discover certain contingent or undisclosed liabilities in businesses that it acquires, or its due diligence to discover any such liabilities may be inadequate; and (vi) it may be necessary to obtain regulatory and other approvals in connection with certain acquisitions and there can be no assurance that such approvals will be obtained and even if granted, that there will be no burdensome conditions attached to such approvals, all of which could materially and adversely affect the Group’s results of operations, financial conditions or prospects.

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The Group could be exposed to industrial action and increased labour costs resulting from a lack of agreement with trade unions.

Within the Group, there are currently two recognised unions for the purposes of collective bargaining. Combined, these collective bargaining arrangements apply to around 95 per cent of the Group’s total workforce.

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Where the Group or its employees or their unions seek to change any of their contractual terms, a consultation and negotiation process is undertaken. Such a process could potentially lead to increased labour costs or, in the event that any such negotiations were to be unsuccessful and result in formal industrial action, the Group could experience a work stoppage that could materially adversely impact its business, financial condition and results of operations.

 

FINANCIAL SOUNDNESS RELATED RISKS

 

The Group’s businesses are subject to inherent risks concerning liquidity and funding, particularly if the availability of traditional sources of funding such as retail deposits or the access to wholesale funding markets becomes more limited.

Liquidity and funding continues to remain a key area of focus for the Group and the industry as a whole. Like all major banks, the Group is dependent on confidence in the short and long-term wholesale funding markets. Should the Group be unable to continue to source sustainable funding, its ability to fund its financial obligations could be impacted.

 

The Group’s profitability or solvency could be adversely affected if access to liquidity and funding is constrained or made more expensive for a prolonged period of time. Under extreme and unforeseen circumstances, such as the closure of financial markets and uncertainty as to the ability of a significant number of firms to ensure they can meet their liabilities as they fall due, the Group’s ability to meet its financial obligations as they fall due or to fulfil its commitments to lend could be impacted through limited access to liquidity (including government and central bank facilities). In such extreme circumstances, the Group may not be in a position to continue to operate without additional funding support, which it may be unable to access. These factors may have a material adverse effect on the Group’s solvency, including its ability to meet its regulatory minimum liquidity requirements. These risks can be exacerbated by operational factors such as an over-reliance on a particular source of funding or changes in credit ratings, as well as market-wide phenomena such as market dislocation, regulatory change or major disasters.

 

In addition, corporate and institutional counterparties may seek to reduce aggregate credit exposures to the Group (or to all banks) which could increase the Group’s cost of funding and limit its access to liquidity. The funding structure employed by the Group may also prove to be inefficient, thus giving rise to a level of funding cost where the cumulative costs are not sustainable over the longer term. The funding needs of the Group may increase and such increases may be material to the Group’s operating results of operations, financial condition or prospects. The Group relies on customer savings and transmission balances, as well as ongoing access to the global wholesale funding markets to meet its funding needs. The ability of the Group to gain access to wholesale and retail funding sources on satisfactory economic terms is subject to a number of factors outside its control, such as liquidity constraints, general market conditions, regulatory requirements, the encouraged or mandated repatriation of deposits by foreign wholesale or central bank depositors and the level of confidence in the UK banking system, any of which could have a material adverse effect on the Group’s profitability or, in the longer term and under extreme circumstances, its ability to meet its financial obligations as they fall due.

 

Medium-term growth in the Group’s lending activities will rely, in part, on the availability of retail deposit funding on appropriate terms, for which there is increasing competition. For more information, see “—Business and economic risks—Economic Risks — The Group’s businesses are conducted in competitive environments, with increased competition scrutiny, and the Group’s financial performance depends upon management’s ability to respond effectively to competitive pressures”. This reliance has increased recently given the Group’s reduction in wholesale funding. above. The ongoing availability of retail deposit funding on appropriate terms is dependent on a variety of factors outside the Group’s control, such as general macro-economicmacroeconomic conditions and market volatility, the confidence of retail depositors in the economy, the financial services industry and the Group, as well as the availability and extent of deposit guarantees. Increases in the cost of retail deposit funding will impact on the Group’s margins and affect profit, and a lack of availability of retail deposit funding could have a material adverse effect on the Group’s future growth.

 

Any loss in consumer confidence in the Group could significantly increase the amount of retail deposit withdrawals in a short period of time. Should the Group experience an unusually high and unforeseen level of withdrawals, in such extreme circumstances the Group may not be in a position to continue to operate without additional funding support, which it may be unable to access, which could have a material adverse effect on the Group’s solvency.

 

In recent years, the Group has also made use of central bank funding schemes such as the Bank of England’s Term Funding Scheme and Funding for Lending Scheme. Following the closures of these Schemes, the Group will have to replace matured central bank scheme funding, which could cause an increased dependence on term funding issuances. If the wholesale funding markets were to suffer stress or central bank provision of liquidity to the financial markets is abruptly curtailed, or the Group’s credit ratings are downgraded, it is likely that wholesale funding will prove more difficult to obtain. Such increased refinancing risk, in isolation or in concert with the related liquidity risks noted above, could have a material adverse effect on the Group’s profitability and, in the longer term under extreme and unforeseen circumstances, its ability to meet its financial obligations as they fall due.

 

The Group’s borrowing costs and access to the capital markets isare dependent on a number of factors, including any reduction in the Group’s longer-term credit rating, and increased costs or reduction in access could materially adversely affect the Group’s results of operations, financial condition or prospects.

A reduction in the credit rating of the Group or deterioration in the capital markets’ perception of the Group’s financial resilience could significantly increase its borrowing costs and limit its issuance capacity in the capital markets. As an indicator, during 2015,2018, the spread between an index of “A” rated long-term senior unsecured bank debt and an index of similar “BBB” rated bank debt, both of which are publicly available, has averaged 5642 basis points. The applicability to and implications for the Group’s funding cost would depend on the type of issuance and prevailing market conditions. The impact on the Group’s funding cost is subject to a number of assumptions and uncertainties and is therefore impossible to quantify precisely.

For the Company’s and its subsidiaries current ratings, see the section titled “Operating and Financial Review—Funding and Liquidity Risk—Funding and Liquidity Management in 2015”.

 

Rating agencies regularly evaluate the Group and the Company, and their ratings of longer-term debt are based on a number of factors, including the Group’s financial strength as well as factors not entirely within the Group’s control, including conditions affecting the financial services industry generally. In light of the difficulties in the financial services industry and the financial markets, there can be no assurance that the Group or the Company will maintain itstheir current ratings. Downgrades of the Group’s longer-term credit rating could lead to additional collateral posting and cash outflow. The effects of a potential downgrade from all three rating agencies are included in the Group liquidity stress testing. As at 31 December 2015, a hypothetical instantaneous two notch downgrade of the Group’s current long-term credit rating and accompanying short-term downgrade implemented simultaneously by all major rating agencies could result in an outflow of £1.5 billion of cash over a period of up to one year, £2.1 billion of collateral posting related to customer financial contracts and £5.6 billion of collateral posting associated with secured funding, calculated on an unaudited basis. Any reduction in the Group’s longer-term credit rating may result in increased borrowing costs, a reduction in access to capital markets or a reduction in liquidity which could materially adversely affect the Group’s results of operations, financial condition or prospects.

 

The regulatory environment in which the Group operates continues to change. Whilst uncertain at present, the Group’s borrowing costs and access to capital markets could also be affected by variousthe outcome of certain regulatory developments such as the Banking Reform Act, amendments to CRD IV and the coming into force of the BRRD.developments. For further detail on the potential impact of these regulatory developments on the

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Group’s business, see “—Regulatory“Regulatory and Legal Risks—Risks — The Group faces risks associated with an uncertain and rapidly evolving international prudential legal and regulatory environment”environment”.

185

The return required by bondholders may also rise if the prospects of bail-in scenarios become more likely which would increase the Group’s funding costs. Unfavourable developments could materially adversely affect the Group’s access to liquidity, increase its funding costs and, hence, have a material adverse effect on the Group’s results of operations, financial condition or prospects.RISK FACTORS

 

The Group is subject to the risk of having insufficient capital resources.

If the Group has or is perceived to have a shortage of capital then it may be subject to regulatory interventions and sanctions and may suffer a loss of confidence in the market with the result that access to liquidity and funding may become constrained or more expensive. Depending on the extent of any actions to improve the capital position there could be a material adverse effect on the Group’s business, including its operating results of operations, financial condition and prospects. This, in turn, may affect the Group’s capacity to continue its business operations, pay future dividends and make other distributions or pursue acquisitions or other strategic opportunities, impacting future growth potential. If, in response to such shortage, the Group raises additional capital through the issuance of share capital or capital instruments,shares, existing shareholders or holders of debt of a capital nature may experience a dilution of their holdings. If a capital or debt instrument is converted to share capitalordinary shares as a result of a trigger within the contractual terms of the instrument or through the exercise of statutory powers then, depending upon the terms of the conversion, existing shareholders may experience a dilution of their holdings. Separately, the Group may address a shortage of capital by taking action to reduce leverage exposures and/or risk-weighted assets, orfor example by way of business disposals. Such actions may impact the underlying profitability of the Group.

 

A shortage of capital could arise from:

 

•a depletion of the Group’s capital resources through increased costs or liabilities and reduced asset values which could arise as a result of the crystallisation of credit-related risks, regulatory and legal risks, business and economic risks, operational risks, financial soundness-related risks government related risks and other risks described herein;risks; and/or
  
•an increase in the amount of capital that is needed to be held. This might be driven by a change to the actual level of risk faced by the Group or to changes in the minimum levels required by legislation or by the regulatory authorities, or it may be driven by an increase to the Group’s view of the management buffer it should hold taking account of, for example, the capital levels or capital targets of the Group’s peer banks or through the changing views of rating agencies.authorities.

 

Risks associated with the regulatory framework are described below:

 

Within the prevailing UK regulatory capital framework, the Group is subject to extensive regulatory supervision in relation to the levels of capital in its business. New or revised minimum and buffer capital requirements (including systemic and/or countercyclical capital requirements) could be applied and/or the manner in which existing regulatory requirements are applied to the Group could be changed by the regulatory authorities. For example:

 

•Some of the Group’s risk-weighted assets are calculated from the Group’s approved models. These are subject to regular review on a rolling basis to ensure that they remain appropriate in prevailing economic and business conditions. In addition, ongoing proposals from the Basel Committee, the EBA and the PRA may result in changes to the Group’s approved models, for example in relation to changes in how firms model probability of default and Loss Given Default. These reviews and model implementation may lead to increased levels of risk-weighted assets and/or expected loss, and so towhich would lower reported capital ratios.
  
•The minimum capital requirements derived from risk-weighted assets are supplemented by the PRA, under Pillar 2 of the regulatory capital framework, through bank specific additional minimum requirements (informed by the ICAAPGroup’s Internal Capital Adequacy Assessment Process (ICAAP) and set through Individualthe PRA’s Total Capital Guidance)Requirement) and through buffer requirements (informed by the outcome of PRA stress testing).requirements. There is a risk that through these Pillar 2 processes the PRA may require the Group to hold more capital than is currently planned. For further detail on the potential impact of buffer requirements on the Company’s ability to pay dividends on its ordinary shares, see “Other Risks – The Company may not pay a dividend on its ordinary shares in any given financial/calendar year”.
•Regulatory capital requirements are applied to the Group as well as to individually regulated firms in the Group, including the Group’s ring-fenced bank group (“the RFB sub-group”). There is a risk that the amount of capital needed to meet the regulatory capital requirements and buffers of the constituent parts of the Group is more than the amount needed to meet the regulatory capital requirements and buffers applied to the Group as a whole, and so the Group may be required to hold more capital than is currently planned.
•In addition to the risk-based capital framework, the Group is also subject to minimum requirements under the UK leverage framework. As at 31 December 2018, the minimum leverage ratio requirement under the UK leverage ratio framework was 3.25 per cent. At least 75 per cent of the minimum 3.25 per cent requirement, and the entirety of any buffers that may apply, must be met by Common Equity Tier 1 capital. The calculation of the leverage ratio under the UK leverage ratio framework differs from CRD IV requirements in that the UK version excludes qualifying central bank claims from the leverage exposure measure. The Group is required to continue to calculate and disclose a leverage ratio on a CRD IV basis, alongside the UK leverage ratio framework. Currently, the UK leverage ratio framework does not give rise to higher capital requirements for the Group than the risk-based capital framework but there is a risk that it could do so as a result of a change in the Group’s financial position or a strengthening of the regulatory requirements.

 

In addition, the regulatory framework continues to evolve, which may impact the Group’s capital position, for further detail see “—Regulatory“Regulatory and Legal Risks—Risks - The Group faces risks associated with an uncertain and rapidly evolving international prudential legal and regulatory environment”.environment” above.

 

The Group has been and could continue to be negatively affected by the soundness and/or the perceived soundness of other financial institutions, which could result in significant systemic liquidity problems, losses or defaults by other financial institutions and counterparties, and which could materially adversely affect the Group’s results of operations, financial condition or prospects.

The Group is subject to the risk of deterioration of the commercial soundness and/or perceived soundness of other financial services institutions within and outside the UK. Financial services institutions that deal with each other are interrelated as a result of trading, investment, clearing, counterparty and other relationships. This presents systemic risk and may adversely affect financial intermediaries, such as clearing agencies, clearing houses, banks, securities firms and exchanges with which the Group interacts on a daily basis, all of which could have a material adverse effect on the Group’s ability to raise new funding.

 

The Group routinely executes a high volume of transactions with counterparties in the financial services industry, resulting in a significant credit concentration. A default by, or even concerns about the financial resilience of, one or more financial services institutions could lead to further significant systemic liquidity problems, or losses or defaults by other financial institutions, which could have a material adverse effect on the Group’s results of operations, financial condition or prospects.

 

The Group’s insurance business and defined benefit pension schemes are subject to insurance risks which could adversely affect the Group’s results of operations, financial condition or prospects.

The insurance business of the Group is exposed to short-term and longer-term variability arising from uncertain longevity due to annuity portfolios. The Group’s defined benefit pension schemes are also exposed to longevity risk. Increases in life expectancy (longevity) beyond current allowances will increase the cost of annuities and pension scheme benefits and may adversely affect the Group’s financial condition and results of operations.

186

RISK FACTORS

 

Customer behaviour in the insurance business may result in increased cancellations or ceasing of contributions at a rate in excess of business assumptions. Consequent reduction in policy persistency and fee income would have an adverse impact upon the profitability of the insurance business of the Group.

 

The insurance business of the Group is also exposed to the risk of uncertain insurance claim rates. For example, extreme weather conditions can result in high property damage claims and higher levels of theft can increase claims on home insurance. These claims rates may differ from business assumptions and negative developments may adversely affect the Group’s financial condition and results of operations.

218

RISK FACTORS

 

To a lesser extent the insurance business is exposed to mortality, morbidity and expense risk. Adverse developments in any of these factors may adversely affect the Group’s financial condition and results of operations.

 

UK banks can recognise an insurance asset in their balance sheets representing the VIF of the business in respect of long-term life assurance contracts, being insurance contracts and investment contracts with discretionary participation features. This asset represents the present value of future profits expected to arise from the portfolio of in-force life assurance contracts. Adoption of this accounting treatment results in the earlier recognition of profit on new business, but subsequently a lower contribution from existing business, when compared to the recognition of profits on investment contracts under IAS 39 (Financial Instruments: “Recognition and Measurement”).IFRS 9. Differences between actual and expected experience may have a significant impact on the value of the VIF asset, as changes in experience can result in significant changes to modelled future cash flows. The VIF asset is calculated based on best-estimate assumptions made by management, including mortality experience and persistency. If these assumptions prove incorrect, the VIF asset could be materially reduced, which in turn could have a material adverse effect on the Group’s results of operations, financial condition or prospects.

 

GOVERNMENT RELATED RISKS

The Solicitor for the Affairs of HM Treasury is the largest shareholder of the Company. Through its shareholding in, and other relationships with, the Company, HM Treasury is in a position to exert significant influence over the Group and its business.

At 31 December 2015, HM Treasury held approximately 9 per cent of the Company’s ordinary share capital. While this shareholding level is expected to decrease over time, there are no express measures in place to limit the level of influence which may be exercised by HM Treasury. The relationship falls within the scope of the revised framework document between HM Treasury and UK Financial Investments (UKFI) published on 1 October 2010, which states that UKFI will manage the investments in the UK financial institutions in which HM Treasury holds an interest “on a commercial basis and will not intervene in day-to-day management decisions of the Investee Companies (as defined therein) (including with respect to individual lending or remuneration decisions)”. The framework document also makes it clear that such UK financial institutions will continue to be separate economic units with independent powers of decision. Nevertheless, there is a risk that HM Treasury might seek to exert influence over the Group in relation to matters including, for example, commercial and consumer lending policies and management of the Group’s assets and/or business. There is also a risk of the existing framework document being replaced or amended, leading to potential interference in the operations of the Group, although there has been no indication that the UK Government intends to change the existing operating arrangements.

There is a risk that, through the interest of HM Treasury in the Company, the UK Government and HM Treasury may attempt to influence the Group in other ways that could affect the Group’s business, including, for example, through voting or shareholders resolutions generally, the election of directors, the appointment of senior management at the Company, senior management and staff remuneration policies, lending policies and commitments and management of the Group’s business (in particular, the management of the Group’s assets such as its existing retail and corporate loan portfolios, significant corporate transactions and the issue of new ordinary shares by Lloyds Banking Group plc). Moreover, HM Treasury also has interests in other UK financial institutions, as well as an interest in the general health of the UK banking industry and the wider UK economy. The pursuit of those interests may not always be aligned with the commercial interests of the Group.

For more information see “—Regulatory and legal risks—The Group’s businesses are subject to substantial regulation, and regulatory and governmental oversight. Adverse regulatory developments could have a significant material adverse effect on the Group’s results of operations, financial condition or prospects”.

OTHER RISKS

 

The Group’s financial statements are based, in part, on assumptions and estimates.

The preparation of the Group’s financial statements requires management to make judgements, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgements and assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Revisions to accounting estimates are recognised in the period in which the estimate is revised and in any future periods affected. TheOn 1 January 2018, the Group adopted IFRS 9 which addresses aspects of the accounting policies deemed critical to the Group’s results and financial position, based upon materiality and significant judgements and estimates, which include impairment offor financial assets valuationand liabilities. In particular, IFRS 9 introduced a new model for recognising and measuring impairment allowances based on expected credit losses, rather than an incurred loss model previously applied under IAS 39 (“Financial Instruments: Recognition and Measurement”), resulting in the earlier recognition of financial instruments, pensions, insurance and taxation are discussed in“Note 3 to the consolidated financial statements—Critical accounting estimates and judgements”.credit losses.

 

The consolidated financial statements are prepared using judgements, estimates and assumptions based on information available at the reporting date. If one or more of these judgements, estimates and assumptions is subsequently revised as a result of new factsfactors or circumstances emerging, there could be a material adverse effect on the Group’s results of operations, financial condition or prospects and a corresponding impact on its funding requirements and capital ratios.

 

In July 2014,applying the Internationalaccounting policies deemed critical to the Group’s results and financial position as set out in Company’s 2018 Annual Report in “Note 2 to the consolidated financial statements – Accounting Standards Board (the “IASB”) published a new accounting standard forPolicies”, management requires to make significant judgements and estimates, which include impairment losses on loans and receivables, valuation of financial instruments, (IFRS9) that will introduce a new model for recognisingpensions, insurance and measuring impairment based on expected credit losses, rather than an incurred loss model currently applied under IAS39 (Financial Instruments: “Recognitiontaxation as set out in “Note 3 to the consolidated financial statements – Critical accounting judgements and Measurement”), resulting in earlier recognition of credit losses. The changes are likely to result in an increase in the Group’s balance sheet provisions for credit losses although the extent of any increase will depend on, amongst other things, the composition of the Group’s lending portfolios and forecast economic conditions at the date of implementation. The new standard is expected to become effective for annual periods beginning on or after January 2018.estimates”.

 

The Company is a holding company and, as a result, dependsdependent on the receipt of dividends from its subsidiaries to meet its obligations, including its payment obligations with respect to its debt securities, and to provide profits for payment of future dividends to ordinary shareholders.securities.

As a matter of applicable company law, the Company may only pay cash dividends and other distributions if and to the extent that, among other requirements, it has distributable reserves and sufficient cash available for this purpose. The Company is a non-operating holding company and as such its ability to pay dividends on its ordinary shares will be affected by a number of factors, including its ability to receive funds for such purposes, directly or indirectly, from its operating subsidiaries and in a manner which creates distributable reserves for the Company.company. The principal sources of the Company’s income are, and are expected to continue to be, distributions from operating subsidiaries which also hold the principal assets of the Group. As a separate legal entity, the Company relies on such distributions in order to be able to meet its obligations (including its payment obligations with respect to its debt securities), and to create distributable reserves for payment of dividends to ordinary shareholders.

219

RISK FACTORS

 

The ability of the Group’sCompany’s subsidiaries (including subsidiaries incorporated outside the UK) to pay dividends and the Company’s ability to receive distributions from its investments in other entities will also be subject not only to their financial performance but also to applicable local laws and other restrictions. These restrictions could include, among others, any regulatory requirements, leverage requirements, any statutory reserve requirements and any applicable tax laws. There may also be restrictions as a result of current or forthcoming local ring-fencing requirements, including those relating to the payment of dividends and the maintenance of sufficient regulatory capital on a sub-consolidated basis at the level of the RFB.RFB sub-group, see “—The Group is subject to the risk of having insufficient capital resources”. These laws and restrictions could limit the payment of dividends and distributions to the Company by its subsidiaries and any other entities in which it holds an investment from time to time, which could restrict the Company’s ability to meet its obligations and/or to pay dividends.dividends to ordinary shareholders.

 

The Company may not be able to pay dividendsa dividend on its ordinary shares.shares in any given financial/calendar year.

The Company’s ability todetermination of the Board of Directors of the Company (the “Board”) in any given year of whether the Company can or should pay dividends toa dividend on its ordinary shareholdersshares, or the amount of such dividend, is subject to a functionnumber of its existing distributable reserves, the future profitability of its subsidiaries and any other investments it holds from time to time and the ability of its operating subsidiaries to distribute profits up to the Company. See “—The Company is a holding company and, as a result, depends on the receipt of dividends from its subsidiaries to meet its obligations, including its payment obligations with respect to its debt securities, and to provide profits for payment of future dividends to ordinary shareholders”.factors.

 

Further,The Board must determine the Company’s abilityoptimum level of investment to pay dividends may be adversely affected byresponsibly foster growth and to fund investment initiatives in the business, including organic growth or growth through acquisitions as part of its growth strategy, as well as the appropriate level of capital for the Group to retain to meet current and evolving regulatory requirements and to cover uncertainties.

These determinations will change year to year based on the performance of the Group’s business in general, factors affecting its financial position (including capital, funding, liquidity and leverage), the economic environment in which the Group operates, the contractual terms of certain of the Group’s regulatory capital securities and other factors outside of the Group’s control. In addition, retention of earnings as determined by the Board may fluctuate over time and restrict the ability of the Company’s Board to recommend the payment of dividends, for examplecontrol, which could arise as a result of the pointcrystallisation of credit- related risks, regulatory and legal risks, business and economic risks, operational risks, financial soundness-related risks and other risks described herein, many of which may impact the amount of capital that is generated over the course of the year. The Board’s decisions in relation to these matters will have an impact on the economic cycle or to reflect uncertainty inability of the regulatory environment. In addition, the Company’s abilityCompany to pay dividends may also be adversely affected by the servicing of paymentsa dividend on more senior instruments.its ordinary shares in any given year.

 

As the parent company of a banking group, the Company’s ability to pay dividends on its ordinary shares in the future ismay also dependent on the maintenance of an adequate level of regulatory capital. The Company’s ability to pay dividends may be affected by minimum regulatory capital and leverage requirements applied to the Group, imposed by the PRA under the CRD IV requirements as implemented in the UK.

187

RISK FACTORS

CRD IV includes a number of capital buffers to provide capital cushions in addition to minimum capital requirements that financial institutions, such as the Group may be subject to. These buffers were fully phased in on 1 January 2019 and comprise: (i) a capital conservation buffer; (ii) a time-varying countercyclical capital buffer; (iii) buffers applicable to global systemically important banks; (iv) buffers applicable to other systemically important banks; and (v) a systemic risk buffer (“SRB”).

Under CRD IV, institutions that fail to meet their “combined buffer requirements” (consisting of buffers (i) and (ii) above, and the higher of (iii), (iv) and (v)) will be subject to restrictions on the making of certain discretionary payments (including dividends on ordinary shares, coupons on Additional Tier 1 securities and variable remuneration). These restrictions are scaled according to the extent of the breach and result in a maximum distributable amount which may be expended on such discretionary payments in each relevant period.

The CompanyGroup is also required by the PRA to maintain a number“PRA buffer” (a capital buffer for individual banks which is the minimum level of regulatory capital buffersbuffer required by the PRA) which may also adversely impact the Company’s ability to distribute its reserves. The level at which these buffers mayPRA buffer is confidential between the Group and the PRA and can be set at a level in excess of the combined buffer requirements and any further sectoral capital measures that the PRA has imposed. The PRA buffer is determinedinformed by the outcome of PRA stress testing and may include an additional buffer to cover the risks posed by any weaknesses in risk management and governance. Although under CRD IV, rules and the requirementsSRB applies to the RFB sub-group, the PRA will include in the Group’s PRA buffer an amount equivalent to the RFB sub-group’s SRB. The PRA may update the PRA buffer only a short time ahead of the PRA buffer. InvestorsCompany’s dividend declaration for the prior year. This means that neither the Board nor the Company’s investors may not be able to predict accurately the proximity of the Company failing to meet these requirements which may adversely affectpredict the Company’s ability to pay dividends. dividends on its ordinary shares.

The Company’s ability to pay dividends on its ordinary shares may also be restricted by a failure of the Group to meet buffer requirements under the UK leverage framework and/or where the Group does not meet both MREL and capital requirements.

For further detail on the potential impact of these requirements on the Company’s ability to pay dividends on its ordinary shares, see “—Regulatory and Legal Risks—Risks – The Group faces risks associated with an uncertain and rapidly evolving international prudential, legal and regulatory environment” and “—environment”, “Financial Soundness Related Risks—Risks – The Group is subject to the risk of having insufficient capital resources” and “Regulatory and Legal Risks – The Group and its UK subsidiaries may become subject to the provisions of the Banking Act 2009, as amended, which could have an adverse impact on the Group’s business”.

 

Volatility in the price of Lloyds Banking Group plcthe Company’s ordinary shares may affect the value of any investment in the CompanyCompany.

The market price of Lloyds Banking Group plcthe Company’s ordinary shares could be volatile and subject to significant fluctuations due to various factors, including changes in market sentiment regarding Lloyds Banking Group plc ordinary shares (or securities similarsome of which may be unrelated to them),the Group’s operating performance or prospects. These include economic or political disruption in the main jurisdictions in which the Group operates, any regulatory changes affecting the Group’s operations, variations in its operating results, developments in the industry or its competitors, the operating and share price performance of other companies in the industries and markets in which the Group operates, the potential placing of large volumes of Lloyds Banking Group plcthe Company’s ordinary shares in the market, by UKFI, or speculation about the Group’s business in the press, media or investment communities. Stock markets have from time to time, and particularly with respect to certain financial institution shares, experienced significant price and volume fluctuations. Such fluctuations have affected market prices for securities, including the Lloyds Banking Group plc ordinary shares, and may be unrelated to the Group’s operating performance or prospects. Furthermore, the Group’s operating results of operations and prospects from time to time may be belowvary from the expectations of rating agencies, market analysts or investors. Any of these events could result in a declinevolatility in the market prices of the Lloyds Banking Group plcCompany’s ordinary shares. In general, prospective investors should be aware that the value of an investment in the Lloyds Banking Group plcCompany’s ordinary shares may go down as well as up.

 

Failure to manage the risks associated with changes in taxation rates or applicable tax laws, or misinterpretation of such tax laws, could materially adversely affect the Group’s results of operations, financial condition or prospects.

Tax risk is the risk associated with changes in taxation rates, applicable tax laws, misinterpretation of such tax laws, disputes with relevant tax authorities in relation to historic transactions, or conducting a challenge to a relevant tax authority. Failure to manage this risk adequately could cause the Group to suffer losses due to additional tax charges and other financial costs including penalties. Such failure could lead to adverse publicity, reputational damage and potentially costs materially exceeding current provisions, in each case to an extent which could have an adverse effect on the Group’s results of operations, financial condition or prospects.

220188

FORWARD LOOKING STATEMENTS

 

This Annual Reportdocument contains certain forward looking statements within the meaning of Section 21E of the US Securities Exchange Act of 1934, as amended, and Sectionsection 27A of the US Securities Act of 1933, as amended, with respect to the business, strategy, plans and plans/ or results of Lloyds Banking Group and its current goals and expectations relating to its future financial condition and performance. Statements that are not historical facts, including statements about Lloyds Banking Group’s or its directors’ and/or management’s beliefs and expectations, are forward looking statements. Words such as ‘believes’, ‘anticipates’, ‘estimates’, ‘expects’, ‘intends’, ‘aims’, ‘potential’, ‘will’, ‘would’, ‘could’, ‘considered’, ‘likely’, ‘estimate’ and variations of these words and similar future or conditional expressions are intended to identify forward looking statements but are not the exclusive means of identifying such statements. By their nature, forward looking statements involve risk and uncertainty because they relate to events and depend upon circumstances that will or may occur in the future.

 

Examples of such forward looking statements include, but are not limited to: projections or expectations of theLloyds Banking Group’s future financial position including profit attributable to shareholders, provisions, economic profit, dividends, capital structure, portfolios, net interest margin, capital ratios, liquidity, risk-weighted assets (RWAs), expenditures or any other financial items or ratios; litigation, regulatory and governmental investigations; theLloyds Banking Group’s future financial performance; the level and extent of future impairments and write-downs; statements of plans, objectives or goals of Lloyds Banking Group or its management including in respect of statements about the future business and economic environments in the UK and elsewhere including, but not limited to, future trends in interest rates, foreign exchange rates, credit and equity market levels and demographic developments; statements about competition, regulation, disposals and consolidation or technological developments in the financial services industry; and statements of assumptions underlying such statements.

 

Factors that could cause actual business, strategy, plans and/or results (including but not limited to the payment of dividends) to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward looking statements made by theLloyds Banking Group or on its behalf include, but are not limited to: general economic and business conditions in the UK and internationally; market related trends and developments; fluctuations in interest rates, inflation, exchange rates, stock markets and currencies; the ability to access sufficient sources of capital, liquidity and funding when required; changes to theLloyds Banking Group’s credit ratings; the ability to derive cost savings;savings and other benefits including, but without limitation as a result of any acquisitions, disposals and other strategic transactions; the ability to achieve strategic objectives; changing customer behaviour including consumer spending, saving and borrowing habits; changes to borrower or counterparty credit quality; concentration of financial exposure; management and monitoring of conduct risk; instability in the global financial markets, including Eurozone instability, instability as a result of uncertainty surrounding the exit by the UK from the European Union (EU) and as a result of such exit and the potential for one or moreother countries to exit the EurozoneEU or European Union (EU) (including the UK as a result of a referendum on its EU membership)Eurozone and the impact of any sovereign credit rating downgrade or other sovereign financial issues; technological changes and risks to the security of IT and operational infrastructure, systems, data and information resulting from increased threat of cyber security;and other attacks; natural, pandemic and other disasters, adverse weather and similar contingencies outside theLloyds Banking Group’s control; inadequate or failed internal or external processes or systems; acts of war, other acts of hostility, terrorist acts and responses to those acts, geopolitical, pandemic or other such events; risks related to climate change; changes in laws, regulations, practices and accounting standards or taxation, including as a result of the exit by the UK from the EU, or a further possible referendum on Scottish devolution;independence; changes to regulatory capital or liquidity requirements and similar contingencies outside theLloyds Banking Group’s control; the policies, decisions and actions of governmental or regulatory authorities or courts in the UK, the EU, the United States or elsewhere including the implementation and interpretation of key legislation and regulation;regulation together with any resulting impact on the future structure of Lloyds Banking Group; the transition from IBORs to alternative reference rates; the ability to attract and retain senior management and other employees; requirements or limitations imposed on the Group as a result of HM Treasury’s investment in the Group;employees and meet its diversity objectives; actions or omissions by theLloyds Banking Group’s directors, management or employees including industrial action; changes to theLloyds Banking Group’s post-retirement defined benefit scheme obligations; the provision of banking operations services to TSB Banking Group plc; the extent of any future impairment charges or write-downs caused by, but not limited to, depressed asset valuations, market disruptions and illiquid markets; the value and effectiveness of any credit protection purchased by theLloyds Banking Group; the inability to hedge certain risks economically; the adequacy of loss reserves; the actions of competitors, including non-bank financial services, lending companies and lending companies;digital innovators and disruptive technologies; and exposure to regulatory or competition scrutiny, legal, regulatory or competition proceedings, investigations or complaints.

 

Lloyds Banking Group may also make or disclose written and/or oral forward looking statements in reports filed with or furnished to the US Securities and Exchange Commission, Lloyds Banking Group annual reviews, half-year announcements, proxy statements, offering circulars, prospectuses, press releases and other written materials and in oral statements made by the directors, officers or employees of Lloyds Banking Group to third parties, including financial analysts. Except as required by any applicable law or regulation, the forward looking statements contained in this Annual Reportdocument are made as of the date hereof, and Lloyds Banking Group expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward looking statements contained in this Annual Reportdocument to reflect any change in Lloyds Banking Group’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

The information, statements and opinions contained in this document do not constitute a public offer under any applicable law or an offer to sell any securities or financial instruments or any advice or recommendation with respect to such securities or financial instruments.

221189

LLOYDS BANKING GROUP STRUCTURE

 

The following is asubsidiaries are disclosed as principal subsidiaries in note 56 to the consolidated financial statements; the list below includes all significant subsidiaries, and certain other subsidiaries as noted below, of the significant subsidiaries of Lloyds Banking Group plcCompany at 31 December 2015.2018.

 

Name of subsidiary undertaking Country of
registration/
incorporation		 Percentage of equity share
capital and voting
rights held		 Nature of business Registered office
Lloyds Bank plc England 100% Banking and financial services 25 Gresham Street
London EC2V 7HN
Scottish Widows Limited Scotland 100%* Life assurance 25 Gresham Street
London EC2V 7HN
HBOS plc Scotland 100%* Holding company The Mound
Edinburgh EH1 1YZ
Bank o fof Scotland plc Scotland 100%* Banking and financial services The Mound
Edinburgh EH1 1YZ
Lloyds Bank Corporate Markets plc1England100%Banking and financial services25 Gresham Street
London EC2V 7HN

 

* Indirect interest

*Indirect interest
1Subsidiary that does not meet quantitative threshold for significance. Included for consistency with the consolidated financial statements.
222190

INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

Report of the Independent Registered Public Accounting FirmF-2
Consolidated income statement for the three years ended 31 December 2015,2018, 31 December 20142017 and 31 December 20132016F-3
Consolidated statement of comprehensive income for the three years ended 31 December 2015,2018, 31 December 20142017 and 31 December 20132016F-4
Consolidated balance sheet at 31 December 20152018 and 31 December 20142017F-5
Consolidated statement of changes in equity for the three years ended 31 December 2015,2018, 31 December 20142017 and 31 December 20132016F-7
Consolidated cash flow statement for the three years ended 31 December 2015,2018, 31 December 20142017 and 31 December 20132016F-10F-9
Notes to the consolidated financial statementsF-11F-10
F-1
 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

TO THE SHAREHOLDERS OF LLOYDS BANKING GROUP PLCTo the board of directors and shareholders of Lloyds Banking Group plc

 

In our opinion,OPINIONS ON THE FINANCIAL STATEMENTS AND INTERNAL CONTROL OVER FINANCIAL REPORTING

We have audited the accompanying consolidated balance sheets of Lloyds Banking Group plc and its subsidiaries (the “Company”) as of 31 December 2018 and 31 December 2017, and the related consolidated income statement,statements, consolidated statementstatements of comprehensive income, consolidated statementstatements of changes in equity and consolidated cash flow statementstatements for each of the three years in the period ended 31 December 2018, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of 31 December 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Lloyds Banking Group plc and its subsidiaries (the Company) atthe Company as of 31 December 20152018 and 201431 December 2017, and the results of theirits operations and theirits cash flows for each of the three years in the period ended 31 December 2015,2018 in conformity with International Financial Reporting Standards (IFRSs) as issued by the International Accounting Standards Board (IASB).Board. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of 31 December 2015,2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organisations ofCOSO.

Change in Accounting Principle

As discussed in Note 1 to the Treadway Commission (COSO). consolidated financial statements, the Company changed the manner in which it accounts for financial instruments and the manner in which it accounts for revenue from contracts with customers in 2018.

BASIS FOR OPINIONS

The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the ManagementManagement’s Report on Internal Control over Financial Reporting appearing on page 182.156 of the 2018 Annual Report on Form 20-F. Our responsibility is to express opinions on thesethe Company’s consolidated financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supportingregarding the amounts and disclosures in the consolidated financial statements, assessingstatements. Our audits also included evaluating the accounting principles used and significant estimates made by management, andas well as evaluating the overall presentation of the consolidated financial statement presentation.statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

DEFINITION AND LIMITATIONS OF INTERNAL CONTROL OVER FINANCIAL REPORTING

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures thatthat: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorisations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorised acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

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

 

/s/ PricewaterhouseCoopers LLP

London, United Kingdom
8 March 2016

25 February 2019

We have served as the Company’s auditor since 1995.

F-2
 

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED INCOME STATEMENT

for the year ended 31 December

 

  2018  2017 2016 
 Note  2015
£ million		   2014
£ million		   2013
£ million		   Note £ million  £ million £ million 
Interest and similar income      17,615   19,211   21,163      16,349   16,006   16,620 
Interest and similar expense      (6,297)  (8,551)  (13,825)    (2,953)  (5,094)  (7,346)
Net interest income  5   11,318    10,660    7,338   5  13,396   10,912   9,274 
                   
Fee and commission income      3,252    3,659    4,119     2,848   2,965   3,045 
Fee and commission expense      (1,442)   (1,402)   (1,385)    (1,386)  (1,382)  (1,356)
Net fee and commission income  6   1,810    2,257    2,734   6  1,462   1,583   1,689 
Net trading income  7   3,714    10,159    16,467   7  (3,876)  11,817   18,545 
Insurance premium income  8   4,792    7,125    8,197   8  9,189   7,930   8,068 
Other operating income  9   1,516    (309)   3,249   9  1,920   1,995   2,035 
Other income      11,832   19,232   30,647     8,695   23,325   30,337 
Total income      23,150   29,892   37,985     22,091   34,237   39,611 
Insurance claims  10   (5,729)  (13,493)  (19,507)  10  (3,465)  (15,578)  (22,344)
Total income, net of insurance claims      17,421   16,399   18,478     18,626   18,659   17,267 
Regulatory provisions      (4,837)  (3,125)  (3,455)    (1,350)  (2,165)  (2,374)
Other operating expenses      (10,550)  (10,760)  (11,867)    (10,379)  (10,181)  (10,253)
Total operating expenses  11   (15,387)  (13,885)  (15,322)  11  (11,729)  (12,346)  (12,627)
Trading surplus      2,034   2,514   3,156     6,897   6,313   4,640 
Impairment  12   (390)  (752)  (2,741)  13  (937)  (688)  (752)
Profit before tax      1,644   1,762   415     5,960   5,625   3,888 
Taxation  13   (688)  (263)  (1,217) 
Profit (loss) for the year      956   1,499   (802) 
Tax expense 14  (1,560)  (1,728)  (1,724)
Profit for the year   4,400   3,897   2,164 
                              
Profit (loss) attributable to ordinary shareholders      466   1,125   (838) 
Profit attributable to ordinary shareholders   3,869   3,392   1,651 
Profit attributable to other equity holders1      394   287   –     433   415   412 
Profit (loss) attributable to equity holders      860   1,412   (838) 
Profit attributable to equity holders   4,302   3,807   2,063 
Profit attributable to non-controlling interests      96   87   36     98   90   101 
Profit (loss) for the year      956   1,499   (802) 
Profit for the year   4,400   3,897   2,164 
                              
Basic earnings (loss) per share  14   0.8p   1.7p   (1.2)p  
Diluted earnings (loss) per share  14   0.8p   1.6p   (1.2)p  
Basic earnings per share 15  5.5p   4.9p   2.4p 
Diluted earnings per share 15  5.5p   4.8p   2.4p 

 

1The profit after tax attributable to other equity holders of £394£433 million (2014: £287(2017: £415 million; 2013: £nil)2016: £412 million) is partly offset in reserves by a tax credit attributable to ordinary shareholders of £80£106 million (2014: £62(2017: £102 million; 2013: £nil)2016: £91 million).

 

The accompanying notes are an integral part of the consolidated financial statements.

F-3
 

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

for the year ended 31 December

 

 2015
£ million		  2014
£ million		  2013
£ million		  2018
£ million		  2017
£ million		 2016
£ million		 
Profit (loss) for the year  956   1,499   (802)
Profit for the year  4,400   3,897   2,164 
Other comprehensive income                        
Items that will not subsequently be reclassified to profit or loss:                        
Post-retirement defined benefit scheme remeasurements:                        
Remeasurements before taxation  (274)  674   (136)
Taxation  59   (135)  28 
Remeasurements before tax  167   628   (1,348)
Tax  (47)  (146)  320 
  120   482   (1,028)
Movements in revaluation reserve in respect of equity shares held at fair value through other comprehensive income:            
Change in fair value  (97)        
Tax  22         
  (75)        
Gains and losses attributable to own credit risk:            
Gains (losses) before tax  533   (55)  – 
Tax  (144)  15   – 
  389   (40)  – 
Share of other comprehensive income of associates and joint ventures  8   –   – 
  (215)  539   (108)            
Items that may subsequently be reclassified to profit or loss:                        
Movements in revaluation reserve in respect of available-for-sale financial assets:            
Movements in revaluation reserve in respect of debt securities held at fair value through other comprehensive income:            
Change in fair value  (37)        
Income statement transfers in respect of disposals  (275)        
Tax  119         
  (193)        
Movements in revaluation reserve in respect of available for sale financial assets:            
Adjustment on transfer from held-to-maturity portfolio      –   1,544 
Change in fair value  (318)  690   (680)      303   356 
Income statement transfers in respect of disposals  (51)  (131)  (629)      (446)  (575)
Income statement transfers in respect of impairment  4   2   18       6   173 
Taxation  (6)  (13)  277 
Tax      63   (301)
  (371)  548   (1,014)      (74)  1,197 
Movement in cash flow hedging reserve:                        
Effective portion of changes in fair value taken to other comprehensive income  537   3,896   (1,229)  234   (363)  2,432 
Net income statement transfers  (956)  (1,153)  (550)  (701)  (651)  (557)
Taxation  7   (549)  374 
Tax  113   283   (466)
  (412)  2,194   (1,405)  (354)  (731)  1,409 
Currency translation differences (tax: nil)  (42)  (3)  (6)  (8)  (32)  (4)
Other comprehensive income for the year, net of tax  (1,040)  3,278   (2,533)  (113)  (395)  1,574 
Total comprehensive income for the year  (84)  4,777   (3,335)  4,287   3,502   3,738 
                        
Total comprehensive income attributable to ordinary shareholders  (574)  4,403   (3,371)  3,756   2,997   3,225 
Total comprehensive income attributable to other equity holders  394   287   –   433   415   412 
Total comprehensive income attributable to equity holders  (180)  4,690   (3,371)  4,189   3,412   3,637 
Total comprehensive income attributable to non-controlling interests  96   87   36   98   90   101 
Total comprehensive income for the year  (84)  4,777   (3,335)  4,287   3,502   3,738 

 

The accompanying notes are an integral part of the consolidated financial statements.

F-4
 

CONSOLIDATED BALANCE SHEET

at 31 December

 

 Note  2015
£ million		  2014
£ million		  Note 31 December
2018
£ million		 1 January
20181
£ million		 31 December
2017
£ million		 
Assets                     
Cash and balances at central banks      58,417   50,492       54,663   58,521   58,521 
Items in the course of collection from banks      697   1,173       647   755   755 
Trading and other financial assets at fair value through profit or loss  15   140,536   151,931 
Financial assets at fair value through profit or loss  16   158,529   176,008   162,878 
Derivative financial instruments  16   29,467   36,128   17   23,595   25,474   25,834 
Loans and receivables:            
Loans and advances to banks  17   25,117   26,155       6,283   4,246   6,611 
Loans and advances to customers  18   455,175   482,704       484,858   461,016   472,498 
Debt securities      4,191   1,213       5,238   3,314   3,643 
      484,483   510,072 
Financial assets at amortised cost  18   496,379   468,576   482,752 
Financial assets at fair value through other comprehensive income  21   24,815   42,917     
Available-for-sale financial assets  22   33,032   56,493   22           42,098 
Held-to-maturity investments  23   19,808   – 
Goodwill  24   2,016   2,016   23   2,310   2,310   2,310 
Value of in-force business  25   4,596   4,864   24   4,762   4,839   4,839 
Other intangible assets  26   1,838   2,070   25   3,347   2,835   2,835 
Property, plant and equipment  27   12,979   12,544   26   12,300   12,727   12,727 
Current tax recoverable      44   127       5   16   16 
Deferred tax assets  38   4,010   4,145   36   2,453   2,609   2,284 
Retirement benefit assets  37   901   1,147   35   1,267   723   723 
Other assets  28   13,864   21,694   27   12,526   12,872   13,537 
Total assets      806,688   854,896       797,598   811,182   812,109 

1See note 54.

 

The accompanying notes are an integral part of the consolidated financial statements.

F-5
 

CONSOLIDATED BALANCE SHEET

Equity and liabilities Note  2015
£ million		  2014
£ million		 
Liabilities            
Deposits from banks  29   16,925   10,887 
Customer deposits  30   418,326   447,067 
Items in course of transmission to banks      717   979 
Trading and other financial liabilities at fair value through profit or loss  31   51,863   62,102 
Derivative financial instruments  16   26,301   33,187 
Notes in circulation      1,112   1,129 
Debt securities in issue  32   82,056   76,233 
Liabilities arising from insurance contracts and participating investment contracts  33   80,294   86,918 
Liabilities arising from non-participating investment contracts  35   22,777   27,248 
Other liabilities  36   29,661   28,425 
Retirement benefit obligations  37   365   453 
Current tax liabilities      279   69 
Deferred tax liabilities  38   33   54 
Other provisions  39   5,687   4,200 
Subordinated liabilities  40   23,312   26,042 
Total liabilities      759,708   804,993 
Equity            
Share capital  41   7,146   7,146 
Share premium account  42   17,412   17,281 
Other reserves  43   12,260   13,216 
Retained profits  44   4,416   5,692 
Shareholders’ equity      41,234   43,335 
Other equity instruments  45   5,355   5,355 
Total equity excluding non-controlling interests      46,589   48,690 
Non-controlling interests      391   1,213 
Total equity      46,980   49,903 
Total equity and liabilities      806,688   854,896 

Equity and liabilities Note 31 December
2018
£ million		 1 January
20181
£ million		  31 December
2017
£ million		 
Liabilities            
Deposits from banks   30,320  29,804   29,804 
Customer deposits   418,066  418,124   418,124 
Items in course of transmission to banks   636  584   584 
Financial liabilities at fair value through profit or loss 28 30,547  50,935   50,877 
Derivative financial instruments 17 21,373  26,124   26,124 
Notes in circulation   1,104  1,313   1,313 
Debt securities in issue 29 91,168  72,402   72,450 
Liabilities arising from insurance contracts and participating investment contracts 31 98,874  103,413   103,413 
Liabilities arising from non-participating investment contracts 33 13,853  15,447   15,447 
Other liabilities 34 19,633  20,741   20,730 
Retirement benefit obligations 35 245  358   358 
Current tax liabilities   377  274   274 
Deferred tax liabilities 36 –  –   – 
Other provisions 37 3,547  5,789   5,546 
Subordinated liabilities 38 17,656  17,922   17,922 
Total liabilities   747,399  763,230   762,966 
Equity            
Share capital 39 7,116  7,197   7,197 
Share premium account 40 17,719  17,634   17,634 
Other reserves 41 13,210  13,553   13,815 
Retained profits 42 5,389  3,976   4,905 
Shareholders’ equity   43,434  42,360   43,551 
Other equity instruments 43 6,491  5,355   5,355 
Total equity excluding non-controlling interests   49,925  47,715   48,906 
Non-controlling interests   274  237   237 
Total equity   50,199  47,952   49,143 
Total equity and liabilities   797,598  811,182   812,109 

1See note 54.

 

The accompanying notes are an integral part of the consolidated financial statements.

F-6
 

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

for the year ended 31 December

 

 Attributable to equity shareholders          Attributable to equity shareholders            
 Share capital
and premium
£ million		 Other
reserves
£ million		 Retained
profits
£ million		 Total
£ million		 Other
equity
instruments
£ million		 Non-
controlling
interests
£ million		 Total
£ million		  Share capital
and premium
£ million		 Other
reserves
£ million		 Retained
profits
£ million		 Total
£ million		 Other
equity
instruments
£ million		 Non-
controlling
interests
£ million		 Total
£ million		 
Balance at 1 January 2015  24,427   13,216   5,692   43,335   5,355   1,213   49,903 
Balance at 31 December 2017  24,831   13,815   4,905   43,551   5,355   237   49,143 
Adjustment on adoption of IFRS 9 and IFRS 151  –   (262)  (929)  (1,191)  –   –   (1,191)
Balance at 1 January 2018  24,831   13,553   3,976   42,360   5,355   237   47,952 
Comprehensive income                                                        
Profit for the year  –   –   860   860   –   96   956   –   –   4,302   4,302   –   98   4,400 
Other comprehensive income                                                        
Post-retirement defined benefit scheme remeasurements, net of taxation  –   –   (215)  (215)  –   –   (215)
Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax  –   (371)  –   (371)  –   –   (371)
Post-retirement defined benefit scheme remeasurements, net of tax  –   –   120   120   –   –   120 
Share of other comprehensive income of associates and joint ventures  –   –   8   8   –   –   8 
Movements in revaluation reserve in respect of financial assets held at fair value through other comprehensive income, net of tax:                            
Debt securities  –   (193)  –   (193)  –   –   (193)
Equity shares  –   (75)  –   (75)  –   –   (75)
Gains and losses attributable to own credit risk, net of tax  –   –   389   389   –   –   389 
Movements in cash flow hedging reserve, net of tax  –   (412)  –   (412)  –   –   (412)  –   (354)  –   (354)  –   –   (354)
Currency translation differences (tax: £nil)  –   (42)  –   (42)  –   –   (42)  –   (8)  –   (8)  –   –   (8)
Total other comprehensive income  –   (825)  (215)  (1,040)  –   –   (1,040)  –   (630)  517   (113)  –   –   (113)
Total comprehensive income  –   (825)  645   (180)  –   96   (84)  –   (630)  4,819   4,189   –   98   4,287 
Transactions with owners                                                        
Dividends  –   –   (1,070)  (1,070)  –   (52)  (1,122)  –   –   (2,240)  (2,240)  –   (61)  (2,301)
Distributions on other equity instruments, net of tax  –   –   (314)  (314)  –   –   (314)  –   –   (327)  (327)  –   –   (327)
Redemption of preference shares  131   (131)  –   –   –   –   – 
Issue of ordinary shares  162   –   –   162   –   –   162 
Share buy-back  (158)  158   (1,005)  (1,005)  –   –   (1,005)
Issue of other equity instruments (note 43)  –   –   (5)  (5)  1,136   –   1,131 
Movement in treasury shares  –   –   (816)  (816)  –   –   (816)  –   –   40   40   –   –   40 
Value of employee services:                                                        
Share option schemes  –   –   107   107   –   –   107   –   –   53   53   –   –   53 
Other employee award schemes  –   –   172   172   –   –   172   –   –   207   207   –   –   207 
Adjustment on sale of interest in TSB Banking Group plc (TSB, note 55)  –   –   –   –   –   (825)  (825)
Other changes in non-controlling interests  –   –   –   –   –   (41)  (41)
Changes in non-controlling interests  –   –   –   –   –   –   – 
Total transactions with owners  131   (131)  (1,921)  (1,921)  –   (918)  (2,839)  4   158   (3,277)  (3,115)  1,136   (61)  (2,040)
Balance at 31 December 2015  24,558   12,260   4,416   41,234   5,355   391   46,980 
Realised gains and losses on equity shares held at fair value through other comprehensive income  –   129   (129)  –   –   –   – 
At 31 December 2018  24,835   13,210   5,389   43,434   6,491   274   50,199 

 

1See note 54.

Further details of movements in the Group’s share capital, reserves and other equity instruments are provided in notes 39, 40, 41, 42 43, 44 and 45.43.

 

The accompanying notes are an integral part of the consolidated financial statements.

F-7
 

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

for the year ended 31 December

  Attributable to equity shareholders    Non-    
  Share capital
and premium
£ million		  Other
reserves
£ million		  Retained
profits
£ million		  Total
£ million		  Other equity
instruments
£ million		  controlling
interests
£ million		  Total
£ million		 
Balance at 1 January 2014  24,424   10,477   4,088   38,989   –   347   39,336 
Comprehensive income                            
Profit for the year  –   –   1,412   1,412   –   87   1,499 
Other comprehensive income                            
Post-retirement defined benefit scheme remeasurements, net of taxation  –   –   539   539   –   –   539 
Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax  –   548   –   548   –   –   548 
Movements in cash flow hedging reserve, net of tax  –   2,194   –   2,194   –   –   2,194 
Currency translation differences (tax: £nil)  –   (3)  –   (3)  –   –   (3)
Total other comprehensive income  –   2,739   539   3,278   –   –   3,278 
Total comprehensive income  –   2,739   1,951   4,690   –   87   4,777 
Transactions with owners                            
Dividends  –   –   –   –   –   (27)  (27)
Distributions on other equity instruments, net of tax  –   –   (225)  (225)  –   –   (225)
Issue of ordinary shares  3   –   –   3   –   –   3 
Issue of other equity instruments (note 45)  –   –   (21)  (21)  5,355   –   5,334 
Movement in treasury shares  –   –   (286)  (286)  –   –   (286)
Value of employee services:                            
Share option schemes  –   –   123   123   –   –   123 
Other employee award schemes  –   –   233   233   –   –   233 
Adjustment on sale of non-controlling interest in TSB  –   –   (171)  (171)  –   805   634 
Other changes in non-controlling interests  –   –   –   –   –   1   1 
Total transactions with owners  3   –   (347)  (344)  5,355   779   5,790 
Balance at 31 December 2014  24,427   13,216   5,692   43,335   5,355   1,213   49,903 

  Attributable to equity shareholders            
  Share capital
and premium
£ million		  Other
reserves
£ million		  Retained
profits
£ million		  Total
£ million		  

Other
equity
instruments

£ million

  Non-
controlling
interests
£ million		  Total
£ million		 
Balance at 1 January 2016  24,558   12,260   4,416   41,234   5,355   391   46,980 
Comprehensive income                            
Profit for the year  –   –   2,063   2,063   –   101   2,164 
Other comprehensive income                            
Post-retirement defined benefit scheme remeasurements, net of tax  –   –   (1,028)  (1,028)  –   –   (1,028)
Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax  –   1,197   –   1,197   –   –   1,197 
Movements in cash flow hedging reserve, net of tax  –   1,409   –   1,409   –   –   1,409 
Currency translation differences (tax: £nil)  –   (4)  –   (4)  –   –   (4)
Total other comprehensive income  –   2,602   (1,028)  1,574   –   –   1,574 
Total comprehensive income  –   2,602   1,035   3,637   –   101   3,738 
Transactions with owners                            
Dividends  –   –   (2,014)  (2,014)  –   (29)  (2,043)
Distributions on other equity instruments, net of tax  –   –   (321)  (321)  –   –   (321)
Redemption of preference shares  210   (210)  –   –   –   –   – 
Movement in treasury shares  –   –   (175)  (175)  –   –   (175)
Value of employee services:                            
Share option schemes  –   –   141   141   –   –   141 
Other employee award schemes  –   –   168   168   –   –   168 
Changes in non-controlling interests  –   –   –   –   –   (23)  (23)
Total transactions with owners  210   (210)  (2,201)  (2,201)  –   (52)  (2,253)
Balance at 31 December 2016  24,768   14,652   3,250   42,670   5,355   440   48,465 
Comprehensive income                            
Profit for the year  –   –   3,807   3,807   –   90   3,897 
Other comprehensive income                            
Post-retirement defined benefit scheme remeasurements, net of tax  –   –   482   482   –   –   482 
Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax  –   (74)  –   (74)  –   –   (74)
Gains and losses attributable to own credit risk, net of tax  –   –   (40)  (40)  –   –   (40)
Movements in cash flow hedging reserve, net of tax  –   (731)  –   (731)  –   –   (731)
Currency translation differences (tax: £nil)  –   (32)  –   (32)  –   –   (32)
Total other comprehensive income  –   (837)  442   (395)  –   –   (395)
Total comprehensive income  –   (837)  4,249   3,412   –   90   3,502 
Transactions with owners                            
Dividends  –   –   (2,284)  (2,284)  –   (51)  (2,335)
Distributions on other equity instruments, net of tax  –   –   (313)  (313)  –   –   (313)
Issue of ordinary shares  63   –   –   63   –   –   63 
Movement in treasury shares  –   –   (411)  (411)  –   –   (411)
Value of employee services:                            
Share option schemes  –   –   82   82   –   –   82 
Other employee award schemes  –   –   332   332   –   –   332 
Changes in non-controlling interests  –   –   –   –   –   (242)  (242)
Total transactions with owners  63   –   (2,594)  (2,531)  –   (293)  (2,824)
Balance at 31 December 2017  24,831   13,815   4,905   43,551   5,355   237   49,143 

 

The accompanying notes are an integral part of the consolidated financial statements.

F-8
 

CONSOLIDATED CASH FLOW STATEMENT OF CHANGES IN EQUITY

for the year ended 31 December

 

  Attributable to equity shareholders      
  Share capital
and premium
£ million		  Other
reserves
£ million		  Retained
profits
£ million		  Total
£ million		  Non-controlling
interests
£ million		  Total
£ million		 
Balance at 1 January 2013  23,914   12,902   5,080   41,896   685   42,581 
Comprehensive income                        
(Loss) profit for the year  –   –   (838)  (838)  36   (802)
Other comprehensive income                        
Post-retirement defined benefit scheme remeasurements, net of taxation  –   –   (108)  (108)  –   (108)
Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax  –   (1,014)  –   (1,014)  –   (1,014)
Movements in cash flow hedging reserve, net of tax  –   (1,405)  –   (1,405)  –   (1,405)
Currency translation differences (tax: £nil)  –   (6)  –   (6)  –   (6)
Total other comprehensive income  –   (2,425)  (108)  (2,533)  –   (2,533)
Total comprehensive income  –   (2,425)  (946)  (3,371)  36   (3,335)
Transactions with owners                        
Dividends  –   –   –   –   (25)  (25)
Issue of ordinary shares  510   –   –   510   –   510 
Movement in treasury shares  –   –   (480)  (480)  –   (480)
Value of employee services:                        
Share option schemes  –   –   142   142   –   142 
Other employee award schemes  –   –   292   292   –   292 
Changes in non-controlling interests  –   –   –   –   (349)  (349)
Total transactions with owners  510   –   (46)  464   (374)  90 
Balance at 31 December 2013  24,424   10,477   4,088   38,989   347   39,336 
  Note 2018
£ million		  2017
£ million		  2016
£ million		 
Profit before tax    5,960   5,625   3,888 
Adjustments for:              
Change in operating assets 53(A)  (4,472)  (15,492)  (12,218)
Change in operating liabilities 53(B)  (8,673)  (4,282)  (2,659)
Non-cash and other items 53(C)  (2,892)  11,982   13,885 
Tax paid    (1,030)  (1,028)  (822)
Net cash (used in) provided by operating activities    (11,107)  (3,195)  2,074 
Cash flows from investing activities              
Purchase of financial assets    (12,657)  (7,862)  (4,930)
Proceeds from sale and maturity of financial assets    26,806   18,675   6,335 
Purchase of fixed assets    (3,514)  (3,655)  (3,760)
Proceeds from sale of fixed assets    1,334   1,444   1,684 
Acquisition of businesses, net of cash acquired 53(E)  (49)  (1,923)  (20)
Disposal of businesses, net of cash disposed 53(F)  1   129   5 
Net cash provided by (used in) investing activities    11,921   6,808   (686)
Cash flows from financing activities              
Dividends paid to ordinary shareholders    (2,240)  (2,284)  (2,014)
Distributions on other equity instruments    (433)  (415)  (412)
Dividends paid to non-controlling interests    (61)  (51)  (29)
Interest paid on subordinated liabilities    (1,268)  (1,275)  (1,687)
Proceeds from issue of subordinated liabilities    1,729   –   1,061 
Proceeds from issue of other equity instruments    1,131   –   – 
Proceeds from issue of ordinary shares    102   14   – 
Share buyback    (1,005)  –   – 
Repayment of subordinated liabilities    (2,256)  (1,008)  (7,885)
Changes in non-controlling interests    –   –   (8)
Net cash used in financing activities    (4,301)  (5,019)  (10,974)
Effects of exchange rate changes on cash and cash equivalents    3   –   21 
Change in cash and cash equivalents    (3,484)  (1,406)  (9,565)
Cash and cash equivalents at beginning of year    58,708   62,388   71,953 
Cash and cash equivalents at end of year 53(D)  55,224   60,982   62,388 
Adjustment on adoption of IFRS 91        (2,274)    
Cash and cash equivalents at 1 January 2018        58,708     

 

1See note 1.

The accompanying notes are an integral part of the consolidated financial statements.

F-9

CONSOLIDATED CASH FLOW STATEMENT

for the year ended 31 December

  Note 2015
£ million		  2014
£ million		  2013
£ million		 
Profit before tax      1,644   1,762   415 
Adjustments for:                
Change in operating assets  54(A)  34,700   (872)  20,383 
Change in operating liabilities  54(B)  (11,985)  11,992   (47,687)
Non-cash and other items  54(C)  (7,808)  (2,496)  11,382 
Tax paid      (179)  (33)  (24)
Net cash provided by (used in) operating activities      16,372   10,353   (15,531)
Cash flows from investing activities                
Purchase of financial assets      (19,354)  (11,533)  (36,959)
Proceeds from sale and maturity of financial assets      22,000   4,668   21,552 
Purchase of fixed assets      (3,417)  (3,442)  (2,982)
Proceeds from sale of fixed assets      1,537   2,043   2,090 
Acquisition of businesses, net of cash acquired      (5)  (1)  (6)
Disposal of businesses, net of cash disposed  54(E)  (4,071)  543   696 
Net cash used in investing activities      (3,310)  (7,722)  (15,609)
Cash flows from financing activities                
Dividends paid to ordinary shareholders      (1,070)  –   – 
Distributions on other equity instruments      (394)  (287)  – 
Dividends paid to non-controlling interests      (52)  (27)  (25)
Interest paid on subordinated liabilities      (1,840)  (2,205)  (2,451)
Proceeds from issue of subordinated liabilities      338   629   1,500 
Proceeds from issue of ordinary shares      –   3   350 
Repayment of subordinated liabilities      (3,199)  (3,023)  (2,442)
Changes in non-controlling interests      (41)  635   – 
Net cash used in financing activities      (6,258)  (4,275)  (3,068)
Effects of exchange rate changes on cash and cash equivalents      2   (6)  (53)
Change in cash and cash equivalents      6,806   (1,650)  (34,261)
Cash and cash equivalents at beginning of year      65,147   66,797   101,058 
Cash and cash equivalents at end of year  54(D)  71,953   65,147   66,797 

The accompanying notes are an integral part of the consolidated financial statements.

F-10
 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1: BASIS OF PREPARATION

 

The consolidated financial statements of Lloyds Banking Group plc have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU). IFRS comprises accounting standards prefixed IFRS issued by the International Accounting Standards Board (IASB) and those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by the IFRS Interpretations Committee (IFRS IC) and its predecessor body. The EU endorsed version of IAS 39Financial Instruments: Recognition and Measurementrelaxes some of the hedge accounting requirements;As noted below, in adopting IFRS 9, the Group has not taken advantage of this relaxation, and therefore there is no difference in applicationelected to the Group between IFRS as adopted by the EU and IFRS as issued by the IASB.continue applying hedge accounting under IAS 39.

 

The financial information has been prepared under the historical cost convention, as modified by the revaluation of investment properties, available-for-sale financial assets measured at fair value through other comprehensive income, trading securities and certain other financial assets and liabilities at fair value through profit or loss and all derivative contracts. As stated on page 182,164, the directors consider that it is appropriate to continue to adopt the going concern basis in preparing the financial statements.

 

During 2015, government debt securitiesThe Group has adopted IFRS 9 and IFRS 15 with effect from 1 January 2018.

(i) IFRS 9Financial Instruments

IFRS 9 replaces IAS 39 and addresses classification, measurement and derecognition of financial assets and liabilities, the impairment of financial assets measured at amortised cost or fair value through other comprehensive income, expected credit loss provisions for loan commitments and financial guarantee contracts and general hedge accounting.

Impairment:IFRS 9 replaces the IAS 39 ‘incurred loss’ impairment approach with an ‘expected credit loss’ approach. The revised approach applies to financial assets including finance lease receivables, recorded at amortised cost or fair value through other comprehensive income; loan commitments and financial guarantees that are not measured at fair value through profit or loss are also in scope. The expected credit loss approach requires an allowance to be established upon initial recognition of an asset reflecting the level of losses anticipated after having regard to, amongst other things, expected future economic conditions. Subsequently the amount of the allowance is affected by changes in the expectations of loss driven by changes in associated credit risk.

Classification and measurement:IFRS 9 requires financial assets to be classified into one of the following measurement categories: fair value through profit or loss, fair value through other comprehensive income and amortised cost. Classification is made on the basis of the objectives of the entity’s business model for managing its financial assets and the contractual cash flow characteristics of the instruments. The requirements for derecognition are broadly unchanged from IAS 39. The standard also retains most of the IAS 39 requirements for financial liabilities except for those designated at fair value through profit or loss whereby that part of the fair value change attributable to the entity’s own credit risk is recorded in other comprehensive income. The Group early adopted this requirement with effect from 1 January 2017.

General hedge accounting:The new hedge accounting model aims to provide a better link between risk management strategy, the rationale for hedging and the impact of hedging on the financial statements. The standard does not explicitly address macro hedge accounting solutions, which are being considered in a separate IASB project – Accounting for Dynamic Risk Management. Until this project is finalised, the IASB has provided an accounting policy choice to retain IAS 39 hedge accounting in its entirety or choose to apply the IFRS 9 hedge accounting requirements. The Group has elected to continue applying hedge accounting as set out in IAS 39.

In adopting IFRS 9, the Group has reclassified loans and advances to banks with a carryingmaturity of less than three months totalling £2,274 million to financial assets measured at fair value through profit or loss, resulting in a corresponding reduction in cash and cash equivalents at 1 January 2018 compared to the amount previously reported at 31 December 2017.

(ii) IFRS 15 Revenue from Contracts with Customers

IFRS 15 has replaced IAS 18Revenueand IAS 11Construction Contracts. The core principle of £19,938 million, previously classified as available-for-sale, were reclassifiedIFRS 15 is that revenue reflects the transfer of goods or services to held-to-maturity. Unrealised gains oncustomers in an amount that reflects the transferred securities of £194 million previously takenconsideration to equity continuewhich an entity expects to be heldentitled. The recognition of such revenue is in accordance with five steps to: identify the available-for-sale revaluation reserve and are being amortisedcontract; identify the performance obligations; determine the transaction price; allocate the transaction price to the income statement overperformance obligations; and recognise revenue when the remaining livesperformance obligations are satisfied.

Details of the securities using the effective interest method or until the assets become impaired.impact of adoption of IFRS 9 and IFRS 15 are provided in note 54.

 

Details of those IFRS pronouncements which will be relevant to the Group but which were not effective at 31 December 20152018 and which have not been applied in preparing these financial statements are given in note 57.55.

 

NOTE 2: ACCOUNTING POLICIES

 

The Group’s accounting policies are set out below. These accounting policies have been applied consistently.

 

(A) CONSOLIDATIONConsolidation

 

The assets, liabilities and results of Group undertakings (including structured entities) are included in the financial statements on the basis of accounts made up to the reporting date. Group undertakings include subsidiaries, associates and joint ventures.

 

(1) SUBSIDIARIES

 

Subsidiaries are entities controlled by the Group. The Group controls an entity when it has power over the entity, is exposed to, or has rights to, variable returns from its involvement with the entity, and has the ability to affect those returns through the exercise of its power. This generally accompanies a shareholding of more than one half of the voting rights although in certain circumstances a holding of less than one half of the voting rights may still result in the ability of the Group to exercise control. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Group controls another entity. The Group reassesses whether or not it controls an entity if facts and circumstances indicate that there are changes to any of the above elements. Subsidiaries are fully consolidated from the date on which control is transferred to the Group; they are de-consolidated from the date that control ceases.

 

The Group consolidates collective investment vehicles if its beneficial ownership interests give it substantive rights to remove the external fund manager over the investment activities of the fund. Where a subsidiary of the Group is the fund manager of a collective investment vehicle, the Group considers a number of factors in determining whether it acts as principal, and therefore controls the collective investment vehicle, including: an assessment of the scope of the Group’s decision making authority over the investment vehicle; the rights held by other parties including substantive removal rights without cause over the Group acting as fund manager; the remuneration to which the Group is entitled in its capacity as decision maker; and the Group’s exposure to variable returns from the beneficial interest it holds in the investment vehicle. Consolidation may be appropriate in circumstances where the Group has less than a majority beneficial interest. Where a collective investment vehicle is consolidated the interests of parties other than the Group are reported in other liabilities.liabilities and the movement in these interests in interest expense.

F-10

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2: ACCOUNTING POLICIES continued

 

Structured entities are entities that are designed so that their activities are not governed by way of voting rights. In assessing whether the Group has power over such entities in which it has an interest, the Group considers factors such as the purpose and design of the entity; its practical ability to direct the relevant activities of the entity; the nature of the relationship with the entity; and the size of its exposure to the variability of returns of the entity.

 

The treatment of transactions with non-controlling interests depends on whether, as a result of the transaction, the Group loses control of the subsidiary. Changes in the parent’s ownership interest in a subsidiary that do not result in a loss of control are accounted for as equity transactions; any difference between the amount by which the non-controlling interests are adjusted and the fair value of the consideration paid or received is recognised directly in equity and attributed to the owners of the parent entity. Where the Group loses control of the subsidiary, at the date when control is lost the amount of any non-controlling interest in that former subsidiary is derecognised and any investment retained in the former subsidiary is remeasured to its fair value; the gain or loss that is recognised in profit or loss on the partial disposal of the subsidiary includes the gain or loss on the remeasurement of the retained interest.

 

Intercompany transactions, balances and unrealised gains and losses on transactions between Group companies are eliminated.

 

The acquisition method of accounting is used to account for business combinations by the Group. The consideration for the acquisition of a subsidiary is the fair value of the assets transferred, the liabilities incurred and the equity interests issued by the Group. The consideration includes the fair value of any asset or liability resulting from a contingent consideration arrangement. Acquisition related costs are expensed as incurred except those relating to the issuance of debt instruments (see (E)(5) below) or share capital (see (Q)(1)(P) below). Identifiable assets acquired and liabilities assumed in a business combination are measured initially at their fair value at the acquisition date.

 

(2) JOINT VENTURES AND ASSOCIATES

 

Joint ventures are joint arrangements over which the Group has joint control with other parties and has rights to the net assets of the arrangements. Associates are entities over which the Group has significant influence. Significant influence is the power to participate in the financial and operating policy decisions of the entity, but is not control or joint control of those policies, and is generally achieved through holding between 20 per cent and 50 per cent of the voting share capital of the entity.

 

The Group utilises the venture capital exemption for investments where significant influence or joint control is present and the business unit operates as a venture capital business. These investments are designated at initial recognition at fair value through profit or loss. Otherwise, the Group’s investments in joint ventures and associates are accounted for by the equity method of accounting and are initially recorded at cost and adjusted each year to reflect the Group’s share of the post-acquisition results of the joint venture or associate based on accounts which are coterminous with the Group or made up

F-11

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2: ACCOUNTING POLICIES continued

to a date which is not more than three months before the Group’s reporting date. The share of any losses is restricted to a level that reflects an obligation to fund such losses.accounting.

 

(B) GOODWILLGoodwill

 

Goodwill arises on business combinations including the acquisition of subsidiaries, and on the acquisition of interests in joint ventures and associates; goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the identifiable assets, liabilities and contingent liabilities acquired. Where the fair value of the Group’s share of the identifiable assets, liabilities and contingent liabilities of the acquired entity is greater than the cost of acquisition, the excess is recognised immediately in the income statement.

 

Goodwill is recognised as an asset at cost and is tested at least annually for impairment. If an impairment is identified the carrying value of the goodwill is written down immediately through the income statement and is not subsequently reversed. Goodwill arising on acquisitions of associates and joint ventures is included in the Group’s investment in joint ventures and associates. At the date of disposal of a subsidiary, the carrying value of attributable goodwill is included in the calculation of the profit or loss on disposal.

 

(C) OTHER INTANGIBLE ASSETSOther intangible assets

 

Other intangible assets include brands, core deposit intangible, purchased credit card relationships, customer-related intangibles and both internally and externally generated capitalised software enhancements. Intangible assets which have been determined to have a finite useful life are amortised on a straight line basis over their estimated useful life as follows: up to 7 years for capitalised software; 10 to 15 years for brands and other intangibles.

Capitalised software enhancementsup to 7 years
Brands (which have been assessed as having finite lives)10-15 years
Customer-related intangiblesup to 10 years
Core deposit intangibleup to 8 years
Purchased credit card relationships5 years

 

Intangible assets with finite useful lives are reviewed at each reporting date to assess whether there is any indication that they are impaired. If any such indication exists the recoverable amount of the asset is determined and in the event that the asset’s carrying amount is greater than its recoverable amount, it is written down immediately. Certain brands have been determined to have an indefinite useful life and are not amortised. Such intangible assets are reassessed annually to reconfirm that an indefinite useful life remains appropriate. In the event that an indefinite life is inappropriate a finite life is determined and an impairment review is performed on the asset.

 

(D) REVENUE RECOGNITIONRevenue recognition

(1) NET INTEREST INCOME

 

Interest income and expense are recognised in the income statement for all interest-bearing financial instruments using the effective interest method, except for those classified at fair value through profit or loss. The effective interest method is a method of calculating the amortised cost of a financial asset or liability and of allocating the interest income or interest expense over the expected life of the financial instrument. The effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the financial instrument or, when appropriate, a shorter period, to the netgross carrying amount of the financial asset (before adjusting for expected credit losses) or financial liability.

The effective interest rate is calculated on initial recognitionto the amortised cost of the financial asset or liability, by estimating the future cash flows after considering all the contractual terms of the instrument but not future credit losses. The calculation includes all amounts expected to be paid or received by the Group including expected early redemption fees, and related penalties, and premiums and discounts that are an integral part of the overall return. Direct incremental transaction costs related to the acquisition, issue or disposal of a financial instrument are also taken into account in the calculation. Once a financial asset or a group of similaraccount. Interest income from non-credit impaired financial assets has been written down as a result of an impairment loss, interest income is recognised usingby applying the effective interest rate to the gross carrying amount of the asset; for credit impaired financial assets, the effective interest usedrate is applied to discount the future cash flowsnet carrying amount after deducting the allowance for the purpose of measuring the impairment loss (seeexpected credit losses. Impairment policies are set out in (H) below).below.

(2) FEE AND COMMISSION INCOME AND EXPENSE

 

Fees and commissions receivable which are not an integral part of the effective interest rate are generally recognised whenas income as the Group fulfils its performance obligations. The Group’s principal performance obligations arising from contracts with customers are in respect of value added current accounts, credit cards and debit cards. These fees are received, and the Group’s provides the service, has been provided. Loan commitmentmonthly; the fees for loans that are likely to be drawn downrecognised in income on this basis. The Group also receives certain fees in respect of its asset finance business where the performance obligations are deferred (together with related direct costs) andtypically fulfilled towards the end of the customer contract; these fees are recognised as an adjustment to the effective interest ratein income on the loan once drawn.this basis. Where it is unlikely that the loan commitments will be drawn, loan commitment fees are recognised in fee and commission income over the life of the facility. Loan syndication fees are recognisedfacility, rather than as revenue whenan adjustment to the syndication has been completed and the Group retains no part of the loan package for itself or retains a part at the same effective interest rate for all interest-bearing financial instruments, including loans expected to be drawn. Incremental costs incurred to generate fee and advances,commission income are charged to fees and commissions expense as for the other participants.they are incurred.

(3) OTHER

 

Dividend income is recognised when the right to receive payment is established.

 

Revenue recognition policies specific to trading income are set out in E(3) below, life insurance and general insurance business are detailed below (see (N)(M) below); those relating to leases are set out in (J)(2) below.

F-11

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2: ACCOUNTING POLICIES continued

 

(E) FINANCIAL ASSETS AND LIABILITIESFinancial assets and liabilities

 

On initial recognition, financial assets are classified intoas measured at amortised cost, fair value through other comprehensive income or fair value through profit or loss, available-for-saledepending on the Group’s business model for managing the financial assets held-to-maturityand whether the cash flows represent solely payments of principal and interest. The Group assesses its business models at a portfolio level based on its objectives for the relevant portfolio, how the performance of the portfolio is managed and reported, and the frequency of asset sales. Financial assets with embedded derivatives are considered in their entirety when considering their cash flow characteristics. The Group reclassifies financial assets when and only when its business model for managing those assets changes. A reclassification will only take place when the change is significant to the Group’s operations and will occur at a portfolio level and not for individual instruments; reclassifications are expected to be rare. Equity investments or loans and receivables. Financial liabilities are measured at amortised cost, except for trading liabilities and other financial liabilities designated at fair value through profit or loss onunless the Group elects at initial recognition which are heldto account for the instruments at fair value. value through other comprehensive income. For these instruments, principally strategic investments, dividends are recognised in profit or loss but fair value gains and losses are not subsequently reclassified to profit or loss following derecognition of the investment.

The Group initially recognises loans and receivables,advances, deposits, debt securities in issue and subordinated liabilities when the Group becomes a party to the contractual provisions of the instrument. Regular way purchases and sales of securities and other financial assets and trading liabilities are recognised on trade date, being the date that the Group is committed to purchase or sell an asset.

 

Financial assets are derecognised when the contractual right to receive cash flows from those assets has expired or when the Group has transferred its contractual right to receive the cash flows from the assets and either: substantially all of the risks and rewards of ownership have been transferred; or the Group has neither retained nor transferred substantially all of the risks and rewards, but has transferred control.

–substantially all of the risks and rewards of ownership have been transferred; or
–the Group has neither retained nor transferred substantially all of the risks and rewards, but has transferred control.

 

Financial liabilities are derecognised when they are extinguished (ie when the obligation is discharged),discharged, cancelled or expire.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2: ACCOUNTING POLICIES continuedexpires.

 

(1) FINANCIAL INSTRUMENTS MEASURED AT AMORTISED COST

Financial assets that are held to collect contractual cash flows where those cash flows represent solely payments of principal and interest are measured at amortised cost. A basic lending arrangement results in contractual cash flows that are solely payments of principal and interest on the principal amount outstanding. Where the contractual cash flows introduce exposure to risks or volatility unrelated to a basic lending arrangement such as changes in equity prices or commodity prices, the payments do not comprise solely principal and interest. Financial assets measured at amortised cost are predominantly loans and advances to customers and banks together with certain debt securities. Loans and advances are initially recognised when cash is advanced to the borrower at fair value inclusive of transaction costs. Interest income is accounted for using the effective interest method (see (D) above).

Financial liabilities are measured at amortised cost, except for trading liabilities and other financial liabilities designated at fair value through profit or loss on initial recognition which are held at fair value.

(2) FINANCIAL ASSETS MEASURED AT FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME

Financial assets that are held to collect contractual cash flows and for subsequent sale, where the assets’ cash flows represent solely payments of principal and interest, are recognised in the balance sheet at their fair value, inclusive of transaction costs. Interest calculated using the effective interest method and foreign exchange gains and losses on assets denominated in foreign currencies are recognised in the income statement. All other gains and losses arising from changes in fair value are recognised directly in other comprehensive income, until the financial asset is either sold or matures, at which time the cumulative gain or loss previously recognised in other comprehensive income is recognised in the income statement other than in respect of equity shares, for which the cumulative revaluation amount is transferred directly to retained profits. The Group recognises a charge for expected credit losses in the income statement (see (H) below). As the asset is measured at fair value, the charge does not adjust the carrying value of the asset, it is reflected in other comprehensive income.

(3) FINANCIAL INSTRUMENTS MEASURED AT FAIR VALUE THROUGH PROFIT OR LOSS

 

Financial instrumentsassets are classified at fair value through profit or loss where they are trading securitiesdo not meet the criteria to be measured at amortised cost or fair value through other comprehensive income or where they are designated at fair value through profit or loss by management. Derivativesto reduce an accounting mismatch. All derivatives are carried at fair value (see (F) below).through profit or loss.

 

TradingThe assets backing the insurance and investment contracts issued by the Group do not meet the criteria to be measured at amortised cost or fair value through other comprehensive income as they are managed on a fair value basis and accordingly are measured at fair value through profit or loss. Similarly, trading securities, which are debt securities and equity shares acquired principally for the purpose of selling in the short term or which are part of a portfolio which is managed for short-term gains. Such securitiesgains, do not meet these criteria and are classified as trading securities andalso measured at fair value through profit or loss. Financial assets measured at fair value through profit or loss are recognised in the balance sheet at their fair value. GainsFair value gains and losses arising from changes in their fair value together with interest coupons and dividend income are recognised in the income statement within net trading income in the period in which they occur.income.

 

Other financialFinancial liabilities are measured at fair value through profit or loss where they are trading liabilities or where they are designated at fair value through profit or loss in order to reduce an accounting mismatch; where the liabilities are part of a group of liabilities (or assets and liabilities) which is managed, and its performance evaluated, on a fair value basis; or where the liabilities contain one or more embedded derivatives that significantly modify the cash flows arising under the contract and would otherwise need to be separately accounted for. Financial liabilities measured at fair value through profit or loss are designated as such by management upon initial recognition. Such assets and liabilities are carriedrecognised in the balance sheet at their fair value. Fair value and gains and losses arising from changes in fair value together with interest coupons and dividend income are recognised in the income statement within net trading income in the period in which they occur. Financial assetsoccur, except that gains and liabilitieslosses attributable to changes in own credit risk are designated at fair value through profit or loss on acquisitionrecognised in the following circumstances:other comprehensive income.

–it eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets and liabilities or recognising gains or losses on different bases. The main type of financial assets designated by the Group at fair value through profit or loss are assets backing insurance contracts and investment contracts issued by the Group’s life insurance businesses. Fair value designation allows changes in the fair value of these assets to be recorded in the income statement along with the changes in the value of the associated liabilities, thereby significantly reducing the measurement inconsistency had the assets been classified as available-for-sale financial assets.
–the assets and liabilities are part of a group which is managed, and its performance evaluated, on a fair value basis in accordance with a documented risk management or investment strategy, with management information also prepared on this basis. As noted in (A)(2) above certain of the Group’s investments are managed as venture capital investments and evaluated on the basis of their fair value and these assets are designated at fair value through profit or loss.
–where the assets and liabilities contain one or more embedded derivatives that significantly modify the cash flows arising under the contract and would otherwise need to be separately accounted for.

 

The fair values of assets and liabilities traded in active markets are based on current bid and offer prices respectively. If the market is not active the Group establishes a fair value by using valuation techniques. These include the useThe fair values of recent arm’s length transactions, referencederivative financial instruments are adjusted where appropriate to other instruments that are substantially the same, discounted cash flow analysis, option pricing modelsreflect credit risk (via credit valuation adjustments (CVAs), debit valuation adjustments (DVAs) and funding valuation adjustments (FVAs)), market liquidity and other valuation techniques commonly used by market participants. Refer to note 3 (Critical accounting estimates and judgements: Fair value of financial instruments) and note 50(3) (Financial instruments: Financial assets and liabilities carried at fair value) for details of valuation techniques and significant inputs to valuation models.

The Group is permitted to reclassify, at fair value at the date of transfer, non-derivative financial assets (other than those designated at fair value through profit or loss by the entity upon initial recognition) out of the trading category if they are no longer held for the purpose of being sold or repurchased in the near term, as follows:

–if the financial assets would have met the definition of loans and receivables (but for the fact that they had to be classified as held for trading at initial recognition), they may be reclassified into loans and receivables where the Group has the intention and ability to hold the assets for the foreseeable future or until maturity; or
–if the financial assets would not have met the definition of loans and receivables, they may be reclassified out of the held for trading category into available-for-sale financial assets in ‘rare circumstances’.

(2) AVAILABLE-FOR-SALE FINANCIAL ASSETS

Debt securities and equity shares that are not classified as trading securities, at fair value through profit or loss, held-to-maturity investments or as loans and receivables are classified as available-for-sale financial assets and are recognised in the balance sheet at their fair value, inclusive of transaction costs. Available-for-sale financial assets are those intended to be held for an indeterminate period of time and may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. Gains and losses arising from changes in the fair value of investments classified as available-for-sale are recognised directly in other comprehensive income, until the financial asset is either sold, becomes impaired or matures, at which time the cumulative gain or loss previously recognised in other comprehensive income is recognised in the income statement. Interest calculated using the effective interest method and foreign exchange gains and losses on debt securities denominated in foreign currencies are recognised in the income statement.

The Group is permitted to transfer a financial asset from the available-for-sale category to the loans and receivables category where that asset would have met the definition of loans and receivables at the time of reclassification (if the financial asset had not been classified as available-for-sale) and where there is both the intention and ability to hold that financial asset for the foreseeable future. Reclassification of a financial asset from the available-for-sale category to the held-to-maturity category is permitted when the Group has the ability and intent to hold that financial asset to maturity.

Reclassifications are made at fair value as of the reclassification date. Fair value becomes the new cost or amortised cost as applicable. Effective interest rates for financial assets reclassified to the loans and receivables and held-to-maturity categories are determined at the reclassification date. Any previous gain or loss on a transferred asset that has been recognised in equity is amortised to profit or loss over the remaining life of the investment using the effective interest method or until the asset becomes impaired. Any difference between the new amortised cost and the expected cash flows is also amortised over the remaining life of the asset using the effective interest method.

When an impairment loss is recognised in respect of available-for-sale assets transferred, the unamortised balance of any available-for-sale reserve that remains in equity is transferred to the income statement and recorded as part of the impairment loss.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2: ACCOUNTING POLICIES continued

(3) LOANS AND RECEIVABLES

Loans and receivables include loans and advances to banks and customers and eligible assets including those transferred into this category out of the fair value through profit or loss or available-for-sale financial assets categories. Loans and receivables are initially recognised when cash is advanced to the borrowers at fair value inclusive of transaction costs or, for eligible assets transferred into this category, their fair value at the date of transfer. Financial assets classified as loans and receivables are accounted for at amortised cost using the effective interest method (see (D) above) less provision for impairment (see (H) below).

The Group has entered into securitisation and similar transactions to finance certain loans and advances to customers. In cases where the securitisation vehicles are funded by the issue of debt, on terms whereby the majority of the risks and rewards of the portfolio of securitised lending are retained by the Group, these loans and advances continue to be recognised by the Group, together with a corresponding liability for the funding.risks.

 

(4) HELD-TO-MATURITY INVESTMENTS

Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group’s management has the positive intention and ability to hold to maturity other than:

–those that the Group designates upon initial recognition as at fair value through profit or loss;
–those that the Group designates as available-for-sale; and
–those that meet the definition of loans and receivables.

These are initially recognised at fair value including direct and incremental transaction costs and measured subsequently at amortised cost, using the effective interest method, less any provision for impairment.

A sale or reclassification of a more than insignificant amount of held-to-maturity investments would result in the reclassification of all held-to-maturity investments to available-for-sale financial assets.

(5) BORROWINGS

 

Borrowings (which include deposits from banks, customer deposits, debt securities in issue and subordinated liabilities) are recognised initially at fair value, being their issue proceeds net of transaction costs incurred. These instruments are subsequently stated at amortised cost using the effective interest method.

 

Preference shares and other instruments which carry a mandatory coupon or are redeemable on a specific date are classified as financial liabilities. The coupon on these instruments is recognised in the income statement as interest expense.

Securities which carry a discretionary coupon and have no fixed maturity or redemption date are classified as other equity instruments. Interest payments on these securities are recognised, net of tax, as distributions from equity in the period in which they are paid.

An exchange of financial liabilities on substantially different terms is accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. The difference between the carrying amount of a financial liability extinguished and the new financial liability is recognised in profit or loss together with any related costs or fees incurred.

 

When a financial liability is exchanged for an equity instrument, the new equity instrument is recognised at fair value and any difference between the original carrying value of the liability and the fair value of the new equity is recognised in the profit or loss.

F-12

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(6)NOTE 2: ACCOUNTING POLICIEScontinued

(5) SALE AND REPURCHASE AGREEMENTS (INCLUDING SECURITIES LENDING AND BORROWING)

 

Securities sold subject to repurchase agreements (repos) continue to be recognised on the balance sheet where substantially all of the risks and rewards are retained. Funds received under these arrangements are included in deposits from banks, customer deposits, or trading liabilities. Conversely, securities purchased under agreements to resell (reverse repos), where the Group does not acquire substantially all of the risks and rewards of ownership, are recorded as loans and receivablesadvances measured at amortised cost or trading securities. The difference between sale and repurchase price is treated as interest and accrued over the life of the agreements using the effective interest method.

 

Securities borrowing and lending transactions are typically secured; collateral takes the form of securities or cash advanced or received. Securities lent to counterparties are retained on the balance sheet. Securities borrowed are not recognised on the balance sheet, unless these are sold to third parties, in which case the obligation to return them is recorded at fair value as a trading liability. Cash collateral given or received is treated as a loan and receivableadvance measured at amortised cost or customer deposit.

 

(F) DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGE ACCOUNTINGDerivative financial instruments and hedge accounting

 

As permitted by IFRS 9, the Group continues to apply the requirements of IAS 39 to its hedging relationships. All derivatives are recognised at their fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and using valuation techniques, including discounted cash flow and option pricing models, as appropriate. Derivatives are carried inon the balance sheet as assets when their fair value is positive and as liabilities when their fair value is negative. Refer to note 3 (Critical accounting estimates and judgements: Fair value of financial instruments) and note 50(3)49(3) (Financial instruments: Financial assets and liabilities carried at fair value) for details of valuation techniques and significant inputs to valuation models.

 

Changes in the fair value of anyall derivative instrument that is not part of ainstruments, other than those in effective cash flow and net investment hedging relationshiprelationships, are recognised immediately in the income statement. As noted in (2) and (3) below, the change in fair value of a derivative in an effective cash flow or net investment hedging relationship is allocated between the income statement and other comprehensive income.

 

Derivatives embedded in a financial instrumentsasset are not considered separately; the financial asset is considered in its entirety when determining whether its cash flows are solely payments of principal and interest. Derivatives embedded in financial liabilities and insurance contracts (unless the embedded derivative is itself an insurance contract) are treated as separate derivatives when their economic characteristics and risks are not closely related to those of the host contract and the host contract is not carried at fair value through profit or loss. These embedded derivatives are measured at fair value with changes in fair value recognised in the income statement. In accordance with IFRS 4Insurance Contracts,, a policyholder’s option to surrender an insurance contract for a fixed amount is not treated as an embedded derivative.

 

The method of recognising the movements in the fair value of derivatives depends on whether they are designated as hedging instruments and, if so, the nature of the item being hedged. Hedge accounting allows one financial instrument, generally a derivative such as a swap, to be designated as a hedge of another financial instrument such as a loan or deposit or a portfolio of such instruments. At the inception of the hedge relationship, formal documentation is drawn up specifying the hedging strategy, the hedged item, the hedging instrument and the methodology that will be used to measure the effectiveness of the hedge relationship in offsetting changes in the fair value or cash flow of the hedged risk. The effectiveness of the

F-14

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2: ACCOUNTING POLICIES continued

hedging relationship is tested both at inception and throughout its life and if at any point it is concluded that it is no longer highly effective in achieving its documented objective, hedge accounting is discontinued.

The Group designates certain derivatives as either: (1) hedges Note 17 provides details of the fair valuetypes of derivatives held by the particular risks inherentGroup and presents separately those designated in recognised assets or liabilities (fair value hedges); (2) hedges of highly probable future cash flows attributable to recognised assets or liabilities (cash flow hedges); or (3) hedges of net investments in foreign operations (net investment hedges). These are accounted for as follows:hedge relationships. Further information on hedge accounting is set out below.

 

(1) FAIR VALUE HEDGES

 

Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk; this also applies if the hedged asset is classified as an available-for-salea financial asset.asset at fair value through other comprehensive income. If the hedge no longer meets the criteria for hedge accounting, changes in the fair value of the hedged item attributable to the hedged risk are no longer recognised in the income statement. The cumulative adjustment that has been made to the carrying amount of the hedged item is amortised to the income statement using the effective interest method over the period to maturity.

 

(2) CASH FLOW HEDGES

 

The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in other comprehensive income in the cash flow hedge reserve. The gain or loss relating to the ineffective portion is recognised immediately in the income statement. Amounts accumulated in equity are reclassified to the income statement in the periods in which the hedged item affects profit or loss. When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity and is recognised in the income statement when the forecast transaction is ultimately recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in equity is immediately transferred to the income statement.

 

(3) NET INVESTMENT HEDGES

 

Hedges of net investments in foreign operations are accounted for similarly to cash flow hedges. Any gain or loss on the hedging instrument relating to the effective portion of the hedge is recognised in other comprehensive income, the gain or loss relating to the ineffective portion is recognised immediately in the income statement. Gains and losses accumulated in equity are included in the income statement when the foreign operation is disposed of. The hedging instrument used in net investment hedges may include non-derivative liabilities as well as derivative financial instruments.

 

(G) OFFSETOffset

 

Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right of set-off and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously. Cash collateral on exchange traded derivative transactions is presented gross unless the collateral cash flows are always settled net with the derivative cash flows. In certain situations, even though master netting agreements exist, the lack of management intention to settle on a net basis results in the financial assets and liabilities being reported gross on the balance sheet.

 

(H) IMPAIRMENT OF FINANCIAL ASSETSImpairment of financial assets

 

(1) ASSETS ACCOUNTED FOR AT AMORTISED COST

At each balance sheet dateThe impairment charge in the income statement includes the change in expected credit losses and certain fraud costs. Expected credit losses are recognised for loans and advances to customers and banks, other financial assets held at amortised cost, financial assets measured at fair value through other comprehensive income, and certain loan commitments and financial guarantee contracts. Expected credit losses are calculated as an unbiased and probability-weighted estimate using an appropriate probability of default, adjusted to take into account a range of possible future economic scenarios, and applying this to the estimated exposure of the Group assesses whether, as a resultat the point of one or more events occurringdefault after initial recognition oftaking into account the financial asset and prior to the balance sheet date, there is objective evidence that a financial asset or group of financial assets has become impaired.

Where such an event has had an impact on the estimated future cash flows of the financial asset or group of financial assets, an impairment allowance is recognised. The amount of impairment allowance is the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted atany collateral held, repayments, or other mitigants of loss and including the asset’s original effective interest rate. Ifimpact of discounting using the asset has a variable rate of interest, the discount rate used for measuring the impairment allowance is the current effective interest rate.

 

Subsequent toAt initial recognition, allowance (or provision in the recognitioncase of an impairment loss onsome loan commitments and financial guarantees) is made for expected credit losses resulting from default events that are possible within the next 12 months (12-month expected credit losses). In the event of a financial asset or a group of financial assets, interest income continues to be recognised on an effective interest rate basis, onsignificant increase in credit risk since origination, allowance (or provision) is made for expected credit losses resulting from all possible default events over the asset’s carrying value net of impairment provisions. If, in a subsequent period, the amountexpected life of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised, such as an improvement in the borrower’s credit rating, the allowance is adjusted and the amount of the reversal is recognised in the income statement.

Impairment allowances are assessed individually for financial assets that are individually significant. Such individual assessment is used primarily for the Group’s commercial lending portfolios. Impairment allowances for portfolios of smaller balance homogenous loans such as most residential mortgages, personal loans and credit card balances in the Group’s retail portfolios in both the Retail and Consumer Finance divisions that are below the individual assessment thresholds, and for loan losses that have been incurred but not separately identified at the balance sheet date, are determined on a collective basis.

INDIVIDUAL ASSESSMENT

In respect of individually significant financial assets in the Group’s commercial lending portfolios, assets are reviewed on a regular basis and those showing potential or actual vulnerability are placed on a watchlist where greater monitoring is undertaken and any adverse or potentially adverse impact on ability to repay is used in assessing whether an asset should be transferred to a dedicated Business Support Unit. Specific examples of trigger events that could lead to the initial recognition of impairment allowances against lending to corporate borrowers (or the recognition of additional impairment allowances) include (i) trading losses, loss of business or major customer of a borrower; (ii) material breaches of the terms and conditions of a loan facility, including non-payment of interest or principal, or a fall in the value of security such that it is no longer considered adequate; (iii) disappearance of an active market because of financial difficulties; or (iv) restructuring a facility with preferential terms to aid recovery of the lending (such as a debt for equity swap).

For such individually identified financial assets, a review is undertaken of the expected future cash flows which requires significant management judgement as to the amount and timing of such cash flows. Where the debt is secured, the assessment reflects the expected cash flows from the realisation of the security, net of costs to realise, whether or not foreclosure or realisation of the collateral is probable.

For impaired debt instruments which are held at amortised cost, impairment losses are recognised in subsequent periods when it is determined that there has been a further negative impact on expected future cash flows. A reduction in fair value caused by general widening of credit spreads would not, of itself, result in additional impairment.

F-15F-13
 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2: ACCOUNTING POLICIES continued

 

COLLECTIVE ASSESSMENT

Impairment is assessed oninstrument (lifetime expected credit losses). Financial assets where 12-month expected credit losses are recognised are considered to be Stage 1; financial assets which are considered to have experienced a collective basis for (1) homogenous groups of loans thatsignificant increase in credit risk since initial recognition are not considered individually impaired;in Stage 2; and (2) to cover lossesfinancial assets which have been incurred but have not yet been identified on loansdefaulted or are otherwise considered to be credit impaired are allocated to Stage 3. Some Stage 3 assets, mainly in Commercial Banking, are subject to individual impairment.rather than collective assessment. Such cases are subject to a risk-based impairment sanctioning process, and these are reviewed and updated at least quarterly, or more frequently if there is a significant change in the credit profile.

 

HOMOGENOUS GROUPS OF LOANS

An assessment of whether credit risk has increased significantly since initial recognition considers the change in the risk of default occurring over the remaining expected life of the financial instrument. The assessment is unbiased, probability-weighted and uses forward-looking information consistent with that used in the measurement of expected credit losses. In respectdetermining whether there has been a significant increase in credit risk, the Group uses quantitative tests based on relative and absolute probability of portfoliosdefault (PD) movements linked to internal credit ratings together with qualitative indicators such as watchlists and other indicators of smaller balance, homogenous loans,historical delinquency, credit weakness or financial difficulty. However, unless identified at an earlier stage, the credit risk of financial assets is deemed to have increased significantly when more than 30 days past due. Where the credit risk subsequently improves such that it no longer represents a significant increase in credit risk since origination, the asset is included in a group of financial assets with similar risk characteristics and collectively assessed for impairment. Segmentation takes into account factors such as the type of asset, industry sector, geographical location, collateral type, past-due status and other relevant factors. These characteristics are relevanttransferred back to the estimation of future cash flows for groups of such assets as they are indicative of the borrower’s ability to pay all amounts due according to the contractual terms of the assets being evaluated.Stage 1.

 

Generally, the impairment trigger used within the impairment calculation for a loan, or group of loans, isAssets are transferred to Stage 3 when they reach a pre-defined level of delinquencyhave defaulted or whereare otherwise considered to be credit impaired. Default is considered to have occurred when there is evidence that the customer is bankrupt. Loans where the Group provides arrangements that forgive a portion of interest or principal are also deemed to be impaired and loans that are originated to refinance currently impaired assets are also defined as impaired.

In respect of the Group’s secured mortgage portfolios, the impairment allowance is calculated based on a definition of impaired loansexperiencing financial difficulty which are those six months or more in arrears (or certain cases where the borrower is bankrupt or is in possession). The estimated cash flows are calculated based on historical experience and are dependent on estimates of the expected value of collateral which takes into account expected future movements in house prices, less costs to sell.

For unsecured personal lending portfolios, the impairment trigger is generally when the balance is two or more instalments in arrears or where the customer has exhibited one or more of the impairment characteristics set out above. While the trigger is based on the payment performance or circumstances of each individual asset, the assessment of future cash flows uses historical experience of cohorts of similar portfolios such that the assessment is considered to be collective. Future cash flows are estimated on the basis of the contractual cash flows of the assets in the cohort and historical loss experience for similar assets. Historical loss experience is adjusted on the basis of current observable data about economic and credit conditions (including unemployment rates and borrowers’ behaviour) to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not exist currently. The methodology and assumptions used for estimating future cash flows are reviewed regularly by the Group to reduce any differences between loss estimates and actual loss experience.

INCURRED BUT NOT YET IDENTIFIED IMPAIRMENT

The collective provision also includes provision for inherent losses, that is losses that have been incurred but have not been separately identified at the balance sheet date. The loans that are not currently recognised as impaired are grouped into homogenous portfolios by key risk drivers. Risk drivers for secured retail lending include the current indexed loan-to-value, previous mortgage arrears, internal cross-product delinquency data and external credit bureau data; for unsecured retail lending they include whether the account is up-to-date and, if not, the number of payments that have been missed; and for commercial lending they include factors such as observed default rates and loss given default. An assessment is made of the likelihood of each account becoming recognised as impaired within the loss emergence period, with the economic loss that each portfolio is likely to generate were itaffect significantly the ability to become impaired.repay the amount due. IFRS 9 contains a rebuttable presumption that default occurs no later than when a payment is 90 days past due. The loss emergence period is determined by local managementGroup uses this 90 day backstop for each portfolio andall its products except for UK mortgages. For UK mortgages, the Group hasuses a rangebackstop of loss emergence periods which are dependent upon180 days past due as mortgage exposures more than 90 days past due, but less than 180 days, typically show high cure rates and this aligns with the characteristics of the portfolios. Loss emergence periods are reviewed regularly and updated when appropriate. In general the periods used across the Group vary between one month and twelve months based on historical experience. Unsecured portfolios tend to have shorter loss emergence periods than secured portfolios.

LOAN RENEGOTIATIONS AND FORBEARANCEGroup’s risk management practices.

 

In certain circumstances, the Group will renegotiate the original terms of a customer’s loan, either as part of an ongoing customer relationship or in response to adverse changes in the circumstances of the borrower. WhereIn the renegotiated payments of interest and principallatter circumstances, the loan will not recoverremain classified as either Stage 2 or Stage 3 until the original carrying value of the asset, the asset continuescredit risk has improved such that it no longer represents a significant increase since origination (for a return to be reported as past due and is considered impaired. Where the renegotiated payments of interest and principal will recover the original carrying value of the asset,Stage 1), or the loan is no longer reported as past due orcredit impaired provided that payments are made in accordance with the revised terms.(for a return to Stage 2). Renegotiation may also lead to the loan and associated provisionallowance being derecognised and a new loan being recognised initially at fair value.

 

WRITE OFFSPurchased or originated credit-impaired financial assets (POCI) are financial assets that are purchased or originated at a deep discount that reflects incurred credit losses. At initial recognition, POCI assets do not carry an impairment allowance; instead, lifetime expected credit losses are incorporated into the calculation of the effective interest rate. All changes in lifetime expected credit losses subsequent to the assets’ initial recognition are recognised as an impairment charge.

 

A loan or advance is normally written off, either partially or in full, against the related allowance when the proceeds from realising any available security have been received or there is no realistic prospect of recovery and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off decrease the amount of impairment losses recorded in the income statement. For both secured and unsecured retail balances, the write-off takes place only once an extensive set of collections processes has been completed, or the status of the account reaches a point where policy dictates that forbearance iscontinuing attempts to recover are no longer appropriate. For commercial lending, a write-off occurs if the loan facility with the customer is restructured, the asset is under administration and the only monies that can be received are the amounts estimated by the administrator, the underlying assets are disposed and a decision is made that no further settlement monies will be received, or external evidence (for example, third party valuations) is available that there has been an irreversible decline in expected cash flows.

 

DEBT FOR EQUITY EXCHANGES

Equity securities acquired in exchange for loans in order to achieve an orderly realisation are accounted for as a disposal of the loan(I) Property, plant and an acquisition of equity securities, held as available-for-sale. Where control is obtained over an entity as a result of the transaction, the entity is consolidated; where the Group has significant influence over an entity as a result of the transaction, the investment is accounted for by the equity method of accounting (see (A) above). Any subsequent impairment of the assets or business acquired is treated as an impairment of the relevant asset or business and not as an impairment of the original instrument.

(2) AVAILABLE-FOR-SALE FINANCIAL ASSETS

The Group assesses, at each balance sheet date, whether there is objective evidence that an available-for-sale financial asset is impaired. In addition to the criteria for financial assets accounted for at amortised cost set out above, this assessment involves reviewing the current financial circumstances (including creditworthiness) and future prospects of the issuer, assessing the future cash flows expected to be realised and, in the case of equity shares, considering whether there has been a significant or prolonged decline in the fair value of the asset below its cost. If an impairment loss has been incurred, the cumulative loss measured as the difference between the acquisition cost (net of any principal repayment and amortisation) and the current

F-16

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2: ACCOUNTING POLICIES continued

fair value, less any impairment loss on that asset previously recognised, is reclassified from equity to the income statement. For impaired debt instruments, impairment losses are recognised in subsequent periods when it is determined that there has been a further negative impact on expected future cash flows; a reduction in fair value caused by general widening of credit spreads would not, of itself, result in additional impairment. If, in a subsequent period, the fair value of a debt instrument classified as available-for-sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised, an amount not greater than the original impairment loss is credited to the income statement; any excess is taken to other comprehensive income. Impairment losses recognised in the income statement on equity instruments are not reversed through the income statement.

(I) PROPERTY, PLANT AND EQUIPMENTequipment

 

Property, plant and equipment (other than investment property) is included at cost less accumulated depreciation. The value of land (included in premises) is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate the difference between the cost and the residual value over their estimated useful lives, as follows: the shorter of 50 years and the remaining period of the lease for freehold/long and short leasehold premises; the shorter of 10 years and, if lease renewal is not likely, the remaining period of the lease for leasehold improvements; 10 to 20 years for fixtures and furnishings; and 2 to 8 years for other equipment and motor vehicles.

Premises (excluding land):

–Freehold/long and short leasehold premises: shorter of 50 years and the remaining period of the lease.
–Leasehold improvements: shorter of 10 years and, if lease renewal is not likely, the remaining period of the lease.
–Equipment:
–Fixtures and furnishings: 10-20 years.
–Other equipment and motor vehicles: 2-8 years.

 

The assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.

 

Assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. In the event that an asset’s carrying amount is determined to be greater than its recoverable amount it is written down immediately. The recoverable amount is the higher of the asset’s fair value less costs to sell and its value in use.

 

Investment property comprises freehold and long leasehold land and buildings that are held either to earn rental income or for capital accretion or both, primarily within the life insurance funds. In accordance with the guidance published by the Royal Institution of Chartered Surveyors, investment property is carried at fair value based on current prices for similar properties, adjusted for the specific characteristics of the property (such as location or condition). If this information is not available, the Group uses alternative valuation methods such as discounted cash flow projections or recent prices in less active markets. These valuations are reviewed at least annually by independent professionally qualified valuers. Investment property being redeveloped for continuing use as investment property, or for which the market has become less active, continues to be valued at fair value. For investment property under construction, the value on disposal is considered to be at the point at which the property is fully constructed. Adjustments are made for the costs and risks associated with construction. Investment property under construction for which fair value is not yet reliably measurable is valued at cost, until the fair value can be reliably measured. Changes in fair value are recognised in the income statement as net trading income.

 

(J) LEASESLeases

 

(1) AS LESSEE

 

The leases entered into by the Group are primarily operating leases. Operating lease rentals payable are charged to the income statement on a straight-line basis over the period of the lease.

 

When an operating lease is terminated before the end of the lease period, any payment made to the lessor by way of penalty is recognised as an expense in the period of termination.

 

(2) AS LESSOR

 

Assets leased to customers are classified as finance leases if the lease agreements transfer substantially all the risks and rewards of ownership to the lessee but not necessarily legal title. All other leases are classified as operating leases. When assets are subject to finance leases, the present value of the lease payments, together with any unguaranteed residual value, is recognised as a receivable, net of provisions,allowances for expected credit losses, within loans and advances to banks and customers. The difference between the gross receivable and the present value of the receivable is recognised as unearned finance lease income. Finance lease income is recognised in interest income over the term of the lease using the net investment method (before tax) so as to give a constant rate of return on the net investment in the leases. Unguaranteed residual values are reviewed regularly to identify any impairment.

 

Operating lease assets are included within tangible fixed assets at cost and depreciated over their estimated useful lives, which equates to the lives of the leases, after taking into account anticipated residual values. Operating lease rental income is recognised on a straight-line basis over the life of the lease.

 

The Group evaluates non-lease arrangements such as outsourcing and similar contracts to determine if they contain a lease which is then accounted for separately.

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NOTE 2: ACCOUNTING POLICIES continued

 

(K) EMPLOYEE BENEFITSEmployee benefits

 

Short-term employee benefits, such as salaries, paid absences, performance-based cash awards and social security costs are recognised over the period in which the employees provide the related services.

(1) PENSION SCHEMES

 

The Group operates a number of post-retirement benefit schemes for its employees including both defined benefit and defined contribution pension plans. A defined benefit scheme is a pension plan that defines an amount of pension benefit that an employee will receive on retirement, dependent on one or more factors such as age, years of service and salary. A defined contribution plan is a pension plan into which the Group pays fixed contributions; there is no legal or constructive obligation to pay further contributions.

 

Full actuarial valuations of the Group’s principal defined benefit schemes are carried out every three years with interim reviews in the intervening years; these valuations are updated to 31 December each year by qualified independent actuaries. For the purposes of these annual updates schemeScheme assets

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NOTE 2: ACCOUNTING POLICIES continued

are included at their fair value and scheme liabilities are measured on an actuarial basis using the projected unit credit method. The defined benefit scheme liabilities are discounted using rates equivalent to the market yields at the balance sheet date on high-quality corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating to the terms of the related pension liability. The Group’s income statement charge includes the current service cost of providing pension benefits, past service costs, net interest expense (income), and plan administration costs that are not deducted from the return on plan assets. Past service costs, which represents the change in the present value of the defined benefit obligation resulting from a plan amendment or curtailment, are recognised when the plan amendment or curtailment occurs. Net interest expense (income) is calculated by applying the discount rate at the beginning of the period to the net defined benefit liability or asset.

 

Remeasurements, comprising actuarial gains and losses, the return on plan assets (excluding amounts included in net interest expense (income) and net of the cost of managing the plan assets), and the effect of changes to the asset ceiling (if applicable) are reflected immediately in the balance sheet with a charge or credit recognised in other comprehensive income in the period in which they occur. Remeasurements recognised in other comprehensive income are reflected immediately in retained profits and will not subsequently be reclassified to profit or loss.

 

The Group’s balance sheet includes the net surplus or deficit, being the difference between the fair value of scheme assets and the discounted value of scheme liabilities at the balance sheet date. Surpluses are only recognised to the extent that they are recoverable through reduced contributions in the future or through refunds from the schemes. In assessing whether a surplus is recoverable, the Group considers its current right to obtain a refund or a reduction in future contributions and does not anticipate any future acts by other parties that could change the amount of the surplus that may ultimately be recovered.

 

The costs of the Group’s defined contribution plans are charged to the income statement in the period in which they fall due.

 

The accounting for share-based compensation is set out in (L) below.

(L)(2) SHARE-BASED COMPENSATION

 

The Group operates a number of equity-settled, share-based compensation plans in respect of services received from certain of its employees. The value of the employee services received in exchange for equity instruments granted under these plans is recognised as an expense over the vesting period of the instruments, with a corresponding increase in equity. This expense is determined by reference to the fair value of the number of equity instruments that are expected to vest. The fair value of equity instruments granted is based on market prices, if available, at the date of grant. In the absence of market prices, the fair value of the instruments at the date of grant is estimated using an appropriate valuation technique, such as a Black-Scholes option pricing model or a Monte Carlo simulation. The determination of fair values excludes the impact of any non-market vesting conditions, which are included in the assumptions used to estimate the number of options that are expected to vest. At each balance sheet date, this estimate is reassessed and if necessary revised. Any revision of the original estimate is recognised in the income statement, together with a corresponding adjustment to equity. Cancellations by employees of contributions to the Group’s Save As You Earn plans are treated as non-vesting conditions and the Group recognises, in the year of cancellation, the amount of the expense that would have otherwise been recognised over the remainder of the vesting period. Modifications are assessed at the date of modification and any incremental charges are charged to the income statement.

 

(M) TAXATION(L) Taxation

Tax expense comprises current and deferred tax. Current and deferred tax are charged or credited in the income statement except to the extent that the tax arises from a transaction or event which is recognised, in the same or a different period, outside the income statement (either in other comprehensive income, directly in equity, or through a business combination), in which case the tax appears in the same statement as the transaction that gave rise to it.

 

Current tax is the amount of corporate income tax which istaxes expected to be payable or recoverable based on taxable profits is recognised as an expense inthe profit for the period as adjusted for items that are not taxable or not deductible, and is calculated using tax rates and laws that were enacted or substantively enacted at the balance sheet date.

Current tax includes amounts provided in whichrespect of uncertain tax positions when management expects that, upon examination of the profits arise.uncertainty by Her Majesty’s Revenue and Customs (HMRC) or other relevant tax authority, it is more likely than not that an economic outflow will occur. Provisions reflect management’s best estimate of the ultimate liability based on their interpretation of tax law, precedent and guidance, informed by external tax advice as necessary. Changes in facts and circumstances underlying these provisions are reassessed at each balance sheet date, and the provisions are re-measured as required to reflect current information.

 

For the Group’s long-term insurance businesses, the tax chargeexpense is analysed between tax that is payable in respect of policyholders’ returns and tax that is payable on the shareholders’ returns. This allocation is based on an assessment of the rates of tax which will be applied to the returns under the current UK tax rules.

 

Deferred tax is provided in full, using the liability method,recognised on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. However, deferred tax is not accounted for if it arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss.balance sheet. Deferred tax is determinedcalculated using tax rates and laws that have been enacted or substantively enacted byat the balance sheet date, and which are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled.

 

Deferred tax assetsliabilities are generally recognised for all taxable temporary differences but not recognised for taxable temporary differences arising on investments in subsidiaries where the reversal of the temporary difference can be controlled and it is probable that future taxable profitthe difference will be available against whichnot reverse in the foreseeable future. Deferred tax liabilities are not recognised on temporary differences can be utilised. Incomethat arise from goodwill which is not deductible for tax payable on profits is recognised as an expense in the period in which those profits arise. Thepurposes.

Deferred tax effects of losses available for carry forwardassets are recognised as an asset whento the extent it is probable that future taxable profits will be available against which these lossesthe deductible temporary differences can be utilised. Deferredutilised, and current tax related to gainsare reviewed at each balance sheet date and losses on the fair value re-measurement of available-for-sale investments and cash flow hedges, where these gains and losses are recognised in other comprehensive income, is also recognised in other comprehensive income. Such tax is subsequently transferredreduced to the income statement together withextent that it is no longer probable that sufficient taxable profits will be available to allow all or part of the gain or loss.asset to be recovered.

 

Deferred and current tax assets and liabilities are offset when theynot recognised in respect of temporary differences that arise on initial recognition of assets and liabilities acquired other than in the samea business combination. Deferred tax reporting group and where there is both a legal right of offset and the intention to settle on a net basis or to realise the asset and settle the liability simultaneously.not discounted.

F-15

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(N) INSURANCENOTE 2: ACCOUNTING POLICIES continued

(M) Insurance

 

The Group undertakes both life insurance and general insurance business. Insurance and participating investment contracts are accounted for under IFRS 4Insurance Contracts, which permits (with certain exceptions) the continuation of accounting practices for measuring insurance and participating investment contracts that applied prior to the adoption of IFRS. The Group, therefore, continues to account for these products using UK GAAP including FRS 27Life Assurance, and UK established practice.

 

Products sold by the life insurance business are classified into three categories:

 

–Insurance contracts – these contracts transfer significant insurance risk and may also transfer financial risk. The Group defines significant insurance risk as the possibility of having to pay benefits on the occurrence of an insured event which are significantly more than the benefits payable if the insured event were not to occur. These contracts may or may not include discretionary participation features.
F-18
 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2: ACCOUNTING POLICIES continued

–Investment contracts containing a discretionary participation feature (participating investment contracts) – these contracts do not transfer significant insurance risk, but contain a contractual right which gives the holder the right to receive, in addition to the guaranteed benefits, further additional discretionary benefits or bonuses that are likely to be a significant proportion of the total contractual benefits and the amount and timing of which is at the discretion of the Group, within the constraints of the terms and conditions of the instrument and based upon the performance of specified assets.
  
–Non-participating investment contracts – these contracts do not transfer significant insurance risk or contain a discretionary participation feature.

 

The general insurance business issues only insurance contracts.

 

1)(1) LIFE INSURANCE BUSINESS

 

(I) ACCOUNTING FOR INSURANCE AND PARTICIPATING INVESTMENT CONTRACTS

 

PREMIUMS AND CLAIMSPremiums and claims

Premiums received in respect of insurance and participating investment contracts are recognised as revenue when due except for unit-linked contracts on which premiums are recognised as revenue when received. Claims are recorded as an expense on the earlier of the maturity date or the date on which the claim is notified.

 

LIABILITIESLiabilities

Changes in the value of liabilities are recognised in the income statement through insurance claims.

 

–Insurance and participating investment contracts in the Group’s with-profit funds

Liabilities of the Group’s with-profit funds, including guarantees and options embedded within products written by these funds, are stated at their realistic values in accordance with the Prudential Regulation Authority’s realistic capital regime, except that projected transfers out of the funds into other Group funds are recorded in the unallocated surplus (see below). Changes in the value of these liabilities are recognised in the income statement through insurance claims.

 

–Insurance and participating investment contracts which are not unit-linked or in the Group’s with-profit funds

A liability for contractual benefits that are expected to be incurred in the future is recorded when the premiums are recognised. The liability is calculated by estimating the future cash flows over the duration of in-force policies and discounting them back to the valuation date allowing for probabilities of occurrence. The liability will vary with movements in interest rates and with the cost of life insurance and annuity benefits where future mortality is uncertain.

 

Assumptions are made in respect of all material factors affecting future cash flows, including future interest rates, mortality and costs.

 

Changes in the value of these liabilities are recognised in the income statement through insurance claims.

–Insurance and participating investment contracts which are unit-linked

Liabilities for unit-linked insurance contracts and participating investment contracts are stated at the bid value of units plus an additional allowance where appropriate (such as for any excess of future expenses over charges). The liability is increased or reduced by the change in the unit prices and is reduced by policy administration fees, mortality and surrender charges and any withdrawals. Changes in the value of the liability are recognised in the income statement through insurance claims. Benefit claims in excess of the account balances incurred in the period are also charged through insurance claims. Revenue consists of fees deducted for mortality, policy administration and surrender charges.

 

UNALLOCATED SURPLUSUnallocated surplus

Any amounts in the with-profit funds not yet determined as being due to policyholders or shareholders are recognised as an unallocated surplus which is shown separately from liabilities arising from insurance contracts and participating investment contracts.

 

(II) ACCOUNTING FOR NON-PARTICIPATING INVESTMENT CONTRACTS

The Group’s non-participating investment contracts are primarily unit-linked. These contracts are accounted for as financial liabilities whose value is contractually linked to the fair values of financial assets within the Group’s unitised investment funds. The value of the unit-linked financial liabilities is determined using current unit prices multiplied by the number of units attributed to the contract holders at the balance sheet date. Their value is never less than the amount payable on surrender, discounted for the required notice period where applicable. Investment returns (including movements in fair value and investment income) allocated to those contracts are recognised in the income statement through insurance claims.

 

Deposits and withdrawals are not accounted for through the income statement but are accounted for directly in the balance sheet as adjustments to the non-participating investment contract liability.

 

The Group receives investment management fees in the form of an initial adjustment or charge to the amount invested. These fees are in respect of services rendered in conjunction with the issue and management of investment contracts where the Group actively manages the consideration received from its customers to fund a return that is based on the investment profile that the customer selected on origination of the contract. These services comprise an indeterminate number of acts over the lives of the individual contracts and, therefore, the Group defers these fees and recognises them over the estimated lives of the contracts, in line with the provision of investment management services.

 

Costs which are directly attributable and incremental to securing new non-participating investment contracts are deferred. This asset is subsequently amortised over the period of the provision of investment management services and its recoverability is reviewed for impairment in circumstances where its carrying amount may not be recoverable. If the asset is greater than its recoverable amount it is written down immediately through fee and commission expense in the income statement. All other costs are recognised as expenses when incurred.

 

(III) VALUE OF IN-FORCE BUSINESS

 

The Group recognises as an asset the value of in-force business in respect of insurance contracts and participating investment contracts. The asset represents the present value of the shareholders’ interest in the profits expected to emerge from those contracts written at the balance sheet date. This is determined after making appropriate assumptions about future economic and operating conditions such as future mortality and persistency rates and includes allowances for both non-market risk and for the realistic value of financial options and guarantees. Each cash flow is valued using the discount rate

F-16

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2: ACCOUNTING POLICIES continued

consistent with that applied to such a cash flow in the capital markets. The asset in the consolidated balance sheet is presented gross of attributable tax and movements in the asset are reflected within other operating income in the income statement.

F-19

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2: ACCOUNTING POLICIES continued

 

The Group’s contractual rights to benefits from providing investment management services in relation to non-participating investment contracts acquired in business combinations and portfolio transfers are measured at fair value at the date of acquisition. The resulting asset is amortised over the estimated lives of the contracts. At each reporting date an assessment is made to determine if there is any indication of impairment. Where impairment exists, the carrying value of the asset is reduced to its recoverable amount and the impairment loss recognised in the income statement.

 

(2) GENERAL INSURANCE BUSINESS

 

The Group both underwrites and acts as intermediary in the sale of general insurance products. Underwriting premiums are included in insurance premium income, net of refunds, in the period in which insurance cover is provided to the customer; premiums received relating to future periods are deferred in the balance sheet within liabilities arising from insurance contracts and participating investment contracts on a basis that reflects the length of time for which contracts have been in force and the projected incidence of risk over the term of the contract and only credited to the income statement when earned. Broking commission is recognised when the underwriter accepts the risk of providing insurance cover to the customer. Where appropriate, provision is made for the effect of future policy terminations based upon past experience.

 

The underwriting business makes provision for the estimated cost of claims notified but not settled and claims incurred but not reported at the balance sheet date. The provision for the cost of claims notified but not settled is based upon a best estimate of the cost of settling the outstanding claims after taking into account all known facts. In those cases where there is insufficient information to determine the required provision, statistical techniques are used which take into account the cost of claims that have recently been settled and make assumptions about the future development of the outstanding cases. Similar statistical techniques are used to determine the provision for claims incurred but not reported at the balance sheet date. Claims liabilities are not discounted.

 

(3) LIABILITY ADEQUACY TEST

 

At each balance sheet date liability adequacy tests are performed to ensure the adequacy of insurance and participating investment contract liabilities net of related deferred cost assets and value of in-force business. In performing these tests current best estimates of discounted future contractual cash flows and claims handling and policy administration expenses, as well as investment income from the assets backing such liabilities, are used. Any deficiency is immediately charged to the income statement, initially by writing off the relevant assets and subsequently by establishing a provision for losses arising from liability adequacy tests.

 

(4) REINSURANCE

 

Contracts entered into by the Group with reinsurers under which the Group is compensated for benefits payable on one or more contracts issued by the Group are recognised as assets arising from reinsurance contracts held. Where the underlying contracts issued by the Group are classified as insurance contracts and the reinsurance contract transfers significant insurance risk on those contracts to the reinsurer, the assets arising from reinsurance contracts held are classified as insurance contracts. Where the underlying contracts issued by the Group are classified as non-participating investment contracts and the reinsurance contract transfers financial risk on those contracts to the reinsurer, the assets arising from reinsurance contracts held are classified as non-participating investment contracts.

 

ASSETS ARISING FROM REINSURANCE CONTRACTS HELDAssets arising from reinsurance contracts held – CLASSIFIED AS INSURANCE CONTRACTSClassified as insurance contracts

Amounts recoverable from or due to reinsurers are measured consistently with the amounts associated with the reinsured contracts and in accordance with the terms of each reinsurance contract and are regularly reviewed for impairment. Premiums payable for reinsurance contracts are recognised as an expense when due within insurance premium income. Changes in the reinsurance recoverable assets are recognised in the income statement through insurance claims.

 

ASSETS ARISING FROM REINSURANCE CONTRACTS HELDAssets arising from reinsurance contracts held – CLASSIFIED AS NON-PARTICIPATING INVESTMENT CONTRACTSClassified as non-participating investment contracts

These contracts are accounted for as financial assets whose value is contractually linked to the fair values of financial assets within the reinsurers’ investment funds. Investment returns (including movements in fair value and investment income) allocated to these contracts are recognised in insurance claims. Deposits and withdrawals are not accounted for through the income statement but are accounted for directly in the balance sheet as adjustments to the assets arising from reinsurance contracts held.

 

(O) FOREIGN CURRENCY TRANSLATION(N) Foreign currency translation

 

Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (the functional currency). The consolidated financial statements are presented in sterling, which is the Company’s functional and presentation currency.

Foreign currency transactions are translated into the appropriate functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement, except when recognised in other comprehensive income as qualifying cash flow or net investment hedges. Non-monetary assets that are measured at fair value are translated using the exchange rate at the date that the fair value was determined. Translation differences on equities and similar non-monetary items held at fair value through profit and loss are recognised in profit or loss as part of the fair value gain or loss. Translation differences on available-for-sale non-monetary financial assets measured at fair value through other comprehensive income, such as equity shares, are included in the fair value reserve in equity unless the asset is a hedged item in a fair value hedge.

 

The results and financial position of all group entities that have a functional currency different from the presentation currency are translated into the presentation currency as follows: the assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on the acquisition of a foreign entity, are translated into sterling at foreign exchange rates ruling at the balance sheet date; and the income and expenses of foreign operations are translated into sterling at average exchange rates unless these do not approximate to the foreign exchange rates ruling at the dates of the transactions in which case income and expenses are translated at the dates of the transactions.

–The assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on the acquisition of a foreign entity, are translated into sterling at foreign exchange rates ruling at the balance sheet date.
–The income and expenses of foreign operations are translated into sterling at average exchange rates unless these do not approximate to the foreign exchange rates ruling at the dates of the transactions in which case income and expenses are translated at the dates of the transactions.

 

Foreign exchange differences arising on the translation of a foreign operation are recognised in other comprehensive income and accumulated in a separate component of equity together with exchange differences arising from the translation of borrowings and other currency instruments designated as hedges of such investments (see (F)(3) above). On disposal or liquidation of a foreign operation, the cumulative amount of exchange differences relating to that foreign operation are reclassified from equity and included in determining the profit or loss arising on disposal or liquidation.

F-20

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2: ACCOUNTING POLICIES continued

(P) PROVISIONS AND CONTINGENT LIABILITIES(O) Provisions and contingent liabilities

 

Provisions are recognised in respect of present obligations arising from past events where it is probable that outflows of resources will be required to settle the obligations and they can be reliably estimated.

F-17

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

The Group recognises provisions in respect of vacant leasehold property where the unavoidable costs of the present obligations exceed anticipated rental income.NOTE 2: ACCOUNTING POLICIES continued

 

Contingent liabilities are possible obligations whose existence depends on the outcome of uncertain future events or those present obligations where the outflows of resources are uncertain or cannot be measured reliably. Contingent liabilities are not recognised in the financial statements but are disclosed unless they are remote.

 

Provision is made for expected credit losses in respect of irrevocable undrawn loan commitments if it is probable that the facility will be drawn and result in the recognition of an asset at an amount less than the amount advanced.financial guarantee contracts (see (H) above).

 

(Q) SHARE CAPITAL

(1) SHARE ISSUE COSTS(P) Share capital

 

Incremental costs directly attributable to the issue of new shares or options or to the acquisition of a business are shown in equity as a deduction, net of tax, from the proceeds.

(2) DIVIDENDS

Dividends paid on the Group’s ordinary shares are recognised as a reduction in equity in the period in which they are paid.

(3) TREASURY SHARES

 

Where the Company or any member of the Group purchases the Company’s share capital, the consideration paid is deducted from shareholders’ equity as treasury shares until they are cancelled. Where suchcancelled; if these shares are subsequently sold or reissued, any consideration received is included in shareholders’ equity.

 

(R) CASH AND CASH EQUIVALENTS  (Q) Cash and cash equivalents

 

For the purposes of the cash flow statement, cash and cash equivalents comprise cash and non-mandatory balances with central banks and amounts due from banks with a maturity of less than three months.

 

NOTE 3: CRITICAL ACCOUNTING ESTIMATESJUDGEMENTS AND JUDGEMENTSESTIMATES

 

The preparation of the Group’s financial statements in accordance with IFRS requires management to make judgements, estimates and assumptions in applying the accounting policies that affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgements and assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.

 

The significant judgements made by management in applying the Group’s accounting policies and the key sources of estimation uncertainty in these financial statements, which together are deemed critical to the Group’s results and financial position, are as follows.follows:

 

ALLOWANCE FOR IMPAIRMENT LOSSES ON LOANS AND RECEIVABLESAllowance for impairment losses

 

At 31 December 2015 gross loans2018 the Group’s expected credit loss allowance was £3,362 million (1 January 2018: £3,533 million), of which £3,169 million (1 January 2018: £3,260 million) was in respect of drawn balances.

The calculation of the Group’s expected credit loss (ECL) allowances and receivables totalled £487,613 million (2014: £516,612 million)provisions against loan commitments and guarantees under IFRS 9 requires the Group to make a number of judgements, assumptions and estimates. The most significant are set out below.

DEFINITION OF DEFAULT

The probability of default (PD) of an exposure, both over a 12 month period and over its lifetime, is a key input to the measurement of the ECL allowance. Default has occurred when there is evidence that the customer is experiencing significant financial difficulty which impairment allowancesis likely to affect the ability to repay amounts due. The definition of £3,130 million (2014: £6,540 million) had been made (see note 21). The Group’s accounting policy for losses arising on financial assets classified as loans and receivablesdefault adopted by the Group is described in note 2(H)(1); this note also provides an overview Impairment of financial assets. The Group has rebutted the methodologies applied.presumption in IFRS 9 that default occurs no later than when a payment is 90 days past due for UK mortgages. As a result, approximately £0.6 billion of UK mortgages were classified as Stage 2 rather than Stage 3 at 31 December 2018; the impact on the Group’s ECL allowance was not material.

LIFETIME OF AN EXPOSURE

 

The PD of a financial asset is dependent on its expected life. A range of approaches, segmented by product type, has been adopted by the Group to estimate a product’s expected life. These include using the full contractual life and taking into account behavioural factors such as early repayments and refinancing. For non-revolving retail assets, the Group has assumed the expected life for each product to be the time taken for all significant losses to be observed and for a material proportion of the assets to fully resolve through either closure or write-off. For retail revolving products, the Group has considered the losses beyond the contractual term over which the Group is exposed to credit risk. For commercial overdraft facilities, the average behavioural life has been used. Changes to the assumed expected lives of the Group’s assets could have a material effect on the ECL allowance recognised by the Group.

SIGNIFICANT INCREASE IN CREDIT RISK

Performing assets are classified as either Stage 1 or Stage 2. An ECL allowance equivalent to 12 months expected losses is established against assets in Stage 1; assets classified as Stage 2 carry an ECL allowance equivalent to lifetime expected losses. Assets are transferred from Stage 1 to Stage 2 when there has been a significant increase in credit risk (SICR) since initial recognition.

The Group uses a quantitative test together with qualitative indicators to determine whether there has been a SICR for impairment losses on loans and receivables is management’s best estimate of losses incurredan asset. For retail, a deterioration in the portfolio atRetail Master Scale of four grades for credit cards, personal loans or overdrafts, three grades for personal mortgages, or two grades in the balance sheet date. In determiningCorporate Master Scale for UK motor finance accounts is treated as a SICR. For Commercial a doubling of PD with a minimum increase in PD of 1 per cent and a resulting change in the required level of impairment provisions, the Group uses the output from various statistical models. Management judgementunderlying grade is requiredtreated as a SICR. All financial assets are assumed to assess the robustness of the outputs from these models and, where necessary, make appropriate adjustments. Impairment allowanceshave suffered a SICR if they are made up of two components, those determined individually and those determined collectively.more than 30 days past due.

 

Individual impairment allowances are generally established againstThe setting of precise trigger points combined with risk indicators requires judgement. The use of different trigger points may have a material impact upon the Group’s commercial lending portfolios. The determination of individual impairment allowances requires the exercise of considerable judgement by management involving matters such as local economic conditions and the resulting trading performance of the customer, and the value of the security held, for which there may not be a readily accessible market. The actual amount of the future cash flows and their timing may differ significantly from the assumptions made for the purposes of determining the impairment allowances and consequently these allowances can be subject to variation as time progresses and the circumstances of the customer become clearer.

Collective impairment allowances are generally established for smaller balance homogenous portfolios such as the retail portfolios. The collective impairment allowance is also subject to estimation uncertainty and in particular is sensitive to changes in economic and credit conditions, including the interdependency of house prices, unemployment rates, interest rates, borrowers’ behaviour, and consumer bankruptcy trends. It is, however, inherently difficult to estimate how changes in one or more of these factors might impact the collective impairment allowance.

Given the relative size of the mortgage portfolio, a key variable is house prices which determineECL allowance. The Group monitors the collateral value supporting loans in such portfolios. The valueeffectiveness of this collateral is estimated by applying changes in house price indices to the original assessed value of the property. If average house prices were ten per cent lower than those estimated at 31 December 2015, the impairment charge would increase by approximately £228 million in respect of UK mortgages.

In addition, a collective unidentified impairment provision is made for loan losses that have been incurred but have not been separately identified at the balance sheet date. This provision is sensitive to changes in the time between the loss event and the date the impairment is specifically identified. This period is known as the loss emergence period. Management use a significant level of judgement when determining the collective unidentified impairment provision, including the assessment of the level of overall risk existing within particular sectors and the impact of the low interest rate environmentSICR criteria on loss emergence periods. In the Commercial Banking division, an increase of one month in the loss emergence period in respect of theongoing basis.

F-21F-18
 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 3: CRITICAL ACCOUNTING ESTIMATESJUDGEMENTS AND ESTIMATEScontinued

ORIGINATION PDS

The assessment of whether there has been a significant increase in credit risk is a relative measure, dependent on an asset’s PD at origination. For assets existing at 1 January 2018, the initial application date of IFRS 9, this information is not generally available and consequently management judgement has been used to determine a reasonable basis for estimating the original PD. Management used various information sources, including regulatory PDs and credit risk data available at origination, or where this is not available the first available data. In addition, the Group has not created a forward looking view of PDs at initial recognition for the back book as to do so would involve the use of hindsight and could introduce the risk of bias. The use of proxies and simplifications is not considered to materially impact the ECL allowance on transition.

POST-MODEL ADJUSTMENTS

Limitations in the Group’s impairment models or input data may be identified through the on-going assessment and validation of the output of the models. In these circumstances, management make appropriate adjustments to the Group’s allowance for impairment losses. These adjustments are generally modelled taking into account the particular attributes of the exposure which have not been adequately captured by the primary impairment models. At 31 December 2018, post-model adjustments were mainly related to UK secured lending with no individual adjustment being material.

FORWARD LOOKING INFORMATION

The measurement of expected credit losses is required to reflect an unbiased probability-weighted range of possible future outcomes. In order to do this, the Group has developed an economic model to project sixteen key impairment drivers using information derived mainly from external sources. These drivers include factors such as the unemployment rate, the house price index, commercial property prices and corporate credit spreads. The model-generated economic scenarios for the six years beyond 2018 are mapped to industry-wide historical loss data by portfolio. Combined losses across portfolios are used to rank the scenarios by severity of loss. Four scenarios from specified points along the loss distribution are selected to reflect the range of outcomes; the central scenario reflects the Group’s base case assumptions used for medium-term planning purposes, an upside and a downside scenario are also selected together with a severe downside scenario. Rare occurrences of adverse economic events can lead to relatively large credit losses which means that typically the most likely outcome is less than the probability-weighted outcome of the range of possible future events. To allow for this a relatively unlikely severe downside scenario is therefore included. At 1 January and 31 December 2018, the base case, upside and downside scenarios each carry a 30 per cent weighting; the severe downside scenario is weighted at 10 per cent. The choice of alternative scenarios and scenario weights is a combination of quantitative analysis and judgemental assessment to ensure that the full range of possible outcomes and material non-linearity of losses are captured. A committee under the chairmanship of the Chief Economist meets quarterly, to review and, if appropriate, recommend changes to the economic scenarios to the Chief Financial Officer and Chief Risk Officer. Findings dealing with all aspects of the expected credit loss calculation are presented to the Group Audit Committee.

For each major product grouping models have been developed which utilise historical credit loss data to produce PDs for each scenario; an overall weighted average PD is used to assist in determining the staging of financial assets and related ECL.

The key UK economic assumptions made by the Group as at 31 December 2018 averaged over a five-year period are shown below:

Economic assumptions  Base Case
%		   Upside
%		   Downside
%		   Severe
downside
%		 
At 31 December 2018                
Interest rate  1.25   2.34   1.30   0.71 
Unemployment rate  4.5   3.9   5.3   6.9 
House price growth  2.5   6.1   (4.8)  (7.5)
Commercial real estate price growth  0.4   5.3   (4.7)  (6.4)
At 1 January 2018                
Interest rate  1.18   2.44   0.84   0.01 
Unemployment rate  5.0   4.0   6.1   7.1 
House price growth  2.7   7.0   (2.4)  (8.2)
Commercial real estate price growth  0.0   3.0   (2.5)  (5.4)

The Group’s base-case economic scenario has changed little over the year and reflects a broadly stable outlook for the economy. Although there remains considerable uncertainty about the economic consequences of the UK’s planned exit from the European Union, the Group considers that at this stage the range of possible economic outcomes is adequately reflected in its choice and weighting of scenarios. The averages shown above do not fully reflect the peak to trough changes in the stated assumptions over the period. The tables below illustrate the variability of the assumptions from the start of the scenario period to the peak and trough.

Economic assumptions – start to peak  Base Case
%		   Upside
%		   Downside
%		   Severe
Downside
%		 
At 31 December 2018                
Interest rate  1.75   4.00   1.75   1.25 
Unemployment rate  4.8   4.3   6.3   8.6 
House price growth  13.7   34.9   0.6   (1.6)
Commercial real estate price growth  0.1   26.9   (0.5)  (0.5)
                 
Economic assumptions – start to trough  Base Case
%		   Upside
%		   Downside
%		   Severe
Downside
%		 
At 31 December 2018                
Interest rate  0.75   0.75   0.75   0.25 
Unemployment rate  4.1   3.5   4.3   4.2 
House price growth  0.4   2.3   (26.5)  (33.5)
Commercial real estate price growth  (0.1)  0.0   (23.8)  (33.8)
F-19

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3: CRITICAL ACCOUNTING JUDGEMENTS AND ESTIMATES continued

 

loan portfolio assessedThe table below shows the extent to which a higher ECL allowance has been recognised to take account of forward looking information from the weighted multiple economic scenarios.

Impact of multiple economic scenarios  Base Case
£m		   Probability
weighted
£m		   Difference
£m		 
UK mortgages  253   460   207 
Other Retail  1,294   1,308   14 
Commercial Banking  1,472   1,513   41 
Other  81   81   – 
At 31 December 2018  3,100   3,362   262 
At 1 January 2018  3,182   3,533   351 

The table below shows the Group’s ECL for collective unidentified impairmentthe upside and downside scenarios using a 100 per cent weighting compared to the base case scenario; both stage allocation and the ECL are based on the single scenario only. All non-modelled provisions, including management judgement, remain unchanged.

   Upside
£m		   Downside
£m		 
ECL allowance  2,775   3,573 

The impact of changes in the UK unemployment rate and House Price Index (HPI) have also been assessed. Although such changes would resultnot be observed in an isolation, as economic indicators tend to be correlated in a coherent scenario, this gives insight into the sensitivity of the Group’s ECL to changes in these two critical economic factors. The assessment has been made against the base case with the reported staging unchanged. The changes to HPI and the unemployment rate have been phased in to the forward-looking economic outlook over three years.

The table below shows the impact on the Group’s ECL resulting from a decrease/increase in the collective unidentified impairment provision of approximately £36 million (at 31 December 2014,Loss Given Default for a one month increase10 percentage point (pp) increase/decrease in the loss emergence period would have increased the collective unidentified impairment provision by an estimated £53 million)UK House Price Index (HPI).

 

   10pp increase
in HPI		   10pp decrease
in HPI		 
ECL impact, £m  (114)  154 

PAYMENT PROTECTION INSURANCE AND OTHER REGULATORY PROVISIONS

The table below shows the impact on the Group’s ECL resulting from a decrease/increase in Loss Given Default for a 1 percentage point (pp) increase/decrease in the UK unemployment rate.

   1pp increase in
unemployment		  1pp decrease in
unemployment		 
ECL impact, £m  172   (155)

Valuation of assets and liabilities arising from insurance business

 

At 31 December 2018, the Group recognised a value of in-force business asset of £4,491 million (2017: £4,533 million) and an acquired value of in-force business asset of £271 million (2017: £306 million).

The value of in-force business asset represents the present value of future profits expected to arise from the portfolio of in-force life insurance and participating investment contracts. The valuation of this asset requires assumptions to be made about future economic and operating conditions which are inherently uncertain and changes could significantly affect the value attributed to this asset. The methodology used to value this asset and the key assumptions that have been made in determining the carrying value of the value of in-force business asset at 31 December 2018 are set out in note 24.

At 31 December 2018, the Group carried total liabilities arising from insurance contracts and participating investment contracts of £98,874 million (2017: £103,413 million). The methodology used to value these liabilities is described in note 31.

Elements of the valuations of liabilities arising from insurance contracts and participating investment contracts require management to estimate future investment returns, future mortality rates and future policyholder behaviour. These estimates are subject to significant uncertainty. The methodology used to value these liabilities and the key assumptions that have been made in determining their carrying value are set out in note 31.

The effect on the Group’s profit before tax and shareholders’ equity of changes in key assumptions used in determining the life insurance assets and liabilities is set out in note 32.

Defined benefit pension scheme obligations

The net asset recognised in the balance sheet at 31 December 2018 in respect of the Group’s defined benefit pension scheme obligations was £1,146 million (comprising an asset of £1,267 million and a liability of £121 million) (2017: a net asset of £509 million comprising an asset of £723 million and a liability of £214 million). The Group’s accounting policy for its defined benefit pension scheme obligations is set out in note 2(K).

The accounting valuation of the Group’s defined benefit pension schemes’ liabilities requires management to make a number of assumptions. The key areas of estimation uncertainty are the discount rate applied to future cash flows and the expected lifetime of the schemes’ members. The discount rate is required to be set with reference to market yields at the end of the reporting period on high quality corporate bonds in the currency and with a term consistent with the defined benefit pension schemes’ obligations. The average duration of the schemes’ obligations is approximately 18 years. The market for bonds with a similar duration is illiquid and, as a result, significant management judgement is required to determine an appropriate yield curve on which to base the discount rate. The cost of the benefits payable by the schemes will also depend upon the life expectancy of the members. The Group considers latest market practice and actual experience in determining the appropriate assumptions for both current mortality expectations and the rate of future mortality improvement. It is uncertain whether this rate of improvement will be sustained going forward and, as a result, actual experience may differ from current expectations. The effect on the net accounting surplus or deficit and on the pension charge in the Group’s income statement of changes to the principal actuarial assumptions is set out in part (iii) of note 35.

F-20

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3: CRITICAL ACCOUNTING JUDGEMENTS AND ESTIMATES continued

Recoverability of deferred tax assets

At 31 December 2018 the Group carried deferred tax assets on its balance sheet of £2,453 million (2017: £2,284 million) principally relating to tax losses carried forward.

Estimation of income taxes includes the assessment of recoverability of deferred tax assets. Deferred tax assets are only recognised to the extent they are considered more likely than not to be recoverable based on existing tax laws and forecasts of future taxable profits against which the underlying tax deductions can be utilised.

The Group has recognised a deferred tax asset of £3,778 million (2017: £4,034 million) in respect of UK trading losses carried forward. Substantially all of these losses have arisen in Bank of Scotland plc and Lloyds Bank plc, and they will be utilised as taxable profits arise in those legal entities in future periods.

The Group’s expectations as to the level of future taxable profits take into account the Group’s long-term financial and strategic plans, and anticipated future tax-adjusting items. In making this assessment, account is taken of business plans, the Board-approved operating plan and the expected future economic outlook as set out in the strategic report, as well as the risks associated with future regulatory change.

Under current law there is no expiry date for UK trading losses not yet utilised, although (since Finance Act 2016) banking losses that arose before 1 April 2015 can only be used against 25 per cent of taxable profits arising after 1 April 2016, and they cannot be used to reduce the surcharge on banking profits. This restriction in utilisation means that the value of the deferred tax asset is only expected to be fully recovered by 2033. It is possible that future tax law changes could materially affect the value of these losses ultimately realised by the Group.

As disclosed in note 36, deferred tax assets totalling £585 million (2017: £683 million) have not been recognised in respect of certain capital and trading losses carried forward, unrelieved foreign tax credits and other tax deductions, as there are currently no expected future taxable profits against which these assets can be utilised.

Payment protection insurance and other regulatory provisions

At 31 December 2018, the Group carried provisions of £4,463£2,385 million (2014: £3,378(2017: £4,070 million) against the cost of making redress payments to customers and the related administration costs in connection with historical regulatory breaches, principally the missellingmis-selling of payment protection insurance (2015: £3,458(2018 £1,524 million; 2014: £2,5492017: £2,778 million). The Group’s accounting policy in respect of these provisions is set out in note 2(P).

 

Determining the amount of the provisions, which represent management’s best estimate of the cost of settling these issues, requires the exercise of significant judgement. It will often be necessary to form a view on matters which are inherently uncertain, such as the scope of reviews required by regulators, the number of future complaints, the extent to which they will be upheld, the average cost of redress and the impact of legal decisions that may be relevant to claims received. Consequently the continued appropriateness of the underlying assumptions is reviewed on a regular basis against actual experience and other relevant evidence and adjustments made to the provisions where appropriate.

 

Note 39 contains moreMore detail on the nature of the assumptions that have been made and key sensitivities.

DEFINED BENEFIT PENSION SCHEME OBLIGATIONS

The net asset recognised in the balance sheet at 31 December 2015 in respect of the Group’s defined benefit pension scheme obligations was £736 million (comprising an asset of £901 million and a liability of £165 million) (2014: a net asset of £890 million comprising an asset of £1,147 million and a liability of £257 million). The Group’s accounting policy for its defined benefit pension scheme obligations is set out in note 2(K).

The value of the Group’s defined benefit pension schemes’ liabilities requires management to make a number of assumptions. The key areas of estimation uncertainty are the discount rate applied to future cash flows and the expected lifetime of the schemes’ members. The discount rate is required to be set with reference to market yields at the end of the reporting period on high quality corporate bonds with the currency and term of the corporate bonds consistent with the defined benefit pension schemes’ obligations. The average duration of the schemes’ obligations is approximately 20 years. The market for bonds with a 20 year duration is illiquid and, as a result, significant management judgement is required to determine an appropriate yield curve on which to base the discount rate. The cost of the benefits payable by the schemes will also depend upon the longevity of the members. Following the completion of the latest triennial funding valuations, the Group has updated its demographic assumptions for both current mortality expectations and the rate of future mortality improvement. However, given the advances in medical science in recent years, it is uncertain whether this rate of improvement will be sustained going forward and, as a result, actual experience may differ from current expectations. The effect on the net accounting surplus or deficit and on the pension charge in the Group’s income statement of changes to the principal actuarial assumptionssensitivities is set out in note 37.

 

FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair value of financial instruments

At 31 December 2015,2018, the carrying value of the Group’s financial instrument assets held at fair value was £203,035£206,939 million (2014: £244,552(2017: £230,810 million), and its financial instrument liabilities held at fair value was £78,212£51,920 million (2014: £95,340(2017: £77,001 million). Included within these balances are derivative assets of £29,467 million (2014: £36,128 million) and derivative liabilities of £26,301 million (2014: £33,187 million). The group’s accounting policy for its financial instruments is set out in note 2(E) and 2(F).

 

In accordance with IFRS 13 Fair Value Measurement, the Group categorises financial instruments carried on the balance sheet at fair value using a three level hierarchy. Financial instruments categorised as level 1 are valued using quoted market prices and therefore there is minimal judgement applied in determining fair value. However, the fair value of financial instruments categorised as level 2 and, in particular, level 3 is determined using valuation techniques including discounted cash flow analysis and valuation models.

The valuation techniques for level 2 and, particularly, level 3 financial instruments involve management judgement and estimates the extent of which depends on the complexity of the instrument and the availability of market observable information. In addition, in line with market practice, the Group applies credit, debit and funding valuation adjustments in determining the fair value of its uncollateralised derivative positions. A description of these adjustments is set out in note 50, on page F-81. These valuation techniques involve management judgement and estimates the extent of which depends on the complexity of the instrument and the availability of market observable information. Valuation techniques for level 2 financial instruments use inputs that are based on observable market data. Level 3 financial instruments are those where at least one input which could have a significant effect on the instrument’s valuation is not based on observable market data. Determining the appropriate assumptions to be used for level 3 financial instruments requires significant management judgement.49. Further details of the Group’s level 3 financial instruments and the sensitivity of their valuation including the effect of applying reasonably possible alternative assumptions in determining their fair value are also set out in note 50.49. Details about sensitivities to market risk arising from trading assets and other treasury positions can be found in the Risk Managementrisk management section on page 94.

RECOVERABILITY OF DEFERRED TAX ASSETS

At 31 December 2015 the Group carried deferred tax assets on its balance sheet of £4,010 million (2014: £4,145 million) and deferred tax liabilities of £33 million (2014: £54 million) (note 38). This presentation takes into account the ability of the Group to net deferred tax assets and liabilities only where there is a legally enforceable right of offset. Note 38 presents the Group’s deferred tax assets and liabilities by type. The largest category of deferred tax asset relates to tax losses carried forward.

The recoverability of the Group’s deferred tax assets in respect of carry forward losses is based on an assessment of future levels of taxable profit expected to arise that can be offset against these losses. The Group’s expectations as to the level of future taxable profits take into account the Group’s long-term financial and strategic plans, and anticipated future tax adjusting items.

In making this assessment account is taken of business plans, the board approved operating plan and the expected future economic outlook as set out in the Group Chief Executive’s Review and Market Overview, as well as the risks associated with future regulatory change.

The Group’s total deferred tax asset includes £4,890 million (2014: £5,758 million) in respect of trading losses carried forward. The tax losses have arisen in individual legal entities and will be used as future taxable profits arise in those legal entities, though substantially all of the unused tax losses for which a deferred tax asset has been recognised arise in Bank of Scotland plc and Lloyds Bank plc.

The deferred tax asset is expected to be utilised over different time periods in each of the entities in which the losses arise. Under current UK tax law there is no expiry date for unused tax losses. Following the enactment of the Finance Act 2015, there is now a restriction imposed on the amount of

F-22

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3: CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS continued

banks’ profits that can be offset by certain carried forward tax losses for the purposes of calculating corporation tax liabilities. The losses are expected to be fully utilised by 2025.

As disclosed in note 38, deferred tax assets totalling £1,109 million (2014: £921 million) have not been recognised in respect of certain capital losses carried forward, trading losses carried forward and unrelieved foreign tax credits as there are no predicted future capital or taxable profits against which these losses can be recognised.

VALUATION OF ASSETS AND LIABILITIES ARISING FROM INSURANCE BUSINESS.

At 31 December 2015, the Group recognised a value of in-force business asset of £4,219 million (2014: £4,446 million) and an acquired value of in-force business asset of £377 million (2014: £418 million). The value of in-force business asset represents the present value of future profits expected to arise from the portfolio of in-force life insurance and participating investment contracts. The acquired value of in-force business asset represents the contractual rights to benefits from providing investment management services in relation to non-participating investment contracts acquired in business combinations and portfolio transfers. The methodology used to value these assets is set out in note 25. The valuation or recoverability of these assets requires assumptions to be made about future economic and operating conditions which are inherently uncertain and changes could significantly affect the value attributed to these assets. The key assumptions that have been made in determining the carrying value of the value of in-force business assets at 31 December 2015 are set out in note 25.

At 31 December 2015, the Group carried total liabilities arising from insurance contracts and participating investment contracts of £80,294 million (2014: £86,918 million). The methodology used to value these liabilities is described in note 33. Elements of the liability valuations require assumptions to be made about future investment returns, future mortality rates and future policyholder behaviour and are subject to significant management judgement and estimation uncertainty. The key assumptions that have been made in determining the carrying value of these liabilities are set out in note 33.

The effect on the Group’s profit before tax and shareholders’ equity of changes in key assumptions used in determining the life insurance assets and liabilities is set out in note 34.96.

 

NOTE 4: SEGMENTAL ANALYSIS

 

Lloyds Banking Group provides a wide range of banking and financial services in the UK and in certain locations overseas.

 

The Group Executive Committee (GEC) has been determined to be the chief operating decision maker for the Group. The Group’s operating segments reflect its organisational and management structures. The Group Executive CommitteeGEC reviews the Group’s internal reporting based around these segments in order to assess performance and allocate resources. GEC considers interest income and expense on a net basis and consequently the total interest income and expense for all reportable segments is presented net. The segments are differentiated by the type of products provided and by whether the customers are individuals or corporate entities.

 

The segmental results and comparatives are presented on an underlying basis, the basis reviewed by the chief operating decision maker. The effects of asset sales, volatile items, liability management, simplification costs, TSB build and dual running costs, regulatory provisions, certain past service pension credits or charges, the amortisation of purchased intangible assets and the unwind of acquisition-related fair value adjustmentsfollowing are excluded in arriving at underlying profit.profit:

–losses on redemption of the Enhanced Capital Notes in 2016 and the volatility in the value of the embedded equity conversion feature;
–market volatility and asset sales, which includes the effects of certain asset sales, the volatility relating to the Group’s own debt and hedging arrangements and that arising in the insurance businesses and insurance gross up;
–the unwind of acquisition-related fair value adjustments and the amortisation of purchased intangible assets;
–restructuring costs, comprising costs relating to the Simplification programme and the costs of implementing regulatory reform and ring-fencing, the rationalisation of the non-branch property portfolio and the integration of MBNA; and
–payment protection insurance.

For the purposes of the underlying income statement, operating lease depreciation (net of gains on disposal of operating lease assets) is shown as an adjustment to total income.

F-21

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

FollowingNOTE 4: SEGMENTAL ANALYSIS continued

In 2018 charges in relation to other conduct provisions (referred to as remediation) have been reclassified so that they are now included in underlying profit. In addition, results in relation to certain assets which are outside the disposalGroup’s risk appetite, previously reported as part of TSB in 2015, therun-off within Other, have been reclassified into Retail and Commercial. Comparative figures have been restated accordingly.

The Group’s activities are organised into fourthree financial reporting segments: Retail; Commercial Banking; Consumer Finance and Insurance. The results of TSB up to the point of disposal are included in Other.Insurance and Wealth.

 

Retail offers a broad range of financial service products, including current accounts, savings, personal loansmortgages, motor finance and mortgages,unsecured consumer lending to UK retail customers, incorporating wealthpersonal and small business customers. It is also a distributor of insurance, protection and credit cards and a range of long-term savings and investment products.

 

Commercial Banking is client led, focusing on SME, Mid Markets, Global Corporatesprovides a range of products and Financial Institution clients providing products across Lending, Global Transaction Banking, Financial Marketsservices such as lending, transactional banking, working capital management, risk management and Debt Capital Marketsdebt capital markets services to SMEs, corporates and private equity financing through Lloyds Development Capital.

Consumer Finance comprises the Group’s consumer and corporate Credit Card businesses, along with the Black Horse motor financing and Lex Autolease car leasing businesses in Asset Finance. The Group’s European deposits, German lending and Dutch retail mortgage businesses are managed within Asset Finance.financial institutions.

 

Insurance is a core part of Lloyds Banking Group and is focused on five key markets: Corporate Pensions, Protection, Retirement, Bulk AnnuitiesWealth offers insurance, investment and Home Insurance, to enable customers to protect themselves todaywealth management products and prepare for a secure financial future.services.

 

Other includes certain assets previously reported as outside of the Group’s risk appetite and the results and gains on sale relating to businesses disposed in 2013 and 2014. Other also includes income and expenditure not rechargedattributed to divisions, including the costs of certain central and head office functions and the costs of managing the Group’s technology platforms, branch and head office property estate, operations (including payments, banking operations and collections) and sourcing, the costs of which are predominantly recharged to the other divisions. It also reflects other items not recharged to the divisions.private equity business, Lloyds Development Capital.

 

Inter-segment services are generally recharged at cost, with the exception of the internal commission arrangements between the UK branch and other distribution networks and the insurance product manufacturing businesses within the Group, where a profit margin is also charged. Inter-segment lending and deposits are generally entered into at market rates, except that non-interest bearing balances are priced at a rate that reflects the external yield that could be earned on such funds.

F-23

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4: SEGMENTAL ANALYSIS continued

 

For the majority of those derivative contracts entered into by business units for risk management purposes, the business unit recognises the net interest income or expense on an accrual accounting basis and transfers the remainder of the movement in the fair value of the derivative to the central group segment where the resulting accounting volatility is managed where possible through the establishment of hedge accounting relationships. Any change in fair value of the hedged instrument attributable to the hedged risk is also recorded within the central group segment. This allocation of the fair value of the derivative and change in fair value of the hedged instrument attributable to the hedged risk avoids accounting asymmetry in segmental results and leads to accounting volatility, which is managed centrally and reported within Other.

F-22

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

     Commercial  Consumer        Underlying 
   Retail   Banking   Finance   Insurance   Other   basis total 
   £m   £m   £m   £m   £m   £m 
Year ended 31 December 2015                        
Net interest income  7,397   2,510   1,287   (163)  451   11,482 
Other income (net of insurance claims)  1,122   2,066   1,358   1,827   (218)  6,155 
Total underlying income, net of insurance claims  8,519   4,576   2,645   1,664   233   17,637 
Total costs  (4,573)  (2,167)  (1,488)  (702)  (145)  (9,075)
Impairment  (432)  22   (152)  –   (6)  (568)
TSB  –   –   –   –   118   118 
Underlying profit  3,514   2,431   1,005   962   200   8,112 
External income  9,391   3,616   2,946   2,065   (381)  17,637 
Inter-segment income  (872)  960   (301)  (401)  614   – 
Segment income  8,519   4,576   2,645   1,664   233   17,637 
Segment external assets  316,343   178,189   28,694   143,217   140,245   806,688 
Segment customer deposits  279,559   126,158   11,082   –   1,527   418,326 
Segment external liabilities  284,882   220,182   15,437   137,233   101,974   759,708 
Other segment items reflected in income statement above:                        
Depreciation and amortisation  409   203   838   124   538   2,112 
(Decrease) increase in value of in-force business  –   –   –   (162)  –   (162)
Defined benefit scheme charges  124   30   9   11   141   315 
Other segment items:                        
Additions to fixed assets  385   146   1,752   344   790   3,417 
Investments in joint ventures and associates at end of year  7   –   –   –   40   47 

NOTE 4: SEGMENTAL ANALYSIS continued

  Retail
£m		  Commercial
Banking
£m		  Insurance
and Wealth
£m		  Other
£m		  Underlying
basis total
£m		 
Year ended 31 December 2018                    
Net interest income  9,066   3,004   123   521   12,714 
Other income, net of insurance claims  2,171   1,653   1,865   321   6,010 
Total underlying income, net of insurance claims  11,237   4,657   1,988   842   18,724 
Operating lease depreciation1  (921)  (35)  –   –   (956)
Net income  10,316   4,622   1,988   842   17,768 
Operating costs  (4,915)  (2,167)  (1,021)  (62)  (8,165)
Remediation  (267)  (203)  (39)  (91)  (600)
Total costs  (5,182)  (2,370)  (1,060)  (153)  (8,765)
Impairment (charge) credit  (862)  (92)  (1)  18   (937)
Underlying profit  4,272   2,160   927   707   8,066 
External income  13,097   4,876   1,895   (1,144)  18,724 
Inter-segment income  (1,860)  (219)  93   1,986   – 
Segment underlying income, net of insurance claims  11,237   4,657   1,988   842   18,724 
Segment external assets  349,719   164,897   140,487   142,495   797,598 
Segment customer deposits  252,808   148,633   14,063   2,562   418,066 
Segment external liabilities  260,378   191,071   147,673   148,277   747,399 
Analysis of segment underlying other income, net of insurance claims:                    
Current accounts  503   142   5   –   650 
Credit and debit card fees  988   4   1   –   993 
Commercial banking and treasury fees  –   305   –   –   305 
Unit trust and insurance broking  13   –   208   –   221 
Private banking and asset management  –   5   92   –   97 
Factoring  –   83   –   –   83 
Other fees and commissions  52   253   163   31   499 
Fees and commissions receivable  1,556   792   469   31   2,848 
Fees and commissions payable  (855)  (57)  (418)  (56)  (1,386)
Net fee and commission income  701   735   51   (25)  1,462 
Operating lease rental income  1,305   38   –   –   1,343 
Rental income from investment properties  –   –   197   –   197 
Gains less losses on disposal of financial assets at fair value through                    
other comprehensive income  –   –   –   275   275 
Lease termination income  –   7   –   –   7 
Net trading income, excluding insurance  71   766   –   227   1,064 
Insurance and other, net of insurance claims  247   358   2,146   (1,089)  1,662 
Other external income, net of insurance claims  1,623   1,169   2,343   (587)  4,548 
Inter-segment other income  (153)  (251)  (529)  933   – 
Segment other income, net of insurance claims  2,171   1,653   1,865   321   6,010 
Other segment items reflected in                    
income statement above:                    
Depreciation and amortisation  1,573   278   154   400   2,405 
Decrease in value of in-force business  –   –   (55)  –   (55)
Defined benefit scheme charges  121   48   20   216   405 
Other segment items:                    
Additions to fixed assets  2,092   208   223   991   3,514 
Investments in joint ventures and associates at end of year  4   6   –   81   91 

1Net of profits on disposal of operating lease assets of £60 million.
F-23

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4: SEGMENTAL ANALYSIS continued

  Retail
£m		  Commercial
Banking
£m		  Insurance
and Wealth
£m		  Other
£m		  Underlying
basis total
£m		 
Year ended 31 December 20171                    
Net interest income  8,706   3,030   133   451   12,320 
Other income, net of insurance claims  2,221   1,798   1,846   340   6,205 
Total underlying income, net of insurance claims  10,927   4,828   1,979   791   18,525 
Operating lease depreciation2  (947)  (105)  –   (1)  (1,053)
Net income  9,980   4,723   1,979   790   17,472 
Operating costs  (4,866)  (2,230)  (1,040)  (48)  (8,184)
Remediation  (633)  (173)  (40)  (19)  (865)
Total costs  (5,499)  (2,403)  (1,080)  (67)  (9,049)
Impairment (charge) credit  (711)  (89)  –   5   (795)
Underlying profit  3,770   2,231   899   728   7,628 
External income  12,682   3,176   1,883   784   18,525 
Inter-segment income  (1,755)  1,652   96   7   – 
Segment underlying income, net of insurance claims  10,927   4,828   1,979   791   18,525 
Segment external assets  350,219   177,808   151,986   132,096   812,109 
Segment customer deposits  253,127   148,313   13,770   2,914   418,124 
Segment external liabilities  258,612   224,577   157,824   121,953   762,966 
Analysis of segment underlying other income, net of insurance claims:                    
Current accounts  572   135   5   –   712 
Credit and debit card fees  948   4   1   –   953 
Commercial banking and treasury fees  –   321   –   –   321 
Unit trust and insurance broking  10   –   214   –   224 
Private banking and asset management  –   5   93   –   98 
Factoring  –   91   –   –   91 
Other fees and commissions  95   273   184   14   566 
Fees and commissions receivable  1,625   829   497   14   2,965 
Fees and commissions payable  (873)  (50)  (380)  (79)  (1,382)
Net fee and commission income  752   779   117   (65)  1,583 
Operating lease rental income  1,281   63   –   –   1,344 
Rental income from investment properties  –   1   212   –   213 
Gains less losses on disposal of available-for-sale financial assets  –   29   (3)  420   446 
Lease termination income  –   74   –   –   74 
Trading income  26   490   –   (98)  418 
Insurance and other, net of insurance claims  6   27   2,223   (129)  2,127 
Other external income, net of insurance claims  1,313   684   2,432   193   4,622 
Inter-segment other income  156   335   (703)  212   – 
Segment other income, net of insurance claims  2,221   1,798   1,846   340   6,205 
Other segment items reflected in income statement above:                    
Depreciation and amortisation  1,547   322   197   304   2,370 
Increase in value of in-force business  –   –   (165)  –   (165)
Defined benefit scheme charges  149   52   25   133   359 
Other segment items:                    
Additions to fixed assets  2,431   130   274   820   3,655 
Investments in joint ventures and associates at end of year  12   6   –   47   65 

1Restated see page F-22.
2Net of profits on disposal of operating lease assets of £32 million.
F-24
 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 4: SEGMENTAL ANALYSIS continued

 

   Commercial Consumer     Underlying  Retail
£m		 Commercial
Banking
£m		 Insurance
and Wealth
£m		 Other
£m		 Underlying
basis total
£m		 
 Retail Banking Finance Insurance Other basis total 
 £m £m £m £m £m £m 
Year ended 31 December 2014                        
Year ended 31 December 20161                    
Net interest income  7,079   2,480   1,290   (131)  257   10,975   8,074   2,863   80   418   11,435 
Other income (net of insurance claims)  1,212   1,956   1,364   1,725   210   6,467 
Other income, net of insurance claims  2,165   1,875   1,878   86   6,004 
Total underlying income, net of insurance claims  8,291   4,436   2,654   1,594   467   17,442   10,239   4,738   1,958   504   17,439 
Operating lease depreciation2  (777)  (118)  –   –   (895)
Net income  9,462   4,620   1,958   504   16,544 
Operating costs  (4,761)  (2,215)  (1,046)  (71)  (8,093)
Remediation  (750)  (148)  (103)  (23)  (1,024)
Total costs  (4,464)  (2,147)  (1,429)  (672)  (330)  (9,042)  (5,511)  (2,363)  (1,149)  (94)  (9,117)
Impairment  (599)  (83)  (215)  –   (205)  (1,102)
TSB  –   –   –   –   458   458 
Impairment (charge) credit  (648)  (11)  –   14   (645)
Underlying profit  3,228   2,206   1,010   922   390   7,756   3,303   2,246   809   424   6,782 
External income  9,034   3,800   2,803   1,206   599   17,442   12,243   3,656   1,373   167   17,439 
Inter-segment income  (743)  636   (149)  388   (132)  –   (2,004)  1,082   585   337   – 
Segment income  8,291   4,436   2,654   1,594   467   17,442 
Segment underlying income, net of insurance claims  10,239   4,738   1,958   504   17,439 
Segment external assets  317,246   241,754   25,646   150,615   119,635   854,896   340,253   193,054   154,782   129,704   817,793 
Segment customer deposits  285,539   119,882   14,955   –   26,691   447,067   256,453   142,439   13,798   2,770   415,460 
Segment external liabilities  295,880   231,400   18,581   144,921   114,211   804,993   265,128   231,450   160,815   111,935   769,328 
Analysis of segment underlying other income, net of insurance claims:Analysis of segment underlying other income, net of insurance claims:
Current accounts  614   131   7   –   752 
Credit and debit card fees  854   4   1   16   875 
Commercial banking and treasury fees  –   303   –   –   303 
Unit trust and insurance broking  –   –   244   –   244 
Private banking and asset management  –   5   94   –   99 
Factoring  –   112   –   –   112 
Other fees and commissions  125   237   292   6   660 
Fees and commissions receivable  1,593   792   638   22   3,045 
Fees and commissions payable  (783)  (54)  (424)  (95)  (1,356)
Net fee and commission income  810   738   214   (73)  1,689 
Operating lease rental income  1,142   83   –   –   1,225 
Rental income from investment properties  –   2   227   –   229 
Gains less losses on disposal of available-for-sale financial assets  –   17   (2)  76   91 
Lease termination income  –   1   –   –   1 
Trading income  46   1,937   –   (570)  1,413 
Insurance and other, net of insurance claims  (2)  (627)  1,613   372   1,356 
Other external income, net of insurance claims  1,186   1,413   1,838   (122)  4,315 
Inter-segment other income  169   (276)  (174)  281   – 
Segment other income, net of insurance claims  2,165   1,875   1,878   86   6,004 
Other segment items reflected in income statement above:                                            
Depreciation and amortisation  353   153   773   127   189   1,595   1,345   326   169   540   2,380 
(Decrease) increase in value of in-force business  –   –   –   (428)  –   (428)
Decrease in value of in-force business  –   –   472   –   472 
Defined benefit scheme charges  121   37   9   9   168   344   141   51   31   64   287 
Other segment items:                                            
Additions to fixed assets  419   242   1,633   449   699   3,442   2,362   145   481   772   3,760 
Investments in joint ventures and associates at end of year  12   –   –   –   62   74   9   28   –   22   59 

 

     Commercial  Consumer        Underlying 
  Retail  Banking  Finance  Insurance  Other  basis total 
  £m  £m  £m  £m  £m  £m 
Year ended 31 December 2013                        
Net interest income  6,500   2,113   1,333   (107)  431   10,270 
Other income (net of insurance claims)  1,435   2,259   1,359   1,864   840   7,757 
Total underlying income, net of insurance claims  7,935   4,372   2,692   1,757   1,271   18,027 
Total costs  (4,160)  (2,084)  (1,384)  (669)  (775)  (9,072)
Impairment  (760)  (398)  (343)  –   (1,394)  (2,895)
TSB  –   –   –   –   106   106 
Underlying profit (loss)  3,015   1,890   965   1,088   (792)  6,166 
External income  8,526   2,959   2,772   2,439   1,331   18,027 
Inter-segment income  (591)  1,413   (80)  (682)  (60)  – 
Segment income  7,935   4,372   2,692   1,757   1,271   18,027 
Segment external assets  317,146   227,771   25,025   155,378   117,060   842,380 
Segment customer deposits  283,189   111,654   18,733   –   25,891   439,467 
Segment external liabilities  300,412   206,729   21,868   149,445   124,590   803,044 
Other segment items reflected in income statement above:                        
Depreciation and amortisation  299   136   754   136   220   1,545 
Increase (decrease) in value of in-force business  –   –   –   425   (9)  416 
Defined benefit scheme charges  109   44   6   12   228   399 
Other segment items:                        
Additions to fixed assets  446   160   1,320   373   683   2,982 
Investments in joint ventures and associates at end of year  23   –   1   –   77   101 
1Restated – see page F-22.
2Net of profits on disposal of operating lease assets of £58 million.
F-25
 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 4: SEGMENTAL ANALYSIS continued

 

RECONCILIATION OF UNDERLYING BASIS TO STATUTORY RESULTS

Reconciliation of underlying basis to statutory results

The underlying basis is the basis on which financial information is presented to the chief operating decision maker which excludes certain items included in the statutory results. The table below reconciles the statutory results to the underlying basis.

 

    Removal of:   
 Lloyds
Banking
Group
statutory
£m		 Volatility
and other
items1
£m		 Insurance
gross up2
£m		 PPI
£m		 Underlying
basis
£m		 
Year ended 31 December 2018                    
Net interest income  13,396   152   (834)  –   12,714 
Other income, net of insurance claims  5,230   107   673   –   6,010 
Total income, net of insurance claims  18,626   259   (161)  –   18,724 
Operating lease depreciation3      (956)  –   –   (956)
Net income  18,626   (697)  (161)  –   17,768 
Operating expenses  (11,729)  2,053   161   750   (8,765)
Impairment  (937)  –   –   –   (937)
Profit before tax  5,960   1,356   –   750   8,066 
                Removal of:                        
 Lloyds              PPI and          Removal of:    
 Banking  Asset           other      Lloyds
Banking
Group
statutory
£m		   Volatility
and other
items4
£m		   Insurance
gross up2
£m		   PPI
£m		   Underlying
basis
£m		 
Year ended 31 December 2017                    
Net interest income  10,912   228   1,180   –   12,320 
Other income, net of insurance claims  7,747   (186)  (1,356)  –   6,205 
Total income, net of insurance claims  18,659   42   (176)  –   18,525 
Operating lease depreciation3      (1,053)  –   –   (1,053)
Net income  18,659   (1,011)  (176)  –   17,472 
Operating expenses  (12,346)  1,821   176   1,300   (9,049)
Impairment  (688)  (107)  –   –   (795)
Profit before tax  5,625   703   –   1,300   7,628 
 Group  sales and        Insurance  conduct  Underlying                     
 statutory  other items1  Simplification  TSB3  gross up  provisions2  basis       Removal of:     
 £m  £m  £m  £m  £m  £m  £m   Lloyds
Banking
Group
statutory
£m		   Volatility
and other
items5
£m		   Insurance
gross up2
£m		   PPI
£m		   Underlying
basis
£m		 
Year ended 31 December 2015                     
Year ended 31 December 2016                    
Net interest income  11,318   318   –   (192)  38   –   11,482   9,274   263   1,898   –   11,435 
Other income, net of insurance claims  6,103   214   –   (36)  (126)  –   6,155   7,993   121   (2,110)  –   6,004 
Total income, net of insurance claims  17,421   532   –   (228)  (88)  –   17,637   17,267   384   (212)  –   17,439 
Operating lease depreciation3      (895)  –   –   (895)
Net income  17,267   (511)  (212)  –   16,544 
Operating expenses  (15,387)  381   170   836   88   4,837   (9,075)  (12,627)  1,948   212   1,350   (9,117)
Impairment  (390)  (197)  –   19   –   –   (568)  (752)  107   –   –   (645)
TSB  –   –   –   118   –   –   118 
Profit  1,644   716   170   745   –   4,837   8,112 
Profit before tax  3,888   1,544   –   1,350   6,782 

1In the year ended 31 December 2018 this comprises the effects of asset sales (loss of £145 million); volatility and other items (gains of £95 million); the amortisation of purchased intangibles (£108 million); restructuring (£879 million, comprising severance related costs, the rationalisation of the non-branch property portfolio, the work on implementing the ring-fencing requirements and the integration of MBNA and Zurich’s UK workplace pensions and savings business); and the fair value unwind and other items (losses of £319 million).
2The Group’s insurance businesses’ income statements include income and expenditure which are attributable to the policyholders of the Group’s long-term assurance funds. These items have no impact in total upon the profit attributable to equity shareholders and, in order to provide a clearer representation of the underlying trends within the business, these items are shown net within the underlying results.
3Net of profits on disposal of operating lease assets of £60 million (2017: £32 million; 2016: £58 million).
4Comprises the effects of asset sales (gain of £54£30 million),; volatile items (loss(gain of £208£263 million),; liability management (loss of £28£14 million), the fair value unwind (loss of £192 million) and; the amortisation of purchased intangibles (£34291 million); restructuring costs (£621 million, principally comprising costs relating to the Simplification programme; the rationalisation of the non-branch property portfolio, the work on implementing the ring-fencing requirements and the integration of MBNA); and the fair value unwind and other items (loss of £270 million).
  
25Comprises the payment protection insurance provision (£4,000write-off of the Enhanced Capital Note embedded derivative and premium paid on redemption of the remaining notes (loss of £790 million) and other regulatory provisions (£837 million).
3Comprises the underlying results of TSB, dual running and build costs and the charge related to the disposal of TSB.
     Removal of:    
  Lloyds              PPI and    
  Banking  Asset           other    
  Group  sales and        Insurance  conduct  Underlying 
  statutory  other items1  Simplification  TSB3  gross up  provisions2  basis 
  £m  £m  £m  £m  £m  £m  £m 
Year ended 31 December 2014                            
Net interest income  10,660   619   –   (786)  482   –   10,975 
Other income, net of insurance claims  5,739   1,460   22   (140)  (614)  –   6,467 
Total income, net of insurance claims  16,399   2,079   22   (926)  (132)  –   17,442 
Operating expenses  (13,885)  (286)  944   928   132   3,125   (9,042)
Impairment  (752)  (448)  –   98   –   –   (1,102)
TSB  –   –   –   458   –   –   458 
Profit  1,762   1,345   966   558   –   3,125   7,756 
1Comprises; the effects of asset sales (gain of £138£217 million),; volatile items (gain of £58£99 million),; liability management (loss(gain of £1,386£123 million), the past service pension credit of £710 million (which represents the curtailment credit of £843 million following the Group’s decision to reduce the cap on pensionable pay partly offset by the cost of other changes to the pay, benefits and reward offered to employees), the fair value unwind (loss of £529 million) and; the amortisation of purchased intangibles (£336340 million).
2Comprises; restructuring costs (£622 million, principally comprising the payment protection insurance provision (£2,200 million)severance related costs related to phase II of the Simplification programme); and other regulatory provisions (£925 million).
3Comprises the underlying results of TSB, dual running and build costs.
    Removal of:    
  Lloyds              PPI and    
  Banking  Asset           other    
  Group  sales and        Insurance  conduct  Underlying 
  statutory  other items1  Simplification  TSB3  gross up  provisions2  basis 
  £m  £m  £m  £m  £m  £m  £m 
Year ended 31 December 2013                            
Net interest income  7,338   617   –   (615)  2,930   –   10,270 
Other income, net of insurance claims  11,140   (146)  –   (163)  (3,074)  –   7,757 
Total income, net of insurance claims  18,478   471   –   (778)  (144)  –   18,027 
Operating expenses  (15,322)  571   830   1,250   144   3,455   (9,072)
Impairment  (2,741)  (263)  –   109   –   –   (2,895)
TSB  –   –   –   106   –   –   106 
Profit  415   779   830   687   –   3,455   6,166 
1Comprises the effects of asset sales (gain of £100 million), volatile items (loss of £10 million), liability management (loss of £142 million), the fair value unwind and other items (loss of £228£231 million), the amortisation of purchased intangibles (£395 million) and the past service pensions charge (£104 million, see note 11).
2Comprises the payment protection insurance provision (£3,050 million) and other regulatory provisions (£405 million).
3Comprises the underlying results of TSB, dual running and build costs.

 

GEOGRAPHICAL AREAS

Geographical areas

Following the reduction in the Group’s non-UK activities, an analysis between UK and non-UK activities is no longer provided.

F-26
 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 5: NET INTEREST INCOME

 

 Weighted average       
 effective interest rate        
 2015  2014 2013 2015  2014 2013  Weighted average
effective interest rate		       
 %  % % £m  £m £m  2018
%		  2017
%		 2016
%		  2018
£m		  2017
£m		 2016
£m		 
Interest and similar income:                                                
Loans and advances to customers  3.50   3.53   3.84   16,256   17,806   19,928   3.17   3.16   3.32   15,078   14,712   15,190 
Loans and advances to banks  0.42   0.52   0.45   397   406   457   0.84   0.40   0.46   565   271   381 
Debt securities held as loans and receivables  1.87   2.57   1.52   40   42   32 
Interest receivable on loans and receivables  2.98   3.12   3.28   16,693   18,254   20,417 
Debt securities held at amortised cost  1.60   1.29   1.47   66   43   56 
Held-to-maturity investments      —   1.44       —   231 
Interest receivable on financial assets held at amortised cost  2.87   2.81   2.83   15,709   15,026   15,858 
Financial assets at fair value through other comprehensive income  1.98           640         
Available-for-sale financial assets  1.77   1.90   1.92   725   957   746       1.96   1.88       980   762 
Held-to-maturity investments  1.49   –   –   197   –   – 
Total interest and similar income  2.86   3.03   3.20   17,615   19,211   21,163 
Total interest and similar income1  2.82   2.73   2.77   16,349   16,006   16,620 
Interest and similar expense:                                                
Deposits from banks, excluding liabilities under sale and repurchase transactions  0.41   0.74   0.65   (43)  (86)  (129)
Customer deposits, excluding liabilities under sale and repurchase transactions  0.87   1.15   1.54   (3,299)  (4,781)  (6,119)
Debt securities in issue  0.69   0.63   1.30   (586)  (552)  (1,451)
Deposits from banks, excluding liabilities under sale and                        
repurchase transactions  1.39   1.18   0.65   (117)  (80)  (68)
Customer deposits, excluding liabilities under sale and                        
repurchase transactions  0.53   0.49   0.69   (1,813)  (1,722)  (2,520)
Debt securities in issue2  0.27   0.37   0.94   (234)  (266)  (799)
Subordinated liabilities  8.37   8.44   8.57   (2,091)  (2,475)  (2,956)  7.63   7.93   8.35   (1,388)  (1,481)  (1,864)
Liabilities under sale and repurchase agreements  0.57   2.61   1.21   (34)  (55)  (79)  0.96   0.58   0.46   (245)  (110)  (38)
Interest payable on liabilities held at amortised cost  1.19   1.45   1.88   (6,053)  (7,949)  (10,734)  0.79   0.79   1.07   (3,797)  (3,659)  (5,289)
Amounts payable to unitholders in consolidated open-ended investment vehicles  1.16   3.23   12.08   (244)  (602)  (3,091)
Total interest and similar expense  1.19   1.51   2.32   (6,297)  (8,551)  (13,825)
Amounts payable to unitholders in consolidated                        
open-ended investment vehicles  (6.07)  9.15   10.85   844   (1,435)  (2,057)
Total interest and similar expense3  0.60   1.06   1.44   (2,953)  (5,094)  (7,346)
Net interest income              11,318   10,660   7,338               13,396   10,912   9,274 

1Includes £31 million (2017: £12 million; 2016: £nil) of interest income on liabilities with negative interest rates.
2The impact of the Group’s hedging arrangements is included on this line; excluding this impact the weighted average effective interest rate in respect of debt securities in issue would be 2.68 per cent (2017: 2.43 per cent; 2016: 2.70 per cent).
3Includes £10 million (2017: £50 million; 2016: £51 million) of interest expense on assets with negative interest rates.

 

Included within interest and similar income is £248£227 million (2014: £407(2017: £179 million; 2013: £9012016: £205 million) in respect of impaired financial assets. Net interest income also includes a credit of £956£701 million (2014:(2017: credit of £1,153£651 million; 2013:2016: credit of £550£557 million) transferred from the cash flow hedging reserve (see note 43)41).

F-27

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6: NET FEE AND COMMISSION INCOME

 

 2015  2014 2013 
 £m  £m £m  2018
£m		  2017
£m		 2016
£m		 
Fee and commission income:                        
Current accounts  804   918   973   650   712   752 
Credit and debit card fees  918   1,050   984   993   953   875 
Other  1,530   1,691   2,162 
Commercial banking and treasury fees  305   321   303 
Unit trust and insurance broking  221   224   244 
Private banking and asset management  97   98   99 
Factoring  83   91   112 
Other fees and commissions  499   566   660 
Total fee and commission income  3,252   3,659   4,119   2,848   2,965   3,045 
Fee and commission expense  (1,442)  (1,402)  (1,385)  (1,386)  (1,382)  (1,356)
Net fee and commission income  1,810   2,257   2,734   1,462   1,583   1,689 

 

Fees and commissions which are an integral part of the effective interest rate form part of net interest income shown in note 5. Fees and commissions relating to instruments that are held at fair value through profit or loss are included within net trading income shown in note 7.

The Group adopted IFRS 15 ‘Revenue from Contracts with Customers’ on 1 January 2018, comparatives have not been restated. Further details on the impact of the new accounting standard, which was not significant, are set out in note 54. At 31 December 2018, the Group held on its balance sheet £282 million in respect of these services and £168 million in respect of amounts received from customers for services to be provided after the balance sheet date. Current unsatisfied performance obligations amount to £314 million at 31 December 2018; the Group expects to receive substantially all of this revenue by 2021.

The most significant performance obligations undertaken by the Group are the provision of bank account and transactional services and other value added offerings in respect of current accounts; factoring and loan commitments for commercial customers; card services to cardholders and merchants in respect of credit cards and debit cards; and the management and administration of policyholders’ funds in accordance with investment mandates.

F-27F-28
 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 7: NET TRADING INCOME

 

 2015  2014  2013  2018
£m		  2017
£m		 2016
£m		 
  £m   £m   £m 
Foreign exchange translation (losses) gains  (80)  (95)  162 
Foreign exchange translation gains/(losses)  342   (174)  1,363 
Gains on foreign exchange trading transactions  335   344   238   580   517   542 
Total foreign exchange  255   249   400   922   343   1,905 
Investment property gains (note 27)  416   513   156 
Investment property gains (losses) (note 26)  139   230   (83)
Securities and other gains (see below)  3,043   9,397   15,911   (4,937)  11,244   16,723 
Net trading income  3,714   10,159   16,467   (3,876)  11,817   18,545 

 

Securities and other gains comprise net gains (losses) arising on assets and liabilities held at fair value through profit or loss and for trading as follows:

 

   2015   2014   2013 
   £m   £m   £m 
Net income arising on assets held at fair value through profit or loss:            
Debt securities, loans and advances  451   4,805   55 
Equity shares  2,384   3,816   15,813 
Total net income arising on assets held at fair value through profit or loss  2,835   8,621   15,868 
Net income (expense) arising on liabilities held at fair value through profit or loss – debt securities in issue  14   (75)  (93)
Total net gains arising on assets and liabilities held at fair value through profit or loss  2,849   8,546   15,775 
Net gains on financial instruments held for trading  194   851   136 
Securities and other gains  3,043   9,397   15,911 
  2018
£m		  2017
£m		  2016
£m		 
Net income arising on assets and liabilities mandatorily held at fair value through profit or loss:            
Financial instruments held for trading  (8)  404   (428)
Other financial instruments mandatorily held at fair value through profit or loss:            
Debt securities, loans and advances  (26)  1,122   4,771 
Equity shares  (4,747)  9,862   12,534 
   (4,781)  11,388   16,877 
Net (expense) income arising on assets and liabilities designated at fair value through profit or loss  (156)  (144)  (154)
Securities and other gains  (4,937)  11,244   16,723 

 

NOTE 8: INSURANCE PREMIUM INCOME

 

 2015  2014  2013 
  £m   £m   £m  2018
£m		  2017
£m		 2016
£m		 
Life insurance                        
Gross premiums:                        
Life and pensions  3,613   6,070   6,823   6,612   6,273   5,613 
Annuities  430   327   549   2,178   1,082   1,685 
Other  —   —   10 
  4,043   6,397   7,382   8,790   7,355   7,298 
Ceded reinsurance premiums  (122)  (142)  (182)  (271)  (168)  (88)
Net earned premiums  3,921   6,255   7,200   8,519   7,187   7,210 
Non-life insurance                        
Net earned premiums  871   870   997   670   743   858 
Total net earned premiums  4,792   7,125   8,197   9,189   7,930   8,068 

 

Premium income in 2015 has been reduced by a charge of £1,959 million relating to the recapture by a third party insurer of a portfolio of policies previously reassured with the Group.NOTE 9: OTHER OPERATING INCOME

  2018
£m		  2017
£m		  2016
£m		 
Operating lease rental income  1,343   1,344   1,225 
Rental income from investment properties (note 26)  197   213   229 
Gains less losses on disposal of financial assets at fair value through other comprehensive income (2017 and 2016: available-for-sale financial assets) (note 41)  275   446   575 
Movement in value of in-force business (note 24)  (55)  (165)  472 
Liability management  –   (14)  (598)
Share of results of joint ventures and associates  9   6   (1)
Other  151   165   133 
Total other operating income  1,920   1,995   2,035 
F-28F-29

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 9: OTHER OPERATING INCOME

   2015   2014   2013 
   £m   £m   £m 
Operating lease rental income  1,165   1,126   1,120 
Rental income from investment properties (note 27)  268   269   308 
Gains less losses on disposal of available-for-sale financial assets (note 43)  51   131   629 
Movement in value of in-force business (note 25)  (162)  (428)  416 
Liability management  (28)  (1,386)  (142)
Share of results of joint ventures and associates  (3)  32   43 
Other  225   (53)  875 
Total other operating income  1,516   (309)  3,249 

LIABILITY MANAGEMENT

In April 2014, the Group completed concurrent Sterling, Euro and Dollar exchange offers with holders of certain series of its Enhanced Capital Notes (ECNs) to exchange the ECNs for new Additional Tier 1 (AT1) securities. In addition the Group completed a tender offer to eligible retail holders outside the United States to sell their Sterling-denominated ECNs for cash. The exchange offers completed with the equivalent of £5.0 billion of ECNs being exchanged for the equivalent of £5.35 billion of AT1 securities, before issue costs. The retail tender offer completed with approximately £58.5 million of ECNs being repurchased for cash. A loss of £1,362 million was recognised in relation to these exchange and tender transactions in the year ended 31 December 2014.

Losses of £28 million arose in the year ended 31 December 2015 (2014: losses of £24 million; 2013: losses of £142 million) on other transactions undertaken as part of the Group’s management of its wholesale funding and subordinated debt.

OTHER

During 2013 the Group had completed a number of disposals of assets and businesses, including the sale of its shareholding in St James’s Place plc (profit of £540 million), a portfolio of US residential mortgage-backed securities (profit of £538 million), its Spanish retail banking operations (loss of £256 million), its Australian operations (profit of £49 million) and its German life insurance business (this disposal completed in the first quarter of 2014, but an impairment of £382 million was recognised in the year ended 31 December 2013).

NOTE 10: INSURANCE CLAIMS

 

Insurance claims comprise:

   2015   2014   2013 
   £m   £m   £m 
Life insurance and participating investment contracts            
Claims and surrenders  (7,983)  (7,506)  (8,495)
Change in insurance and participating investment contracts (note 33)  2,898   (4,392)  (5,184)
Change in non-participating investment contracts  (438)  (1,448)  (5,409)
   (5,523)  (13,346)  (19,088)
Reinsurers’ share  101   109   60 
   (5,422)  (13,237)  (19,028)
Change in unallocated surplus  63   74   (123)
Total life insurance and participating investment contracts  (5,359)  (13,163)  (19,151)
Non-life insurance            
Total non-life insurance claims, net of reinsurance  (370)  (330)  (356)
Total insurance claims  (5,729)  (13,493)  (19,507)
Life insurance and participating investment contracts gross claims and surrenders can also be analysed as follows:            
Deaths  (631)  (549)  (611)
Maturities  (1,348)  (1,656)  (2,240)
Surrenders  (4,811)  (4,102)  (4,489)
Annuities  (902)  (884)  (860)
Other  (291)  (315)  (295)
Total life insurance gross claims and surrenders  (7,983)  (7,506)  (8,495)
F-29

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Insurance claims comprise: 2018
£m		  2017
£m		  2016
£m		 
Life insurance and participating investment contracts            
Claims and surrenders  (8,735)  (8,898)  (8,617)
Change in insurance and participating investment contracts (note 31)  4,565   (9,067)  (14,160)
Change in non-participating investment contracts  628   2,836   679 
   (3,542)  (15,129)  (22,098)
Reinsurers’ share  404   35   106 
   (3,138)  (15,094)  (21,992)
Change in unallocated surplus  8   (147)  14 
Total life insurance and participating investment contracts  (3,130)  (15,241)  (21,978)
Non-life insurance            
Total non-life insurance claims, net of reinsurance  (335)  (337)  (366)
Total insurance claims  (3,465)  (15,578)  (22,344)
Life insurance and participating investment contracts gross claims and surrenders can also be analysed as follows:     
Deaths  (721)  (675)  (635)
Maturities  (1,198)  (1,280)  (1,347)
Surrenders  (5,548)  (5,674)  (5,444)
Annuities  (1,032)  (985)  (949)
Other  (236)  (284)  (242)
Total life insurance gross claims and surrenders  (8,735)  (8,898)  (8,617)

 

NOTE 11: OPERATING EXPENSES

 

 2015  2014  2013 
  £m   £m   £m  2018
£m		  2017
£m		 2016
£m		 
Staff costs:                        
Salaries  2,808   3,178   3,331   2,482   2,679   2,750 
Performance-based compensation  409   390   473   509   473   475 
Social security costs  349   398   385   343   361   363 
Pensions and other post-retirement benefit schemes (note 37):            
Past service (credits) charges1  –   (822)    104 
Other  548   596   654 
  548   (226)   758 
Pensions and other post-retirement benefit schemes (note 35)  705   625   555 
Restructuring costs  104   264   111   249   24   241 
Other staff costs  459   741   783   474   448   433 
  4,677   4,745   5,841   4,762   4,610   4,817 
Premises and equipment:                        
Rent and rates  368   424   467   370   365   365 
Repairs and maintenance  173   221   178   190   231   187 
Other  174   246   325   169   134   120 
  715   891   970   729   730   672 
Other expenses:                        
Communications and data processing  893   1,118   1,169   1,121   882   848 
Advertising and promotion  253   336   313   197   208   198 
Professional fees  262   481   425   287   328   265 
UK bank levy  270   237   238   225   231   200 
TSB disposal (note 55)  665   —   — 
Other  703   1,017   971   653   814   873 
  3,046   3,189   3,116   2,483   2,463   2,384 
Depreciation and amortisation:                        
Depreciation of property, plant and equipment (note 27)  1,534   1,391   1,374 
Amortisation of acquired value of in-force non-participating investment contracts (note 25)  41   43   54 
Amortisation of other intangible assets (note 26)  537   501   512 
Depreciation of property, plant and equipment (note 26)  1,852   1,944   1,761 
Amortisation of acquired value of in-force non-participating investment contracts (note 24)  40   34   37 
Amortisation of other intangible assets (note 25)  513   392   582 
 2,112  1,935  1,940   2,405   2,370   2,380 
Goodwill impairment (note 23)  –   8   – 
Total operating expenses, excluding regulatory provisions  10,550   10,760   11,867   10,379   10,181   10,253 
Regulatory provisions:                        
Payment protection insurance provision (note 39)  4,000   2,200   3,050 
Other regulatory provisions (note 39)  837   925   405 
Payment protection insurance provision (note 37)  750   1,300   1,350 
Other regulatory provisions1(note 37)  600   865   1,024 
  4,837   3,125   3,455   1,350   2,165   2,374 
Total operating expenses  15,387   13,885   15,322   11,729   12,346   12,627 

 

1On 11 March 2014 the Group announced a change to its defined benefit pension schemes, revising the existing cap on the increases in pensionable pay used in calculating the pension benefit, from 2 per cent to nil with effect from 2 April 2014. The effect of this change was to reduce the Group’s retirement benefit obligations recognised on the balance sheet by £843 million with a corresponding curtailment gain recognised in the income statement. This has been partly offset by a charge of £21 million following changes to pension arrangements for staff within the TSB business.
 In 2013, the Group agreed certain changes to early retirement and commutation factors in two2016, regulatory provisions of its principal defined benefit pension schemes, resulting in a curtailment cost of £104£61 million recognised in the Group’s income statement in the year ended 31 December 2013.were charged against income.
F-30

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 11: OPERATING EXPENSEScontinued

 

PERFORMANCE-BASED COMPENSATION

Performance-based compensation

The table below analyses the Group’s performance-based compensation costs between those relating to the current performance year and those relating to earlier years.

 

 2015  2014  2013 
  £m   £m   £m  2018
£m		  2017
£m		 2016
£m		 
Performance-based compensation expense comprises:                        
Awards made in respect of the year ended 31 December  280   324   394   362   334   312 
Awards made in respect of earlier years 129  66  79   147   139   163 
 409  390  473   509   473   475 
            
Performance-based compensation expense deferred until later years comprises:                        
Awards made in respect of the year ended 31 December  114   152   47   152   127   123 
Awards made in respect of earlier years  56   32   30   37   35   41 
  170   184   77   189   162   164 

 

Performance-based awards expensed in 20152018 include cash awards amounting to £96£137 million (2014: £104(2017: £102 million; 2013: £1262016: £116 million).

 

AVERAGE HEADCOUNT

Average headcount

The average number of persons on a headcount basis employed by the Group during the year was as follows:

 

  2015   2014  2013  2018  2017 2016 
UK  84,922   94,241   96,001   71,857   75,150   79,606 
Overseas  781   847  1,868   769   794   812 
Total  85,703   95,088  97,869   72,626   75,944   80,418 

 

FEES PAYABLE TO THE AUDITORS

NOTE 12: AUDITORS’ REMUNERATION

Fees payable to the Company’s auditors by the Group are as follows:

 

   2015   2014   2013 
   £m   £m   £m 
             
Fees payable for the audit of the Company’s current year annual report  1.2   1.4   1.5 
Fees payable for other services:            
Audit of the Company’s subsidiaries pursuant to legislation  14.9   15.5   17.4 
Other services supplied pursuant to legislation  2.2   2.1   2.6 
Total audit fees  18.3   19.0   21.5 
Other services – audit related fees  3.2   9.1   4.5 
Total audit and audit related fees  21.5   28.1   26.0 
Services relating to taxation:            
Taxation compliance services  0.2   0.2   0.3 
All other taxation advisory services  0.1   0.3   0.3 
   0.3   0.5   0.6 
Other non-audit fees:            
Services relating to corporate finance transactions  0.2   0.3   0.3 
Other services  2.3   3.2   5.6 
Total other non-audit fees  2.5   3.5   5.9 
Total fees payable to the Company’s auditors by the Group  24.3   32.1   32.5 
F-31

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11: OPERATING EXPENSEScontinued

  2018
£m		  2017
£m		  2016
£m		 
             
Fees payable for the audit of the Company’s current year annual report  1.5   1.5   1.5 
Fees payable for other services:            
Audit of the Company’s subsidiaries pursuant to legislation  19.1   18.6   14.7 
Other services supplied pursuant to legislation  2.9   3.0   3.1 
Total audit fees  23.5   23.1   19.3 
Other services – audit related fees  1.2   1.2   3.1 
Total audit and audit related fees  24.7   24.3   22.4 
Services relating to taxation:            
Taxation compliance services  –   –   0.2 
All other taxation advisory services  –   –   0.1 
   –   –   0.3 
Other non-audit fees:            
Services relating to corporate finance transactions  –   1.2   0.1 
Other services  2.0   2.4   1.5 
Total other non-audit fees  2.0   3.6   1.6 
Total fees payable to the Company’s auditors by the Group  26.7   27.9   24.3 

 

The following types of services are included in the categories listed above:

 

Audit fees: This category includes fees in respect of the audit of the Group’s annual financial statements and other services in connection with regulatory filings. Other services supplied pursuant to legislation relate primarily to the costs associated with the Sarbanes-Oxley Act audit requirements together with the cost of the audit of the Group’s Form 20-F filing.

 

Audit related fees:This category includes fees in respect of services for assurance and related services that are reasonably related to the performance of the audit or review of the financial statements, for example acting as reporting accountants in respect of debt prospectuses and circulars required by the UKLA listing rules.

 

Services relating to taxation: This category includesFollowing a change in policy in 2017, the Group’s auditors are not engaged to provide tax complianceservices except in exceptional circumstances and tax advisory services.where permitted by applicable guidance.

 

Other non-audit fees: This category includes due diligence relating to corporate finance, including venture capital transactions and other assurance and advisory services.

 

It is the Group’s policy to use the auditors on assignments in cases where their knowledge of the Group means that it is neither efficient nor cost effective to employ another firm of accountants. Such assignments typically relate to the provision of advice on tax issues, assistance in transactions involving the acquisition and disposal of businesses and accounting advice.

F-31

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12: AUDITORS’ REMUNERATION continued

 

The Group has procedures that are designed to ensure auditor independence, including that fees for audit andprohibiting certain non-audit services are approved in advance. This approval can be obtained either on an individual engagement basis or, for certain types of non-audit services, particularly those of a recurring nature, through the approval of a fee cap covering all engagements of that type provided the fee is below that cap.

services. All statutory audit work as well as most non-audit assignments where the fee is expected to exceed the relevant fee cap must be pre-approved by the Audit Committeeaudit committee on an individual engagement basis.basis; for certain types of non-audit engagements where the fee is ‘de minimis’ the audit committee has pre-approved all assignments subject to confirmation by management. On a quarterly basis, the Audit Committeeaudit committee receives and reviews a report detailing all pre-approved services and amounts paid to the auditors for such pre-approved services.

 

During the year, the auditors also earned fees payable by entities outside the consolidated Lloyds Banking Group in respect of the following:

 

   2015   2014   2013 
   £m   £m   £m 
Audits of Group pension schemes  0.3   0.3   0.3 
Audits of the unconsolidated Open Ended Investment Companies managed by the Group  0.4   0.4   0.5 
Reviews of the financial position of corporate and other borrowers  3.1   5.0   6.5 
Acquisition due diligence and other work performed in respect of potential venture capital investments  1.2   1.0   2.1 

  2018
£m		  2017
£m		  2016
£m		 
Audits of Group pension schemes  0.1   0.1   0.3 
Audits of the unconsolidated Open Ended Investment Companies managed by the Group  0.3   0.3   0.4 
Reviews of the financial position of corporate and other borrowers  0.4   0.2   1.2 
Acquisition due diligence and other work performed in respect of potential venture capital investments  –   0.1   1.0 

 

NOTE 12:13: IMPAIRMENT

 

   2015   2014   2013 
   £m   £m   £m 
Impairment losses on loans and receivables:            
Loans and advances to customers  443   735   2,725 
Debt securities classified as loans and receivables  (2)  2   1 
Total impairment losses on loans and receivables (note 21)  441   737   2,726 
Impairment of available-for-sale financial assets  4   5   15 
Other credit risk provisions  (55)  10   — 
Total impairment charged to the income statement  390   752   2,741 
  Stage 1
£m		  Stage 2
£m		  Stage 3
£m		  Purchased or
originated
credit-impaired
£m		  Total
£m		 
Year ended 31 December 2018                    
Impact of transfers between stages  (12)  51   446   –   485 
Other changes in credit quality  (20)  (47)  541   69   543 
Additions (repayments)  18   (82)  43   (69)  (90)
Methodology changes  (71)  (21)  72   –   (20)
Other items  (13)  –   32   –   19 
Other items impacting the impairment charge  (86)  (150)  688   –   452 
Total impairment  (98)  (99)  1,134   –   937 
                     
In respect of:                    
Loans and advances to banks  1   –   –   –   1 
Loans and advances to customers  (66)  (51)  1,139   –   1,022 
Debt securities  –   –   –   –   – 
Financial assets at amortised cost  (65)  (51)  1,139   –   1,023 
Other assets  –   –   1   –   1 
Impairment charge on drawn balances  (65)  (51)  1,140   –   1,024 
Loan commitments and financial guarantees  (19)  (48)  (6)  –   (73)
Financial assets at fair value through other comprehensive income  (14)  –   –   –   (14)
Total impairment  (98)  (99)  1,134   –   937 

The Group’s impairment charge comprises the following items:

TRANSFERS BETWEEN STAGES

The net impact on the impairment charge of transfers between stages.

OTHER CHANGES IN CREDIT QUALITY

Changes in loss allowance as a result of movements in risk parameters that reflect changes in customer quality, but which have not resulted in a transfer to a different stage. This also contains the impact on the impairment charge as a result of write-offs and recoveries, where the related loss allowances are reassessed to reflect ultimate realisable or recoverable value.

ADDITIONS (REPAYMENTS)

Expected loss allowances are recognised on origination of new loans or further drawdowns of existing facilities. Repayments relate to the reduction of loss allowances as a result of repayments of outstanding balances.

METHODOLOGY CHANGES

Increase or decrease in impairment charge as a result of adjustments to the models used for expected credit loss calculations; either as changes to the model inputs (risk parameters) or to the underlying assumptions.

F-32

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 13: TAXATION

(A) ANALYSIS OF TAX CHARGE FOR THE YEAR

   2015   2014   2013 
   £m   £m   £m 
             
UK corporation tax:            
Current tax on profit for the year  (485)  (162)  (226)
Adjustments in respect of prior years  (90)  213   (205)
   (575)  51   (431)
Foreign tax:            
Current tax on profit for the year  (24)  (39)  (60)
Adjustments in respect of prior years  27   3   26 
   3   (36)  (34)
Current tax (charge) credit  (572)  15   (465)
Deferred tax (note 38):            
Origination and reversal of temporary differences  (185)  (72)  (434)
Due to change in UK corporation tax rate  (27)  (24)  (594)
Adjustments in respect of prior years  96   (182)  276 
   (116)  (278)  (752)
Tax charge  (688)  (263)  (1,217)

The charge for tax on the profit for 2015 is based on a UK corporation tax rate of 20.25 per cent (2014: 21.5 per cent; 2013: 23.25 per cent).

The income tax charge is made up as follows:

   2015   2014   2013 
   £m   £m   £m 
Tax credit (charge) attributable to policyholders  3   (18)  (328)
Shareholder tax charge  (691)  (245)  (889)
Tax charge  (688)  (263)  (1,217)

(B) FACTORS AFFECTING THE TAX CHARGE FOR THE YEAR

A reconciliation of the charge that would result from applying the standard UK corporation tax rate to the profit before tax to the actual tax charge for the year is given below:

   2015   2014   2013 
   £m   £m   £m 
Profit before tax  1,644   1,762   415 
Tax charge thereon at UK corporation tax rate of 20.25 per cent            
(2014: 21.5 per cent; 2013: 23.25 per cent)  (333)  (379)  (96)
Factors affecting charge:            
UK corporation tax rate change and related impacts  (27)  (24)  (594)
Disallowed items1  (630)  (195)  (167)
Non-taxable items  162   153   132 
Overseas tax rate differences  (4)  (24)  (116)
Gains exempted or covered by capital losses  67   181   57 
Policyholder tax  3   (14)  (251)
Deferred tax on losses no longer recognised following sale of Australian operations  —   —   (348)
Deferred tax on Australian tax losses not previously recognised  —   —   60 
Tax losses not previously recognised  42   —   — 
Adjustments in respect of previous years  33   34   97 
Effect of results of joint ventures and associates  (1)  7   9 
Other items  —   (2)  — 
Tax charge on profit on ordinary activities  (688)  (263)  (1,217)

1The Finance (No. 2) Act 2015 introduced restrictions on the tax deductibility of provisions for conduct charges arising on or after 8 July 2015. This has resulted in an additional income statement tax charge of £459 million.
F-33

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 13: TAXATIONIMPAIRMENTcontinued

 

  2017
£m		  2016
£m		 
Impairment losses on loans and receivables:        
Loans and advances to customers  697   592 
Debt securities classified as loans and receivables  (6)  – 
Total impairment losses on loans and receivables  691   592 
Impairment of available-for-sale financial assets  6   173 
Other credit risk provisions  (9)  (13)
Total impairment charged to the income statement  688   752 

The Finance (No. 2) Act 2015 (the Act) was substantively enacted on 26 October 2015. The Act reduced the main rate of corporation tax to 19 per cent from 1 April 2017 and 18 per cent from 1 April 2020; however from 1 January 2016 banking profits will be subject to an additional surcharge of 8 per cent. The change in the main rate of corporation tax from 20 per cent to 18 per cent, and the additional surcharge of 8 per cent, have resulted in a movement

Movements in the Group’s net deferred tax asset at 31 December 2015 of £123 million, comprising the £27 million charge includedimpairment allowances are shown in the income statement and a £96 million charge included in equity.note 20.

 

NOTE 14: TAXATION

(A) Analysis of tax expense for the year

  2018
£m		  2017
£m		  2016
£m		 
UK corporation tax:            
Current tax on profit for the year  (1,386)  (1,342) (1,010)
Adjustments in respect of prior years  11   122   156 
   (1,375)  (1,220)  (854)
Foreign tax:            
Current tax on profit for the year  (34)  (40)  (20)
Adjustments in respect of prior years  5   10   2 
   (29)  (30)  (18)
Current tax expense  (1,404)  (1,250)  (872)
             
Deferred tax:            
Current year  (127)  (430)  (758)
Adjustments in respect of prior years  (29)  (48)  (94)
Deferred tax expense  (156)  (478)  (852)
Tax expense  (1,560)  (1,728) (1,724)
             
The income tax expense is made up as follows:            
             
   2018
£m		   2017
£m		   2016
£m		 
Tax (expense) credit attributable to policyholders  14   (82)  (301)
Shareholder tax expense  (1,574)  (1,646)  (1,423)
Tax expense  (1,560)  (1,728)  (1,724)
F-33

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 14: TAXATION continued

(B) Factors affecting the tax expense for the year

The UK corporation tax rate for the year was 19.0 per cent (2017: 19.25 per cent; 2016: 20 per cent). An explanation of the relationship between tax expense and accounting profit is set out below:

  2018
£m		  2017
£m		  2016
£m		 
Profit before tax  5,960   5,625   3,888 
UK corporation tax thereon  (1,132)  (1,083)  (778)
Impact of surcharge on banking profits  (432)  (452)  (266)
Non-deductible costs: conduct charges  (101)  (287)  (289)
Non-deductible costs: bank levy  (43)  (44)  (40)
Other non-deductible costs  (90)  (59)  (135)
Non-taxable income  87   72   75 
Tax-exempt gains on disposals  124   128   19 
(Derecognition) recognition of losses that arose in prior years  (9)  –   59 
Remeasurement of deferred tax due to rate changes  32   (9)  (201)
Differences in overseas tax rates  6   (15)  10 
Policyholder tax  (62)  (66)  (57)
Policyholder deferred tax asset in respect of life assurance expenses  73   –   (184)
Adjustments in respect of prior years  (13)  88   64 
Tax effect of share of results of joint ventures  –   (1)  (1)
Tax expense  (1,560)  (1,728)  (1,724)

NOTE 15: EARNINGS PER SHARE

 

   2015   2014   2013 
   £m   £m   £m 
Profit (loss) attributable to equity shareholders – basic and diluted  466   1,125   (838)
Tax relief on distributions to other equity holders  80   62   — 
   546   1,187   (838)
   2015   2014   2013 
   million   million   million 
Weighted average number of ordinary shares in issue – basic  71,272   71,350   71,009 
Adjustment for share options and awards  1,068   1,097   — 
Weighted average number of ordinary shares in issue – diluted  72,340   72,447   71,009 
Basic earnings (loss) per share  0.8p  1.7p  (1.2)p
Diluted earnings (loss) per share  0.8p  1.6p  (1.2)p
  2018
£m		  2017
£m		  2016
£m		 
Profit attributable to equity shareholders – basic and diluted  3,869   3,392   1,651 
Tax credit on distributions to other equity holders  106   102   91 
   3,975   3,494   1,742 
             
   2018
million		   2017
million		   2016
million		 
Weighted average number of ordinary shares in issue – basic  71,638   71,710   71,234 
Adjustment for share options and awards  641   683   790 
Weighted average number of ordinary shares in issue – diluted  72,279   72,393   72,024 
Basic earnings per share  5.5p  4.9p  2.4p
Diluted earnings per share  5.5p  4.8p  2.4p

 

Basic earnings per share are calculated by dividing the net profit attributable to equity shareholders by the weighted average number of ordinary shares in issue during the year, which has been calculated after deducting 10138 million (2014: 22(2017: 57 million; 2013: 182016: 140 million) ordinary shares representing the Group’s holdings of own shares in respect of employee share schemes.

 

For the calculation of diluted earnings per share the weighted average number of ordinary shares in issue is adjusted to assume conversion of all dilutive potential ordinary shares that arise in respect of share options and awards granted to employees. The number of shares that could have been acquired at the average annual share price of the Company’s shares based on the monetary value of the subscription rights attached to outstanding share options and awards is determined. This is deducted from the number of shares issuable under such options and awards to leave a residual bonus amount of shares which are added to the weighted-average number of ordinary shares in issue, but no adjustment is made to the profit attributable to equity shareholders.

 

The weighted-average number ofThere were no anti-dilutive share options and awards excluded from the calculation of diluted earnings per share was 1 million at 31 December 2015 (2014: 7 million; 2013: 28(2017: none; 2016: weighted-average of 0.3 million).

F-34

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 15: TRADING AND OTHER16: FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS

These assets are comprised as follows:

 

 2015  2014 
    Other financial        Other financial    
    assets at fair        assets at fair    
 Trading  value through     Trading  value through    
 assets  profit or loss  Total  assets  profit or loss  Total  31 December 2018 1 January 2018 31 December 2017
  £m   £m   £m   £m   £m   £m  Trading
assets
£m		 Other financial
assets
mandatorily at
fair value
through
profit or loss
£m		 Total
£m		  Trading
assets
£m		 Other financial
assets
mandatorily at
fair value
through
profit or loss
£m		 Total
£m		 Trading
assets
£m		 Other financial
assets at
fair value
through
profit or loss
£m		 Total
£m		 
Loans and advances to customers  30,109   —   30,109   28,513   —   28,513   26,886   10,964   37,850   29,976   11,434   41,410   29,976   –   29,976 
Loans and advances to banks  3,065   —   3,065   8,212   —   8,212   848   2,178   3,026   1,614   2,582   4,196   1,614   –   1,614 
Debt securities:                                                            
Government securities  8,269   13,848   22,117   7,976   17,497   25,473   7,192   10,903   18,095   9,833   11,117   20,950   9,833   12,187   22,020 
Other public sector securities  —   2,039   2,039   —   2,170   2,170   –   2,064   2,064   –   1,543   1,543   –   1,527   1,527 
Bank and building society certificates of deposit  —   135   135   554   —   554   –   1,105   1,105   –   222   222   –   222   222 
Asset-backed securities:                                                            
Mortgage-backed securities  516   842   1,358   187   847   1,034   10   215   225   189   213   402   189   211   400 
Other asset-backed securities  85   762   847   129   721   850   63   286   349   95   233   328   95   926   1,021 
Corporate and other debt securities  612   19,704   20,316   1,486   20,604   22,090   247   18,063   18,310   523   19,707   20,230   523   19,467   19,990 
  9,482   37,330   46,812   10,332   41,839   52,171   7,512   32,636   40,148   10,640   33,035   43,675   10,640   34,540   45,180 
Equity shares  5   60,471   60,476   —   61,576   61,576   –   77,485   77,485   6   86,703   86,709   6   86,084   86,090 
Treasury and other bills  —   74   74   1,437   22   1,459   –   20   20   –   18   18   –   18   18 
Total  42,661   97,875   140,536   48,494   103,437   151,931   35,246   123,283   158,529   42,236   133,772   176,008   42,236   120,642   162,878 

 

Other financial assets at fair value through profit or loss include the following assets designated into that category:backing insurance contracts and investment contracts of £116,903 million (1 January 2018: £126,968 million; 31 December 2017: £117,323 million). Included within these assets are investments in unconsolidated structured entities of £26,028 million (1 January 2018: £28,759 million; 31 December 2017: £28,759 million), see note 48.

(i)financial assets backing insurance contracts and investment contracts of £90,492 million (2014: £94,314 million) which are so designated because the related liabilities either have cash flows that are contractually based on the performance of the assets or are contracts whose measurement takes
F-34

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 15: TRADING AND OTHER FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSScontinued

account of current market conditions and where significant measurement inconsistencies would otherwise arise. Included within these assets are investments in unconsolidated structured entities of £13,282 million (2014: £27,255 million), see note 20; and
(ii)private equity investments of £2,415 million (2014: £2,350 million) that are managed, and evaluated, on a fair value basis in accordance with a documented risk management or investment strategy and reported to key management personnel on that basis.

 

For amounts included above which are subject to repurchase and reverse repurchase agreements see note 53.52.

F-35

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 16:17: DERIVATIVE FINANCIAL INSTRUMENTS

The fair values and notional amounts of derivative instruments are set out in the following table:

  31 December 2018 31 December 2017
  Contract/
notional
amount
£m		  Fair value
assets
£m		  Fair value
liabilities
£m		  Contract/
notional
amount
£m		  Fair value
assets
£m		  Fair value
liabilities
£m		 
Trading and other                        
Exchange rate contracts:                        
Spot, forwards and futures  41,571   746   549   31,716   1,023   789 
Currency swaps  311,491   4,566   3,709   223,624   3,157   3,534 
Options purchased  10,202   485   –   8,191   580   – 
Options written  11,393   –   495   6,684   –   627 
   374,657   5,797   4,753   270,215   4,760   4,950 
Interest rate contracts:                        
Interest rate swaps  4,381,271   13,624   12,629   2,264,834   15,791   15,364 
Forward rate agreements  494,430   –   2   239,797   5   1 
Options purchased  30,724   2,107   –   32,097   2,329   – 
Options written  26,463   –   1,997   32,817   –   2,524 
Futures  128,211   16   4   35,542   9   7 
   5,061,099   15,747   14,632   2,605,087   18,134   17,896 
Credit derivatives  13,757   99   181   4,568   77   423 
Equity and other contracts  15,145   389   699   25,150   982   1,242 
Total derivative assets/liabilities – trading and other  5,464,658   22,032   20,265   2,905,020   23,953   24,511 
Hedging                        
Derivatives designated as fair value hedges:                        
Currency swaps  490   3   29   1,327   19   38 
Interest rate swaps  150,971   947   187   109,670   1,145   407 
   151,461   950   216   110,997   1,164   445 
Derivatives designated as cash flow hedges:                        
Interest rate swaps  556,945   358   844   549,099   597   1,053 
Futures  –   –   –   73,951   –   1 
Currency swaps  10,578   255   48   7,310   120   114 
   567,523   613   892   630,360   717   1,168 
Total derivative assets/liabilities – hedging  718,984   1,563   1,108   741,357   1,881   1,613 
Total recognised derivative assets/liabilities  6,183,642   23,595   21,373   3,646,377   25,834   26,124 

The notional amount of the contract does not represent the Group’s real exposure to credit risk which is limited to the current cost of replacing contracts with a positive value to the Group should the counterparty default. To reduce credit risk the Group uses a variety of credit enhancement techniques such as netting and collateralisation, where security is provided against the exposure. Further details are provided in note 52 Credit risk.

 

The Group holds derivatives as part of the following strategies:

 

–Customer driven, where derivatives are held as part of the provision of risk management products to Group customers;
  
–To manage and hedge the Group’s interest rate and foreign exchange risk arising from normal banking business. The hedge accounting strategy adopted by the Group is to utilise a combination of fair value and cash flow hedge approaches as described in note 53;52; and
  
–Derivatives held in policyholder funds as permitted by the investment strategies of those funds.
F-36

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

Derivatives are classified as trading except those designated as effective hedging instruments which meet the criteria under IAS 39. Derivatives are held at fair value on the Group’s balance sheet. A description of the methodology used to determine the fair value of derivative financial instruments and the effect of using reasonably possible alternative assumptions for those derivatives valued using unobservable inputs is set out in note 50.NOTE 17: DERIVATIVE FINANCIAL INSTRUMENTS continued

 

The principal derivatives used by the Group are as follows:

 

–Interest rate related contracts include interest rate swaps, forward rate agreements and options. An interest rate swap is an agreement between two parties to exchange fixed and floating interest payments, based upon interest rates defined in the contract, without the exchange of the underlying principal amounts. Forward rate agreements are contracts for the payment of the difference between a specified rate of interest and a reference rate, applied to a notional principal amount at a specific date in the future. An interest rate option gives the buyer, on payment of a premium, the right, but not the obligation, to fix the rate of interest on a future loan or deposit, for a specified period and commencing on a specified future date.
  
–Exchange rate related contracts include forward foreign exchange contracts, currency swaps and options. A forward foreign exchange contract is an agreement to buy or sell a specified amount of foreign currency on a specified future date at an agreed rate. Currency swaps generally involve the exchange of interest payment obligations denominated in different currencies; the exchange of principal can be notional or actual. A currency option gives the buyer, on payment of a premium, the right, but not the obligation, to sell specified amounts of currency at agreed rates of exchange on or before a specified future date.
  
–Credit derivatives, principally credit default swaps, are used by the Group as part of its trading activity and to manage its own exposure to credit risk. A credit default swap is a swap in which one counterparty receives a premium at pre-set intervals in consideration for guaranteeing to make a specific payment should a negative credit event take place. The Group also uses credit default swaps to securitise, in combination with external funding, £455 million (2014: £611 million) of corporate and commercial banking loans.
  
–Equity derivatives are also used by the Group as part of its equity-based retail product activity to eliminate the Group’s exposure to fluctuations in various international stock exchange indices. Index-linked equity options are purchased which give the Group the right, but not the obligation, to buy or sell a specified amount of equities, or basket of equities, in the form of published indices on or before a specified future date.

Details of the Group’s hedging instruments are set out below:

  Maturity
31 December 2018 Up to 1 month
£m		  1-3 months
£m		  3-12 months
£m		  1-5 years
£m		  Over 5 years
£m		  Total
£m		 
Fair value hedges                        
Interest rate                        
Cross currency swap                        
Notional  –   36   –   283   171   490 
Average fixed interest rate  –   4.82%  –   5.88%  4.44%    
Average EUR/USD exchange rate  –   –   –   1.13   –     
Average USD/GBP exchange rate  –   –   –   1.30   –     
Average NOK/GBP exchange rate  –   9.22   –   9.19   9.03     
Interest rate swap                        
Notional  393   417   32,876   86,451   30,834   150,971 
Average fixed interest rate  1.38%  2.06%  1.65%  1.75%  2.98%    
Cash flow hedges                        
Foreign exchange                        
Currency swap                        
Notional  67   47   2,234   2,111   6,119   10,578 
Average USD/EUR exchange rate  1.15   –   1.13   1.10   1.07     
Average USD/GBP exchange rate  –   1.32   1.34   1.27   1.28     
Interest rate                        
Interest rate swap                        
Notional  4,874   11,204   66,312   292,712   181,843   556,945 
Average fixed interest rate  1.47%  1.03%  0.99%  1.46%  1.85%    

The carrying amounts of the Group’s hedging instruments are as follows:

  Carrying amount of the hedging instrument
  Contract/notional
amount		  Assets  Liabilities  Changes in fair
value used for
calculating hedge
ineffectiveness
(YTD)		 
31 December 2018 £m  £m  £m  £m 
Fair value hedges                
Interest rate                
Currency swaps  490   3   29   (10)
Interest rate swaps  150,971   947   187   104
Cash flow hedges                
Foreign exchange                
Currency swaps  10,578   255   48   229 
Interest rate                
Interest rate swaps  556,945   358   844   (781)

All amounts are held within Derivative financial instruments.

F-35F-37

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 16:17: DERIVATIVE FINANCIAL INSTRUMENTScontinued

The fair values and notional amounts of derivative instruments are set out in the following table:

  31 December 2015   31 December 2014 
   Contract/ notional   Fair value   Fair value   Contract/notional   Fair value   Fair value 
   amount   assets   liabilities   amount   assets   liabilities 
   £m   £m   £m   £m   £m   £m 
Trading and other                        
Exchange rate contracts:                        
Spot, forwards and futures  39,817   852   774   36,894   941   801 
Currency swaps  293,536   5,585   4,323   301,451   4,849   4,706 
Options purchased  20,352   751   –   49,085   1,244   – 
Options written  22,708   –   984   49,784   –   1,443 
   376,413   7,188   6,081   437,214   7,034   6,950 
Interest rate contracts:                        
Interest rate swaps  2,316,071   14,442   13,050   3,999,343   18,733   16,569 
Forward rate agreements  1,159,099   6   57   1,791,219   9   56 
Options purchased  55,962   3,003   –   58,600   3,755   – 
Options written  52,202   –   3,116   54,031   –   3,725 
Futures  105,475   7   8   134,117   9   24 
   3,688,809   17,458   16,231   6,037,310   22,506   20,374 
Credit derivatives  4,566   295   407   18,063   279   1,066 
Embedded equity conversion feature  –   545   –   –   646   – 
Equity and other contracts  14,174   1,295   1,145   14,842   1,430   1,181 
Total derivative assets/liabilities – trading and other  4,083,962   26,781   23,864   6,507,429   31,895   29,571 
Hedging                        
Derivatives designated as fair value hedges:                        
Currency swaps  2,649   52   107   7,281   113   131 
Interest rate swaps  121,063   1,572   724   115,394   2,342   831 
Options purchased  –   –   –   553   17   – 
   123,712   1,624   831   123,228   2,472   962 
Derivatives designated as cash flow hedges:                        
Interest rate swaps  460,829   816   1,534   518,746   1,606   2,536 
Futures  150,085   3   –   151,102   –   5 
Currency swaps  11,228   243   72   11,720   155   113 
   622,142   1,062   1,606   681,568   1,761   2,654 
Total derivative assets/liabilities – hedging  745,854   2,686   2,437   804,796   4,233   3,616 
Total recognised derivative assets/liabilities  4,829,816   29,467   26,301   7,312,225   36,128   33,187 

The principal amount of the contract does not represent the Group’s real exposure to credit risk which is limited to the current cost of replacing contracts with a positive value to the Group should the counterparty default. To reduce credit risk the Group uses a variety of credit enhancement techniques such as netting and collateralisation, where security is provided against the exposure. Further details are provided in note 53 Credit risk.

 

The embedded equity conversion featureGroup’s hedged items are as follows:

             
  Carrying amount of the hedged
item		  Accumulated amount of fair
value adjustment on the
hedged item		  Change in fair
value of
hedged item
for		  Cash flow hedge/currency
translation reserve		 
  Assets  Liabilities  Assets  Liabilities  ineffectiveness
assessment
(YTD)		  Continuing
hedges		  Discontinued
hedges		 
31 December 2018 £m  £m  £m  £m  £m  £m  £m 
Fair value hedges                            
Interest rate                            
Fixed rate mortgages1  53,136   –   (45)  –   (173)        
Fixed rate issuance2  –   63,746   –   1,598   807         
Fixed rate bonds3  23,285   –   232   –   (666)        
Cash flow hedges                            
Foreign exchange                            
Foreign currency issuance2                  (165)  114   327 
Customer deposits4                  (62)  70   (78)
Interest rate                            
Customer loans1                  456   867   60 
Central bank balances5                  (16)  30   20 
Customer deposits4                  (118)  (9)  (6)

1 Included within Loans and advances to customers
2Included within Debt securities in issue
3Included within Financial assets at fair value through other comprehensive income
4Included within Customer deposits
5Included within Cash and balances at central banks

The accumulated amount of £545 million (2014: £646 million) reflects thefair value of the equity conversion feature containedhedge adjustments remaining in the Enhanced Capital Notes issued by the Group in 2009; the lossbalance sheet for hedged items that have ceased to be adjusted for hedging gains and losses is a liability of £101 million£170 million.

Gains and losses arising from the change in fair value over 2015 (2014: gain of £401 million; 2013: loss of £209 million) is included within net gains on financial instruments held for trading within net trading income (note 7).

F-36

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTShedge accounting are summarised as follows:

 

NOTE 16: DERIVATIVE FINANCIAL INSTRUMENTScontinued

        Amounts reclassified from reserves to
income statement as:		 
  Gain (loss)
recognised in
other
comprehensive
income		  Hedge
ineffectiveness
recognised in the
income statement1		  Hedged item
affected income
statement		  Income statement
line item that
includes reclassified
amount		 
31 December 2018  £m   £m   £m     
Fair value hedge                
Interest rate                
Fixed rate mortgages      106        
Fixed rate issuance      (17)        
Fixed rate bonds      (27)        
Cash flow hedges                
Foreign exchange                
Foreign currency issuance  85   –   (81) Interest expense 
Customer deposits  (22)  (2)  (32) Interest expense 
Interest rate                
Customer loans  (418)  (17)  (467) Interest income 
Central bank balances  (63)  (5)  (52) Interest income 
Customer deposits  (49)  (1)  (69) Interest expense 

 

HEDGED CASH FLOWS

For designated cash flow hedges the following table shows when the Group’s hedged cash flows are expected to occur and when they will affect income. 

  0-1 years  1-2 years  2-3 years  3-4 years  4-5 years  5-10 years  10-20 years  Over 20 years  Total 
2015 £m  £m  £m  £m  £m  £m  £m  £m  £m 
Hedged forecast cash flows                           
expected to occur:                           
Forecast receivable cash flows 363  298  499  500  376  1,876  137  75  4,124 
Forecast payable cash flows (1,235) (758) (714) (667) (440) (1,116) (532) (145) (5,607)
Hedged forecast cash flows affect                           
profit or loss:                           
Forecast receivable cash flows 381  439  515  453  345  1,777  136  78  4,124 
Forecast payable cash flows (1,261) (741) (715) (671) (440) (1,115) (523) (141) (5,607)
                            
  0-1 years  1-2 years  2-3 years  3-4 years  4-5 years  5-10 years  10-20 years  Over 20 years  Total 
2014 £m  £m  £m  £m  £m  £m  £m  £m  £m 
Hedged forecast cash flows expected to occur:                           
Forecast receivable cash flows 250  458  680  845  745  1,928  112  111  5,129 
Forecast payable cash flows (130) (136) (53) (58) (57) (346) (459) (104) (1,343)
Hedged forecast cash flows affect                           
profit or loss:                           
Forecast receivable cash flows 391  536  769  830  646  1,736  114  107  5,129 
Forecast payable cash flows (174) (105) (54) (57) (63) (358) (433) (99) (1,343)

1 Hedge ineffectiveness is included in the income statement within net trading income.

 

There were no forecast transactions for which cash flow hedge accounting had to be ceasedcease in 2015 or 20142018 as a result of the highly probable cash flows no longer being expected to occur.

NOTE 17: LOANS AND ADVANCES TO BANKS

  2015 2014
  £m £m
Lending to banks 2,273 2,902
Money market placements with banks 22,844 23,253
Total loans and advances to banks before allowance for impairment losses 25,117 26,155
Allowance for impairment losses – –
Total loans and advances to banks 25,117 26,155

For amounts included above which are subject to reverse repurchase agreements see note 53.

F-37F-38

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 18: LOANS AND ADVANCES TO CUSTOMERS

  2015  2014 
  £m  £m 
Agriculture, forestry and fishing 6,924  6,586 
Energy and water supply 3,247  3,853 
Manufacturing 5,953  6,000 
Construction 4,952  6,425 
Transport, distribution and hotels 13,526  15,112 
Postal and telecommunications 2,563  2,624 
Property companies 32,228  36,682 
Financial, business and other services 43,072  44,979 
Personal:      
Mortgages 312,877  333,318 
Other 20,579  23,123 
Lease financing 2,751  3,013 
Hire purchase 9,536  7,403 
Total loans and advances to customers before allowance for impairment losses 458,208  489,118 
Allowance for impairment losses (note 21) (3,033) (6,414)
Total loans and advances to customers 455,175  482,704 

For amounts included above which are subject to reverse repurchase agreements see note 53.FINANCIAL ASSETS AT AMORTISED COST

 

(A) Loans and advances to customers include

  Stage 1
£m		  Stage 2
£m		  Stage 3
£m		  Purchased or
originated
credit-impaired
£m		  Total
£m		 
At 31 December 2017                  474,699 
Adjustment on adoption of IFRS 9 (note 54)                  (10,460)
At 1 January 2018  403,881   37,245   5,140   17,973   464,239 
Exchange and other movements  958   32   –   –   990 
Additions (repayments)  34,942   (2,187)  (2,074)  (2,609)  28,072 
Transfers to Stage 1  19,524   (19,501)  (23)      – 
Transfers to Stage 2  (15,743)  15,996   (253)      – 
Transfers to Stage 3  (2,031)  (2,220)  4,251       – 
   1,750   (5,725)  3,975       – 
Recoveries  –   –   553   27   580 
Disposal of businesses  –   (4,020)  (277)  –   (4,297)
Financial assets that have been written off during the year          (1,576)  –   (1,576)
At 31 December 2018  441,531   25,345   5,741   15,391   488,008 
Allowance for impairment losses  (525)  (994)  (1,553)  (78)  (3,150)
Total loans and advances to customers  441,006   24,351   4,188   15,313   484,858 

Stage 2 balances show a large reduction in the year largely as a result of the refinements to the transfer criteria approach in mortgages. There is also a reduction from the disposal of the Irish mortgage portfolio together with improvements in credit quality.

(B) Loans and advances to banks

  Stage 1
£m		  Stage 2
£m		  Stage 3
£m		  Purchased or
originated
credit-impaired
£m		  Total
£m		 
At 31 December 2017                  6,611 
Adjustment on adoption of IFRS 9 (note 54)                  (2,364)
At 1 January 2018  4,245   2   –   –   4,247 
Exchange and other movements  (29)  1   –   –   (28)
Additions (repayments)  2,066   –   –   –   2,066 
At 31 December 2018  6,282   3   –   –   6,285 
Allowance for impairment losses  (2)  –   –   –   (2)
Total loans and advances to banks  6,280   3   –   –   6,283 

(C) Debt securities

  Stage 1
£m		  Stage 2
£m		  Stage 3
£m		  Purchased or
originated
credit-impaired
£m		  Total
£m		 
At 31 December 2017                  3,669 
Adjustment on adoption of IFRS 9 (note 54)                  (329)
At 1 January 2018  3,291   –   49   –   3,340 
Exchange and other movements  77   –   (14)   –   63 
Additions (repayments)  1,870   –   –   –   1,870 
Financial assets that have been written off during the year          (29)  –   (29)
At 31 December 2018  5,238   –   6   –   5,244 
Allowance for impairment losses  –   –   (6)  –   (6)
Total debt securities  5,238   –   –   –   5,238 
Total financial assets at amortised cost  452,524   24,354   4,188   15,313   496,379 

Transfers between stages are deemed to have taken place at the start of the reporting period, with all other movements shown in the stage in which the asset is held at 31 December, with the exception of those held within Purchased or originated credit-impaired, which are not transferrable.

Net increase and decrease in balances comprise new loans originated and repayments of outstanding balances throughout the reporting period. Loans which are written off in the period are first transferred to Stage 3 before acquiring a full allowance and subsequent write-off.

F-39

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 19: FINANCE LEASE RECEIVABLES

The Group’s finance lease receivables which may beare classified as loans and advances to customers and accounted for at amortised cost. The balance is analysed as follows:

 

 2015  2014 
 £m  £m  2018
£m		  2017
£m		 
Gross investment in finance leases, receivable:              
Not later than 1 year 497  573   458   680 
Later than 1 year and not later than 5 years 1,225  1,214   1,351   1,106 
Later than 5 years 2,407  3,136   1,104   1,053 
 4,129  4,923   2,913   2,839 
Unearned future finance income on finance leases (1,316) (1,837)  (1,068)  (692)
Rentals received in advance (62) (73)  (23)  (53)
Net investment in finance leases 2,751  3,013   1,822   2,094 

 

The net investment in finance leases represents amounts recoverable as follows:

 

 2015  2014 
 £m  £m  2018
£m		  2017
£m		 
Not later than 1 year 319  339   152   546 
Later than 1 year and not later than 5 years 859  763   679   887 
Later than 5 years 1,573  1,911   991   661 
Net investment in finance leases 2,751  3,013   1,822   2,094 

 

Equipment leased to customers under finance leases primarily relates to structured financing transactions to fund the purchase of aircraft, ships and other large individual value items. During 20152017 and 20142018 no contingent rentals in respect of finance leases were recognised in the income statement. There was noan allowance for uncollectable finance lease receivables included in the allowance for impairment losses (2014:of £1 million)million (2017: £nil).

F-38F-40

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 20: ALLOWANCE FOR IMPAIRMENT LOSSES

ANALYSIS OF MOVEMENT IN THE ALLOWANCE FOR IMPAIRMENT LOSSES BY STAGE

  Stage 1
£m		   Stage 2
£m		   Stage 3
£m		   Purchased or
originated
credit-impaired
£m		   Total
£m		  
In respect of drawn balances                         
Balance at 31 December 2017                      2,227  
Adjustment on adoption of IFRS 9 (note 54)                      1,033  
Balance at 1 January 2018  590    1,147    1,491    32    3,260  
Exchange and other adjustments  2    –    133    –    135  
                          
Transfers to Stage 1  304    (299)   (5)        –  
Transfers to Stage 2  (46)   85    (39)        –  
Transfers to Stage 3  (32)   (131)   163         –  
Impact of transfers between stages  (233)   401    325         493  
   (7)   56    444         493  
Other items charged to the income statement  (58)   (107)   696    –    531  
Charge to the income statement (note 13)  (65)   (51)   1,140    –    1,024  
Advances written off            (1,605)   –    (1,605) 
Disposal of businesses1  –    (102)   (79)   –    (181) 
Recoveries of advances written off in previous years            553    27    580  
Discount unwind            (63)   19    (44) 
At 31 December 2018  527    994    1,570    78    3,169  
                          
In respect of undrawn balances                         
Balance at 31 December 2017                      30  
Adjustment on adoption of IFRS 9 (note 54)                      243  
Balance at 1 January 2018  147    126    –    –    273  
Exchange and other adjustments  (5)   (14)   12    –    (7) 
                          
Transfers to Stage 1  28    (28)   –         –  
Transfers to Stage 2  (6)   6    –         –  
Transfers to Stage 3  (2)   (5)   7         –  
Impact of transfers between stages  (25)   22    (5)        (8) 
   (5)   (5)   2         (8) 
Other items charged to the income statement  (14)   (43)   (8)   –    (65) 
Charge to the income statement (note 13)  (19)   (48)   (6)   –    (73) 
At 31 December 2018  123    64    6    –    193  
Total  650    1,058    1,576    78    3,362  
                          
In respect of:                         
Loans and advances to banks  2    –    –    –    2  
Loans and advances to customers  525    994    1,553    78    3,150  
Debt securities  –    –    6    –    6  
Financial assets at amortised cost  527    994    1,559    78    3,158  
Other assets  –    –    11    –    11  
Provisions in relation to loan commitments and financial guarantees  123    64    6    –    193  
Total  650    1,058    1,576    78    3,362  
Expected credit loss in respect of financial assets at fair value through other comprehensive income (memorandum item)  1    –    –    –    1  

1Reflects the sale of the Group’s Irish mortgage portfolio.

The Group income statement charge comprises:

£m
Drawn balances1,024
Undrawn balances(73)
Financial assets at fair value through other comprehensive income(14)
Total937

Transfers between stages are deemed to have taken place at the start of the reporting period, with all other movements shown in the stage in which the asset is held at 31 December, with the exception of those held within Purchased or originated credit-impaired, which are not transferrable. As assets are transferred between stages, the resulting change in expected credit loss of £493 million for drawn balances, and £8 million for undrawn balances, is presented separately as Impacts of transfers between stages, in the stage in which the expected credit loss is recognised at the end of the reporting period.

Net increase and decrease in balances comprise the movements in the expected credit loss as a result of new loans originated and repayments of outstanding balances throughout the reporting period. Loans which are written off in the period are first transferred to Stage 3 before acquiring a full allowance and subsequent write-off. Consequently, recoveries on assets previously written-off also occur in Stage 3 only.

F-41

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 20: ALLOWANCE FOR IMPAIRMENT LOSSES continued

For the year ended 31 December 2017

  Loans and
advances
to customers
£m		  Debt
securities
£m		  Total
£m		 
At 1 January 2017  2,412   76   2,488 
Exchange and other adjustments  132   –   132 
Advances written off  (1,499)  (44)  (1,543)
Recoveries of advances written off in previous years  482   –   482 
Unwinding of discount  (23)  –   (23)
Charge (release) to the income statement (note 13)  697   (6)  691 
At 31 December 2017  2,201   26   2,227 

Of the total allowance in respect of loans and advances to customers at 31 December 2017 £1,772 million related to lending that had been determined to be impaired (either individually or on a collective basis) at that reporting date.

Of the total allowance in respect of loans and advances to customers at 31 December 2017 £1,201 million was assessed on a collective basis.

NOTE 21: FINANCIAL ASSETS AT FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME

  31 December
2018
£m		  1 January
2018
£m		 
Debt securities:        
Government securities  18,971   34,708 
Bank and building society certificates of deposit  118   167 
Asset-backed securities:        
Mortgage-backed securities  120   2,381 
Other asset-backed securities  131   467 
Corporate and other debt securities  5,151   4,615 
   24,491   42,338 
Treasury and other bills  303   – 
Equity shares  21   579 
Total financial assets at fair value through other comprehensive income  24,815   42,917 

All assets have been assessed at Stage 1 at 1 January and 31 December 2018.

NOTE 22: AVAILABLE-FOR-SALE FINANCIAL ASSETS

2017
£m
Debt securities:
Government securities34,708
Bank and building society certificates of deposit167
Asset-backed securities:
Mortgage-backed securities1,156
Other asset-backed securities255
Corporate and other debt securities4,615
40,901
Equity shares1,197
Total available-for-sale financial assets42,098

NOTE 23: GOODWILL

  2018
£m		  2017
£m		 
At 1 January  2,310   2,016 
Acquisition of businesses  –   302 
Impairment charged to the income statement (note 11)  –   (8)
At 31 December  2,310   2,310 
Cost1  2,664   2,664 
Accumulated impairment losses  (354)  (354)
At 31 December  2,310   2,310 

1For acquisitions made prior to 1 January 2004, the date of transition to IFRS, cost is included net of amounts amortised up to 31 December 2003.
F-42

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 23: GOODWILLcontinued

The goodwill held in the Group’s balance sheet is tested at least annually for impairment. For the purposes of impairment testing the goodwill is allocated to the appropriate cash generating unit; of the total balance of £2,310 million (2017: £2,310 million), £1,836 million, or 79 per cent of the total (2017: £1,836 million, 79 per cent of the total) has been allocated to Scottish Widows in the Group’s Insurance and Wealth division; £302 million, or 13 per cent of the total (2017: £302 million, or 13 per cent of the total) has been allocated to Cards in the Group’s Retail division; and £170 million, or 7 per cent of the total (2017: £170 million, 7 per cent of the total) to Motor Finance in the Group’s Retail division.

The recoverable amount of the goodwill relating to Scottish Widows has been based on a value-in-use calculation. The calculation uses pre-tax projections of future cash flows based upon budgets and plans approved by management covering a three-year period, the related run-off of existing business in force and a discount rate of 9 per cent. The budgets and plans are based upon past experience adjusted to take into account anticipated changes in sales volumes, product mix and margins having regard to expected market conditions and competitor activity. The discount rate is determined with reference to internal measures and available industry information. New business cash flows beyond the three-year period have been extrapolated using a steady 2 per cent growth rate which does not exceed the long-term average growth rate for the life assurance market. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of Scottish Widows to fall below its balance sheet carrying value.

The recoverable amount of the goodwill relating to Motor Finance has also been based on a value-in-use calculation using pre-tax cash flow projections based on financial budgets and plans approved by management covering a five-year period and a discount rate of 14 per cent. The cash flows beyond the five-year period are extrapolated using a growth rate of 0.5 per cent which does not exceed the long-term average growth rates for the markets in which Motor Finance participates. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of Motor Finance to fall below the balance sheet carrying value.

The recoverable amount of the goodwill relating to the Cards business has been based on a value-in-use calculation using pre-tax cash flow projections based on financial budgets and plans approved by management covering a five-year period and a discount rate of 14 per cent. The cash flows beyond the five year period are extrapolated using a growth rate of 0.5 per cent which does not exceed the long-term average growth rates for the markets in which Cards participates. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of the Cards business to fall below the balance sheet carrying value.

NOTE 24: VALUE OF IN-FORCE BUSINESS

KEY ASSUMPTIONS

The impact of reasonably possible changes in the key assumptions made in respect of the Group’s life insurance business, which include the impact on the value of in force business, are disclosed in note 32.

The principal features of the methodology and process used for determining key assumptions used in the calculation of the value of in-force business are set out below:

ECONOMIC ASSUMPTIONS

Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. In practice, to achieve the same result, where the cash flows are either independent of or move linearly with market movements, a method has been applied known as the ‘certainty equivalent’ approach whereby it is assumed that all assets earn a risk-free rate and all cash flows are discounted at a risk-free rate. The certainty equivalent approach covers all investment assets relating to insurance and participating investment contracts, other than the annuity business (where an illiquidity premium is included, see below).

A market-consistent approach has been adopted for the valuation of financial options and guarantees, using a stochastic option pricing technique calibrated to be consistent with the market price of relevant options at each valuation date. Further information on options and guarantees can be found in note 31.

The liabilities in respect of the Group’s UK annuity business are matched by a portfolio of fixed interest securities, including a large proportion of corporate bonds and illiquid loan assets. The value of the in-force business asset for UK annuity business has been calculated after taking into account an estimate of the market premium for illiquidity in respect of corporate bond holdings and relevant illiquid loan assets. In determining the market premium for illiquidity, a range of inputs are considered which reflect actual asset allocation and relevant observable market data. The illiquidity premium is estimated to be 128 basis points at 31 December 2018 (2017: 114 basis points).

The risk-free rate is derived from the relevant swap curve with a deduction for credit risk.

The table below shows the resulting range of yields and other key assumptions at 31 December:

  2018
%		  2017
%		 
Risk-free rate (value of in-force non-annuity business)1  0.00 to 4.05   0.00 to 4.20 
Risk-free rate (value of in-force annuity business)1  1.28 to 5.33   1.14 to 5.34 
Risk-free rate (financial options and guarantees)1  0.00 to 4.05   0.00 to 4.20 
Retail price inflation  3.43   3.43 
Expense inflation  3.75   3.67 

1All risk-free rates are quoted as the range of rates implied by the relevant forward swap curve.

NON-MARKET RISK

An allowance for non-market risk is made through the choice of best estimate assumptions based upon experience, which generally will give the mean expected financial outcome for shareholders and hence no further allowance for non-market risk is required. However, in the case of operational risk, reinsurer default and the with-profit funds these can be asymmetric in the range of potential outcomes for which an explicit allowance is made.

NON-ECONOMIC ASSUMPTIONS

Future mortality, morbidity, expenses, lapse and paid-up rate assumptions are reviewed each year and are based on an analysis of past experience and on management’s view of future experience. Further information on these assumptions is given in note 31 and the effect of changes in key assumptions is given in note 32.

F-43

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 24: VALUE OF IN-FORCE BUSINESScontinued

The gross value of in-force business asset in the consolidated balance sheet is as follows:

  2018
£m		  2017
£m		 
Acquired value of in-force non-participating investment contracts  271   306 
Value of in-force insurance and participating investment contracts  4,491   4,533 
Total value of in-force business  4,762   4,839 

The movement in the acquired value of in-force non-participating investment contracts over the year is as follows:

  2018
£m		  2017
£m		 
At 1 January  306   340 
Acquisition of business  5   – 
Amortisation (note 11)  (40)  (34)
At 31 December  271   306 

The acquired value of in-force non-participating investment contracts includes £167 million (2017: £185 million) in relation to OEIC business.

Movement in value of in-force business

The movement in the value of in-force insurance and participating investment contracts over the year is as follows:

  2018
£m		  2017
£m		 
At 1 January  4,533   4,702 
Exchange and other adjustments  13   (4)
Movements in the year:        
New business  675   348 
Existing business:        
Expected return  (304)  (318)
Experience variances  (122)  (226)
Assumption changes  (67)  (238)
Economic variance  (237)  269 
Movement in the value of in-force business (note 9)  (55)  (165)
At 31 December  4,491   4,533 

This breakdown shows the movement in the value of in-force business only, and does not represent the full contribution that each item in the breakdown makes to profit before tax. This will also contain changes in the other assets and liabilities, including the effects of changes in assumptions used to value the liabilities, of the relevant businesses. The presentation of economic variance includes the impact of financial market conditions being different at the end of the year from those included in assumptions used to calculate new and existing business returns.

NOTE 25: OTHER INTANGIBLE ASSETS

  Brands
£m		  Core deposit
intangible
£m		  Purchased
credit card
relationships
£m		  Customer-
related
intangibles
£m		  Capitalised
software
enhancements
£m		  Total
£m		 
Cost:                        
At 1 January 2017  596   2,770   315   538   2,167   6,386 
Acquisition of businesses  –   –   702   –   –   702 
Additions  –   –   –   –   850   850 
Disposals  –   –   –   –   (77)  (77)
At 31 December 2017  596   2,770   1,017   538   2,940   7,861 
Additions  –   –   –   –   1,046   1,046 
Disposals  –   –   (15)  –   (55)  (70)
At 31 December 2018  596   2,770   1,002   538   3,931   8,837 
Accumulated amortisation:                        
At 1 January 2017  171   2,757   311   499   967   4,705 
Charge for the year  22   13   44   20   293   392 
Disposals  –   –   –   –   (71)  (71)
At 31 December 2017  193   2,770   355   519   1,189   5,026 
Charge for the year  23   –   71   19   400   513 
Disposals  –   –   (15)  –   (34)  (49)
At 31 December 2018  216   2,770   411   538   1,555   5,490 
Balance sheet amount at 31 December 2018  380   –   591   –   2,376   3,347 
Balance sheet amount at 31 December 2017  403   –   662   19   1,751   2,835 
F-44

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Note 25: Other intangible assetscontinued

Included within brands above are assets of £380 million (31 December 2017: £380 million) that have been determined to have indefinite useful lives and are not amortised. These brands use the Bank of Scotland name which has been in existence for over 300 years. These brands are well established financial services brands and there are no indications that they should not have an indefinite useful life.

The purchased credit card relationships represent the benefit of recurring income generated from portfolios of credit cards purchased. The balance sheet amount at 31 December 2018 is expected to be amortised over its remaining useful life of nine years.

NOTE 26: PROPERTY, PLANT AND EQUIPMENT

  Investment
properties
£m		  Premises
£m		  Equipment
£m		  Operating
lease assets
£m		  Total
£m		 
Cost or valuation:                    
At 1 January 2017  3,764   2,550   5,965   6,206   18,485 
Exchange and other adjustments  –   (37)  –   (44)  (81)
Acquisition of businesses  –   3   3   –   6 
Additions  –   70   382   2,262   2,714 
Expenditure on investment properties (see below)  209   –   –   –   209 
Change in fair value of investment properties (note 7)  230   –   –   –   230 
Disposals  (504)  (795)  (1,282)  (1,896)  (4,477)
At 31 December 2017  3,699   1,791   5,068   6,528   17,086 
Exchange and other adjustments  –   –   (6)  11   5 
Additions  –   72   519   1,755   2,346 
Expenditure on investment properties (see below)  143   –   –   –   143 
Change in fair value of investment properties (note 7)  139   –   –   –   139 
Disposals  (211)  (647)  (574)  (1,540)  (2,972)
At 31 December 2018  3,770   1,216   5,007   6,754   16,747 
Accumulated depreciation and impairment:                    
At 1 January 2017  –   1,333   2,671   1,509   5,513 
Exchange and other adjustments  –   (8)  (9)  (34)  (51)
Depreciation charge for the year  –   125   734   1,085   1,944 
Disposals  –   (722)  (1,271)  (1,054)  (3,047)
At 31 December 2017  –   728   2,125   1,506   4,359 
Exchange and other adjustments  –   1   (8)  6   (1)
Depreciation charge for the year  –   121   715   1,016   1,852 
Disposals  –   (634)  (534)  (595)  (1,763)
At 31 December 2018  –   216   2,298   1,933   4,447 
Balance sheet amount at 31 December 2018  3,770   1,000   2,709   4,821   12,300 
Balance sheet amount at 31 December 2017  3,699   1,063   2,943   5,022   12,727 
Expenditure on investment properties is comprised as follows:                    
               2018
£m		   2017
£m		 
Acquisitions of new properties              81   82 
Additional expenditure on existing properties              62   127 
               143   209 

Rental income of £197 million (2017: £213 million) and direct operating expenses arising from properties that generate rental income of £23 million (2017: £24 million) have been recognised in the income statement.

Capital expenditure in respect of investment properties which had been contracted for but not recognised in the financial statements was £33 million (2017: £21 million).

The table above analyses movements in investment properties, all of which are categorised as level 3. See note 49 for details of levels in the fair value hierarchy.

At 31 December the future minimum rentals receivable under non-cancellable operating leases were as follows:

  2018
£m		  2017
£m		 
Receivable within 1 year  1,095   1,301 
1 to 5 years  1,156   1,419 
Over 5 years  6   128 
Total future minimum rentals receivable  2,257   2,848 

Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2017 and 2018 no contingent rentals in respect of operating leases were recognised in the income statement.

Total future minimum sub-lease income of £60 million at 31 December 2018 (£71 million at 31 December 2017) is expected to be received under non-cancellable sub-leases of the Group’s premises.

F-45

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 19:27: OTHER ASSETS

  2018
£m		  2017
£m		 
Assets arising from reinsurance contracts held (notes 31 and 33)  749   602 
Deferred acquisition and origination costs  90   104 
Settlement balances  743   720 
Corporate pension asset  7,111   7,786 
Investments in joint ventures and associates  91   65 
Other assets and prepayments  3,742   4,260 
Total other assets  12,526   13,537 

NOTE 28: FINANCIAL LIABILITIES AT FAIR VALUE THROUGH PROFIT OR LOSS

  2018
£m		  2017
£m		 
Liabilities designated at fair value through profit or loss:        
Debt securities in issue  7,085   7,812 
Other  11   3 
   7,096   7,815 
Trading liabilities:        
Liabilities in respect of securities sold under repurchase agreements  21,595   41,378 
Other deposits  242   381 
Short positions in securities  1,614   1,303 
   23,451   43,062 
Financial liabilities at fair value through profit or loss  30,547   50,877 

Liabilities designated at fair value through profit or loss primarily represent debt securities in issue which either contain substantive embedded derivatives which would otherwise need to be recognised and measured at fair value separately from the related debt securities, or which are accounted for at fair value to significantly reduce an accounting mismatch.

The amount contractually payable on maturity of the debt securities held at fair value through profit or loss at 31 December 2018 was £15,435 million, which was £8,350 million higher than the balance sheet carrying value (2017: £14,224 million, which was £6,412 million higher than the balance sheet carrying value). At 31 December 2018 there was a cumulative £386 million decrease in the fair value of these liabilities attributable to changes in credit spread risk; this is determined by reference to the quoted credit spreads of Lloyds Bank plc, the issuing entity within the Group. Of the cumulative amount a decrease of £533 million arose in 2018 and an increase of £52 million arose in 2017.

For the fair value of collateral pledged in respect of repurchase agreements see note 52.

NOTE 29: DEBT SECURITIES IN ISSUE

  2018
£m		  2017
£m		 
Medium-term notes issued  37,490   29,418 
Covered bonds (note 30)  28,194   26,132 
Certificates of deposit issued  12,020   9,999 
Securitisation notes (note 30)  5,426   3,660 
Commercial paper  8,038   3,241 
Total debt securities in issue  91,168   72,450 
F-46

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 30: SECURITISATIONS AND COVERED BONDS

 

SECURITISATION PROGRAMMES

Loans and advances to customers and debt securities classified as loans and receivablescarried at amortised cost include loans securitised under the Group’s securitisation programmes, the majority of which have been sold by subsidiary companies to bankruptcy remote structured entities. As the structured entities are funded by the issue of debt on terms whereby the majority of the risks and rewards of the portfolio are retained by the subsidiary, the structured entities are consolidated fully and all of these loans are retained on the Group’s balance sheet, with the related notes in issue included within debt securities in issue.

 

COVERED BOND PROGRAMMES

 

Certain loans and advances to customers have been assigned to bankruptcy remote limited liability partnerships to provide security for issues of covered bonds by the Group. The Group retains all of the risks and rewards associated with these loans and the partnerships are consolidated fully with the loans retained on the Group’s balance sheet and the related covered bonds in issue included within debt securities in issue.

 

The Group’s principal securitisation and covered bond programmes, together with the balances of the advances subject to these arrangements and the carrying value of the notes in issue at 31 December, are listed below. The notes in issue are reported in note 32.29.

 

 2015 2014  2018 2017
 Loans and     Loans and     Loans and
advances
securitised
£m		 Notes
in issue
£m		 Loans and
advances
securitised
£m		 Notes
in issue
£m		 
 advances  Notes  advances  Notes 
 securitised  in issue  securitised  in issue 
 £m  £m  £m  £m 
Securitisation programmes1            
Securitisation programmes         
UK residential mortgages 39,154  20,931  50,250  28,392   25,018   22,485   21,158   14,105 
Commercial loans 9,345  8,720  13,372  12,533   5,746   6,577   6,616   7,001 
Credit card receivables 7,305  5,277  6,762  4,278   8,060   5,263   7,701   4,090 
Dutch residential mortgages 1,981  2,044  3,866  4,004 
Personal loans –  –  1,318  751 
PFI/PPP and project finance loans 305  94  402  99 
Motor vehicle finance  2,850   2,855   –   – 
 58,090  37,066  75,970  50,057   41,674   37,180   35,475   25,196 
Less held by the Group    (29,303)    (38,149)      (31,701)      (21,536)
Total securitisation programmes (note 32)    7,763     11,908 
Total securitisation programmes (notes 28 and 29)1      5,479       3,660 
Covered bond programmes                            
Residential mortgage-backed 43,323  29,697  47,795  31,730   34,963   27,694   30,361   25,632 
Social housing loan-backed 2,544  1,700  2,826  1,800   1,839   1,200   1,628   1,200 
 45,867  31,397  50,621  33,530   36,802   28,894   31,989   26,832 
Less held by the Group    (4,197)    (6,339)      (700)      (700)
Total covered bond programmes (note 32)    27,200     27,191 
Total covered bond programmes (note 29)      28,194       26,132 
Total securitisation and covered bond programmes    34,963     39,099       33,673       29,792 

 

1Includes securitisations utilising a combination£53 million (2017: £nil) of external funding and credit default swaps.securitisation notes held at fair value through profit or loss.

 

Cash deposits of £8,383£4,102 million (2014: £11,251(2017: £3,507 million) held by the Group are restricted in use to repayment ofwhich support the debt securities issued by the structured entities, the term advances relatingrelated to covered bonds and other legal obligations.obligations are held by the Group. Additionally, the Group had certain contractual arrangements to provide liquidity facilities to some of these structured entities. At 31 December 20152018 these obligations had not been triggered; the maximum exposure under these facilities was £381£88 million (2014: £392(2017: £95 million).

 

The Group has a number of covered bond programmes, for which Limited Liability Partnerships have been established to ring-fence asset pools and guarantee the covered bonds issued by the Group. At the reporting date the Group had over-collateralised these programmes as set out in the table above to meet the terms of the programmes, to secure the rating of the covered bonds and to provide operational flexibility. From time-to-time, the obligations of the Group to provide collateral may increase due to the formal requirements of the programmes. The Group may also voluntarily contribute collateral to support the ratings of the covered bonds.

 

The Group recognises the full liabilities associated with its securitisation and covered bond programmes within debt securities in issue, although the obligations of the Group are limited to the cash flows generated from the underlying assets. The Group could be required to provide additional support to a number of the securitisation programmes to support the credit ratings of the debt securities issued, in the form of increased cash reserves and the holding of subordinated notes. Further, certain programmes contain contractual obligations that require the Group to repurchase assets should they become credit impaired.

 

The Group has not voluntarily offered to repurchase assets from any of its public securitisation programmes during 2015 (2014:2018 (2017: none). Such repurchases are made in order to ensure that the expected maturity dates of the notes issued from these programmes are met.

F-39F-47

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 20: STRUCTURED ENTITIES

The Group’s interests in structured entities are both consolidated and unconsolidated. Detail of the Group’s interests in consolidated structured entities are set out in: note 19 for securitisations and covered bond vehicles, note 37 for structured entities associated with the Group’s pension schemes, and below in part (A) and (B). Details of the Group’s interests in unconsolidated structured entities are included below in part (C).

(A) ASSET-BACKED CONDUITS

In addition to the structured entities discussed in note 19, which are used for securitisation and covered bond programmes, the Group sponsors an active asset-backed conduit, Cancara, which invests in debt securities and client receivables. The total consolidated exposure of Cancara at 31 December 2015 was £7,295 million (2014: £5,245 million), comprising £6,440 million of loans and advances (2014: £4,605 million) and £855 million of asset-backed securities (2014: £640 million).

All debt securities and lending assets held by the Group in Cancara are restricted in use, as they are held by the collateral agent for the benefit of the commercial paper investors and the liquidity providers only. The Group provides liquidity facilities to Cancara under terms that are usual and customary for standard lending activities in the normal course of the Group’s banking activities. The Group could be asked to provide support under the contractual terms of these arrangements if Cancara experienced a shortfall in external funding, which may occur in the event of market disruption. As at 31 December 2015 and 2014 these obligations had not been triggered.

In addition, the Group sponsors a further asset-backed conduit, which is being run down. This asset-backed conduit has no commercial paper in issue and no external liquidity providers.

The external assets in all of the Group’s conduits are consolidated in the Group’s financial statements.

(B) CONSOLIDATED COLLECTIVE INVESTMENT VEHICLES

The assets and liabilities of the Insurance business held in consolidated collective investment vehicles, such as Open-Ended Investment Companies and limited partnerships, are not directly available for use by the Group. However, the Group’s investment in the majority of these collective investment vehicles is readily realisable. As at 31 December 2015, the total carrying value of these consolidated collective investment vehicle assets and liabilities held by the Group was £67,122 million (2014: £66,070 million).

The Group has no contractual arrangements (such as liquidity facilities) that would require it to provide financial or other support to the consolidated collective investment vehicles; the Group has not previously provided such support and has no current intentions to provide such support.

(C) UNCONSOLIDATED COLLECTIVE INVESTMENT VEHICLES AND LIMITED PARTNERSHIPS

The Group’s direct interests in unconsolidated structured entities comprise investments in collective investment vehicles, such as Open-Ended Investment Companies, and limited partnerships with a total carrying value of £13,282 million at 31 December 2015 (2014: £27,255 million), included within financial assets designated at fair value through profit and loss (see note 15). These investments include both those entities managed by third parties and those managed by the Group. At 31 December 2015, the total asset value of these unconsolidated structured entities, including the portion in which the Group has no interest, was £603 billion (2014: £620 billion).

The Group’s maximum exposure to loss is equal to the carrying value of the investment. However, the Group’s investments in these entities are primarily held to match policyholder liabilities in the Insurance division and the majority of the risk from a change in the value of the Group’s investment is matched by a change in policyholder liabilities. The collective investment vehicles are primarily financed by investments from investors in the vehicles.

During the year the Group has not provided any non-contractual financial or other support to these entities and has no current intention of providing any financial or other support. There were no transfers from/to these unconsolidated collective investment vehicles and limited partnerships.

The Group considers itself the sponsor of a structured entity where it is primarily involved in the design and establishment of the structured entity; and further where the Group transfers assets to the structured entity; market products associated with the structured entity in its own name and/or provide guarantees regarding the structured entity’s performance.

The Group sponsors a range of diverse investment funds and limited partnerships where it acts as the fund manager or equivalent decision maker and markets the funds under one of the Group’s brands.

The Group earns fees from managing the investments of these funds. The investment management fees that the Group earned from these entities, including those in which the Group held no ownership interest at 31 December 2015, are reported in note 6.

F-40

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 21: ALLOWANCE FOR IMPAIRMENT LOSSES ON LOANS AND RECEIVABLES

  2015 2014
  Loans and        Loans and       
  advances  Debt     advances  Debt    
  to customers  securities  Total  to customers  securities  Total 
  £m  £m  £m  £m  £m  £m 
At 1 January  6,414   126   6,540   11,966   125   12,091 
Exchange and other adjustments  (246)  –   (246)  (410)  9   (401)
Disposal of businesses  (82)  –   (82)  –   –   – 
Advances written off  (4,204)  (31)  (4,235)  (6,432)  (10)  (6,442)
Recoveries of advances written off in previous years  764   4   768   681   –   681 
Unwinding of discount  (56)  –   (56)  (126)  –   (126)
Charge (release) to the income statement (note 12)  443   (2)  441   735   2   737 
At 31 December  3,033   97   3,130   6,414   126   6,540 

Of the total allowance in respect of loans and advances to customers, £2,425 million (2014: £5,551 million) related to lending that had been determined to be impaired (either individually or on a collective basis) at the reporting date.

Of the total allowance in respect of loans and advances to customers, £1,170 million (2014: £1,482 million) was assessed on a collective basis.

NOTE 22: AVAILABLE-FOR-SALE FINANCIAL ASSETS

  2015  2014 
  Conduits  Other  Total  Conduits  Other  Total 
  £m  £m  £m  £m  £m  £m 
Debt securities:                        
Government securities  –   25,329   25,329   –   47,402   47,402 
Bank and building society certificates of deposit  –   186   186   –   298   298 
Asset-backed securities:                        
Mortgage-backed securities  26   171   197   27   647   674 
Other asset-backed securities  209   110   319   223   462   685 
Corporate and other debt securities  –   5,808   5,808   –   5,529   5,529 
   235   31,604   31,839   250   54,338   54,588 
Equity shares  –   1,193   1,193   –   1,042   1,042 
Treasury and other bills  –   –   –   –   863   863 
Total available-for-sale financial assets  235   32,797   33,032   250   56,243   56,493 

Details of the Group’s asset-backed conduits shown in the table above are included in note 20.

All assets have been individually assessed for impairment. The criteria used to determine whether an impairment loss has been incurred are disclosed in note 2(H).

NOTE 23: HELD-TO-MATURITY INVESTMENTS

  2015  2014 
  £m  £m 
Debt securities: government securities  19,808   – 

On 1 May 2015, the Group reclassified £19,938 million of government securities from available-for-sale financial assets to held-to-maturity investments.

F-41

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 24: GOODWILL    

  2015  2014 
  £m  £m 
At 1 January and 31 December  2,016   2,016 
Cost1  2,362   2,362 
Accumulated impairment losses  (346)  (346)
At 31 December  2,016   2,016 

1 For acquisitions made prior to 1 January 2004, the date of transition to IFRS, cost is included net of amounts amortised up to 31 December 2003.

The goodwill held in the Group’s balance sheet is tested at least annually for impairment. For the purposes of impairment testing the goodwill is allocated to the appropriate cash generating unit; of the total balance of £2,016 million (2014: £2,016 million), £1,836 million, or 91 per cent of the total (2014: £1,836 million, 91 per cent of the total) has been allocated to Scottish Widows in the Group’s Insurance division and £170 million, or 8 per cent of the total (2014: £170 million, 8 per cent of the total) to Asset Finance in the Group’s Consumer Finance division.

The recoverable amount of the goodwill relating to Scottish Widows has been based on a value-in-use calculation. The calculation uses pre-tax projections of future cash flows based upon budgets and plans approved by management covering a five-year period, and a discount rate of 10 per cent. The budgets and plans are based upon past experience adjusted to take into account anticipated changes in sales volumes, product mix and margins having regard to expected market conditions and competitor activity. The discount rate is determined with reference to internal measures and available industry information. Cash flows beyond the five-year period have been extrapolated using a steady 3 per cent growth rate which does not exceed the long-term average growth rate for the life assurance market. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of Scottish Widows to fall below its balance sheet carrying value. The recoverable amount of the goodwill relating to Asset Finance has also been based on a value-in-use calculation using pre-tax cash flow projections based on financial budgets and plans approved by management covering a five-year period and a discount rate of 14 per cent. The cash flows beyond the five-year period are extrapolated using a growth rate of 0.5 per cent which does not exceed the long-term average growth rates for the markets in which Asset Finance participates. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of Asset Finance to fall below the balance sheet carrying value.

NOTE 25: VALUE OF IN-FORCE BUSINESS

The gross value of in-force business asset in the consolidated balance sheet is as follows:

  2015  2014 
   £m   £m 
Acquired value of in-force non-participating investment contracts  377   418 
Value of in-force insurance and participating investment contracts  4,219   4,446 
Total value of in-force business  4,596   4,864 

The movement in the acquired value of in-force non-participating investment contracts over the year is as follows:

  2015  2014 
  £m  £m 
At 1 January  418   461 
Amortisation taken to income statement (note 11)  (41)  (43)
Disposal of businesses  –   – 
At 31 December  377   418 

The acquired value of in-force non-participating investment contracts includes £228 million (2014: £251 million) in relation to OEIC business.

The movement in the value of in-force insurance and participating investment contracts over the year is as follows:

  2015  2014 
  £m  £m 
At 1 January  4,446   4,874 
Exchange and other adjustments  (5)  – 
Movements in the year:        
New business  454   425 
Existing business:        
Expected return  (365)  (441)
Experience variances  (130)  (65)
Assumption changes  (209)  (586)
Economic variance  88   239 
Movement in the value of in-force business taken to income statement (note 9)  (162)  (428)
Disposal of businesses  (60)  – 
At 31 December  4,219   4,446 
F-42

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 25: VALUE OF IN-FORCE BUSINESS continued

This breakdown shows the movement in the value of in-force business only, and does not represent the full contribution that each item in the breakdown contributes to profit before tax. This will also contain changes in the other assets and liabilities, including the effects of changes in assumptions used to value the liabilities, of the relevant businesses. The presentation of economic variance includes the impact of financial market conditions being different at the end of the reporting period from those included in assumptions used to calculate new and existing business returns.

The principal features of the methodology and process used for determining key assumptions used in the calculation of the value of in-force business are set out below:

ECONOMIC ASSUMPTIONS

Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. In practice, to achieve the same result, where the cash flows are either independent of or move linearly with market movements, a method has been applied known as the ‘certainty equivalent’ approach whereby it is assumed that all assets earn a risk-free rate and all cash flows are discounted at a risk-free rate. The certainty equivalent approach covers all investment assets relating to insurance and participating investment contracts, other than the annuity business (where an illiquidity premium is included, see below).

A market-consistent approach has been adopted for the valuation of financial options and guarantees, using a stochastic option pricing technique calibrated to be consistent with the market price of relevant options at each valuation date. Further information on options and guarantees can be found in note 33.

The liabilities in respect of the Group’s UK annuity business are matched by a portfolio of fixed interest securities, including a large proportion of corporate bonds and illiquid loan assets. The value of the in-force business asset for UK annuity business has been calculated after taking into account an estimate of the market premium for illiquidity in respect of corporate bond holdings and relevant illiquid loan assets. The determination of the market premium for illiquidity reflects actual asset allocation and relevant observable market data, and has been checked for consistency with the capital markets. The illiquidity premium is estimated to be in the range of 85 to 144 basis points at 31 December 2015 (2014: 120 basis points).

The risk-free rate is derived from the relevant swap curve with a deduction for credit risk.

The table below shows the resulting range of yields and other key assumptions at 31 December:

  2015  2014 
  %  % 
Risk-free rate (value of in-force non-annuity business)1  0.00 to 4.20   0.00 to 3.27 
Risk-free rate (value of in-force annuity business)1  0.85 to 5.64   1.02 to 4.56 
Risk-free rate (financial options and guarantees)1  0.00 to 2.54   0.29 to 2.20 
Retail price inflation  3.27   3.26 
Expense inflation  3.65   3.92 

1 All risk-free rates are quoted as the range of rates implied by the relevant swap curve.

NON-MARKET RISK

An allowance for non-market risk is made through the choice of best estimate assumptions based upon experience, which generally will give the mean expected financial outcome for shareholders and hence no further allowance for non-market risk is required. However, in the case of operational risk, reinsurer default and the with-profit funds these can be asymmetric in the range of potential outcomes for which an explicit allowance is made.

NON-ECONOMIC ASSUMPTIONS

Future mortality, morbidity, expenses, lapse and paid-up rate assumptions are reviewed each year and are based on an analysis of past experience and on management’s view of future experience. Further information on these assumptions is given in note 33 and the effect of changes in key assumptions is given in note 34.

F-43

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 26: OTHER INTANGIBLE ASSETS

        Purchased  Customer-  Capitalised    
     Core deposit  credit card  related  software    
  Brands  intangible  relationships  intangibles  enhancements  Total 
  £m  £m  £m  £m  £m  £m 
Cost:                        
At 1 January 2014  596   2,770   315   538   1,320   5,539 
Additions  –   –   –   –   297   297 
Disposals  –   –   –   –   (108)  (108)
At 31 December 2014  596   2,770   315   538   1,509   5,728 
Additions  –   –   –   –   306   306 
Disposals  –   –   –   –   (1)  (1)
At 31 December 2015  596   2,770   315   538   1,814   6,033 
Accumulated amortisation:                        
At 1 January 2014  107   1,860   300   442   551   3,260 
Charge for the year  21   300   5   14   161   501 
Disposals  –   –   –   –   (103)  (103)
At 31 December 2014  128   2,160   305   456   609   3,658 
Charge for the year  21   300   4   16   196   537 
Disposals  –   –   –   –   –   – 
At 31 December 2015  149   2,460   309   472   805   4,195 
Balance sheet amount at 31 December 2015  447   310   6   66   1,009   1,838 
Balance sheet amount at 31 December 2014  468   610   10   82   900   2,070 

Included within brands above are assets of £380 million (31 December 2014: £380 million) that have been determined to have indefinite useful lives and are not amortised. These brands use the Bank of Scotland name which has been in existence for over 300 years. These brands are well established financial services brands and there are no indications that they should not have an indefinite useful life.

The core deposit intangible is the benefit derived from a large stable deposit base that has low interest rates, and the balance sheet amount at 31 December 2015 shown above will be amortised, in accordance with the Group’s accounting policy, on a straight line basis over its remaining useful life of one year.

The purchased credit card relationships represent the benefit of recurring income generated from the portfolio of credit cards purchased.

The customer-related intangibles include customer lists and the benefits of customer relationships that generate recurring income.

Capitalised software enhancements principally comprise identifiable and directly associated internal staff and other costs.

F-44

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 27: PROPERTY, PLANT AND EQUIPMENT

  Investment        Operating    
  properties  Premises  Equipment  lease assets  Total 
  £m  £m  £m  £m  £m 
Cost or valuation:                    
At 1 January 2014  4,864   2,866   3,894   4,667   16,291 
Exchange and other adjustments  (6)  1   1   24   20 
Additions  –   212   971   1,673   2,856 
Expenditure on investment properties (see below)  376   –   –   –   376 
Change in fair value of investment properties (note 7)  513   –   –   –   513 
Disposals  (1,255)  (186)  (223)  (1,759)  (3,423)
At 31 December 2014  4,492   2,893   4,643   4,605   16,633 
Exchange and other adjustments  (5)  –   –   23   18 
Additions  –   141   1,071   1,702   2,914 
Expenditure on investment properties (see below)  272   –   –   –   272 
Change in fair value of investment properties (note 7)  416   –   –   –   416 
Disposals  (814)  (172)  (281)  (1,307)  (2,574)
Disposal of businesses  –   (273)  (167)  –   (440)
At 31 December 2015  4,361   2,589   5,266   5,023   17,239 
Accumulated depreciation and impairment:                    
At 1 January 2014  –   1,299   1,573   985   3,857 
Exchange and other adjustments  –   –   1   7   8 
Depreciation charge for the year  –   142   462   787   1,391 
Disposals  –   (67)  (153)  (947)  (1,167)
At 31 December 2014  –   1,374   1,883   832   4,089 
Exchange and other adjustments  –   9   (2)  7   14 
Depreciation charge for the year  –   116   588   830   1,534 
Disposals  –   (90)  (245)  (752)  (1,087)
Disposal of businesses  –   (162)  (128)  –   (290)
At 31 December 2015  –   1,247   2,096   917   4,260 
Balance sheet amount at 31 December 2015  4,361   1,342   3,170   4,106   12,979 
Balance sheet amount at 31 December 2014  4,492   1,519   2,760   3,773   12,544 

Expenditure on investment properties is comprised as follows:                                        

  2015  2014 
  £m  £m 
Acquisitions of new properties  165   293 
Additional expenditure on existing properties  107   83 
   272   376 

Rental income of £268 million (2014: £269 million) and direct operating expenses arising from properties that generate rental income of £27 million (2014: £37 million) have been recognised in the income statement.

Capital expenditure in respect of investment properties which had been contracted for but not recognised in the financial statements was £37 million (2014: £47 million).

The table above analyses movements in investment properties, all of which are categorised as level 3. See note 50 for details of levels in the fair value hierarchy.

At 31 December the future minimum rentals receivable under non-cancellable operating leases were as follows:

  2015  2014 
  £m  £m 
Receivable within 1 year  1,003   965 
1 to 5 years  1,163   1,103 
Over 5 years  172   203 
Total future minimum rentals receivable  2,338   2,271 

Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2015 and 2014 no contingent rentals in respect of operating leases were recognised in the income statement.

In addition, total future minimum sub-lease income of £72 million at 31 December 2015 (£45 million at 31 December 2014) is expected to be received under non-cancellable sub-leases of the Group’s premises.

F-45

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 28: OTHER ASSETS

  2015  2014 
  £m  £m 
Assets arising from reinsurance contracts held (notes 33 and 35)  675   682 
Deferred acquisition and origination costs  106   114 
Settlement balances  264   1,676 
Corporate pension asset  7,725   12,741 
Investments in joint ventures and associates  47   74 
Other assets and prepayments  5,047   6,407 
Total other assets  13,864   21,694 

NOTE 29: DEPOSITS FROM BANKS

  2015  2014 
  £m  £m 
Liabilities in respect of securities sold under repurchase agreements  7,061   1,075 
Other deposits from banks  9,864   9,812 
Deposits from banks  16,925   10,887 

For amounts included above which are subject to repurchase agreements, see note 53.

NOTE 30: CUSTOMER DEPOSITS

  2015  2014 
  £m  £m 
Non-interest bearing current accounts  48,518   46,487 
Interest bearing current accounts  85,491   86,131 
Savings and investment accounts  224,137   256,701 
Liabilities in respect of securities sold under repurchase agreements  –   – 
Other customer deposits  60,180   57,748 
Customer deposits  418,326   447,067 

For amounts included above which are subject to repurchase agreements, see note 53.

Included in the amounts reported above are deposits of £230,110 million (2014: £260,129 million) which are protected under the UK Financial Services Compensation Scheme.

NOTE 31: TRADING AND OTHER FINANCIAL LIABILITIES AT FAIR VALUE THROUGH PROFIT OR LOSS

  2015  2014 
  £m  £m 
Liabilities held at fair value through profit or loss  7,879   6,744 
Trading liabilities:        
Liabilities in respect of securities sold under repurchase agreements  38,431   50,007 
Short positions in securities  4,440   3,219 
Other  1,113   2,132 
   43,984   55,358 
Trading and other financial liabilities at fair value through profit or loss  51,863   62,102 

Liabilities designated at fair value through profit or loss primarily represent debt securities in issue which either contain substantive embedded derivatives which would otherwise need to be recognised and measured at fair value separately from the related debt securities, or which are accounted for at fair value to significantly reduce an accounting mismatch.

The amount contractually payable on maturity of the debt securities held at fair value through profit or loss at 31 December 2015 was £12,034 million, which was £4,156 million higher than the balance sheet carrying value (2014: £10,112 million, which was £3,373 million higher than the balance sheet carrying value). At 31 December 2015 there was a cumulative £67 million increase in the fair value of these liabilities attributable to changes in credit spread risk; this is determined by reference to the quoted credit spreads of Lloyds Bank plc, the issuing entity within the Group. Of the cumulative amount a decrease of £114 million arose in 2015 and a decrease of £33 million arose in 2014.

For the fair value of collateral pledged in respect of repurchase agreements see note 53.

F-46

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 32: DEBT SECURITIES IN ISSUE

  2015  2014 
  £m  £m 
Medium-term notes issued  29,329   22,728 
Covered bonds (note 19)  27,200   27,191 
Certificates of deposit issued  11,101   7,033 
Securitisation notes (note 19)  7,763   11,908 
Commercial paper  6,663   7,373 
Total debt securities in issue  82,056   76,233 

NOTE 33: LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS

 

Insurance contract and participating investment contract liabilities are comprised as follows:

 

 2015 2014 2018 2017
 Gross Reinsurance1 Net  Gross Reinsurance1 Net  Gross
£m		 Reinsurance1
£m		 Net
£m		 Gross1
£m		 Reinsurance2
£m		 Net
£m		 
 £m £m £m  £m £m £m 
Life insurance (see below):                        
Life insurance (see (1) below):                  
Insurance contracts  66,122   (629)  65,493   72,168   (636)  71,532   84,366   (716)  83,650   86,949   (563)  86,386 
Participating investment contracts  13,460   –   13,460   14,102   –   14,102   13,912   –   13,912   15,881   –   15,881 
  79,582   (629)  78,953   86,270   (636)  85,634   98,278   (716)  97,562   102,830   (563)  102,267 
Non-life insurance contracts:                        
Non-life insurance contracts (see (2) below):                        
Unearned premiums  461   (12)  449   424   (7)  417   342   (13)  329   358   (13)  345 
Claims outstanding  251   –   251   224   –   224   254   –   254   225   –   225 
  712   (12)  700   648   (7)  641   596   (13)  583   583   (13)  570 
Total  80,294   (641)  79,653   86,918   (643)  86,275   98,874   (729)  98,145   103,413   (576)  102,837 

1During the year the Group has reviewed the classification of pre-2007 unitised pension savings products and as a result these products have been reclassified from insurance contracts to participating investment contracts; comparatives have been restated accordingly.
2Reinsurance balances are reported within other assets (note 27).

 

1 Reinsurance balances are reported within other assets (note 28).

LIFE INSURANCE(1) Life insurance

 

The movement in life insurance contract and participating investment contract liabilities over the year can be analysed as follows:

 

   Participating        Insurance
contracts
£m		 Participating
investment
contracts
£m		 Gross
£m		 Reinsurance
£m		 Net
£m		 
 Insurance investment       
 contracts contracts Gross Reinsurance Net 
  £m   £m   £m   £m   £m 
At 1 January 2014  67,626   14,416   82,042   (675)  81,367 
At 1 January 2017  77,881   15,896   93,777   (671)  93,106 
New business  3,123   28   3,151   (20)  3,131   4,154   43   4,197   (21)  4,176 
Changes in existing business  1,582   (341)  1,241   12   1,253   4,928   (58)  4,870   129   4,999 
Change in liabilities charged to the income statement (note 10)  4,705   (313)  4,392   (8)  4,384   9,082   (15)  9,067   108   9,175 
Exchange and other adjustments  (163)  (1)  (164)  47   (117)  (14)  –   (14)  –   (14)
At 31 December 2014  72,168   14,102   86,270   (636)  85,634 
At 31 December 2017  86,949   15,881   102,830   (563)  102,267 
New business  2,422   28   2,450   (4)  2,446   5,476   31   5,507   (42)  5,465 
Changes in existing business  (4,681)  (667)  (5,348)  11   (5,337)  (8,072)  (2,000)  (10,072)  (111)  (10,183)
Change in liabilities charged to the income statement (note 10)  (2,259)  (639)  (2,898)  7   (2,891)  (2,596)  (1,969)  (4,565)  (153)  (4,718)
Exchange and other adjustments  39   (1)  38   –   38   13   –   13   –   13 
Disposal of businesses  (3,826)  (2)  (3,828)  –   (3,828)
At 31 December 2015  66,122   13,460   79,582   (629)  78,953 
At 31 December 2018  84,366   13,912   98,278   (716)  97,562 

 

Liabilities for insurance contracts and participating investment contracts can be split into with-profit fund liabilities, accounted for using the PRA’s realistic capital regime (realistic liabilities) and non-profit fund liabilities, accounted for using a prospective actuarial discounted cash flow methodology, as follows:

 

  2015 2014
  With-profit  Non-profit     With-profit  Non-profit    
  fund  fund  Total  fund  fund  Total 
  £m  £m  £m  £m  £m  £m 
Insurance contracts  9,023   57,099   66,122   12,334   59,834   72,168 
Participating investment contracts  9,341   4,119   13,460   8,957   5,145   14,102 
Total  18,364   61,218   79,582   21,291   64,979   86,270 
F-47

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 33: LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS continued

  2018 2017
  With-profit
fund
£m		  Non-profit
fund
£m		  Total
£m		  With-profit
fund
£m		  Non-profit
fund
£m		  Total
£m		 
Insurance contracts  7,851   76,515   84,366   8,946   78,003   86,949 
Participating investment contracts  7,438   6,474   13,912   8,481   7,400   15,881 
Total  15,289   82,989   98,278   17,427   85,403   102,830 

 

WITH-PROFIT FUND REALISTIC LIABILITIES

 

(i) Business description(I) BUSINESS DESCRIPTION

During the year the Group had with-profit funds within Scottish Widows plc and Clerical Medical Investment Group Limited (CMIG) containing both insurance contracts and participating investment contracts. On 31 December 2015, the long-term insurance businesses of seven life insurance companies within the Group were transferred to CMIG pursuant to an insurance business transfer scheme, under Part VII of the Financial Services and Markets Act 2000, and the Scottish Widows plc with-profit fund was transferred to a with-profit fund within CMIG. On 31 December 2015, CMIG changed its name to Scottish Widows Limited, and Scottish Widows plc changed its name to SW Funding plc. From 31 December 2015,

Scottish Widows Limited has the only with-profit funds within the Group.

The primary purpose of the conventional and unitised business written in the with-profit funds is to provide a smoothed investment vehicle to policyholders, protecting them against short-term market fluctuations. Payouts may be subject to a guaranteed minimum payout if certain policy conditions are met. With-profit policyholders are entitled to at least 90 per cent of the distributed profits, with the shareholders receiving the balance. The policyholders are also usually insured against death and the policy may carry a guaranteed annuity option at retirement.

 

(ii) Method of calculation of liabilities(II) METHOD OF CALCULATION OF LIABILITIES

With-profit liabilities are stated at their realistic value, the main components of which are:

 

–With-profit benefit reserve, the total asset shares for with-profit policies;
  
–Cost of options and guarantees (including guaranteed annuity options);
  
–Deductions levied against asset shares;
  
–Planned enhancements to with-profits benefits reserve; and
  
–Impact of the smoothing policy.
F-48

The realistic assessment is carried out using a stochastic simulation model which values liabilities on a market-consistent basis. The calculation of realistic liabilities uses best estimate assumptions for mortality, persistency rates and expenses. These are calculated in a similar manner to those used for the value of in-force business as discussed in note 25.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(iii) AssumptionsNote 31: Liabilities arising from insurance contracts and participating investment contractscontinued

(III) ASSUMPTIONS

Key assumptions used in the calculation of with-profit liabilities, and the processes for determining these, are:

 

INVESTMENT RETURNS AND DISCOUNT RATESInvestment returns and discount rates

 

The realistic capital regime dictates that with-profitWith-profit fund liabilities are valued on a market-consistent basis. This isbasis, achieved by the use of a valuation model which values liabilities on a basis calibrated to tradable market option contracts and other observable market data. The with-profit fund financial options and guarantees are valued using a stochastic simulation model where all assets are assumed to earn, on average, the risk-free yield and all cash flows are discounted using the risk-free yield. The risk-free yield is defined as the spot yield derived from the relevant swap curve, adjusted for credit risk. Further information on significant options and guarantees is given below.

 

GUARANTEED ANNUITY OPTION TAKE-UP RATESGuaranteed annuity option take-up rates

 

Certain pension contracts contain guaranteed annuity options that allow the policyholder to take an annuity benefit on retirement at annuity rates that were guaranteed at the outset of the contract. For contracts that contain such options, key assumptions in determining the cost of options are economic conditions in which the option has value, mortality rates and take up rates of other options. The financial impact is dependent on the value of corresponding investments, interest rates and longevity at the time of the claim.

 

INVESTMENT VOLATILITYInvestment volatility

 

The calibration of the stochastic simulation model uses implied volatilities of derivatives where possible, or historical volatility where it is not possible to observe meaningful prices.

 

MORTALITYMortality

 

The mortality assumptions, including allowances for improvements in longevity for annuitants, are set with regard to the Group’s actual experience where this is significant, and relevant industry data otherwise.

 

LAPSE RATES (PERSISTENCY)Lapse rates (persistency)

 

Lapse rates refer to the rate of policy termination or the rate at which policyholders stop paying regular premiums due under the contract.

 

Historical persistency experience is analysed using statistical techniques. As experience can vary considerably between different product types and for contracts that have been in force for different periods, the data is broken down into broadly homogenous groups for the purposes of this analysis.

 

The most recent experience is considered along with the results of previous analyses and management’s views on future experience, taking into consideration potential changes in future experience that may result from guarantees and options becoming more valuable under adverse market conditions, in order to determine a ‘best estimate’ view of what persistency will be. In determining this best estimate view a number of factors are considered, including the credibility of the results (which will be affected by the volume of data available), any exceptional events that have occurred during the period under consideration, any known or expected trends in underlying data and relevant published market data.

 

(iv) Options and guarantees within the With-Profit Funds(IV) OPTIONS AND GUARANTEES WITHIN THE WITH-PROFIT FUNDS

The most significant options and guarantees provided from within the With-Profit Funds are in respect of guaranteed minimum cash benefits on death, maturity, retirement or certain policy anniversaries, and guaranteed annuity options on retirement for certain pension policies.

 

For those policies written in Scottish Widows pre-demutualisation containing potentially valuable options and guarantees, under the terms of the Scheme a separate memorandum account was set up, within the With-Profit Fund originally held in Scottish Widows plc and subsequently transferred into Scottish Widows Limited, called the Additional Account which is available, inter alia, to meet any additional costs of providing guaranteed benefits in respect of those policies. The Additional Account had a value at 31 December 20152018 of £2.5 billion (2014: £2.6(2017: £2.8 billion). The eventual cost of providing

F-48

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 33: LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS continued

benefits on policies written both pre and post demutualisation is dependent upon a large number of variables, including future interest rates and equity values, demographic factors, such as mortality, and the proportion of policyholders who seek to exercise their options. The ultimate cost will therefore not be known for many years.

 

As noted above, under the realistic capital regime of the PRA, the liabilities of the With-Profit Funds are valued using a market-consistent stochastic simulation model which places a value on the options and guarantees which captures both their intrinsic value and their time value.

 

The most significant economic assumptions included in the model are risk-free yield and investment volatility.

 

NON-PROFIT FUND LIABILITIES

 

(i) Business description(I) BUSINESS DESCRIPTION

The Group principally writes the following types of life insurance contracts within its non-profit funds. Shareholder profits on these types of business arise from management fees and other policy charges.

 

Unit-linked business–

This includes unit-linked pensions and unit-linked bonds, the primary purpose of which is to provide an investment vehicle where the policyholder is also insured against death.

 

Life insurance–

The policyholder is insured against death or permanent disability, usually for predetermined amounts. Such business includes whole of life and term assurance and long-term creditor policies.

 

Annuities–

The policyholder is entitled to payments for the duration of their life and is therefore insured against surviving longer than expected.

 

(ii) Method of calculation of liabilities(II) METHOD OF CALCULATION OF LIABILITIES

The non-profit fund liabilities are determined on the basis of recognised actuarial methods and consistent with the approach required by regulatory rules. The methods used involve estimating future policy cash flows over the duration of the in-force book of policies, and discounting the cash flows back to the valuation date allowing for probabilities of occurrence.

 

(iii) Assumptions(III) ASSUMPTIONS

Generally, assumptions used to value non-profit fund liabilities are prudent in nature and therefore contain a margin for adverse deviation. This margin for adverse deviation is based on management’s judgement and reflects management’s views on the inherent level of uncertainty. The key assumptions used in the measurement of non-profit fund liabilities are:

F-49

Notes to the consolidated financial statements

 

INTEREST RATESNote 31: Liabilities arising from insurance contracts and participating investment contracts continued

Interest rates

 

The rates of interest used are derived in accordance with the guidelines set by local regulatory bodies. These limit the rates of interest that can be useddetermined by reference to a number of factors including the redemption yields on fixed interest assets at the valuation date.

 

Margins for risk are allowed for in the assumed interest rates. These are derived from the limits in the guidelines set by local regulatory bodies, including reductions made to the available yields to allow for default risk based upon the credit rating of the securities allocated to the insurance liability.

 

MORTALITY AND MORBIDITYMortality and morbidity

 

The mortality and morbidity assumptions, including allowances for improvements in longevity for annuitants, are set with regard to the Group’s actual experience where this provides a reliable basis, and relevant industry data otherwise, and include a margin for adverse deviation.

 

LAPSE RATES (PERSISTENCY)Lapse rates (persistency)

 

Lapse rates are allowed for on some non-profit fund contracts. The process for setting these rates is as described for with-profit liabilities, however a prudent scenario is assumed by the inclusion of a margin for adverse deviation within the non-profit fund liabilities.

 

MAINTENANCE EXPENSESMaintenance expenses

 

Allowance is made for future policy costs explicitly. Expenses are determined by reference to an internal analysis of current and expected future costs plus a margin for adverse deviation. Explicit allowance is made for future expense inflation.

 

KEY CHANGES IN ASSUMPTIONSKey changes in assumptions

 

A detailed review of the Group’s assumptions in 20152018 resulted in the following key impacts on profit before tax:

 

–Change in persistency assumptions (£196 million decrease).
–Change in the assumption in respect of current and future mortality rates (£224 million increase).
–Change in expenses assumptions (£70 million increase).

– Change in persistency assumptions (£135 million decrease).

– Change in the assumption in respect of current and future mortality and morbidity rates (£173 million increase).

– Change in expenses assumptions (£43 million decrease).

 

These amounts include the impacts of movements in liabilities and value of the in-force business in respect of insurance contracts and participating investment contracts.)

 

(iv) Options and guarantees outside the With-Profit Funds(IV) OPTIONS AND GUARANTEES OUTSIDE THE WITH-PROFIT FUNDS

A number of typical guarantees are provided outside the With-Profit Funds such as guaranteed payments on death (e.g. term assurance) or guaranteed income for life (e.g. annuities). In addition, certain personal pension policyholders in Scottish Widows, for whom reinstatement to their occupational pension scheme was not an option, have been given a guarantee that their pension and other benefits will correspond in value to the benefits of the relevant occupational pension scheme. The key assumptions affecting the ultimate value of the guarantee are future salary growth, gilt yields at retirement, annuitant mortality at retirement, marital status at retirement and future investment returns. There is currently a provision, calculated on a deterministic basis, of £68£39 million (2014: £61(2017: £35 million) in respect of those guarantees.

(2) Non-life insurance

For non-life insurance contracts, the methodology and assumptions used in relation to determining the bases of the earned premium and claims provisioning levels are derived for each individual underwritten product. Assumptions are intended to be neutral estimates of the most likely or expected outcome. There has been no significant change in the assumptions and methodologies used for setting reserves.

The movements in non-life insurance contract liabilities and reinsurance assets over the year have been as follows:

  2018
£m		  2017
£m		 
Provisions for unearned premiums        
Gross provision at 1 January  358   404 
Increase in the year  681   724 
Release in the year  (697)  (770)
Change in provision for unearned premiums charged to income statement  (16)  (46)
Gross provision at 31 December  342   358 
Reinsurers’ share  (13)  (13)
Net provision at 31 December  329   345 

These provisions represent the liability for short-term insurance contracts for which the Group’s obligations are not expired at the year end.

  2018
£m		  2017
£m		 
Claims outstanding        
Gross claims outstanding at 1 January  225   209 
Cash paid for claims settled in the year  (306)  (321)
Increase/(decrease) in liabilities charged to the income statement1  335   337 
   29   16 
Gross claims outstanding at 31 December  254   225 
Reinsurers’ share  –   – 
Net claims outstanding at 31 December  254   225 
Notified claims  170   174 
Incurred but not reported  84   51 
Net claims outstanding at 31 December  254   225 

1Of which an increase of £367 million (2017: £350 million) was in respect of current year claims and a decrease of £32 million (2017: a decrease of £13 million) was in respect of prior year claims.
F-49F-50

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSNotes to the consolidated financial statements

 

NOTE 34:32: LIFE INSURANCE SENSITIVITY ANALYSIS

 

The following table demonstrates the effect of reasonably possible changes in key assumptions on profit before tax and equity disclosed in these financial statements assuming that the other assumptions remain unchanged. In practice this is unlikely to occur, and changes in some assumptions may be correlated. These amounts include movements in assets, liabilities and the value of the in-force business in respect of insurance contracts and participating investment contracts. The impact is shown in one direction but can be assumed to be reasonably symmetrical.

 

   2015  2014 
   Increase    Increase   
   (reduction) Increase  (reduction) Increase 
   in profit (reduction)  in profit (reduction) 
 Change in before tax in equity  before tax in equity   2018 2017
 variable £m £m  £m £m  Change in
variable		 Increase
(reduction
in profit
before tax
£m		)



 Increase
(reduction
in equity
£m		)


 Increase
(reduction
in profit
before tax
£m		)



 Increase
(reduction
in equity
£m		)


Non-annuitant mortality and morbidity1 5% reduction  32   26   37   30  5% reduction  22   18   23   19 
Annuitant mortality2 5% reduction  (190)  (156)  (176)  (141) 5% reduction  (234)  (194)  (221)  (184)
Lapse rates3 10% reduction  85   70   105   84  10% reduction  89   74   75   62 
Future maintenance and investment expenses4 10% reduction  231   190   259   208  10% reduction  262   217   289   240 
Risk-free rate5 0.25% reduction  (44)  (37)  (10)  (8) 0.25% reduction  76   63   (40)  (33)
Guaranteed annuity option take up6 5% addition  2   2   1   1  5% addition  (3)  (2)  (6)  (5)
Equity investment volatility7 1% addition  (7)  (5)  (3)  (3) 1% addition  (5)  (4)  (7)  (6)
Widening of credit default spreads on corporate bonds8 0.25% addition  (183)  (151)  (168)  (132) 0.25% addition  (364)  (303)  (235)  (195)
Increase in illiquidity premia9 0.10% addition  120   98   101   81  0.10% addition  153   127   145   120 

 

Assumptions have been flexed on the basis used to calculate the value of in-force business and the realistic and statutory reserving bases.

 

1This sensitivity shows the impact of reducing mortality and morbidity rates on non-annuity business to 95 per cent of the expected rate.
2This sensitivity shows the impact on the annuity and deferred annuity business of reducing mortality rates to 95 per cent of the expected rate.
3This sensitivity shows the impact of reducing lapse and surrender rates to 90 per cent of the expected rate.
4This sensitivity shows the impact of reducing maintenance expenses and investment expenses to 90 per cent of the expected rate.
5This sensitivity shows the impact on the value of in-force business, financial options and guarantee costs, statutory reserves and asset values of reducing the risk-free rate by 25 basis points.
6This sensitivity shows the impact of a flat 5 per cent addition to the expected rate.
7This sensitivity shows the impact of a flat 1 per cent addition to the expected rate.
8This sensitivity shows the impact of a 25 basis point increase in credit default spreads on corporate bonds and the corresponding reduction in market values. Swap curves, the risk-free rate and illiquidity premia are all assumed to be unchanged.
9This sensitivity shows the impact of a 10 basis point increase in the allowance for illiquidity premia. It assumes the overall spreads on assets are unchanged and hence market values are unchanged. Swap curves and the non-annuity risk-free rate are both assumed to be unchanged. The increased illiquidity premium increases the annuity risk-free rate.

 

NOTE 35:33: LIABILITIES ARISING FROM NON-PARTICIPATING INVESTMENT CONTRACTS

 

The movement in liabilities arising from non-participating investment contracts may be analysed as follows:

 

 2015  2014 
 £m  £m  2018
£m		  2017
£m		 
At 1 January  27,248   27,590   15,447   20,112 
New business  539   257   668   608 
Changes in existing business  (4,461)  (583)  (2,262)  (5,273)
Disposal of businesses  (549)  – 
Exchange and other adjustments  –   (16)
At 31 December  22,777   27,248   13,853   15,447 

 

The balances above are shown gross of reinsurance. As at 31 December 2015,2018, related reinsurance balances were £34£20 million (2014: £39(2017: £26 million); reinsurance balances are reported within other assets (note 28)27). Liabilities arising from non-participating investment contracts are categorised as level 2. See note 5049 for details of levels in the fair value hierarchy.

NOTE 34: OTHER LIABILITIES

  2018
£m		  2017
 £m		 
Settlement balances  485   501 
Unitholders’ interest in Open Ended Investment Companies  12,933   14,480 
Unallocated surplus within insurance businesses  382   390 
Other creditors and accruals  5,833   5,359 
Total other liabilities  19,633   20,730 
F-50F-51

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSNotes to the consolidated financial statements

 

NOTE 36: OTHER LIABILITIES

  2015  2014 
  £m  £m 
Settlement balances  467   1,024 
Unitholders’ interest in Open Ended Investment Companies  22,621   19,525 
Unallocated surplus within insurance businesses  257   320 
Other creditors and accruals  6,316   7,556 
Total other liabilities  29,661   28,425 

NOTE 37:35: RETIREMENT BENEFIT OBLIGATIONS

 

  2015  2014  2013 
  £m  £m  £m 
Charge to the income statement            
Past service (credits) charges1  –   (822)  104 
Other  307   334   392 
Defined benefit pension schemes  307   (488)  496 
Other post-retirement benefit schemes  8   10   7 
Total defined benefit schemes  315   (478)  503 
Defined contribution pension schemes  233   252   255 
Total charge (credit) to the income statement (note 11)  548   (226)  758 

1On 11 March 2014 the Group announced a change to its defined benefit pension schemes, revising the existing cap on the increases in pensionable pay used in calculating the pension benefit, from 2 per cent to nil with effect from 2 April 2014. The effect of this change was to reduce the Group’s retirement benefit obligations recognised on the balance sheet by £843 million with a corresponding curtailment gain recognised in the income statement. This was partly offset by a charge of £21 million following changes to pension arrangements for staff within the TSB business. In 2013, the Group agreed certain changes to early retirement and commutation factors in two of its principal defined benefit pension schemes, resulting in a cost of £104 million recognised in the Group’s income statement in the year ended 31 December 2013.

 2018
£m		 2017
£m		 2016
£m		 
Charge to the income statement            
Defined benefit pension schemes  401   362   279 
Other post-retirement benefit schemes  4   7   8 
Total defined benefit schemes  405   369   287 
Defined contribution pension schemes  300   256   268 
Total charge to the income statement (note 11)  705   625   555 
 2015  2014             
 £m  £m     2018
£m		 2017
£m		 
Amounts recognised in the balance sheet                    
Retirement benefit assets  901   1,147       1,267   723 
Retirement benefit obligations  (365)  (453)      (245)  (358)
Total amounts recognised in the balance sheet  536   694       1,022   365 
                    
The total amount recognised in the balance sheet relates to:                    
  2015   2014     2018
£m		 2017
£m		 
  £m   £m 
Defined benefit pension schemes  736   890       1,146   509 
Other post-retirement benefit schemes  (200)  (196)      (124)  (144)
Total amounts recognised in the balance sheet  536   694       1,022   365 

 

PENSION SCHEMESPension schemes

DEFINED BENEFIT SCHEMES

 

(i) Characteristics of and risks associated with the Group’s schemes(I) CHARACTERISTICS OF AND RISKS ASSOCIATED WITH THE GROUP’S SCHEMES

The Group has established a number of defined benefit pension schemes in the UK and overseas. All significant schemes are based in the UK, with the three most significant being the defined benefit sectionssection of the Lloyds Bank Pension Schemes No’sNo. 1, andthe Lloyds Bank Pension Scheme No. 2 and the HBOS Final Salary Pension Scheme. At 31 December 2018, these schemes represented 94 per cent of the Group’s total gross defined benefit pension assets (2017: 95 per cent). These schemes provide retirement benefits calculated as a percentage of final pensionable salary depending upon the length of service; the minimum retirement age under the rules of the schemes at 31 December 20152018 is generally 55 although certain categories of member are deemed to have a contractual right to retire at 50.

 

The Group operates a number of funded and unfunded pension arrangements, the majority, including the three most significant schemes, are funded schemes in the UK. All these schemes are operated as separate legal entities under trust law by the trustees. All UK schemesand are funded in compliance with the Pensions Act 2004. A valuation exercise is carried out for each scheme at least every three years, whereby scheme assets are measured at market value and liabilities (‘Technical Provisions’) are measured using prudent assumptions, if a deficit is identified a recovery plan is agreed and sent to the Pensions Regulator for review. The outcome of this valuation process, including agreement of any recovery plans, is agreed between the Group and the scheme Trustee. The Group has not provided for these deficit contributions as the future economic benefits arising from these contributions are expected to be available to the Group. The Group’s overseas defined benefit pension schemes are subject to local regulatory arrangements.

The latest full valuations of the three main schemes were carried out as at 30 June 2014; the results have been updated to 31 December 2015 by qualified independent actuaries. The last full valuations of other Group schemes were carried out on a number of different dates; these have been updated to 31 December 2015 by qualified independent actuaries.

During 2009, the Group made one-off contributions to the Lloyds Bank Pension Scheme No 1 and Lloyds Bank Pension Scheme No 2 of approximately £1 billion in aggregate. These contributions took the form of interests in limited liability partnerships for each of the two schemes which contained assets of approximately £5.4 billion in aggregate entitling the schemes to annual payments of approximately £215 million in aggregate until 31 December 2014.

F-51

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 37: RETIREMENT BENEFIT OBLIGATIONS continued

As all scheduled distributions have now been made, the value of the partnership interests equates to a nominal amount and the limited liability partnerships will continue to hold assets to provide security for the Group’s obligations to the Lloyds Bank Pension Scheme No 1 and Lloyds Bank Pension Scheme No 2. At 31 December 2015, the limited liability partnerships held assets of approximately £5.2 billion and no cash payments were made to the pension schemes during the year (2014: £215 million). The limited liability partnerships are consolidated fully in the Group’s balance sheet (see note 20).

The Group has also established three private limited companies which hold assets to provide security for the Group’s obligations to the HBOS Final Salary Pension Scheme, a section of the Lloyds Bank Pension Scheme No 1 and the Lloyds Bank Offshore Pension Scheme. At 31 December 2015 these held assets of approximately £4.1 billion in aggregate; they do not make any distributions to the pension schemes. The private limited companies are consolidated fully in the Group’s balance sheet. The terms of these arrangements require the Group to maintain assets in these vehicles to agreed minimum values in order to secure obligations owed to the relevant Group pension schemes. The Group has satisfied this requirement during 2015.

The Group currently expects to pay contributions of approximately £600 million to its defined benefit schemes in 2016.

The responsibility for the governance of the Group’s funded defined benefit pension schemes lies with the Pension Trustees. EachAll of the Group’s funded UK defined benefit pension schemes are managed by a Trustee Board (the Trustee) whose role is to ensure that their Scheme is administered in accordance with the Scheme rules and relevant legislation, and to safeguard the assets in the best interests of all members and beneficiaries. The Trustee is solely responsible for setting investment policy and for agreeing funding requirements with the employer through the triennialfunding valuation process. The Board of Trustees must be composed of representatives of the Company and plan participants in accordance with the Scheme’s regulations.

 

(ii) AmountsA valuation to determine the funding status of each scheme is carried out at least every three years, whereby scheme assets are measured at market value and liabilities (technical provisions) are measured using prudent assumptions. If a deficit is identified a recovery plan is agreed between the Group and the scheme Trustee and sent to the Pensions Regulator for review. The Group has not provided for these deficit contributions as the future economic benefits arising from these contributions are expected to be available to the Group. The Group’s overseas defined benefit pension schemes are subject to local regulatory arrangements.

The most recent triennial funding valuation of the Group’s three main schemes, based on the position as at 31 December 2016, was completed during 2018. The valuation showed an aggregate funding deficit of £7.3 billion (a funding level of 85.6 per cent) compared to a £5.2 billion deficit (a funding level of 85.9 per cent) for the previous valuation as at 30 June 2014. In the light of this funding deficit, and in contemplation of the changes that the Group has made as a result of its Structural Reform Programme, the Group agreed a recovery plan with the trustees. Under the plan, deficit contributions of £412 million were paid during 2018, and these will rise to £618 million in 2019, £798 million in 2020, £1,287 million in 2021 and £1,305 million per annum from 2022 to 2024. Contributions in the financial statementslater years will be subject to review and renegotiation at subsequent funding valuations. The next funding valuation is due to be completed by March 2021 with an effective date of 31 December 2019. The deficit contributions are in addition to the regular contributions to meet of benefits accruing over the year. The Group currently expects to pay contributions of approximately £1,050 million to its defined benefit schemes in 2019.

 

  2015  2014 
  £m  £m 
Amount included in the balance sheet        
Present value of funded obligations  (36,903)  (37,243)
Fair value of scheme assets  37,639   38,133 
Net amount recognised in the balance sheet  736   890 
   2015   2014 
   £m   £m 
Net amount recognised in the balance sheet        
At 1 January  890   (787)
Net defined benefit pension (charge) credit  (307)  488 
Actuarial gains (losses) on defined benefit obligation  607   (4,272)
Return on plan assets  (879)  4,928 
Employer contributions  427   531 
Exchange and other adjustments  (2)  2 
At 31 December  736   890 
         
   2015
£m		   2014
£m		 
Movements in the defined benefit obligation        
At 1 January  (37,243)  (33,355)
Current service cost  (302)  (277)
Interest expense  (1,340)  (1,471)
Remeasurements:        
Actuarial (losses) gains – experience  195   186 
Actuarial (losses) gains – demographic assumptions  (747)  (13)
Actuarial (losses) gains – financial assumptions  1,159   (4,445)
Benefits paid  1,371   1,147 
Past service cost  (12)  (20)
Employee contributions  (1)  (2)
Curtailments  –   822 
Settlements  8   117 
Exchange and other adjustments  9   68 
At 31 December  (36,903)  (37,243)

During 2009, the Group made one-off contributions to the Lloyds Bank Pension Scheme No 1 and Lloyds Bank Pension Scheme No 2 in the form of interests in limited liability partnerships for each of the two schemes which hold assets to provide security for the Group’s obligations to the two schemes. At 31 December 2018, the limited liability partnerships held assets of approximately £6.7 billion. The limited liability partnerships are consolidated fully in the Group’s balance sheet.

The Group has also established three private limited companies which hold assets to provide security for the Group’s obligations to the HBOS Final Salary Pension Scheme, a section of the Lloyds Bank Pension Scheme No 1 and the Lloyds Bank Offshore Pension Scheme. At 31 December 2018 these held assets of approximately £4.6 billion in aggregate. The private limited companies are consolidated fully in the Group’s balance sheet. The terms of these arrangements require the Group to maintain assets in these vehicles to agreed minimum values in order to secure obligations owed to the relevant Group pension schemes. The Group has satisfied this requirement during 2018.

The last funding valuations of other Group schemes were carried out on a number of different dates. In order to report the position under IAS 19 as at 31 December 2018 the most recent valuation results for all schemes have been updated by qualified independent actuaries. The main differences between the funding and IAS 19 valuations are different and more prudent approach to setting the discount rate and more conservative longevity assumptions used in the funding valuations.

F-52

NOTES TONotes to the consolidated financial statements

Note 35: Retirement benefit obligations continued

In July 2018 a decision was sought from the High Court in respect of the requirement to equalise the Guaranteed Minimum Pension (GMP) benefits accrued between 1990 and 1997 from contracting out of the State Earnings Related Pension Scheme. In its judgment handed down on 26 October 2018 the High Court confirmed the requirement to treat men and women equally with respect to these benefits and a range of methods that the Trustee is entitled to adopt to achieve equalisation. The Group continues to work with the Trustee on the detail of implementing this judgment and has recognised a past service cost of £108 million consistent with the principles outlined within the judgment. This is based on a number of assumptions and the actual impact may be different.

(II) AMOUNTS IN THE CONSOLIDATED FINANCIAL STATEMENTS

 

  2018
£m		  2017
£m		 
Amount included in the balance sheet        
Present value of funded obligations  (41,092)  (44,384)
Fair value of scheme assets  42,238   44,893 
Net amount recognised in the balance sheet  1,146   509 
         
  2018
£m		  2017
£m		 
Net amount recognised in the balance sheet        
At 1 January  509   (244)
Net defined benefit pension charge  (401)  (362)
Actuarial gains (losses) on defined benefit obligation  1,707   (731)
Return on plan assets  (1,558)  1,267 
Employer contributions  863   580 
Exchange and other adjustments  26   (1)
At 31 December  1,146   509 
         
  2018
£m		  2017
£m		 
Movements in the defined benefit obligation        
At 1 January  (44,384)  (45,822)
Current service cost  (261)  (295)
Interest expense  (1,130)  (1,241)
Remeasurements:        
Actuarial losses – experience  (439)  (347)
Actuarial (losses) gains – demographic assumptions  (201)  1,084 
Actuarial gains (losses) – financial assumptions  2,347   (1,468)
Benefits paid  3,079   3,714 
Past service cost  (108)  (14)
Curtailments  (12)  (10)
Settlements  17   15 
Exchange and other adjustments  –   – 
At 31 December  (41,092)  (44,384)
         
  2018
£m		  2017
£m		 
Analysis of the defined benefit obligation:        
Active members  (6,448)  (7,947)
Deferred members  (14,208)  (15,823)
Pensioners  (18,885)  (19,014)
Dependants  (1,551)  (1,600)
   (41,092)  (44,384)
F-53

NOTE 37: RETIREMENT BENEFIT OBLIGATIONSNotes to the consolidated financial statements

Note 35: Retirement benefit obligations continued

 

 2015  2014 
 £m  £m  2018
£m		  2017
£m		 
Changes in the fair value of scheme assets                
At 1 January  38,133   32,568   44,893   45,578 
Return on plan assets excluding amounts included in interest income  (879)  4,928   (1,558)  1,267 
Interest income  1,383   1,477   1,152   1,242 
Employer contributions  427   531   863   580 
Employee contributions  1   2 
Benefits paid  (1,371)  (1,147)  (3,079)  (3,714)
Settlements  (14)  (124)  (18)  (18)
Administrative costs paid  (30)  (36)  (41)  (41)
Exchange and other adjustments  (11)  (66)  26   (1)
At 31 December  37,639   38,133   42,238   44,893 

 

The expense recognised in the income statement for the year ended 31 December comprises:

  2018
£m		  2017
£m		  2016
£m		 
Current service cost  261   295   257 
Net interest amount  (22)  (1)  (40)
Past service credits and curtailments  12   10   – 
Settlements  1   3   6 
Past service cost – plan amendments  108   14   20 
Plan administration costs incurred during the year  41   41   36 
Total defined benefit pension expense  401   362   279 

(III) COMPOSITION OF SCHEME ASSETS:ASSETS

 

 2015 2014
 Quoted Unquoted Total  Quoted Unquoted Total  2018 2017
 £m £m £m  £m £m £m  Quoted
£m		 Unquoted
£m		 Total
£m		  Quoted
£m		 Unquoted
£m		 Total
£m		 
Equity instruments  947   —   947   1,047   —   1,047   637   222   859   846   5   851 
Debt instruments1:                                                
Fixed interest government bonds  4,841   –   4,841   4,150   –   4,150   7,449   –   7,449   5,344   –   5,344 
Index-linked government bonds  9,944   –   9,944   10,396   –   10,396   16,477   –   16,477   17,439   –   17,439 
Corporate and other debt securities  7,243   –   7,243   6,623   –   6,623   8,813   –   8,813   6,903   –   6,903 
Asset-backed securities  74   –   74   74   –   74   138   –   138   121   –   121 
  22,102   –   22,102   21,243   –   21,243   32,877   –   32,877   29,807   –   29,807 
Property  –   1,361   1,361   –   1,138   1,138   –   556   556   –   544   544 
Pooled investment vehicles  3,464   9,698   13,162   3,603   10,555   14,158   4,578   10,494   15,072   3,937   13,443   17,380 
Money market instruments, cash, derivatives and other assets and liabilities  525   (458)  67   1,179   (632)  547   (283)  (6,843)  (7,126)  1,501   (5,190)  (3,689)
At 31 December  27,038   10,601   37,639   27,072   11,061   38,133   37,809   4,429   42,238   36,091   8,802   44,893 

 

1 Of the total debt instruments, £18,428 million (31 December 2014: £19,209 million) were investment grade (credit ratings equal to or better than ‘BBB’).

1Of the total debt instruments, £29,033 million (31 December 2017: £27,732 million) were investment grade (credit ratings equal to or better than ‘BBB’).

 

The assets of all the funded plans are held independently of the Group’s assets in separate trustee administered funds.

 

The pension schemes’ pooled investment vehicles comprise:

 

  2015  2014 
  £m  £m 
Equity funds  2,412   2,581 
Hedge and mutual funds  2,078   2,170 
Liquidity funds  918   2,566 
Bond and debt funds  2,807   2,570 
Other  4,947   4,271 
At 31 December  13,162   14,158 

The expense (credit) recognised in the income statement for the year ended 31 December comprises:

  2015  2014  2013 
  £m  £m  £m 
Current service cost  302   277   351 
Net interest amount  (43)  (6)  22 
Past service credits and curtailments (see note 11)  –   (822)  104 
Settlements  6   7   (7)
Past service cost – plan amendments  12   20   5 
Plan administration costs incurred during the year  30   36   21 
Total defined benefit pension expense (credit)  307   (488)  496 
  2018
£m		  2017
£m		 
Equity funds  2,329   2,669 
Hedge and mutual funds  2,487   2,377 
Liquidity funds  2,329   2,877 
Bond and debt funds  313   1,830 
Other  7,614   7,627 
At 31 December  15,072   17,380 
F-53F-54

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSNotes to the consolidated financial statements

 

NOTE 37: RETIREMENT BENEFIT OBLIGATIONSNote 35: Retirement benefit obligations continued

 

(IV) ASSUMPTIONS

 

The principal actuarial and financial assumptions used in valuations of the defined benefit pension schemes were as follows:

 

 2015 2014 
 % %  2018
%		 2017
%
Discount rate  3.87   3.67   2.90   2.59 
Rate of inflation:                
Retail Prices Index  2.99   2.95   3.20   3.20 
Consumer Price Index  1.99   1.95   2.15   2.15 
Rate of salary increases  0.00   0.00   0.00   0.00 
Weighted-average rate of increase for pensions in payment  2.58   2.59   2.73   2.73 
  2015   2014         
  Years   Years   2018
Years		   2017
Years		 
Life expectancy for member aged 60, on the valuation date:                
Men  28.1   27.5   27.8   27.9 
Women  30.4   29.8   29.4   29.5 
Life expectancy for member aged 60, 15 years after the valuation date:                
Men  29.5   28.7   28.8   28.9 
Women  31.9   31.1   30.6   30.7 

 

The mortality assumptions used in the scheme valuations are based on standard tables published by the Institute and Faculty of Actuaries which were adjusted in line with the actual experience of the relevant schemes. The table shows that a member retiring at age 60 at 31 December 20152018 is assumed to live for, on average, 28.127.8 years for a male and 30.429.4 years for a female. In practice there will be much variation between individual members but these assumptions are expected to be appropriate across all members. It is assumed that younger members will live longer in retirement than those retiring now. This reflects the expectation that mortality rates will continue to fall over time as medical science and standards of living improve. To illustrate the degree of improvement assumed the table also shows the life expectancy for members aged 45 now, when they retire in 15 yearsyears’ time at age 60.

 

(iii) Amount timing and uncertainty(V) AMOUNT TIMING AND UNCERTAINTY OF FUTURE CASH FLOWS

Risk exposure of future cash flows

RISK EXPOSURE OF THE DEFINED BENEFIT SCHEMESthe defined benefit schemes

 

Whilst the Group is not exposed to any unusual, entity specific or scheme specific risks in its defined benefit pension schemes, it is exposed to a number of significant risks, detailed below:

 

Inflation rate risk: the majority of the plans’ benefit obligations are linked to inflation both in deferment and once in payment. Higher inflation will lead to higher liabilities although this will be partiallymaterially offset by holdings of inflation-linked gilts and, in most cases, caps on the level of inflationary increases are in place to protect against extreme inflation.

 

Interest rate risk: The defined benefit obligation is determined using a discount rate derived from yields on AA-rated corporate bonds. A decrease in corporate bond yields will increase plan liabilities although this will be partiallymaterially offset by an increase in the value of bond holdings.

 

Longevity risk: The majority of the schemes obligations are to provide benefits for the life of the members so increases in life expectancy will result in an increase in the plans’ liabilities.

 

Investment risk: Scheme assets are invested in a diversified portfolio of debt securities, equities and other return-seeking assets. If the assets underperform the discount rate used to calculate the defined benefit obligation, it will reduce the surplus or increase the deficit. Volatility in asset values and the discount rate will lead to volatility in the net pension liabilityasset on the Group’s balance sheet and in other comprehensive income. To a lesser extent this will also lead to volatility in the pension expense in the Group’s income statement.

 

The ultimate cost of the defined benefit obligations to the Group will depend upon actual future events rather than the assumptions made. The assumptions made are unlikely to be borne out in practice and as such the cost may be higher or lower than expected.

 

SENSITIVITY ANALYSISSensitivity analysis

 

The effect of reasonably possible changes in key assumptions on the value of scheme liabilities and the resulting pension charge in the Group’s income statement and on the net defined benefit pension scheme liability, for the Group’s three most significant schemes, is set out below. The sensitivities provided assume that all other assumptions and the value of the schemes’ assets remain unchanged, and are not intended to represent changes that are at the extremes of possibility. The calculations are approximate in nature and full detailed calculations could lead to a different result. It is unlikely that isolated changes to individual assumptions will be experienced in practice. Due to the correlation of assumptions, aggregating the effects of these isolated changes may not be a reasonable estimate of the actual effect of simultaneous changes in multiple assumptions.

F-54F-55

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 37:35: RETIREMENT BENEFIT OBLIGATIONS continued

 

 Effect of reasonably possible alternative assumptions
 Increase (decrease)
in the income
statement charge		 Increase (decrease) in the
net defined benefit pension
scheme liability		 Effect of reasonably possible alternative assumptions
 2015  2014 2015  2014  Increase (decrease)
in the income
statement charge		 Increase (decrease) in the
net defined benefit pension
scheme liability
 £m  £m  £m  £m  2018
£m		  2017
£m		  2018
£m		  2017
£m		 
Inflation (including pension increases):1                                
Increase of 0.1 per cent  17   18   363   383   14   16   410   472 
Decrease of 0.1 per cent  (16)  (16)  (346)  (362)  (14)  (15)  (395)  (453)
Discount rate:2                                
Increase of 0.1 per cent  (29)  (30)  (605)  (611)  (27)  (28)  (670)  (773)
Decrease of 0.1 per cent  30   29   621   623   25   26   686   794 
Expected life expectancy of members:                                
Increase of one year  43   34   952   750   43   44   1,299   1,404 
Decrease of one year  (41)  (32)  (927)  (738)  (42)  (41)  (1,257)  (1,357)

 

1At 31 December 2015,2018, the assumed rate of RPI inflation is 2.993.20 per cent and CPI inflation 1.992.15 per cent (2014:(2017: RPI 2.953.20 per cent and CPI 1.952.15 per cent).
  
2At 31 December 2015,2018, the assumed discount rate is 3.872.90 per cent (2014: 3.67(2017: 2.59 per cent).

 

SENSITIVITY ANALYSIS METHOD AND ASSUMPTIONSSensitivity analysis method and assumptions

 

The sensitivity analysis above reflects the impact on the Group’s three most significant schemes which account for over 90 per cent of the Group’s defined benefit obligations. Whilst differences in the underlying liability profiles for the remainder of the Group’s pension arrangements mean they may exhibit slightly different sensitivities to variations in these assumptions, the sensitivities provided above are indicative of the impact across the Group as a whole.

 

The inflation assumption sensitivity applies to both the assumed rate of increase in the Consumer Prices Index (CPI) and the Retail Prices Index (RPI), and include the impact on the rate of increases to pensions, both before and after retirement. These pension increases are linked to inflation (either CPI or RPI) subject to certain minimum and maximum limits.

 

The sensitivity analysis (including the inflation sensitivity) does not include the impact of any change in the rate of salary increases as pensionable salaries have been frozen since 2 April 2014.

 

The life expectancy assumption has been applied by allowing for an increase/decrease in life expectation from age 60 of one year, based upon the approximate weighted average age for each scheme. Whilst this is an approximate approach and will not give the same result as a one year increase in life expectancy at every age, it provides an appropriate indication of the potential impact on the schemes from changes in life expectancy.

 

There was no change in the methods and assumptions used in preparing the sensitivity analysis from the prior year.

 

ASSET-LIABILITY MATCHING STRATEGIESAsset-liability matching strategies

 

The main schemes’ assets are invested in a diversified portfolio, consisting primarily of debt securities. The investment strategy is not static and will evolve to reflect the structure of liabilities within the schemes. Specific asset-liability matching strategies for each pension plan are independently determined by the responsible governance body for each scheme and in consultation with the employer.

 

A significant goal of the asset-liability matching strategies adopted by Group schemes is to reduce volatility caused by changes in market expectations of interest rates and inflation. In the main schemes, this is achieved by investing scheme assets in bonds, primarily fixed interest gilts and index linked gilts, and by entering into interest rate and inflation swap arrangements. These investments are structured to take into account the profile of scheme liabilities, and actively managed to reflect both changing market conditions and changes to the liability profile.

 

TheAt 31 December 2018 the asset-liability matching strategy currently mitigates substantially allmitigated 105 per cent of the liability sensitivity to interest rate movements and inflation rate volatility106 per cent of the liabilities.liability sensitivity to inflation movements. In addition a small amount of interest rate sensitivity arises through holdings of corporate and other debt securities.

 

DURATION OF DEFINED BENEFIT OBLIGATIONMaturity profile of defined benefit obligation

 

The following table provides information on the weighted average duration of the defined benefit pension obligation was 19 years (31 December 2014: 19 years).obligations and the distribution and timing of benefit payments:

  2018
Years		  2017
Years		 
Duration of the defined benefit obligation  18   19 
  2018
£m		  2017
£m		 
Maturity analysis of benefits expected to be paid:        
Within 12 months  1,225   1,174 
Between 1 and 2 years  1,299   1,235 
Between 2 and 5 years  4,303   4,089 
Between 5 and 10 years  8,305   8,082 
Between 10 and 15 years  9,416   9,360 
Between 15 and 25 years  18,417   19,044 
Between 25 and 35 years  15,631   16,735 
Between 35 and 45 years  9,924   11,156 
In more than 45 years  4,270   5,219 
F-56

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 35: RETIREMENT BENEFIT OBLIGATIONS continued

Maturity analysis method and assumptions

The projected benefit payments are based on the assumptions underlying the assessment of the obligations, including allowance for expected future inflation. They are shown in their undiscounted form and therefore appear large relative to the discounted assessment of the defined benefit obligations recognised in the Group’s balance sheet. They are in respect of benefits that have been accrued prior to the respective year-end date only and make no allowance for any benefits that may have been accrued subsequently.

 

DEFINED CONTRIBUTION SCHEMES

 

The Group operates a number of defined contribution pension schemes in the UK and overseas, principally Your Tomorrow and the defined contribution sections of the Lloyds Bank Pension Scheme No. 1.

 

During the year ended 31 December 20152018 the charge to the income statement in respect of defined contribution schemes was £233£300 million (2014: £252(2017: £256 million; 2013: £2552016: £268 million), representing the contributions payable by the employer in accordance with each scheme’s rules.

 

OTHER POST-RETIREMENT BENEFIT SCHEMESOther post-retirement benefit schemes

 

The Group operates a number of schemes which provide post-retirement healthcare benefits and concessionary mortgages to certain employees, retired employees and their dependants. The principal scheme relates to former Lloyds Bank staff and under this scheme the Group has undertaken to meet the cost of post-retirement healthcare for all eligible former employees (and their dependants) who retired prior to 1 January 1996. The Group has entered into an insurance contract to provide these benefits and a provision has been made for the estimated cost of future insurance premiums payable.

 

For the principal post-retirement healthcare scheme, the latest actuarial valuation of the liability was carried out at 31 December 20142018 by qualified independent actuaries. The principal assumptions used were as set out above, except that the rate of increase in healthcare premiums has been assumed at 6.596.81 per cent (2014: 6.55(2017: 6.81 per cent).

F-55

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 37: RETIREMENT BENEFIT OBLIGATIONS continued

 

Movements in the other post-retirement benefits obligation:

 

 2015  2014 
 £m  £m  2018
£m		  2017
£m		 
At 1 January  (196)  (211)  (144)  (236)
Actuarial (loss) gain  (2)  18 
Actuarial gains  18   92 
Insurance premiums paid  6   7   5   7 
Charge for the year  (8)  (10)  (4)  (7)
Exchange and other adjustments  1   – 
At 31 December  (200)  (196)  (124)  (144)

 

NOTE 38:36: DEFERRED TAX

 

The movement in the netGroup’s deferred tax balance isassets and liabilities are as follows:

 

  2015  2014 
  £m  £m 
Asset at 1 January  4,091   5,101 
Exchange and other adjustments  5   9 
Disposals  (59)  (60)
Income statement charge (note 13):        
Due to change in UK corporation tax rate and related impacts  (27)  (24)
Other  (89)  (254)
   (116)  (278)
Amount credited (charged) to equity:        
Post-retirement defined benefit scheme remeasurements  59   (135)
Available-for-sale financial assets (note 43)  (7)  (13)
Cash flow hedges (note 43)  7   (549)
Share-based compensation  (3)  16 
   56   (681)
Asset at 31 December  3,977   4,091 
Statutory position 2018
£m		  2017
£m		  Tax disclosure 2018
£m		  2017
£m		 
Deferred tax assets  2,453   2,284  Deferred tax assets  4,731   4,989 
Deferred tax liabilities  –   –  Deferred tax liabilities  (2,278)  (2,705)
Asset at 31 December  2,453   2,284  Asset at 31 December  2,453   2,284 

 

The statutory position reflects the deferred tax assets and liabilities as disclosed in the consolidated balance sheet and takes into account the ability of the inabilityGroup to offsetnet assets and liabilities where there is noa legally enforceable right of offset. The tax disclosure of deferred tax assets and liabilities ties to the amounts outlined in the tabletables below which splits the deferred tax assets and liabilities by type.

  2015  2014    2015  2014 
Statutory position £m  £m  Tax disclosure £m  £m 
Deferred tax assets  4,010   4,145  Deferred tax assets  6,400   7,033 
Deferred tax liabilities  (33)  (54) Deferred tax liabilities  (2,423)  (2,942)
Asset at 31 December  3,977   4,091  Asset at 31 December  3,977   4,091 

The deferred tax charge in the income statement comprises the following temporary differences: 

  2015  2014  2013 
  £m  £m  £m 
Accelerated capital allowances  377   34   482 
Pensions and other post-retirement benefits  (40)  (243)  (14)
Long-term assurance business  303   312   86 
Allowances for impairment losses  (5)  (24)  (86)
Tax losses carried forward  (855)  (565)  (1,049)
Tax on fair value of acquired assets  178   159   322 
Other temporary differences  (74)  49   (493)
Deferred tax charge in the income statement  (116)  (278)  (752)
F-56

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTStype, before such netting.

 

NOTE 38: DEFERRED TAX continued

DeferredAs a result of legislation enacted in 2016, the UK corporation tax rate will reduce from 19 per cent to 17 per cent on 1 April 2020. The Group measures its deferred tax assets and liabilities are comprised as follows:

  2015  2014 
  £m  £m 
Deferred tax assets:        
Accelerated capital allowances  1,089   682 
Allowances for impairment losses  –   5 
Other provisions  28   15 
Tax losses carried forward  4,890   5,758 
Other temporary differences  393   573 
Total deferred tax assets  6,400   7,033 
   2015   2014 
   £m   £m 
Deferred tax liabilities:        
Pensions and other post-retirement benefits  (72)  (87)
Long-term assurance business  (641)  (944)
Available-for-sale asset revaluation  (11)  (13)
Tax on fair value of acquired assets  (891)  (1,072)
Effective interest rates  –   (10)
Derivatives  (395)  (421)
Other temporary differences  (413)  (395)
Total deferred tax liabilities  (2,423)  (2,942)

The Finance (No. 2) Act 2015 (the Act) was substantively enactedat the value expected to be recoverable or payable in future periods, and re-measures them at each reporting date based on 26 October 2015.the most recent estimates of utilisation or settlement, including the impact of bank surcharge where appropriate. The Act reduced the main rate of corporation tax to 19 per cent from 1 April 2017 and 18 per cent from 1 April 2020.

In addition, the Government announced that from 1 January 2016 banking profits will be subject to an additional surcharge of 8 per cent.

The change in the main rate of corporation tax from 20 per cent to 18 per cent, and the additional surcharge of 8 per cent, have resulted in a movement in the Group’s net deferred tax asset at 31 December 2015impact of £123this re-measurement in 2018 is a credit of £32 million comprising the £27 million charge included in the income statement and a £96charge of £19 million charge included in equity.other comprehensive income.

 

DEFERRED TAX ASSETS

Deferred tax assets are recognised forOn 29 October 2018, the UK government announced its intention to restrict the use of capital tax losses carried forward to 50 per cent of any future gains arising. Had this restriction been substantively enacted at 31 December 2018, the extent that the realisation of the related tax benefit through future taxable profits is probable. Group companieseffect would have recognisedbeen to reduce net deferred tax assets of £4,890 million (2014: £5,758 million) in relation to trading tax losses carried forward. After reviews of medium-term profit forecasts, the Group considers that there will be sufficient profits in the future against which these losses will be offset (see note 3).

Deferred tax assets of £140 million (2014: £190 million) have not been recognised in respect of capital losses carried forward as there are no predicted future capital profits. Capital losses can be carried forward indefinitely.

Deferred tax assets of £893 million (2014: £614 million) have not been recognised in respect of trading losses carried forward, mainly in certain overseas companies and in respect of other temporary differences in the insurance businesses. Trading losses can be carried forward indefinitely, except for losses in the USA which expire after 20 years.

In addition, deferred tax assets have not been recognised in respect of unrelieved foreign tax carried forward at 31 December 2015 of £76 million (2014: £117 million), as there are no predicted future taxable profits against which the unrelieved foreign tax credits can be utilised. These tax credits can be carried forward indefinitely.by £41 million.

F-57

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 39:36: DEFERRED TAX continued

Movements in deferred tax liabilities and assets (before taking into consideration the offsetting of balances within the same taxing jurisdiction) can be summarised as follows:

Deferred tax assets Tax losses
£m		  Property,
plant and
equipment
£m		  Pension
liabilities
£m		  Provisions
£m		  Share-based
payments
£m		  Other
temporary
differences
£m		  Total
£m		 
At 1 January 2017  4,298   969   228   40   61   38   5,634 
(Charge) credit to the income statement  (264)  (226)  (287)  (7)  7   (28)  (805)
(Charge) credit to other comprehensive income  –   –   149   25   –   –   174 
Other (charge) credit to equity  –   –   –   –   (17)  –   (17)
Impact of acquisitions and disposals  –   –   –   –   –   3   3 
At 31 December 2017  4,034   743   90   58   51   13   4,989 
Adjustment on adoption of IFRS 9 and IFRS 15 (note 54)  –   –   –   322   –   3   325 
At 1 January 2018  4,034   743   90   380   51   16   5,314 
(Charge) credit to the income statement  (256)  (100)  64   (45)  (6)  (5)  (348)
(Charge) credit to other comprehensive income  –   –   (92)  (138)  –   –   (230)
Other (charge) credit to equity  –   –   –   –   (5)  –   (5)
At 31 December 2018  3,778   643   62   197   40   11   4,731 
                             
Deferred tax liabilities Long-term
assurance
business
£m		  Acquisition
fair value
£m		  Pension
assets
£m		  Derivatives
£m		  Asset
revaluations1
£m		  Other
temporary
differences
£m		  Total
£m		 
At 1 January 2017  (914)  (798)  (85)  (643)  (234)  (254)  (2,928)
(Charge) credit to the income statement  115   76   199   (139)  (40)  116   327 
(Charge) credit to other comprehensive income  –   –   (295)  283   67   –   55 
Impact of acquisitions and disposals  –   (157)  –   –   –   (2)  (159)
At 31 December 2017  (799)  (879)  (181)  (499)  (207)  (140)  (2,705)
(Charge) credit to the income statement  162   142   (67)  (19)  (33)  7   192 
(Charge) credit to other comprehensive income  –   –   (25)  113   141   –   229 
Exchange and other adjustments  –   –   –   –   –   6   6 
At 31 December 2018  (637)  (737)  (273)  (405)  (99)  (127)  (2,278)

1 Financial assets at fair value through other comprehensive income (2017: available-for-sale financial assets).

Deferred tax not recognised

No deferred tax has been recognised in respect of the future tax benefit of certain expenses of the life assurance business carried forward. The deferred tax asset not recognised in respect of these expenses is approximately £371 million (2017: £470 million), and these expenses can be carried forward indefinitely. The unrecognised deferred tax asset has reduced in 2018, as the Group’s utilisation estimate has improved over the year.

Deferred tax assets of approximately £78 million (2017: £76 million) have not been recognised in respect of £438 million of UK tax losses and other temporary differences which can only be used to offset future capital gains. UK capital losses can be carried forward indefinitely.

In addition, no deferred tax asset is recognised in respect of unrelieved foreign tax credits of £46 million (2017: £46 million), as there are no expected future taxable profits against which the credits can be utilised. These credits can be carried forward indefinitely.

No deferred tax has been recognised in respect of foreign trade losses where it is not more likely than not that we will be able to utilise them in future periods. Of the asset not recognised, £36 million (2017: £35 million) relates to losses that will expire if not used within 20 years, and £53 million (2017: £56 million) relates to losses with no expiry date.

As a result of parent company exemptions on dividends from subsidiaries and on capital gains on disposal there are no significant taxable temporary differences associated with investments in subsidiaries, branches, associates and joint arrangements.

F-58

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 37: OTHER PROVISIONS

 

   Payment Other Vacant      Provisions for
financial
commitments
and guarantees
£m		 Payment
protection
insurance
£m		 Other
regulatory
provisions
£m		 Vacant
leasehold
property
£m		 Other
£m		 Total
£m		 
 Provisions for protection regulatory leasehold     
 commitments insurance provisions property Other Total 
 £m £m £m £m £m £m 
At 1 January 2015  101   2,549   829   70   651   4,200 
At 31 December 2017  30   2,778   1,292   56   1,390   5,546 
Adjustment on adoption of IFRS 9 (note 54)  243                   243 
Balance at 1 January 2018  273                   5,789 
Exchange and other adjustments  26   –   –   (2)  34   58   (7)  100   1   –   41   135 
Provisions applied  (22)  (3,091)  (661)  (34)  (349)  (4,157)  –   (2,104)  (1,032)  (44)  (619)  (3,799)
Charge for the year  (55)  4,000   837   3   801   5,586   (73)  750   600   50   95   1,422 
At 31 December 2015  50   3,458   1,005   37   1,137   5,687 
At 31 December 2018  193   1,524   861   62   907   3,547 

 

PROVISIONS FOR COMMITMENTSProvisions for financial commitments and guarantees

 

Provisions are held in cases where the Group is irrevocably committed to advance additional funds, but where there is doubt as to the customer’s ability to meet its repayment obligations. See also note 20.

 

PAYMENT PROTECTION INSURANCEPayment protection insurance (excluding MBNA)

 

The Group increased the provision for PPI costs by a further £4,000£750 million in 2015,the year ended 31 December 2018, bringing the total amount provided to £16,025£19,425 million. This included

The charge in 2018 related to a number of factors including higher expected complaint volumes, which increased to 13,000 per week, and associated administration costs, an increase in average redress per complaint, additional £2,600 millionoperational costs to deal with potential complaint volatility and continued improvements in data interrogation and the second halfGroup’s ability to identify valid complaints. The remaining provision is consistent with an average of 2015, largelyapproximately 13,000 complaints per week to reflect the impact of our interpretationindustry deadline of the proposals contained within the Financial Conduct Authority’s (FCA) consultation paper regarding a potential time bar and the Plevin case. As atend of August 2019.

At 31 December 2015, £3,4582018, a provision of £1,329 million or 22 per cent of the total provision, remained unutilised with £2,950 million relating to reactive complaints and associated administration costs.

The volume of reactive PPI complaints has continued to fall, with an 8 per cent reduction in 2015 compared with 2014, to approximately 8,000 complaints per week. Whilst direct customer complaint levels fell 30 per cent year-on-year, those from Claims Management Companies (CMCs) have remained broadly stable and as a result, CMCs now account for over 70 per cent of complaints.

On 26 November 2015, the FCA published a consultation paper (CP15/39: Rules and guidance on payment protection insurance complaints) proposing (i) the introduction of a deadline by which consumers would need to make their PPI complaints including an FCA led communications campaign, and (ii) rules and guidance about how firms should handle PPI complaints in light of the Supreme Court’s decision in Plevin v Paragon Personal Finance Limited [2014] UKSC 61 (Plevin).

Based on recent trends, and in light of the proposals from the FCA, the Group now expects a higher level of complaints than previously assumed including those related to Plevin. As a result the Group has increased the total expected reactive complaint volumes to 4.7 Total cash payments were £1,859 million with approximately 1.3 million still expected to be received. This is equivalent to approximately 10,000 net complaints per week on average through to the proposed time bar of mid 2018.

Monthly complaints trends could vary significantly throughout this period, given they are likely to be impacted by a number of factors including the potential impact of the FCA’s proposed communication campaign as well as changes in the regulation of CMCs.

The provision includes an estimate to cover redress that would be payable under the FCA’s proposed new rules and guidance in light of Plevin.

  Average monthly       
  reactive complaint  Quarter on quarter  Year on year 
Quarter  volume   %   % 
Q1 2013  61,259   (28%)    
Q2 2013  54,086   (12%)    
Q3 2013  49,555   (8%)    
Q4 2013  37,457   (24%)    
Q1 2014  42,259   13%  (31%)
Q2 2014  39,426   (7%)  (27%)
Q3 2014  40,624   3%  (18%)
Q4 2014  35,910   (12%)  (4%)
Q1 2015  37,791   5%  (11%)
Q2 2015  36,957   (2%)  (6%)
Q3 2015  37,586   2%  (7%)
Q4 2015  33,998   (10%)  (5%)

The Group continues to progress the re-review of previously handled cases and expects this to be substantially complete by the end of the first quarter of 2016. Duringduring the year the scope has been extended by 0.5 million to 1.7 million cases relating largely to previously redressed cases, in addition to which, higher overturn rates and average redress have been experienced. At the end of January 2016, 77 per cent of cases had been reviewed and 77 per cent of all cash payments made.

The Group has completed its Past Business Review (PBR) where it has been identified that there was a risk of potential mis-sale for certain customers, albeit active monitoring continues. No further change has been made to the amount provided.

The Group expects to maintain the PPI operation on its current scale for longer than previously anticipated given the update to volume related assumptions and the re-review of previously handled cases continuing into the first quarter of 2016. The estimate for administrative expenses, which comprise complaint handling costs and costs arising from cases subsequently referred to the FOS, is included in the provision increase outlined above.

F-58

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 39: OTHER PROVISIONS continuedended 31 December 2018.

 

SENSITIVITIES

 

The Group estimates that it has sold approximately 16 million PPI policies since 2000. These include policies that were not mis-sold.mis-sold and those that have been successfully claimed upon. Since the commencement of the PPI redress programme in 2011 the Group estimates that it has contacted, settled or provided for almost 49approximately 53 per cent of the policies sold since 2000, covering both customer-initiated complaints and actual and PBR mailings undertaken by the Group.2000.

 

The total amount provided for PPI represents the Group’s best estimate of the likely future cost. However a number of risks and uncertainties remain in particularincluding with respect to future complaint volumes. The cost could differ materially from the Group’s estimates and the assumptions underpinning them, and could result in a further provision being required. There is significantalso uncertainty around the impact of the proposed FCAregulatory changes, Financial Conduct Authority media campaign and CMCClaims Management Company and customer activity, in the lead up to the proposed time bar.

Key metrics and sensitivities are highlighted in the table below:

           
Sensitivities1 To date unless noted  Future   Sensitivity 
Customer initiated complaints since origination (m)2  3.4   1.3 �� 0.1 = £200m 
Average uphold rate per policy3  76%  89%  1% = £35m 
Average redress per upheld policy4 £1,810  £1,400   £100 = £170m 
Administrative expenses (£m)  2,710   665   1 case = £450 

1All sensitivities exclude claims where no PPI policy was held.
2Sensitivity includes complaint handling costs. Future volume includes complaints falling into the Plevin rules and guidance. As a result, the sensitivity per 100,000 complaints includes cases where the average redress would be lower than historical trends.
3The percentage of complaints where the Group finds in favour of the customer excluding PBR. The 76 per cent uphold rate per policy is based on the six months to 31 December 2015. Future uphold rate and sensitivitities are influenced by a proportion of complaints falling under the Plevin rules and guidance which would otherwise be defended.
4The amount that is paid in redress in relation to a policy found to have been mis-sold, comprising, where applicable, the refund of premium, compound interest charged and interest at 8 per cent per annum. Actuals are based on the six months to 31 December 2015. Future average redress is influenced by expected compensation payments for complaints falling under the Plevin rules and guidance.

OTHER REGULATORY PROVISIONS

CUSTOMER CLAIMS IN RELATION TO INSURANCE BRANCH BUSINESS IN GERMANY

The Group has received a number of claims from customers relating to policies issued by Clerical Medical Investment Group Limited (recently renamed Scottish Widows Limited) but sold by independent intermediaries in Germany, principally during the late 1990s and early 2000s. Following decisions in July 2012potential additional remediation arising from the Federal Court of Justice (FCJ) in Germany the Group recognised provisions totalling £520 million during the period to 31 December 2014. Recent experience has been slightly adverse to expectations and the Group has noted decisions of the FCJ in 2014 and 2015 involving German insurers in relation to a German industry-wide issue regarding notification of contractual ‘cooling off’ periods. Accordingly, a provision increase of £25 million has been recognised giving a total provision of £545 million. The remaining unutilised provision as at 31 December 2015 is £124 million (31 December 2014: £199 million).

The validity of the claims facing the Group depends upon the facts and circumstances in respect of each claim. As a result the ultimate financial effect, which could be significantly different from the current provision, will only be known once all relevant claims have been resolved.

INTEREST RATE HEDGING PRODUCTS

In June 2012, a number of banks, including the Group, reached agreement with the FSA (now FCA) to carry out a review of sales made since 1 December 2001 of interest rate hedging products (IRHP) to certain small and medium-sized businesses. As at 31 December 2015 the Group had identified 1,735 sales of IRHPs to customers within scope of the agreement with the FCA which have opted in and are being reviewed and, where appropriate, redressed. The Group agreed that it would provide redress to any in-scope customers where appropriate. The Group continues to review the remaining cases within the scope of the agreement with the FCA and has met all of the regulator’s requirements to date.

During 2015, the Group has charged a further £40 million in respect of redress and related administration costs, increasing the total amount provided for redress and related administration costs for in-scope customers to £720 million (31 December 2014: £680 million). As at 31 December 2015, the Group has utilised £652 million (31 December 2014: £571 million), with £68 million (31 December 2014: £109 million) of the provision remaining.

FCA REVIEW OF COMPLAINTS HANDLING

On 5 June 2015 the FCA announced a settlement with the Group totalling £117 million following its investigation into aspectscontinuous improvement of the Group’s PPI complaint handling process duringoperational practices.

For every additional 1,000 reactive complaints per week above 13,000 on average from January 2019 through to the period March 2012 to May 2013. The FCA did not find thatindustry deadline of the end of August 2019, the Group acted deliberately. The Group has reviewed all customer complaints fully defended during the Relevant Period. The remediation costswould expect an additional charge of reviewing these affected cases are not materially in excess of existing provisions.approximately £85 million.

 

Payment protection insurance (MBNA)

As announced in December 2016, the Group’s exposure is capped at £240 million, which is already provided for through an indemnity received from Bank of America. MBNA increased its PPI provision by £100 million in the year ended 31 December 2018 but the Group’s exposure continues to remain capped at £240 million under the arrangement with Bank of America, notwithstanding this increase by MBNA.

F-59

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 37 OTHER LEGAL ACTIONS AND REGULATORY MATTERSPROVISIONS continued

Other provisions for legal actions and regulatory matters

 

In the course of its business, the Group is engaged in discussions with the PRA, FCA and other UK and overseas regulators and other governmental authorities on a range of matters. The Group also receives complaints and claims from customers in connection with its past conduct and whereclaims brought by or on behalf of current and former employees, customers, investors and other third parties and is subject to legal proceedings and other legal actions. Where significant, provisions are held against the costs expected to be incurred as a result ofin relation to these matters and matters arising from related internal reviews. During the conclusions reached. During 2015,year ended 31 December 2018 the Group charged a further £600 million in respect of legal actions and other regulatory matters, and the unutilised balance at 31 December 2018 was £861 million (31 December 2017: £1,292 million). The most significant items are as follows.

ARREARS HANDLING RELATED ACTIVITIES

The Group has provided an additional £655£151 million (2014: £430 million), including £225in the year ended 31 December 2018 for the costs of identifying and rectifying certain arrears management fees and activities, taking the total provided to date to £793 million. The Group has put in place a number of actions to improve its handling of customers in these areas and has made good progress in reimbursing arrears fees to impacted customers.

PACKAGED BANK ACCOUNTS

The Group has provided a further £45 million (2014: £nil) in responsethe year ended 31 December 2018 (£245 million was provided in the year ended 31 December 2017) in respect of complaints relating to complaints concerningalleged mis-selling of packaged bank accounts, raising the total amount provided to £795 million. A number of risks and £282uncertainties remain particularly with respect to future volumes.

CUSTOMER CLAIMS IN RELATION TO INSURANCE BRANCH BUSINESS IN GERMANY

The Group continues to receive claims in Germany from customers relating to policies issued by Clerical Medical Investment Group Limited (subsequently renamed Scottish Widows Limited), with smaller numbers received from customers in Austria and Italy. The industry-wide issue regarding notification of contractual ‘cooling off’ periods continued to lead to an increasing number of claims in 2016 and 2017 levelling out in 2018. Up to 31 December 2017 the Group had provided a total of £639 million, (2014: £318 million)with no further amounts provided during the year ended 31 December 2018. The validity of the claims facing the Group depends upon the facts and circumstances in respect of other matters withineach claim. As a result the Retail division. In addition, the Group has charged a further £148 million (2014: £112 million) in respect of a number of other product rectifications primarily in Insurance and Commercial Banking.

At 31 December 2015, provisions for other legal actions and regulatory matters of £813 million (31 December 2014: £521 million) remained unutilised, principally in relation to the sale of bancassurance products and packaged bank accounts and other Retail provisions. The ultimate financial effect, which could be significantly different from the current provision, of these matters will only be known only once theyall relevant claims have been resolved, the timing of which is uncertain.

F-59

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSresolved.

 

NOTE 39: OTHER PROVISIONS continuedHBOS READING – CUSTOMER REVIEW

 

VACANT LEASEHOLD PROPERTYThe Group has now completed its compensation assessment for all 71 business customers within the customer review, with more than 96 per cent of these offers accepted. In total, more than £96 million has been offered of which £78 million has so far been accepted, in addition to £9 million for ex-gratia payments and £5 million for the re-imbursements of legal fees.

The review follows the conclusion of a criminal trial in which a number of individuals, including two former HBOS employees, were convicted of conspiracy to corrupt, fraudulent trading and associated money laundering offences which occurred prior to the acquisition of HBOS by the Group in 2009. The Group has provided a further £15 million in the year ended 31 December 2018 for customer settlements, raising the total amount provided to £115 million and is now nearing the end of the process of paying compensation to the victims of the fraud including ex-gratia payments and re-imbursements of legal fees.

Vacant leasehold property

 

Vacant leasehold property provisions are made by reference to a prudent estimate of expected sub-let income, compared to the head rent, and the possibility of disposing of the Group’s interest in the lease, taking into account conditions in the property market. These provisions are reassessed on a biannual basis and will normally run off over the period of under-recovery of the leases concerned, currently averaging fourthree years; where a property is disposed of earlier than anticipated, any remaining balance in the provision relating to that property is released.

 

OTHEROther

 

Following the sale of TSB Banking Group plc, (TSB, see note 55) the Group raised a provision of £665 million in relation to the Transitional Service Agreement entered into between Lloyds Bank plc and TSB and the contribution to be provided to TSB in moving to alternative IT provision.various ongoing commitments; £168 million of this provision remained unutilised at 31 December 2018.

 

Provisions are made for staff and other costs related to Group restructuring initiatives at the point at which the Group becomes irrevocably committed to the expenditure. At 31 December 2018 provisions of £191 million (31 December 2017: £104 million) were held.

 

OtherThe Group carries provisions also include those arising out of the insolvency of a third party insurer, which remains exposed£122 million (2017: £136 million) for indemnities and other matters relating to asbestos and pollution claimslegacy business disposals in the US. The ultimate cost and timing of payments are uncertain. The provision held of £30 million at 31 December 2015 represents management’s current best estimate of the cost after having regard to actuarial estimates of future losses.prior year.

F-60

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 40:38: SUBORDINATED LIABILITIES

 

The movement in subordinated liabilities during the year was as follows:

 

  Preference
shares
£m		  Preferred
securities
£m		  Undated
subordinated
liabilities
£m		  Dated
subordinated
liabilities
£m		  Total
£m		 
At 1 January 2017  864   4,134   599   14,234   19,831 
Repurchases and redemptions during the year1  –   (237)  –   (771)  (1,008)
Foreign exchange movements  (43)  (221)  (34)  (487)  (785)
Other movements (all non-cash)  (8)  14   –   (122)  (116)
At 31 December 2017  813   3,690   565   12,854   17,922 
Issued during the year1  –   –   –   1,729   1,729 
Repurchases and redemptions during the year1  –   (614)  –   (1,642)  (2,256)
Foreign exchange movements  18   131   20   377   546 
Other movements (all non-cash)  (28)  (2)  3   (258)  (285)
At 31 December 2018  803   3,205   588   13,060   17,656 

        Undated     Dated    
  Preference  Preferred  subordinated  Enhanced capital  subordinated    
  shares  securities  liabilities  notes  liabilities  Total 
  £m  £m  £m  £m  £m  £m 
At 1 January 2015 1,091  3,819  1,852  3,683  15,597  26,042 
Issued during the year:                  
5.3% Subordinated Fixed Rate Notes 2045 (US$824 million) –  –  –  –  543  543 
4.582% Subordinated Fixed Rate Notes 2025 (US$1,353 million) –  –  –  –  893  893 
  –  –  –  –  1,436  1,436 
Repurchases and redemptions during the year:                  
6.625% Subordinated Notes 2015 –  –  –  –  (350) (350)
4.875% Subordinated Notes 2015 –  –  –  –  (723) (723)
7.834% Sterling Step-up Non-Voting Non-Cumulative Preferred Securities callable 2015 –  (5) –  –  –  (5)
8.117% Non-cumulative Perpetual Preferred Securities (Class A) –  (250) –  –  –  (250)
6.0884% Non-Cumulative Fixed to Floating Rate Preference Shares callable 2015 (10) –  –  –  –  (10)
6.625% Undated Subordinated Step-Up Notes callable 2010 –  –  (5) –  –  (5)
6.9625% Callable Subordinated Fixed to Floating Rate Notes 2020 callable 2015 –  –  –  –  (737) (737)
5.125% Step-up Perpetual Subordinated Notes callable 2015 (Scottish Widows plc) –  –  (560) –  –  (560)
5.92% Non-cumulative Fixed to Floating Rate Preference shares callable 2015 (140) –  –  –  –  (140)
Floating Rate Undated Subordinated Step-up Notes –  –  (29) –  –  (29)
6.05% Fixed to Floating Rate Undated Subordinated Notes –  –  (18) –  –  (18)
5.125% Undated Subordinated Fixed to Floating Rate Notes –  –  (50) –  –  (50)
5.109% Callable Fixed to Floating Rate Notes 2017 –  –  –  –  (14) (14)
6.305% Subordinated Callable Fixed to Floating Notes 2017 –  –  –  –  (35) (35)
6.50% Subordinated Fixed Rate Notes 2020 –  –  –  –  (764) (764)
6% Subordinated Notes 2033 –  –  –  –  (191) (191)
4.25% Perpetual Fixed to Floating Rate Reset Subordinated Guaranteed Notes –  –  (276) –  –  (276)
  (150) (255) (938) –  (2,814) (4,157)
Foreign exchange and other movements 39  184  51  (73) (210) (9)
At 31 December 2015 980  3,748  965  3,610  14,009  23,312 
1 The repurchases and redemptions resulted in cash outflows of £2,256 million (2017: £1,008 million).

Issued during 2018
Dated subordinated liabilities£m
1.75% Subordinated Fixed Rate Notes 2028 callable 2023664
4.344% Subordinated Fixed Rate Notes callable 20481,065
1,729
Repurchases and redemptions during 2018
Preferred securities£m
6.461% Guaranteed Non-voting Non-cumulative Perpetual Preferred Securities600
Undated Perpetual Preferred Securities14
614
Dated subordinated liabilities£m
10.5% Subordinated Bonds callable 2018150
6.75% Subordinated Fixed Rate Notes callable 20181,492
1,642
Repurchases and redemptions during 2017
Preferred securities£m
7.627% Fixed to Floating Rate Guaranteed Non-voting Non-cumulative163
Preferred Securities
4.385% Step-up Perpetual Capital Securities callable 2017 (€750 million)74
237
Dated subordinated liabilities£m
Subordinated Callable Notes 2017771
771

There were no repurchases of preference shares or undated subordinated liabilities during 2017 or 2018.

 

These securities will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer, other than creditors whose claims rank equally with, or are junior to, the claims of the holders of the subordinated liabilities. The subordination of specific subordinated liabilities is determined in respect of the issuer and any guarantors of that liability. The claims of holders of preference shares and preferred

F-60

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 40: SUBORDINATED LIABILITIES continued

securities are generally junior to those of the holders of undated subordinated liabilities, which in turn are junior to the claims of holders of the dated subordinated liabilities. The subordination of the dated Enhanced Capital Notes (ECNs) ranks equally with that of the dated subordinated liabilities. The Group has not had any defaults of principal, interest or other breaches with respect to its subordinated liabilities during 2015 (2014:2018 (2017: none). No repayment or purchase by the issuer of the subordinated liabilities may be made prior to their stated maturity without the consent of the Prudential Regulation Authority.

F-61

        Undated     Dated    
  Preference  Preferred  subordinated  Enhanced capital  subordinated    
  shares  securities  liabilities  notes  liabilities  Total 
  £m  £m  £m  £m  £m  £m 
At 1 January 2014 876  4,301  1,916  8,938  16,281  32,312 
Issued during the year:                  
4.5% Fixed Rate Subordinated Debt Securities due 2024 (US$1,000 million) –  –  –  –  629  629 
Exchange offer in respect of Enhanced Capital Notes –  –  –  (4,961) –  (4,961)
Other repurchases and redemptions during the year:                  
Retail tender offer in respect of Enhanced Capital Notes –  –  –  (58) –  (58)
6.35% Step-up Perpetual Capital Securities callable 2013 –  (215) –  –  –  (215)
6.071% Non-cumulative Perpetual Preferred Securities –  (439) –  –  –  (439)
4.875% Undated Subordinated Fixed to Floating Rate Instruments –  –  (78) –  –  (78)
Floating Rate Undated Subordinated Notes –  –  (50) –  –  (50)
11% Subordinated Bonds 2014 –  –  –  –  (250) (250)
5.875% Subordinated Notes 2014 –  –  –  –  (150) (150)
6.90% Perpetual Capital Securities –  (207) –  –  –  (207)
5.875% Subordinated Guaranteed Bonds 2014 –  –  –  –  (596) (596)
Subordinated Step-up Floating Rate Notes 2016 –  –  –  –  (165) (165)
Subordinated Step-up Floating Rate Notes 2016 –  –  –  –  (179) (179)
6.75% Subordinated Callable Fixed to Floating Rate Instruments 2017 –  –  –  –  (9) (9)
Subordinated Callable Floating Rate Instruments 2017 –  –  –  –  (36) (36)
4.375% Callable Fixed to Floating Rate Subordinated Notes 2019 –  –  –  –  (591) (591)
  –  (861) (128) (58) (1,976) (3,023)
Foreign exchange and other movements 215  379  64  (236) 663  1,085 
At 31 December 2014 1,091  3,819  1,852  3,683  15,597  26,042 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 41:39: SHARE CAPITAL

 

(1) AUTHORISED SHARE CAPITALAuthorised share capital

 

As permitted by the Companies Act 2006, the Company removed references to authorised share capital from its articles of association at the annual general meeting on 5 June 2009. This change took effect from 1 October 2009.

 

(2) ISSUED AND FULLY PAID SHARE CAPITALIssued and fully paid share capital

 

  2015 2014 2013 2015 2014 2013 
  Number of shares Number of shares Number of shares £m £m £m 
Ordinary shares of 10p (formerly 25p) each             
At 1 January 71,373,735,357 71,368,435,941 70,342,844,289 7,138 7,137 7,034 
Issued in relation to the payment of coupons on certain hybrid capital securities – – 712,973,022 – – 71 
Issued under employee share schemes – 5,299,416 312,618,630 – 1 32 
At 31 December 71,373,735,357 71,373,735,357 71,368,435,941 7,138 7,138 7,137 
Limited voting ordinary shares of 10p (formerly 25p) each             
At 1 January and 31 December 80,921,051 80,921,051 80,921,051 8 8 8 
Total issued share capital       7,146 7,146 7,145 
F-61

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 41: SHARE CAPITAL continued

  2018
Number of shares		  2017
Number of shares		  2016
Number of shares		  2018
£m		  2017
£m		  2016
£m		 
Ordinary shares of 10p (formerly 25p) each                        
At 1 January  71,972,949,589   71,373,735,357   71,373,735,357   7,197   7,138   7,138 
Issued under employee share schemes  768,551,098   518,293,181   –   77   51   – 
Share buy-back programme (note 41)  (1,577,908,423)  –   –   (158)  –   – 
Redesignation of limited voting ordinary shares (see below)  –   80,921,051   –   –   8   – 
At 31 December  71,163,592,264   71,972,949,589   71,373,735,357   7,116   7,197   7,138 
Limited voting ordinary shares of 10p (formerly 25p) each                        
At 1 January  –   80,921,051   80,921,051   –   8   8 
Redesignation to ordinary shares (see below)  –   (80,921,051)  –   –   (8)  – 
At 31 December  –   –   80,921,051   –   –   8 
Total issued share capital              7,116   7,197   7,146 

 

SHARE ISSUANCES

 

NoIn 2018, 769 million shares (2017: 518 million shares) were issued in 2015 in respect of employee share schemes (2014: 5 million shares; 2013: 312 million shares). In 2013 the Groupschemes; no shares were issued 713 million new ordinary shares in relation to payment of coupons in the year on certain hybrid capital securities that are non-cumulative.2016.

 

(3) SHARE CAPITAL AND CONTROLShare capital and control

 

There are no restrictions on the transfer of shares in the Company other than as set out in the articles of association and:

 

– certain restrictions which may from time to time be imposed by law and regulations (for example, insider trading laws);
  
–pursuant to the UK Listing Authority’s listing rules where directors and certain employees of the Company require the approval of the Company to deal in the Company’s shares; and
  
–pursuant to the rules of some of the Company’s employee share plans where certain restrictions may apply while the shares are subject to the plans. Where, under an employee share plan operated by the Company, participants are the beneficial owners of shares but not the registered owners, the voting rights are normally exercised by the registered owner at the direction of the participant. Outstanding awards and options would normally vest and become exercisable on a change of control, subject to the satisfaction of any performance conditions at that time.

Where, under an employee share plan operated by the Company, participants are the beneficial owners of shares but not the registered owners, the voting rights are normally exercised by the registered owner at the direction of the participant. Outstanding awards and options would normally vest and become exercisable on a change of control, subject to the satisfaction of any performance conditions at that time.

 

In addition, the Company is not aware of any agreements between shareholders that may result in restrictions on the transfer of securities and/or voting rights.

 

Information regarding significant direct or indirect holdings of shares in the Company can be found on page 183.157.

 

The directors have authority to allot and issue ordinary and preference shares and to make market purchases of ordinary and preference shares as granted at the annual general meeting on 1424 May 2015.2018. The authority to issue shares and the authority to make market purchases of shares will expire at the next annual general meeting. Shareholders will be asked, at the annual general meeting, to give similar authorities.

 

Subject to any rights or restrictions attached to any shares, on a show of hands at a general meeting of the Company every holder of shares present in person or by proxy and entitled to vote has one vote and on a poll every member present and entitled to vote has one vote for every share held.

 

Further details regarding voting at the annual general meeting can be found in the notes to the notice of the annual general meeting.

 

ORDINARY SHARES

 

The holders of ordinary shares, (excluding the limited voting ordinary shares), who held 99.9100 per cent of the total ordinary share capital at 31 December 2015,2018, are entitled to receive the Company’s report and accounts, attend, speak and vote at general meetings and appoint proxies to exercise voting rights. Holders of ordinary shares (excluding the limited voting ordinary shares) may also receive a dividend (subject to the provisions of the Company’s articles of association) and on a winding up may share in the assets of the Company.

 

LIMITED VOTING ORDINARY SHARES

 

TheAt the annual general meeting on 11 May 2017, the Company’s shareholders approved the redesignation of the 80,921,051 limited voting ordinary shares are held by the Lloyds Bank Foundations (the Foundations). The holders of the limited votingas ordinary shares who held 0.1 per cent of 10 pence each. The redesignation took effect on 1 July 2017 and the total ordinary share capital at 31 December 2015, are entitled to receive copies of every circular or other document sent out by the Company to the holders of other ordinary shares. Theseredesignated shares carry no rights to dividends but rank pari passu with the ordinary shares in respect of other distributions and in the event of winding up. These shares do not have any right to vote at general meetings other than on resolutions concerning acquisitions or disposals of such importance that they require shareholder consent, or for the winding up of the Company, or for a variation in the class rights of the limited voting ordinary shares. In the event of an offer for more than 50 per cent of the issued ordinary share capital of the Company, each limited voting ordinary share will convert into an ordinary share and shallnow rank equally with the existing issued ordinary shares in all respects fromof the date of conversion.Company.

 

The Company has entered into deeds of covenant with the Foundations under the terms of which the Company makes annual donations. The deeds of covenant can be cancelled byin effect as at 31 December 2018 provide that such annual donations will cease in certain circumstances, including the Company atproviding nine years’ notice, at which point the limited voting ordinary share capital would convert into ordinary shares.notice. Such notice has been given to the Lloyds BankTSB Foundation for Scotland.

 

PREFERENCE SHARES

 

The Company has in issue various classes of preference shares which are all classified as liabilities under IFRSaccounting standards and details of which are shownincluded in note 40.38.

NOTE 42: SHARE PREMIUM ACCOUNT

  2015 2014 2013 
  £m £m £m 
At 1 January 17,281 17,279 16,872 
Issued in relation to the settlement of coupons on certain hybrid capital securities – – 279 
Issued under employee share schemes – 2 128 
Redemption of preference shares1 131 – – 
At 31 December 17,412 17,281 17,279 

1  During the year ended 31 December 2015, the Company redeemed all of its outstanding 6.0884% Non-cumulative Fixed to Floating Rate Preference Shares and 5.92% Non-cumulative Fixed to Floating Rate Preference Shares at their combined sterling equivalent par value of £131 million. These preference shares had been accounted for as subordinated liabilities. On redemption an amount of £131 million was transferred from the distributable merger reserve to the share premium account.
F-62

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 43:40: SHARE PREMIUM ACCOUNT

  2018
£m		  2017
£m		  2016
£m		 
At 1 January  17,634   17,622   17,412 
Issued under employee share schemes  85   12   – 
Redemption of preference shares1  –   –   210 
At 31 December  17,719   17,634   17,622 

1 During the year ended 31 December 2016, the Company redeemed all of its outstanding 6.267% Non-cumulative Fixed to Floating Rate Callable US Dollar Preference Shares at their combined sterling equivalent par value of £210 million. These preference shares had been accounted for as subordinated liabilities. On redemption an amount of £210 million was transferred from the distributable merger reserve to the share premium account.

NOTE 41: OTHER RESERVES

 

 2015  2014 2013 
 £m  £m £m  2018
£m		  2017
£m		 2016
£m		 
Other reserves comprise:                        
Merger reserve  7,976   8,107   8,107   7,766   7,766   7,766 
Capital redemption reserve1  4,115   4,115   4,115 
Capital redemption reserve  4,273   4,115   4,115 
Revaluation reserve in respect of debt securities held at fair value through other comprehensive income  279         
Revaluation reserve in respect of equity shares held at fair value through other comprehensive income  5         
Revaluation reserve in respect of available-for-sale financial assets  (438)  (67)  (615)      685   759 
Cash flow hedging reserve  727   1,139   (1,055)  1,051   1,405   2,136 
Foreign currency translation reserve  (120)  (78)  (75)  (164)  (156)  (124)
At 31 December  12,260   13,216   10,477   13,210   13,815   14,652 

 

1There were no movements in this reserve during 2015, 2014 or 2013.


The merger reserve primarily comprises the premium on shares issued on 13in January 2009 underas part of the placingrecapitalisation of the Group and open offer and shares issued on 16 January 2009 on the acquisition of HBOS plc.

 

The capital redemption reserve represents transfers from the mergerdistributable reserve in accordance with companies’ legislation upon the redemption of ordinary and amounts transferred frompreference share capital following the cancellation of the deferred shares.capital.

 

The revaluation reservereserves in respect of available-for-sale financial assets representsdebt securities and equity shares held at fair value through other comprehensive income represent the cumulative after tax unrealised change in the fair value of financial assets so classified as available-for-sale since initial recognition; or in the case of available-for-sale financial assets obtained on acquisitions of businesses, since the date of acquisition; and in the case of transferred assets that were previously held at amortised cost, by reference to that amortised cost.acquisition.

 

The cash flow hedging reserve represents the cumulative after tax gains and losses on effective cash flow hedging instruments that will be reclassified to the income statement in the periods in which the hedged item affects profit or loss.

 

The foreign currency translation reserve represents the cumulative after-tax gains and losses on the translation of foreign operations and exchange differences arising on financial instruments designated as hedges of the Group’s net investment in foreign operations.

 

  2015  2014  2013 
  £m  £m  £m 
Merger reserve            
At 1 January  8,107   8,107   8,107 
Redemption of preference shares1  (131)  —   — 
At 31 December  7,976   8,107   8,107 

1During the year ended 31 December 2015, the Company redeemed all of its outstanding 6.0884% Non-cumulative Fixed to Floating Rate Preference Shares and 5.92% Non-cumulative Fixed to Floating Rate Preference Shares at their combined par value of £131 million. These preference shares had been accounted for as subordinated liabilities. On redemption an amount of £131 million was transferred from the distributable merger reserve to the share premium account.
  2018
£m		  2017
£m		  2016
£m		 
Merger reserve            
At 1 January  7,766   7,766   7,976 
Redemption of preference shares (note 40)  –   –   (210)
At 31 December  7,766   7,766   7,766 
             
  2018
£m		  2017
£m		  2016
£m		 
Capital redemption reserve            
At 1 January  4,115   4,115   4,115 
Shares cancelled under share buy-back programme (see below)  158   –   – 
At 31 December  4,273   4,115   4,115 

 

MovementsOn 8 March 2018 the Group announced the launch of a share buy-back programme to repurchase up to £1 billion of its outstanding ordinary shares; the programme ended on 24 August 2018. The Group entered into an agreement with UBS AG, London Branch (UBS) to conduct the share buy-back programme on its behalf and to make trading decisions under the programme independently of the Group. UBS purchased the Group’s ordinary shares as principal and sold them to the Group in other reserves were as follows:accordance with the terms of their engagement. The Group cancelled the shares that it purchased through the programme.

  2015  2014  2013 
  £m  £m  £m 
Revaluation reserve in respect of available-for-sale financial assets            
At 1 January  (67)  (615)  399 
Change in fair value of available-for-sale financial assets  (318)  690   (680)
Deferred tax  (18)  (65)  86 
Current tax  2   —   3 
   (334)  625   (591)
Income statement transfers:            
Disposals (note 9)  (51)  (131)  (629)
Deferred tax  3   52   191 
Current tax  (1)  —   — 
   (49)  (79)  (438)
Impairment  4   2   18 
Deferred tax  8   —   (3)
   12   2   15 
At 31 December  (438)  (67)  (615)

The Group bought back and cancelled 1,578 million shares under the programme, for a total consideration, including expenses, of £1,005 million. Upon cancellation, £158 million being the nominal value of the shares repurchased was transferred to the capital redemption reserve.

F-63

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 43:41: OTHER RESERVES continued

 

  2015  2014  2013 
  £m  £m  £m 
Cash flow hedging reserve            
At 1 January  1,139   (1,055)  350 
Change in fair value of hedging derivatives  537   3,896   (1,229)
Deferred tax  (186)  (765)  320 
   351   3,131   (909)
Income statement transfers (note 5)  (956)  (1,153)  (550)
Deferred tax  193   216   54 
   (763)  (937)  (496)
At 31 December  727   1,139   (1,055)
             
   2015   2014   2013 
   £m   £m    £m 
Foreign currency translation reserve            
At 1 January  (78)  (75)  (69)
Currency translation differences arising in the year  (59)  (25)  (155)
Foreign currency gains on net investment hedges (tax: £nil)  17   22   149 
At 31 December  (120)  (78)  (75)
             
NOTE 44: RETAINED PROFITS            
             
   2015   2014   2013 
   £m    £m    £m 
At 1 January  5,692   4,088   5,080 
Profit (loss) for the year  860   1,412   (838)
Dividends paid (note 46)  (1,070)  –   – 
Issue costs of other equity instruments (net of tax) (note 45)  –   (21)  – 
Distributions on other equity instruments (net of tax) (note 45)  (314)  (225)  – 
Post-retirement defined benefit scheme remeasurements  (215)  539   (108)
Movement in treasury shares  (816)  (286)  (480)
Value of employee services:            
Share option schemes  107   123   142 
Other employee award schemes  172   233   292 
Adjustment on sale of non-controlling interest in TSB (note 55)  –   (171)  – 
At 31 December  4,416   5,692   4,088 
2018
£m
Revaluation reserve in respect of debt securities held at fair value through other comprehensive income
At 31 December 2017
Adjustment on adoption of IFRS 9 (note  54)472
At 1 January 2018472
Change in fair value(37)
Deferred tax35
Current tax–
(2)
Income statement transfers:
Disposals (note 9)(275)
Deferred tax84
Current tax–
(191)
At 31 December 2018279
2018
£m
Revaluation reserve in respect of equity shares held at fair value through other comprehensive income
At 31 December 2017
Adjustment on adoption of IFRS 9 (note  54)(49)
At 1 January 2018(49)
Change in fair value(97)
Deferred tax22
Current tax–
(75)
Realised gains and losses transferred to retained profits151
Deferred tax(22)
Current tax–
129
At 31 December 20185
F-64

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 41: OTHER RESERVES continued

Movements in other reserves were as follows:

     2017
£m		  2016
£m		 
Revaluation reserve in respect of available-for-sale financial assets            
At 1 January      759   (438)
Adjustment on transfer from held-to-maturity portfolio      –   1,544 
Deferred tax      –   (417)
       –   1,127 
             
Change in fair value of available-for-sale financial assets      303   356 
Deferred tax      (26)  (25)
Current tax      (4)  (3)
       273   328 
Income statement transfers:            
Disposals (note 9)      (446)  (575)
Deferred tax      93   196 
Current tax      –   (52)
       (353)  (431)
             
Impairment      6   173 
Deferred tax      –   – 
       6   173 
At 31 December      685   759 
             
   2018
£m		   2017
£m		   2016
£m		 
Cash flow hedging reserve            
At 1 January  1,405   2,136   727 
Change in fair value of hedging derivatives  234   (363)  2,432 
Deferred tax  (69)  121   (610)
   165   (242)  1,822 
Income statement transfers (note 5)  (701)  (651)  (557)
Deferred tax  182   162   144 
   (519)  (489)  (413)
At 31 December  1,051   1,405   2,136 
             
   2018
£m		   2017
£m		   2016
£m		 
Foreign currency translation reserve            
At 1 January  (156)  (124)  (120)
Currency translation differences arising in the year  (8)  (21)  (110)
Foreign currency gains on net investment hedges (tax: £nil)  –   (11)  106 
At 31 December  (164)  (156)  (124)
F-65

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 42: RETAINED PROFITS

  2018
£m		  2017
£m		  2016
£m		 
At 31 December 2017  4,905         
Adjustment on adoption of IFRS 9 and IFRS 15 (note 54)  (929)        
At 1 January  3,976   3,250   4,416 
Profit for the year  4,302   3,807   2,063 
Dividends paid1  (2,240)  (2,284)  (2,014)
Issue costs of other equity instruments (net of tax) (note 43)  (5)  –   – 
Distributions on other equity instruments (net of tax)  (327)  (313)  (321)
Share buy-back programme (note 41)  (1,005)  –   – 
Realised gains and losses on equity shares held at fair value through other comprehensive income  (129)        
Post-retirement defined benefit scheme remeasurements  120   482   (1,028)
Share of other comprehensive income of associates and joint ventures  8   –   – 
Gains and losses attributable to own credit risk (net of tax)2  389   (40)  – 
Movement in treasury shares  40   (411)  (175)
Value of employee services:            
Share option schemes  53   82   141 
Other employee award schemes  207   332   168 
At 31 December  5,389   4,905   3,250 

1 In 2017 and 2016, net of a credit in respect of unclaimed dividends written-back in accordance with the Company’s Articles of Association.
2During 2017 the Group derecognised, on redemption, financial liabilities on which cumulative fair value movements relating to own credit of £3 million net of tax, had been recognised directly in retained profits (2018: £nil).

 

Retained profits are stated after deducting £740£499 million (2014: £565(2017: £611 million; 2013: £4802016: £495 million) representing 943909 million (2014: 648(2017: £861 million; 2013: 5782016: £730 million) treasury shares held.

 

The payment of dividends by subsidiaries and the ability of members of the Group to lend money to other members of the Group may be subject to regulatory or legal restrictions, the availability of reserves and the financial and operating performance of the entity. Details of such restrictions and the methods adopted by the Group to manage the capital of its subsidiaries are provided under Capital Risk on page 113.80.

 

NOTE 45:43: OTHER EQUITY INSTRUMENTS

 

  2015  2014  2013 
  £m  £m  £m 
At 1 January  5,355   –   – 
Additional Tier 1 securities issued in the year:            
Sterling notes (£3,725 million nominal)  –   3,725   – 
Euro notes (€750 million nominal)  –   622   – 
US dollar notes ($1,675 million nominal)  –   1,008   – 
At 31 December  5,355   5,355   – 
  2018
£m		  2017
£m		  2016
£m		 
At 1 January  5,355   5,355   5,355 
Issued in the year:            
US dollar notes ($1,500 million nominal)  1,136   –   – 
At 31 December  6,491   5,355   5,355 

During the year ended 31 December 2018 the Group issued £1,136 million (US$1,500 million) of Additional Tier 1 (AT1) securities; issue costs of £5 million, net of tax, have been charged to retained profits.

 

The AT1 securities are Fixed Rate Resetting Perpetual Subordinated Contingent Convertible Securities with no fixed maturity or redemption date.

F-64

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 45: OTHER EQUITY INSTRUMENTS continued

 

The principal terms of the AT1 securities are described below:

 

– The securities rank behind the claims against Lloyds Banking Group plc of (a) unsubordinated creditors, (b) claims which are, or are expressed to be, subordinated to the claims of unsubordinated creditors of Lloyds Banking Group plc but not further or otherwise or (c) whose claims are, or are expressed to be, junior to the claims of other creditors of Lloyds Banking Group, whether subordinated or unsubordinated, other than those whose claims rank, or are expressed to rank, pari passu with, or junior to, the claims of the holders of the AT1 Securities in a winding-up occurring prior to the Conversion Trigger.
  
–The securities bear a fixed rate of interest until the first call date. After the initial call date, in the event that they are not redeemed, the AT1 securities will bear interest at rates fixed periodically in advance for five year periods based on market rates.
  
–Interest on the securities will be due and payable only at the sole discretion of Lloyds Banking Group plc, and Lloyds Banking Group plc may at any time elect to cancel any Interest Payment (or any part thereof) which would otherwise be payable on any Interest Payment Date. There are also certain restrictions on the payment of interest as specified in the terms.
  
–The securities are undated and are repayable, at the option of Lloyds Banking Group plc, in whole at the first call date, or on any fifth anniversary after the first call date. In addition, the AT1 securities are repayable, at the option of Lloyds Banking Group plc, in whole for certain regulatory or tax reasons. Any repayments require the prior consent of the PRA.
  
–The securities convert into ordinary shares of Lloyds Banking Group plc, at a pre-determined price, should the fully loaded Common Equity Tier 1 ratio of the Group fall below 7.0 per cent.
F-66

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 46:44: DIVIDENDS ON ORDINARY SHARES

 

The directors have recommended a final dividend, which is subject to approval by the shareholders at the Annual General Meeting, of 1.52.14 pence per share (2014: 0.75(2017: 2.05 pence per share; 2013: nil2016: 1.7 pence per share) representing a total dividend of £1,070£1,523 million (2014: £535(2017: £1,475 million; 2013: £nil)2016: £1,212 million), which will be paid on 1721 May 2016. The2019. At 31 December 2016 the directors have also recommended a special dividend of 0.5 pence per share (2014: nil; 2013: nil) representing a total dividend of £357 million (2014: nil; 2013: nil). These£356 million. The financial statements do not reflect these recommended dividends.

 

Dividends paid during the year were as follows:

 

 2015  2014 2013         2018
pence
per share		  2017
pence
per share		 2016
pence
per share		 2018
£m		  2017
£m		 2016
£m		 
 pence  pence pence 2015  2014 2013 
 per share  per share per share £m  £m £m 
Recommended by directors at previous year end  0.75   –   –   535   –   – 
Recommended by directors at previous year end:                        
Final dividend  2.05   1.70   1.50   1,475   1,212   1,070 
Special dividend  –   0.50   0.50   –   356   357 
Interim dividend paid in the year  0.75   –   –   535   –   –   1.07   1.00   0.85   765   720   607 
  1.50   –   –   1,070   –   –   3.12   3.20   2.85   2,240   2,288   2,034 

The cash cost of the dividends paid in the year was £2,240 million (2017: £2,284 million; 2016: £2,014 million), in 2017 and 2016 this was net of a credit in respect of unclaimed dividends written-back in accordance with the Company’s Articles of Association.

In addition, the Group intends to implement a share buyback of up to £1.75 billion (2017: £1 billion) which will commence in March 2019 and is expected to be completed by 31 December 2019.

 

The trustees of the following holdings of Lloyds Banking Group plc shares in relation to employee share schemes retain the right to receive dividends but have chosen to waive their entitlement to the dividends on those shares as indicated: the Lloyds Banking Group Share Incentive Plan (holding at 31 December 2015: 24,275,8242018: 5,538,164 shares, 31 December 2014: 21,158,6512017: 12,414,401 shares, waived rights to all dividends), the HBOS Share Incentive Plan Trust (holding at 31 December 2015: 446,1692018: 445,625 shares, 31 December 2014: 433,2522017: 445,625 shares, waived rights to all dividends), the Lloyds Banking Group Employee Share Ownership Trust (holding at 31 December 2015: 164,141,1792018: 5,679,119 shares, 31 December 2014: 18,704,4122017: 13,346,132 shares, on which it waived rights to all dividends), and Lloyds Group Holdings (Jersey) Limited (holding at 31 December 2015:2018: 42,846 shares, 31 December 2014:2017: 42,846 shares, waived rights to all but a nominal amount of one penny in total) and the Lloyds Banking Group Qualifying Employee Share Ownership Trust (holding at 31 December 2015: 1,398 shares, 31 December 2014: 1,398 shares, waived rights to all but a nominal amount of one penny in total).

 

NOTE 47:45: SHARE-BASED PAYMENTS

 

CHARGE TO THE INCOME STATEMENTCharge to the income statement

 

The charge to the income statement is set out below:

 

 2015 2014 2013
 £m £m £m 2018
£m		 2017
£m		 2016
£m		 
Deferred bonus plan 255 213 276  325   313   266 
Executive and SAYE plans:                  
Options granted in the year 12 29 42  14   17   16 
Options granted in prior years 99 78 74  71   81   138 
 111 107 116  85   98   154 
Share plans:                  
Shares granted in the year 15 14 3  16   17   15 
Shares granted in prior years 6 6 4  17   9   7 
 21 20 7  33   26   22 
Total charge to the income statement 387 340 399  443   437   442 

 

During the year ended 31 December 20152018 the Group operated the following share-based payment schemes, all of which are equity settled.

Group Performance Share plan

The Group operates a Group Performance Share plan that is equity settled. Bonuses in respect of employee performance in 2018 have been recognised in the charge in line with the proportion of the deferral period completed.

F-65F-67

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 47:45: SHARE-BASED PAYMENTS continued

 

DEFERRED BONUS PLANS

The Group operates a number of deferred bonus plans that are equity settled. Bonuses in respect of employee performance in 2015 have been recognised in the charge in line with the proportion of the deferral period completed.

SAVE-AS-YOU-EARN SCHEMES Save-As-You-Earn schemes

 

Eligible employees may enter into contracts through the Save-As-You-Earn (SAYE) schemes to save up to £500 per month and, at the expiry of a fixed term of three or five years, have the option to use these savings within six months of the expiry of the fixed term to acquire shares in the Group at a discounted price of no less than 80 per cent of the market price at the start of the invitation.

 

Movements in the number of share options outstanding under the SAYE schemes are set out below:

 

 2015  2014 
   Weighted    Weighted 
   average    average 
 Number of exercise price  Number of exercise price  2018 2017
 options (pence)  options (pence)  Number of
options		 Weighted
average
exercise price
(pence		) Number of
options		 Weighted
average
exercise price
(pence		)
Outstanding at 1 January  783,626,383   48.73   500,969,617   41.16   860,867,088   51.34   678,692,896   51.76 
Granted  156,797,949   60.70   326,565,564   60.02   188,866,162   47.92   268,653,890   51.03 
Exercised  (32,683,177)  41.83   (7,287,899)  41.29   (135,721,404)  59.00   (13,119,229)  55.58 
Forfeited  (27,740,207)  48.69   (18,949,167)  41.68   (22,909,999)  49.85   (18,545,569)  51.70 
Cancelled  (24,943,674)  56.04   (15,561,144)  54.04   (78,073,042)  50.66   (41,211,075)  52.77 
Expired  (4,911,054)  48.34   (2,110,588)  48.15   (10,033,887)  55.20   (13,603,825)  56.98 
Outstanding at 31 December  850,146,220   50.99   783,626,383   48.73   802,994,918   49.30   860,867,088   51.34 
Exercisable at 31 December  533,654   180.66   1,852   180.66   68,378   60.02   –   – 

 

The weighted average share price at the time that the options were exercised during 20152018 was £0.77 (2014: £0.77)£0.67 (2017: £0.67). The weighted average remaining contractual life of options outstanding at the end of the year was 1.92.16 years (2014: 2.6(2017: 1.4 years).

 

The weighted average fair value of SAYE options granted during 20152018 was £0.17 (2014: £0.22)£0.13 (2017: £0.15). The fair values of the SAYE options have been determined using a standard Black-Scholes model.

 

For the HBOS sharesave plan, no options were exercised during 2015 or 2014. The options outstanding at 31 December 2015 had an exercise price of £1.8066 (2014: £1.8066) and a weighted average remaining contractual life of 0.4 years (2014: 1.4 years).

OTHER SHARE OPTION PLANSOther share option plans

 

LLOYDS BANKING GROUP EXECUTIVE SHARE PLAN 2003

 

The Plan was adopted in December 2003 and under the Plan share options may be granted to senior employees. Options under this plan have been granted specifically to facilitate recruitment and as such were not subject to any performance conditions. The Plan is used not only to(to compensate new recruits for any lost share awards butawards), and also to make grants to key individuals for retention purposes with, inpurposes. In some instances, the grant beinggrants may be made subject to individual performance conditions.

For options granted on 27 March 2014 under the Commercial Banking Transformation Plan (CBTP), the number of options that may be delivered in March 2017 may vary by a factor of 0-4 from the original ‘on-target’ award, depending on the degree to which the performance conditions have been met. An ‘on-target’ vesting is contingent upon Commercial Banking achieving £2.5 billion Underlying Profit and 2 per cent Return on Risk Weighted Assets (‘RoRWA’) on 31 December 2016. The Plan will pay out at between £1.9 billion and £3 billion underlying profit, and between 1.6 per cent and 2.5 per cent RoRWA.

 

Participants are not entitled to any dividends paid during the vesting period.

 

 2015  2014 
   Weighted    Weighted 
   average    average 
 Number of exercise price  Number of exercise price  2018 2017
 options (pence)  options (pence)  Number of
options		 Weighted
average
exercise price
(pence		) Number of
options		 Weighted
average
exercise price
(pence		)
Outstanding at 1 January  233,389,084   Nil   37,354,979   Nil   14,523,989   Nil   218,962,281   Nil 
Granted  9,813,363   Nil   225,424,109   Nil   3,914,599   Nil   5,466,405   Nil 
Exercised  (13,313,421)  Nil   (21,870,649)  Nil   (6,854,043)  Nil   (104,967,667)  Nil 
Vested  (148,109)  Nil   –   – 
Forfeited  (8,374,250)  Nil   (7,114,199)  Nil   (662,985)  Nil   (81,883)  Nil 
Lapsed  (117,179)  Nil   (405,156)  Nil   (510,423)  Nil   (104,855,147)  Nil 
Outstanding at 31 December  221,397,597   Nil   233,389,084   Nil   10,263,028   Nil   14,523,989   Nil 
Exercisable at 31 December  3,972,911   Nil   9,068,802   Nil   3,305,442   Nil   7,729,919   Nil 

 

The weighted average fair value of options granted in the year was £0.75 (2014: £0.72)£0.55 (2017: £0.62). The fair values of options granted have been determined using a standard Black-Scholes model. The weighted average share price at the time that the options were exercised during 20152018 was £0.83 (2014: £0.75)£0.65 (2017: £0.69). The weighted average remaining contractual life of options outstanding at the end of the year was 6.15.2 years (2014: 7.0(2017: 4.9 years).

F-66F-68

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 47:45: SHARE-BASED PAYMENTScontinued

 

OTHER SHARE PLANSOther share plans

 

LLOYDS BANKING GROUP LONG-TERM INCENTIVEEXECUTIVE SHARE OWNERSHIP PLAN

 

The Long-Term Incentive Plan (LTIP)plan, introduced in 2006, is aimed at delivering shareholder value by linking the receipt of shares to an improvement in the performance of the Group over a three year period. Awards are made within limits set by the rules of the Plan,plan, with the limits determining the maximum number of shares that can be awarded equating to three times annual salary. In exceptional circumstances this may increase to four times annual salary.

 

ParticipantsFor the 2016 and 2017 plan participants may be entitled to any dividends paid during the vesting period if the performance conditions are met. An amount equal in value to any dividends paid between the award date and the date the Remuneration Committee determine that the performance conditions were met may be paid, based on the number of shares that vest. The Remuneration Committee will determine if any dividends are to be paid in cash or in shares. Details of the performance conditions for the plan are provided in the Directors’ remuneration report.

 

At the end of the performance period for the 20122015 grant, the targets had not been fully met and therefore these awards vested in 20152018 at a rate of 96.666.3 per cent.

 

 2015  2014 
 Number of  Number of 
 shares  shares  2018
Number of
shares		  2017
Number of
shares		 
Outstanding at 1 January  522,836,111   548,885,895   370,804,915   358,228,028 
Granted  121,676,131   120,952,253   160,586,201   139,812,788 
Vested  (196,193,904)  (73,516,122)  (73,270,301)  (57,406,864)
Forfeited  (50,251,592)  (73,485,915)  (48,108,870)  (73,268,966)
Dividend award  7,373,691   3,439,929 
Outstanding at 31 December  398,066,746   522,836,111   417,385,636   370,804,915 

 

Awards in respect of the 20132016 grant will vestvested in 20162019 at a rate of 94.1868.7 per cent.

The weighted average fair value of awards granted in the year was £0.48 (2017: £0.57).

 

The fair value calculations at 31 December 20152018 for grants made in the year, using Black-Scholes models and Monte Carlo simulation, are based on the following assumptions:

 

       Commercial
   Executive   Banking
 Save-As-You- Share Plan   Transformation
 Earn 2003 LTIP Program Save-As-You-Earn Executive
Share Plan
2003		 LTIP 
Weighted average risk-free interest rate 0.76% 0.56% 0.85% 0.68%  0.96%   0.74%  0.94% 
Weighted average expected life 3.3 years 1.4 years 3.0 years 1.7 years  3.3 years   1.3 years   3.7 years 
Weighted average expected volatility 24% 21% 28% 20%  28%   21%   29% 
Weighted average expected dividend yield 2.5% 2.5% 2.5% 2.5%  4.0%   4.0%   4.0% 
Weighted average share price £0.76 £0.80 £0.80 £0.78 £0.59   £0.58   £0.67 
Weighted average exercise price £0.61 nil nil nil  £0.48   Nil   Nil 

 

Expected volatility is a measure of the amount by which the Group’s shares are expected to fluctuate during the life of an option. The expected volatility is estimated based on the historical volatility of the closing daily share price over the most recent period that is commensurate with the expected life of the option. The historical volatility is compared to the implied volatility generated from market traded options in the Group’s shares to assess the reasonableness of the historical volatility and adjustments made where appropriate.

Share Incentive Plan

FREE SHARES

An award of shares may be made annually to employees up to a maximum of £3,000. The shares awarded are held in trust for a mandatory period of three years on the employee’s behalf, during which period the employee is entitled to any dividends paid on such shares. The award is subject to a non-market based condition. If an employee leaves the Group within this three year period for other than a ‘good’ reason, all of the shares awarded will be forfeited.

On 10 May 2018, the Group made an award of £200 (2017: £200) of shares to all eligible employees. The number of shares awarded was 21,513,300 (2017: 21,566,047), with an average fair value of £0.67 (2017: £0.69) based on the market price at the date of award.

 

MATCHING SHARES

 

The Group undertakes to match shares purchased by employees up to the value of £45 per month; these matching shares are held in trust for a mandatory period of three years on the employee’s behalf, during which period the employee is entitled to any dividends paid on such shares. The award is subject to a non-market based condition: if an employee leaves within this three year period for other than a ‘good’ reason, 100 per cent of the matching shares are forfeited. Similarly if the employees sell their purchased shares within three years, their matching shares are forfeited.

 

The number of shares awarded relating to matching shares in 20152018 was 18,001,413 (2014: 16,248,562)34,174,161 (2017: 32,025,497), with an average fair value of £0.78 (2014: £0.78)£0.63 (2017: £0.67), based on market prices at the date of award.

 

FIXED SHARE AWARDS

 

Fixed share awards were introduced in 2014 in order to ensure that total fixed remuneration is commensurate with role and to provide a competitive reward package for certain Lloyds Banking Group employees, with an appropriate balance of fixed and variable remuneration, in line with regulatory requirements. The fixed share awards are delivered in Lloyds Banking Group shares, released over five years with 20 per cent being released each year following the year of award. The number of shares purchased in 20152018 was 8,237,469 (2014: 7,761,624)8,965,562 (2017: 9,313,314).

 

The fixed share award is not subject to any performance conditions, performance adjustment or clawback. On an employee leaving the Group, there is no change to the timeline for which shares will become unrestricted.

F-67F-69

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 48:46: RELATED PARTY TRANSACTIONS

 

KEY MANAGEMENT PERSONNELKey management personnel

 

Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of an entity; the Group’s key management personnel are the members of the Lloyds Banking Group plc Group Executive Committee together with its Non-Executive Directors.

 

The table below details, on an aggregated basis, key management personnel compensation:

 

 2015  2014 2013 
 £m  £m £m  2018
£m		 2017
£m		 2016
£m		 
Compensation                        
Salaries and other short-term benefits  14   15   15   14   13   17 
Post-employment benefits  –   1   –   –   –   – 
Share-based payments  18   17   21   18   22   23 
Total compensation  32   33   36   32   35   40 

 

Aggregate contributions in respect of key management personnel to defined contribution pension schemes were £0.1£nil million (2014:(2017: £0.05 million; 2016: £0.1 million; 2013: £0.2 million).

 

  2015  2014  2013 
  million  million  million 
Share option plans            
At 1 January  13   14   25 
Granted, including certain adjustments (includes entitlements of appointed key management personnel)  3   –   5 
Exercised/lapsed (includes entitlements of former key management personnel)  (7)  (1)  (16)
At 31 December  9   13   14 

 2018
million		  2017
million		 2016
million		 
Share option plans            
At 1 January  1   3   9 
Granted, including certain adjustments (includes entitlements of appointed key management personnel)  –   –   3 
Exercised/lapsed (includes entitlements of former key management personnel)  (1)  (2)  (9)
At 31 December  –   1   3 
 2015  2014 2013             
 million  million million   2018
million		   2017
million		   2016
million		 
Share plans                        
At 1 January  102   105   70   82   65   82 
Granted, including certain adjustments (includes entitlements of appointed key management personnel)  37   19   42   39   37   29 
Exercised/lapsed (includes entitlements of former key management personnel)  (57)  (22)  (7)  (37)  (20)  (46)
At 31 December  82   102   105   84   82   65 

 

The tables below detail, on an aggregated basis, balances outstanding at the year end and related income and expense, together with information relating to other transactions between the Group and its key management personnel:

 

 2015  2014 2013 
 £m  £m £m  2018
£m		  2017
£m		 2016
£m		 
Loans                        
At 1 January  3   2   2   2   4   5 
Advanced (includes loans of appointed key management personnel)  4   2   2   1   1   3 
Repayments (includes loans of former key management personnel)  (2)  (1)  (2)  (1)  (3)  (4)
At 31 December  5   3   2   2   2   4 

 

The loans are on both a secured and unsecured basis and are expected to be settled in cash. The loans attracted interest rates of between 3.996.70 per cent and 23.9524.20 per cent in 2015 (2014: 0.52018 (2017: 6.45 per cent and 23.95 per cent; 2013: 2.52016: 2.49 per cent and 23.923.95 per cent).

 

No provisions have been recognised in respect of loans given to key management personnel (2014(2017 and 2013:2016: £nil).

 

 2015  2014 2013 
 £m  £m  £m  2018
£m		  2017
£m		 2016
£m		 
Deposits                        
At 1 January  16   13   10   20   12   13 
Placed (includes deposits of appointed key management personnel)  58   32   29   33   41   41 
Withdrawn (includes deposits of former key management personnel)  (61)  (29)  (26)  (33)  (33)  (42)
At 31 December  13   16   13   20   20   12 

 

Deposits placed by key management personnel attracted interest rates of up to 4.73.5 per cent (2014: 4.7(2017: 4.0 per cent; 2013: 2.92016: 4.0 per cent).

At 31 December 2015,2018, the Group did not provide any guarantees in respect of key management personnel (2014(2017 and 2013:2016: none).

F-68

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 48: RELATED PARTY TRANSACTIONS continued

 

At 31 December 2015,2018, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons included amounts outstanding in respect of loans and credit card transactions of £1£0.5 million with four3 directors and six3 connected persons (2014: £1(2017: £0.01 million with sixthree directors and sixtwo connected persons; 2013: £12016: £0.4 million with sixfive directors and fivetwo connected persons).

F-70

SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

Details of the Group’s significant subsidiaries are given on page 222. NOTE 46: RELATED PARTY TRANSACTIONScontinued

Subsidiaries

In accordance with IFRS 10 Consolidated financial statements, transactions and balances with subsidiaries have been eliminated on consolidation.

 

UK GOVERNMENT

In January 2009, the UK government through HM Treasury became a related party of the Company following its subscription for ordinary shares issued under a placing and open offer. As at 31 December 2015, HM Treasury held an interest of 9.14 per cent in the Company’s ordinary share capital, with its interest having fallen below 20 per cent on 11 May 2015. As a consequence of HM Treasury no longer being considered to have a significant influence, it ceased to be a related party of the Company for IAS 24 purposes at that date.

In accordance with IAS 24, UK government-controlled entities were related parties of the Group until 11 May 2015. The Group regarded the Bank of England and entities controlled by the UK government, including The Royal Bank of Scotland Group plc (RBS), NRAM plc and Bradford & Bingley plc, as related parties.

During the year ended 31 December 2015, the Group participated in a number of schemes operated by the UK government and central banks and made available to eligible banks and building societies.

NATIONAL LOAN GUARANTEE SCHEME

The Group participates in the UK government’s National Loan Guarantee Scheme, providing eligible UK businesses with discounted funding based on the Group’s existing lending criteria. Eligible businesses who have taken up the funding benefit from a 1 per cent discount on their funding rate for a pre-agreed period of time.

FUNDING FOR LENDING

The Funding for Lending Scheme represents a further source of cost effective secured term funding available to the Group. The initiative supports a broard range of UK-based customers, focussing primarily on providing small businesses with cheaper finance to invest and grow. In November 2015, the Bank of England announced that the deadline for banks to draw down their borrowing allowance would be extended for a further two years until 31 January 2018. At 31 December 2015, the Group had drawn down £32 billion (31 December 2014: £20 billion) under the Scheme.

ENTERPRISE FINANCE GUARANTEE SCHEME

The Group participates in the Enterprise Finance Guarantee Scheme which supports viable businesses with access to lending where they would otherwise be refused a loan due to a lack of lending security. The Department for Business, Innovation and Skills provides the lender with a guarantee of up to 75 per cent of the capital of each loan subject to the eligibility of the customer. As at 31 December 2015, the Group had offered 6,509 loans to customers, worth over £550 million. Under the most recent renewal of the terms of the scheme, Lloyds Bank plc and Bank of Scotland plc, on behalf of the Group, contracted with The Secretary of State for Business, Innovation and Skills.

HELP TO BUY

The Help to Buy Scheme is a scheme promoted by the UK government and is aimed to encourage participating lenders to make mortgage loans available to customers who require higher loan-to-value mortgages. Halifax and Lloyds are currently participating in the Scheme whereby customers borrow between 90 per cent and 95 per cent of the purchase price. In return for the payment of a commercial fee, HM Treasury has agreed to provide a guarantee to the lender to cover a proportion of any loss made by the lender. £3,133 million of outstanding loans at 31 December 2015 (31 December 2014: £1,950 million) had been advanced under this scheme.

BUSINESS GROWTH FUND

The Group has invested £176 million (31 December 2014: £118 million) in the Business Growth Fund (under which an agreement was entered into with RBS amongst others) and, as at 31 December 2015, carries the investment at a fair value of £170 million (31 December 2014: £105 million).

BIG SOCIETY CAPITAL

The Group has invested £36 million (31 December 2014: £31 million) in the Big Society Capital Fund under which an agreement was entered into with RBS amongst others.

HOUSING GROWTH PARTNERSHIP

The Group has committed to invest up to £50 million into the Housing Growth Partnership under which an agreement was entered into with the Homes and Communities Agency.

CENTRAL BANK FACILITIES

In the ordinary course of business, the Group may from time to time access market-wide facilities provided by central banks.

OTHER GOVERNMENT-RELATED ENTITIES

Other than the transactions referred to above, there were no other significant transactions with the UK government and UK government-controlled entities (including UK government-controlled banks) during the period that were not made in the ordinary course of business or that were unusual in their nature or conditions.

OTHER RELATED PARTY TRANSACTIONS

PENSION FUNDSPension funds 

 

The Group provides banking and some investment management services to certain of its pension funds. At 31 December 2015,2018, customer deposits of £145£225 million (2014: £129(2017: £337 million) and investment and insurance contract liabilities of £694£79 million (2014: £3,278(2017: £307 million) related to the Group’s pension funds.

F-69

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 48: RELATED PARTY TRANSACTIONS continued

COLLECTIVE INVESTMENT VEHICLESCollective investment vehicles

 

The Group manages 168 (2014: 132)131 (2017: 134) collective investment vehicles, such as Open Ended Investment Companies (OEICs) and of these 95 (2014: 80)82 (2017: 83) are consolidated. The Group invested £818£620 million (2014: £811(2017: £418 million) and redeemed £616£404 million (2014: £984(2017: £616 million) in the unconsolidated collective investment vehicles during the year and had investments, at fair value, of £2,129£2,513 million (2014: £2,243(2017: £2,328 million) at 31 December. The Group earned fees of £187£128 million from the unconsolidated collective investment vehicles during 2015 (2014: £2012018 (2017: £133 million).

 

JOINT VENTURES AND ASSOCIATESJoint ventures and associates

 

At 31 December 20152018 there were loans and advances to customers of £225£57 million (2014: £1,901(2017: £123 million) outstanding and balances within customer deposits of £8£2 million (2014: £24(2017: £9 million) relating to joint ventures and associates.

 

In addition to the above balances, the Group has a number of other associates held by its venture capital business that it accounts for at fair value through profit or loss. At 31 December 2015,2018, these companies had total assets of approximately £3,911£4,091 million (2014: £5,553(2017: £4,661 million), total liabilities of approximately £4,104£4,616 million (2014: £6,312(2017: £5,228 million) and for the year ended 31 December 20152018 had turnover of approximately £4,660£4,522 million (2014: £5,634(2017: £4,601 million) and made a loss of approximately £181£125 million (2014:(2017: net loss of £272£87 million). In addition, the Group has provided £1,710£1,141 million (2014: £2,364(2017: £1,226 million) of financing to these companies on which it received £125£49 million (2014: £149(2017: £81 million) of interest income in the year.

 

NOTE 49:47: CONTINGENT LIABILITIES AND COMMITMENTS

 

INTERCHANGE FEESInterchange fees

 

With respect to multi-lateral interchange fees (MIFs), the Group is not directly involved in the on-goingongoing investigations and litigation (as described below) which involve card schemes such as Visa and MasterCard.Mastercard. However, the Group is a member / licensee of Visa and MasterCardMastercard and other card schemes.schemes:

 

–  The European Commission continues to pursue certain competition investigations into MasterCard and Visa probing, amongst other things, MIFs paid in respect of cards issued outside the EEA;

– The European Commission continues to pursue competition investigations against Mastercard and Visa probing, amongst other things, MIFs paid in respect of cards issued outside the EEA;
–Litigation brought by retailers continues in the English Courts against both Visa and Mastercard;
–Any ultimate impact on the Group of the above investigations and litigation against Visa and Mastercard remains uncertain at this time.

 

–  Litigation continues in the English Courts against both Visa and MasterCard. This litigation has been brought by several retailers who are seeking damages for allegedly ‘overpaid’ MIFs. From publicly available information, it is understood these damages claims are running to different timescales with respect to the litigation process, and their outcome remains uncertain. It is also possible that new claims may be issued.

On 2 November 2015, Visa Inc announcedcompleted its proposed acquisition of Visa Europe which remains subject to completion. As set out in the announcement by the Group on 2 November, the Group’s share of the sale proceeds will comprise upfront consideration of cash (the amount of which remains subject to adjustment prior to completion) and preferred stock. The preferred stock will be convertible into Class A Common Stock of Visa Inc or its equivalent upon occurrence of certain events.21 June 2016. As part of this transaction, the Group and certain other UK banks also entered into a Loss Sharing Agreement (LSA) with Visa Inc, which clarifies howthe allocation of liabilities will be allocated between the parties should the litigation referred to above result in Visa Inc being liable for damages payable by Visa Europe. Visa Inc may only have recourse to the LSA once €1 billion of damages have been applied to the value of the UK preferred stock received by Visa UK members (including the Group) as part of the consideration to the transaction. The value of the preferred stock will be reduced (by making a downward adjustment to the conversion rate) in an amount equal to any covered losses. The maximum amount of liability to which the Group may be subject under the LSA is capped at the cash consideration to bewhich was received by the Group.Group at completion. Visa Inc may also have recourse to a general indemnity, currentlypreviously in place under Visa Europe’s Operating Regulations, for damages claims concerning inter or intra-regional MIF setting activities.

 

The ultimate impact on the Group of the above investigationsLIBOR and the litigation against Visa and MasterCard cannot be known before the conclusion of these matters.

LIBOR AND OTHER TRADING RATES other trading rates

 

In July 2014, the Group announced that it had reached settlements totalling £217 million (at 30 June 2014 exchange rates) to resolve with UK and US federal authorities legacy issues regarding the manipulation several years ago of Group companies’ submissions to the British Bankers’ Association (BBA) London Interbank Offered Rate (LIBOR) and Sterling Repo Rate. The Group continues to cooperate with various other government and regulatory authorities, including the Serious Fraud Office, the Swiss Competition Commission, and a number of US State Attorneys General, in conjunction with their investigations into submissions made by panel members to the bodies that set LIBOR and various other interbank offered rates.

 

Certain Group companies, together with other panel banks, have also been named as defendants in private lawsuits, including purported class action suits, in the US in connection with their roles as panel banks contributing to the setting of US Dollar, Japanese Yen and Sterling LIBOR. The lawsuits, which contain broadly similar allegations, allege violations of the Sherman Antitrust Act, the Racketeer Influenced and Corrupt Organizations ActLIBOR and the Commodity Exchange Act, as well as various state statutes and common law doctrines.Australian BBSW Reference Rate. Certain of the plaintiffs’ claims, including those asserted under US anti-trust laws, have been dismissed by the US Federal Court for Southern District of New York (the District Court). That court’s dismissal of plaintiffs’ anti-trust claims has been appealed(subject to the New York Federal Court of Appeal. The OTC and Exchange – Based plaintiffs’ claims were dismissed in November 2015 for lack of personal jurisdiction against the Group.appeals).

 

Certain Group companies are also named as defendants in (i) UK based claimsclaims; and (ii) in 2 Dutch class actions, raising LIBOR manipulation allegationsallegations. A number of the claims against the Group in connection withrelation to the alleged mis-sale of interest rate hedging products.products also include allegations of LIBOR manipulation.

 

It is currently not possible to predict the scope and ultimate outcome on the Group of the various outstanding regulatory investigations not encompassed by the settlements, any private lawsuits or any related challenges to the interpretation or validity of any of the Group’s contractual arrangements, including their timing and scale.

 

UK SHAREHOLDER LITIGATIONshareholder litigation

 

In August 2014, the Group and a number of former directors were named as defendants in a claim filed in the English High Court by a number of claimants who held shares in Lloyds TSB Group plc (LTSB) prior to the acquisition of HBOS plc, alleging breaches of fiduciary and tortious duties in relation to information provided to shareholders in connection with the acquisition and the recapitalisation of LTSB. The defendants refute all claims made. A trial commenced in the English High Court on 18 October 2017 and concluded on 5 March 2018 with judgment to follow. It is currently not possible to determine the ultimate impact on the Group (if any), but the Group intends to defend the claim vigorously.

F-70

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.

 

NOTE 49: CONTINGENT LIABILITIES AND COMMITMENTS continuedTax authorities

 

FINANCIAL SERVICES COMPENSATION SCHEME

The Financial Services Compensation Scheme (FSCS) is the UK’s independent statutory compensation fund of last resort for customers of authorised financial services firms and pays compensation if a firm is unable or likely to be unable to pay claims against it. The FSCS is funded by levies on the authorised financial services industry. Each deposit-taking institution contributes towards the FSCS levies in proportion to their share of total protected deposits on 31 December of the year preceding the scheme year, which runs from 1 April to 31 March.

Following the default of a number of deposit takers in 2008, the FSCS borrowed funds from HM Treasury to meet the compensation costs for customers of those firms. At 31 March 2015, the end of the latest FSCS scheme year, the principal balance outstanding on these loans was £15,797 million (31 March 2014: £16,591 million). Although the substantial majority of this loan will be repaid from funds the FSCS receives from asset sales, surplus cash flow or other recoveries in relation to the assets of the firms that defaulted, any shortfall will be funded by deposit-taking participants of the FSCS. The amount of future levies payable by the Group depends on a number of factors including the amounts recovered by the FSCS from asset sales, the Group’s participation in the deposit-taking market at 31 December, the level of protected deposits and the population of deposit-taking participants.

TAX AUTHORITIES

The Group provides for potential tax liabilities that may arise on the basis of the amounts expected to be paid to tax authorities including open matters where Her Majesty’s Revenue and Customs (HMRC) adopt a different interpretation and application of tax law. The Group has an open matter in relation to a claim for group relief of losses incurred in its former Irish banking subsidiary, which ceased trading on 31 December 2010. In 2013 HMRC informed the Group that their interpretation of the UK rules permittingwhich allow the offset of such losses denies the claim; ifclaim. If HMRC’s position is found to be correct management estimate that this would result in an increase in current tax liabilities of approximately £600£770 million (including interest) and a reduction in the Group’s deferred tax asset of approximately £400£250 million. The Group does not agree with HMRC’s position and, having taken appropriate advice, does not consider that this is a case where additional tax will ultimately fall due. There are a number of other open matters on which the Group is in discussion with HMRC;HMRC (including the tax treatment of certain costs arising from the divestment of TSB Banking Group plc), none of thesewhich is expected to have a material impact on the financial position of the Group.

F-71

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

RESIDENTIAL MORTGAGE REPOSSESSIONSNote 47:Contingent liabilities and commitments continued

Residential mortgage repossessions

 

In August 2014, the Northern Ireland High Court handed down judgment in favour of the borrowers in relation to three residential mortgage test cases concerning certain aspects of the Group’s practice with respect to the recalculation of contractual monthly instalments of customers in arrears. The FCA has indicated that it will issue a Consultation Paperbeen actively engaged with the industry in relation to industry practice in this area in February 2016.these considerations and has published Guidance on the treatment of customers with mortgage payment shortfalls. The Guidance covers remediation for mortgage customers who may have been affected by the way firms calculate these customers’ monthly mortgage instalments. The Group will respond as appropriateis implementing the Guidance and has now contacted nearly all affected customers with any remaining customers anticipated to this and any investigations, proceedings, or regulatory action that may in due course be instigated as a resultcontacted by the end of these issues.March 2019.

 

THE FINANCIAL CONDUCT AUTHORITY’S ANNOUNCEMENT ON TIME-BARRING FOR PPI COMPLAINTS AND PLEVIN V PARAGON PERSONAL FINANCE LIMITEDMortgage arrears handling activities- FCA investigation

 

On 26 November 2015May 2016, the Group was informed that an enforcement team at the FCA issued a Consultation Paper onhad commenced an investigation in connection with the introduction of a deadline by which consumers would needGroup’s mortgage arrears handling activities. This investigation is ongoing and the Group continues to cooperate with the FCA. It is not currently possible to make their PPI complaints or else lose their right to have them assessed by firms or the Financial Ombudsman Service, and proposed rules and guidance concerning the handling of PPI complaints in light of the Supreme Court’s decision inPlevin v Paragon Personal Finance Limited[2014] UKSC 61 (Plevin). The Financial Ombudsman Service is also considering the implications ofPlevinfor PPI complaints. The implications of potential time-barring and thePlevindecision in terms of the scopea reliable assessment of any court proceedingsliability that may result from the investigation including any financial penalty or regulatory action remain uncertain.public censure.

 

OTHER LEGAL ACTIONS AND REGULATORY MATTERSHBOS Reading – FCA investigation

On 7 April 2017 the FCA announced that it had resumed its investigation into the events surrounding the discovery of misconduct within the Reading-based Impaired Assets team of HBOS. The investigation is ongoing and the Group continues to cooperate with the FCA. It is not currently possible to make a reliable assessment of any liability that may result from the investigation including any financial penalty or public censure.

Other legal actions and regulatory matters

 

In addition, during the ordinary course of business the Group is subject to other complaints and threatened or actual legal proceedings (including class or group action claims) brought by or on behalf of current or former employees, customers, investors or other third parties, as well as legal and regulatory reviews, challenges, investigations and enforcement actions, both in the UK and overseas. All such material matters are periodically reassessed, with the assistance of external professional advisers where appropriate, to determine the likelihood of the Group incurring a liability. In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management’smanagement's best estimate of the amount required at the relevant balance sheet date. In some cases it will not be possible to form a view, for example because the facts are unclear or because further time is needed properly to assess the merits of the case, and no provisions are held in relation to such matters. In these circumstances, specific disclosure in relation to a contingent liability will be made where material. However the Group does not currently expect the final outcome of any such case to have a material adverse effect on its financial position, operations or cash flows.

 

  2015  2014 
  £m  £m 
Contingent liabilities        
Acceptances and endorsements  52   59 
Other:        
Other items serving as direct credit substitutes  458   330 
Performance bonds and other transaction-related contingencies  2,123   2,293 
   2,581   2,623 
Total contingent liabilities  2,633   2,682 
F-71

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 49: CONTINGENT LIABILITIES AND COMMITMENTS continued

  2018
£m		  2017
£m		 
Contingent liabilities      
Acceptances and endorsements  194   71 
Other:        
Other items serving as direct credit substitutes  632   740 
Performance bonds and other transaction-related contingencies  2,425   2,300 
   3,057   3,040 
Total contingent liabilities  3,251   3,111 

 

The contingent liabilities of the Group arise in the normal course of its banking business and it is not practicable to quantify their future financial effect.

 

 2015  2014  2018
£m		 2017
£m		 
 £m  £m 
Commitments        
Commitments and guarantees     
Documentary credits and other short-term trade-related transactions  –   101   1   – 
Forward asset purchases and forward deposits placed  421   162   731   384 
Undrawn formal standby facilities, credit lines and other commitments to lend:                
Less than 1 year original maturity:                
Mortgage offers made  9,995   8,809   11,594   11,156 
Other commitments  57,809   64,015 
Other commitments and guarantees  85,060   85,015 
  67,804   72,824   96,654   96,171 
1 year or over original maturity  44,691   34,455   37,712   39,074 
Total commitments  112,916   107,542 
Total commitments and guarantees  135,098   135,629 

 

Of the amounts shown above in respect of undrawn formal standby facilities, credit lines and other commitments to lend, £63,086£64,884 million (2014: £55,029(2017: £65,946 million) was irrevocable.

F-72

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

OPERATING LEASE COMMITMENTSNote 47:Contingent liabilities and commitments continued

Operating lease commitments

 

Where a Group company is the lessee the future minimum lease payments under non-cancellable premises operating leases are as follows:

 

  2015   2014 
  £m   £m  2018
£m		 2017
£m		 
Not later than 1 year  267   301   259   275 
Later than 1 year and not later than 5 years  885   945   807   845 
Later than 5 years  1,049   1,141   977   934 
Total operating lease commitments  2,201   2,387   2,043   2,054 

 

Operating lease payments represent rental payable by the Group for certain of its properties. Some of these operating lease arrangements have renewal options and rent escalation clauses, although the effect of these is not material. No arrangements have been entered into for contingent rental payments.

 

CAPITAL COMMITMENTSCapital commitments

 

Excluding commitments in respect of investment property (note 27)26), capital expenditure contracted but not provided for at 31 December 20152018 amounted to £388£378 million (2014: £373(2017: £444 million). Of this amount, £380£369 million (2014: £368(2017: £440 million) related to assets to be leased to customers under operating leases. The Group’s management is confident that future net revenues and funding will be sufficient to cover these commitments.

NOTE 48: STRUCTURED ENTITIES

The Group’s interests in structured entities are both consolidated and unconsolidated. Detail of the Group’s interests in consolidated structured entities are set out in: note 30 for securitisations and covered bond vehicles, note 35 for structured entities associated with the Group’s pension schemes, and below in part (A) and (B). Details of the Group’s interests in unconsolidated structured entities are included below in part (C).

(A) Asset-backed conduits

In addition to the structured entities discussed in note 30, which are used for securitisation and covered bond programmes, the Group sponsors an active asset-backed conduit, Cancara, which invests in client receivables and debt securities. The total consolidated exposure of Cancara at 31 December 2018 was £5,122 million (2017: £6,049 million), comprising £5,012 million of loans and advances (2017: £5,939 million) and £110 million of debt securities (2017: £110 million).

All lending assets and debt securities held by the Group in Cancara are restricted in use, as they are held by the collateral agent for the benefit of the commercial paper investors and the liquidity providers only. The Group provides liquidity facilities to Cancara under terms that are usual and customary for standard lending activities in the normal course of the Group’s banking activities. During 2018 there have continued to be planned drawdowns on certain liquidity facilities for balance sheet management purposes, supporting the programme to provide funding alongside the proceeds of the asset-backed commercial paper issuance. The Group could be asked to provide support under the contractual terms of these arrangements including, for example, if Cancara experienced a shortfall in external funding, which may occur in the event of market disruption.

The external assets in Cancara are consolidated in the Group’s financial statements.

(B) Consolidated collective investment vehicles and limited partnerships

The assets of the Insurance business held in consolidated collective investment vehicles, such as Open-Ended Investment Companies and limited partnerships, are not directly available for use by the Group. However, the Group’s investment in the majority of these collective investment vehicles is readily realisable. As at 31 December 2018, the total carrying value of these consolidated collective investment vehicle assets and liabilities held by the Group was £62,648 million (2017: £68,124 million).

The Group has no contractual arrangements (such as liquidity facilities) that would require it to provide financial or other support to the consolidated collective investment vehicles; the Group has not previously provided such support and has no current intentions to provide such support.

(C) Unconsolidated collective investment vehicles and limited partnerships

The Group’s direct interests in unconsolidated structured entities comprise investments in collective investment vehicles, such as Open-Ended Investment Companies, and limited partnerships with a total carrying value of £26,028 million at 31 December 2018 (2017: £28,759 million), included within financial assets designated at fair value through profit and loss (see note 16). These investments include both those entities managed by third parties and those managed by the Group. At 31 December 2018, the total asset value of these unconsolidated structured entities, including the portion in which the Group has no interest, was £2,435 billion (2017: £2,338 billion).

The Group’s maximum exposure to loss is equal to the carrying value of the investment. However, the Group’s investments in these entities are primarily held to match policyholder liabilities in the Insurance division and the majority of the risk from a change in the value of the Group’s investment is matched by a change in policyholder liabilities. The collective investment vehicles are primarily financed by investments from investors in the vehicles.

During the year the Group has not provided any non-contractual financial or other support to these entities and has no current intention of providing any financial or other support. There were no transfers from/to these unconsolidated collective investment vehicles and limited partnerships.

The Group considers itself the sponsor of a structured entity where it is primarily involved in the design and establishment of the structured entity; and further where the Group transfers assets to the structured entity; market products associated with the structured entity in its own name and/or provide guarantees regarding the structured entity’s performance.

The Group sponsors a range of diverse investment funds and limited partnerships where it acts as the fund manager or equivalent decision maker and markets the funds under one of the Group’s brands.

The Group earns fees from managing the investments of these funds. The investment management fees that the Group earned from these entities, including those in which the Group held no ownership interest at 31 December 2018, are reported in note 6.

F-72F-73

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 50:49: FINANCIAL INSTRUMENTS

 

(1) MEASUREMENT BASIS OF FINANCIAL ASSETS AND LIABILITIESMeasurement basis of financial assets and liabilities

 

The accounting policies in note 2 describe how different classes of financial instruments are measured, and how income and expenses, including fair value gains and losses, are recognised. The following table analyses the carrying amounts of the financial assets and liabilities by category and by balance sheet heading.

 

     At fair value                
  Derivatives  through profit or loss                
  designated     Designated        Held at       
  as hedging  Held for  upon initial  Available-  Loans and  amortised  Insurance    
  instruments  trading  recognition  for-sale  receivables  cost  contracts  Total 
  £m  £m  £m  £m  £m  £m  £m  £m 
At 31 December 2015                                
Financial assets                                
Cash and balances at central banks  –   –   –   –   –   58,417   –   58,417 
Items in the course of collection from banks  –   –   –   –   –   697   –   697 
Trading and other financial assets at fair value                                
through profit or loss  –   42,661   97,875   –   –   –   –   140,536 
Derivative financial instruments  2,686   26,781   –   –   –   –   –   29,467 
Loans and receivables:                                
Loans and advances to banks  –   –   –   –   25,117   –   –   25,117 
Loans and advances to customers  –   –   –   –   455,175   –   –   455,175 
Debt securities  –   –   –   –   4,191   –   –   4,191 
   –   –   –   –   484,483   –   –   484,483 
Available-for-sale financial assets  –   –   –   33,032   –   –   –   33,032 
Held-to-maturity investments  –   –   –   –   –   19,808   –   19,808 
Total financial assets  2,686   69,442   97,875   33,032   484,483   78,922   –   766,440 
Financial liabilities                                
Deposits from banks  –   –   –   –   –   16,925   –   16,925 
Customer deposits  –   –   –   –   –   418,326   –   418,326 
Items in course of transmission to banks  –   –   –   –   –   717   –   717 
Trading and other financial liabilities at fair value                                
through profit or loss  –   43,984   7,879   –   –   –   –   51,863 
Derivative financial instruments  2,437   23,864   –   –   –   –   –   26,301 
Notes in circulation  –   –   –   –   –   1,112   –   1,112 
Debt securities in issue  –   –   –   –   –   82,056   –   82,056 
Liabilities arising from insurance contracts                                
and participating investment contracts  –   –   –   –   –   –   80,294   80,294 
Liabilities arising from non-participating investment                                
contracts  –   –   –   –   –   –   22,777   22,777 
Unallocated surplus within insurance businesses  –   –   –   –   –   –   260   260 
Financial guarantees  –   –   48   –   –   –   –   48 
Subordinated liabilities  –   –   –   –   –   23,312   –   23,312 
Total financial liabilities  2,437   67,848   7,927   –   –   542,448   103,331   723,991 
F-73

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 50: FINANCIAL INSTRUMENTS continued

   At fair value            Mandatorily held at fair value
 through profit or loss		 
 Derivatives through profit or loss            Derivatives
designated
as hedging
instruments
£m		 Held for
trading
£m		 Other
£m		 Designated at
fair value
through profit
or loss
£m		 At fair value
through other
comprehensive
income
£m		 Held at
amortised
cost
£m		 Insurance
contracts
£m		 Total
£m		 
 designated   Designated     Held at     
 as hedging Held for upon initial Available- Loans and amortised Insurance   
 instruments trading recognition for-sale receivables cost contracts Total 
 £m £m £m £m £m £m £m £m 
At 31 December 2014                                
At 31 December 2018 
Financial assets                                 
Cash and balances at central banks  –   –   –   –   –   50,492   –   50,492  – – – – – 54,663 – 54,663 
Items in the course of collection from banks  –   –   –   –   –   1,173   –   1,173  – – – – – 647 – 647 
Trading and other financial assets at fair value                                
through profit or loss  –   48,494   103,437   –   –   –   –   151,931 
Financial assets at fair value through profit or loss – 35,246 123,283 – – – – 158,529 
Derivative financial instruments  4,233   31,895   –   –   –   –   –   36,128  1,563 22,032 – – – – – 23,595 
Loans and receivables:                                
Loans and advances to banks  –   –   –   –   26,155   –   –   26,155  – – – – – 6,283 – 6,283 
Loans and advances to customers  –   –   –   –   482,704   –   –   482,704  – – – – – 484,858 – 484,858 
Debt securities  –   –   –   –   1,213   –   –   1,213  – – – – – 5,238 – 5,238 
  –   –   –   –   510,072   –   –   510,072 
Available-for-sale financial assets  –   –   –   56,493   –   –   –   56,493 
Financial assets at amortised cost – – – – – 496,379 – 496,379 
Financial assets at fair value through other 
comprehensive income – – – – 24,815 – – 24,815 
Total financial assets  4,233   80,389   103,437   56,493   510,072   51,665   –   806,289  1,563 57,278 123,283 – 24,815 551,689 – 758,628 
Financial liabilities                                 
Deposits from banks  –   –   –   –   –   10,887   –   10,887  – – – – – 30,320 – 30,320 
Customer deposits  –   –   –   –   –   447,067   –   447,067  – – – – – 418,066 – 418,066 
Items in course of transmission to banks  –   –   –   –   –   979   –   979  – – – – – 636 – 636 
Trading and other financial liabilities at fair value                                
through profit or loss  –   55,358   6,744   –   –   –   –   62,102 
Financial liabilities at fair value through profit or loss – 23,451 – 7,096 – – – 30,547 
Derivative financial instruments  3,616   29,571   –   –   –   –   –   33,187  1,108 20,265 – – – – – 21,373 
Notes in circulation  –   –   –   –   –   1,129   –   1,129  – – – – – 1,104 – 1,104 
Debt securities in issue  –   –   –   –   –   76,233   –   76,233  – – – – – 91,168 – 91,168 
Liabilities arising from insurance contracts                                
and participating investment contracts  –   –   –   –   –   –   86,918   86,918 
Liabilities arising from non-participating investment                                
contracts  –   –   –   –   –   –   27,248   27,248 
Liabilities arising from insurance contracts and participating investment contracts – – – – – – 98,874 98,874 
Liabilities arising from non-participating investment contracts – – – – – – 13,853 13,853 
Unallocated surplus within insurance businesses  –   –   –   –   –   –   320   320  – – – – – – 382 382 
Financial guarantees  –   –   51   –   –   –   –   51 
Subordinated liabilities  –   –   –   –   –   26,042   –   26,042  – – – – – 17,656 – 17,656 
Total financial liabilities  3,616   84,929   6,795   –   –   562,337   114,486   772,163  1,108 43,716 – 7,096 – 558,950 113,109 723,979 
F-74

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NoteNOTE 50: FINANCIAL INSTRUMENTS 49:Financial instruments continued

 

     At fair value
through profit or loss		            
  Derivatives
designated
as hedging
instruments
£m		  Held for
trading
£m		  Other
£m		  Available-
for-sale
£m		  Held at
amortised
cost
£m		  Insurance
contracts
£m		  Total
£m		 
At 31 December 2017                            
Financial assets                            
Cash and balances at central banks  –   –   –   –   58,521   –   58,521 
Items in the course of collection from banks  –   –   –   –   755   –   755 
Financial assets at fair value through profit or loss  –   42,236   120,642   –   –   –   162,878 
Derivative financial instruments  1,881   23,953   –   –   –   –   25,834 
Loans and advances to banks  –   –   –   –   6,611   –   6,611 
Loans and advances to customers  –   –   –   –   472,498   –   472,498 
Debt securities  –   –   –   –   3,643   –   3,643 
Financial assets at amortised cost  –   –   –   –   482,752   –   482,752 
Available-for-sale financial assets  –   –   –   42,098   –   –   42,098 
Total financial assets  1,881   66,189   120,642   42,098   542,028   –   772,838 
Financial liabilities                            
Deposits from banks  –   –   –   –   29,804   –   29,804 
Customer deposits  –   –   –   –   418,124   –   418,124 
Items in course of transmission to banks  –   –   –   –   584   –   584 
Financial liabilities at fair value through profit or loss  –   43,062   7,815   –   –   –   50,877 
Derivative financial instruments  1,613   24,511   –   –   –   –   26,124 
Notes in circulation  –   –   –   –   1,313   –   1,313 
Debt securities in issue  –   –   –   –   72,450   –   72,450 
Liabilities arising from insurance contracts                            
and participating investment contracts  –   –   –   –   –   103,413   103,413 
Liabilities arising from non-participating investment                            
contracts  –   –   –   –   –   15,447   15,447 
Unallocated surplus within insurance businesses  –   –   –   –   –   390   390 
Subordinated liabilities  –   –   –   –   17,922   –   17,922 
Total financial liabilities  1,613   67,573   7,815   –   540,197   119,250   736,448 

(2) FAIR VALUE MEASUREMENTFair value measurement

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is a measure as at a specific date and may be significantly different from the amount which will actually be paid or received on maturity or settlement date.

 

Wherever possible, fair values have been calculated using unadjusted quoted market prices in active markets for identical instruments held by the Group. Where quoted market prices are not available, or are unreliable because of poor liquidity, fair values have been determined using valuation techniques which, to the extent possible, use market observable inputs, but in some cases use non-market observable inputs. Valuation techniques used include discounted cash flow analysis and pricing models and, where appropriate, comparison to instruments with characteristics similar to those of the instruments held by the Group.

 

The Group manages valuation adjustments for its derivative exposures on a net basis; the Group determines their fair values on the basis of their net exposures. In all other cases, fair values of financial assets and liabilities measured at fair value are determined on the basis of their gross exposures.

 

The carrying amount of the following financial instruments is a reasonable approximation of fair value: cash and balances at central banks, items in the course of collection from banks, items in course of transmission to banks, notes in circulation and liabilities arising from non-participating investment contracts.

 

Because a variety of estimation techniques are employed and significant estimates made, comparisons of fair values between financial institutions may not be meaningful. Readers of these financial statements are thus advised to use caution when using this data to evaluate the Group’s financial position.

 

Fair value information is not provided for items that are not financial instruments or for other assets and liabilities which are not carried at fair value in the Group’s consolidated balance sheet. These items include intangible assets, such as the value of the Group’s branch network, the long-term relationships with depositors and credit card relationships; premises and equipment; and shareholders’ equity. These items are material and accordingly the Group believes that the fair value information presented does not represent the underlying value of the Group.

F-75

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Note 49:Financial instruments continued

 

VALUATION CONTROL FRAMEWORK

 

The key elements of the control framework for the valuation of financial instruments include model validation, product implementation review and independent price verification. These functions are carried out by appropriately skilled risk and finance teams, independent of the business area responsible for the products.

 

Model validation covers both qualitative and quantitative elements relating to new models. In respect of new products, a product implementation review is conducted pre- and post-trading. Pre-trade testing ensures that the new model is integrated into the Group’s systems and that the profit and loss and risk reporting are consistent throughout the trade life cycle. Post-trade testing examines the explanatory power of the implemented model, actively monitoring model parameters and comparing in-house pricing to external sources. Independent price verification procedures cover financial instruments carried at fair value. The frequency of the review is matched to the availability of independent data, monthly being the minimum. Valuation differences in breach of established thresholds are escalated to senior management. The results from independent pricing and valuation reserves are reviewed monthly by senior management.

 

Formal committees, consisting of senior risk, finance and business management, meet at least quarterly to discuss and approve valuations in more judgemental areas, in particular for unquoted equities, structured credit, over-the-counter options and the Credit Valuation Adjustment (CVA) reserve.

 

VALUATION OF FINANCIAL ASSETS AND LIABILITIES

 

Assets and liabilities carried at fair value or for which fair values are disclosed have been classified into three levels according to the quality and reliability of information used to determine the fair values.

 

LevelLEVEL 1

Level 1 fair value measurements are those derived from unadjusted quoted prices in active markets for identical assets or liabilities. Products classified as level 1 predominantly comprise equity shares, treasury bills and other government securities.

 

LevelLEVEL 2

Level 2 valuations are those where quoted market prices are not available, for example where the instrument is traded in a market that is not considered to be active or valuation techniques are used to determine fair value and where these techniques use inputs that are based significantly on observable market data. Examples of such financial instruments include most over-the-counter derivatives, financial institution issued securities, certificates of deposit and certain asset-backed securities.

 

LevelLEVEL 3

Level 3 portfolios are those where at least one input which could have a significant effect on the instrument’s valuation is not based on observable market data. Such instruments would include the Group’s venture capital and unlisted equity investments which are valued using various valuation techniques that require significant management judgement in determining appropriate assumptions, including earnings multiples and estimated future cash flows. Certain of the Group’s asset-backed securities and derivatives, principally where there is no trading activity in such securities, are also classified as level 3.

 

Transfers out of the level 3 portfolio arise when inputs that could have a significant impact on the instrument’s valuation become market observable after previously having been non-market observable. In the case of asset-backed securities this can arise if more than one consistent independent source of data becomes available. Conversely transfers into the portfolio arise when consistent sources of data cease to be available.

F-75F-76

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NoteNOTE 50: FINANCIAL INSTRUMENTS 49:Financial instruments continued

 

(3) FINANCIAL ASSETS AND LIABILITIES CARRIED AT FAIR VALUEFinancial assets and liabilities carried at fair value

(A) FINANCIAL ASSETS, EXCLUDING DERIVATIVES

 

Valuation hierarchyVALUATION HIERARCHY

At 31 December 2015,2018, the Group’s financial assets carried at fair value, excluding derivatives, totalled £173,568£183,344 million (31 December 2014: £208,4242017: £204,976 million). The table below analyses these financial assets by balance sheet classification, asset type and valuation methodology (level 1, 2 or 3, as described on page F-75)F-76). The fair value measurement approach is recurring in nature. There were no significant transfers between level 1 and 2 during the year.

 

VALUATION HIERARCHY

  Level 1  Level 2  Level 3  Total 
  £m  £m  £m  £m 
At 31 December 2015                
Trading and other financial assets at fair value through profit or loss                
Loans and advances to customers  –   30,109   –   30,109 
Loans and advances to banks  –   3,065   –   3,065 
Debt securities:                
Government securities  20,881   1,235   1   22,117 
Other public sector securities  –   759   1,280   2,039 
Bank and building society certificates of deposit  –   135   –   135 
Asset-backed securities:                
Mortgage-backed securities  –   1,295   63   1,358 
Other asset-backed securities  –   839   8   847 
Corporate and other debt securities  38   18,241   2,037   20,316 
   20,919   22,504   3,389   46,812 
Equity shares  58,457   292   1,727   60,476 
Treasury and other bills  74   –   –   74 
Total trading and other financial assets at fair value through profit or loss  79,450   55,970   5,116   140,536 
Available-for-sale financial assets                
Debt securities:                
Government securities  25,259   70   –   25,329 
Bank and building society certificates of deposit  –   186   –   186 
Asset-backed securities:                
Mortgage-backed securities  –   197   –   197 
Other asset-backed securities  –   264   55   319 
Corporate and other debt securities  7   5,801   –   5,808 
   25,266   6,518   55   31,839 
Equity shares  43   521   629   1,193 
Treasury and other bills  –   –   –   – 
Total available-for-sale financial assets  25,309   7,039   684   33,032 
Total financial assets carried at fair value, excluding derivatives  104,759   63,009   5,800   173,568 
F-76

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSValuation hierarchy

 

NOTE 50: FINANCIAL INSTRUMENTS continued

 Level 1 Level 2 Level 3 Total  Level 1
£m		 Level 2
£m		 Level 3
£m		 Total
£m		 
 £m £m £m £m 
At 31 December 2014                
Trading and other financial assets at fair value through profit or loss                
At 31 December 2018                
Financial assets at fair value through profit or loss                
Loans and advances to customers  –   28,513   –   28,513   –   27,285   10,565   37,850 
Loans and advances to banks  –   8,212   –   8,212   –   3,026   –   3,026 
Debt securities:                                
Government securities  23,950   1,523   –   25,473   17,926   169   –   18,095 
Other public sector securities  –   781   1,389   2,170   –   2,064   –   2,064 
Bank and building society certificates of deposit  –   554   –   554   84   1,021   –   1,105 
Asset-backed securities:                                
Mortgage-backed securities  24   963   47   1,034   –   219   6   225 
Other asset-backed securities  1   849   –   850   –   231   118   349 
Corporate and other debt securities  255   19,814   2,021   22,090   –   16,840   1,470   18,310 
  24,230   24,484   3,457   52,171   18,010   20,544   1,594   40,148 
Treasury and other bills  20   –   –   20 
Equity shares  59,607   322   1,647   61,576   75,701   26   1,758   77,485 
Treasury and other bills  1,459   –   –   1,459 
Total trading and other financial assets at fair value through profit or loss  85,296   61,531   5,104   151,931 
Available-for-sale financial assets                
Total financial assets at fair value through profit or loss  93,731   50,881   13,917   158,529 
Financial assets at fair value through other comprehensive income                
Debt securities:                                
Government securities  47,402   –   –   47,402   18,847   124   –   18,971 
Bank and building society certificates of deposit  –   298   –   298   –   118   –   118 
Asset-backed securities:                                
Mortgage-backed securities  –   674   –   674   –   –   120   120 
Other asset-backed securities  –   685   –   685   –   5   126   131 
Corporate and other debt securities  35   5,494   –   5,529   32   5,119   –   5,151 
  47,437   7,151   –   54,588   18,879   5,366   246   24,491 
Treasury and other bills  303   –   –   303 
Equity shares  45   727   270   1,042   –   –   21   21 
Treasury and other bills  852   11   –   863 
Total available-for-sale financial assets  48,334   7,889   270   56,493 
Total financial assets at fair value through other comprehensive income  19,182   5,366   267   24,815 
Total financial assets carried at fair value, excluding derivatives  133,630   69,420   5,374   208,424   112,913   56,247   14,184   183,344 
F-77

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 50:49: FINANCIAL INSTRUMENTS continued

 

  Level 1
£m		  Level 2
£m		  Level 3
£m		  Total
£m		 
At 31 December 2017            
Financial assets at fair value through profit or loss            
Loans and advances to customers  –   29,976   –   29,976 
Loans and advances to banks  –   1,614   –   1,614 
Debt securities:                
Government securities  20,268   1,729   23   22,020 
Other public sector securities  –   1,526   1   1,527 
Bank and building society certificates of deposit  –   222   –   222 
Asset-backed securities:                
Mortgage-backed securities  3   348   49   400 
Other asset-backed securities  5   229   787   1,021 
Corporate and other debt securities  –   18,542   1,448   19,990 
   20,276   22,596   2,308   45,180 
Treasury and other bills  18   –   –   18 
Equity shares  84,694   18   1,378   86,090 
Total trading and other financial assets at fair value through profit or loss  104,988   54,204   3,686   162,878 
Available-for-sale financial assets                
Debt securities:                
Government securities  34,534   174   –   34,708 
Bank and building society certificates of deposit  –   167   –   167 
Asset-backed securities:                
Mortgage-backed securities  –   1,156   –   1,156 
Other asset-backed securities  –   163   92   255 
Corporate and other debt securities  229   4,386   –   4,615 
   34,763   6,046   92   40,901 
Equity shares  555   38   604   1,197 
Total available-for-sale financial assets  35,318   6,084   696   42,098 
Total financial assets carried at fair value, excluding derivatives  140,306   60,288   4,382   204,976 

Movements in Level

MOVEMENTS IN LEVEL 3 portfolioPORTFOLIO

The table below analyses movements in level 3 financial assets, excluding derivatives, carried at fair value (recurring measurement).

 

 2015  2014    2018 2017
 Trading and
other financial
assets at fair
value through
profit or loss
£m		 Available-
for-sale
£m		 Total level 3
assets carried
at fair value,
excluding
derivatives
(recurring basis)
£m		  Trading and other
financial assets at
fair value through
profit or loss
£m		 Available-
for-sale
£m		 Total level 3
assets carried
at fair value,
excluding
derivatives
(recurring basis)
£m		  Financial
assets at fair
value through
profit or loss
£m		 At fair value
through other
comprehensive
income
£m		 Available-
for-sale
£m		 Total level 3
assets carried
at fair value,
excluding
derivatives
(recurring basis)
£m		  Financial assets
at fair value
through profit or
loss
£m		 Available-
for-sale
£m		 Total level 3
assets carried at
fair value,
excluding
derivatives
(recurring basis)
£m		 
At 31 December 2017  3,686       696   4,382             
Adjustment on adoption of IFRS 9 (note 54)  10,466   302   (696)  10,072             
At 1 January  5,104   270   5,374   4,232   449   4,681   14,152   302       14,454   3,806   894   4,700 
Exchange and other adjustments  –   –   –   5   (7)  (2)  87   (2)      85   (1)  (24)  (25)
Gains recognised in the income statement within other income  192   –   192   579   –   579   439   –       439   202   –   202 
Gains recognised in other comprehensive income within the revaluation reserve in respect of available-for-sale financial assets  –   302   302   –   (61)  (61)
Purchases  965   68   1,033   552   229   781 
(Losses) gains recognised in other comprehensive income within the revaluation reserve in respect of financial assets at fair value through other comprehensive income (2017: available-for-sale financial assets)  –   (4)      (4)  –   (117)  (117)
Purchases/increases to customer loans  2,480   2       2,482   774   41   815 
Sales  (1,070)  (11)  (1,081)  (587)  (266)  (853)  (3,593)  (95)      (3,688)  (1,005)  (61)  (1,066)
Transfers into the level 3 portfolio  71   55   126   708   –   708   815   348       1,163   152   2   154 
Transfers out of the level 3 portfolio  (146)  –   (146)  (385)  (74)  (459)  (463)  (284)      (747)  (242)  (39)  (281)
At 31 December  5,116   684   5,800   5,104   270   5,374   13,917   267       14,184   3,686   696   4,382 
Gains recognised in the income statement, within other income, relating to the change in fair value of those assets held at 31 December  34   –   34   547   –   547 
Gains (losses) recognised in the income statement, within other income, relating to the change in fair value of those assets held at 31 December  (104)  –       (104)  125   –   125 
F-78

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

Valuation methodology for financial assets, excluding derivativesNOTE 49: FINANCIAL INSTRUMENTScontinued

LOANS AND ADVANCES TO CUSTOMERS AND BANKS

VALUATION METHODOLOGY FOR FINANCIAL ASSETS, EXCLUDING DERIVATIVES

Loans and advances to customers and banks

 

These assets are principally reverse repurchase agreements. The fair value of these assets is determined using discounted cash flow techniques. The discount rates are derived from observable repo curves specific to the type of security purchased under the reverse repurchase agreement.

 

DEBT SECURITIESDebt securities

 

Debt securities measured at fair value and classified as level 2 are valued by discounting expected cash flows using an observable credit spread applicable to the particular instrument.

 

Where there is limited trading activity in debt securities, the Group uses valuation models, consensus pricing information from third party pricing services and broker or lead manager quotes to determine an appropriate valuation. Debt securities are classified as level 3 if there is a significant valuation input that cannot be corroborated through market sources or where there are materially inconsistent values for an input. Asset classes classified as level 3 mainly comprise certain collateralised loan obligations and collateralised debt obligations.

 

EQUITY INVESTMENTSEquity investments

Unlisted equity and fund investments are valued using different techniques in accordance with the Group’s valuation policy and International Private Equity and Venture Capital Guidelines.

 

Depending on the business sector and the circumstances of the investment, unlisted equity valuations are based on earnings multiples, net asset values or discounted cash flows.

 

–A number of earnings multiples are used in valuing the portfolio including price earnings, earnings before interest and tax and earnings before interest, tax, depreciation and amortisation. The particular multiple selected being appropriate for the type of business being valued and is derived by reference to the current market-based multiple. Consideration is given to the risk attributes, growth prospects and financial gearing of comparable businesses when selecting an appropriate multiple.
  
–Discounted cash flow valuations use estimated future cash flows, usually based on management forecasts, with the application of appropriate exit yields or terminal multiples and discounted using rates appropriate to the specific investment, business sector or recent economic rates of return. Recent transactions involving the sale of similar businesses may sometimes be used as a frame of reference in deriving an appropriate multiple.
  
–For fund investments the most recent capital account value calculated by the fund manager is used as the basis for the valuation and adjusted, if necessary, to align valuation techniques with the Group’s valuation policy.

 

Unlisted equity investments and investments in property partnerships held in the life assurance funds are valued using third party valuations. Management take account of any pertinent information, such as recent transactions and information received on particular investments, to adjust the third party valuations where necessary.

F-78

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 50: FINANCIAL INSTRUMENTS continued

 

(B) FINANCIAL LIABILITIES, EXCLUDING DERIVATIVES

 

Valuation hierarchyVALUATION HIERARCHY

At 31 December 2015,2018, the Group’s financial liabilities carried at fair value, excluding derivatives, comprised its financial liabilities at fair value through profit or loss and totalled £51,911£30,547 million (31 December 2014: £62,1532017: £50,877 million). The table below analyses these financial liabilities by balance sheet classification and valuation methodology (level 1, 2 or 3, as described on page F-75)F-76). The fair value measurement approach is recurring in nature. There were no significant transfers between level 1 and 2 during the year.

 

 Level 1 Level 2 Level 3 Total
 £m £m £m £m
At 31 December 2015       
Trading and other financial liabilities at fair value through profit or loss       
Liabilities held at fair value through profit or loss– 7,878 1 7,879
Trading liabilities:       
Liabilities in respect of securities sold under repurchase agreements– 38,431 – 38,431
Short positions in securities4,153 287 – 4,440
Other– 1,113 – 1,113
 4,153 39,831 – 43,984
Total trading and other financial liabilities at fair value through profit or loss4,153 47,709 1 51,863
Financial guarantees– – 48 48
Total financial liabilities carried at fair value, excluding derivatives4,153 47,709 49 51,911
At 31 December 2014       
Trading and other financial liabilities at fair value through profit or loss       
Liabilities held at fair value through profit or loss– 6,739 5 6,744
Trading liabilities:       
Liabilities in respect of securities sold under repurchase agreements– 50,007 – 50,007
Short positions in securities2,700 519 – 3,219
Other– 2,132 – 2,132
 2,700 52,658 – 55,358
Total trading and other financial liabilities at fair value through profit or loss2,700 59,397 5 62,102
Financial guarantees– – 51 51
Total financial liabilities carried at fair value, excluding derivatives2,700 59,397 56 62,153

The table below analyses movements in the level 3 financial liabilities portfolio, excluding derivatives. There were no transfers into or out of Level 3 during 2014 or 2015

  2015  2014 
        Total level 3          
  Trading and     financial  Trading and other     Total level 3 
  other financial     liabilities carried  financial liabilities     financial liabilities 
  liabilities at fair     at fair value,  at fair value     carried at fair 
  value through  Financial  excluding  through profit  Financial  value, excluding 
  profit or loss  guarantees  derivatives  or loss  guarantees  derivatives 
  £m  £m  £m  £m  £m  £m 
At 1 January  5   51   56   39   50   89 
Losses (gains) recognised in the income statement within other income  –   (3)  (3)  (5)  1   (4)
Redemptions  (4)  –   (4)  (29)  –   (29)
At 31 December  1   48   49   5   51   56 
Gains (losses) recognised in the income statement, within other income, relating to the change in fair value of those liabilities held at 31 December  –   3   3   –   1   1 
  Level 1
£m		  Level 2
£m		  Level 3
£m		  Total
£m		 
At 31 December 2018                
Financial liabilities at fair value through profit or loss                
Liabilities held at fair value through profit or loss  –   7,085   11   7,096 
Trading liabilities:                
Liabilities in respect of securities sold under repurchase agreements  –   21,595   –   21,595 
Other deposits  –   242   –   242 
Short positions in securities  1,464   150   –   1,614 
   1,464   21,987   –   23,451 
Total financial liabilities carried at fair value, excluding derivatives  1,464   29,072   11   30,547 
At 31 December 2017                
Financial liabilities at fair value through profit or loss                
Liabilities held at fair value through profit or loss  3   7,812   –   7,815 
Trading liabilities:                
Liabilities in respect of securities sold under repurchase agreements  –   41,378   –   41,378 
Other deposits  –   381   –   381 
Short positions in securities  1,106   197   –   1,303 
   1,106   41,956   –   43,062 
Total financial liabilities carried at fair value, excluding derivatives  1,109   49,768   –   50,877 
F-79

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 50:49: FINANCIAL INSTRUMENTS continued

The table below analyses movements in the level 3 financial liabilities portfolio, excluding derivatives.

  2018
£m		  2017
£m		 
At 1 January  –   2 
Losses (gains) recognised in the income statement within other income  –   (2)
Redemptions  –   – 
Transfers into the level 3 portfolio  11   – 
Transfers out of the level 3 portfolio  –   – 
At 31 December  11   – 
Gains recognised in the income statement, within other income, relating to the change in fair value of those liabilities held at 31 December  –   – 

 

VALUATION METHODOLOGY FOR FINANCIAL LIABILITIES, EXCLUDING DERIVATIVES

 

Liabilities held at fair value through profit or loss

These principally comprise debt securities in issue which are classified as level 2 and their fair value is determined using techniques whose inputs are based on observable market data. The carrying amount of the securities is adjusted to reflect the effect of changes in own credit spreads. Thespreads and the resulting gain or loss is recognised in the income statement.other comprehensive income.

 

At 31 December 2015,2018, the own credit adjustment arising from the fair valuation of £7,878£7,085 million (2014: £6,739(2017: £7,812 million) of the Group’s debt securities in issue designated at fair value through profit or loss resulted in a gain of £114£533 million (2014: gain(2017: loss of £33£55 million)., before tax, recognised in other comprehensive income.

 

Trading liabilities isin respect of securititessecurities sold under repurchase agreements.agreements

The fair value of these liabilities is determined using discounted cash flow techniques. The discount rates are derived from observable repo curves specific to the type of security sold under the repurchase agreement.

 

(C) DERIVATIVES

 

All of the Group’s derivative assets and liabilities are carried at fair value. At 31 December 2015,2018, such assets totalled £29,467£23,595 million (31 December 2014: £36,1282017: £25,834 million) and liabilities totalled £26,301£21,373 million (31 December 2014: £33,1872017: £26,124 million). The table below analyses these derivative balances by valuation methodology (level 1, 2 or 3, as described on page F-75)F-76). The fair value measurement approach is recurring in nature. There were no significant transfers between level 1 and level 2 during the year.

 

 2015  2014 
 Level 1 Level 2 Level 3 Total  Level 1 Level 2 Level 3 Total  2018 2017
 £m £m £m £m  £m £m £m £m  Level 1
£m		 Level 2
£m		 Level 3
£m		 Total
£m		  Level 1
£m		 Level 2
£m		 Level 3
£m		 Total
£m		 
Derivative assets  43   27,955   1,469   29,467   94   33,263   2,771   36,128   93   22,575   927   23,595   246   24,532   1,056   25,834 
Derivative liabilities  (41)  (25,537)  (723)  (26,301)  (68)  (31,663)  (1,456)  (33,187)  (132)  (20,525)  (716)  (21,373)  (587)  (24,733)  (804)  (26,124)

 

Where the Group’s derivative assets and liabilities are not traded on an exchange, they are valued using valuation techniques, including discounted cash flow and options pricing models, as appropriate. The types of derivatives classified as level 2 and the valuation techniques used include:

 

–Interest rate swaps which are valued using discounted cash flow models; the most significant inputs into those models are interest rate yield curves which are developed from publicly quoted rates.
  
–Foreign exchange derivatives that do not contain options which are priced using rates available from publicly quoted sources.
  
–Credit derivatives which are valued using standard models with observable inputs, except for the items classified as level 3, which are valued using publicly available yield and credit default swap (CDS) curves.
  
–Less complex interest rate and foreign exchange option products which are valued using volatility surfaces developed from publicly available interest rate cap, interest rate swaption and other option volatilities; option volatility skew information is derived from a market standard consensus pricing service. For more complex option products, the Group calibrates its models using observable at-the-money data; where necessary, the Group adjusts for out-of-the-money positions using a market standard consensus pricing service.

 

Complex interest rate and foreign exchange products where there is significant dispersion of consensus pricing or where implied funding costs are material and unobservable are classified as level 3.

 

Where credit protection, usually in the form of credit default swaps, has been purchased or written on asset-backed securities, the security is referred to as a negative basis asset-backed security and the resulting derivative assets or liabilities have been classified as either level 2 or level 3 according to the classification of the underlying asset-backed security.

 

The Group’s level 3 derivative assets include £545 million (2014: £646 million)Certain unobservable inputs are used to calculate CVA, FVA, and own credit adjustments, but are not considered significant in respectdetermining the classification of the valuederivative and debt portfolios. Consequently, those inputs do not form part of the embedded equity conversion feature of the Enhanced Capital Notes issued in December 2009. The embedded equity conversion feature is valued by comparing the market price of the Enhanced Capital Notes with the market price of similar bonds without the conversion feature. The latter is calculated by discounting the expected Enhanced Capital Note cash flows in the absence of a conversion using prevailing market yields for similar capital securities without the conversion feature. The market price of the Enhanced Capital Notes was calculated with reference to multiple broker quotes.Level 3 sensitivities presented.

F-80

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 50:49: FINANCIAL INSTRUMENTS continued

 

The table below analyses movements in level 3 derivative assets and liabilities carried at fair value. Following changes in the valuation methodology in 2015, uncollateralised inflation swaps are considered not to have significant unobservable inputs and have been transferred from level 3 to level 2.

 

 2015  2014 
 Derivative Derivative  Derivative Derivative 
 assets liabilities  assets liabilities  2018 2017
 £m £m  £m £m  Derivative
assets
£m		 Derivative
liabilities
£m		  Derivative
assets
£m		 Derivative
liabilities
£m		 
At 1 January  2,771   (1,456)  3,019   (986)  1,056   (804)  1,399   (960)
Exchange and other adjustments  (25)  18   (11)  4   7   (5)  24   (20)
Gains (losses) recognised in the income statement within other income  (87)  (36)  755   (375)
Losses (gains) recognised in the income statement within other income  (84)  49   (208)  215 
Purchases (additions)  72   (74)  68   (59)  –   (68)  103   (18)
(Sales) redemptions  (125)  120   (154)  66   (52)  112   (79)  53 
Derecognised pursuant to exchange and retail tender offers in respect of Enhanced Capital Notes  –   –   (967)  – 
Transfers into the level 3 portfolio  126   (114)  114   (110)  –   –   33   (74)
Transfers out of the level 3 portfolio  (1,263)  819   (53)  4   –   –   (216)  – 
At 31 December  1,469   (723)  2,771   (1,456)  927   (716)  1,056   (804)
Gains (losses) recognised in the income statement, within other income, relating to the change in fair value of those assets or liabilities held at 31 December  (95)  (12)  755   (376)  (424)  82   (208)  213 

 

DERIVATIVE VALUATION ADJUSTMENTS

 

Derivative financial instruments which are carried in the balance sheet at fair value are adjusted where appropriate to reflect credit risk, market liquidity and other risks.

 

(i)Uncollateralised derivative valuation adjustments, excluding monoline counterparties

(i) Uncollateralised derivative valuation adjustments, excluding monoline counterparties

The following table summarises the movement on this valuation adjustment account during 20152017 and 2014:2018:

 

   2015   2014 
   £m   £m 
At 1 January  608   498 
Income statement (credit) charge  (38)  95 
Transfers  28   15 
At 31 December  598   608 
         
Represented by:        
   2015   2014 
   £m   £m 
Credit Valuation Adjustment  511   568 
Debit Valuation Adjustment  (78)  (85)
Funding Valuation Adjustment  165   125 
   598   608 
  2018
£m		  2017
£m		 
At 1 January  521   744 
Income statement charge (credit)  47   (260)
Transfers  (6)  37 
At 31 December  562   521 

Represented by:

  2018
£m		  2017
£m		 
Credit Valuation Adjustment  409   408 
Debit Valuation Adjustment  (79)  (37)
Funding Valuation Adjustment  232   150 
   562   521 

 

Credit and Debit Valuation Adjustments (CVA and DVA) are applied to the Group’s over-the-counter derivative exposures with counterparties that are not subject to standard interbank collateral arrangements. These exposures largely relate to the provision of risk management solutions for corporate customers within the Commercial Banking division.

 

A CVA is taken where the Group has a positive future uncollateralised exposure (asset). A DVA is taken where the Group has a negative future uncollateralised exposure (liability). These adjustments reflect interest rates and expectations of counterparty creditworthiness and the Group’s own credit spread respectively.

 

The CVA is sensitive to:

 

–the current size of the mark-to-market position on the uncollateralised asset;
  
–expectations of future market volatility of the underlying asset; and
  
–expectations of counterparty creditworthiness.

 

In circumstances where exposures to a counterparty become impaired, any associated derivative valuation adjustment is transferred and assessed for specific loss alongside other non-derivative assets and liabilities that the counterparty may have with the Group.

 

Market Credit Default Swap (CDS) spreads are used to develop the probability of default for quoted counterparties. For unquoted counterparties, internal credit ratings and market sector CDS curves and recovery rates are used. The Loss Given Default (LGD) is based on market recovery rates and internal credit assessments.

 

The combination of a one notch deterioration in the credit rating of derivative counterparties and a ten per cent increase in LGD increases the CVA by £99£89 million. Current market value is used to estimate the projected exposure for products not supported by the model, which are principally complex interest rate options that are traded in very low volumes. For these, the CVA is calculated on an add-on basis (in total contributing £2 million of the overall CVA balance(although no such adjustment was required at 31 December 2015)2018).

F-81

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 50: FINANCIAL INSTRUMENTS continued

 

The DVA is sensitive to:

 

–the current size of the mark-to-market position on the uncollateralised liability;
  
–expectations of future market volatility of the underlying liability; and
  
–the Group’s own CDS spread.
F-81

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 49: FINANCIAL INSTRUMENTS continued

 

A one per cent rise in the CDS spread would lead to an increase in the DVA of £122£67 million to £200£146 million.

 

The risk exposures that are used for the CVA and DVA calculations are strongly influenced by interest rates. Due to the nature of the Group’s business the CVA/DVA exposures tend to be on average the same way around such that the valuation adjustments fall when interest rates rise. A 1one per cent rise in interest rates would lead to a £200£108 million fall in the overall valuation adjustment to £233£222 million. The CVA model used by the Group does not assume any correlation between the level of interest rates and default rates.

 

The Group has also recognised a Funding Valuation Adjustment to adjust for the net cost of funding uncollateralised derivative positions. This adjustment is calculated on the expected future exposure discounted at a suitable cost of funds. A ten basis points increase in the cost of funds will increase the funding valuation adjustment by approximately £30£23 million.

 

(ii) Market liquidity

The Group includes mid to bid-offer valuation adjustments against the expected cost of closing out the net market risk in the Group’s trading positions within a timeframe that is consistent with historical trading activity and spreads that the trading desks have accessed historically during the ordinary course of business in normal market conditions.

 

At 31 December 2015,2018, the Group’s derivative trading business held mid to bid-offer valuation adjustments of £76£80 million (2014:(2017: £74 million).

F-82

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 50: FINANCIAL INSTRUMENTS continued

 

(D) SENSITIVITY OF LEVEL 3 VALUATIONS

      At 31 December 2015 At 31 December 2014
        Effect of reasonably
possible
alternative assumptions2		   Effect of reasonably
possible
alternative assumptions2
  Valuation techniques Significant unobservable
inputs1		 Carrying
value
£m		 Favourable
changes
£m		 Unfavourable
changes
£m		 Carrying
value
£m		 Favourable
changes
£m		 Unfavourable
changes
£m
Trading and other financial assets at fair value through profit or loss              
Debt securities Discounted cash flows Credit spreads (bps) (168bps/211bps) 92 7 (7)35 5 (5)
Asset-backed securities Lead manager or broker quote n/a 62 – – 65 – (2)
Equity and venture capital investments Market approach Earnings multiple (1.0/17.5) 2,279 72 (72)2,214 75 (75)
  Underlying asset/net asset value (incl. property prices)3 n/a 145 8 (14)173 26 (23)
Unlisted equities and debt securities, property partnerships in the life funds Underlying asset/net asset value (incl. property prices)3 n/a 2,538 – (48)2,617 4 (2)
      5,116     5,104    
Available-for-sale financial assets              
Asset-backed securities Lead manager or broker quote/consensus pricing n/a 55 – – – – –
Equity and venture capital investments Underlying asset/net asset value (incl. property prices)3 n/a 339 25 (27)270 10 (18)
Other��Various n/a 290 – – – – –
      684     270    
Derivative financial assets              
Embedded equity conversion feature Lead manager or broker quote Equity conversion feature spread (171 bps/386 bps) 545 14 (14)646 21 (21)
Interest rate derivatives Discounted cash flow Inflation swap rate – funding component (55 bps/107bps) – – – 1,382 17 (16)
  Option pricing model Interest rate volatility (1%/63%) 924 20 (19)743 6 (6)
      1,469     2,771    
Level 3 financial assets carried at fair value   7,269     8,145    
Trading and other financial liabilities at fair value through profit or loss   1 – – 5 – –
Derivative financial liabilities              
Interest rate derivatives Discounted cash flow Inflation swap rate – funding component (55 bps/107 bps) – – – 807 – –
  Option pricing model Interest rate volatility (1%/63%) 723 – – 649 – –
      723     1,456    
Financial guarantees     48     51    
Level 3 financial liabilities carried at fair value   772     1,512    

      At 31 December 2018 At 31 December 2017
         Effect of reasonably possible
alternative assumptions2		     Effect of reasonably possible
alternative assumptions2
  Valuation techniques Significant unobservable
inputs1		 Carrying
value
£m		  Favourable
 changes
£m		  Unfavourable
changes
£m		  Carrying
value
£m		  Favourable
changes
£m		  Unfavourable
changes
£m		 
Financial assets at fair value through profit or loss                          
Loans and advances to customers Discounted cash flows Gross interest rates, inferred spreads (bps) 97bps/208bps  10,565   380   (371)  –   –   – 
Debt securities Discounted cash flows Credit spreads (bps) (1bps/2bps)  274   92   (21)  11   –   – 
Equity and venture capital investments Market approach Earnings multiple (0.9/14.6)  1,657   54   (55)  1,879   65   (65)
  Underlying asset/net asset value (incl. property prices)3 n/a  523   48   (57)  50   5   (5)
Unlisted equities, debt securities and property partnerships in the life funds Underlying asset/net asset value (incl. property prices), broker quotes or discounted cash flows3 n/a  898   2   (45)  1,746   26   (76)
       13,917           3,686         
Financial assets at fair value through other comprehensive income/available-for-sale financial assets                          
Asset-backed securities Lead manager or broker quote/consensus pricing n/a  246   3   (5)  92   –   (4)
Equity and venture capital investments Underlying asset/net asset value (incl. property prices)3 n/a  21   2   (2)  604   83   (42)
       267           696         
Derivative financial assets                          
Interest rate derivatives Option pricing model Interest rate volatility (19%/80%)  927   7   (5)  1,056   11   (3)
       927           1,056         
Level 3 financial assets carried at fair value    15,111           5,438         
Financial liabilities at fair value through profit or loss    11   –   –   –   –   – 
Derivative financial liabilities                          
Interest rate derivatives Option pricing model Interest rate volatility (19%/80%)  716   –   –   804   –   – 
       716           804         
Level 3 financial liabilities carried at fair value  727           804         

 

1Ranges are shown where appropriate and represent the highest and lowest inputs used in the level 3 valuations.
  
2Where the exposure to an unobservable input is managed on a net basis, only the net impact is shown in the table.
  
3Underlying asset/net asset values represent fair value.
F-83F-82

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 50:49: FINANCIAL INSTRUMENTS continued

 

Unobservable inputs UNOBSERVABLE INPUTS

Significant unobservable inputs affecting the valuation of debt securities, unlisted equity investments and derivatives are as follows:

 

–Interest rates and inflation rates are referenced in some derivatives where the payoff that the holder of the derivative receives depends on the behaviour of those underlying references through time.
  
–Credit spreads represent the premium above the benchmark reference instrument required to compensate for lower credit quality; higher spreads lead to a lower fair value.
  
–Volatility parameters represent key attributes of option behaviour; higher volatilities typically denote a wider range of possible outcomes.
  
–Earnings multiples are used to value certain unlisted equity investments; a higher earnings multiple will result in a higher fair value.

 

Reasonably possible alternative assumptionsREASONABLY POSSIBLE ALTERNATIVE ASSUMPTIONS

Valuation techniques applied to many of the Group’s level 3 instruments often involve the use of two or more inputs whose relationship is interdependent. The calculation of the effect of reasonably possible alternative assumptions included in the table above reflects such relationships.

 

DEBT SECURITIESDebt securities

 

Reasonably possible alternative assumptions have been determined in respect of the Group’s structured credit investment by flexing credit spreads.

 

DERIVATIVESDerivatives

 

Reasonably possible alternative assumptions have been determined in respect of swaptions in the Group’s derivative portfolios as follows:which are priced using industry standard option pricing models. Such models require interest rate volatilities which may be unobservable at longer maturities. To derive reasonably possible alternative valuations these volatilities have been flexed within a range of 19 per cent to 80 per cent (2017: 9 per cent to 94 per cent).

 

–In respect of the embedded equity conversion feature of the Enhanced Capital Notes, the sensitivity was based on the absolute difference between the actual price of the enhanced capital note and the closest, alternative broker quote available plus the impact of applying a 10 bps increase/decrease in the market yield used to derive a market price for similar bonds without the conversion feature. The effect of interdependency of the assumptions is not material to the effect of applying reasonably possible alternative assumptions to the valuations of derivative financial instruments.
–Uncollateralised inflation swaps are valued using appropriate discount spreads for such transactions. These spreads are not generally observable for longer maturities. The reasonably possible alternative valuations reflect flexing of the spreads for the differing maturities to alternative values of between 55 bps and 107 bps (2014: 3 bps and 167 bps).
–Swaptions are priced using industry standard option pricing models. Such models require interest rate volatilities which may be unobservable at longer maturities. To derive reasonably possible alternative valuations these volatilities have been flexed within a range of 1 per cent to 63 per cent (2014: 4 per cent and 120 per cent).

UNLISTED EQUITY, VENTURE CAPITAL INVESTMENTS AND INVESTMENTS IN PROPERTY PARTNERSHIPSUnlisted equity, venture capital investments and investments in property partnerships

 

The valuation techniques used for unlisted equity and venture capital investments vary depending on the nature of the investment. Reasonably possible alternative valuations for these investments have been calculated by reference to the approach taken, as appropriate to the business sector and investment circumstances and as such the following inputs have been considered:

 

–for valuations derived from earnings multiples, consideration is given to the risk attributes, growth prospects and financial gearing of comparable businesses when selecting an appropriate multiple;
  
–the discount rates used in discounted cash flow valuations; and
  
–in line with International Private Equity and Venture Capital Guidelines, the values of underlying investments in fund investments portfolios.
F-84

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 50: FINANCIAL INSTRUMENTS continued(4) Financial assets and liabilities carried at amortised cost

(4) FINANCIAL ASSETS AND LIABILITIES CARRIED AT AMORTISED COST 

(A) FINANCIAL ASSETS

 

Valuation hierarchy VALUATION HIERARCHY

The table below analyses the fair values of the financial assets of the Group which are carried at amortised cost by valuation methodology (level 1, 2 or 3, as described on page F-75)F-76). Loans and receivablesFinancial assets carried at amortised cost are mainly classified as level 3 due to significant unobservable inputs used in the valuation models. Where inputs are observable, debt securities are classified as level 1 or 2.

 

      Valuation hierarchy      Valuation hierarchy
 Carrying value
£m		 Fair value
£m		 Level 1
£m		 Level 2
£m		 Level 3
£m		  Carrying value
£m		 Fair value
£m		 Level 1
£m		 Level 2
£m		 Level 3
£m		 
At 31 December 2015                    
Loans and receivables:                    
Loans and advances to customers: unimpaired  448,010   447,808   –   –   447,808 
Loans and advances to customers: impaired  7,165   6,989   –   –   6,989 
At 31 December 2018                    
Financial assets at amortised cost:                    
Loans and advances to customers: Stage 1  441,006   440,542   –   40,483   400,059 
Loans and advances to customers: Stage 2  24,351   25,516   –   –   25,516 
Loans and advances to customers: Stage 3  4,188   3,289   –   –   3,289 
Loans and advances to customers: purchased or originated credit-impaired  15,313   15,313   –   –   15,313 
Loans and advances to customers  455,175   454,797   –   –   454,797   484,858   484,660   –   40,483   444,177 
Loans and advances to banks  25,117   25,130   –   –   25,130   6,283   6,286   –   461   5,825 
Debt securities  4,191   4,107   7   4,090   10   5,238   5,244   –   5,233   11 
Held-to-maturity investments  19,808   19,851   19,851   –   – 
Reverse repos included in above amounts:                                        
Loans and advances to customers  –   –   –   –   –   40,483   40,483   –   40,483   – 
Loans and advances to banks  963   963   –   –   963   461   461   –   461   – 
At 31 December 2014                    
Loans and receivables:                    
At 31 December 2017                    
Financial assets at amortised cost:                    
Loans and advances to customers: unimpaired  473,947   472,036   –   –   472,036   467,670   467,276   –   16,832   450,444 
Loans and advances to customers: impaired  8,757   8,595   –   –   8,595   4,828   4,809   –   –   4,809 
Loans and advances to customers  482,704   480,631   –   –   480,631   472,498   472,085   –   16,832   455,253 
Loans and advances to banks  26,155   26,031   –   –   26,031   6,611   6,564   –   771   5,793 
Debt securities  1,213   1,100   7   1,050   43   3,643   3,586   –   3,571   15 
Reverse repos included in above amounts:                                        
Loans and advances to customers  5,148   5,148   –   –   5,148   16,832   16,832   –   16,832   – 
Loans and advances to banks  1,899   1,899   –   –   1,899   771   771   –   771   – 
F-83

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

Valuation methodologyNOTE 49: FINANCIAL INSTRUMENTScontinued

VALUATION METHODOLOGY

 

Loans and advances to customers

The Group provides loans and advances to commercial, corporate and personal customers at both fixed and variable rates due to their short term nature. The carrying value of the variable rate loans and those relating to lease financing is assumed to be their fair value.

 

To determine the fair value of loans and advances to customers, loans are segregated into portfolios of similar characteristics. A number of techniques are used to estimate the fair value of fixed rate lending; these take account of expected credit losses based on historic trends, prevailing market interest rates and expected future cash flows. For retail exposures, fair value is usually estimated by discounting anticipated cash flows (including interest at contractual rates) at market rates for similar loans offered by the Group and other financial institutions. Certain loans secured on residential properties are made at a fixed rate for a limited period, typically two to five years, after which the loans revert to the relevant variable rate. The fair value of such loans is estimated by reference to the market rates for similar loans of maturity equal to the remaining fixed interest rate period. The fair value of commercial loans is estimated by discounting anticipated cash flows at a rate which reflects the effects of interest rate changes, adjusted for changes in credit risk. No adjustment is made to put it in place by the Group to manage its interest rate exposure.

 

Loans and advances to banks

 

The carrying value of short dated loans and advances to banks is assumed to be their fair value. The fair value of loans and advances to banks is estimated by discounting the anticipated cash flows at a market discount rate adjusted for the credit spread of the obligor or, where not observable, the credit spread of borrowers of similar credit quality.

 

Debt securities

 

The fair values of debt securities which were previously within assets held for trading and were reclassified to loans and receivables, are determined predominantly from lead manager quotes and, where these are not available, by alternative techniques including reference to credit spreads on similar assets with the same obligor, market standard consensus pricing services, broker quotes and other research data.

 

Reverse repurchase agreements

 

The carrying amount is deemed a reasonable approximation of fair value given the short-term nature of these instruments.

F-85

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 50: FINANCIAL INSTRUMENTS continued

 

(B) FINANCIAL LIABILITIES

 

Valuation hierarchyVALUATION HIERARCHY

 

The table below analyses the fair values of the financial liabilities of the Group which are carried at amortised cost by valuation methodology (level 1, 2 or 3, as described on page F-75)F-76).

        Valuation hierarchy 
  Carrying value
£m		  Fair value
£m		  Level 1
£m		  Level 2
£m		  Level 3
£m		 
At 31 December 2015                    
Deposits from banks  16,925  ��16,934   –   16,934   – 
Customer deposits  418,326   418,512   –   407,417   11,095 
Debt securities in issue  82,056   85,093   –   81,132   3,961 
Subordinated liabilities  23,312   26,818   –   26,818   – 
Repos included in above amounts:                    
Deposits from banks  7,061   7,061   –   7,061   – 
Customer deposits  –   –   –   –   – 
At 31 December 2014                    
Deposits from banks  10,887   10,902   –   10,902   – 
Customer deposits  447,067   450,038   –   435,073   14,965 
Debt securities in issue  76,233   80,244   –   80,244   – 
Subordinated liabilities  26,042   30,175   –   30,175   – 
Repos included in above amounts:                    
Deposits from banks  1,075   1,075   –   1,075   – 
Customer deposits  –   –   –   –   – 

        Valuation hierarchy
  Carrying value
£m		  Fair value
£m		  Level 1
£m		  Level 2
£m		  Level 3
£m		 
At 31 December 2018                    
Deposits from banks  30,320   30,322   –   30,322   – 
Customer deposits  418,066   418,450   –   412,283   6,167 
Debt securities in issue  91,168   93,233   –   93,233   – 
Subordinated liabilities  17,656   19,564   –   19,564   – 
Repos included in above amounts:                    
Deposits from banks  21,170   21,170   –   21,170   – 
Customer deposits  1,818   1,818   –   1,818   – 
At 31 December 2017                    
Deposits from banks  29,804   29,798   –   29,798   – 
Customer deposits  418,124   418,441   –   411,591   6,850 
Debt securities in issue  72,450   75,756   –   75,756   – 
Subordinated liabilities  17,922   21,398   –   21,398   – 
Repos included in above amounts:                    
Deposits from banks  23,175   23,175   –   23,175   – 
Customer deposits  2,638   2,638   –   2,638   – 

 

Valuation methodologyVALUATION METHODOLOGY

 

Deposits from banks and customer deposits

The fair value of bank and customer deposits repayable on demand is assumed to be equal to their carrying value.

 

The fair value for all other deposits is estimated using discounted cash flows applying either market rates, where applicable, or current rates for deposits of similar remaining maturities.

 

Debt securities in issue

 

The fair value of short-term debt securities in issue is approximately equal to their carrying value. Fair value for other debt securities is calculated based on quoted market prices where available. Where quoted market prices are not available, fair value is estimated using discounted cash flow techniques at a rate which reflects market rates of interest and the Group’s own credit spread.

 

Subordinated liabilities

 

The fair value of subordinated liabilities is determined by reference to quoted market prices where available or by reference to quoted market prices of similar instruments. Subordinated liabilities are classified as level 2, since the inputs used to determine their fair value are largely observable.

 

Repurchase agreements

 

The carrying amount is deemed a reasonable approximation of fair value given the short term nature of these instruments.

(5) RECLASSIFICATION OF FINANCIAL ASSETS 

In 2015 the Group reviewed its approach to managing a portfolio of government securities held as a separately identifiable component of the Group’s liquidity portfolio. Given the long-term nature of this portfolio, the Group concluded that certain of these securities will be able to be held until they reach maturity. Consequently, on 1 May 2015, government securities with a fair value of £19,938 million were reclassified from available-for-sale financial assets to held-to-maturity investments reflecting the Group’s positive intent and ability to hold them until maturity.

No financial assets were reclassified in 2014. 

F-86F-84

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 51:49: FINANCIAL INSTRUMENTS continued

(5) Reclassifications of financial assets

Other than the reclassifications on adoption of IFRS 9 on 1 January 2018 (note 54), there have been no reclassifications of financial assets in 2017 or 2018.

NOTE 50: TRANSFERS OF FINANCIAL ASSETS

 

(1) TRANSFERRED FINANCIAL ASSETS THAT CONTINUE TO BE RECOGNISED IN FULL There were no significant transferred financial assets which were derecognised in their entirety, but with ongoing exposure. Details of transferred financial assets that continue to be recognised in full are as follows.

 

The Group enters into repurchase and securities lending transactions in the normal course of business that do not result in derecognition of the financial assets covered as substantially all of the risks and rewards, including credit, interest rate, prepayment and other price risks are retained by the Group. In all cases, the transferee has the right to sell or repledge the assets concerned.

 

As set out in note 19,30, included within loans and receivablesfinancial assets measured at amortised cost are loans transferred under the Group’s securitisation and covered bond programmes. As the Group retains all of a majority of the risks and rewards associated with these loans, including credit, interest rate, prepayment and liquidity risk, they remain on the Group’s balance sheet. Assets transferred into the Group’s securitisation and covered bond programmes are not available to be used by the Group whilst the assets are within the programmes. However, the Group retains the right to remove loans from the covered bond programmes where they are in excess of the programme’s requirements. In addition, where the Group has retained some of the notes issued by securitisation and covered bond programmes, the Group has the ability to sell or pledge these retained notes.

 

The table below sets out the carrying values of the transferred assets and the associated liabilities. For repurchase and securities lending transactions, the associated liabilities represent the Group’s obligation to repurchase the transferred assets. For securitisation programmes, the associated liabilities represent the external notes in issue (note 32)30). Except as otherwise noted below, none of the liabilities shown in the table below have recourse only to the transferred assets.

 

  2015  2014 
  Carrying
value of
transferred
assets
£m		  Carrying
value of
associated
liabilities
£m		  Carrying
value of
transferred
assets
£m		  Carrying
value of
associated
liabilities
£m		 
Repurchase and securities lending transactions                
Trading and other financial assets at fair value through profit or loss  13,711   7,460   16,803   6,673 
Available-for-sale financial assets  18,141   14,295   18,835   10,301 
Loans and receivables:                
Loans and advances to customers  1,491   –   2,353   908 
Debt securities classified as loans and receivables  –   –   88   – 
Securitisation programmes                
Loans and receivables:                
Loans and advances to customers1  58,090   7,763   75,970   11,908 
  2018 2017
  Carrying
value of
transferred
assets
£m		  Carrying
value of
associated
liabilities
£m		  Carrying
value of
transferred
assets
£m		  Carrying
value of
associated
liabilities
£m		 
Repurchase and securities lending transactions                
Financial assets at fair value through profit or loss  6,815   961   9,946   3,257 
Financial assets at fair value through other comprehensive income
(2017: available-for-sale financial assets)		  7,279   5,337   19,359   16,753 
Securitisation programmes                
Financial assets at amortised cost:                
Loans and advances to customers1  41,674   5,479   35,475   3,660 

 

1The carrying value of associated liabilities excludes securitisation notes held by the Group of £29,303£31,701 million (31 December 2014: £38,1492017: £21,536 million).

(2) TRANSFERRED FINANCIAL ASSETS DERECOGNISED IN THEIR ENTIRETY WITH ONGOING EXPOSURE

Transferred financial assets which were derecognised in their entirety, but with ongoing exposure, consisted of £9 million of debt securities (2014: £33 million) with a fair value of £9 million (2014: £33 million) and a maximum exposure to loss of £9 million (2014: £33 million). 

F-87F-85

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 52:51: OFFSETTING OF FINANCIAL ASSETS AND LIABILITIES

 

The following information relates to financial assets and liabilities which have been offset in the balance sheet and those which have not been offset but for which the Group has enforceable master netting agreements or collateral arrangements in place with counterparties.

 

             Related amounts where set            Related amounts where set off in
the balance sheet not permitted3		 Potential 
             off in the balance sheet not  Potential 
         permitted3  net amounts 
       Net amounts    Non-cash  if offset 
 Gross amounts Amounts offset  presented Cash collateral  collateral  of related 
 of assets and  in the balance  in the balance  received/  received/  amounts 
At 31 December 2015  liabilities1 sheet2 sheet  pledged  pledged  permitted 
£m  £m  £m  £m  £m  £m 
At 31 December 2018 Gross amounts
of assets and
liabilities1
£m		 Amounts offset
in the balance
sheet2
£m		 Net amounts
presented in
the balance
sheet
£m		 Cash collateral
received/
pledged
 £m		 Non-cash
collateral
received/
pledged
£m		 net amounts
if offset
of related
amounts
permitted
£m		 
Financial assets                                                
Trading and other financial assets at fair value through profit or loss:                        
Financial assets at fair value through profit or loss:                        
Excluding reverse repos  107,362   –   107,362   –   (7,175)  100,187   130,172   –   130,172   –   (978)  129,194 
Reverse repos  39,083   (5,909)  33,174   –   (33,174)  –   33,472   (5,115)  28,357   (622)  (27,735)  – 
  146,445   (5,909)  140,536   –   (40,349)  100,187   163,644   (5,115)  158,529   (622)  (28,713)  129,194 
Derivative financial instruments  62,937   (33,470)  29,467   (3,228)  (20,091)  6,148   78,607   (55,012)  23,595   (6,039)  (15,642)  1,914 
Loans and advances to banks:                                                
Excluding reverse repos  24,154   –   24,154   (1,810)  –   22,344   5,822   –   5,822   (2,676)  –   3,146 
Reverse repos  963   –   963   –   (963)  –   461   –   461   –   (461)  – 
  25,117   –   25,117   (1,810)  (963)  22,344   6,283   –   6,283   (2,676)  (461)  3,146 
Loans and advances to customers:                                                
Excluding reverse repos  457,546   (2,371)  455,175   (1,001)  (7,250)  446,924   447,020   (2,645)  444,375   (1,319)  (3,241)  439,815 
Reverse repos  –   –   –   –   –   –   42,494   (2,011)  40,483   –   (40,483)  – 
  457,546   (2,371)  455,175   (1,001)  (7,250)  446,924   489,514   (4,656)  484,858   (1,319)  (43,724)  439,815 
Debt securities  4,191   –   4,191   –   –   4,191   5,238   –   5,238   –   –   5,238 
Available-for-sale financial assets  33,032   –   33,032   –   (13,895)  19,137 
Held-to-maturity investments  19,808   –   19,808   –   –   19,808 
Financial assets at fair value through other comprehensive income  24,815   –   24,815   –   (5,361)  19,454 
Financial liabilities                                                
Deposits from banks:                                                
Excluding repos  9,864   –   9,864   (2,770)  (1,387)  5,707   9,150   –   9,150   (5,291)  –   3,859 
Repos  7,061   –   7,061   –   (7,061)  –   21,170   –   21,170   –   (21,170)  – 
  16,925   –   16,925   (2,770)  (8,448)  5,707   30,320   –   30,320   (5,291)  (21,170)  3,859 
Customer deposits:                                                
Excluding repos  420,330   (2,004)  418,326   (458)  (7,250)  410,618   417,652   (1,404)  416,248   (1,370)  (3,241)  411,637 
Repos  –   –   –   –   –   –   1,818   –   1,818   –   (1,818)  – 
  420,330   (2,004)  418,326   (458)  (7,250)  410,618   419,470   (1,404)  418,066   (1,370)  (5,059)  411,637 
Trading and other financial liabilities at fair value through profit or loss:                        
Financial liabilities at fair value through profit or loss:                        
Excluding repos  13,432   –   13,432   –   –   13,432   8,952   –   8,952   –   –   8,952 
Repos  44,340   (5,909)  38,431   –   (38,431)  –   28,721   (7,126)  21,595   –   (21,595)  – 
  57,772   (5,909)  51,863   –   (38,431)  13,432   37,673   (7,126)  30,547   –   (21,595)  8,952 
Derivative financial instruments  60,138   (33,837)  26,301   (2,811)  (22,586)  904   77,626   (56,253)  21,373   (3,995)  (17,313)  65 
F-88F-86

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 52:51: OFFSETTING OF FINANCIAL ASSETS AND LIABILITIEScontinued

 

              Related amounts where set off in  Potential 
              the balance sheet not permitted3  net amounts 
                      if offset 
  Gross amounts  Amounts offset in  Net amounts      Non-cash  of related 
  of assets and  the balance  presented in  Cash collateral  collateral  amounts 
At 31 December 2014 liabilities1 sheet2 the balance sheet  received/pledged  received/pledged  permitted 
 £m  £m  £m  £m  £m  £m 
Financial assets                        
Trading and other financial assets at fair value through profit or loss:                        
Excluding reverse repos  115,206   –   115,206   –   (6,670)  108,536 
Reverse repos  42,640   (5,915)  36,725   –   (36,725)  – 
   157,846   (5,915)  151,931   –   (43,395)  108,536 
Derivative financial instruments  72,378   (36,250)  36,128   (3,651)  (22,336)  10,141 
Loans and advances to banks:                        
Excluding reverse repos  24,256   –   24,256   (2,133)  –   22,123 
Reverse repos  1,899   –   1,899   –   (1,899)  – 
   26,155   –   26,155   (2,133)  (1,899)  22,123 
Loans and advances to customers:                        
Excluding reverse repos  480,376   (2,820)  477,556   (1,254)  (4,967)  471,335 
Reverse repos  5,148   –   5,148   –   (5,148)  – 
   485,524   (2,820)  482,704   (1,254)  (10,115)  471,335 
Debt securities  1,213   –   1,213   –   –   1,213 
Available-for-sale financial assets  56,493   –   56,493   –   (10,299)  46,194 
Financial liabilities                        
Deposits from banks:                        
Excluding repos  9,812   –   9,812   (3,119)  –   6,693 
Repos  1,075   –   1,075   –   (1,075)  – 
   10,887   –   10,887   (3,119)  (1,075)  6,693 
Customer deposits:                        
Excluding repos  449,361   (2,294)  447,067   (532)  (4,094)  442,441 
Repos  –   –   –   –   –   – 
   449,361   (2,294)  447,067   (532)  (4,094)  442,441 
Trading and other financial liabilities at fair value through profit or loss:                        
Excluding repos  12,095   –   12,095   –   –   12,095 
Repos  55,922   (5,915)  50,007   –   (50,007)  – 
   68,017   (5,915)  62,102   –   (50,007)  12,095 
Derivative financial instruments  69,963   (36,776)  33,187   (3,387)  (25,559)  4,241 

           Related amounts where set off in
the balance sheet not permitted3		  Potential 
At 31 December 2017 Gross amounts
of assets and
liabilities1
£m		  Amounts offset
in the balance
sheet2
£m		  Net amounts
presented in
the balance
sheet
£m		  Cash collateral
received/
pledged
£m		  Non-cash
collateral
received/
pledged
£m		  net amounts
if offset
of related
amounts
permitted
£m		 
Financial assets                        
Financial assets at fair value through profit or loss:                        
Excluding reverse repos  131,288   –   131,288   –   (3,322)  127,966 
Reverse repos  38,882   (7,292)  31,590   –   (31,590)  – 
   170,170   (7,292)  162,878   –   (34,912)  127,966 
Derivative financial instruments  72,869   (47,035)  25,834   (5,419)  (13,807)  6,608 
Loans and advances to banks:                        
Excluding reverse repos  5,840   –   5,840   (2,293)  –   3,547 
Reverse repos  771   –   771   (646)  (125)  – 
   6,611   –   6,611   (2,939)  (125)  3,547 
Loans and advances to customers:                        
Excluding reverse repos  457,382   (1,716)  455,666   (1,656)  (7,030)  446,980 
Reverse repos  16,832   –   16,832   –   (16,832)  – 
   474,214   (1,716)  472,498   (1,656)  (23,862)  446,980 
Debt securities  3,643   –   3,643   –   –   3,643 
Available-for-sale financial assets  42,098   –   42,098   –   (16,751)  25,347 
Financial liabilities                        
Deposits from banks:                        
Excluding repos  6,629   –   6,629   (4,860)  –   1,769 
Repos  23,175   –   23,175   –   (23,175)  – 
   29,804   –   29,804   (4,860)  (23,175)  1,769 
Customer deposits:                        
Excluding repos  417,009   (1,523)  415,486   (1,205)  (7,030)  407,251 
Repos  2,638   –   2,638   –   (2,638)  – 
   419,647   (1,523)  418,124   (1,205)  (9,668)  407,251 
Financial liabilities at fair value through profit or loss:                        
Excluding repos  9,499   –   9,499   –   –   9,499 
Repos  48,670   (7,292)  41,378   –   (41,378)  – 
   58,169   (7,292)  50,877   –   (41,378)  9,499 
Derivative financial instruments  73,352   (47,228)  26,124   (3,949)  (17,459)  4,716 

1After impairment allowance.
  
2The amounts set off in the balance sheet as shown above represent derivatives and repurchase agreements with central clearing houses which meet the criteria for offsetting under IAS 32.
  
3The Group enters into derivatives and repurchase and reverse repurchase agreements with various counterparties which are governed by industry standard master netting agreements. The Group holds and provides cash and securities collateral in respectiverespect of derivative transactions covered by these agreements. The right to set off balances under these master netting agreements or to set off cash and securities collateral only arises in the event of non-payment or default and, as a result, these arrangements do not qualify for offsetting under IAS 32.

 

The effects of over collateralisation have not been taken into account in the above table.

F-89F-87

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 53:52: FINANCIAL RISK MANAGEMENT

 

As a bancassurer, financial instruments are fundamental to the Group’s activities and, as a consequence, the risks associated with financial instruments represent a significant component of the risks faced by the Group.

 

The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk; liquidity risk; capital risk; and insurance risk. Information about the Group’s exposure to each of the above risks and capital can be found on pages 40 to 120.35–103. The following additional disclosures, which provide quantitative information about the risks within financial instruments held or issued by the Group, should be read in conjunction with that earlier information.

 

MARKET RISKMarket risk

 

(A) INTEREST RATE RISK

 

In the Group’s retail banking business interestInterest rate risk arises from the different repricing characteristics of the assets and liabilities. Liabilities are either insensitive to interest rate movements, for example interest free or very low interest customer deposits, or are sensitive to interest rate changes but bear rates which may be varied at the Group’s discretion and that for competitive reasons generally reflect changes in the Bank of England’s base rate. There is a relatively small volume ofThe rates on the remaining deposits whose rate isare contractually fixed for their term to maturity.

 

Many banking assets are sensitive to interest rate movements; there is a large volume of managed rate assets such as variable rate mortgages which may be considered as a natural offset to the interest rate risk arising from the managed rate liabilities. However, a significant proportion of the Group’s lending assets, for example many personal loans and mortgages, bear interest rates which are contractually fixed.

The Group’s risk management policy is to optimise reward whilst managing its market risk exposures within the risk appetite defined by the Board. The largest residual risk exposure arises from balances that are deemed to be insensitive to changes in market rates (including current accounts, a portion of variable rate deposits and investable equity), and is managed through the Group’s structural hedge. The structural hedge consists of longer-term fixed for periodsrate assets or interest rate swaps and the amount and duration of up to five years or longer.the hedging activity is reviewed regularly by the Group Asset and Liability Committee. Further details on the Group market risk policy can be found on page 96.

 

The Group establishes two types of hedge accounting relationships for interest rate risk:risk using cash flow hedges and fair value hedges andhedges. The Group is exposed to cash flow hedges.interest rate risk on its variable rate loans and deposits together with its floating rate subordinated debt. The derivatives used to manage the structural hedge may be designated into cash flow hedges to manage income statement volatility. The economic items related to the structural hedge, for example current accounts, are not suitable hedge items to be documented into accounting hedge relationships. The Group is exposed to fair value interest rate risk on its fixed rate customer loans, its fixed rate customer deposits and the majority of its subordinated debt, and to cash flow interest rate risk on its variable rate loans and deposits together with its floating rate subordinated debt. The Group applies netting between similar risks before applying hedge accounting.

Hedge ineffectiveness arises during the management of interest rate risk due to residual unhedged risk. Sources of ineffectiveness, which the Group may decide to not fully mitigate, can include basis differences, timing differences and notional amount differences. The effectiveness of accounting hedge relationships is assessed between the hedging derivatives and the documented hedged item, which can differ to the underlying economically hedged item.

 

At 31 December 20152018 the aggregate notional principal of interest rate swaps designated as fair value hedges was £121,063£150,971 million (2014: £115,394(2017: £109,670 million) with a net fair value asset of £848£760 million (2014:(2017: asset of £1,511£738 million) (note 16)17). The lossesgains on the hedging instruments were £618£94 million (2014:(2017: losses of £2,866£420 million). The gainslosses on the hedged items attributable to the hedged risk were £511£32 million (2014:(2017: gains of £2,720£484 million). The gains and losses relating to the fair value hedges are recorded in net trading income.

 

In addition the Group has cash flow hedges which are primarily used to hedge the variability in the cost of funding within the commercial business. Note 1617 shows when the hedged cash flows are expected to occur and when they will affect income for designated cash flow hedges. The notional principal of the interest rate swaps designated as cash flow hedges at 31 December 20152018 was £460,829£556,945 million (2014: £518,746(2017: £549,099 million) with a net fair value liability of £718£486 million (2014:(2017: liability of £930£456 million) (note 16)17). In 2015,2018, ineffectiveness recognised in the income statement that arises from cash flow hedges was a gainloss of £3£25 million (2014: gain(2017: loss of £56£21 million).

 

(B) CURRENCY RISK

 

The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to the market and liquidity risk function in London. Associated VaR and the closing, average, maximum and minimum are disclosed on page 100.102. The Group also manages foreign currency risk via cash flow hedge accounting, utilising currency swaps.

 

Risk arises from the Group’s investments in its overseas operations. The Group’s structural foreign currency exposure is represented by the net asset value of the foreign currency equity and subordinated debt investments in its subsidiaries and branches. Gains or losses on structural foreign currency exposures are taken to reserves.

 

The Group hedges partceased all hedging of the currency translation risk of the net investment in certain foreign operations using currency borrowings.on 1 January 2018. At 31 December 20152017 the Group used foreign currency borrowings with an aggregate principal of these£41 million to hedge currency borrowings was £670 million (2014: £587 million).translation risk. In 2015,2017, an ineffectiveness gainloss of £5£11 million before tax and £4£8 million after tax (2014: ineffectiveness loss of £1 million before and after tax) was recognised in the income statement arising from net investment hedges.

 

The Group’s main overseas operations are in the Americas and Europe. Details of the Group’s structural foreign currency exposures, after net investment hedges, are as follows:

 

(C) FUNCTIONAL CURRENCY OF GROUP OPERATIONS

 

  Euro
£m		   US Dollar
£m		   Other non-
sterling
£m		  2018 2017
31 December 2015            
 Euro
£m		 US Dollar
£m		 Other
non-sterling
£m		  Euro
£m		 US Dollar
£m		 Other
non-sterling
£m		 
Gross exposure  246   447   32   112   59   60   73   374   32 
Net investment hedges  (254)  (415)  (1)  –   –   –   (41)  –   – 
Total structural foreign currency exposures, after net investment hedges  (8)  32   31   112   59   60   32   374   32 
31 December 2014            
Gross exposure  286   392   100 
Net investment hedges  (218)  (342)  (27)
Total structural foreign currency exposures, after net investment hedges  68   50   73 
F-90F-88

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 53:52: FINANCIAL RISK MANAGEMENTcontinued

 

CREDIT RISKCredit risk

 

The Group’s credit risk exposure arises in respect of the instruments below and predominantly in the United Kingdom. Information about the Group’s exposure to credit risk, credit risk management, measurement and mitigation can be found on pages 56 to 93.51–65.

 

A.(A) MAXIMUM CREDIT EXPOSURE

 

The maximum credit risk exposure of the Group in the event of other parties failing to perform their obligations is detailed below. No account is taken of any collateral held and the maximum exposure to loss, which includes amounts held to cover unit-linked and With Profits funds liabilities, is considered to be the balance sheet carrying amount or, for non-derivative off-balance sheet transactions and financial guarantees, their contractual nominal amounts.

 

 At 31 December 2015 At 31 December 2014 At 31 December 2018 At 31 December 2017
  Maximum
exposure
£m		   Offset2
£m		  Net exposure
£m		   Maximum
exposure
£m		   Offset2
£m		   Net exposure
£m		  Maximum
exposure
£m		 Offset2
£m		 Net exposure
£m		  Maximum
exposure
£m		 Offset2
£m		 Net exposure
£m		 
Loans and receivables:                        
Loans and advances to banks, net1  25,117   –   25,117   26,155   –   26,155   6,283   –   6,283   6,611   –   6,611 
Loans and advances to customers, net1  455,175   (7,250)  447,925   482,704   (4,094)  478,610   484,858   (3,241)  481,617   472,498   (7,030)  465,468 
Debt securities, net1  4,191   –   4,191   1,213   –   1,213   5,238   –   5,238   3,643   –   3,643 
  484,483   (7,250)  477,233   510,072   (4,094)  505,978 
Available-for-sale financial assets3  31,839   –   31,839   55,451   –   55,451 
Held-to-maturity investments  19,808   –   19,808   –   –   – 
Trading and other financial assets at fair value through profit or loss:3,4                        
Financial assets at amortised cost  496,379   (3,241)  493,138   482,752   (7,030)  475,722 
Financial assets at fair value through other comprehensive income/available-for-sale financial assets3  24,794   –   24,794   40,901   –   40,901 
Financial assets at fair value through profit or loss:3,4                        
Loans and advances  33,174   –   33,174   36,725   –   36,725   40,876   –   40,876   31,590   –   31,590 
Debt securities, treasury and other bills  46,886   –   46,886   53,630   –   53,630   40,168   –   40,168   45,198   –   45,198 
  80,060   –   80,060   90,355   –   90,355   81,044   –   81,044   76,788   –   76,788 
Derivative assets  29,467   (19,466)  10,001   36,128   (21,929)  14,199   23,595   (14,327)  9,268   25,834   (13,049)  12,785 
Assets arising from reinsurance contracts held  675   –   675   682   –   682   749   –   749   602   –   602 
Financial guarantees  7,165   –   7,165   7,161   –   7,161 
Off-balance sheet items:                                                
Acceptances and endorsements  52   –   52   59   –   59   194   –   194   71   –   71 
Other items serving as direct credit substitutes  458   –   458   330   –   330   632   –   632   740   –   740 
Performance bonds and other transaction-related contingencies  2,123   –   2,123   2,293   –   2,293   2,425   –   2,425   2,300   –   2,300 
Irrevocable commitments  63,086   –   63,086   55,029   –   55,029 
Irrevocable commitments and guarantees  64,884   –   64,884   65,946   –   65,946 
  65,719   –   65,719   57,711   –   57,711   68,135   –   68,135   69,057   –   69,057 
  719,216   (26,716)  692,500   757,560   (26,023)  731,537   694,696   (17,568)  677,128   695,934   (20,079)  675,855 

1Amounts shown net of related impairment allowances.
  
2Offset items comprise deposit amounts available for offset, and amounts available for offset under master netting arrangements, that do not meet the criteria under IAS 32 to enable loans and advances and derivative assets respectively to be presented net of these balances in the financial statements.
  
3Excluding equity shares.
  
4Includes assets within the Group’s unit-linked funds for which credit risk is borne by the policyholders and assets within the Group’s With-Profits funds for which credit risk is largely borne by the policyholders. Consequently, the Group has no significant exposure to credit risk for such assets which back related contract liabilities.
F-89

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

B.NOTE 52: FINANCIAL RISK MANAGEMENT continued

(B) CONCENTRATIONS OF EXPOSURE

 

The Group’s management of concentration risk includes single name, industry sector and country limits as well as controls over the Group’s overall exposure to certain products. Further information on the Group’s management of this risk is included within Credit risk mitigation, Risk management on page 57.51.

 

At 31 December 20152018 the most significant concentrations of exposure were in mortgages (comprising 6861 per cent of total loans and advances to customers) and to financial, business and other services (comprising 916 per cent of the total). For further information on concentrations of the Group’s loans, refer to note 18.

  31 December
2018
£m		  1 January
 2018
£m		  31 December
2017
£m		 
Agriculture, forestry and fishing  7,314   7,074   7,461 
Energy and water supply  1,517   1,384   1,609 
Manufacturing  8,260   7,886   7,886 
Construction  4,684   4,378   4,428 
Transport, distribution and hotels  14,113   14,074   14,074 
Postal and telecommunications  2,711   2,148   2,148 
Property companies  28,451   27,631   30,980 
Financial, business and other services  77,505   50,707   57,006 
Personal:            
Mortgages  297,498   304,515   304,665 
Other  28,699   28,757   28,757 
Lease financing  1,822   2,094   2,094 
Hire purchase�� 15,434   13,591   13,591 
Total loans and advances to customers before allowance for impairment losses  488,008   464,239   474,699 
Allowance for impairment losses (note 20)  (3,150)  (3,223)  (2,201)
Total loans and advances to customers  484,858   461,016   472,498 

 

Following the continuing reduction in the Group’s non-UK activities, an analysis of credit risk exposures by geographical region has not been provided.

F-90

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 52: FINANCIAL RISK MANAGEMENT continued

(C) CREDIT QUALITY OF ASSETS

LOANS AND ADVANCES

The analysis of lending has been prepared based on the division in which the asset is held; with the business segment in which the exposure is recorded reflected in the ratings system applied. The internal credit ratings systems used by the Group differ between Retail and Commercial, reflecting the characteristics of these exposures and the way that they are managed internally; these credit ratings are set out below. All probabilities of default (PDs) include forward-looking information and are based on 12 month values, with the exception of credit impaired.

 Retail Corporate
 Grade IFRS 9 PD% Grade IFRS 9 PD%
Good quality1–6 0.00–4.50 1–10 0.00–0.50
Satisfactory quality7–9 4.51–14.00 11–14 0.51–3.00
Lower quality10 14.01–20.00 15–18 3.01–20.00
Below standard11–13 20.01–99.99 19 20.01–99.99
Credit impaired14 100.00 20–23 100.00

      Loans and advances to customers
Gross carrying amount Loans and
advances
to banks
£m		  Retail –
mortgages
£m		  Retail –
other
£m		  Commercial
£m		  Other
£m		  Total
£m		 
At 31 December 2018                        
Stage 1                        
Good quality  6,177   257,740   44,314   65,089   44,369   411,512 
Satisfactory quality  105   57   2,562   25,472   –   28,091 
Lower quality  –   –   72   1,441   –   1,513 
Below standard, but not credit-impaired  –   –   415   –   –   415 
   6,282   257,797   47,363   92,002   44,369   441,531 
Stage 2                        
Good quality  3   10,784   2,737   100   6   13,627 
Satisfactory quality  –   1,709   1,158   3,450   6   6,323 
Lower quality  –   262   285   2,988   –   3,535 
Below standard, but not credit-impaired  –   899   907   54   –   1,860 
   3   13,654   5,087   6,592   12   25,345 
Stage 3                        
Credit-impaired  –   1,393   997   3,296   55   5,741 
Purchased or originated credit-impaired                        
Credit-impaired  –   15,391   –   –   –   15,391 
Total  6,285   288,235   53,447   101,890   44,436   488,008 
Expected credit losses                        
Stage 1                        
Good quality  2   37   279   32   43   391 
Satisfactory quality  –   –   65   50   –   115 
Lower quality  –   –   4   11   –   15 
Below standard, but not credit-impaired  –   –   4   –   –   4 
   2   37   352   93   43   525 
Stage 2                        
Good quality  –   141   89   1   1   232 
Satisfactory quality  –   34   100   86   6   226 
Lower quality  –   9   40   231   –   280 
Below standard, but not credit-impaired  –   42   207   7   –   256 
   –   226   436   325   7   994 
Stage 3                        
Credit-impaired  –   118   366   1,058   11   1,553 
Purchased or originated credit-impaired                        
Credit-impaired  –   78   –   –   –   78 
Total  2   459   1,154   1,476   61   3,150 

Stage 3 assets include balances of approximately £250 million (with outstanding amounts due of approximately £2,200 million) which have been subject to a partial write off and where the Group continues to enforce recovery action.

Stage 2 and Stage 3 assets with a carrying amount of approximately £1,000 million were modified during the year. No material gain or loss was recognised by the Group.

F-91

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 53:52: FINANCIAL RISK MANAGEMENT continued

 

C. CREDIT QUALITY OF ASSETS

Loans and receivables 

The disclosures in the table below and those on pages F-93 and F-94 are produced under the underlying basis used for the Group’s segmental reporting. The Group believes that, for reporting periods following a significant acquisition such as the acquisition of HBOS in 2009, this underlying basis, which includes the allowance for loan losses at the acquisition date on a gross basis, more fairly reflects the underlying provisioning status of the loans. The remaining acquisition-related fair value adjustments in respect of this lending are therefore identified separately in this table.

The analysis of lending between retail and commercial has been prepared based upon the type of exposure and not the business segment in which the exposure is recorded. Included within retail are exposures to personal customers and small businesses, whilst included within commercial are exposures to corporate customers and other large institutions.

Loans and advances

                 Loans and 
                 advances 
                 designated 
  Loans and  Loans and advances to customers  at fair value 
  advances  Retail –  Retail –        through 
  to banks  mortgages  other  Commercial  Total  profit or loss 
   £m   £m   £m   £m   £m   £m 
At 31 December 2015                        
Neither past due nor impaired  25,006   302,063   38,886   100,001   440,950   33,174 
Past due but not impaired  111   8,233   393   463   9,089   – 
Impaired – no provision required  –   732   690   1,092   2,514   – 
– provision held  –   3,269   911   2,896   7,076   – 
Gross  25,117   314,297   40,880   104,452   459,629   33,174 
Allowance for impairment losses  –   (1,617)  (448)  (2,107)  (4,172)  – 
Fair value adjustments  –               (282)  – 
Net balance sheet carrying value  25,117               455,175   33,174 
At 31 December 2014                        
Neither past due nor impaired  26,003   320,324   37,886   106,768   464,978   36,725 
Past due but not impaired  152   10,311   674   488   11,473   – 
Impaired – no provision required  –   578   938   847   2,363   – 
– provision held  –   3,766   1,109   7,070   11,945   – 
Gross  26,155   334,979   40,607   115,173   490,759   36,725 
Allowance for impairment losses  –   (1,702)  (577)  (5,373)  (7,652)  – 
Fair value adjustments  –               (403)  – 
Net balance sheet carrying value  26,155               482,704   36,725 

The criteria that the Group uses to determine that there is objective evidence of an impairment loss are disclosed in note 2(H). Included in loans and receivables are advances which are individually determined to be impaired with a gross amount before impairment allowances of £4,406 million (31 December 2014: £8,522 million).

The table below sets out the reconciliation of the allowance for impairment losses of £3,033 million (2014: £6,414 million) shown in note 21 to the allowance for impairment losses on an underlying basis of £4,172 million (2014: £7,652 million) shown above:

  2015
£m		  2014
£m		 
Allowance for impairment losses on loans and advances to customers  3,033   6,414 
HBOS allowance at 16 January 20091  11,147   11,147 
HBOS charge covered by fair value adjustments2  12,166   12,066 
Amounts subsequently written off  (22,623)  (22,426)
   690   787 
Foreign exchange and other movements  449   451 
Allowance for impairment losses on loans and advances to customers on an underlying basis  4,172   7,652 

1Comprises an allowance held at 31 December 2008 of £10,693 million and a charge for the period from 1 January 2009 to 16 January 2009 of £454 million.
2This represents the element of the charge on loans and advances to customers in HBOS’s results that was included within the Group’s fair value adjustments in respect of the acquisition of HBOS on 16 January 2009.
Loan commitments and financial guarantees Retail –
mortgages
£m		  Retail –
other
£m		  Commercial
£m		  Other
£m		  Total
£m		 
At 31 December 2018                    
Stage 1                    
Good quality  12,024   60,379   51,632   246   124,281 
Satisfactory quality  2   532   6,501   –   7,035 
Lower quality  –   10   126   –   136 
Below standard, but not credit-impaired  –   363   31   –   394 
   12,026   61,284   58,290   246   131,846 
Stage 2                    
Good quality  19   1,858   –   –   1,877 
Satisfactory quality  1   156   693   –   850 
Lower quality  –   27   297   –   324 
Below standard, but not credit-impaired  –   50   11   –   61 
   20   2,091   1,001   –   3,112 
Stage 3                    
Credit-impaired  5   39   6   –   50 
Purchased or originated credit-impaired                    
Credit-impaired  90   –   –   –   90 
Total  12,141   63,414   59,297   246   135,098 
Expected credit losses                    
Stage 1                    
Good quality  1   98   9   1   109 
Satisfactory quality  –   5   7   –   12 
Lower quality  –   –   1   –   1 
Below standard, but not credit-impaired  –   –   1   –   1 
   1   103   18   1   123 
Stage 2                    
Good quality  –   28   –   –   28 
Satisfactory quality  –   10   7   –   17 
Lower quality  –   3   5   –   8 
Below standard, but not credit-impaired  –   10   1   –   11 
   –   51   13   –   64 
Stage 3                    
Credit-impaired  –   –   6   –   6 
Total  1   154   37   1   193 
F-92

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 53:52: FINANCIAL RISK MANAGEMENT continued

 

Loans and advances which are neither past due nor impaired

                 Loans and 
                 advances 
                 designated 
  Loans and  Loans and advances to customers  at fair value 
  advances  Retail –  Retail –        through 
  to banks  mortgages  other  Commercial  Total  profit or loss 
   £m   £m   £m   £m   £m   £m 
At 31 December 2015                       
Good quality  24,670   301,403   33,589   63,453       33,156 
Satisfactory quality  311   527   4,448   28,899       15 
Lower quality  4   27   476   7,210       3 
Below standard, but not impaired  21   106   373   439       – 
Total loans and advances which are neither past due nor impaired  25,006   302,063   38,886   100,001   440,950   33,174 
At 31 December 2014                        
Good quality  25,654   318,967   30,993   65,106       36,482 
Satisfactory quality  263   1,159   5,675   28,800       238 
Lower quality  49   72   623   11,204       5 
Below standard, but not impaired  37   126   595   1,658       – 
Total loans and advances which are neither past due nor impaired  26,003   320,324   37,886   106,768   464,978   36,725 

The definitions of good quality, satisfactory quality, lower quality and below standard, but not impaired applying to retail and commercial are not the same, reflecting the different characteristics of these exposures and the way they are managed internally, and consequently totals are not provided. Commercial lending has been classified using internal probability of default rating models mapped so that they are comparable to external credit ratings. Good quality lending comprises the lower assessed default probabilities, with other classifications reflecting progressively higher default risk. Classifications of retail lending incorporate expected recovery levels for mortgages, as well as probabilities of default assessed using internal rating models. Further information about the Group’s internal probabilities of default rating models can be found on page 56.

Loans and advances which are past due but not impaired

                 Loans and 
                 advances 
                 designated 
  Loans and  Loans and advances to customers  at fair value 
  advances  Retail –  Retail –        through 
  to banks  mortgages  other  Commercial  Total  profit or loss 
   £m   £m   £m   £m   £m   £m 
At 31 December 2015                        
0-30 days  111   4,066   276   248   4,590   – 
30-60 days  –   1,732   81   100   1,913   – 
60-90 days  –   1,065   9   52   1,126   – 
90-180 days  –   1,370   8   19   1,397   – 
Over 180 days  –   –   19   44   63   – 
Total loans and advances which are past due but not impaired  111   8,233   393   463   9,089   – 
At 31 December 2014                        
0-30 days  152   4,854   453   198   5,505   – 
30-60 days  –   2,309   110   51   2,470   – 
60-90 days  –   1,427   90   139   1,656   – 
90-180 days  –   1,721   5   38   1,764   – 
Over 180 days  –   –   16   62   78   – 
Total loans and advances which are past due but not impaired  152   10,311   674   488   11,473   – 

A financial asset is ‘past due’ if a counterparty has failed to make a payment when contractually due. 

      Loans and advances to customers
Gross carrying amount Loans and
advances
to banks
£m		  Retail –
mortgages
£m		  Retail –
other
£m		  Commercial
£m		  Other
£m		  Total
£m		 
At 1 January 2018                        
Stage 1                        
Good quality  4,245   251,663   40,951   64,207   17,276   374,097 
Satisfactory quality  –   44   3,203   25,577   –   28,824 
Lower quality  –   –   127   557   –   684 
Below standard, but not credit-impaired  –   –   276   –   –   276 
   4,245   251,707   44,557   90,341   17,276   403,881 
Stage 2                        
Good quality  2   17,599   2,711   210   67   20,587 
Satisfactory quality  –   1,359   1,377   4,470   4,094   11,300 
Lower quality  –   290   299   2,616   –   3,205 
Below standard, but not credit-impaired  –   861   823   469   –   2,153 
   2   20,109   5,210   7,765   4,161   37,245 
Stage 3                        
Credit-impaired  –   1,232   873   2,714   321   5,140 
Purchased or originated credit-impaired                        
Credit-impaired  –   17,973   –   –   –   17,973 
Total  4,247   291,021   50,640   100,820   21,758   464,239 
Expected credit losses                        
Stage 1                        
Good quality  1   30   276   35   72   413 
Satisfactory quality  –   –   104   60   –   164 
Lower quality  –   –   9   6   –   15 
Below standard, but not credit-impaired  –   –   5   –   –   5 
   1   30   394   101   72   597 
Stage 2                        
Good quality  –   169   92   1   16   278 
Satisfactory quality  –   24   123   134   110   391 
Lower quality  –   7   42   183   –   232 
Below standard, but not credit-impaired  –   36   147   64   –   247 
   –   236   404   382   126   1,148 
Stage 3                        
Credit-impaired  –   86   313   957   90   1,446 
Purchased or originated credit-impaired                        
Credit-impaired  –   32   –   –   –   32 
Total  1   384   1,111   1,440   288   3,223 
F-93

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 53:52: FINANCIAL RISK MANAGEMENT continued

 

Loan commitments and financial guarantees Retail –
mortgages
£m		  Retail –
other
£m		  Commercial
£m		  Other
£m		  Total
£m		 
At 1 January 2018                    
Stage 1                    
Good quality  11,690   60,305   53,335   287   125,617 
Satisfactory quality  –   801   5,463   –   6,264 
Lower quality  –   26   226   –   252 
Below standard, but not credit-impaired  –   7   –   –   7 
   11,690   61,139   59,024   287   132,140 
Stage 2                    
Good quality  50   1,908   59   –   2,017 
Satisfactory quality  –   221   577   –   798 
Lower quality  –   32   347   –   379 
Below standard, but not credit-impaired  –   45   76   –   121 
   50   2,206   1,059   –   3,315 
Stage 3                    
Credit-impaired  –   61   –   –   61 
Purchased or originated credit-impaired                    
Credit-impaired  113   –   –   –   113 
Total  11,853   63,406   60,083   287   135,629 
Expected credit losses                    
Stage 1                    
Good quality  1   91   11   2   105 
Satisfactory quality  –   19   19   –   38 
Lower quality  –   2   1   –   3 
Below standard, but not credit-impaired  –   1   –   –   1 
   1   113   31   2   147 
Stage 2                    
Good quality  –   37   –   –   37 
Satisfactory quality  –   15   28   –   43 
Lower quality  –   4   14   –   18 
Below standard, but not credit-impaired  –   20   8   –   28 
   –   76   50   –   126 
Total  1   189   81   2   273 

Debt securities classified

Loans and advances carried at fair value through profit or loss comprise £27,734 million (1 January 2018: £31,590 million) of trading assets of which £27,685 million (1 January 2018: £31,548 million) have a good quality rating and £49 million (1 January 2018: £42 million) have a satisfactory rating; and £13,142 million (1 January 2018: £14,016 million) of other assets mandatorily held at fair value through profit or loss of which £12,509 million (1 January 2018: £13,338 million) is viewed by the business as loans and receivablesinvestment grade.

F-94

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 52: FINANCIAL RISK MANAGEMENT continued

DEBT SECURITIES HELD AT AMORTISED COST

An analysis by credit rating of the Group’s debt securities classified as loans and receivablesheld at amortised cost is provided below:

 

 2015  2014  31 December 2018 1 January 2018
 Investment
grade
£m		1 Other
£m		2 Total
£m		  Investment
grade
£m		1 Other
£m		2 Total
£m		  Investment
grade1
£m		 Other2
£m		 Total
£m		  Investment
grade1
£m		 Other2
£m		 Total
£m		 
Asset-backed securities:                                                
Mortgage-backed securities  2,528   –   2,528   190   –   190   3,263   9   3,272   2,265   –   2,265 
Other asset-backed securities  1,140   94   1,234   780   205   985   763   17   780   1,025   7   1,032 
  3,668   94   3,762   970   205   1,175   4,026   26   4,052   3,290   7   3,297 
Corporate and other debt securities  417   109   526   –   164   164   1,176   16   1,192   27   16   43 
Gross exposure  4,085   203   4,288   970   369   1,339   5,202   42   5,244   3,317   23   3,340 
Allowance for impairment losses          (97)          (126)          (6)          (26)
Total debt securities classified as loans and receivables          4,191           1,213 
Total debt securities held at amortised cost          5,238           3,314 

 

1Credit ratings equal to or better than ‘BBB’.
  
2Other comprises sub-investment grade (2015: £87(31 December 2018: £6 million; 2014: £198 million)1 January 2018: £nil) and not rated (2015: £116(31 December 2018: £36 million; 2014: £1711 January 2018: £23 million).

 

Available-for-sale financial assets (excluding equity shares)FINANCIAL ASSETS AT FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME/AVAILABLE-FOR-SALE FINANCIAL ASSETS (EXCLUDING EQUITY SHARES)

An analysis of the Group’s available-for-sale financial assets at fair value through other comprehensive income (available-for-sale financial assets at 31 December 2017) is included in note 22.21. The credit quality of the Group’s available-for-sale financial assets at fair value through other comprehensive income (available-for-sale financial assets at 31 December 2017) (excluding equity shares) is set out below:

 

 2015  2014  31 December 2018 1 January 2018
 Investment
grade
£m		1 Other
£m		2 Total
£m		  Investment
grade
£m		1 Other
£m		2 Total
£m		  Investment
grade1
£m		 Other2
£m		 Total
£m		  Investment
grade1
£m		 Other2
£m		 Total
£m		 
Debt securities:                                                
Government securities  25,329   –   25,329   47,402   –   47,402   18,971   –   18,971   34,708   –   34,708 
Bank and building society certificates of deposit  186   –   186   298   –   298   118   –   118   167   –   167 
Asset-backed securities:                                                
Mortgage-backed securities  197   –   197   674   –   674   120   –   120   2,381   –   2,381 
Other asset-backed securities  315   4   319   681   4   685   –   131   131   358   109   467 
  512   4   516   1,355   4   1,359   120   131   251   2,739   109   2,848 
Corporate and other debt securities  5,808   –   5,808   5,490   39   5,529   4,934   217   5,151   4,250   365   4,615 
Total debt securities  31,835   4   31,839   54,545   43   54,588   24,143   348   24,491   41,864   474   42,338 
Treasury bills and other bills  –   –   –   863   –   863 
Total held as available-for-sale financial assets  31,835   4   31,839   55,408   43   55,451 
Treasury and other bills  303   –   303   –   –   – 
Total financial assets at fair value through other comprehensive income/available-for-sale financial assets  24,446   348   24,794   41,864   474   42,338 

 

1Credit ratings equal to or better than ‘BBB’.
  
2Other comprises sub-investment grade (2015: £4(31 December 2018: £85 million; 2014: £201 January 2018: £98 million) and not rated (2015: £nil; 2014: £23(31 December 2018: £263 million; 1 January 2018: £376 million).

Held-to-maturity investments

An analysis of the credit quality of the Group’s held-to-maturity investments at 31 December 2015 is set out below:

  Investment       
  grade1 Other  Total 
  £m  £m  £m 
Government securities  19,808   –   19,808 

1Credit ratings equal to or better than ‘BBB’.

The Group did not carry any held-to-maturity investments at 31 December 2014. 

F-94F-95

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 53:52: FINANCIAL RISK MANAGEMENT continued

 

Debt securities, treasury and other bills held at fair value through profit or lossDEBT SECURITIES, TREASURY AND OTHER BILLS HELD AT FAIR VALUE THROUGH PROFIT OR LOSS

 

An analysis of the Group’s trading and other financial assets at fair value through profit or loss is included in note 15.16. The credit quality of the Group’s debt securities, treasury and other bills held at fair value through profit or loss is set out below:

 

  2015  2014 
  Investment           Investment         
  grade1  Other2  Total   grade1  Other2  Total  2018 2017
  £m   £m   £m   £m   £m   £m  Investment
grade1
£m		 Other2
£m		 Total
£m		  Investment
grade1
£m		 Other2
£m		 Total
£m		 
Debt securities, treasury and other bills held at fair value through profit or loss                                                
Trading assets:                                                
Government securities  8,269   –   8,269   7,976   –   7,976   7,192   –   7,192   9,833   –   9,833 
Bank and building society certificates of deposit  –   –   –   554   –   554 
Asset-backed securities:                                                
Mortgage-backed securities  516   –   516   187   –   187   10   –   10   84   105   189 
Other asset-backed securities  85   –   85   117   12   129   63   –   63   95   –   95 
  601   –   601   304   12   316   73   –   73   179   105   284 
Corporate and other debt securities  582   30   612   1,288   198   1,486   228   19   247   469   54   523 
Total debt securities held as trading assets  9,452   30   9,482   10,122   210   10,332 
Treasury bills and other bills  –   –   –   1,437   –   1,437 
Total held as trading assets  9,452   30   9,482   11,559   210   11,769   7,493   19   7,512   10,481   159   10,640 
Other assets held at fair value through profit or loss:                                                
Government securities  13,848   –   13,848   17,496   1   17,497   10,903   –   10,903   12,180   7   12,187 
Other public sector securities  2,023   16   2,039   2,170   –   2,170   2,059   5   2,064   1,519   8   1,527 
Bank and building society certificates of deposit  135   –   135   –   –   –   1,105   –   1,105   222   –   222 
Asset-backed securities:                                                
Mortgage-backed securities  801   41   842   845   2   847   208   7   215   208   3   211 
Other asset-backed securities  762   –   762   699   22   721   283   3   286   924   2   926 
  1,563   41   1,604   1,544   24   1,568   491   10   501   1,132   5   1,137 
Corporate and other debt securities  17,371   2,333   19,704   18,119   2,485   20,604   16,141   1,922   18,063   17,343   2,124   19,467 
Total debt securities held at fair value through profit or loss  34,940   2,390   37,330   39,329   2,510   41,839   30,699   1,937   32,636   32,396   2,144   34,540 
Treasury bills and other bills  74   –   74   22   –   22   20   –   20   18   –   18 
Total other assets held at fair value through profit or loss  35,014   2,390   37,404   39,351   2,510   41,861   30,719   1,937   32,656   32,414   2,144   34,558 
Total held at fair value through profit or loss  44,466   2,420   46,886   50,910   2,720   53,630   38,212   1,956   40,168   42,895   2,303   45,198 

 

1Credit ratings equal to or better than ‘BBB’.
  
2Other comprises sub-investment grade (2015: £544(2018: £411 million; 2014: £6292017: £331 million) and not rated (2015: £1,876(2018: £1,545 million; 2014: £2,0912017: £1,972 million).

 

Credit risk in respect of trading and other financial assets at fair value through profit or loss held within the Group’s unit-linked funds is borne by the policyholders and credit risk in respect of with-profits funds is largely borne by the policyholders. Consequently, the Group has no significant exposure to credit risk for such assets which back those contract liabilities.

F-95

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 53: FINANCIAL RISK MANAGEMENTcontinuedDERIVATIVE ASSETS

 

Derivative assets

An analysis of derivative assets is given in note 16.17. The Group reduces exposure to credit risk by using master netting agreements and by obtaining collateral in the form of cash or highly liquid securities. In respect of the Group’s maximumnet credit risk relating to derivative assets of £10,001£9,268 million (2014: £14,199(2017: £12,785 million), cash collateral of £3,228£6,039 million (2014: £3,651(2017: £5,419 million) was held and a further £94213 million was due from OECD banks (2014: £2,043(2017: £275 million).

 

  2015   2014
  Investment           Investment         
  grade1  Other2  Total   grade1  Other2  Total  2018 2017
  £m   £m   £m   £m   £m   £m  Investment
grade1
£m		 Other2
£m		 Total
£m		  Investment
grade1
£m		 Other2
£m		 Total
£m		 
Trading and other  24,764   2,017   26,781   26,574   5,321   31,895   19,797   2,235   22,032   21,742   2,211   23,953 
Hedging  2,653   33   2,686   4,185   48   4,233   1,534   29   1,563   1,874   7   1,881 
Total derivative financial instruments  27,417   2,050   29,467   30,759   5,369   36,128   21,331   2,264   23,595   23,616   2,218   25,834 

1Credit ratings equal to or better than ‘BBB’.
  
2Other comprises sub-investment grade (2015: £1,418(2018: £1,920 million; 2014: £1,8962017: £1,878 million) and not rated (2015: £632(2018: £344 million; 2014: £3,4732017: £340 million).

 

Financial guarantees and irrevocable loan commitmentsFINANCIAL GUARANTEES AND IRREVOCABLE LOAN COMMITMENTS

Financial guarantees represent undertakings that the Group will meet a customer’s obligation to third parties if the customer fails to do so. Commitments to extend credit represent unused portions of authorisations to extend credit in the form of loans, guarantees or letters of credit. The Group is theoretically exposed to loss in an amount equal to the total guarantees or unused commitments, however, the likely amount of loss is expected to be significantly less; most commitments to extend credit are contingent upon customers maintaining specific credit standards.

 

D.(D) COLLATERAL HELD AS SECURITY FOR FINANCIAL ASSETS

 

A general description of collateral held as security in respect of financial instruments is provided on page 58.52. The Group holds collateral against loans and receivablesadvances and irrevocable loan commitments; qualitative and, where appropriate, quantitative information is provided in respect of this collateral below. Collateral held as security for trading and other financial assets at fair value through profit or loss and for derivative assets is also shown below.

Loans and receivables

The disclosures below are produced under the underlying basis used for the Group’s segmental reporting. The Group believes that, for reporting periods following a significant acquisition, such as the acquisition of HBOS in 2009, this underlying basis, which includes the allowance for loan losses at the acquisition on a gross basis, more fairly reflects the underlying provisioning status of the loans.

 

The Group holds collateral in respect of loans and advances to banks and customers as set out below. The Group does not hold collateral against debt securities, comprising asset-backed securities and corporate and other debt securities, which are classified as loans and receivables.financial assets held at amortised cost.

F-96

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

Loans and advances to banksNOTE 52: FINANCIAL RISK MANAGEMENT continued

LOANS AND ADVANCES TO BANKS

There were reverse repurchase agreements which are accounted for as collateralised loans within loans and advances to banks with a carrying value of £963£461 million (2014: £1,899(2017: £771 million), against which the Group held collateral with a fair value of £1,009£481 million (2014: £1,886(2017: £796 million).

 

These transactions were generally conducted under terms that are usual and customary for standard secured lending activities.

 

Loans and advances to customersLOANS AND ADVANCES TO CUSTOMERS

RETAIL LENDING

Retail lending

Mortgages

 

An analysis by loan-to-value ratio of the Group’s residential mortgage lending is provided below. The value of collateral used in determining the loan-to-value ratios has been estimated based upon the last actual valuation, adjusted to take into account subsequent movements in house prices, after making allowanceallowances for indexation error and dilapidations.

 

  2015  2014
  Neither              Neither            
  past due  Past due but         past due  Past due but        
  nor impaired  not impaired  Impaired  Gross  nor impaired  not impaired  Impaired  Gross 
  £m  £m  £m  £m  £m  £m  £m  £m 
Less than 70 per cent  211,631   4,907   1,965   218,503   202,789   4,895   1,601   209,285 
70 per cent to 80 per cent  45,764   1,350   671   47,785   58,837   1,998   726   61,561 
80 per cent to 90 per cent  27,529   935   528   28,992   32,771   1,526   702   34,999 
90 per cent to 100 per cent  10,908   610   247   11,765   15,858   1,005   486   17,349 
Greater than 100 per cent  6,231   431   590   7,252   10,069   887   829   11,785 
Total  302,063   8,233   4,001   314,297   320,324   10,311   4,344   334,979 
F-96

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSIn some circumstances, where the discounted value of the estimated net proceeds from the liquidation of collateral (i.e. net of costs, expected haircuts and anticipated changes in the value of the collateral to the point of sale) is greater than the estimated exposure at default, no credit losses are expected and no ECL allowance is recognised.

 

  Stage 1
£m		  Stage 2
£m		  Stage 3
£m		  Purchased or
originated
credit-impaired
£m		  Total gross
£m		 
At 31 December 2018                    
Less than 70 per cent  186,974   10,853   1,058   11,658   210,543 
70 per cent to 80 per cent  38,865   1,704   176   1,864   42,609 
80 per cent to 90 per cent  26,353   837   90   1,024   28,304 
90 per cent to 100 per cent  5,136   154   33   349   5,672 
Greater than 100 per cent  469   106   36   496   1,107 
Total  257,797   13,654   1,393   15,391   288,235 

NOTE 53: FINANCIAL RISK MANAGEMENT continued

  Neither past due
nor impaired
£m		  Past due but not
impaired
£m		  Impaired
£m		  Gross
£m		 
At 31 December 2017                
Less than 70 per cent  211,366   4,211   2,348   217,925 
70 per cent to 80 per cent  41,323   754   544   42,621 
80 per cent to 90 per cent  22,421   422   398   23,241 
90 per cent to 100 per cent  5,036   145   209   5,390 
Greater than 100 per cent  1,326   95   387   1,808 
Total  281,472   5,627   3,886   290,985 

 

Other

 

The majority of non-mortgage retail lending is unsecured. At 31 December 2015, impaired2018, Stage 3 non-mortgage lending amounted to £1,153£631 million, net of an impairment allowance of £448£366 million (2014: £1,470(2017: impaired non-mortgage lending amounted to £817 million, net of an impairment allowance of £577£542 million). The fair value of the collateral held in respect of this lending was £107 million (2014: £110 million). In determining the fair value of collateral, no specific amounts have been attributed to the costs of realisation and the value of collateral for each loan has been limited to the principal amount of the outstanding advance in order to eliminate the effects of any over-collateralisation and to provide a clearer representation of the Group’s exposure.

 

UnimpairedStage 1 and Stage 2 non-mortgage retail lending amounted to £39,279£52,450 million (2014: £38,560(2017: unimpaired non-mortgage lending amounted to £49,482 million). Lending decisions are predominantly based on an obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. Collateral values are rigorously assessed at the time of loan origination and are thereafter monitored in accordance with business unit credit policy.

 

The Group credit risk disclosures for unimpaired non-mortgage retail lending report assets gross of collateral and therefore disclose the maximum loss exposure. The Group believes that this approach is appropriate. The value of collateral is reassessed if there is observable evidence of distress of the borrower. Unimpaired non-mortgage retail lending, including any associated collateral, is managed on a customer-by-customer basis rather than a portfolio basis. No aggregated collateral information for the entire unimpaired non-mortgage retail lending portfolio is provided to key management personnel.

 

COMMERCIAL LENDINGCommercial lending

 

Reverse repurchase transactions

 

At 31 December 20142018 there were reverse repurchase agreements which were accounted for as collateralised loans with a carrying value of £5,148£40,483 million (2017: £16,832 million), against which the Group held collateral with a fair value of £5,155£42,339 million (2017: £17,122 million), all of which the Group was able to repledge. Included in these amounts were collateral balances in the form of cash provided in respect of reverse repurchase agreements amounting to £35 million.of £nil (2017: £nil). These transactions were generally conducted under terms that are usual and customary for standard secured lending activities.

 

There were no such transactions in 2015.

ImpairedStage 3 secured lending

 

The value of collateral is re-evaluated and its legal soundness re-assessed if there is observable evidence of distress of the borrower; this evaluation is used to determine potential loss allowances and management’s strategy to try to either repair the business or recover the debt.

 

At 31 December 2015, impaired2018, Stage 3 secured commercial lending amounted to £1,245£658 million, net of an impairment allowance of £577£215 million (2014: £2,539(2017: impaired secured commercial lending amounted to £698 million, net of an impairment allowance of £3,799£242 million). The fair value of the collateral held in respect of impaired secured commercial lending was £1,367£590 million (2014: £2,517(2017: £797 million). In determining the fair value of collateral, no specific amounts have been attributed to the costs of realisation. For the purposes of determining the total collateral held by the Group in respect of impaired secured commercial lending, the value of collateral for each loan has been limited to the principal amount of the outstanding advance in order to eliminate the effects of any over-collateralisation and to provide a clearer representation of the Group’s exposure.

F-97

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

ImpairedNOTE 52: FINANCIAL RISK MANAGEMENT continued

Stage 3 secured commercial lending and associated collateral relates to lending to property companies and to customers in the financial, business and other services; transport, distribution and hotels; and construction industries.

 

UnimpairedStage 1 and Stage 2 secured lending

 

Unimpaired secured commercial lending amounted to £51,298 million (2014: £57,647 million).

For unimpairedStage 1 and Stage 2 secured commercial lending, the Group reports assets gross of collateral and therefore discloses the maximum loss exposure. The Group believes that this approach is appropriate as collateral values at origination and during a period of good performance may not be representative of the value of collateral if the obligor enters a distressed state.

 

UnimpairedStage 1 and Stage 2 secured commercial lending is predominantly managed on a cash flow basis. On occasion, it may include an assessment of underlying collateral, although, for impairedStage 3 lending, this will not always involve assessing it on a fair value basis. No aggregated collateral information for the entire unimpaired secured commercial lending portfolio is provided to key management personnel.

 

TRADING AND OTHER FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS (EXCLUDING EQUITY SHARES)

 

Included in trading and other financial assets at fair value through profit or loss are reverse repurchase agreements treated as collateralised loans with a carrying value of £33,174£28,356 million (2014: £36,725(2017: £31,590 million). Collateral is held with a fair value of £36,493£36,101 million (2014: £42,858(2017: £39,099 million), all of which the Group is able to repledge. At 31 December 2015, £15,4382018, £31,013 million had been repledged (2014: £10,319(2017: £31,281 million).

 

In addition, securities held as collateral in the form of stock borrowed amounted to £58,621£51,202 million (2014: £33,721(2017: £61,469 million). Of this amount, £29,859£49,233 million (2014: £32,686(2017: £44,432 million) had been resold or repledged as collateral for the Group’s own transactions.

 

These transactions were generally conducted under terms that are usual and customary for standard secured lending activities.

 

DERIVATIVE ASSETS, AFTER OFFSETTING OF AMOUNTS UNDER MASTER NETTING ARRANGEMENTS

 

The Group reduces exposure to credit risk by using master netting agreements and by obtaining collateral in the form of cash or highly liquid securities. In respect of the net derivative assets after offsetting of amounts under master netting arrangements of £10,001£14,327 million (2014: £14,199(2017: £12,785 million), cash collateral of £3,228£6,039 million (2014: £3,651(2017: £5,419 million) was held.

 

IRREVOCABLE LOAN COMMITMENTS AND OTHER CREDIT-RELATED CONTINGENCIES

 

At 31 December 2015,2018, the Group held irrevocable loan commitments and other credit-related contingencies of £65,719£62,640 million (2014: £57,711(2017: £63,237 million). Collateral is held as security, in the event that lending is drawn down, on £9,551£10,661 million (2014: £8,673(2017: £10,956 million) of these balances.

 

COLLATERAL REPOSSESSED

 

During the year, £203£245 million of collateral was repossessed (2014: £828(2017: £297 million), consisting primarily of residential property.

 

In respect of retail portfolios, the Group does not take physical possession of properties or other assets held as collateral and uses external agents to realise the value as soon as practicable, generally at auction, to settle indebtedness. Any surplus funds are returned to the borrower or are otherwise

F-97

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 53: FINANCIAL RISK MANAGEMENTcontinued

dealt with in accordance with appropriate insolvency regulations. In certain circumstances the Group takes physical possession of assets held as collateral against commercial lending. In such cases, the assets are carried on the Group’s balance sheet and are classified according to the Group’s accounting policies.

 

E.(E) COLLATERAL PLEDGED AS SECURITY

The Group pledges assets primarily for repurchase agreements and securities lending transactions which are generally conducted under terms that are usual and customary for standard securitised borrowing contracts.

 

REPURCHASE TRANSACTIONS

 

Deposits from banks

Included in deposits from banks are deposits held as collateral for facilities granted, with a carrying valuebalances arising from repurchase transactions of £7,061£21,170 million (2014: £1,075(2017: £23,175 million) and a; the fair value of £6,707the collateral provided under these agreements at 31 December 2018 was £19,615 million (2014: £1,075(2017: £23,082 million).

 

Customer deposits

Customer

Included in customer deposits included no deposits held asare balances arising from repurchase transactions of £1,818 million (2017: £2,638 million); the fair value of the collateral for facilities granted (2014: £nil). Collateral balances in the form of cash provided in respect of repurchaseunder these agreements amounted to £5at 31 December 2018 was £1,710 million (2014: £6(2017: £2,640 million).

 

Trading and other financialFinancial liabilities at fair value through profit or loss

The fair value of collateral pledged in respect of repurchase transactions, accounted for as secured borrowing, where the secured party is permitted by contract or custom to repledge was £44,655£28,438 million (2014: £56,696(2017: £48,765 million).

 

SECURITIES LENDING TRANSACTIONS

 

The following on balance sheet financial assets have been lent to counterparties under securities lending transactions:

 

   2015   2014 
   £m   £m 
Trading and other financial assets at fair value through profit or loss  6,478   9,955 
Loans and advances to customers  1,491   1,393 
Debt securities classified as loans and receivables  –   88 
Available-for-sale financial assets  4,247   8,363 
   12,216   19,799 
  2018
£m		  2017
£m		 
Financial assets at fair value through profit or loss  5,837   6,622 
Loans and advances to customers  –   197 
Financial assets at fair value through other comprehensive income (2017: available-for-sale financial assets)  1,917   2,608 
   7,754   9,427 

 

SECURITISATIONS AND COVERED BONDS

 

In addition to the assets detailed above, the Group also holds assets that are encumbered through the Group’s asset-backed conduits and its securitisation and covered bond programmes. Further details of these assets are provided in notes 1930 and 20.48.

 

LIQUIDITY RISKLiquidity risk

 

Liquidity risk is defined as the risk that the Group has insufficient financial resources to meet its commitments as they fall due, or can only secure them at excessive cost. Liquidity risk is managed through a series of measures, tests and reports that are primarily based on contractual maturity. The Group carries out monthly stress testing of its liquidity position against a range of scenarios, including those prescribed by the PRA. The Group’s liquidity risk appetite is also calibrated against a number of stressed liquidity metrics.

F-98

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 53:52: FINANCIAL RISK MANAGEMENT continued

 

The table below analyses assets and liabilities of the Group into relevant maturity groupings based on the remaining contractual period at the balance sheet date; balances with no fixed maturity are included in the over 5 years category. Certain balances, included in the table below on the basis of their residual maturity, are repayable on demand upon payment of a penalty.

 

(A) MATURITIES OF ASSETS AND LIABILITIES

 

 Up to 1-3 3-6 6-9 9-12 1-2 2-5 Over 5   Up to
1 month
£m		 1-3
months
£m		 3-6
months
£m		 6-9
months
£m		 9-12
months
£m		 1-2
years
£m		 2-5
years
£m		 Over 5
years
£m		 Total
£m		 
 1 month months months months months years years years Total
 £m £m £m £m £m £m £m £m £m
At 31 December 2015                  
At 31 December 2018                                    
Assets                                                  ��   
Cash and balances at central banks 58,411 2 4 – – – – – 58,417  54,662   1   –   –   –   –   –   –   54,663 
Trading and other financial assets at fair value through profit or loss 25,696 12,877 6,526 3,008 680 1,495 6,411 83,843 140,536
Financial assets at fair value through profit or loss  10,686   8,826   8,492   5,133   2,587   2,090   5,467   115,248   158,529 
Derivative financial instruments 1,226 1,257 841 585 607 1,480 3,889 19,582 29,467  579   688   418   336   441   1,064   3,075   16,994   23,595 
Loans and advances to banks 9,802 4,676 4,157 915 1,095 1,784 2,076 612 25,117  2,594   520   584   172   203   160   –   2,050   6,283 
Loans and advances to customers 19,392 6,351 11,864 8,318 11,426 28,061 68,685 301,078 455,175  36,326   19,383   18,415   14,378   11,318   30,459   72,028   282,551   484,858 
Debt securities held as loans and receivables 9 – – 1 98 208 28 3,847 4,191
Available-for-sale financial assets 109 269 56 535 120 1,000 7,178 23,765 33,032
Held-to-maturity investments – – – – – 297 3,357 16,154 19,808
Debt securities held at amortised cost  7   –   –   521   –   –   2,262   2,448   5,238 
Financial assets at fair value through other comprehensive income  166   453   249   800   1,685   2,536   11,496   7,430   24,815 
Other assets 4,620 1,068 884 1,589 1,421 2,204 9,561 19,598 40,945  2,667   1,552   196   238   219   387   1,118   33,240   39,617 
Total assets 119,265 26,500 24,332 14,951 15,447 36,529 101,185 468,479 806,688  107,687   31,423   28,354   21,578   16,453   36,696   95,446   459,961   797,598 
Liabilities                                                      
Deposits from banks 6,586 1,076 5,958 42 132 22 2,543 566 16,925  2,793   1,688   748   54   45   4,758   16,052   4,182   30,320 
Customer deposits 340,445 20,365 13,758 10,584 9,277 15,927 6,742 1,228 418,326  380,753   10,623   5,628   4,543   4,431   6,421   3,244   2,423   418,066 
Derivative financial instruments, trading and other financial liabilities at fair value through profit or loss 24,326 14,191 5,070 1,625 806 4,020 5,135 22,991 78,164
Derivative financial instruments and financial liabilities at fair value through profit or loss  5,160   11,877   5,048   1,663   522   1,104   4,108   22,438   51,920 
Debt securities in issue 5,822 7,273 5,556 4,757 1,661 11,697 21,984 23,306 82,056  4,172   5,692   9,007   4,668   1,694   13,062   28,676   24,197   91,168 
Liabilities arising from insurance and investment contracts 1,580 1,558 2,279 2,066 2,269 7,817 20,674 64,828 103,071  1,844   1,850   2,316   2,302   2,104   7,995   20,986   73,330   112,727 
Other liabilities 4,240 2,800 449 2,326 1,906 634 5,079 20,420 37,854  4,403   3,201   733   1,182   1,383   756   232   13,652   25,542 
Subordinated liabilities 269 307 329 466 2,083 648 9,321 9,889 23,312  85   145��  95   251   –   2,600   2,559   11,921   17,656 
Total liabilities 383,268 47,570 33,399 21,866 18,134 40,765 71,478 143,228 759,708  399,210   35,076   23,575   14,663   10,179   36,696   75,857   152,143   747,399 
At 31 December 2014                  
At 31 December 2017                                    
Assets                                                      
Cash and balances at central banks 50,476 1 13 2 – – – – 50,492  58,519   2   –   –   –   –   –   –   58,521 
Trading and other financial assets at fair value through profit or loss 31,766 10,523 6,818 2,982 1,526 1,880 5,976 90,460 151,931
Financial assets at fair value through profit or loss  11,473   13,345   4,858   2,781   1,056   2,655   5,341   121,369   162,878 
Derivative financial instruments 1,460 1,562 1,096 867 562 2,326 4,627 23,628 36,128  449   601   763   451   503   965   2,763   19,339   25,834 
Loans and advances to banks 10,709 4,926 3,107 1,274 1,170 1,107 2,579 1,283 26,155  3,104   314   190   190   192   131   2,405   85   6,611 
Loans and advances to customers 20,072 11,026 10,860 10,216 11,332 27,292 80,257 311,649 482,704  28,297   15,953   13,585   11,881   10,482   29,340   70,967   291,993   472,498 
Debt securities held as loans and receivables – – – – – 32 4 1,177 1,213  10   29   –   –   7   350   2,775   472   3,643 
Available-for-sale financial assets 963 1,533 724 28 203 939 6,085 46,018 56,493  59   365   286   1,025   265   3,040   15,366   21,692   42,098 
Other assets 4,684 1,284 1,347 1,933 1,393 4,801 9,490 24,848 49,780  3,807   897   414   1,170   854   725   5,618   26,541   40,026 
Total assets 120,130 30,855 23,965 17,302 16,186 38,377 109,018 499,063 854,896  105,718   31,506   20,096   17,498   13,359   37,206   105,235   481,491   812,109 
Liabilities                                                      
Deposits from banks 4,270 1,711 603 530 176 93 2,840 664 10,887  2,810   2,318   1,885   87   28   –   22,378   298   29,804 
Customer deposits 364,040 13,852 14,051 12,706 11,517 20,845 9,528 528 447,067  366,778   18,821   10,615   5,524   5,074   7,823   2,986   503   418,124 
Derivative financial instruments, trading and other financial liabilities at fair value through profit or loss 34,690 14,446 5,078 3,708 846 3,867 6,461 26,193 95,289
Derivative financial instruments and financial liabilities at fair value through profit or loss  19,215   16,932   4,933   3,419   948   1,961   4,298   25,295   77,001 
Debt securities in issue 8,862 5,678 2,850 5,024 3,409 7,257 17,330 25,823 76,233  3,248   6,014   4,431   3,506   2,902   6,333   25,669   20,347   72,450 
Liabilities arising from insurance and investment contracts 1,436 1,693 2,434 2,286 2,303 8,232 20,969 74,813 114,166  1,898   2,003   2,484   2,466   2,425   8,532   21,842   77,210   118,860 
Other liabilities 4,689 4,473 313 1,788 2,425 518 2,829 18,274 35,309  4,229   2,805   239   2,216   1,894   1,498   1,933   13,991   28,805 
Subordinated liabilities 74 1,241 1,331 10 192 3,174 5,428 14,592 26,042  –   202   1,588   –   570   574   3,983   11,005   17,922 
Total liabilities 418,061 43,094 26,660 26,052 20,868 43,986 65,385 160,887 804,993  398,178   49,095   26,175   17,218   13,841   26,721   83,089   148,649   762,966 

 

The above tables are provided on a contractual basis. The Group’s assets and liabilities may be repaid or otherwise mature earlier or later than implied by their contractual terms and readers are, therefore, advised to use caution when using this data to evaluate the Group’s liquidity position. In particular, amounts in respect of customer deposits are usually contractually payable on demand or at short notice. However, in practice, these deposits are not usually withdrawn on their contractual maturity.

F-99

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 53:52: FINANCIAL RISK MANAGEMENT continued

 

The table below analyses financial instrument liabilities of the Group, excluding those arising from insurance and participating investment contracts, on an undiscounted future cash flow basis according to contractual maturity, into relevant maturity groupings based on the remaining period at the balance sheet date; balances with no fixed maturity are included in the over 5 years category.

 

  Up to 1-3 3-12 1-5 Over 5  
  1 month months months years years Total
  £m £m £m £m £m £m
At 31 December 2015            
Deposits from banks 6,673 1,143 6,156 2,785 400 17,157
Customer deposits 339,387 21,234 34,012 23,932 312 418,877
Trading and other financial liabilities at fair value through profit or loss 15,055 15,465 5,365 5,897 10,662 52,444
Debt securities in issue 7,526 9,131 18,467 34,515 24,540 94,179
Liabilities arising from non-participating investment contracts 22,777 – – – – 22,777
Subordinated liabilities 522 366 4,132 13,238 20,476 38,734
Total non-derivative financial liabilities 391,940 47,339 68,132 80,367 56,390 644,168
Derivative financial liabilities:            
Gross settled derivatives – outflows 31,932 28,059 27,510 29,962 28,508 145,971
Gross settled derivatives – inflows (30,432) (26,967) (26,337) (27,883) (26,521) (138,140)
Gross settled derivatives – net flows 1,500 1,092 1,173 2,079 1,987 7,831
Net settled derivatives liabilities 16,600 115 321 953 2,587 20,576
Total derivative financial liabilities 18,100 1,207 1,494 3,032 4,574 28,407
At 31 December 2014            
Deposits from banks 4,288 1,734 1,427 2,895 954 11,298
Customer deposits 365,261 13,672 38,520 31,614 578 449,645
Trading and other financial liabilities at fair value through profit or loss 32,209 15,145 1,316 3,658 7,508 59,836
Debt securities in issue 11,070 6,163 15,186 34,028 31,116 97,563
Liabilities arising from non-participating investment contracts 17,136 – – – – 17,136
Subordinated liabilities 757 1,433 2,842 12,908 19,784 37,724
Total non-derivative financial liabilities 430,721 38,147 59,291 85,103 59,940 673,202
Derivative financial liabilities:            
Gross settled derivatives – outflows 39,616 32,166 34,932 42,416 41,128 190,258
Gross settled derivatives – inflows (37,928) (30,408) (32,999) (39,883) (35,858) (177,076)
Gross settled derivatives – net flows 1,688 1,758 1,933 2,533 5,270 13,182
Net settled derivatives liabilities 21,959 114 341 1,150 3,650 27,214
Total derivative financial liabilities 23,647 1,872 2,274 3,683 8,920 40,396

The Group’s financial guarantee contracts are accounted for as financial instruments and measured at fair value on the balance sheet. The majority of the Group’s financial guarantee contracts are callable on demand, were the guaranteed party to fail to meet its obligations. It is, however, expected that most guarantees will expire unused. The contractual nominal amounts of these guarantees totalled £7,165 million at 31 December 2015 (2014: £7,161 million) with £4,014 million expiring within one year; £942 million between one and three years; £1,182 million between three and five years; and £1,027 million over five years (2014: £4,133 million expiring within one year; £1,823 million between one and three years; £674 million between three and five years; and £531 million over five years).

  Up to
1 month
£m		  1-3
months
£m		  3-12
months
£m		  1-5
years
£m		  Over 5
years
£m		  Total
£m		 
At 31 December 2018                        
Deposits from banks  2,820   2,710   1,022   20,920   3,502   30,974 
Customer deposits  380,985   10,584   14,169   11,634   1,554   418,926 
Financial liabilities at fair value through profit or loss  9,693   10,984   7,553   930   10,771   39,931 
Debt securities in issue  5,942   7,314   22,564   48,233   24,201   108,254 
Liabilities arising from non-participating investment contracts  13,853   –   –   –   –   13,853 
Subordinated liabilities  247   1,017   1,144   8,231   19,328   29,967 
Total non-derivative financial liabilities  413,540   32,609   46,452   89,948   59,356   641,905 
Derivative financial liabilities:                        
Gross settled derivatives – outflows  39,165   27,976   23,978   43,239   33,763   168,121 
Gross settled derivatives – inflows  (38,301)  (27,283)  (23,134)  (40,690)  (28,933)  (158,341)
Gross settled derivatives – net flows  864   693   844   2,549   4,830   9,780 
Net settled derivatives liabilities  13,511   103   209   782   2,193   16,798 
Total derivative financial liabilities  14,375   796   1,053   3,331   7,023   26,578 
At 31 December 2017                        
Deposits from banks  2,516   3,545   2,096   21,498   660   30,315 
Customer deposits  367,103   18,854   21,308   11,198   2,375   420,838 
Financial liabilities at fair value through profit or loss  21,286   14,424   6,499   4,251   13,044   59,504 
Debt securities in issue  3,444   6,331   12,562   36,999   23,923   83,259 
Liabilities arising from non-participating investment contracts  15,447   –   –   –   –   15,447 
Subordinated liabilities  231   454   2,907   7,170   19,164   29,926 
Total non-derivative financial liabilities  410,027   43,608   45,372   81,116   59,166   639,289 
Derivative financial liabilities:                        
Gross settled derivatives – outflows  23,850   31,974   24,923   43,444   30,605   154,796 
Gross settled derivatives – inflows  (23,028)  (30,972)  (23,886)  (43,523)  (32,065)  (153,474)
Gross settled derivatives – net flows  822   1,002   1,037   (79)  (1,460)  1,322 
Net settled derivatives liabilities  17,425   128   776   974   2,795   22,098 
Total derivative financial liabilities  18,247   1,130   1,813   895   1,335   23,420 

 

The majority of the Group’s non-participating investment contract liabilities are unit-linked. These unit-linked products are invested in accordance with unit fund mandates. Clauses are included in policyholder contracts to permit the deferral of sales, where necessary, so that linked assets can be realised without being a forced seller.

 

The principal amount for undated subordinated liabilities with no redemption option is included within the over five years column; interest of approximately £39£27 million (2014: £80(2017: £24 million) per annum which is payable in respect of those instruments for as long as they remain in issue is not included beyond five years.

F-100

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 53:52: FINANCIAL RISK MANAGEMENTcontinued

 

Further information on the Group’s liquidity exposures is provided on pages 103 to 107.88–94.

 

Liabilities arising from insurance and participating investment contracts are analysed on a behavioural basis, as permitted by IFRS 4, as follows:

 

  Up to  1-3  3-12  1-5  Over 5    
  1 month  months  months  years  years  Total 
  £m  £m  £m  £m  £m  £m 
At 31 December 2015  1,477   1,081   4,745   10,444   62,547   80,294 
At 31 December 2014  1,036   1,276   5,100   20,916   58,590   86,918 
  Up to
1 month
£m		  1-3
months
£m		  3-12
months
£m		  1-5
years
£m		  Over 5
years
£m		  Total
£m		 
At 31 December 2018  1,667   1,624   5,925   25,414   64,244   98,874 
At 31 December 2017  1,708   1,747   6,467   26,479   67,012   103,413 

 

For insurance and participating investment contracts which are neither unit-linked nor in the Group’s with-profit funds, in particular annuity liabilities, the aim is to invest in assets such that the cash flows on investments match those on the projected future liabilities.

 

The following tables set out the amounts and residual maturities of the Group’s off balance sheet contingent liabilities and commitments.

 

 Up to 1-3 3-6 6-9 9-12 1-3 3-5 Over 5   Up to
1 month
£m		 1-3
months
£m		 3-6
months
£m		 6-9
months
£m		 9-12
months
£m		 1-3
years
£m		 3-5
years
£m		 Over 5
years
£m		 Total
£m		 
 1 month months months months months years years years Total
 £m £m £m £m £m £m £m £m £m
At 31 December 2015                  
At 31 December 2018                                    
Acceptances and endorsements 16 34 – – – 1 1 – 52  64   83   34   13   –   –   –   –   194 
Other contingent liabilities 331 441 433 116 142 365 107 646 2,581  450   484   203   223   150   665   133   749   3,057 
Total contingent liabilities 347 475 433 116 142 366 108 646 2,633  514   567   237   236   150   665   133   749   3,251 
Lending commitments 46,443 1,989 4,444 3,276 11,575 18,803 19,234 6,731 112,495
Lending commitments and guarantees  67,055   2,947   4,474   6,055   16,123   17,737   15,374   4,602   134,367 
Other commitments – – 2 31 5 4 83 296 421  428   –   –   2   92   20   13   176   731 
Total commitments 46,443 1,989 4,446 3,307 11,580 18,807 19,317 7,027 112,916
Total commitments and guarantees  67,483   2,947   4,474   6,057   16,215   17,757   15,387   4,778   135,098 
Total contingents and commitments 46,790 2,464 4,879 3,423 11,722 19,173 19,425 7,673 115,549  67,997   3,514   4,711   6,293   16,365   18,422   15,520   5,527   138,349 
 Up to 1-3 3-6 6-9 9-12 1-3 3-5 Over 5  
 1 month months months months months years years years Total
 £m £m £m £m £m £m £m £m £m
At 31 December 2014                  
At 31 December 2017                                    
Acceptances and endorsements 51 6 1 – – – – 1 59  12   51   4   –   –   4   –   –   71 
Other contingent liabilities 432 415 217 80 162 504 130 683 2,623  392   669   210   131   205   506   271   656   3,040 
Total contingent liabilities 483 421 218 80 162 504 130 684 2,682  404   720   214   131   205   510   271   656   3,111 
Lending commitments 49,773 2,576 4,738 3,397 12,209 13,750 15,733 5,103 107,279
Lending commitments and guarantees  66,964   3,137   5,966   5,525   14,572   18,001   16,577   4,503   135,245 
Other commitments 38 32 – 31 – 162 – – 263  19   –   –   38   –   46   71   210   384 
Total commitments 49,811 2,608 4,738 3,428 12,209 13,912 15,733 5,103 107,542
Total commitments and guarantees  66,983   3,137   5,966   5,563   14,572   18,047   16,648   4,713   135,629 
Total contingents and commitments 50,294 3,029 4,956 3,508 12,371 14,416 15,863 5,787 110,224  67,387   3,857   6,180   5,694   14,777   18,557   16,919   5,369   138,740 

 

NOTE 54:53: CONSOLIDATED CASH FLOW STATEMENT

 

(A) CHANGE IN OPERATING ASSETSChange in operating assets

 

 2015  2014 2013  2018
£m		  2017
 £m		 2016
£m		 
 £m  £m £m 
Change in loans and receivables  6,081   12,852   29,909 
Change in derivative financial instruments, trading and other financial assets at fair value through profit or loss  20,689   (11,767)  (5,078)
Change in financial assets held at amortised cost  (27,038)  (24,747)  710 
Change in derivative financial instruments and financial assets at fair value through profit or loss  22,046   9,916   (13,889)
Change in other operating assets  7,930   (1,957)  (4,448)  520   (661)  961 
Change in operating assets  34,700   (872)  20,383   (4,472)  (15,492)  (12,218)
                        
(B) CHANGE IN OPERATING LIABILITIES            
(B) Change in operating liabilities            
                        
  2015   2014   2013  2018  2017  2016 
  £m   £m   £m  £m  £m  £m 
Change in deposits from banks  6,107   (3,029)  (25,529)  515   13,415   (654)
Change in customer deposits  (4,252)  7,745   15,599   (322)  2,913   (3,690)
Change in debt securities in issue  5,657   (11,089)  (29,032)  18,579   (3,600)  (6,552)
Change in derivative financial instruments, trading and other liabilities at fair value through profit or loss  (16,924)  24,020   (8,376)
Change in derivative financial instruments and liabilities at fair value through profit or loss  (24,606)  (12,481)  11,265 
Change in investment contract liabilities  (3,922)  (342)  3,171   (1,594)  (4,665)  (2,665)
Change in other operating liabilities  1,349   (5,313)  (3,520)  (1,245)  136   (363)
Change in operating liabilities  (11,985)  11,992   (47,687)  (8,673)  (4,282)  (2,659)
F-101

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 54:53: CONSOLIDATED CASH FLOW STATEMENT continued

 

(C) NON-CASH AND OTHER ITEMSNon-cash and other items  

 

 2015  2014 2013 
 £m  £m £m  2018
£m		  2017
£m		 2016
£m		 
Depreciation and amortisation  2,112   1,935   1,940   2,405   2,370   2,380 
Revaluation of investment properties  (416)  (513)  (156)  (139)  (230)  83 
Provision for impairment of disposal groups  –   –   382 
Allowance for loan losses  441   737   2,726   1,024   691   592 
Write-off of allowance for loan losses  (3,467)  (5,761)  (5,858)
Impairment of available-for-sale financial assets  4   2   15 
Write-off of allowance for loan losses, net of recoveries  (1,025)  (1,061)  (1,272)
Impairment charge relating to undrawn balances  (73)  (9)  (13)
Impairment of financial assets at fair value through other comprehensive income (2017: available-for-sale financial assets)  (14)   6   173 
Change in insurance contract liabilities  (2,856)  4,070   5,300   (4,547)  9,168   14,084 
Payment protection insurance provision  4,000   2,200   3,050   750   1,300   1,350 
Other regulatory provisions  837   925   405   600   865   1,085 
Other provision movements  337   222   153   (518)  (8)  (27)
Net charge (credit) in respect of defined benefit schemes  315   (478)  503   405   369   287 
Impact of consolidation and deconsolidation of OEICs1  (5,978)  (5,277)  6,303   –   –   (3,157)
Unwind of discount on impairment allowances  (56)  (126)  (351)  (44)  (23)  (32)
Foreign exchange impact on balance sheet2  507   770   89   191   125   (155)
Liability management losses (gains) within other income3  –   –   80 
Loss on ECN exchange transaction  –   1,336   – 
Loss on ECN transactions  –   –   721 
Interest expense on subordinated liabilities  1,970   2,374   2,956   1,388   1,436   1,864 
Loss (profit) on disposal of businesses  46   (208)  (362)  –   –   – 
Net gain on sale of available-for-sale financial assets  (51)  (131)  (629)
Net gain on sale of financial assets at fair value through other comprehensive income (2017: available-for-sale financial assets)  (275)  (446)  (575)
Hedging valuation adjustments on subordinated debt  (162)  559   (1,083)  (429)  (327)  153 
Value of employee services  279   340   434   260   414   309 
Issue of shares (non-cash)  –   –   160 
Transactions in own shares  (816)  (286)  (480)  40   (411)  (175)
Accretion of discounts and amortisation of premiums and issue costs  339   122   286   1,947   1,701   465 
Share of post-tax results of associates and joint ventures  3   (32)  (43)  (9)  (6)  1 
Transfers to income statement from reserves  (956)  (1,153)  (550)  (701)  (650)  (557)
Profit on disposal of tangible fixed assets  (51)  (44)  (43)  (104)  (120)  (93)
Other non-cash items  (11)  (8)  (26)  (34)  –   (17)
Total non-cash items  (3,630)  1,575   15,201   1,098   15,154   17,474 
Contributions to defined benefit schemes  (433)  (538)  (811)  (868)  (587)  (630)
Payments in respect of payment protection insurance provision  (3,091)  (2,458)  (2,674)  (2,104)  (1,657)  (2,200)
Payments in respect of other regulatory provisions  (661)  (1,104)  (360)  (1,032)  (928)  (761)
Other  7   29   26   14   –   2 
Total other items  (4,178)  (4,071)  (3,819)  (3,990)  (3,172)  (3,589)
Non-cash and other items  (7,808)  (2,496)  11,382   (2,892)  11,982   13,885 

 

1These OEICs (Open-ended investment companies) are mutual funds which are consolidated if the Group manages the funds and also has a sufficient beneficial interest. The population of OEICs to be consolidated varies at each reporting date as external investors acquire and divest holdings in the various funds. The consolidation of these funds is effected by the inclusion of the fund investments and a matching liability to the unitholders; and changes in funds consolidated represent a non-cash movement on the balance sheet.
  
2When considering the movement on each line of the balance sheet, the impact of foreign exchange rate movements is removed in order to show the underlying cash impact.
3A number of capital transactions entered into by the Group involved the exchange of existing securities for new issues and as a result there was no related cash flow.
F-102

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 54: CONSOLIDATED CASH FLOW STATEMENT continued

 

(D) ANALYSIS OF CASH AND CASH EQUIVALENTS AS SHOWN IN THE BALANCE SHEETAnalysis of cash and cash equivalents as shown in the balance sheet  

 

 2015  2014 2013 
 £m  £m £m  2018
£m		  2017
£m		 2016
£m		 
                        
Cash and balances at central banks  58,417   50,492   49,915   54,663   58,521   47,452 
Less: mandatory reserve deposits1  (941)  (980)  (937)  (2,553)  (957)  (914)
  57,476   49,512   48,978   52,110   57,564   46,538 
Loans and advances to banks  25,117   26,155   25,365   6,283   6,611   26,902 
Less: amounts with a maturity of three months or more  (10,640)  (10,520)  (7,546)  (3,169)  (3,193)  (11,052)
  14,477   15,635   17,819   3,114   3,418   15,850 
Total cash and cash equivalents  71,953   65,147   66,797   55,224   60,982   62,388 

 

1Mandatory reserve deposits are held with local central banks in accordance with statutory requirements; these deposits are not available to finance the Group’s day-to-day operations.

 

Included within cash and cash equivalents at 31 December 20152018 is £13,545£40 million (2014: £12,855(31 December 2017: £2,322 million; 2013: £14,0581 January 2018 £48 million; 31 December 2016: £14,475 million) held within the Group’s life funds,long-term insurance and investments businesses, which is not immediately available for use in the business.

F-102

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 53: CONSOLIDATED CASH FLOW STATEMENTcontinued

 

(E) DISPOSAL AND CLOSURE OF GROUP UNDERTAKINGS AND BUSINESSESAcquisition of group undertakings and businesses

 

  2015  2014  2013 
  £m  £m  £m 
Trading and other assets at fair value through profit or loss  3,420   11   35,159 
Loans and advances to customers  21,333   256   2,612 
Loans and advances to banks  5,539   55   1,701 
Available-for-sale financial assets  654   –   – 
Investment property  –   –   582 
Value of in-force business  60   –   831 
Other intangible assets  –   –   251 
Property, plant and equipment  150   –   67 
   31,156   322   41,203 
             
Customer deposits  (24,613)  (266)  (1,923)
Debt securities in issue  (9)  –   (264)
Liabilities arising from insurance contracts and participating investment contracts  (3,828)  –   (451)
Liabilities arising from non-participating investment contracts  (549)  –   (29,953)
Non-controlling interests  (825)  –   (357)
Other net assets (liabilities)  (314)  802   (6,160)
   (30,138)  536   (39,108)
             
Net assets  1,018   858   2,095 
             
Non-cash consideration received  –   (518)  (59)
(Loss) profit on sale  (46)  208   362 
Cash consideration received on losing control of group undertakings and businesses  972   548   2,398 
Cash and cash equivalents disposed  (5,043)  (5)  (1,702)
Net cash inflow (outflow)  (4,071)  543   696 
  2018
£m		  2017
£m		  2016
£m		 
Net assets acquired:            
Cash and cash equivalents  –   123   – 
Loans and advances to customers  –   7,811   – 
Available-for-sale financial assets  –   16   – 
Intangible assets  21   702   – 
Property, plant and equipment  –   6   – 
Other assets  6   414   – 
Deposits from banks1  –   (6,431)  – 
Other liabilities  (1)  (927)  – 
Goodwill arising on acquisition  –   302   – 
Cash consideration  26   2,016   – 
Less: Cash and cash equivalents acquired  –   (123)  – 
Net cash outflow arising from acquisition of subsidiaries and businesses  26   1,893   – 
Acquisition of and additional investment in joint ventures  23   30   20 
Net cash outflow from acquisitions in the year  49   1,923   20 

1 Upon acquisition in 2017, the funding of MBNA was assumed by Lloyds Bank plc.

(F) Disposal and closure of group undertakings and businesses

  2018
£m		  2017
£m		  2016
£m		 
Loans and advances to customers  –   342   – 
Non-controlling interests  –   (242)  – 
Other net assets (liabilities)  1   29   5 
   1   129  5 
             
Net assets  1   129   5 
             
Non-cash consideration received  –   –   – 
(Loss) profit on sale  –   –   – 
Cash consideration received on losing control of group undertakings and businesses  1   129   5 
Cash and cash equivalents disposed  –   –   – 
Net cash inflow (outflow)  1   129   5 
F-103

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 55: DISPOSAL54: ADOPTION OF INTEREST IN TSB BANKING GROUP PLC

On 20 March 2015 the Group announced that it had agreed to sell a 9.99 per cent interest in TSB Banking Group plc (TSB) to Banco de Sabadell S.A. (Banco Sabadell) and that it had entered into an irrevocable undertaking to accept Banco Sabadell’s recommended cash offer in respect of its remaining 40.01 per cent interest in TSB. The offer by Banco Sabadell was conditional upon, amongst other things, regulatory approval.

The sale of the 9.99 per cent interest completed on 24 March 2015, reducing the Group’s holding in TSB to 40.01 per cent; this sale led to a loss of control and the deconsolidation of TSB. The Group’s residual investment in 40.01 per cent of TSB was then recorded at fair value, as an asset held for sale. The Group recognised a loss of £660 million reflecting the net costs of the Transitional Service Agreement between Lloyds and TSB, the contribution to be provided by Lloyds to TSB in moving to alternative IT provision and the net result on sale of the 9.99 per cent interest and fair valuation of the residual investment.

The Group announced on 30 June 2015 that all relevant regulatory clearances for the sale of its remaining 40.01 per cent holding in TSB had been received and that the sale was therefore unconditional in all respects; the proceeds were received on 10 July 2015.

At 31 December 2015, the Group held a £2,349 million interest in Cape Funding No.1 PLC, a securitisation funding vehicle set up by TSB.

NOTE 56: EVENTS SINCE THE BALANCE SHEET DATE

In 2015, the Group participated in the UK-wide concurrent stress testing run by the Bank of England; the Enhanced Capital Notes (ECNs) in issue were not taken into account for the purposes of core capital in the PRA stress tests and the Group has determined that a Capital Disqualification Event (CDE), as defined in the conditions of the ECNs, has occurred. This determination was confirmed by a unanimous decision by the Court of Appeal on 10 December 2015 and on 29 January 2016 the Group announced the redemption of certain series of ECNs using the Regulatory Call Right. The Group also launched tender offers for the remaining series of ECNs on 29 January 2016 and has announced that, subsequent to completion of such offers, it will redeem those ECNs not validly tendered using the Regulatory Call Right. The offers and redemptions will be completed before the end of the first quarter, resulting in a net loss to the Group currently estimated to be approximately £700 million, principally comprising the write-off of the embedded equity conversion feature and premiums paid under the terms of the transaction.

The trustee of the ECNs has been granted leave by the Supreme Court to appeal the Court of Appeal decision. In the event that the Supreme Court were to determine that a CDE had not occurred, the Group would compensate fairly the holders of the ECNs whose securities are redeemed using the Regulatory Call Right for losses suffered as a result of early redemption.

NOTE 57: FUTURE ACCOUNTING DEVELOPMENTSIFRS 9 AND IFRS 15

 

The following pronouncements are not applicable fortable summarises the year ending 31 December 2015 and have not been applied in preparing these financial statements. Save as disclosed below,adjustments arising on the full impactadoption of these accounting changes is being assessed by the Group.

IFRS 9Financial Instruments

IFRS 9 replaces IAS 39 Financial Instruments: Recognition and Measurement. IFRS 9 requires financial assets15 (see below) to be classified into one of three measurement categories, fair value through profit or loss, fair value through other comprehensive income and amortised cost, on the basis of the objectives of the entity’s business model for managing its financial assets and the contractual cash flow characteristics of the instruments. These changes are not expected to have a significant impact on the Group.

IFRS 9 also replaces the existing ‘incurred loss’ impairment approach with an expected credit loss approach, resulting in earlier recognition of credit losses. The IFRS 9 impairment model has three stages. Entities are required to recognise a 12 month expected loss allowance on initial recognition (stage 1) and a lifetime expected loss allowance when there has been a significant increase in credit risk (stage 2). The assessment of whether a significant increase in credit risk has occurred is a key aspect of the IFRS 9 methodology and involves quantitative measures, such as forward looking probabilities of default, and qualitative factors and therefore requires considerable management judgement. Stage 3 requires objective evidence of impairment which is similar to the guidance on incurred losses in IAS 39. IFRS 9 requires the use of more forward looking information including reasonable and supportable forecasts of future economic conditions. The need to consider multiple economic scenarios and how they could impact the loss allowance is a very subjective feature of the IFRS 9 impairment model. Loan commitments and financial guarantees not measured at fair value through profit or loss are also in scope.

These changes may result in a material increase in the Group’s balance sheet provisions for credit losses although the extent of any increase will depend upon, amongst other things, the composition of the Group’s lending portfolios and forecast economic conditionsas at the date of implementation. The requirement to transfer assets between stages and to incorporate forward looking data into the expected credit loss calculation, including multiple economic scenarios, is likely to result in impairment charges being more volatile when compared to the current IAS 39 impairment model.1 January 2018.

 

The IFRS 9 expected credit loss model differs from the regulatory models in a number of ways, for example stage 2 assets under IFRS 9 carry a lifetime expected loss amount whereas regulatory models generate 12 month expected losses for non defaulted loans. In addition, different assets are in scope of each reporting base and therefore the size of the regulatory expected losses should not be taken as a proxy to the size of the loss allowance under IFRS 9.

In 2015, the Basel Committee on Banking Supervision published finalised guidance on credit risk and accounting for expected credit losses. The paper sets out supervisory guidance on how expected credit loss accounting models should interact with a bank’s credit risk practices. The existing impairment processes, controls and governance will be reviewed and changed where necessary to reflect the increased demands of an expected credit loss impairment model.

The hedge accounting requirements of IFRS 9 are more closely aligned with risk management practices and follow a more principle-based approach than IAS 39. The accounting policy choice to continue with IAS 39 hedge accounting is still being considered by the Group.

The Group has an established IFRS 9 programme to ensure a high quality implementation in compliance with the standard and regulatory guidance. The programme involves Finance and Risk functions across the Group with Divisional and Group steering committees providing oversight. The key responsibilities of the programme include defining IFRS 9 methodology and accounting policy, identifying data and system requirements, and establishing an appropriate operating model and governance framework. The impairment workstreams have developed methodologies for many of the IFRS 9 requirements, although additional validation of these decisions will be on-going to reflect the uncertainty around regulatory and audit expectations. Some risk model build has started and detailed plans, including resource needs, are in place. We expect the majority of model build to be completed in 2016 to allow robust testing and the development of management information to take place in 2017.

  As at
31 December
2017
£m		  IFRS 9:
Classification and
measurement
£m		  IFRS 9:
Impairment
£m		  IFRS 15
£m		  Adjusted as at
1 January 2018
£m		 
Assets                    
Cash and balances at central banks  58,521   –   –   –   58,521 
Items in course of collection from banks  755   –   –   –   755 
Financial assets at fair value through profit or loss  162,878   13,130   –   –   176,008 
Derivative financial instruments  25,834   (360)  –   –   25,474 
Loans and advances to banks  6,611   (2,364)  (1)  –   4,246 
Loans and advances to customers  472,498   (10,460)  (1,022)  –   461,016 
Debt securities  3,643   (329)  –   –   3,314 
Financial assets at amortised cost  482,752   (13,153)  (1,023)  –   468,576 
Financial assets at fair value through other comprehensive income      42,917   –   –   42,917 
Available-for-sale financial assets  42,098   (42,098)  –   –     
Goodwill  2,310   –   –   –   2,310 
Value of in-force business  4,839   –   –   –   4,839 
Other intangible assets  2,835   –   –   –   2,835 
Property, plant and equipment  12,727   –   –   –   12,727 
Current tax recoverable  16   –   –   –   16 
Deferred tax assets  2,284   22   300   3   2,609 
Retirement benefit assets  723   –   –   –   723 
Other assets  13,537   (655)  (10)  –   12,872 
Total assets  812,109   (197)  (733)  3   811,182 
Equity and liabilities                    
Liabilities                    
Deposits from banks  29,804   –   –   –   29,804 
Customer deposits  418,124   –   –   –   418,124 
Items in course of transmission to banks  584   –   –   –   584 
Financial liabilities at fair value through profit or loss  50,877   58   –   –   50,935 
Derivative financial instruments  26,124   –   –   –   26,124 
Notes in circulation  1,313   –   –   –   1,313 
Debt securities in issue  72,450   (48)  –   –   72,402 
Liabilities arising from insurance contracts and participating investment contracts  103,413   –   –   –   103,413 
Liabilities arising from non-participating investment contracts  15,447   –   –   –   15,447 
Other liabilities  20,730   –   (3)  14   20,741 
Retirement benefit obligations  358   –   –   –   358 
Current tax liabilities  274   –   –   –   274 
Other provisions  5,546   –   243   –   5,789 
Subordinated liabilities  17,922   –   –   –   17,922 
Total liabilities  762,966   10   240   14   763,230 
Equity                    
Shareholders’ equity  43,551   (207)  (973)  (11)  42,360 
Other equity instruments  5,355   –   –   –   5,355 
Non-controlling interests  237   –   –   –   237 
Total equity  49,143   (207)  (973)  (11)  47,952 
Total equity and liabilities  812,109   (197)  (733)  3   811,182 
F-104

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 57: FUTURE ACCOUNTING DEVELOPMENTS54: ADOPTION OF IFRS 9 AND IFRS 15continued

 

IFRS 9 Financial Instruments

Impairment

The Group adopted IFRS 9 from 1 January 2018. In accordance with the transition requirements of IFRS 9, comparative information for 2017 has not been restated and transitional adjustments have been accounted for through retained earnings as at 1 January 2018, the date of initial application; and as a result shareholders’ equity reduced by £1,180 million, driven by the effects of additional impairment provisions following the implementation of the expected credit loss methodology and measurement adjustments following the reclassification of certain financial assets to be measured at fair value rather than amortised cost. It is effectivenot practicable to quantify the impact of adoption of IFRS 9 on the results for annual periods beginningthe current year.

The following table summarises the impact of the transitional adjustment on or afterthe Group’s loss allowances at 1 January 2018:

  IAS 39 allowance
at 31 December
2017
£m		  Transitional
adjustment to loss
allowance
£m		  IFRS 9 loss
allowance at
1 January 2018
£m		 
Loans and advances to banks  –   1   1 
Loans and advances to customers  2,201   1,022   3,223 
Debt securities  26   –   26 
Other  –   10   10 
   2,227   1,033   3,260 
Provisions for undrawn commitments and financial guarantees  30   243   273 
Total loss allowance  2,257   1,276   3,533 

There were no impacts on the Group’s loss allowances as a result of changes in the measurement category of financial assets at 1 January 2018.

 

The net impact of IFRS 15Revenue from Contracts with Customers9 on transition was an increase in impairment allowances of £1,276 million which is analysed as follows:

 

  IAS 39
Latent risk
£m		  12-month
expected loss
£m		  Lifetime
expected loss
£m		  Undrawn
commitments
£m		  Multiple
economic
scenarios
£m		  Total
£m		 
Retail                        
Secured  (561)  24   371   1   226   61 
Unsecured  (133)  279   251   161   8   566 
UK Motor Finance  (99)  112   72   1   1   87 
Other  (30)  30   29   13   4   46 
   (823)  445   723   176   239   760 
Commercial Banking  (190)  108   330   60   63   371 
Insurance and Wealth  (5)  15   6   –   1   17 
Other  (115)  51   144   –   48   128 
Total  (1,133)  619   1,203   236   351   1,276 

The key drivers for the provision movements from IAS 39 to IFRS 15 replaces IAS 18 Revenue and IAS 11 Construction Contracts. Financial instruments, leases and insurance contracts9 for the Group are out of scope and so this standard is not expected to have a significant impact on the Group.as follows:

 

IFRS 15 is effective for annual periods beginning on or after 1 January 2018.

IFRS 16Leases

On 13 January 2016 the IASB issued IFRS 16 to replace IAS 17 Leases. IFRS 16 requires lessees to recognise a right of use asset and a liability for future payments arising from a lease contract. Lessor accounting requirements remain aligned to the current approach under IAS 17.

IFRS 16 is effective for annual periods beginning on or after 1 January 2019.

Amendments to IAS 7 Statement of Cash Flows and IAS 12 Income Taxes

In January 2016, the IASB issued amendments to IAS 7 Statement of Cash Flows which require additional disclosure about an entity’s financing activities and IAS 12 Income Taxes which clarify when a deferred tax asset should be recognised for unrealised losses. These revised requirements, which are effective for annual periods beginning on or after 1 January 2017, are not expected to have a significant impact on the Group.

– Latent risk: under IAS 39 provisions were held against losses that had been incurred at the balance sheet date but had either not been specifically identified or not been adequately captured in the provisioning models. Under IFRS 9 assets which had not defaulted are allocated to Stages 1 and 2 and an appropriate expected credit loss allowance made.
–12-month expected loss: IFRS 9 requires that for financial assets where there has been no significant increase in credit risk since origination (Stage 1) a loss allowance equivalent to 12-month expected credit losses should be held. Under IAS 39 these balances would not be specifically provided against although a provision for latent risk would be held.
–Lifetime expected credit loss: financial assets that have experienced a significant increase in credit risk since initial recognition (Stage 2) and credit impaired assets (Stage 3) are required to carry a lifetime expected credit loss allowance. Under IAS 39, Stage 2 assets were treated as performing and consequently no specific impairment provision was held, although a proportion of the provision held against latent risks was held against these assets. Assets treated as impaired under IAS 39 carried a provision reducing the carrying value to the estimated recoverable amount.
–Undrawn commitments: IFRS 9 requires a loss allowance to be held against undrawn lending commitments. Previously, an impairment provision would only have been held in the event that the commitment was irrevocable and a loss event had occurred.
–Multiple economic scenarios: IFRS 9 requires that the expected credit loss allowance should reflect an unbiased range of possible future economic outcomes. This was not required under IAS 39.
F-105

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 58: PARENT COMPANY DISCLOSURES54: ADOPTION OF IFRS 9 AND IFRS 15 continued

 

A COMPANY INCOME STATEMENTReclassifications

 

   2015
£ million		   2014
£ million		   2013
£ million		 
Net interest income  276   255   166 
Other income  983   283   (1,009)
Total income  1,259   538   (843)
Operating expenses  (290)  (265)  (248)
Profit (loss) on ordinary activities before tax  969   273   (1,091)
Taxation  (72)  106   245 
Profit (loss) for the year  897   379   (846)

On transition to IFRS 9, the Group assessed its business models in order to determine the appropriate classification. The Retail and Commercial Banking loan books are generally held to collect contractual cash flows until the lending matures and met the criteria to remain at amortised cost. Certain portfolios which are subject to higher levels of sales were reclassified as fair value through other comprehensive income. Within the Group’s insurance business, assets are managed on a fair value basis and so continued to be accounted for at fair value through profit or loss.

      IFRS 9 reclassification to          
  IAS 39 carrying
amount
£m		   At fair value
through profit or
loss
£m		  At fair value
through other
comprehensive
income
£m		  Total
reclassification
£m		  IFRS 9
remeasurement
£m		  At
1 January 2018
before IFRS 9
impairment
adjustments
£m		 
Financial assets                         
Financial assets at fair value through profit or loss  162,878    14,447   (1,139)  13,308   (178)  176,008 
Derivatives  25,834    (360)  –   (360)  –   25,474 
Loans and advances to banks  6,611    (2,274)  (90)  (2,364)  –   4,247 
Loans and advances to customers  472,498    (10,474)  –   (10,474)  14   462,038 
Debt securities  3,643    –   (329)  (329)  –   3,314 
Financial assets at amortised cost  482,752    (12,748)  (419)  (13,167)  14   469,599 
Financial assets at fair value through other comprehensive income       –   42,972   42,972   (55)  42,917 
Available-for-sale financial assets  42,098    (684)  (41,414)  (42,098)  –   – 
Other assets  13,537    (655)  –   (655)  –   12,882 
Total  727,099    –   –   –   (219)  726,880 
Financial liabilities                         
Financial liabilities at fair value through profit or loss  50,877    48   –   48   10   50,935 
Debt securities in issue  72,450    (48)  –   (48)  –   72,402 
Total  123,327    –   –   –   10   123,337 

 

B COMPANY BALANCE SHEETLoans and advances accounted for at amortised cost reduced by £13,167 million largely driven by:

 

   2015
£ million		   2014
£ million		 
Assets        
Non-current assets:        
Investment in subsidiaries  40,785   41,102 
Loans to subsidiaries  13,963   13,848 
Deferred tax assets  51   19 
   54,799   54,969 
Current assets:        
Derivative financial instruments  590   752 
Other assets  909   791 
Amounts due from subsidiaries  67   67 
Cash and cash equivalents  24   195 
Current tax recoverable  32   – 
   1,622   1,805 
Total assets  56,421   56,774 
Equity and liabilities        
Capital and reserves:        
Share capital  7,146   7,146 
Share premium account  17,412   17,281 
Merger reserve  7,633   7,764 
Capital redemption reserve  4,115   4,115 
Retained profits  785   1,720 
Shareholders’ equity  37,091   38,026 
Other equity instruments  5,355   5,355 
Total equity  42,446   43,381 
Non-current liabilities:        
Debt securities in issue  –   561 
Subordinated liabilities  3,065   1,688 
   3,065   2,249 
Current liabilities:        
Current tax liabilities  –   107 
Other liabilities  10,910   11,037 
   10,910   11,144 
Total liabilities  13,975   13,393 
Total equity and liabilities  56,421   56,774 
– lending assets transferred from the banking business to the insurance business in recent years totalling £6,882 million which had been accounted for at amortised cost in the Group’s accounts under IAS 39. Upon implementation of IFRS 9, these assets were been designated at FVTPL, in common with other assets within the insurance business, as they are backing insurance and investment contract liabilities which either have cash flows that are contractually based upon the performance of the assets or are contracts whose measurement takes account of current market conditions and where significant measurement inconsistencies would otherwise arise. Loans and advances to banks of £2,274 million were transferred to FVTPL for similar reasons.
–assets held by the Commercial business totalling £3,116 million were reclassified to FVTPL having not met the requirements of the SPPI test. These assets are principally holdings of notes issued by securitisation vehicles. Whilst the credit quality of these notes is generally good, there is a contractual linkage to the underlying asset pools which are exposed to residual value risk.
–A further £847 million of Commercial lending assets were reclassified following changes in the business model.

At 1 January 2018, the Group was required to reclassify certain assets from fair value through profit or loss to fair value through other comprehensive income; these assets were sold during the course of the year. If these assets had not been reclassified, the Group would have recognised a loss of £0.2 million in the period before being sold. The effective interest rate applied to these assets on 1 January 2018 was 1.97 per cent, and the interest revenue recognised prior to the sale was £20 million.

F-106

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 58: PARENT COMPANY DISCLOSURES54: ADOPTION OF IFRS 9 AND IFRS 15continued

 

C COMPANY STATEMENT OF CHANGES IN EQUITYRemeasurements

 

   Share capital
and premium
£ million		   Merger
reserve
£ million		   Capital
redemption
reserve
£ million		   Retained
profits
£ million		1  Total shareholders’
equity
£ million		   Other equity
investments
£ million		   Total
equity
£ million		 
Balance at 1 January 2013  23,914   7,764   4,115   2,017   37,810   –   37,810 
Total comprehensive income1  –   –   –   (846)  (846)  –   (846)
Issue of ordinary shares  510   –   –   –   510   –   510 
Movement in treasury shares  –   –   –   (165)  (165)  –   (165)
Value of employee services:                            
Share option schemes  –   –   –   116   116   –   116 
Other employee award schemes  –   –   –   292   292   –   292 
Balance at 31 December 2013  24,424   7,764   4,115   1,414   37,717   –   37,717 
Total comprehensive income1  –   –   –   379   379   –   379 
Distributions on other equity instruments, net of tax  –   –   –   (225)  (225)  –   (225)
Issue of ordinary shares  3   –   –   –   3   –   3 
Issue of other equity instruments  –   –   –   (21)  (21)  5,355   5,334 
Movement in treasury shares  –   –   –   (182)  (182)  –   (182)
Value of employee services:                            
Share option schemes, net of tax  –   –   –   122   122   –   122 
Other employee award schemes  –   –   –   233   233   –   233 
Balance at 31 December 2014  24,427   7,764   4,115   1,720   38,026   5,355   43,381 
Total comprehensive income1  –   –   –   897   897   –   897 
Dividends paid  –   –   –   (1,070)  (1,070)  –   (1,070)
Distributions on other equity instruments, net of tax  –   –   –   (314)  (314)  –   (314)
Redemption of preference shares  131   (131)  –   –   –   –   – 
Movement in treasury shares  –   –   –   (753)  (753)  –   (753)
Value of employee services:                            
Share option schemes  –   –   –   133   133   –   133 
Other employee award schemes  –   –   –   172   172   –   172 
Balance at 31 December 2015  24,558   7,633   4,115   785   37,091   5,355   42,446 

There has been a pre-tax charge of £229 million (£207 million net of tax) arising from the reclassification of financial assets and liabilities to fair value through profit or loss and fair value through other comprehensive income and consequent remeasurement to fair value.

 

IFRS 15 Revenue from Contracts with Customers

The Group has adopted IFRS 15 from 1Total January 2018 and in nearly all cases the Group’s existing accounting policy was consistent with the requirements of IFRS 15; however, certain income streams within the Group’s car leasing business are now deferred, resulting in an additional £14 million being recognised as deferred income at 1 January 2018 with a corresponding debit of £11 million, net of tax, to shareholders’ equity. As permitted by the transition options under IFRS 15, comparative figures for the prior year have not been restated. The impact of adoption of IFRS 15 on the current period is not material.

Accounting policies applied for comparative periods

In accordance with the transition requirements of IFRS 9 and IFRS 15, comparative information has not been restated. The comparative information was prepared in accordance with IAS 39 and IAS 18. With the exception of certain income streams within the Group’s car leasing business, the Group accounting policy under IAS 18 was substantially aligned with the requirements of IFRS 15 and is not reproduced here; the principal policies applied by the Group under IAS 39 are set out below:

Impairment

At each balance sheet date the Group assesses whether, as a result of one or more events occurring after initial recognition of a financial asset accounted for at amortised cost and prior to the balance sheet date, there is objective evidence that a financial asset or group of financial assets has become impaired. Where such an event, including the identification of fraud, has had an impact on the estimated future cash flows of the financial asset or group of financial assets, an impairment allowance is recognised. The amount of impairment allowance is the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the asset’s original effective interest rate.

The Group assesses, at each balance sheet date, whether there is objective evidence that an available-for-sale financial asset is impaired. In addition to the criteria for financial assets accounted for at amortised cost set out above, this assessment involves reviewing the current financial circumstances (including creditworthiness) and future prospects of the issuer, assessing the future cash flows expected to be realised and, in the case of equity shares, considering whether there has been a significant or prolonged decline in the fair value of the asset below its cost. If an impairment loss has been incurred, the cumulative loss measured as the difference between the acquisition cost (net of any principal repayment and amortisation) and the current fair value, less any impairment loss on that asset previously recognised, is reclassified from equity to the income statement.

Classification and measurement

On initial recognition, financial assets are classified into fair value through profit or loss, available for sale financial assets, held to maturity investments or loans and receivables. Financial liabilities are measured at amortised cost, except for trading liabilities and other financial liabilities designated at fair value through profit or loss on initial recognition which are held at fair value. Financial instruments are classified at fair value through profit or loss where they are trading securities or where they are designated at fair value through profit or loss by management. Derivatives are carried at fair value. Loans and receivables include loans and advances to banks and customers and are accounted for at amortised cost using the effective interest method. Debt securities and equity shares that are not classified as trading securities, at fair value through profit or loss, held-to-maturity investments or as loans and receivables are classified as available-for-sale financial assets and are recognised in the balance sheet at their fair value, inclusive of transaction costs. Gains and losses arising from changes in fair value are recognised directly in other comprehensive income, comprises onlyuntil the profit (loss)financial asset is either sold, becomes impaired or matures, at which time the cumulative gain or loss previously recognised in other comprehensive income is recognised in the income statement. Interest calculated using the effective interest method is recognised in the income statement.

NOTE 55: FUTURE ACCOUNTING DEVELOPMENTS

The following pronouncements are not applicable for the year.year ending 31 December 2018 and have not been applied in preparing these financial statements. Save as disclosed below, the impact of these accounting changes is still being assessed by the Group and reliable estimates cannot be made at this stage.

IFRS 16 Leases

IFRS 16 replaces IAS 17 ‘Leases’ and is effective for annual periods beginning on or after 1 January 2019.

The Group’s accounting as a lessor will remain aligned to the current approach under IAS 17; however for lessee accounting there will no longer be a distinction between finance and operating leases. The transition approach adopted by the Group will result in the recognition of right of use assets and lease liabilities of approximately £1.8 billion in respect of leased properties previously accounted for as operating leases; there will be no impact on shareholders’ equity. As permitted by the transition options under IFRS 16, comparative figures for the prior year will not be restated. Going forward, the Group will recognise a finance charge on the lease liability and a depreciation charge on the right-of-use asset, whereas previously the Group included lease rentals within operating expenses. The Group intends to take advantage of a number of exemptions within IFRS 16, including the election not to recognise a lease liability and a right-of-use asset for leases for which the underlying asset is of low value.

IFRS 17 Insurance Contracts

IFRS 17 replaces IFRS 4 ‘Insurance Contracts’ and is currently effective for annual periods beginning on or after 1 January 2021 although the International Accounting Standards Board have proposed delaying implementation until 1 January 2022.

IFRS 17 requires insurance contracts and participating investment contracts to be measured on the balance sheet as the total of the fulfilment cash flows and the contractual service margin. Changes to estimates of future cash flows from one reporting date to another are recognised either as an amount in profit or loss or as an adjustment to the expected profit for providing insurance coverage, depending on the type of change and the reason for it. The effects of some changes in discount rates can either be recognised in profit or loss or in other comprehensive income as an accounting policy choice. The risk adjustment is released to profit and loss as an insurer’s risk reduces. Profits which are currently recognised through a Value in Force asset, will no longer be recognised at inception of an insurance contract. Instead, the expected profit for providing insurance coverage is recognised in profit or loss over time as the insurance coverage is provided.

The standard will have a significant impact on the accounting for the insurance and participating investment contracts issued by the Group.

Minor amendments to other accounting standards

The IASB has issued a number of minor amendments to IFRSs effective 1 January 2019 and 1 January 2020 (including IAS 19 Employee Benefits, IAS 12 Income Taxes and IFRIC 23 Uncertainty over Income Tax Treatments). The Group will adopt the changes to IAS 12 Income Taxes with effect from 1 January 2019, resulting in the presentation of the tax benefit of distributions on other equity instruments in the Group’s income statement; these impacts are currently recognised directly in equity. Comparative information will be restated. For the comparative year ended 31 December 2018, this will result in the reclassification of a tax credit of £106 million (2017: £102 million). These changes will have no impact on the Group’s reported balance sheet or profit before tax. The amendments to other accounting standards are not expected to have a significant impact on the Group.

F-107

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 58:56: PARENT COMPANY DISCLOSURES

A COMPANY INCOME STATEMENT

  2018
£m		  2017
£m		  2016
£m		 
Net interest (expense) income  (173)  (121)  66 
Other income  4,524   2,792   3,618 
Total income  4,351   2,671   3,684 
Operating expenses  (246)  (255)  (221)
Trading surplus  4,105   2,416   3,463 
Impairment  (3)  –   – 
Profit on ordinary activities before tax  4,102   2,416   3,463 
Tax expense  (80)  (17)  (328)
Profit for the year  4,022   2,399   3,135 
Profit attributable to ordinary shareholders  3,589   1,984   2,723 
Profit attributable to other equity holders1  433   415   412 
Profit for the year  4,022   2,399   3,135 

1The profit after tax attributable to other equity holders of £433 million (2017: £415 million; 2016: £412 million) is offset in reserves by a tax credit attributable to ordinary shareholders of £82 million (2017: £79 million; 2016: £82 million).

B COMPANY BALANCE SHEET

  2018
£m		  2017
£m		 
Assets        
Non-current assets:        
Investment in subsidiaries  46,725   44,863 
Loans to subsidiaries  24,211   14,379 
Deferred tax assets  9   22 
   70,945   59,264 
Current assets:        
Derivative financial instruments  256   265 
Financial assets at fair value through profit or loss  588   – 
Other assets  955   961 
Amounts due from subsidiaries  27   47 
Cash and cash equivalents  57   272 
Current tax recoverable  76   724 
   1,959   2,269 
Total assets  72,904   61,533 
Equity and liabilities        
Capital and reserves:        
Share capital  7,116   7,197 
Share premium account  17,719   17,634 
Merger reserve  7,423   7,423 
Capital redemption reserve  4,273   4,115 
Retained profits  2,103   1,500 
Shareholders’ equity  38,634   37,869 
Other equity instruments  6,491   5,355 
Total equity  45,125   43,224 
Non-current liabilities:        
Debt securities in issue  20,394   10,886 
Subordinated liabilities  6,043   3,993 
   26,437   14,879 
Current liabilities:        
Derivative financial instruments  209   327 
Other liabilities  1,133   3,103 
   1,342   3,430 
Total liabilities  27,779   18,309 
Total equity and liabilities  72,904   61,533 
F-108

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 56: PARENT COMPANY DISCLOSUREScontinued

C COMPANY STATEMENT OF CHANGES IN EQUITY

  Share capital
and premium
£m		  Merger
reserve
£m		  Capital
redemption
reserve
£m		  Retained
profits1
£m		  Total
shareholders’
equity
£m		  Other equity
instruments
£m		  Total
equity
£m		 
Balance at 1 January 2016  24,558   7,633   4,115   785   37,091   5,355   42,446 
Total comprehensive income1  –   –   –   3,135   3,135   –   3,135 
Dividends paid  –   –   –   (2,014)  (2,014)  –   (2,014)
Distributions on other equity instruments, net of tax2  –   –   –   (330)  (330)  –   (330)
Redemption of preference shares  210   (210)  –   –   –   –   – 
Movement in treasury shares  –   –   –   (301)  (301)  –   (301)
Value of employee services:                            
Share option schemes  –   –   –   141   141   –   141 
Other employee award schemes  –   –   –   168   168   –   168 
Balance at 31 December 2016  24,768   7,423   4,115   1,584   37,890   5,355   43,245 
Total comprehensive income1  –   –   –   2,399   2,399   –   2,399 
Dividends paid  –   –   –   (2,284)  (2,284)  –   (2,284)
Distributions on other equity instruments, net of tax2  –   –   –   (336)  (336)  –   (336)
Issue of ordinary shares  63   –   –   –   63   –   63 
Movement in treasury shares  –   –   –   (277)  (277)  –   (277)
Value of employee services:                            
Share option schemes  –   –   –   82   82   –   82 
Other employee award schemes  –   –   –   332   332   –   332 
Balance at 31 December 2017  24,831   7,423   4,115   1,500   37,869   5,355   43,224 
Adjustment on adoption of IFRS 9  –   –   –   (2)  (2)  –   (2)
Balance at 1 January 2018  24,831   7,423   4,115   1,498   37,867   5,355   43,222 
Total comprehensive income1  –   –   –   4,022   4,022   –   4,022 
Dividends paid  –   –   –   (2,240)  (2,240)  –   (2,240)
Distributions on other equity instruments, net of tax2  –   –   –   (351)  (351)  –   (351)
Issue of ordinary shares  162   –   –   –   162   –   162 
Share buy-back programme  (158)  –   158   (1,005)  (1,005)  –   (1,005)
Issue of AT1 securities  –   –   –   (7)  (7)  1,136   1,129 
Movement in treasury shares  –   –   –   (74)  (74)  –   (74)
Value of employee services:                            
Share option schemes  –   –   –   53   53   –   53 
Other employee award schemes  –   –   –   207   207   –   207 
Balance at 31 December 2018  24,835   7,423   4,273   2,103   38,634   6,491   45,125 

1Total comprehensive income comprises only the profit for the year.
2Distributions on other equity instruments are shown net of tax of £82 million (2017: £79 million; 2016: £82 million) credited to retained profits.
F-109

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 56: PARENT COMPANY DISCLOSUREScontinued

 

D COMPANY CASH FLOW STATEMENT

 

  2015
£ million		   2014
£ million		   2013
£ million		  2018
£m		  2017
£m		 2016
£m		 
Profit (loss) before tax  969   273   (1,090)
Profit before tax  4,102   2,416   3,463 
Fair value and exchange adjustments and other non-cash items  (594)  1,118   137   (715)  495   1,986 
Change in other assets  (566)  558   124   (572)  18   (50)
Change in other liabilities and other items  (127)  (4,242)  4,699   7,538   8,431   (8,392)
Dividends received  (1,080)  (720)  –   (4,000)  (2,650)  (3,759)
Tax received (paid)  (142)  301   (35)
Distributions on other equity instruments received  (324)  (292)  (119)
Tax (paid) received  660   (197)  (679)
Net cash provided by (used in) operating activities  (1,540)  (2,712)  3,835   6,689   8,221   (7,550)
Cash flows from investing activities                        
Return of capital contribution  600   198   –   9   77   441 
Dividends received  1,080   720   –   4,000   2,650   3,759 
Distributions on other equity instruments received  324   292   119 
Acquisition of and capital injections to subsidiaries  (12,753)  (320)  (3,522)
Return of capital  11,114   –   – 
Amounts advanced to subsidiaries  (1,157)  (7,892)  (3,082)  (21,577)  (8,476)  (4,978)
Redemption of loans to subsidiaries  1,155   4,420   197 
Net cash used in investing activities  1,678   (2,554)  (2,885)
Repayment of loans to subsidiaries  12,602   475   13,166 
Interest received on loans to subsidiaries  370   244   496 
Net cash (used in) provided by investing activities  (5,911)  (5,058)  9,481 
Cash flows from financing activities                        
Dividends paid to ordinary shareholders  (1,070)  –   –   (2,240)  (2,284)  (2,014)
Distributions on other equity instruments  (394)  (287)  –   (433)  (415)  (412)
Issue of other equity instruments  –   5,329   – 
Issue of subordinated liabilities  1,436   629   –   1,729   –   1,061 
Interest paid on subordinated liabilities  (129)  (128)  (253)  (275)  (248)  (229)
Share buy-back  (1,005)  –   – 
Issue of other equity instruments  1,129   –   – 
Repayment of subordinated liabilities  (152)  (596)  (2,767)  –   –   (319)
Proceeds from issue of ordinary shares  –   3   350   102   14   – 
Net cash provided by financing activities  (309)  4,950   (2,670)  (993)  (2,933)  (1,913)
Change in cash and cash equivalents  (171)  (316)  (1,720)  (215)  230   18 
Cash and cash equivalents at beginning of year  195   511   2,231   272   42   24 
Cash and cash equivalents at end of year  24   195   511   57   272   42 

 

E INTERESTS IN SUBSIDIARIES

 

The principal subsidiaries, all of which have prepared accounts to 31 December and whose results are included in the consolidated accounts of Lloyds Banking Group plc, are:

 

  Country of
registration/
Incorporation		 Percentage
of equity
share capital
and voting
rights held		 Nature of business
Lloyds Bank plc England 100% Banking and financial services
Scottish Widows Limited Scotland 100%1 Life assurance
HBOS plc Scotland 100%1 Holding company
Bank of Scotland plc Scotland 100%1Banking and financial services
Lloyds Bank Corporate Markets plcEngland100% Banking and financial services

1 Indirect interest.

1Indirect interest.

 

The principal area of operation for each of the above subsidiaries is the United Kingdom.

F-108F-110

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSnotes to the consolidated financial statements

 

NOTE 59:57: CONDENSED CONSOLIDATING FINANCIAL INFORMATION

 

The Company owns 100 per cent of the share capital of Lloyds Bank plc (Lloyds Bank), which intends to offer and sell certain securities in the US from time to time utilising a registration statement on Form F-3 filed with the SEC by the Company. This will be accompanied by a full and unconditional guarantee by the Company.

 

Lloyds Bank intends to utilise an exception provided in Rule 3-10 of Regulation S-X, which allows it to not file its financial statements with the SEC. In accordance with the requirements to qualify for the exception, presented below is condensed consolidating financial information for:

 

–The Company on a stand-alone basis as guarantor;
–Lloyds Bank on a stand-alone basis as issuer;
–Non-guarantor subsidiaries of the Company and Lloyds Bank on a combined basis (Subsidiaries);
–Consolidation adjustments; and
–Lloyds Banking Group’s consolidated amounts (the Group).

– The Company on a stand-alone basis as guarantor;

– Lloyds Bank on a stand-alone basis as issuer;

– Non-guarantor subsidiaries of the Company and Lloyds Bank on a combined basis (Subsidiaries);

– Consolidation adjustments; and

– Lloyds Banking Group’s consolidated amounts (the Group).

 

Under IAS 27, the Company and Lloyds Bank account for investments in their subsidiary undertakings at cost less impairment. Rule 3-10 of Regulation S-X requires a company to account for its investments in subsidiary undertakings using the equity method, which would increase/(decrease) the results of the Company and Lloyds Bank in the information below by £(431)£280 million and £(10,248)£(1,453) million, respectively, for the year ended 31 December 2015;2018; by £1,033£1,408 million and £(545)£(1,140) million, respectively, for the year ended 31 December 2014;2017; and by £8£(1,072) million and £(2,976)£(851) million, respectively, for the year ended 31 December 2013.2016. The net assets of the Company and Lloyds Bank in the information below would also be increased/(decreased) by £4,143£4,800 million and £(7,366)£(11,994) million, respectively, at 31 December 2015;2018; and by £5,309£5,682 million and £3,447£(9,962) million, respectively, at 31 December 2014.2017.

 

INCOME STATEMENTS

 

For the year ended 31 December 2015  Company
£m		   Lloyds Bank
£m		   Subsidiaries
£m		   Consolidation
adjustments
£m		   Group
£m		 
Net interest income  276   4,170   7,129   (257)  11,318 
Other income  983   16,057   10,035   (15,243)  11,832 
Total income  1,259   20,227   17,164   (15,500)  23,150 
Insurance claims  –   –   (5,729)  –   (5,729)
Total income, net of insurance claims  1,259   20,227   11,435   (15,500)  17,421 
Operating expenses  (290)  (8,994)  (6,948)  845   (15,387)
Trading surplus (deficit)  969   11,233   4,487   (14,655)  2,034 
Impairment  –   (265)  (222)  97   (390)
(Loss) profit before tax  969   10,968   4,265   (14,558)  1,644 
Taxation  (72)  (57)  (803)  244   (688)
(Loss) profit for the year  897   10,911   3,462   (14,314)  956 

For the year ended 31 December 2014  Company
£m		   Lloyds Bank
£m		   Subsidiaries
£m		   Consolidation
adjustments
£m		   Group
£m		 
Net interest income  255   3,800   7,158   (553)  10,660 
Other income  283   7,180   20,039   (8,270)  19,232 
Total income  538   10,980   27,197   (8,823)  29,892 
Insurance claims  –   –   (13,493)  –   (13,493)
Total income, net of insurance claims  538   10,980   13,704   (8,823)  16,399 
Operating expenses  (265)  (7,927)  (6,602)  909   (13,885)
Trading (deficit) surplus  273   3,053   7,102   (7,914)  2,514 
Impairment  –   (585)  (777)  610   (752)
Profit (loss) before tax  273   2,468   6,325   (7,304)  1,762 
Taxation  106   (143)  (716)  490   (263)
Profit (loss) for the year  379   2,325   5,609   (6,814)  1,499 
F-109

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 59: CONDENSED CONSOLIDATING FINANCIAL INFORMATION continued

For the year ended 31 December 2013  Company
£m		   Lloyds Bank
£m		   Subsidiaries
£m		   Consolidation
adjustments
£m		   Group
£m		 
Net interest income  166   2,398   5,525   (751)  7,338 
Other income  (1,009)  9,425   29,711   (7,480)  30,647 
Total income  (843)  11,823   35,236   (8,231)  37,985 
Insurance claims  –   –   (19,507)  –   (19,507)
Total income, net of insurance claims  (843)  11,823   15,729   (8,231)  18,478 
Operating expenses  (248)  (8,907)  (6,870)  703   (15,322)
Trading surplus (deficit)  (1,091)  2,916   8,859   (7,528)  3,156 
Impairment  –   (649)  (2,636)  544   (2,741)
(Loss) profit before tax  (1,091)  2,267   6,223   (6,984)  415 
Taxation  245   307   (1,697)  (72)  (1,217)
(Loss) profit for the year  (846)  2,574   4,526   (7,056)  (802)
                     
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME                 
                  
For the year ended 31 December 2015  Company
£m		   Lloyds Bank
£m		   Subsidiaries
£m		   Consolidation
adjustments
£m		   Group
£m		 
Profit (loss) for the year  897   10,911   3,462   (14,314)  956 
Other comprehensive income                    
Items that will not subsequently be reclassified to profit or loss:                    
Post-retirement defined benefit scheme remeasurements:                    
Remeasurements before taxation  –   31   (305)  –   (274)
Taxation  –   (1)  60   –   59 
   –   30   (245)  –   (215)
Items that may subsequently be reclassified to profit or loss:                    
Movements in revaluation reserve in respect of available-for-sale financial assets:                    
Change in fair value  –   (300)  (27)  9   (318)
Income statement transfers in respect of disposals  –   (14)  (37)  –   (51)
Income statement transfers in respect of impairment  –   1   38   (35)  4 
Taxation  –   (17)  2   9   (6)
   –   (330)  (24)  (17)  (371)
Movements in cash flow hedging reserve:                    
Effective portion of changes in fair value  –   294   183   60   537 
Net income statement transfers  –   (421)  (557)  22   (956)
Taxation  –   (76)  59   24   7 
   –   (203)  (315)  106   (412)
Currency translation differences (tax: nil)  –   (13)  52   (81)  (42)
Other comprehensive income for the year, net of tax  –   (516)  (532)  8   (1,040)
Total comprehensive income for the year  897   10,395   2,930   (14,306)  (84)
Total comprehensive income attributable to ordinary shareholders  503   10,395   2,834   (14,306)  (574)
Total comprehensive income attributable to other equity holders  394   –   –   –   394 
Total comprehensive income attributable to equity holders  897   10,395   2,834   (14,306)  (180)
Total comprehensive income attributable to non-controlling interests  –   –   96   –   96 
Total comprehensive income for the year  897   10,395   2,930   (14,306)  (84)
F-110

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 59: CONDENSED CONSOLIDATING FINANCIAL INFORMATION continued

For the year ended 31 December 2014  Company
£m		   Lloyds Bank
£m		   Subsidiaries
£m		   Consolidation
adjustments
£m		   Group
£m		 
Profit (loss) for the year  379   2,325   5,609   (6,814)  1,499 
Other comprehensive income                    
Items that will not subsequently be reclassified to profit or loss:                    
Post-retirement defined benefit scheme remeasurements:                    
Remeasurements before taxation  –   309   365   –   674 
Taxation  –   (62)  (73)  –   (135)
   –   247   292   –   539 
Items that may subsequently be reclassified to profit or loss:                    
Movements in revaluation reserve in respect of available-for-sale financial assets:                    
Change in fair value  –   364   256   70   690 
Income statement transfers in respect of disposals  –   11   (129)  (13)  (131)
Income statement transfers in respect of impairment  –   1   7   (6)  2 
Taxation  –   (14)  (1)  2   (13)
   –   362   133   53   548 
Movements in cash flow hedging reserve:                    
Effective portion of changes in fair value  –   1,799   (56)  2,153   3,896 
Net income statement transfers  –   (227)  (474)  (452)  (1,153)
Taxation  –   (315)  106   (340)  (549)
   –   1,257   (424)  1,361   2,194 
Currency translation differences (tax: nil)  –   3   (13)  7   (3)
Other comprehensive income for the year, net of tax  –   1,869   (12)  1,421   3,278 
Total comprehensive income for the year  379   4,194   5,597   (5,393)  4,777 
Total comprehensive income attributable to ordinary shareholders  92   4,194   5,510   (5,393)  4,403 
Total comprehensive income attributable to other equity holders  287   –   –   –   287 
Total comprehensive income attributable to equity holders  379   4,194   5,510   (5,393)  4,690 
Total comprehensive income attributable to non-controlling interests  –   –   87   –   87 
Total comprehensive income for the year  379   4,194   5,597   (5,393)  4,777 
For the year ended 31 December 2018 Company
£m		  Lloyds Bank
£m		  Subsidiaries
£m		  Consolidation
adjustments
£m		  Group
£m		 
Net interest income  (173)  6,129   7,769   (329)  13,396 
Other income  4,524   7,992   7,136   (10,957)  8,695 
Total income  4,351   14,121   14,905   (11,286)  22,091 
Insurance claims  –   –   (3,465)  –   (3,465)
Total income, net of insurance claims  4,351   14,121   11,440   (11,286)  18,626 
Operating expenses  (246)  (6,492)  (7,033)  2,042   (11,729)
Trading surplus  4,105   7,629   4,407   (9,244)  6,897 
Impairment  (3)  (504)  (480)  50   (937)
Profit before tax  4,102   7,125   3,927   (9,194)  5,960 
Taxation  (80)  (853)  (795)  168   (1,560)
Profit for the year  4,022   6,272   3,132   (9,026)  4,400 
                     
For the year ended 31 December 2017  Company
£m		   Lloyds Bank
£m		   Subsidiaries
£m		   Consolidation
adjustments
£m		   Group
£m		 
Net interest (expense) income  (121)  5,829   5,360   (156)  10,912 
Other income  2,792   7,642   22,553   (9,662)  23,325 
Total income  2,671   13,471   27,913   (9,818)  34,237 
Insurance claims  –   –   (15,578)  –   (15,578)
Total income, net of insurance claims  2,671   13,471   12,335   (9,818)  18,659 
Operating expenses  (255)  (7,201)  (6,939)  2,049   (12,346)
Trading surplus  2,416   6,270   5,396   (7,769)  6,313 
Impairment  –   (462)  (281)  55   (688)
Profit before tax  2,416   5,808   5,115   (7,714)  5,625 
Taxation  (17)  (529)  (1,153)  (29)  (1,728)
Profit for the year  2,399   5,279   3,962   (7,743)  3,897 
F-111

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSnotes to the consolidated financial statements

 

NOTE 59:57: CONDENSED CONSOLIDATING FINANCIAL INFORMATION continued

 

For the year ended 31 December 2013  Company
£m		   Lloyds Bank
£m		   Subsidiaries
£m		   Consolidation
adjustments
£m		   Group
£m		 
Loss for the year  (845)  2,574   4,526   (7,057)  (802)
Other comprehensive income                    
Items that will not subsequently be reclassified to profit or loss:                    
Post–retirement defined benefit scheme remeasurements:                    
Remeasurements before taxation  –   400   (536)  –   (136)
Taxation  –   (80)  108   –   28 
   –   320   (428)  –   (108)
Items that may subsequently be reclassified to profit or loss:                    
Movements in revaluation reserve in respect of available-for-sale financial assets:                    
Change in fair value  –   (889)  188   21   (680)
Income statement transfers in respect of disposals  –   (842)  165   48   (629)
Income statement transfers in respect of impairment  –   –   44   (26)  18 
Taxation  –   366   (106)  17   277 
   –   (1,365)  291   60   (1,014)
Movements in cash flow hedging reserve:                    
Effective portion of changes in fair value  –   21   (68)  (1,182)  (1,229)
Net income statement transfers  –   –   (393)  (157)  (550)
Taxation  –   (5)  143   236   374 
   –   16   (318)  (1,103)  (1,405)
Currency translation differences (tax: nil)  –   (26)  17   3   (6)
Other comprehensive income for the year, net of tax  –   (1,055)  (438)  (1,040)  (2,533)
Total comprehensive income for the year  (845)  1,519   4,088   (8,097)  (3,335)
Total comprehensive income attributable to non-controlling interests  –   –   36   –   36 
Total comprehensive income attributable to equity shareholders  (845)  1,519   4,052   (8,097)  (3,371)
Total comprehensive income for the year  (845)  1,519   4,088   (8,097)  (3,335)
For the year ended 31 December 2016 Company
£m		  Lloyds Bank
£m		  Subsidiaries
£m		  Consolidation
adjustments
£m		  Group
£m		 
Net interest income  66   4,883   4,661   (336)  9,274 
Other income  3,618   5,489   30,349   (9,119)  30,337 
Total income  3,684   10,372   35,010   (9,455)  39,611 
Insurance claims  –   –   (22,344)  –   (22,344)
Total income, net of insurance claims  3,684   10,372   12,666   (9,455)  17,267 
Operating expenses  (221)  (7,722)  (6,380)  1,696   (12,627)
Trading surplus  3,463   2,650   6,286   (7,759)  4,640 
Impairment  –   (620)  (239)  107   (752)
Profit before tax  3,463   2,030   6,047   (7,652)  3,888 
Taxation  (328)  (77)  (1,815)  496   (1,724)
Profit for the year  3,135   1,953   4,232   (7,156)  2,164 
F-112

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSnotes to the consolidated financial statements

 

NOTE 59:57: CONDENSED CONSOLIDATING FINANCIAL INFORMATIONcontinued

 

BALANCE SHEETSCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

At 31 December 2015 Company
£m		  Lloyds Bank
£m		  Subsidiaries
£m		  Consolidation
adjustments
£m		  Group
£m		 
Assets                    
Cash and balances at central banks  –   55,919   2,498   –   58,417 
Items in course of collection from banks  –   518   179   –   697 
Trading and other financial assets at fair value through profit or loss  –   52,064   103,789   (15,317)  140,536 
Derivative financial instruments  590   30,992   17,363   (19,478)  29,467 
Loans and receivables:                    
Loans and advances to banks  –   2,625   22,467   25   25,117 
Loans and advances to customers  –   158,117   291,529   5,529   455,175 
Debt securities  –   2,865   1,247   79   4,191 
Due from fellow Lloyds Banking Group undertakings  14,054   132,199   88,957   (235,210)  – 
Available-for-sale financial assets  –   32,476   4,835   (4,279)  33,032 
Held-to-maturity investments  –   19,808   –   –   19,808 
Goodwill  –   –   2,343   (327)  2,016 
Value of in-force business  –   –   4,280   316   4,596 
Other intangible assets  –   720   303   815   1,838 
Property, plant and equipment  –   3,522   9,389   68   12,979 
Current tax recoverable  32   250   21   (259)  44 
Deferred tax assets  51   3,490   2,777   (2,308)  4,010 
Retirement benefit assets  –   402   675   (176)  901 
Investment in subsidiary undertakings  40,785   39,241   –   (80,026)  – 
Other assets  909   916   13,028   (989)  13,864 
Total assets  56,421   536,124   565,680   (351,537)  806,688 
Equity and liabilities                    
Liabilities                    
Deposits from banks  –   13,614   3,313   (2)  16,925 
Customer deposits  –   205,717   212,798   (189)  418,326 
Due to fellow Lloyds Banking Group undertakings  10,516   70,656   122,031   (203,203)  – 
Items in course of transmission to banks  –   326   391   –   717 
Trading and other financial liabilities at fair value through profit or loss  –   56,332   5,043   (9,512)  51,863 
Derivative financial instruments  –   31,040   14,739   (19,478)  26,301 
Notes in circulation  –   –   1,112   –   1,112 
Debt securities in issue  –   78,430   27,504   (23,878)  82,056 
Liabilities arising from insurance contracts and participating investment contracts  –   –   80,316   (22)  80,294 
Liabilities arising from non-participating investment contracts  –   –   22,777   –   22,777 
Other liabilities  394   2,988   28,340   (2,061)  29,661 
Retirement benefit obligations  –   148   255   (38)  365 
Current tax liabilities  –   –   807   (528)  279 
Deferred tax liabilities  –   –   1,053   (1,020)  33 
Other provisions  –   3,421   2,236   30   5,687 
Subordinated liabilities  3,065   19,124   14,106   (12,983)  23,312 
Total liabilities  13,975   481,796   536,821   (272,884)  759,708 
Equity                    
Shareholders’ equity  37,091   54,328   26,968   (77,153)  41,234 
Other equity instruments  5,355   –   1,500   (1,500)  5,355 
Total equity excluding non-controlling interests  42,446   54,328   28,468   (78,653)  46,589 
Non-controlling interests  –   –   391   –   391 
Total equity  42,446   54,328   28,859   (78,653)  46,980 
Total equity and liabilities  56,421   536,124   565,680   (351,537)  806,688 
For the year ended 31 December 2018 Company
£m		  Lloyds Bank
£m		  Subsidiaries
£m		  Consolidation
adjustments
£m		  Group
£m		 
Profit (loss) for the year  4,022   6,272   3,132   (9,026)  4,400 
Other comprehensive income                    
Items that will not subsequently be reclassified to profit or loss:                    
Post-retirement defined benefit scheme remeasurements:                    
Remeasurements before taxation  –   (206)  373   –   167 
Taxation  –   44   (91)  –   (47)
   –   (162)  282   –   120 
Movements in revaluation reserve in respect of equity shares held at fair value through other comprehensive income:                    
Change in fair value  –   (102)  9   (4)  (97)
Tax  –   –   –   22   22 
   –   (102)  9   18   (75)
Gains and losses attributable to own credit risk:                    
Gains (losses) before tax  –   533   –   –   533 
Tax  –   (144)  –   –   (144)
   –   389   –   –   389 
Share of other comprehensive income of associates and joint ventures  –   –   –   8   8 
Items that may subsequently be reclassified to profit or loss:                    
Movements in revaluation reserve in respect of debt securities held at fair value through other comprehensive income:                    
Change in fair value  –   (58)  (35)  56   (37)
Income statement transfers in respect of disposals  –   (258)  (6)  (11)  (275)
Taxation  –   114   5   –   119 
   –   (202)  (36)  45   (193)
Movements in cash flow hedging reserve:                    
Effective portion of changes in fair value  –   255   (89)  68   234 
Net income statement transfers  –   (628)  (29)  (44)  (701)
Taxation  –   87   31   (5)  113 
   –   (286)  (87)  19   (354)
Currency translation differences (tax: nil)  –   2   (10)  –   (8)
Other comprehensive income for the year, net of tax  –   (361)  158   90   (113)
Total comprehensive income for the year  4,022   5,911   3,290   (8,936)  4,287 
                     
Total comprehensive income attributable to ordinary shareholders  3,589   5,636   3,085   (8,554)  3,756 
Total comprehensive income attributable to other equity holders  433   275   107   (382)  433 
Total comprehensive income attributable to equity holders  4,022   5,911   3,192   (8,936)  4,189 
Total comprehensive income attributable to non-controlling interests  –   –   98   –   98 
Total comprehensive income for the year  4,022   5,911   3,290   (8,936)  4,287 
F-113

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 59: CONDENSED57:condensed CONSOLIDATING FINANCIAL INFORMATIONcontinued

 

At 31 December 2014 Company
£m		  Lloyds Bank
£m		  Subsidiaries
£m		  Consolidation
adjustments
£m		  Group
£m		 
Assets                    
Cash and balances at central banks  –   40,965   9,527   –   50,492 
Items in course of collection from banks  –   802   371   –   1,173 
Trading and other financial assets at fair value through profit or loss  –   66,321   115,737   (30,127)  151,931 
Derivative financial instruments  752   40,150   26,155   (30,929)  36,128 
Loans and receivables:  –                 
Loans and advances to banks  –   4,591   21,539   25   26,155 
Loans and advances to customers  –   165,967   312,697   4,040   482,704 
Debt securities  –   –   1,148   65   1,213 
Due from fellow Lloyds Banking Group undertakings  14,110   130,018   113,164   (257,292)  – 
Available-for-sale financial assets  –   51,412   7,187   (2,106)  56,493 
Goodwill  –   –   2,343   (327)  2,016 
Value of in-force business  –   –   4,502   362   4,864 
Other intangible assets  –   647   277   1,146   2,070 
Property, plant and equipment  –   3,089   9,388   67   12,544 
Current tax recoverable  –   951   280   (1,104)  127 
Deferred tax assets  19   3,691   3,200   (2,765)  4,145 
Retirement benefit assets  –   351   827   (31)  1,147 
Investment in subsidiary undertakings  41,102   38,818   –   (79,920)  – 
Other assets  791   2,451   19,419   (967)  21,694 
Total assets  56,774   550,224   647,761   (399,863)  854,896 
Equity and liabilities                    
Liabilities                    
Deposits from banks  –   8,206   2,683   (2)  10,887 
Customer deposits  –   194,699   252,586   (218)  447,067 
Due to fellow Lloyds Banking Group undertakings  10,944   91,882   119,973   (222,799)  – 
Items in course of transmission to banks  –   560   419   –   979 
Trading and other financial liabilities at fair value through profit or loss  –   73,227   14,464   (25,589)  62,102 
Derivative financial instruments  –   41,320   22,796   (30,929)  33,187 
Notes in circulation  –   –   1,129   –   1,129 
Debt securities in issue  561   66,062   32,875   (23,265)  76,233 
Liabilities arising from insurance contracts and participating investment contracts  –   –   86,941   (23)  86,918 
Liabilities arising from non-participating investment contracts  –   –   27,248   –   27,248 
Other liabilities  93   4,358   25,147   (1,173)  28,425 
Retirement benefit obligations  –   190   197   66   453 
Current tax liabilities  107   5   1,321   (1,364)  69 
Deferred tax liabilities  –   –   1,268   (1,214)  54 
Other provisions  –   2,795   1,990   (585)  4,200 
Subordinated liabilities  1,688   21,590   16,907   (14,143)  26,042 
Total liabilities  13,393   504,894   607,944   (321,238)  804,993 
Equity                    
Shareholders’ equity  38,026   45,330   38,604   (78,625)  43,335 
Other equity instruments  5,355   –   –   –   5,355 
Total equity excluding non-controlling interests  43,381   45,330   38,604   (78,625)  48,690 
Non-controlling interests  –   –   1,213   –   1,213 
Total equity  43,381   45,330   39,817   (78,625)  49,903 
Total equity and liabilities  56,774   550,224   647,761   (399,863)  854,896 
For the year ended 31 December 2017 Company
£m		  Lloyds Bank
£m		  Subsidiaries
£m		  Consolidation
adjustments
£m		  Group
£m		 
Profit (loss) for the year  2,399   5,279   3,962   (7,743)  3,897 
Other comprehensive income                    
Items that will not subsequently be reclassified to profit or loss:                    
Post–retirement defined benefit scheme remeasurements:                    
Remeasurements before taxation  –   442   186   –   628 
Taxation  –   (110)  (36)  –   (146)
   –   332   150   –   482 
Gains and losses attributable to own credit risk:                    
Gains (losses) before taxation  –   (55)  –   –   (55)
Taxation  –   15   –   –   15 
   –   (40)  –   –   (40)
Items that may subsequently be reclassified to profit or loss:                    
Movements in revaluation reserve in respect of available-for-sale financial assets:                    
Change in fair value  –   231   38   34   303 
Income statement transfers in respect of disposals  –   (333)  (131)  18   (446)
Income statement transfers in respect of impairment  –   –   9   (3)  6 
Taxation  –   46   17   –   63 
   –   (56)  (67)  49   (74)
Movements in cash flow hedging reserve:                    
Effective portion of changes in fair value  –   15   (136)  (242)  (363)
Net income statement transfers  –   (436)  46   (261)  (651)
Taxation  –   130   23   130   283 
   –   (291)  (67)  (373)  (731)
Currency translation differences (tax: nil)  –   (5)  (27)  –   (32)
Other comprehensive income for the year, net of tax  –   (60)  (11)  (324)  (395)
Total comprehensive income for the year  2,399   5,219   3,951   (8,067)  3,502 
Total comprehensive income attributable to ordinary shareholders  1,984   4,946   3,740   (7,673)  2,997 
Total comprehensive income attributable to other equity holders  415   273   121   (394)  415 
Total comprehensive income attributable to equity holders  2,399   5,219   3,861   (8,067)  3,412 
Total comprehensive income attributable to non-controlling interests  –   –   90   –   90 
Total comprehensive income for the year  2,399   5,219   3,951   (8,067)  3,502 
F-114

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 59: CONDENSED57:condensed CONSOLIDATING FINANCIAL INFORMATIONcontinued

 

For the year ended 31 December 2015 Company
£m		  Lloyds Bank
£m		  Subsidiaries
£m		  Consolidation
adjustments
£m		  Group
£m		 
Net cash provided by (used in) operating activities  (1,540)  8,124   7,472   2,316   16,372 
                     
Cash flows from investing activities                    
Dividends received from subsidiaries  1,080   12,820   –   (13,900)  – 
Return of capital contribution  600   –   –   (600)  – 
Available-for-sale financial assets and held-to-maturity investments                    
Purchases  –   (7,903)  (13,593)  2,142   (19,354)
Proceeds from sale and maturity  –   7,055   14,945   –   22,000 
Purchase of fixed assets  –   (1,279)  (2,138)  –   (3,417)
Proceeds from sale of fixed assets  –   61   1,476   –   1,537 
Additional capital injections to subsidiaries  –   (64)  –   64   – 
Purchase of other equity instruments issued by subsidiaries  –   (1,500)  –   1,500   – 
Capital lending to Lloyds Bank  (1,157)  –   –   1,157   – 
Capital repayments by Lloyds Bank  1,155   –   –   (1,155)  – 
Acquisition of businesses, net of cash acquired  –   –   (5)  –   (5)
Disposal of businesses, net of cash disposed  –   850   122   (5,043)  (4,071)
Net cash flows from investing activities  1,678   10,040   807   (15,835)  (3,310)
                     
Cash flows from financing activities                    
Dividends paid to ordinary shareholders  (1,070)  (1,080)  (12,820)  13,900   (1,070)
Distributions on other equity instruments  (394)  –   –   –   (394)
Dividends paid to non-controlling interests  –   –   (52)  –   (52)
Interest paid on subordinated liabilities  (129)  (1,755)  (956)  1,000   (1,840)
Proceeds from issue of subordinated liabilities  1,436   –   –   (1,098)  338 
Repayment of subordinated liabilities  (152)  (1,851)  (2,151)  955   (3,199)
Issue of other equity instruments  –   –   1,500   (1,500)  – 
Capital contribution received  –   –   165   (165)  – 
Return of capital contribution  –   (600)  –   600   – 
Capital borrowing from the Company  –   1,157   –   (1,157)  – 
Capital repayments to the Company  –   (1,155)  –   1,155   – 
Changes in non-controlling interests  –   –   (41)  –   (41)
Net cash used in financing activities  (309)  (5,284)  (14,355)  13,690   (6,258)
                     
Effects of exchange rate changes on cash and cash equivalents  –   –   2   –   2 
Change in cash and cash equivalents  (171)  12,880   (6,074)  171   6,806 
Cash and cash equivalents at beginning of year  195   42,972   22,175   (195)  65,147 
Cash and cash equivalents at end of year  24   55,852   16,101   (24)  71,953 
For the year ended 31 December 2016 Company
£m		  Lloyds Bank
£m		  Subsidiaries
£m		  Consolidation
adjustments
£m		  Group
£m		 
Profit (loss) for the year  3,135   1,953   4,232   (7,156)  2,164 
Other comprehensive income                    
Items that will not subsequently be reclassified to profit or loss:                    
Post-retirement defined benefit scheme remeasurements:                    
Remeasurements before taxation  –   (682)  (666)  –   (1,348)
Taxation  –   184   136   –   320 
   –   (498)  (530)  –   (1,028)
Items that may subsequently be reclassified to profit or loss:                    
Movements in revaluation reserve in respect of available-for-sale financial assets:                    
Adjustment on transfer from held-to-maturity portfolio  –   1,544   –   –   1,544 
Change in fair value  –   268   84   4   356 
Income statement transfers in respect of disposals  –   (507)  (68)  –   (575)
Income statement transfers in respect of impairment  –   172   1   –   173 
Taxation  –   (269)  (32)  –   (301)
   –   1,208   (15)  4   1,197 
Movements in cash flow hedging reserve:                    
Effective portion of changes in fair value  –   1,290   125   1,017   2,432 
Net income statement transfers  –   (241)  (233)  (83)  (557)
Taxation  –   (258)  29   (237)  (466)
   –   791   (79)  697   1,409 
Currency translation differences (tax: nil)  –   19   44   (67)  (4)
Other comprehensive income for the year, net of tax  –   1,520   (580)  634   1,574 
Total comprehensive income for the year  3,135   3,473   3,652   (6,522)  3,738 
Total comprehensive income attributable to ordinary shareholders  2,723   3,354   3,450   (6,302)  3,225 
Total comprehensive income attributable to other equity holders  412   119   101   (220)  412 
Total comprehensive income attributable to equity holders  3,135   3,473   3,551   (6,522)  3,637 
Total comprehensive income attributable to non-controlling interests  –   –   101   –   101 
Total comprehensive income for the year  3,135   3,473   3,652   (6,522)  3,738 
F-115

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 59: CONDENSED57:condensed CONSOLIDATING FINANCIAL INFORMATIONcontinued

 

For the year ended 31 December 2014 Company
£m		  Lloyds Bank
£m		  Subsidiaries
£m		  Consolidation
adjustments
£m		  Group
£m		 
Net cash (used in) provided by operating activities  (2,712)  1,978   11,927   (840)  10,353 
Cash flows from investing activities                    
Dividends received from subsidiary undertakings  720   2,873   –   (3,593)  – 
Return of capital contribution  198   –   –   (198)  – 
Available-for-sale financial assets                    
Purchases  –   (6,052)  (5,657)  176   (11,533)
Proceeds from sale and maturity  –   1,626   7,776   (4,734)  4,668 
Purchase of fixed assets  –   (1,182)  (2,260)  –   (3,442)
Proceeds from sale of fixed assets  –   100   1,943   –   2,043 
Additional capital lending to subsidiaries  (7,892)  (750)  –   8,642   – 
Capital repayments by subsidiaries  4,420   1,930   –   (6,350)  – 
Acquisition of businesses, net of cash acquired  –   –   (1)  –   (1)
Disposal of businesses, net of cash disposed  –   728   905   (1,090)  543 
Net cash flows from investing activities  (2,554)  (727)  2,706   (7,147)  (7,722)
                     
Cash flows from financing activities                    
Distributions on other equity instruments  (287)  –   –   –   (287)
Dividends paid to equity shareholders  –   –   (3,593)  3,593   – 
Dividends paid to non-controlling interests  –   –   (27)  –   (27)
Interest paid on subordinated liabilities  (128)  (1,832)  (1,624)  1,379   (2,205)
Proceeds from issue of subsordinated liabilities  629   –   –   –   629 
Proceeds from issue of ordinary shares  3   –   –   –   3 
Proceeds from issue of other equity instruments  5,329   –   (5,329)  –   – 
Repayment of subordinated liabilities  (596)  (1,380)  (6,472)  5,425   (3,023)
Capital contribution received  –   –   8,642   (8,642)  – 
Sale of non-controlling interest in TSB  –   634   –   –   634 
Other changes in non-controlling interests  –   –   1   –   1 
Return of capital contribution  –   (198)  –   198   – 
Capital repayments to parent company  –   –   (6,350)  6,350   – 
Net cash used in financing activities  4,950   (2,776)  (14,752)  8,303   (4,275)
                     
Effects of exchange rate changes on cash and cash equivalents  –   6   (12)  –   (6)
Change in cash and cash equivalents  (316)  (1,519)  (131)  316   (1,650)
Cash and cash equivalents at beginning of year  511   44,491   22,306   (511)  66,797 
Cash and cash equivalents at end of year  195   42,972   22,175   (195)  65,147 
BALANCE SHEETS          
           
At 31 December 2018 Company
£m		  Lloyds Bank
£m		  Subsidiaries
£m		  Consolidation
adjustments
£m		  Group
£m		 
Assets                    
Cash and balances at central banks  –   37,632   17,031   –   54,663 
Items in course of collection from banks  –   464   183   –   647 
Financial assets at fair value through profit or loss  588   20,843   139,339   (2,241)  158,529 
Derivative financial instruments  256   15,431   26,872   (18,964)  23,595 
At amortised cost:                    
Loans and advances to banks  –   3,153   3,105   25   6,283 
Loans and advances to customers  –   172,315   312,388   155   484,858 
Debt securities  –   4,960   271   7   5,238 
Due from fellow Lloyds Banking Group undertakings  24,295   173,475   99,186   (296,956)  – 
Financial assets at fair value through other comprehensive income  –   23,208   1,607   –   24,815 
Goodwill  –   –   2,331   (21)  2,310 
Value of in-force business  –   –   4,543   219   4,762 
Other intangible assets  –   2,062   318   967   3,347 
Property, plant and equipment  –   2,940   9,346   14   12,300 
Current tax recoverable  76   –   227   (298)  5 
Deferred tax assets  9   1,980   2,278   (1,814)  2,453 
Retirement benefit assets  –   704   551   12   1,267 
Investment in subsidiary undertakings, including assets held for sale  46,725   32,656   –   (79,381)  – 
Other assets  955   849   11,366   (644)  12,526 
Total assets  72,904   492,672   630,942   (398,920)  797,598 
Equity and liabilities                    
Liabilities                    
Deposits from banks  –   5,320   25,002   (2)  30,320 
Customer deposits  –   229,402   188,735   (71)  418,066 
Due to fellow Lloyds Banking Group undertakings  51   88,383   175,761   (264,195)  – 
Items in course of transmission to banks  –   341   295   –   636 
Financial liabilities at fair value through profit or loss  –   17,719   14,177   (1,349)  30,547 
Derivative financial instruments  209   14,546   25,582   (18,964)  21,373 
Notes in circulation  –   –   1,104   –   1,104 
Debt securities in issue  20,394   70,556   30,102   (29,884)  91,168 
Liabilities arising from insurance contracts and participating investment contracts  –   –   98,890   (16)  98,874 
Liabilities arising from non-participating investment contracts  –   –   13,853   –   13,853 
Other liabilities  1,082   2,643   18,793   (2,885)  19,633 
Retirement benefit obligations  –   121   122   2   245 
Current tax liabilities  –   231   639   (493)  377 
Deferred tax liabilities  –   –   750   (750)  – 
Other provisions  –   1,608   2,135   (196)  3,547 
Subordinated liabilities  6,043   9,528   6,611   (4,526)  17,656 
Total liabilities  27,779   440,398   602,551   (323,329)  747,399 
Equity                    
Shareholders’ equity  38,634   49,057   25,530   (69,787)  43,434 
Other equity instruments  6,491   3,217   2,587   (5,804)  6,491 
Total equity excluding non-controlling interests  45,125   52,274   28,117   (75,591)  49,925 
Non-controlling interests  –   –   274   –   274 
Total equity  45,125   52,274   28,391   (75,591)  50,199 
Total equity and liabilities  72,904   492,672   630,942   (398,920)  797,598 
F-116

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 59:57: CONDENSED CONSOLIDATING FINANCIAL INFORMATION continued

 

For the year ended 31 December 2013 Company
£m		  Lloyds Bank
£m		  Subsidiaries
£m		  Consolidation
adjustments
£m		  Group
£m		 
Net cash provided by (used in) operating activities  3,835   (16,358)  (3,463)  455   (15,531)
Cash flows from investing activities                    
Dividends received from subsidiary undertakings  –   6,838   –   (6,838)  – 
Available-for-sale financial assets                    
Purchases  –   (30,009)  (3,743)  (3,207)  (36,959)
Proceeds from sale and maturity  –   16,671   9,885   (5,004)  21,552 
Purchase of fixed assets  –   (1,093)  (1,889)  –   (2,982)
Proceeds from sale of fixed assets  –   22   2,068   –   2,090 
Additional capital lending to subsidiaries  (3,082)  –   –   3,082   – 
Capital repayments by subsidiaries  197   –   –   (197)  – 
Additional capital injections to subsidiaries  –   (621)  –   621   – 
Acquisition of businesses, net of cash acquired  –   (773)  (6)  773   (6)
Disposal of businesses, net of cash disposed  –   (9)  1,491   (786)  696 
Net cash flows from investing activities  (2,885)  (8,974)  7,806   (11,556)  (15,609)
                     
Cash flows from financing activities                    
Dividends paid to equity shareholders  –   –   (6,838)  6,838   – 
Dividends paid to non-controlling interests  –   –   (25)  –   (25)
Interest paid on subordinated liabilities  (253)  (1,694)  (1,898)  1,394   (2,451)
Proceeds from issue of subordinated liabilities  –       1,500   –   1,500 
Repayment of subordinated liabilities  (2,767)  (3,539)  (1,149)  5,013   (2,442)
Proceeds from issue of ordinary shares  350   –   –   –   350 
Capital contribution received  –   –   621   (621)  – 
Capital repayments to the Company  –   –   (197)  197   – 
Change in stake of non-controlling interests  –   –   –   –   – 
Net cash used in financing activities  (2,670)  (5,233)  (7,986)  12,821   (3,068)
                     
Effects of exchange rate changes on cash and cash equivalents  –   (52)  (1)  –   (53)
Change in cash and cash equivalents  (1,720)  (30,617)  (3,644)  1,720   (34,261)
Cash and cash equivalents at beginning of year  2,231   75,108   25,950   (2,231)  101,058 
Cash and cash equivalents at end of year  511   44,491   22,306   (511)  66,797 
           Consolidation    
  Company  Lloyds Bank  Subsidiaries  adjustments  Group 
At 31 December 2017 £m  £m  £m  £m  £m 
Assets               
Cash and balances at central banks  –   55,835   2,686   –   58,521 
Items in course of collection from banks  –   490   265   –   755 
Financial assets at fair value through profit or loss  –   43,977   126,864   (7,963)  162,878 
Derivative financial instruments  265   26,764   14,785   (15,980)  25,834 
At amortised cost:                    
Loans and advances to banks  –   3,611   2,975   25   6,611 
Loans and advances to customers  –   170,804   294,463   7,231   472,498 
Debt securities  –   3,182   420   41   3,643 
Due from fellow Lloyds Banking Group undertakings  14,698   180,772   119,914   (315,384)  – 
Available-for-sale financial assets  –   42,566   1,582   (2,050)  42,098 
Goodwill  –   –   2,332   (22)  2,310 
Value of in-force business  –   –   4,590   249   4,839 
Other intangible assets  –   1,415   345   1,075   2,835 
Property, plant and equipment  –   3,252   9,526   (51)  12,727 
Current tax recoverable  724   –   26   (734)  16 
Deferred tax assets  22   1,995   2,285   (2,018)  2,284 
Retirement benefit assets  –   673   69   (19)  723 
Investment in subsidiary undertakings, including assets held for sale  44,863   40,500   –   (85,363)  – 
Other assets  961   1,117   12,107   (648)  13,537 
Total assets  61,533   576,953   595,234   (421,611)  812,109 
Equity and liabilities                    
Liabilities                    
Deposits from banks  –   7,538   22,268   (2)  29,804 
Customer deposits  –   234,397   183,830   (103)  418,124 
Due to fellow Lloyds Banking Group undertakings  2,168   112,769   179,952   (294,889)  – 
Items in course of transmission to banks  –   304   280   –   584 
Financial liabilities at fair value through profit or loss  –   51,045   53   (221)  50,877 
Derivative financial instruments  327   28,267   13,510   (15,980)  26,124 
Notes in circulation  –   –   1,313   –   1,313 
Debt securities in issue  10,886   66,249   15,847   (20,532)  72,450 
Liabilities arising from insurance contracts and participating investment contracts  –   –   103,434   (21)  103,413 
Liabilities arising from non-participating investment contracts  –   –   15,447   –   15,447 
Other liabilities  935   3,425   18,480   (2,110)  20,730 
Retirement benefit obligations  –   143   134   81   358 
Current tax liabilities  –   105   1,242   (1,073)  274 
Deferred tax liabilities  –   –   779   (779)  – 
Other provisions  –   2,593   2,865   88   5,546 
Subordinated liabilities  3,993   9,341   8,288   (3,700)  17,922 
Total liabilities  18,309   516,176   567,722   (339,241)  762,966 
Equity                    
Shareholders’ equity  37,869   57,560   25,470   (77,348)  43,551 
Other equity instruments  5,355   3,217   1,805   (5,022)  5,355 
Total equity excluding non-controlling interests  43,224   60,777   27,275   (82,370)  48,906 
Non-controlling interests  –   –   237   –   237 
Total equity  43,224   60,777   27,512   (82,370)  49,143 
Total equity and liabilities  61,533   576,953   595,234   (421,611)  812,109 
F-117

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

[THIS PAGE IS INTENTIONALLY LEFT BLANK]

NOTE 57: CONDENSED CONSOLIDATING FINANCIAL INFORMATION continued

CASH FLOW STATEMENTS

For the year ended 31 December 2018 Company
£m		     Lloyds Bank
£m		     Subsidiaries
£m		     Consolidation
adjustments
£m		     Group
£m		 
Net cash provided by (used in) operating activities  6,689   (27,290)  8,871   623   (11,107)
                     
Cash flows from investing activities                    
Dividends received from subsidiary undertakings  4,000   4,867   –   (8,867)  – 
Distributions on other equity instruments received  324   101   –   (425)  – 
Financial assets at fair value through other comprehensive income:                    
Purchases  –   (11,699)  (958)  –   (12,657)
Proceeds from sale and maturity  –   25,927   918   (39)  26,806 
Purchase of fixed assets  –   (1,486)  (2,028)  –   (3,514)
Proceeds from sale of fixed assets  –   113   1,221   –   1,334 
Acquisitions of and capital injections to subsidiaries  (12,753)  (111)  (131)  12,946   (49)
Return of capital  11,114   210   –   (11,324)  – 
Return of capital contribution  9   –   –   (9)  – 
Capital lending to subsidiaries  (21,577)  –   –   21,577   – 
Capital loan repayments by subsidiaries  12,602   –       (12,602)  – 
Interest received on lending to subsidiaries  370   –       (370)  – 
Disposal of businesses, net of cash disposed  –   7,704   1,373   (9,076)  1 
Net cash flows from investing activities  (5,911)  25,626   395   (8,189)  11,921 
                     
Cash flows from financing activities                    
Dividends paid to ordinary shareholders  (2,240)  (11,022)  (5,467)  16,489   (2,240)
Distributions on other equity instruments  (433)  (275)  (150)  425   (433)
Dividends paid to non-controlling interests  –   –   (61)  –   (61)
Interest paid on subordinated liabilities  (275)  (659)  (673)  339   (1,268)
Issue of ordinary shares  102   –   –   –   102 
Share buy-back programme  (1,005)  –   –   –   (1,005)
Issue of other equity instruments  1,129   –   782   (780)  1,131 
Proceeds from issue of subordinated liabilities  1,729   –   –   –   1,729 
Repayment of subordinated liabilities  –   –   (2,273)  17   (2,256)
Capital contributions received  –   –   3,088   (3,088)  – 
Return of capital contributions  –   (9)  –   9   – 
Return of capital to parent company  –   (2,975)  –   2,975   – 
Capital borrowing from the Company  –   9,860   11,717   (21,577)  – 
Capital repayments to the Company  –   (10,354)  (2,248)  12,602   – 
Interest paid on borrowing from the Company  –   (370)  –   370   – 
Changes in non-controlling interests  –   –   –   –   – 
Net cash used in financing activities  (993)  (15,804)  4,715   7,781   (4,301)
                     
Effects of exchange rate changes on cash and cash equivalents  –   2   1   –   3 
Change in cash and cash equivalents  (215)  (17,466)  13,982   215   (3,484)
Cash and cash equivalents at beginning of year1  272   56,120   2,588   (272)  58,708 
Cash and cash equivalents at end of year  57   38,654   16,570   (57)  55,224 

1Adjusted for IFRS 9
F-118

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 57: CONDENSED CONSOLIDATING FINANCIAL INFORMATIONcontinued

For the year ended 31 December 2017 Company
£m		      Lloyds Bank
£m		      Subsidiaries
£m		    Consolidation
adjustments
£m		      Group
£m		 
Net cash (used in) provided by operating activities  8,221   (3,430)  (5,959)  (2,027)  (3,195)
Cash flows from investing activities                    
Dividends received from subsidiary undertakings  2,650   4,378   –   (7,028)  – 
Distributions on other equity instruments received  292   101   –   (393)  – 
Return of capital contributions  77   –   –   (77)  – 
Available-for-sale financial assets:                    
Purchases  –   (7,550)  (482)  170   (7,862)
Proceeds from sale and maturity  –   16,480   2,195   –   18,675 
Purchase of fixed assets  –   (1,155)  (2,500)  –   (3,655)
Proceeds from sale of fixed assets  –   85   1,359   –   1,444 
Additional capital lending to subsidiaries  (8,476)  (34)  –   8,510   – 
Capital repayments by subsidiaries  475   –   –   (475)  – 
Interest received on lending to Lloyds Bank  244   –   –   (244)  – 
Acquisition of businesses, net of cash acquired  (320)  (2,026)  (622)  1,045   (1,923)
Disposal of businesses, net of cash disposed  –   592   129   (592)  129 
Net cash flows from investing activities  (5,058)  10,871   79   916   6,808 
                     
Cash flows from financing activities                    
Dividends paid to equity shareholders  (2,284)  (2,650)  (4,378)  7,028   (2,284)
Distributions on other equity instruments  (415)  (273)  (120)  393   (415)
Dividends paid to non-controlling interests  –   –   (51)  –   (51)
Interest paid on subordinated liabilities  (248)  (668)  (700)  341   (1,275)
Proceeds from issue of subsordinated liabilities  –   –   –   –   – 
Proceeds from issue of ordinary shares  14   –   –   –   14 
Repayment of subordinated liabilities  –   (675)  (1,132)  799   (1,008)
Capital contributions received  –   –   –   –   – 
Changes in non-controlling interests  –   –   –   –   – 
Return of capital contribution  –   (77)  –   77   – 
Capital borrowing from the Company  –   8,476   –   (8,476)  – 
Capital repayments to parent company  –   (475)  –   475   – 
Interest paid on borrowing from the Company  –   (244)  –   244   – 
Net cash used in financing activities  (2,933)  3,414   (6,381)  881   (5,019)
                     
Effects of exchange rate changes on cash and cash equivalents  –   (1)  1   –   – 
Change in cash and cash equivalents  230   10,854   (12,260)  (230)  (1,406)
Cash and cash equivalents at beginning of year  42   45,266   17,122   (42)  62,388 
Cash and cash equivalents at end of year  272   56,120   4,862   (272)  60,982 
F-119

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 57: CONDENSED CONSOLIDATING FINANCIAL INFORMATIONcontinued

For the year ended 31 December 2016  Company
£m		       Lloyds Bank
£m		       Subsidiaries
£m		      Consolidation
adjustments
£m		       Group
£m		 
Net cash provided by (used in) operating activities  (7,550)  1,073   11,131   (2,580)  2,074 
Cash flows from investing activities                    
Dividends received from subsidiary undertakings  3,759   3,984   –   (7,743)  – 
Distributions on other equity instruments received  119   –   –   (119)  – 
Return of capital contributions  441   –   –   (441)  – 
Available-for-sale financial assets and held-to-maturity investments:                    
Purchases  –   (4,664)  (322)  56   (4,930)
Proceeds from sale and maturity  –   6,429   2,350   (2,444)  6,335 
Purchase of fixed assets  –   (1,122)  (2,638)  –   (3,760)
Proceeds from sale of fixed assets  –   19   1,665   –   1,684 
Purchase of other equity instruments issued by subsidiaries  –   –   –   –   – 
Capital lending to Lloyds Bank  –   –   –   –   – 
Capital repayments by Lloyds Bank  –   –   –   –   – 
Additional capital lending to subsidiaries  (4,978)  –   –   4,978   – 
Capital repayments by subsidiaries  13,166   –   –   (13,166)  – 
Interest received on lending to Lloyds Bank  496   –   –   (496)  – 
Additional capital injections to subsidiaries  (3,522)  (309)  –   3,831   – 
Acquisition of businesses, net of cash acquired  –   –   (20)  –   (20)
Disposal of businesses, net of cash disposed  –   231   5   (231)  5 
Net cash flows from investing activities  9,481   4,568   1,040   (15,775)  (686)
                     
Cash flows from financing activities                    
Dividends paid to ordinary shareholders  (2,014)  (3,040)  (4,602)  7,642   (2,014)
Distributions on other equity instruments  (412)  (119)  (101)  220   (412)
Dividends paid to non-controlling interests  –   –   (29)  –   (29)
Interest paid on subordinated liabilities  (229)  (1,516)  (893)  951   (1,687)
Proceeds from issue of subordinated liabilities  1,061   2,753   –   (2,753)  1,061 
Repayment of subordinated liabilities  (319)  (13,200)  (4,952)  10,586   (7,885)
Proceeds from issue of other equity instruments  –   3,217   305   (3,522)  – 
Capital contribution received  –   –   309   (309)  – 
Return of capital contributions  –   (441)  –   441   – 
Capital borrowing from the Company  –   –   –   –   – 
Capital repayments to the Company  –   (3,387)  (1,198)  4,585   – 
Interest paid on borrowing from the Company  –   (496)  –   496   – 
Change in stake of non-controlling interests  –   –   (8)  –   (8)
Net cash used in financing activities  (1,913)  (16,229)  (11,169)  18,337   (10,974)
                     
Effects of exchange rate changes on cash and cash equivalents  –   2   19   –   21 
Change in cash and cash equivalents  18   (10,586)  1,021   (18)  (9,565)
Cash and cash equivalents at beginning of year  24   55,852   16,101   (24)  71,953 
Cash and cash equivalents at end of year  42   45,266   17,122   (42)  62,388 
F-120

GLOSSARY

 

Term usedUS equivalent or brief description.
AccountsFinancial statements.
AllottedIssued.
AssociatesLong-term equity investments accounted for by the equity method.
Attributable profitNet income.
ATMAutomatic Teller Machine.
ATM interchangeSystem allowing customers of different ATM operators to use any ATM that is part of the system.
Balance sheetStatement of financial position.
BrokingBrokerage.
Building societyA building society is a mutual institution set up to lend money to its members for house purchases.
See also ‘Demutualisation’.
Buy-to-let mortgagesBuy-to-let mortgages are those mortgages offered to customers purchasing residential property as a rental investment.
Called-up share capitalOrdinary shares, issued and fully paid.
Contract hireLeasing.
CreditorsPayables.
DebtorsReceivables.
Deferred taxDeferred income tax.
DemutualisationProcess by which a mutual institution is converted into a public limited company.
DepreciationAmortisation.
Endowment mortgageAn interest-only mortgage to be repaid by the proceeds of an endowment insurance policy which is assigned to the lender providing the mortgage. The sum insured, which is payable on maturity or upon the death of the policyholder, is used to repay the mortgage.
Finance leaseCapital lease.
FreeholdOwnership with absolute rights in perpetuity.
ISAIndividual Savings Account.
LeaseholdLand or property which is rented from the owner for a specified term under a lease. At the expiry of the term the land or property reverts back to the owner.
LienUnder UK law, a right to retain possession pending payment.
Life assuranceLife insurance.
Loan capitalLong-term debt.
MembersShareholders.
Memorandum and articles of associationArticles and bylaws.
National InsuranceA form of taxation payable in the UK by employees, employers and the self-employed, used to fund benefits at the national level including state pensions, medical benefits through the National Health Service (NHS), unemployment and maternity.self-employed. It is part of the UK’s national social security system and ultimately controlled by HM Revenue & Customs.
Nominal valuePar value.
Open Ended Investment Company (OEIC)Mutual fund.
Ordinary sharesCommon stock.
OverdraftA line of credit, contractually repayable on demand unless a fixed-term has been agreed, established through a customer’s current account.
Preference sharesPreferred stock.
223

GLOSSARY

Term usedUS equivalent or brief description.
PremisesReal estate.
Profit attributable to equity shareholdersNet income.
ProvisionsReserves.
Regular premiumPremiums which are payable throughout the duration of a policy or for some shorter fixed period.
ReinsuranceThe insuring again by an insurer of the whole or part of a risk that it has already insured with another insurer called a reinsurer.
191

GLOSSARY

Term usedUS equivalent or brief description.
Retained profitsRetained earnings.
Share capitalCapital stock.
Shareholders’ equityStockholders’ equity.
Share premium accountAdditional paid-in capital.
Shares in issueShares outstanding.
Single premiumA premium in relation to an insurance policy payable once at the commencement of the policy.
Specialist mortgagesSpecialist mortgages include those mortgage loans provided to customers who have self-certified their income (normally as a consequence of being self-employed) or who are otherwise regarded as a sub-prime credit risk.income. New mortgage lending of this type has not been offered by the Group since early 2009.
Tangible fixed assetsProperty and equipment.
Undistributable reservesRestricted surplus.
Write-offsCharge-offs.
224192

FORM 20-F CROSS REFERENCE SHEET

 

 Form 20–F Item Number and CaptionLocationPage
Part I    
Item 1.Identity of Directors, Senior Management and Advisers  
 A.Directors and senior managementNot applicable. 
 B.AdvisersNot applicable. 
 C.AuditorsNot applicable. 
Item 2.Offer Statistics and Expected Timetable  
 A.Offer statisticsNot applicable. 
 B.Method and expected timetableNot applicable. 
Item 3.Key Information  
 A.Selected financial data“Selected consolidated financial data”3
 “Exchange rates”4
B.Capitalisation and indebtednessNot applicable. 
 C.Reason for the offer and use of proceedsNot applicable. 
 D.Risk factors“Risk factors”205172–188
Item 4.Information on the Company  
 A.History and development of the company“Business overview”2
   “Business – History and development of Lloyds Banking Group”4
   “Business – Legal actions and regulatory matters”78–-10
   “Operating and financial review and prospects – Line of business information”24–26
“Where you can find more information”171
“Corporate Governance – Governance in action”135–136
 B.Business overview“Business overview”2
   “Business – Legal actions and regulatory matters”78–10
   “Operating and financial review and prospects – Line of business information”24–26
   “Regulation”187158–160
 C.Organisational structure“Lloyds Banking Group structure”222190
 D.Property, plant and equipment“Business – Properties”7
Item 4A.Unresolved Staff CommentsNot applicable. 
Item 5.Operating and Financial Review and Prospects  
 A.Operating results“Operating and financial review and prospects”1211–106
 “Operating and financial review and prospects – Credit risk”56
   “Regulation”187158–160
   “Operating and financial review and prospects – Market Risk”9496–102
 B.Liquidity and capital resources“Operating and financial review and prospects – Risk elements in the loan portfolio and potential problem loans – Cross border outstandings”9374
   “Operating and financial review and prospects – Funding and Liquidity Risk”10388–94
   “Operating and financial review and prospects – Capital risk”11179–88
   “Operating and financial review and prospects – Investment portfolio, maturities, deposits, short-term borrowings”121104–106
   “Dividends”194162
   “Notes to the consolidated financial statements – note 53”47”F-90F-71–F-73
 C.Research and development, patents and licenses, etc.Not applicable. 
 D.Trend information“Operating and financial review and prospects –
Overview and trend information”1312
 E.Off-balance sheet arrangements“Operating and financial review and prospects –
Funding and liquidity risk – Off balance sheet arrangements”94
“Notes to the consolidated financial statements – also refer to financial notesnote 52”110F-88–F-101
 F.Tabular disclosure of contractual obligations“Operating and financial review and prospects – Funding and liquidity risk – Contractual cash obligations”11094
 G.Safe harbor“Forward looking statements”221189
Item 6.Directors, Senior Management and Employees  
 A.Directors and senior management“Management and employees – Directors and senior management”125107–109
 B.Compensation“Compensation”111–130
“Notes to the consolidated financial statements – also refer to financial notesnote 11”129F-30–F-31
 C.Board practices“Management and employees”125107–110
   “Management and employees – Employees”128“Articles of association of Lloyds Banking Group plc”163–168
   “Compensation – Service agreements”137128
   “Corporate governance – Leadership”157142–143
   “Corporate governance – the Board in 2015”159
“Corporate Governance – Audit Committee Report”174147–150
   “Compensation – Annual report on remuneration – Remuneration Committee”140125
 D.Employees“Management and employees – Employees”125110
 E.Share ownership“Compensation – OutstandingDirectors’ share interests and share awards”148120–123
“Notes to the consolidated financial statements – note 2”F-15
Item 7.Major Shareholders and Related Party Transactions  
 A.Major shareholders“Major shareholders and related party transactions – Major shareholders”183
“Major shareholders and related party transactions – Information about the Lloyds Banking Group’s relationship with the UK Government”184157
225193

FORM 20-F CROSS REFERENCE SHEET

 

 Form 20–F Item Number and CaptionLocationPage
 B.Related party transactions“Major shareholders and related party transactions – Related party transactions”183157
   “Notes to the consolidated financial statements – note 48”46”F-68F-70–F-71
 C.Interests of experts and counselNot applicable. 
Item 8.Financial Information  
 A.Consolidated statements and other financial information“Consolidated financial statements”F-1F-3–F-9
“Notes to the consolidated financial statements”F10–F-120
“Report of the Independent Registered Public Accounting Firm”F-2
   “Business – Legal actions and regulatory matters”78–10
   “Operating and financial review and prospects”1211–106
   “Dividends”194162
 B.Significant changes Not Applicable 
Item 9.The Offer and Listing  
 A.Offer and listing details“Listing information”191161
 B.Plan of distributionNot applicable. 
 C.Markets“Listing information”191161
 D.Selling shareholdersNot applicable. 
 E.DilutionNot applicable. 
 F.Expenses of the issueNot applicable. 
Item 10.Additional Information  
 A.Share capitalNot applicable. 
 B.Memorandum and articles of association“Memorandum and articlesArticles of association of Lloyds Banking Group plc”195163–168
 C.Material contracts“Business – Material contracts”5
 D.Exchange controls“Exchange controls”200168
 E.Taxation“Taxation”201169–170
 F.Dividends and paying agentsNot applicable. 
 G.Statements by expertsNot applicable. 
 H.Documents on display“Where you can find more information”204171
 I.Subsidiary information“Lloyds Banking Group structure”222190
Item 11. Quantitative and Qualitative Disclosures about Market Risk“Operating and financial review and prospects – Credit risk”5651–74
   “Operating and financial review and prospects – Market risk”9496–102
Item 12.Description of Securities Other than Equity Securities  
 A.Debt securitiesNot applicable. 
 B.Warrants and rightsNot applicable. 
 C.Other securitiesNot applicable. 
 D.American Depositary Shares“Listing information – ADR fees”193161
Part II    
Item 13.Defaults, Dividends Arrearages and DelinquenciesNot applicable. 
Item 14.Material Modifications to the Rights of Security Holders andNot applicable.
Use of ProceedsNot applicable. 
Item 15.Controls and Procedures“Corporate governance”131–156
“Report of Independent Registered Public Accounting Firm”F-2
Item 16.[Reserved by the Securities and Exchange Commission]Commission  
 A.Audit committee financial expert“Management and Employees – Directors and Senior Management”125
 “Corporate governance – Audit Committee report”174147–150
 B.Code of ethics“Management and employees – Employees”128110
 C.Principal accountant fees and services“Corporate governance – Risk Management and internal control
systems – Auditor independence and remuneration”177150
   “Notes to the consolidated financial statements – note 1112 – Operating expenses”Auditors’ Remuneration”F-30F-31–F-32
 D.Exemptions from the listing standards for audit committeesNot applicable.
committees 
 E.Purchases of equity securities by the issuer and affiliated purchasersNot applicable.
purchasers 
 F.Change in registrant’s certifying accountantNot applicable. 
 G.Corporate governance “Corporate governance – Statement on US corporate governance standards”156131
 H.Mine safety disclosureNot applicableapplicable. 
Part III    
Item 17.Financial statementsSee response to item 18. 
Item 18.Financial statements“Consolidated financial statements”F-1F-3–F-9
“Notes to the consolidated financial statements”F-10–F-120
“Report of the Independent Registered Public Accounting Firm”F-2
Item 19.ExhibitsSee “Exhibit index”227195
226194

EXHIBIT INDEX

 

1.Articles of association of Lloyds Banking Group plc
2.Neither Lloyds Banking Group plc nor any subsidiary is party to any single long-term debt instrument pursuant to which a total amount of securities exceeding 10 per cent of the Group’s total assets (on a consolidated basis) is authorised to be issued. Lloyds Banking Group plc hereby agrees to furnish to the Securities and Exchange Commission (the Commission), upon its request, a copy of any instrument defining the rights of holders of its long-term debt or the rights of holders of the long-term debt issued by it or any subsidiary for which consolidated or unconsolidated financial statements are required to be filed with the Commission.
4.(a)(i)Registration Rights Agreement dated 12 January 2009 between Lloyds Banking Group plc and The Commissioners of Her Majesty’s Treasury (as amended with effect from 11 June 2009)▲
  (ii)Resale Rights Agreement effective 11 June 2009 between Lloyds Banking Group plc and The Commissioners of Her Majesty’s Treasury▲
(iii)Deed of Withdrawal dated 3 November 2009 between Lloyds Banking Group plc and The Lords Commissioners of Her Majesty’s Treasury²▲
4.(b)(i)Service agreement dated 3 November 2010 between Lloyds Bank plc and António Horta-Osórioo
  (ii)Letter of appointment dated 23 February 2009 between Lloyds Banking Group plc and Anthony Watson†
(iii)Letter of appointment dated 17 November 2010 between Lloyds Banking Group plc and Anita Frewo
  (iv)
(iii)Letter of appointment dated 31 January 2012 between Lloyds Banking Group plc and Sara Weller▪■
  (v)
(iv)Service agreement dated 1 March 2012 between Lloyds Bank plc and George Culmer∆Δ
  (vi)Letter of appointment dated 28 May 2012 between Lloyds Banking Group plc and Carolyn Fairbairn∆
  (vii)(v)Letter of appointment dated 25 February 2013 between Lloyds Banking Group plc and Nick Luff∆
(viii)Letter of appointment dated 28 October 2013 between Lloyds Banking Group plc and Dyfrig John•
(ix)Service agreement dated 30 November 2010 between Lloyds Bank plc and Juan Colombás•s•
  (x)
(vi)Letter of appointment dated 31 March 2014 between Lloyds Banking Group plc and Lord Blackwell□
  (xi)
(vii)Letter of appointment dated 1 April 2014 between Lloyds Banking Group plc and Nick Prettejohn□
  (xii)
(viii)Letter of appointment dated 1 May 2014 between Lloyds Banking Group plc and Simon Henry□
  (xii)
(ix)Letter of appointment dated 26 June 2014 between Lloyds Banking Group plc and Alan Dickinson□
  (xiv)
(x)Letter of appointment dated 26 November 2015 between Lloyds Banking Group plc and Deborah McWhinney+
  (xv)
(xi)Letter of appointment dated 26 November 2015 between Lloyds Banking Group plc and Stuart Sinclair+
(xii)Letter of appointment dated 2 March 2017 between Lloyds Banking Group plc and Lord Lupton†
(xiii)Supplementary letter dated 5 December 2017 to the letter of appointment dated 2 March 2017 between Lloyds Banking Group plc and Lord Lupton†
(xiv)Letter of appointment dated 17 April 2018 between Lloyds Banking Group plc and Amanda Mackenzie
(xv)Supplementary letter dated 3 September 2018 to the letter of appointment dated 17 April 2018 between Lloyds Banking Group plc and Amanda Mackenzie
8.1List of subsidiaries, their jurisdiction of incorporation and the names under which they conduct business
12.1Certification of António Horta-Osório filed pursuant to 17 CFR 240.13a-14(a) and 15 U.S.C. 7241
12.2Certification of George Culmer filed pursuant to 17 CFR 240.13a-14(a) and 15 U.S.C. 7241
13.1Certification of António Horta-Osório and George Culmer furnished pursuant to 17 CFR 240.13a-14(b) and 18 U.S.C. 1350
15.1Consent of PricewaterhouseCoopers LLP
  
†15.1Previously filed with the SEC on Lloyds Banking Group’s Form 20–F filed 7 May 2009Consent of PricewaterhouseCoopers LLP
5Previously filed with the SEC on Lloyd’s Banking Group’s Form 20-F filed 13 May 2010
oPreviously filed with the SEC on Lloyds Banking Group’s Form 20–F filed 13 May 2011
▪
■Previously filed with the SEC on Lloyds Banking Group’s Form 20–F filed 16 March 2012
∆ΔPreviously filed with the SEC on Lloyds Banking Group’s Form 20–F filed 25 March 2013
•Previously filed with the SEC on Lloyds Banking Group’s Form 20-F filed 5 March 2014
□Previously filed with the SEC on Lloyds Banking Group’s Form 20-F filed 12 March 2015
²Pursuant to a request for confidential treatment
+Previously filed with the SEC the confidential portions of this exhibit have been omitted andon Lloyds Banking Group’s Form 20-F filed separately8 March 2016
†Previously filed with the SEC.SEC on Lloyds Banking Group’s Form 20–F filed 9 March 2018

 

The exhibits shown above are listed according to the number assigned to them by the Form 20–F.

227195

SIGNATURE

 

The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorised the undersigned to sign this annual report on its behalf.

 

 LLOYDS BANKING GROUP plc 
 By:/s/ G Culmer 
    
 Name:George Culmer 
 Title:Chief Financial Officer 
    
 Dated:8 March 201625 February 2019 
228196