Annual Financial Report - 25 of 48

RNS Number : 3813B

HSBC Holdings PLC

03 April 2013

Risk

	Page	App¹

Risk profile² ...........................................	123
Risk governance .......................................		252

Managing risk² ......................................	124
Risks faced by HSBC .................................	124
Risk culture ...............................................	124
Risk governance and ownership ................	124
Risk profile ...............................................	126
Risk appetite ............................................	126
Stress testing .............................................	127

Areas of special interest .......................	128
Compliance ..............................................	128
Commercial real estate .............................	128
Eurozone crisis .........................................	129
Personal lending - US lending....................	130

Top and emerging risks² .......................	130
Macroeconomic and geopolitical risk ........	131
Macro-prudential, regulatory and legal risks to our business model ............................	132
Risks related to our business operations, governance and internal control systems ..............................................................	134

Credit risk⁴ ............................................	137	252
Eurozone exposures⁴ .............................	192
Liquidity and funding³ .........................	203	261
Market risk⁴ ...........................................	217	265

Operational risk² ..................................	227	270
Compliance risk ........................................	230	271
Fiduciary risk ............................................	231	273

Risk management of insurance operations³ .........................................	232	273

Other material risks² ...........................	246
Reputational risk .....................................	246	278
Pension risk .............................................	246	278
Sustainability risk .....................................	249	280

1 Appendix to Risk - risk policies and practices.

2 Unaudited. 3 Audited. 4 Audited where indicated.

For details of HSBC's policies and practices regarding risk management and governance
see the Appendix to Risk on page 252.

Risk profile

(Unaudited)

Managing our risk profile

· A strong balance sheet remains core to our philosophy.

· Our portfolios remain aligned to our risk appetite and strategy.

· Our risk management framework is supported by strong forward-looking risk identification.

Maintaining capital strength and strong liquidity position

· Our core tier 1 capital ratio remains strong at 12.3%.

· We have sustained our strong liquidity position throughout 2012.

· Our ratio of customer advances to deposits remains below 90%.

Strong governance

· Robust risk governance and accountability is embedded across the Group.

· The Board, advised by the Group Risk Committee, approves our risk appetite.

· The compliance control function is being restructured and expanded to improve focus on financial crime and regulatory compliance.

· Our global risk operating model supports adherence to globally consistent standards and risk management policies across the Group.

Our top and emerging risks

· Macroeconomic and geopolitical risk.

· Macro-prudential, regulatory and legal risk to our business model.

· Risks related to our business operations, governance and internal control systems.

Managing risk

(Unaudited)

Risks faced by HSBC

All of our activities involve, to varying degrees, the analysis, evaluation, acceptance and management of risks or combinations of risks. These are described in the table below.

Risk culture

All staff are required to identify, assess and manage risk within the scope of their assigned responsibilities. Our global standards set the tone from the top and are central to our approach to balancing risk and reward. Personal accountability is reinforced by our HSBC Values, with staff expected to act with courageous integrity in conducting their duties and being:

· dependable, doing the right thing;

· open to different ideas and culture; and

· connected to our customers, regulators and each other.

Staff are supported by a disclosure line which enables them to raise concerns in a confidential manner. We also have in place a suite of mandatory training to ensure a clear and consistent attitude is communicated to staff; our mandatory training not only focuses on the technical aspects of risk but also on our attitude towards risk and the behaviours expected by our policies.

Our risk cultureis reinforced by our approach to remuneration, which is discussed in the Report of the Remuneration Committee on page 347. Individual awards are based on the achievement of both financial and non-financial (relating to our values) objectives which are aligned to our global strategy.

Risk governance and ownership

An established risk governance framework and ownership structure ensures oversight of and accountability for the effective management of risk at Group, regional and global business levels. The governance structure for the management of risk is set out in the report of the Group Risk Committee on page 323, with similar arrangements in place in major operating subsidiaries. This structure has been augmented by the establishment of the Financial System Vulnerabilities Committee, details of which are set out on page 328. Our risk management framework fosters the continuous monitoring of the risk environment and an integrated evaluation of risks and their interactions. Integral to our risk management framework are risk appetite, stress testing and the identification of top and emerging risks, all of which are discussed below.

Description of risks

Risks	Arising from	Measurement, monitoring and management of risk
Credit risk
The risk of financial loss if a customer or counterparty fails to meet an obligation under a contract.	Credit risk arises principally from direct lending, trade finance and leasing business, but also from certain other products such as guarantees and derivatives.	Credit risk: · is measured as the amount which could be lost if a customer or counterparty fails to make repayments. In the case of derivatives, the measurement of exposure takes into account the current mark to market value to HSBC of the contract and the expected potential change in that value over time caused by movements in market rates; · is monitored within limits, approved by individuals within a framework of delegated authorities. These limits represent the peak exposure or loss to which HSBC could be subjected should the customer or counterparty fail to perform its contractual obligations; and · is managed through a robust risk control framework which outlines clear and consistent policies, principles and guidance for risk managers.
Liquidity and funding risk
The risk that we do not have sufficient financial resources to meet our obligations as they fall due or that we can only do so at excessive cost.	Liquidity risk arises from mismatches in the timing of cash flows. Funding risk arises when the liquidity needed to fund illiquid asset positions cannot be obtained at the expected terms and when required.	Liquidity and funding risk: · is measured using internal metrics including stressed operational cash flow projections, coverage ratio and advances to core funding ratios; · is monitored against the Group's liquidity and funding risk framework and overseen by regional Asset and Liability Management Committees ('ALCO's), Group ALCO and the Risk Management Meeting; and · is managed on a stand-alone basis with no reliance on any Group entity (unless pre-committed) or central bank unless this represents routine established business as usual market practice.

Risks	Arising from	Measurement, monitoring and management of risk
Market risk
The risk that movements in market factors, including foreign exchange rates and commodity prices, interest rates, credit spreads and equity prices, will reduce our income or the value of our portfolios.	Exposure to market risk is separated into two portfolios: · Trading portfolios comprise positions arising from market-making and warehousing of customer-derived positions · Non-trading portfolios comprise positions that primarily arise from the interest rate management of our retail and commercial banking assets and liabilities, financial investments designated as available for sale and held to maturity, and exposures arising from our insurance operations	Market risk: · is measured in terms of value at risk, which is used to estimate potential losses on risk positions as a result of movements in market rates and prices over a specified time horizon and to a given level of confidence, augmented with stress testing to evaluate the potential impact on portfolio values of more extreme, though plausible, events or movements in a set of financial variables; · is monitored using measures including the sensitivity of net interest income and the sensitivity of structural foreign exchange which are applied to the market risk positions within each risk type; and · is managed using risk limits approved by the GMB for HSBC Holdings and our various global businesses. These units are allocated across business lines and to the Group's legal entities.
Operational risk
The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events, including legal risk (along with accounting, tax, security and fraud, people, systems, projects, operations and organisational change risk).	Operational risk arises from day to day operations or external events, and is relevant to every aspect of our business	Operational risk: · is measured using both the top risk analysis process and the risk and control assessment process, which assess the level of risk and effectiveness of controls; · is monitored using key indicators and other internal control activities; and · is primarily managed by global business and functional managers. They identify and assess risks, implement controls to manage them and monitor the effectiveness of these controls utilising the operational risk management framework. The Global Operational Risk and Internal Control function is responsible for the framework and for overseeing the management of operational risks within businesses and functions.
Compliance risk
The risk that we fail to observe the letter and spirit of all relevant laws, codes, rules, regulations and standards of good market practice, and incur fines and penalties and suffer damage to our business as a consequence.	Compliance risk is part of operational risk, and arises from rules, regulations, other standards and Group policies, including those relating to anti-money laundering, anti-bribery and corruption, conduct of business, counter- terrorist financing and sanctions compliance.	Compliance risk: · is measured by reference to identified metrics, incident assessments (whether affecting HSBC or the wider industry), regulatory feedback and the judgement and assessment of the managers of our global businesses and functions; · is monitored against our compliance risk assessments and metrics, the results of the monitoring and control activities of the second line of defence functions, including the Global Compliance function, and the results of internal and external audits and regulatory inspections; and · is managed by establishing and communicating appropriate policies and procedures, training employees in them, and monitoring activity to assure their observance. Proactive risk control and/or remediation work is undertaken where required.
Insurance risk
The risk that over time, the combined cost of acquiring and administering a contract, claims and benefits may exceed the aggregate amount of premiums received and investment income.	Insurance risk arises from mortality and morbidity experience. Lapse and surrender rates and if, the policy has a savings element, the performance of the assets held to support the liabilities also impact the cost of claims and benefits. The performance of assets supporting insurance liabilities depends on financial risks such as market, credit and liquidity.	Insurance risk: · is measured in terms of life insurance liabilities and non-life written premiums for their respective contract types; · is monitored by the Group Insurance Risk Management Committee, which checks the risk profile of the insurance operations against a risk appetite for insurance business agreed by the GMB; and · is managed both centrally and locally using product design, underwriting, reinsurance and claims-handling procedures.

Risks	Arising from	Measurement, monitoring and management of risk
Fiduciary risk
The risk of breaching our fiduciary duties.	Fiduciary risk arises from our business activities where we act in a fiduciary capacity as Trustee, Investment Manager or as mandated by law or regulation.	Fiduciary risk: · is measured by monitoring against risk appetite; · is monitored through the use of key indicators; and · is managed within the designated businesses via a comprehensive policy framework.
Reputational risk
The risk that illegal, unethical or inappropriate behaviour by the Group itself, members of staff or clients or representatives of the Group will damage HSBC's reputation, leading, potentially, to a loss of business, fines or penalties.	Reputational risk encompasses negative reaction not only to activities which may be illegal or against regulations, but also to activities that may be counter to societal standards, values and expectations. It arises from a wide variety of causes, including how we conduct our business and the way in which clients to whom we provide financial services, and bodies who represent HSBC, conduct themselves.	Reputational risk: · is measured by reference to our reputation as indicated by our dealings with all relevant stakeholders, including media, regulators, customers and employees; · is monitored through a reputational risk management framework, taking into account the results of the compliance risk monitoring activity outlined above; and · is managed by every member of staff and is covered by a number of policies and guidelines. There is a clear structure of committees and individuals charged with mitigating reputational risk, including the Group Reputational Risk Policy Committee and regional/business equivalents.
Pension risk
The risk that contributions from Group companies and members fail to generate sufficient funds to meet the cost of accruing benefits for the future service of active members, and the risk that the performance of assets held in pension funds is insufficient to cover existing pension liabilities.	Pension risk arises from investments delivering an inadequate return, economic conditions leading to corporate failures, adverse changes in interest rates or inflation, or members living longer than expected (longevity risk). Pension risk includes operational risks listed above.	Pension risk: · is measured in terms of the schemes' ability to generate sufficient funds to meet the cost of their accrued benefits; · is monitored through the specific risk appetite that has been developed at both Group and regional levels; and · is managed locally through the appropriate pension risk governance structure and globally through the Risk Management Meeting.
Sustainability risk
The risk that the environmental and social effects of providing financial services outweigh the economic benefits.	Sustainability risk arises from the provision of financial services to companies or projects which run counter to the needs of sustainable development.	Sustainability risk: · is measured by assessing the potential sustainability effect of a customer's activities and assigning a Sustainability Risk Rating to all high risk transactions; · is monitored quarterly by the Risk Management Meeting and monthly by Group Sustainability Risk management; and · is managed using sustainability risk policies covering project finance lending and sector-based sustainability polices for sectors with high environmental or social impacts.

Risk profile

Risks are assumed by our global businesses in accordance with their risk appetite and are managed at Group, global business and regional levels. All risks are identified through our risk map process, which sets out the Group's risk profile in relation to key risk categories in different regions and global businesses. In addition to those listed above, risks including model, financial management, capital, Islamic finance and strategic risk are identified and monitored through the risk map process.

These risks are then regularly assessed through our risk appetite framework, subjected to stress testing and considered for classification as top and emerging risks. These processes are discussed in further detail below.

Credit, market and operational risks are measured using the Pillar 1 framework for regulatory capital through the allocation of risk-weighted assets. We measure other risks using our economic capital model under Pillar 2 (as described in our Pillar 3 Disclosures 2012 report.)

Risk appetite

Risk appetite is set out in the Group's Risk Appetite Statement, which describes the types and levels of risk that the Group is prepared to accept in executing our strategy. It is approved by the Board on the advice of the Group Risk Committee, and is a key component of our risk management framework. It is central to the annual planning process, in which global businesses, geographical regions and functions are required to articulate their risk appetite statements. These are aligned with Group strategy, and provide a risk profile of each global business, region or function in the context of the risk categories discussed above.

Quantitative and qualitative metrics are assigned to nine key categories: earnings, capital, liquidity and funding, securitisations, cost of risk, intra-group lending, strategic investments, risk categories and risk diversification and concentration. Measurement against the metrics:

· guides underlying business activity, ensuring it is aligned to risk appetite statements;

· informs risk-adjusted remuneration;

· enables the key underlying assumptions to be monitored and, where necessary, adjusted through subsequent business planning cycles; and

· promptly identifies business decisions needed to mitigate risk.

Some of the core metrics that are measured, monitored and presented to the Board monthly are tabulated below:

Risk appetite metrics

	Target	Actual

Core tier 1 ratio .......	9.5% to 10.5%	12.3%
Return on equity ......	12% to 15%	8.4%
Return on RWAs ......	1.8% to 2.6%	1.8%
Dividend payout ratio	40% to 60%	55.4%
Cost efficiency ratio	48% to 52%	62.8%
Advances to customer accounts ratio........	Below 90%	74.4%
Cost of risk (LICs) ...	Below 20% of operating income	9.9%

Stress testing

Our stress testing and scenario analysis programme is central to the monitoring of top and emerging risks. We conduct a range of Group stress-testing scenarios including, but not limited to, severe global economic downturn, country, sector and counterparty failures and a variety of projected major operational risk events. The outcomes of the stress testing are used to assess the potential demand for regulatory capital under the various scenarios. We also participate, where appropriate, in scenario analyses requested by regulatory bodies.

In the course of 2012, we examined several scenarios reflecting potential developments in the eurozone and more widely. Those reported to senior management during 2012 included an assessment of the annual operating plan 2012 under two macroeconomic stress scenarios, as described below. The results of the two scenarios demonstrated that HSBC would remain satisfactorily capitalised under the mild and severe scenarios after taking account of assumed management actions.

In addition to the suite of risk scenarios considered for the Group, each major HSBC subsidiary conducts regular macroeconomic and event-driven scenario analyses specific to their region.

Stress testing is used across risk categories such as market risk, liquidity and funding risk and credit risk to evaluate the potential impact of stress scenarios on portfolio values, structural long-term funding positions, income or capital.

Stress scenario assumptions

Scenario

Mild scenario assumptions

Severe scenario assumptions

Assumptions

· the situation in Greece worsens and there is an orderly default in Greece;

· Greek banks also default and, with support from the EU and the International Monetary Fund, are bailed out;

· increasing bond yields in Portugal, Ireland, Spain and Italy trigger further fiscal austerity measures, and governments strive to disassociate their countries from Greece;

· through financial and trade linkages, an orderly default in Greece results in the spread of contagion to the rest of the world;

· the UK, US and emerging markets are adversely affected, albeit to varying degrees; and

· slower global demand curbs growth and increases the risk premium on interest rates as well as commodity prices.

· a disorderly default in Greece, where the eurozone governments are unable to ring-fence peripheral countries and their banks;

· default of Portugal and Ireland with increases in bond yields for high debt countries;

· the ensuing credit crunch together with declining business and consumer confidence more than offset any relief gained from the depreciation of the euro;

· investors become increasingly uncomfortable with the US and the UK's fiscal positions, with the severe scenario resulting in a global slowdown; and

· emerging economies are less affected by the financial shock.

We also conduct reverse stress testing.

Reverse stress testing is a process of working backwards from the event of non-viability of the business model to identification of a range of events that could bring that event about. Non-viability might occur before the bank's capital is depleted, and could result from a variety of events. These include idiosyncratic, systemic or combinations of events, and/or could imply failure of the Group's holding company or one of its major subsidiaries and does not necessarily mean the simultaneous failure of all the major subsidiaries.

We use reverse stress testing as part of our risk management process to strengthen resilience by helping to inform early-warning triggers, management actions and contingency plans to mitigate against potential stresses and vulnerabilities which the Group might face.

Areas of special interest

(Unaudited)

Compliance

In 2012, we experienced increasing levels of compliance risk as regulators and other agencies pursued investigations into historical activities, and we continued to work with them in relation to existing issues. Manifestation of these risks included an appearance before the US Senate Permanent Subcommittee on Investigations and the Deferred Prosecution Agreement reached with US authorities in relation to investigations regarding inadequate compliance with anti-money laundering and sanctions law, plus a related undertaking with the FSA. We have also been involved in investigations into the mis-selling of interest rate derivative products to SMEs in the UK and investigations and reviews related to certain past submissions made by panel banks and the process for making submissions in connection with the setting of Libor, Euribor and other benchmark interest and foreign exchange rates.

With a new senior leadership team and a new strategy in place since 2011, we have already taken significant steps to address these issues including making changes to strengthen compliance, risk management and culture. These steps, which should also enhance our compliance risk management capabilities, include the following:

· the creation of a new global structure which will make HSBC easier to manage and control;

· simplifying our business through the ongoing implementation of our organisational effectiveness programme and our five economic filters strategy;

· developing a sixth global risk filter which should help to standardise our approach to doing business in higher risk countries;

· substantially increasing resources, doubling global expenditure and significantly strengthening Compliance as a control (rather than as an advisory) function;

· continuing to roll out the HSBC Values programme that defines the way everyone in the Group should act;

· appointing a new Chief Legal Officer and Head of Group Financial Crime Compliance with particular expertise and experience in US law and regulation;

· appointing a new Global Head of Regulatory Compliance and starting to restructure the Global Compliance function accordingly;

· designing and implementing new global standards by which we conduct our businesses; and

· enforcing a consistent global sanctions policy.

It is clear from both our own and wider industry experience that the level of activity among regulators and law enforcement agencies in investigating possible breaches of regulations has increased, and that the direct and indirect costs of such breaches can be significant. Coupled with a substantial increase in the volume of new regulation, much of which has some element of extra-territorial reach, and the geographical spread of our businesses, we believe that the level of inherent compliance risk that we face as a Group will continue to remain high for the foreseeable future.

Commercial real estate

Our exposure to commercial real estate lending continued to be concentrated in Hong Kong, the UK, Rest of Asia-Pacific and North America. The market in Hong Kong and most other Asian markets in which we conduct commercial real estate lending, after relative buoyancy in 2011, began to stabilise in 2012, partly due to initiatives taken by various supervisory authorities. In the UK, many regions were negatively affected by weak growth in the economy, though London and the South East, where more than 50% of our UK CRE lending is based, continued to exhibit relative strength. In North America, the market remained stable, in part supported by the continued low levels of interest rates.

Refinance risk, which is subject to close scrutiny in key commercial real estate markets, is the risk that a loan which is due to be repaid through refinancing over the short term cannot, at maturity, be refinanced on current market terms. Such cases may either lead to the loan being treated as impaired because the borrower's ability to pay is considered doubtful or, if refinanced by HSBC, may result in it being treated as a renegotiated loan because of the degree of forbearance required (see page 158 for a description of renegotiated loans). In commercial real estate markets, refinance risk can arise particularly when a loan is serviced exclusively by the property to which it relates, i.e. when the bank does not, or is not able to, place principal reliance on other cash flows available to the borrower. We monitor the commercial real estate portfolio, assessing those drivers that may indicate potential issues with refinancing. The principal driver is the vintage of the loan, where origination reflected previous market norms which no longer apply in the current market. Examples are higher loan-to-value ratios and/or lower interest cover ratios. The range of refinancing sources in the local market is also an important consideration, with concern increasing when this is restricted to banks and when bank liquidity is limited. In addition, the quality of underlying fundamentals such as tenant reliability, ability to let, and the condition of the property itself is also important, as it influences property value. With the exception of the UK, in our material commercial real estate portfolios globally, the behaviour of the market and the quality of assets does not cause undue concern. In the UK, the above drivers combine to cause a concern regarding our sensitivity to risks of refinance that warrant enhanced management attention.

At 31 December 2012, the UK had US$24.5bn of commercial real estate loans, of which US$7.4bn were due to be refinanced within the next 12 months, of which US$2.4bn were assessed as possessing characteristics that indicated an increased risk of refinancing difficulty. Such cases are monitored closely with US$1.9bn already under special management within our Loan Management Units. US$0.9bn were disclosed as impaired with impairment allowances of US$0.4bn. Where these loans are not considered impaired it is because, while they may possess characteristics that indicate a potential issue with refinancing, as described above, there is no evidence to indicate that all contractual cash flows will not be recovered or that the loans will need to be refinanced on terms we would consider below market norms.

The relevance of current market conditions to impairment assessment is particularly relevant over a 12-month period. Over a 12 to 24-month horizon, US$3.3bn of UK commercial real estate and other property-related lending loans are due to be refinanced. Reviews of more sensitive assets due between 12 and 24 months have been conducted to ensure that there are no further cases currently requiring special management or that should be considered impaired.

Eurozone crisis

Eurozone countries are members of the EU and part of the euro single currency bloc. The peripheral eurozone countries are those that have exhibited levels of market volatility that exceeded other eurozone countries, demonstrating fiscal or political uncertainty which may persist through the first half of 2013. In 2012, in spite of improvements through austerity and structural reforms, the peripheral eurozone countries of Greece, Ireland, Italy, Portugal, Spain and Cyprus continued to exhibit a high ratio of sovereign debt to GDP or short to medium-term maturity concentration of their liabilities, with Greece, Spain and Cyprus seeking assistance.

Exposure to eurozone countries is analysed in the table on page 193.

Risk reduction in 2012

At 31 December 2012, our net exposure to the peripheral eurozone countries was US$38bn, including net exposure to sovereign borrowers, agencies and banks of US$12bn. During the year, we continued to reduce our overall net exposure to sovereigns, agencies and banks of peripheral eurozone countries. In addition, we continued to actively reduce exposures to counterparties domiciled in other eurozone countries that had exposures to sovereigns and/or banks in peripheral eurozone countries of sufficient size to threaten their on-going viability in the event of an unfavourable conclusion to the current crisis.

This was undertaken through an analysis of publicly available information, reviews of external analyst reports and meetings with the counter-parties' officials. Vulnerable counterparties were identified and subjected to enhanced monitoring, and our exposure was managed in a similar manner to the monitoring and management of direct exposures to the peripheral eurozone countries. One of the primary issues underpinning this process was the management of our surplus liquidity, resulting in the placement of funds directly with central banks in the most highly-rated countries.

Our businesses in peripheral eurozone countries are funded from a mix of local deposits, local wholesale funding and intra-Group loans extended from HSBC operations with surplus funds. Intra-Group funding carries the risk that a member country might exit the eurozone and redenominate its national currency, which could result in a significant currency devaluation. A description of risks relating to currency redenomination in the event of the exit of a eurozone member is provided on page 131.

Risk management and contingency planning

There is an established framework for dealing with counterparty and systemic crisis situations, both regionally and globally, which is complemented by regular specific and enterprise-wide stress testing and scenario planning. The framework functions both in pre and in-crisis situations and ensures that we have detailed operational plans in the event of an adverse scenario materialising. It was deployed in 2011 and has continued to operate throughout 2012 to ensure that pre-crisis preparation remains apposite and robust.

The main focus of preparation for eurozone exit continues to be on Greece and Spain although, as the eurozone situation has developed in 2012, we have also considered other scenarios including contagion risk to non-eurozone countries or the exit of a higher impact eurozone member. Management actions include regular meetings of a Eurozone Major Incident Group and a tested regional eurozone contingency plan covering all global businesses and functions. The plan considers payments, legal, client account, internal and external communication and regulatory and compliance issues associated with eurozone breakup.

Personal lending - US lending

The slight improvement in US economic conditions continued throughout 2012. Real GDP grew by 2.2% and consumer spending growth remained moderate. Threats to economic growth remained, primarily with the uncertainty in the housing market and elevated unemployment levels, although both of them demonstrated modest improvements during the year.

We remained focused on managing the run-off of balances in our HSBC Finance portfolio and completed the sales of our US Card and Retail Services business and 195 retail branches principally in upstate New York in 2012. Total lending balances, including loans held for sale, within HSBC Finance were US$43bn at 31 December 2012, a decline of US$6.8bn compared with the end of 2011. The rate at which balances in the CML portfolio are declining continues to be affected by the lack of refinancing opportunities available to customers and the continued impact of the temporary suspension of foreclosure activity in 2010. Foreclosure processing has now resumed in substantially all states, although there continues to be a backlog of loans which have not yet been referred to foreclosure. In addition, our loan modification programmes, which are designed to improve cash collections and avoid foreclosure, continued to slow repayment rates.

In the third quarter of 2012, we reclassified non-real estate personal loan balances of US$3.7bn, net of impairment allowances, from our consumer finance portfolio to 'Assets held for sale' as we actively marketed the portfolio. We also identified real estate secured loan balances, with a carrying amount of US$3.8bn which, as part of our strategy, we have announced that we plan to actively market in multiple transactions generally over the next two years. At 31 December 2012, the carrying value of the non-real estate and the real estate secured loans which we intend to sell was approximately US$1bn greater than their estimated fair value. We expect to recognise a loss on sale for these loans over the next few years, the actual amount of which will depend on market conditions at the time of the sales.

Total mortgage lending in the US was US$55bn at 31 December 2012, a decline of 7% compared with the end of 2011, mainly due to the continued run-off of the CML portfolio.

Top and emerging risks

(Unaudited)

Identifying and monitoring top and emerging risks is integral to our approach to risk management. We define a 'top risk' as being a current, emerged risk which has arisen across any of our risk categories, regions or global businesses and has the potential to have a material impact on our financial results or our reputation and the sustainability of our long-term business model, and which may form and crystallise within a one-year horizon. We consider an 'emerging risk' to be one which has large uncertain outcomes that may form beyond a one-year horizon which, if they were to crystallise, could have a material effect on our long-term strategy. Our top and emerging risk framework enables us to focus on current and forward looking aspects of our risk exposures and ensure our risk profile remains in line with our risk appetite and that our appetite remains appropriate. Our current top and emerging risks are as follows:

Macroeconomic and geopolitical risk

· Emerging market slowdown.

· Macroeconomic risks within developed economies.

· Increased geopolitical risk in certain regions.

Emerging market slowdown

World growth is slowing as demand in mature economies is subdued and credit availability and investment activity remain constrained. A number of mature economies are implementing austerity measures in order to reduce their deficits and public debt. This is expected to help resolve the sovereign and banking crisis in the medium term but, in the short term, it is limiting growth, leaving labour markets weak and thereby making fiscal consolidation a bigger challenge. This is affecting the rest of the world through lower trade, reduced international financing as banks are deleveraging, and the potential disruption to capital flows. In addition, it makes emerging countries more vulnerable to a slowdown in mature economies.

Potential impact on HSBC

· Trade and capital flows may contract as a result of lower world production, banks deleveraging, the introduction of protectionist measures in certain markets or the emergence of geopolitical risks, which in turn might curtail profitability.

· A prolonged period of low interest rates due to policy actions taken to address the economic crisis in mature economies will constrain through spread compression and low returns on assets the interest income we earn from investing our excess deposits.

· During 2012, we continued to reduce our sovereign and financial institution counterparty credit positions in peripheral eurozone countries. In addition, we actively sought to identify and reduce exposures to those counterparties domiciled in core European countries that had exposures to sovereigns and/or banks in peripheral eurozone countries of sufficient size to threaten their ongoing viability in the event of an unfavourable conclusion to the current situation.

Macroeconomic risks within developed economies

There is still some risk of one or more countries leaving the euro, although the situation improved in 2012. Even without a eurozone break-up, the currency will remain vulnerable to market perception. Banks in some countries remain very fragile and the rest of the European banking industry could be affected through its exposure to the weakest countries. Banks are therefore expected to continue to deleverage. In the current context of very low growth due to austerity measures, this could further aggravate the economic crisis and could push European countries into a vicious circle of economic crisis and sovereign difficulties. Although our exposure to the peripheral eurozone countries is relatively limited, we are exposed to counterparties in the core European countries which could be affected by any sovereign or currency crisis. Our eurozone exposures are described in more detail on page 192.

Potential impact on HSBC

· We could incur significant losses stemming from the exit of one or more countries from the eurozone and the redenomination of their currencies.

· Our exposures to European banks may come under stress, heightening the potential for credit and market risk losses, if the sovereign debt and banking system crisis in the region increases the need to recapitalise parts of the sector.

· In the event of contagion from stress in the peripheral eurozone sovereign and financial sectors, our ability to borrow from other financial institutions or to engage in funding transactions may be adversely affected by market dislocation and tightening liquidity.

· A sovereign default without co-ordinated intervention to protect the rest of the eurozone could trigger banking defaults in companies with which we do business and have a knock-on effect on the global banking system.We have actively managed the risk of sovereign defaults during 2012 by reducing exposures and other measures.

· In seeking to manage and mitigate these risks, we have prepared and tested detailed operational contingency plans to deal with such a scenario. However, such plans may not be adequate or may not prove effective.

Increased geopolitical risk in certain regions

Weak global economic growth is exacerbating the risk of protectionism and some countries may impose restrictions on trade or on capital flows to protect their domestic economies.

In Egypt, the political process remains in transition with a continuing risk of instability. In addition, the fighting in Syria may disrupt global international relations, with tensions between Israel and Iran adding to the risks in the region.

Potential impact on HSBC

· Our results are subject to the risk of loss from unfavourable political developments, currency fluctuations, social instability and changes in government policies on matters such as expropriation, authorisations, international ownership, interest-rate caps, foreign exchange transferability and tax in the jurisdictions in which we operate. Actual conflict could bring about loss of life among our staff and physical damage to our assets.

· We have increased our monitoring of the geopolitical and economic outlook, in particular in countries where we have material exposures and a physical presence. Our internal credit risk rating of sovereign counterparties takes these factors into account and drives our appetite for conducting business in those countries. Where necessary, we adjust our country limits and exposures to reflect our appetite and mitigate these risks as appropriate.

Macro-prudential, regulatory and legal risks to our business model

· Regulatory developments affecting our business model and Group profitability.

· Regulatory investigations, fines, sanctions and requirements relating to conduct of business and financial crime negatively affecting our results and brand.

· Dispute risk.

Financial service providers face increasingly stringent and costly regulatory and supervisory requirements, particularly in the areas of capital and liquidity management, conduct of business, operational structures and the integrity of financial services delivery. Increased government intervention and control over financial institutions, together with measures to reduce systemic risk, may significantly alter the competitive landscape. These measures may be introduced as formal requirements in a supra-equivalent manner and to differing timetables across regulatory regimes.

Regulatory developments affecting our business model and Group profitability

Several regulatory changes are likely to affect our activities, both of the Group as a whole and of some or all of our principal subsidiaries. These changes include (i) the introduction of Basel III measures in the EU through CRD IV and uncertainty on both the timing and final form of implementation given that certain areas, such as, the operation of capital buffers have yet to be finalised and the technical guidance from the European Banking Authority ('EBA') across numerous areas has yet to be published, (ii) a new regulatory structure within the UK comprising the Financial Policy Committee ('FPC'), Prudential Regulatory Authority ('PRA') and Financial Conduct Authority ('FCA') and, in particular, the effects of the ability of the FPC to seek additional capital for lending to sectors perceived as higher risk, (iii) the designation of the Group by the Financial Stability Board as a global systemically important bank; (iv) proposed legislation in the UK to give effect to the recommendations of the ICB in relation to 'ring-fencing' of the UK retail banking from wholesale banking activities, the structural separation of other activities envisaged in legislative proposals in the US (including the Volcker Rule proposed under the Dodd-Frank Act) and in France and, in the EU, considerations following the Liikanen Group recommendations; (v) changes in the regime for the operation of capital markets with increasing standardisation, central clearing, reporting and margin requirements; (vi) requirements flowing from arrangements for the recovery and resolution of the Group and its main operating entities; and (v) changing standards for the conduct of business. There is also continued risk of further changes to regulation relating to remuneration and other taxes.

Potential impact on HSBC

· Proposed changes relating to capital and liquidity requirements, remuneration and/or taxes could increase the Group's cost of doing business, reducing future profitability.

· Proposed changes in and the implementation of regulations for derivatives and central counterparties, the ICB ring-fencing proposals, recovery and resolution plans, the Volcker Rule and the Foreign Account Tax Compliance Act ('FATCA') may affect the manner in which we conduct our activities and structure ourselves, with the potential both to increase the costs of doing business and curtail the types of business we can carry out, with the risk of decreased profitability as a result. Due to the fact that the development and implementation of many of

these various regulations are in their early stages, it is not possible to estimate the effect, if any, on our operations.

We are closely engaged with the governments and regulators in the countries in which we operate to help ensure that the new requirements are properly considered and can be implemented in an effective manner. We are also ensuring that our capital and liquidity plans take into account the potential effects of the changes. Capital allocation and liquidity management disciplines have been expanded to incorporate future increased capital and liquidity requirements and drive appropriate risk management and mitigating actions.

Regulatory investigations, fines, sanctions and requirements relating to conduct of business and financial crime negatively affecting our results and brand

Financial service providers are at risk of regulatory sanctions or fines related to conduct of business and financial crime. The incidence of regulatory proceedings and other adversarial proceedings against financial service firms is increasing.

In December 2012, HSBC reached agreement with US authorities in relation to investigations regarding inadequate compliance with anti-money laundering, the US Bank Secrecy Act and sanctions law. This includes a DPA with the US Department of Justice ('DoJ'). We also reached agreement to achieve a resolution with all other US government agencies that have investigated our past conduct related to these issues, and finalised an undertaking with the FSA to comply with certain forward-looking obligations with respect to anti-money laundering and sanctions requirements over a five-year term. Under these agreements, we made payments totalling US$1,921m to US authorities and undertook to continue cooperating fully with US and UK regulatory and law enforcement authorities and take further action to strengthen our compliance policies and procedures. Over the five-year term of the agreement with the DoJ and the FSA, an independent monitor (who will, for FSA purposes, be a 'skilled person' under section 166 of the Financial Services and Markets Act (FSMA)) will evaluate and assess our progress in fully implementing these and other measures it recommends and will produce regular assessments of the effectiveness of our Compliance function.

As reflected in the agreement entered into with the Office of the Comptroller of the Currency ('OCC') in December 2012 (the 'GLBA Agreement'), the OCC has determined that HSBC Bank USA is not in compliance with the requirements which provide that a national bank and each depository institution affiliate of the national bank must be both well capitalised and well managed in order to own or control a financial subsidiary. As a result, HSBC Bank USA and its parent holding companies, including HSBC, no longer meet the qualification requirements for financial holding company status, and may not engage in any new types of financial activities without the prior approval of the Federal Reserve Board. In addition, HSBC Bank USA may not directly or indirectly acquire control of, or hold an interest in, any new financial subsidiary, nor commence a new activity in its existing financial subsidiary, unless it receives prior approval from the OCC.

In the UK, the FSA has continued to increase its focus on 'conduct risk' including attention to sales processes and incentives, product and investment suitability and conduct of business concerns more generally. These measures are concerned principally, but not exclusively, with the conduct of business with retail customers and in conjunction with this focus, the UK regulators are making increasing use of existing and new powers of intervention and enforcement, including powers to consider past business undertaken and implement customer compensation and redress schemes or other, potentially significant remedial work. Additionally, the UK and other regulators increasingly take actions in response to customer complaints either specific to an institution or more generally in relation to a particular product. We have seen recent examples of this approach in the context of the mis-selling of payment protection insurance and of interest rate derivative products to SMEs.

The Group also continues to be subject to a number of other regulatory proceedings, including investigations and reviews by various regulators and competition and enforcement authorities around the world, including in the UK, the US, Canada, the EU, Switzerland and Asia, who are conducting investigations and reviews related to certain past submissions made by panel banks and the process for making submissions in connection with the setting of London interbank offered rates ('Libor'), European interbank offered rates ('Euribor') and other benchmark interest and foreign exchange rates. As certain HSBC entities are members of such panels, HSBC and/or its subsidiaries have been the subject of regulatory demands for information and are cooperating with those investigations and reviews. In addition, HSBC and other panel banks have been named as defendants in private lawsuits filed in the US with respect to the setting of Libor, including putative class action lawsuits which have been consolidated before the US District Court for the Southern District of New York. The complaints in those actions assert claims against HSBC and other panel banks under various US laws including US antitrust laws, the US Commodities Exchange Act, and state law.

Potential impact on HSBC

· It is difficult to predict the outcome of the regulatory proceedings involving our businesses. Unfavourable outcomes may have a material adverse effect on our reputation, brand and results, including loss of business and withdrawal of funding.

· In relation to the DPA, the Group has committed to take or continue to adhere to a number of remedial measures. Breach of the DPA at any time during its term may allow the DoJ or the New York County District Attorney's Office to prosecute HSBC in relation to the matters which are the subject of the DPA.

· In relation to the GLBA Agreement, if all of our affiliate depositary institutions are not in compliance with these requirements within the time periods specified in the GLBA Agreement, HSBC could be required either to divest HSBC Bank USA or to divest or terminate any financial activities conducted in reliance on the Gramm-Leach Bliley Act ('GLB Act'). Similar consequences could result for subsidiaries of HSBC Bank USA that engage in financial activities in reliance on expanded powers provided for in the GLB Act. Any such divestiture or termination of activities would have an adverse material effect on the consolidated results and operation of HSBC.

· The UK and other regulators may identify future industry-wide mis-selling or other issues that could affect the Group. This may lead from time to time to: (i) significant direct costs or liabilities (including in relation to mis-selling); and (ii) changes in the practices of such businesses which benefit customers at a cost to shareholders. Further, decisions taken in the UK by the Financial Ombudsman Service in relation to customer complaints (or any overseas equivalent that has jurisdiction) could, if applied to a wider class or grouping of customers, have a material adverse effect on the operating results, financial condition and prospects of the Group.

Steps to address many of the requirements of the DPA and the GLBA Agreement have either already been taken or are under way. These include simplifying the Group's control structure, strengthening the governance structure with new leadership appointments, revising key policies and establishing bodies to implement single global standards shaped by the highest or most effective standards available in any location where the Group operates, as well as substantially increasing spending and staffing in the anti-money laundering and regulatory compliance areas in the past few years. There can be no assurance that these steps will be effective or that HSBC will not have to take additional remedial measures in the future to comply with the terms of the DPA or the GLBA Agreement.

Dispute risk

The current economic environment has increased the Group's exposure to actual and potential litigation. Further details are provided in Note 43 on the Financial Statements.

Potential impact on HSBC

Dispute risk gives rise to potential financial loss and significant reputational damage which could adversely affect customer and investor confidence.

Risks related to our business operations, governance and internal control systems

· Regulatory commitments and consent orders including under the Deferred Prosecution Agreements.

· Challenges to achieving our strategy in a downturn.

· Internet crime and fraud.

· Level of change creating operational complexity and heightened operational risk.

· Information security risk.

· Model risk.

Regulatory commitments and consent orders including under the Deferred Prosecution Agreements

There is a risk that we fail to meet our deadlines or we are judged to have material gaps in our plans or implementation compared with the requirements of the DPAs and other orders. Further details of this risk are provided on page 128.

Potential impact on HSBC

If, during the term of the DPA, HSBC is determined to have breached the DPA, the DoJ or the New York County District Attorney's Office may prosecute HSBC in relation to the matters which are the subject of the DPA. The FSA may, in similar vein, take enforcement action against the Group as a result of a breach of the DPA or of our related undertakings to the FSA.

Challenges to achieving our strategy in a downturn

The external environment remains challenging and the structural changes which the financial sector is going through are creating obstacles to the achievement of strategic objectives. This, combined with the prolonged global economic slowdown, could affect the achievement of our strategic targets for the Group as a whole and our global businesses.

Potential impact on HSBC

· The slowdown may put pressure on our ability to earn returns on equity in excess of our cost of equity while operating within the overall parameters of our risk appetite.

· Through our strategic initiatives, which have heightened the focus on capital allocation and cost efficiency, we are actively seeking to manage and mitigate this risk.

Internet crime and fraud

With the ever-growing acceptance of and demand for internet and mobile services by customers, HSBC is increasingly exposed to fraudulent and criminal activities via these channels. Internet crime could result in financial loss and/or customer data and sensitive information being compromised. Along with internet fraud, the overall threat of external fraud may increase during adverse economic conditions, particularly in retail and commercial banking.

We also face the risk of breakdowns in processes or procedures and systems failure or unavailability, and our business is subject to disruption from events that are wholly or partially beyond our control, such as internet crime and acts of terrorism.

Potential impact on HSBC

· Internet crime and fraud may give rise to losses in service to customers and/or economic loss to HSBC. The same threats apply equally when we rely on external suppliers or vendors to provide services to us and our customers.

· We have increased our defences through enhanced monitoring and have implemented additional controls, such as two-factor authentication, to reduce the possibility of losses from fraud. We continually assess these threats as they evolve and adapt our controls to mitigate them.

Level of change creating operational complexity and heightened operational risk

There are many drivers of change affecting HSBC and the banking industry, including new banking regulations, the increased globalisation of economic and business activities, new products and delivery channels and organisational change.

Operational complexity has the potential to heighten all types of operational risk arising from our activities. These risks include process errors, systems failures and fraud. Complexity can also increase operational costs.

The implementation of our strategy to simplify our business, which involves withdrawing from certain markets, presents disposal risks which must be carefully managed. Implementing organisational changes to support the Group's strategy also requires close management oversight.

Potential impact on HSBC

· The implementation of our strategy has involved the re-organisation and clarification of management accountabilities. There is consequently a risk that issues are missed during the transition. This change activity is being monitored through a comprehensive review programme and robust governance arrangements.

· Critical systems failure and a prolonged loss of service availability could cause serious damage to our ability to serve our customers, breach regulations under which we operate and cause long-term damage to our business, reputation and brand. Systems and controls could be degraded as a result of organisational effectiveness initiatives unless there is strong governance and an oversight framework to monitor the risk and control environment. We seek to ensure that our critical systems infrastructure, including IT services, essential buildings, offshore processes and key vendors, is constantly monitored and properly resourced to mitigate against systems failures.

· We pro-actively review relevant external events and assess the impact they may have on our systems. Within HSBC, we have a strong focus on industry best practices. We rigorously test and review all planned updates to our systems environment. All changes are risk-assessed, and appropriate mitigating controls are required for any planned changes classified as high risk. During periods of heightened risk, comprehensive change embargoes are imposed to minimise the risk of customers being affected. Following the systems outage at a major UK bank in 2012, we assessed our own exposure to similar risks and implemented appropriate steps in mitigation. We also assessed the systems scheduling tools used in the Group. There are controls in place to manage inter-dependencies, report exceptions and alert file data corruption. These additional controls are intended to ensure that the effect of any similar product failure at HSBC would be limited. In addition, a continuity test of a similar problem within our major datacentres in the UK and Hong Kong was conducted in the second half of 2012.

· The potential effects of disposal risks include regulatory breaches, industrial action, loss of key personnel and interruption to systems and processes during business transformation, and they can have both financial and reputational implications. Steps taken to manage these risks proactively include maintaining a close dialogue with regulators and customers and involving HR, legal, compliance and other functional experts. Some disposals also involve Transitional Service Agreements where there are ongoing risks, which are subject to close management oversight.

Information security risk

The security of our information and technology infrastructure is crucial for maintaining our banking applications and processes while protecting our customers and the HSBC brand.

Potential impact on HSBC

· These risks give rise to potential financial loss and reputational damage which could adversely affect customer and investor confidence. Loss of customer data would also trigger regulatory breaches which could result in fines and penalties being incurred.

· We have invested significantly in addressing this risk through increased training to raise staff awareness of the requirements and enhanced multi-layered controls protecting our information and technical infrastructure.

Model risk

More stringent regulatory requirements governing the development of parameters applied to and controls around models used for measuring risk can give rise to changes, including increases in capital requirements. Furthermore, the changing external economic and legislative environment and changes in customer behaviour can lead to the assumptions we have made in our models becoming invalid.

Potential impact on HSBC

· These model risks can result in a potentially increased and volatile capital requirement.

· We continue to address these risks through enhanced model development, independent review and model oversight to ensure our models remain fit for purpose.

Credit risk

	Page	App¹	Tables	Page

Credit risk management .................................		252

Summary of credit risk in 2012 ................	139		Maximum exposure to credit risk .................................	139
			Loans and advances excluding held for sale: total exposure, impairment allowances and charges ........	139
			Personal lending .........................................................	140
			Wholesale lending ........................................................	141
			Credit quality of gross loans and advances ..................	142
Impairment of loans and advances .................	143		LICs by geographical region .......................................	143
			LICs by industry ...........................................................	143
Assets held for sale ........................................	143		Loans and advances to customers and banks measured at amortised cost ......................................................	143
			Loan impairment charges and other credit risk provisions ................................................................	144

Credit exposure ..........................................	144
Maximum exposure to credit risk ...................	144		Maximum exposure to credit risk .................................	146
			Loans and other credit-related commitments ...............	146

Personal lending ........................................	147		Total personal lending .................................................	147
Mortgage lending ...........................................	148		Mortgage lending products ..........................................	149
Mortgage lending in the US ............................	150		HSBC Finance US CML - residential mortgages .........	150
Credit quality of personal lending in the US ...	151		HSBC Finance: foreclosed properties in the US ...........	151
			Trends in two months and over contractual delinquency in the US ..................................................................	152

Wholesale lending .....................................	152		Total wholesale lending ...............................................	153
Corporate and commercial .............................	154
Financial (non-bank) .....................................	154
Loans and advances to banks .........................	154

Credit quality of financial instruments ..	154	253	Credit quality classification ..........................................	253
2012 compared with 2011 .............................	154		Distribution of financial instruments by credit quality ..	155
Past due but not impaired gross financial instruments ................................................	156		Past due but not impaired loans and advances to customers and banks by geographical region ..........	157
			Ageing analysis of days past due but not impaired gross financial instruments ................................................	157
Renegotiated loans and forbearance ...............	158	254	Renegotiated loans and advances to customers ...........	158
			Renegotiated loans and advances to customers by geographical region ................................................	158
2012 compared with 2011 .............................	159
HSBC Finance loan modifications and re-ageing ...................................................................	159		Gross loan portfolio of HSBC Finance real estate secured balances ......................................................	161
			Movement in HSBC Finance renegotiated real estate balances ..................................................................	161
			Number of renegotiated real estate secured accounts remaining in HSBC Finance's portfolio ...................	161
Corporate and commercial forbearance ..........	161
Impaired loans ...............................................	162		Movement in impaired loans by geographical region ..	163

Collateral ....................................................	163
Collateral and other credit enhancements held	163		Residential mortgage loans .........................................	164
			Commercial real estate loans and advances by collateral .................................................................................	165
			Other corporate, commercial and financial (non-bank) loans and advances by collateral .............................	166
			Loans and advances to banks including loan commitments by collateral .............................................................	167
Collateral and other credit enhancements obtained .....................................................	168		Carrying amount .........................................................	168

Impairment of loans and advances ...........	168	258	Impairment allowances on loans and advances to customers by geographical region ...........................	169
			Net loan impairment charge to the income statement by geographical region ................................................	170
2012 compared with 2011 .............................	170
Further analysis of impairment ......................	172		Movement in impairment allowances by industry sector	174
			Movement in impairment allowances on loans and advances to customers and banks ............................	175

	Page	App¹	Tables	Page

Impairment of loans and advances Further analysis of impairment (continued)			Individually and collectively assessed impairment charge to the income statement by industry sector ...............	175
			Net loan impairment charge to the income statement ..	176
			Charge for impairment losses as a percentage of gross loans and advances to customers by geographical region ......................................................................	176
			Charge for impairment losses as a percentage of average gross loans and advances to customers ....................	177
			Reconciliation of reported and constant currency changes by geographical region ............................................	177
Impairment assessment ..................................		258

Concentration of exposure .......................	178	259	Trading assets ..............................................................	178
			Gross loans and advances by industry sector................	179
			Gross loans and advances to customers by industry sector and by geographical region ...........................	181
			Loans and advances to banks by geographical region .	182
			Gross loans and advances to customers by country ......	182

HSBC Holdings ..........................................	184		HSBC Holdings - maximum exposure to credit risk .....	184

Securitisation exposures and other structured products ................................	184	259
Business model ...............................................	185
Exposure in 2012 ..........................................	185		Overall exposure of HSBC ...........................................	185
			Movement in the available-for-sale reserve ..................	186
Securities investment conduits .......................	186		Available-for-sale reserve and economic first loss protection in SICs, excluding Solitaire .....................	186
Impairment methodologies ............................	186	260
Analysis of exposures and significant movements ................................................	186		Carrying amount of HSBC's consolidated holdings of ABSs, and direct lending held at fair value through profit or loss .............................................................	187
Transactions with monoline insurers ..............	189		HSBC's exposure to derivative transactions entered into directly with monoline insurers .................................	189

Leveraged finance transactions ................	190		HSBC's exposure to leveraged finance transactions .....	190

Representations and warranties related to mortgage sales and securitisation activities ..................................................	191


1. Appendix to Risk - risk policies and practices.

Credit risk is the risk of financial loss if a customer or counterparty fails to meet an obligation under a contract. It arises principally from direct lending, trade finance and leasing business, but also from certain other products such as guarantees and credit derivatives and from holding assets in the form of debt securities.

There were no material changes to our policies and practices for the management of credit risk in 2012.

A summary of our current policies and practices regarding credit risk is provided in the Appendix to Risk on page 252.

Summary of credit risk in 2012

(Unaudited)

Maximum exposure to credit risk

	At 31 December
	2012	2011
	US$m	US$m

Trading assets ...........................	367,177	309,449
Financial assets designated at fair value ..............................	12,714	12,926
Derivatives ...............................	357,450	346,379
Loans and advances held at amortised cost ......................	1,150,169	1,121,416
- to banks .............................	152,546	180,987
- to customers ......................	997,623	940,429

Financial investments ...............	415,312	392,834
Assets held for sale ...................	9,292	37,808
Other assets ..............................	203,561	192,024
Off-balance sheet exposures .....	624,462	694,228
- financial guarantees and similar contracts ...............	44,993	39,324
- loan and other credit-related commitments ...................	579,469	654,904


	3,140,137	3,107,064

In 2012, net loans and advances to customers continued to represent our most significant exposure to credit risk, making up 32% of total credit exposure compared with 30% in 2011. Other significant components of our credit exposures were financial investments at 13%, unchanged from 2011, trading assets at 12% (2011: 10%) and derivatives at 11% (unchanged from 2011). Loans and advances to banks fell as a proportion of the Group's credit exposure from 6% in 2011 to 5% in 2012. Off-balance sheet assets contributed 20% of our total credit exposure, mainly relating to loan and other credit-related commitments (2011: 22%).

Of our net loans and advances to customers, corporate and commercial lending made up the largest proportion at 51% (2011: 49%), with significant exposures in Europe, Hong Kong and Rest of Asia-Pacific. First lien residential mortgages represented 30% of total gross loans and advances, mainly in the UK, the US and Hong Kong. Other personal lending (including second lien residential mortgages) made up the bulk of the remaining exposure.

Loans and advances excluding held for sale: total exposure, impairment allowances and charges

(Unaudited)

	2012	2011
	US$bn	US$bn
At 31 December
Total gross loans and advances (A)	1,166.3	1,139.1
Impairment allowances ..............	16.2	17.6
- as a percentage of A ............	1.39%	1.55%

Loans and advances net of impairment allowances.............	1,150.2	1,121.5

Year ended 31 December
Impairment charges ...................	8.2	11.5

The increase in corporate and commercial lending stemmed mainly from Europe, due to a rise in overdrafts which did not meet accounting criteria for netting against corresponding current account balances. Increases in North America reflected CMB's focus on target segments in the US, partly offset by the continued decline in balances in the run-off CML portfolio. In addition, during the year we reclassified US$3.7bn of non-real estate personal loan balances in the CML portfolio and US$2.2bn of lending balances associated with certain operations in Latin America, net of impairment allowances, to 'Assets held for sale'. The disposal of the Card and Retail Services business in the US during the year did not contribute to the decline as the related balances had been transferred to 'Assets held for sale' during 2011.

The increase in first lien residential mortgages reflected the success of marketing campaigns and competitive pricing in the UK, the continued strength of the property market in Hong Kong and distribution network expansion in Rest of Asia-Pacific.

Within net loans and advances, loan impairment allowances fell by US$1.4bn, driven by run-off in the CML portfolio and the reclassification of non-real estate personal loan balances to 'Assets held for sale'.

Trading assets include debt securities (principally government and government-related securities), reverse repo and stock borrowing balances. Balances recovered in 2012 from the subdued levels seen at the end of 2011, when client activity declined due to the eurozone debt concerns dominating the global economy.

Loans and advances to banks fell, driven by a reduction in reverse repo balances, in part reflecting the redeployment of liquidity in Europe to central banks, together with maturities and repayments in Hong Kong.

Loan and other credit-related commitments declined from US$655bn to US$579bn. The reduction in exposure in 2012 was largely driven by the sale of Card and Retail Services in the US.

For a more detailed analysis of our maximum exposure to credit risk, see page 144.

Personal lending

(Unaudited)

	Europe	Hong Kong	Rest of Asia- Pacific	MENA	North America	Latin America	Total
	US$m	US$m	US$m	US$m	US$m	US$m	US$m
2012
First lien residential mortgages
Gross amount (B) .................	135,172	52,296	36,906	2,144	70,133	5,211	301,862
Impairment allowances .........	489	4	66	136	4,163	47	4,905
- as a percentage of B .........	0.4%	0.0%	0.2%	6.3%	5.9%	0.9%	1.6%

Other personal lending¹
Gross amount (C) .................	51,102	18,045	12,399	4,088	14,221	13,376	113,231
Impairment allowances .........	977	57	143	189	684	1,257	3,307
- as a percentage of C .........	1.9%	0.3%	1.2%	4.6%	4.8%	9.4%	2.9%

Total personal lending
Gross amount (D) .................	186,274	70,341	49,305	6,232	84,354	18,587	415,093
Impairment allowances .........	1,466	61	209	325	4,847	1,304	8,212
- as a percentage of D ..........	0.8%	0.1%	0.4%	5.2%	5.7%	7.0%	2.0%

2011
First lien residential mortgages
Gross amount (E) .................	119,902	46,817	32,136	1,837	73,278	4,993	278,963
Impairment allowances .........	441	12	58	126	4,578	106	5,321
- as a percentage of E .........	0.4%	0.0%	0.2%	6.9%	6.2%	2.1%	1.9%

Other personal lending¹
Gross amount (F) ..................	46,245	16,364	11,445	3,432	22,058	15,118	114,662
Impairment allowances .........	1,111	52	138	198	1,768	1,172	4,439
- as a percentage of F ..........	2.4%	0.3%	1.2%	5.8%	8.0%	7.8%	3.9%

Total personal lending
Gross amount (G) .................	166,147	63,181	43,581	5,269	95,336	20,111	393,625
Impairment allowances .........	1552	64	196	324	6,346	1,278	9,760
- as a percentage of G .........	0.9%	0.1%	0.4%	6.1%	6.7%	6.4%	2.5%

For footnote, see page 249.

Our personal lending balances increased from US$394bn at 31 December 2011 to US$415bn at 31 December 2012. This was primarily due to growth in residential mortgages in Europe, Hong Kong and Rest of Asia-Pacific. In Europe, this was due to successful marketing campaigns and competitive pricing in the UK. The growth in mortgage balances in Hong Kong was driven by the low interest rate environment, and robust residential property market. The latter was also a factor in Rest of Asia-Pacific, most notably in Singapore, mainland China, Australia and Malaysia. This growth in total personal lending balances was partly offset by a decline in North America, in part due to the run-off of the CML portfolio and the reclassification of non-real estate personal loan balances to 'Assets held for sale'. In Latin America personal lending decreased, mainly reflecting the transfer of balances relating

to the operations in Colombia, Peru and Paraguay to 'Assets held for sale' in the second quarter of 2012, as well as lower balances in Brazil, where we continued to manage down our exposure to non-strategic portfolios.

Impairment allowances declined by 16%, primarily in North America in the CML portfolio, reflecting the reclassification of non-real estate personal loan balances to 'Assets held for sale' and the continued run-off. In Hong Kong and Rest of Asia-Pacific, impairment allowances remained at low levels throughout 2012. In Europe, in other personal lending, impairment allowances as a percentage of lending balances, declined from 2.4% to 1.9% as we focused our lending growth on higher quality assets.

For a more detailed analysis of our personal lending, see page 147.

Wholesale lending

(Unaudited)

	Europe	Hong Kong	Rest of Asia- Pacific	MENA	North America	Latin America	Total
	US$m	US$m	US$m	US$m	US$m	US$m	US$m
2012
Corporate and commercial
Gross amount (H) ..................	226,755	99,199	85,305	22,452	48,083	35,590	517,384
Impairment allowances .........	3,537	383	526	1,312	732	856	7,346
- as a percentage of H ..........	1.56%	0.39%	0.62%	5.84%	1.52%	2.41%	1.42%

Financial²
Gross amount (I) ...................	101,052	28,046	48,847	10,394	27,400	18,122	233,861
Impairment allowances .........	358	29	11	174	37	2	611
- as a percentage of I ...........	0.35%	0.10%	0.02%	1.67%	0.14%	0.01%	0.26%

2011
Corporate and commercial
Gross amount (J) ...................	209,760	91,592	77,887	21,152	41,775	35,930	478,096
Impairment allowances .........	3,256	492	576	1,242	756	729	7,051
- as a percentage of J ...........	1.55%	0.54%	0.74%	5.87%	1.81%	2.03%	1.47%

Financial²
Gross amount (K) ..................	118,077	38,632	50,492	9,739	27,648	22,743	267,331
Impairment allowances .........	484	26	11	166	135	3	825
- as a percentage of K ..........	0.41%	0.07%	0.02%	1.70%	0.49%	0.01%	0.31%

For footnote, see page 249.

At 31 December 2012, our corporate and commercial lending balances were US$517bn. The increase of 8% compared with the end of 2011 was mainly in the international trade and services sector, largely in Europe despite muted demand for credit, and in Hong Kong, driven by growth in trade finance volumes as we capitalised on trade and capital flows. In the manufacturing sector in Europe, balances increased due to growth in the UK of overdraft balances and corresponding customer accounts which did not, however, meet netting criteria under accounting rules.

Financial sector lending decreased from US$267bn at 31 December 2011 to US$234bn at 31 December 2012. This was mainly in Europe due to a fall in reverse repo activity as liquidity was

redeployed to central banks, together with maturities and repayments in Hong Kong and Rest of Asia-Pacific.

Impairment allowances remained at low levels as a percentage of wholesale lending balances. In North America, impairment allowances as a percentage of financial lending balances declined from 0.49% to 0.14% reflecting a few large write-offs in 2012. Lending balances in this category remained broadly unchanged. In Europe, impairment allowances declined from US$484m to US$358m reflecting the disposal of a small number of exposures.

For a more detailed analysis of our wholesale lending, see page 152.

Credit quality of gross loans and advances

(Unaudited)

	Europe	Hong Kong	Rest of Asia- Pacific	MENA	North America	Latin America	Total
	US$m	US$m	US$m	US$m	US$m	US$m	US$m
2012
Neither past due nor impaired ...........................	500,599	200,110	179,337	35,628	127,457	65,520	1,108,651
Of which renegotiated ...................................	3,871	275	199	1,300	6,061	1,109	12,815

Past due but not impaired .................................	2,339	1,311	2,974	975	7,721	3,591	18,911
Of which renegotiated ...................................	371	8	35	168	3104	133	3,819

Impaired ...........................................................	11,145	477	1,147	2,474	20,345	3,188	38,776
Of which renegotiated ...................................	5,732	109	318	921	16,997	1516	25,593

2011
Neither past due nor impaired ...........................	480,173	191,691	168,571	32,550	131,785	72,534	1,077,304
Of which renegotiated ...................................	5,136	309	264	1,532	6,570	909	14,720

Past due but not impaired .................................	1,990	1,107	2,319	1,165	10,216	3,212	20,009
Of which renegotiated ...................................	282	4	47	311	4,061	168	4,873

Impaired ...........................................................	11,819	608	1,070	2,445	22,758	3,039	41,739
Of which renegotiated ...................................	6,046	134	137	812	17,844	1,399	26,372

At 31 December 2012, US$1,109bn of gross loans and advances were classified as neither past due nor impaired. This was an increase of 3%, mainly in Europe and in Rest of Asia-Pacific.

At 31 December 2012, US$19bn of gross loans and advances were classified as past due but not impaired compared with US$20bn at the end of 2011. The largest concentration of these balances was in HSBC Finance. The decline of 5% was mainly in North America due to the reclassification of non-real estate personal loan balances to 'Assets held for sale', as well as the continued run-off of the mortgage balances in the CML portfolio. This was partly offset by an increase in Rest of Asia-Pacific in the personal and corporate and commercial sectors.

Gross loans and advances classified as impaired decreased by 7%, mainly in North America due to the continued run-off of the CML portfolio, as well as the reclassification of non-real estate personal loan balances to 'Assets held for sale' in our CML portfolio.

Renegotiated loans totalled US$42bn at 31 December 2012, compared with US$46bn at the end of 2011. North America accounted for the largest volume of renegotiated loans which amounted to US$26bn or 62% of total renegotiated loans at 31 December 2012 (2011: US$28bn or 62%), most of which were first lien residential mortgages held by HSBC Finance. Of the total renegotiated loans in North America, US$17bn were presented as impaired at 31 December 2012 (2011: US$18bn). Of total renegotiated loans, US$3.8bn were presented as past due but not impaired at 31 December 2012, down from US$4.9bn at 31 December 2011. This was mainly in North America in the CML portfolio due to the reclassification of non-real estate personal loan balances to 'Assets held for sale' as well as the continued run-off of the lending balances.

For a more detailed analysis of the credit quality of financial instruments, see page 154.

Impairment of loans and advances

(Unaudited)

Loan impairment charges by geographical region

Loan impairment charges by industry

Loan impairment charges decreased from US$12bn to US$8.2bn on a reported basis, a decline of 29% compared with 2011. On a constant currency basis, they were 27% lower.

The improvement in loan impairment charges was most significant in RBWM in North America due to the continued decline in the CML portfolio that is in run-off and the sale of the Card and Retail Services business.

This was in part reduced by higher loan impairment charges in Latin America. In Brazil, delinquencies in RBWM and CMB increased, reflecting lower economic growth in 2012. In Rest of Asia-Pacific, loan impairment charges increased as a result of individually assessed impairments on a single corporate exposure in Australia and a small number of corporate exposures in other countries.

For a more detailed analysis of the impairment of loans and advances, see page 168.

Assets held for sale

During 2012, the growth in gross loans and advances was affected by a reclassification of certain lending balances to 'Assets held for sale'. Disclosures relating to assets held for sale are provided in the following credit risk management tables, primarily where the disclosure is relevant to the measurement of these financial assets:

· Maximum exposure to credit risk (page 146);

· Distribution of financial instruments by credit quality (page 155); and

· Ageing analysis of days past due but not impaired gross financial instruments (page 157).

Although gross loans and advances and related impairment allowances are reclassified from 'Loans and advances to customers' and 'Loans and advances to banks' in the balance sheet, there is no equivalent income statement reclassification. As a result, charges for loan impairment losses shown in the credit risk disclosures include loan impairment charges relating to financial assets classified as 'Assets held for sale'.

Loans and advances to customers and banks measured at amortised cost

(Audited)

	At 31 December 2012		At 31 December 2011
	Gross loans and advances	Impairment allowances on loans and advances	Gross loans and advances	Impairment allowances on loans and advances
	US$m	US$m	US$m	US$m

Reported in 'Loans and advances to customers and banks'..	1,166,338	16,169	1,139,052	17,636
Reported in 'Assets held for sale' .......................................	7,350	718	37,273	1,614

	1,173,688	16,887	1,176,325	19,250

The lending balances in 'Assets held for sale' at the end of 2012 included non-real estate personal loan balances from our CML portfolio in North America and balances associated with the disposal of our operations in Colombia, Paraguay and Peru, net of impairment allowances. The lending balances and impairment allowances reported in 'Assets held for sale' at the end of 2011 included the US Card and Retail Services portfolio which was disposed of in 2012. As the latter was reclassified in 2011, the disposal had no impact on the year-on-year movement in loans and advances or impairment allowances in 2012.

Lending balances held for sale continue to be measured at amortised cost less allowances for impairment; such carrying amounts may differ from fair value. Any difference between the carrying amount and the sales price, which is the fair value at the time of sale, would be recognised as a gain or loss. See Note 16 on the Financial Statements for the carrying amount and the fair value at 31 December 2012 of loans and advances to banks and customers classified as held for sale.

The table below analyses the amount of loan impairment charges and other credit risk provisions ('LIC's) arising from assets held for sale. They primarily related to the non-real estate personal loans reclassified to held-for-sale in the CML portfolio, as well as to the US Card and Retail Services business classified as such at 31 December 2011 which was sold in 2012.

Loan impairment charges and other credit risk provisions

(Unaudited)

	2012
	US$m
LICs arising from:
- disposals and assets held for sale ....	766
- assets not held for sale ...................	7,545

	8,311

Credit exposure

Maximum exposure to credit risk

(Audited)

In 2012, our exposure to credit risk remained well diversified across asset classes. We increased our overall exposure to credit risk in 2012, largely from increases in trading assets in Europe and North America, driven by higher client trading activity. Loans and advances to customers also rose, mainly in the UK, Hong Kong and Rest of Asia-Pacific.

'Maximum exposure to credit risk' table (page 146)

The table presents our maximum exposure to credit risk from balance sheet and off‑balance sheet financial instruments before taking account of any collateral held or other credit enhancements (unless such enhancements meet accounting offsetting requirements). For financial assets recognised on the balance sheet, the maximum exposure to credit risk equals their carrying amount; for financial guarantees and similar contracts granted, it is the maximum amount that we would have to pay if the guarantees were called upon. For loan commitments and other credit-related commitments that are irrevocable over the life of the respective facilities, it is generally the full amount of the committed facilities.

Loans and advances

Our maximum exposure to loans and advances carried at amortised cost increased by 3% compared with the end of 2011. The rise primarily reflected growth in residential mortgage balances in the UK following the continued focus on sales and competitive pricing, the ongoing strength of the property market in Hong Kong and in Rest of Asia-Pacific, coupled with expansion of our distribution network in the latter. Term and trade-related lending rose in Europe despite muted demand for credit in the UK and in Hong Kong and Rest of Asia-Pacific, reflecting our focus on corporate and commercial customers that trade internationally. Lending also rose in Europe as overdraft balances that did not meet netting criteria increased in the UK, with a corresponding rise in related customer accounts. In North America corporate and commercial lending increased, reflecting our focus on target segments in the US.

These increases were partly offset by a decline in North America from repayments and write-offs on the run-off CML portfolio. In addition, during the year we reclassified US$3.7bn of non real estate personal loan balances in the CML portfolio and US$2.2bn of lending balances associated with certain operations in Latin America, net of impairment allowances, to 'Assets held for sale'. Reverse repo balances also declined, mainly in Europe.

Our exposure to loans and advances to banks decreased in Hong Kong and Rest of Asia-Pacific due to maturities and repayments, and in Europe as reverse repo balances declined due, in part, to the redeployment of liquidity to central banks. Balances also decreased in Latin America.

The loans and advances offset adjustment in the table on page 146 primarily relates to customer loans and deposits and balances arising from repo and reverse repo transactions where there is a legally enforceable right of offset in the event of counterparty default and where, as a result, there is a net exposure for credit risk management purposes.

However, as there is no intention to settle these balances on a net basis under normal circumstances, they do not qualify for net presentation for accounting purposes.

Financial investments

Maximum exposure to financial investments increased by 6% compared with the end of 2011. This largely reflected the deployment of surplus liquidity into available-for-sale investments, notably treasury bills in Hong Kong and highly-rated debt securities in North America.

Trading assets

In 2012, our exposure to trading assets rose by 19% reflecting increased client activity compared with the subdued levels seen in 2011. This resulted in higher reverse repo balances in Europe and North America, and higher securities borrowing balances in Rest of Asia-Pacific and Europe, which vary in line with levels of trading activity.

Cashand balances at central banks

The Group's maximum exposure to cash and balances at central banks increased by 9%, driven by redeployment of excess liquidity in Europe and Hong Kong to central banks. This reflected the Group's risk appetite coupled with growth in customer deposit balances. In North America, we reduced balances at the US Federal Reserve as surplus liquidity was redeployed into highly-rated financial investments.

Derivatives

Our maximum exposure to derivatives increased slightly, primarily reflecting a rise in the fair value of interest rate derivative contracts in Europe and, to a lesser extent, in the US due to downward movements in yield curves in major currencies. This was partly offset by a decrease in the fair value of credit derivative contracts, primarily in Europe and the US, as credit spreads tightened. Nearly half of all trades are exchange traded or otherwise settled centrally, the majority of these being interest rate derivatives.

The derivative offset amount in the table on page 146 relates to exposures where the counterparty has an offsetting derivative exposure with HSBC, a master netting arrangement is in place and the credit risk exposure is managed on a net basis, or the position is specifically collateralised, normally in the form of cash. At 31 December 2012, the total amount of such offsets was US$311bn (2011: US$306bn), of which US$270bn (2011: US$272bn) were offsets under a master netting arrangement, US$39bn (2011: US$33bn) was collateral received in cash and US$1.8bn (2011: US$0.7bn) was other collateral. These amounts do not qualify for net presentation for accounting purposes as settlement is not intended to be made on a net basis.

Other credit risk mitigants

While not disclosed as offset in the maximum exposure to credit risk table on page 146, other arrangements including short positions in securities and financial assets held as part of linked insurance/

investment contracts where the risk is predominately borne by the policyholder, reduce our maximum exposure to credit risk. In addition, we hold collateral in respect of individual loans and advances (see page 163).

Loans and other credit-related commitments

Loans and other credit-related commitments remain well diversified across geographical regions. For more details, see page 146.

Counterparty analysis of notional contract amounts of derivatives by product type

(Unaudited)

		Traded over the counter
	Traded on recognised exchanges	Settled by central counterparties	Not settled by central counterparties	Total
	US$m	US$m	US$m	US$m
At 31 December 2012
HSBC
Foreign exchange ...............................................................	27,869	11,156	4,413,532	4,452,557
Interest rate .......................................................................	837,604	12,316,673	8,459,665	21,613,942
Equity ................................................................................	225,452	−	270,216	495,668
Credit ................................................................................	−	73,281	828,226	901,507
Commodity and other ........................................................	19,006	−	61,213	80,219

	1,109,931	12,401,110	14,032,852	27,543,893

The purpose for which HSBC uses derivatives is set out in Note 19 on the Financial Statements.

Maximum exposure to credit risk

(Audited)

	At 31 December 2012			At 31 December 2011
	Maximum exposure	Offset	Net	Maximum exposure	Offset	Net
	US$m	US$m	US$m	US$m	US$m	US$m

Cash and balances at central banks ...............	141,532	-	141,532	129,902	-	129,902
Items in the course of collection from other banks .......................................................	7,303	-	7,303	8,208	-	8,208
Hong Kong Government certificates of indebtedness .............................................	22,743	-	22,743	20,922	-	20,922

Trading assets ..............................................	367,177	(19,700)	347,477	309,449	(4,656)	304,793
Treasury and other eligible bills ................	26,282	-	26,282	34,309	-	34,309
Debt securities .........................................	144,677	-	144,677	130,487	-	130,487
Loans and advances to banks ...................	78,271	-	78,271	75,525	-	75,525
Loans and advances to customers .............	117,947	(19,700)	98,247	69,128	(4,656)	64,472

Financial assets designated at fair value ........	12,714	-	12,714	12,926	-	12,926
Treasury and other eligible bills ................	54	-	54	123	-	123
Debt securities .........................................	12,551	-	12,551	11,834	-	11,834
Loans and advances to banks ...................	55	-	55	119	-	119
Loans and advances to customers .............	54	-	54	850	-	850

Derivatives ..................................................	357,450	(310,859)	46,591	346,379	(305,616)	40,763

Loans and advances held at amortised cost ..	1,150,169	(95,578)	1,054,591	1,121,416	(87,978)	1,033,438
- to banks ................................................	152,546	(3,732)	148,814	180,987	(3,066)	177,921
- to customers .........................................	997,623	(91,846)	905,777	940,429	(84,912)	855,517

Financial investments ..................................	415,312	-	415,312	392,834	-	392,834
Treasury and other similar bills ................	87,550	-	87,550	65,223	-	65,223
Debt securities .........................................	327,762	-	327,762	327,611	-	327,611

Assets held for sale ......................................	9,292	(164)	9,128	37,808	(204)	37,604
- disposal groups ......................................	5,359	(164)	5,195	37,746	(204)	37,542
- non-current assets held for sale .............	3,933	-	3,933	62	-	62

Other assets .................................................	31,983	-	31,983	32,992	-	32,992
Endorsements and acceptances ................	12,032	-	12,032	11,010	-	11,010
Other .......................................................	19,951	-	19,951	21,982	-	21,982

Financial guarantees and similar contracts ...	44,993	-	44,993	39,324	-	39,324
Loan and other credit-related commitments³	579,469	-	579,469	654,904	-	654,904

	3,140,137	(426,301)	2,713,836	3,107,064	(398,454)	2,708,610

For footnote, see page 249.

Loan and other credit-related commitments

(Unaudited)

	Asia	Europe	Americas	Total
	US$m	US$m	US$m	US$m
At 31 December 2012
Personal..............................................................................	79,021	80,596	31,566	191,183
Corporate and commercial .................................................	139,897	91,957	110,401	342,255
Financial.............................................................................	10,330	15,080	20,621	46,031

	229,248	187,633	162,588	579,469

At 31 December 2011
Personal..............................................................................	76,901	76,658	139,458	293,017
Corporate and commercial .................................................	122,618	84,797	101,861	309,276
Financial.............................................................................	8,646	21,060	22,905	52,611

	208,165	182,515	264,224	654,904

A description of loan and other credit related commitments is set out in Note 40 on the Financial Statements. The reduction in the total amount from 2011 to 2012 is mainly due to the disposal of the US Cards business and US branch network in 2012. In the table above, Asia includes amounts in Hong Kong, Rest of Asia-Pacific and the Middle East and North Africa.

Personal lending

(Unaudited)

We provide a broad range of secured and unsecured personal lending products to meet customer needs. Given the diverse nature of the markets in which we operate, the range is not standard across all countries but is tailored to meet the demands of individual markets.

Personal lending includes advances to customers for asset purchases, such as residential property, where the loans are typically secured by the assets being acquired. We also offer loans secured on existing assets, such as first and second liens on residential property; unsecured lending products such as overdrafts, credit cards and payroll loans; and debt consolidation loans which may be secured or unsecured.

Total personal lending

(Unaudited)

	UK	Rest of Europe	Hong Kong	US⁴	Rest of North America	Other regions⁵	Total
	US$m	US$m	US$m	US$m	US$m	US$m	US$m
At 31 December 2012
First lien residential mortgages ........	127,024	8,148	52,296	49,417	20,716	44,261	301,862
Other personal lending ....................	23,446	27,656	18,045	7,382	6,839	29,863	113,231
- motor vehicle finance ..............	-	24	-	-	20	3,871	3,915
- credit cards ...............................	11,369	3,060	5,930	821	735	8,881	30,796
- second lien residential mortgages	508	-	-	5,959	363	131	6,961
- other ........................................	11,569	24,572	12,115	602	5,721	16,980	71,559


Total personal lending (A) ..............	150,470	35,804	70,341	56,799	27,555	74,124	415,093

Impairment allowances on personal lending
First lien residential mortgages ....	(425)	(64)	(4)	(4,133)	(30)	(249)	(4,905)
Other personal lending ................	(576)	(401)	(57)	(590)	(94)	(1,589)	(3,307)
- motor vehicle finance ..............	-	(4)	-	-	(1)	(144)	(149)
- credit cards ...............................	(150)	(184)	(28)	(40)	(14)	(385)	(801)
- second lien residential mortgages	(44)	-	-	(542)	(6)	-	(592)
- other ........................................	(382)	(213)	(29)	(8)	(73)	(1,060)	(1,765)


Total ..............................................	(1,001)	(465)	(61)	(4,723)	(124)	(1,838)	(8,212)

- as a percentage of A .....................	0.7%	1.3%	0.1%	8.3%	0.5%	2.5%	2.0%

At 31 December 2011
First lien residential mortgages ........	111,224	8,678	46,817	52,484	20,794	38,966	278,963
Other personal lending ....................	22,218	24,027	16,364	14,087	7,971	29,995	114,662
- motor vehicle finance ..............	-	24	-	20	29	4,494	4,567
- credit cards ...............................	11,279	2,192	5,304	833	1,262	8,618	29,488
- second lien residential mortgages	694	-	-	7,063	468	233	8,458
- other ........................................	10,245	21,811	11,060	6,171	6,212	16,650	72,149


Total personal lending (B) ..............	133,442	32,705	63,181	66,571	28,765	68,961	393,625

Impairment allowances on personal lending
First lien residential mortgages ....	(383)	(58)	(12)	(4,551)	(27)	(290)	(5,321)
Other personal lending ................	(745)	(366)	(52)	(1,659)	(109)	(1,508)	(4,439)
- motor vehicle finance ..............	-	(4)	-	-	-	(164)	(168)
- credit cards ...............................	(177)	(148)	(22)	(46)	(35)	(406)	(834)
- second lien residential mortgages	(42)	(1)	-	(740)	(9)	-	(792)
- other ........................................	(526)	(213)	(30)	(873)	(65)	(938)	(2645)


Total ..............................................	(1,128)	(424)	(64)	(6,210)	(136)	(1,798)	(9,760)

- as a percentage of B .....................	0.8%	1.3%	0.1%	9.3%	0.5%	2.6%	2.5%

For footnotes, see page 249.

In 2012, the credit quality of the majority of our personal lending portfolios improved, reflecting the continued low levels of interest rates and strong customer repayments in many markets, as well as actions taken in previous years to tighten our lending criteria and focus on higher quality and secured assets.

In the US, the origination of new personal lending was limited as we have discontinued all new consumer finance real estate lending following the closure of the consumer finance distribution network. Customer lending balances across HSBC Finance portfolios continued to decline and, in May and August 2012 respectively, we completed the sales of the Card and Retail Services business and non-strategic branches, in the US. We continue to explore options to accelerate the liquidation of the CML portfolio and, to this effect, reclassified certain non-real estate personal loan balances, net of impairment allowances, to 'Assets held for sale' as we actively marketed this portfolio.

The commentary that follows is on a constant currency basis.

At 31 December 2012, the Group's exposure to personal lending was US$415bn, 3% higher than at 31 December 2011, reflecting a rise in first lien residential mortgage lending, partly offset by a reduction in other personal lending. Loan impairment allowances on our personal lending portfolios were US$8.2bn compared with US$9.8bn at the end of 2011, while the ratio of loan impairment allowances to total personal lending reduced from 2.4% at 31 December 2011 to 2.0% at 31 December 2012. This decline reflected volume and performance-based improvements, predominantly in our US portfolios, due to the continued run-off of the CML portfolio as well as the reclassification of impairment allowances on non-real estate personal loan balances to 'Assets held for sale'. We also continued to focus on growing our lower-risk residential mortgage portfolios in the UK, Hong Kong and rest of Asia-Pacific, where our loss experience and impairment allowance requirements are typically lower.

Loan impairment charges in our personal lending portfolios were US$5.4bn in 2012, US$3.8bn or 41% lower than in 2011 and representing 66% of the overall Group's LICs. The decline was predominantly in the US reflecting the reduction in balances in the CML portfolio and the sale of the Card and Retail Services business in May 2012.

At 31 December 2012, total personal lending increased by US$13.7bn reflecting growth in first lien residential mortgages, notably in the UK, Hong Kong and Rest of Asia-Pacific. Balances in the UK increased following the success of marketing campaigns and competitive pricing. The rise in Hong Kong reflected the low interest rate environment and active property market, whereas growth in the Rest of Asia-Pacific, mainly in Singapore, mainland China, Australia and Malaysia, reflected the continued strength of property markets and expansion of our distribution network.

Total personal lending balances in the US at 31 December 2012 were US$57bn, a decrease of 15% compared with the end of 2011. The decline reflected the run-off of our CML portfolio, which also fell due to the reclassification of non-real estate personal loan balances to 'Assets held for sale'.

In Latin America, personal lending decreased by 4% compared with 31 December 2011, following a reduction in other personal lending in Brazil, where we managed down our exposure to non-strategic portfolios and focused on higher quality lending including first lien residential mortgage lending. This complemented a range of corrective actions, including improving our collections capabilities, reducing third party originations and improving credit scoring models. These actions were implemented to limit our exposure to further market weakness following a rise in delinquency in 2011 which continued in 2012. We also reclassified lending balances in Colombia, Paraguay and Peru to 'Assets held for sale'.

Mortgage lending

(Unaudited)

We offer a wide range of mortgage products designed to meet customer needs, including capital repayment, interest-only, affordability and offset mortgages.

Group credit policy prescribes the range of acceptable residential property loan-to-value ('LTV') thresholds with the maximum upper limit for new loans set between 75% and 95%. Specific LTV thresholds and debt-to-income ratios are managed at regional and country levels and, although the parameters must comply with Group policy, strategy and risk appetite, they differ in the various locations in which we operate to reflect the local economic and housing market conditions, regulations, portfolio performance, pricing and other product features.

The commentary that follows is on a constant currency basis.

At 31 December 2012, total mortgage lending, comprising first lien and second lien residential mortgages, was US$309bn, 5% higher than at the end of 2011. Our most significant concentrations of mortgage lending were in the UK, the US and Hong Kong.

Mortgage lending products

(Unaudited)

	UK	Rest of Europe	Hong Kong	US⁴	Rest of North America	Other regions⁵	Total
	US$m	US$m	US$m	US$m	US$m	US$m	US$m
At 31 December 2012
First lien residential mortgages ........	127,024	8,148	52,296	49,417	20,716	44,261	301,862
Second lien residential mortgages.....	508	-	-	5,959	363	131	6,961

Total mortgage lending (A) ............	127,532	8,148	52,296	55,376	21,079	44,392	308,823

Second lien as a percentage of A .....	0.4%	-	0.0%	10.8%	1.7%	0.3%	2.3%

Impairment allowances on mortgage lending ........................................	(469)	(64)	(4)	(4,675)	(36)	(249)	(5,497)
First lien residential mortgages ....	(425)	(64)	(4)	(4,133)	(30)	(249)	(4,905)
Second lien residential mortgages.	(44)	-	-	(542)	(6)	-	(592)

Interest-only (including offset) mortgages....................................	49,650	52	30	-	531	1,146	51,409
Affordability mortgages, including adjustable-rate mortgages ('ARM's)	6	532	19	18,456	-	5,135	24,148
Other ..............................................	99	-	-	-	-	204	303

Total interest-only, affordability mortgages and other ....................	49,755	584	49	18,456	531	6,485	75,860

- as a percentage of A .................	39.0%	7.2%	0.1%	33.3%	2.5%	14.6%	24.6%

At 31 December 2011
First lien residential mortgages ........	111,224	8,678	46,817	52,484	20,794	38,966	278,963
Second lien residential mortgages ....	694	-	-	7,063	468	233	8,458

Total mortgage lending (B) .............	111,918	8,678	46,817	59,547	21,262	39,199	287,421

Second lien as a percentage of B .....	0.6%	-	-	11.9%	2.2%	0.6%	2.9%

Impairment allowances on mortgage lending ........................................	(425)	(59)	(12)	(5,291)	(36)	(290)	(6,113)
First lien residential mortgages ....	(383)	(58)	(12)	(4,551)	(27)	(290)	(5,321)
Second lien residential mortgages	(42)	(1)	-	(740)	(9)	-	(792)

Interest-only (including offset) mortgages ...................................	46,886	48	46	-	667	1,210	48,857
Affordability mortgages, including ARMs .........................................	177	496	31	17,089	277	6,863	24,933
Other ..............................................	106	-	-	-	-	189	295

Total interest-only, affordability mortgages and other ....................	47,169	544	77	17,089	944	8,262	74,085

- as a percentage of B .................	42.1%	6.3%	0.2%	28.7%	4.4%	21.1%	25.8%

For footnotes, see page 249.

Mortgage lending in the UK was US$128bn at 31 December 2012, representing the Group's largest concentration of mortgage exposure, an increase of 9% compared with the end of 2011.

The credit quality of our UK mortgage portfolio remained high, reflecting actions taken in previous years which included restrictions on lending to purchase residential property for the purpose of

rental. Almost all lending was originated through our own sales force, and the self-certification of income was not permitted. The majority of our mortgage lending in the UK was to existing customers who held current or savings accounts with HSBC. The average LTV ratio for new business was 59% during December 2012, while loan impairment charges and delinquency levels in our UK mortgage book remained stable, aided by the continued low levels of interest rates.

Interest-only mortgage products in the UK totalled US$50bn or 39% of the UK mortgage portfolio, US$23bn or (47%) of which related to the first direct offset product where customers may adopt a capital repayment profile or make significant regular or one-off repayments, but are able to redraw additional funds within the agreed limit.

Our affordability underwriting criteria for interest-only products are consistent with those for equivalent capital repayment mortgages, and such products are typically originated at more conservative LTV ratios. We monitor specific risk characteristics within the interest-only portfolio, such as current LTV ratio, age at expiry, current income levels and credit bureau scores. There are currently no concentrations of higher risk characteristics that cause the interest-only portfolio to be considered as carrying unduly high credit risk, and delinquency and impairment charges remain low, demonstrating similar performance characteristics to our capital repayment products. We run contact programmes to ensure we build an informed relationship with customers whereby they receive the appropriate support in meeting the final repayment of principal and understand the alternative repayment options available.

In Hong Kong, mortgage lending was US$52bn, an increase of 11% compared with the end of 2011. The quality of our mortgage book was strong with loan impairment charges at very low levels. The average LTV ratio on new mortgage lending was 48% and the average LTV for the overall portfolio was 32%.

Mortgage balances in Rest of Asia-Pacific grew by 10% to US$37bn, mainly in Singapore, mainland China, Australia and Malaysia reflecting the continued strength of property markets and expansion of our distribution networks.

Mortgage lending in the US

(Unaudited)

In the US, total mortgage lending balances were US$55bn at 31 December 2012, a decline of 7% compared with the end of 2011. Overall, US mortgage lending represented 13% of our total personal lending and 18% of our total mortgage lending, compared with 15% and 20%, respectively, at 31 December 2011.

HSBC Finance

At 31 December 2012, mortgage lending balances at HSBC Finance were US$39bn, a decline of 12% compared with the end of 2011 due to the continued run-off of the CML portfolio.

Our CML portfolio continued to be affected by high unemployment levels and a housing market that is slow to recover. In addition, our loan modification programmes, which are designed to manage customer relationships, improve cash collections and avoid foreclosure, contributed to slower loan repayment rates.

HSBC Finance US CML⁶- residential mortgages

(Unaudited)

	At 31 December
	2012	2011
	US$m	US$m
Residential mortgages
First lien .................................	35,092	39,608
Second lien ..............................	3,651	4,520

Total (A) ................................	38,743	44,128

Impairment allowances ...........	4,480	5,088
- as a percentage of (A) ......	11.6%	11.5%

For footnote, see page 249.

HSBC Bank USA

In HSBC Bank USA, we continued to sell a substantial portion of new originations to the secondary market as a means of managing our interest rate risk and improving structural liquidity. Mortgage lending balances of US$17bn at 31 December 2012 remained broadly unchanged compared with the end of 2011, despite an increase in first lien residential mortgages, driven by increased origination to our Premier customers including higher balances of adjustable-rate mortgages. This was offset by a decline in other mortgages.

Credit quality of personal lending in the US

(Unaudited)

For further information on renegotiated loans in North America, see page 158.

Mortgage lending

In our CML first lien residential mortgage portfolio, two months and over delinquent balances were US$7.6bn at 31 December 2012, compared with US$7.9bn at 31 December 2011. The decline mainly reflected the continued run-off of balances and the improvement in economic conditions. The reduction was partly offset by the increase in late stage delinquency driven by the suspension of foreclosure activities which began in late 2010. In our HSBC Bank USA portfolio, two months and over delinquent balances increased by 8% to US$1.4bn due also to foreclosure delays.

In the US, second lien mortgage balances declined by 16% to US$6.0bn at 31 December 2012, representing 11% of the overall US mortgage lending portfolio. Two months and over delinquent

balances were US$477m at 31 December 2012 compared with US$674m at 31 December 2011.

The majority of second lien residential mortgages are taken up by customers who hold a first lien mortgage issued by a third party. Second lien residential mortgage loans have a risk profile characterised by higher LTV ratios, because in the majority of cases the loans were taken out to complete the refinancing of properties. Loss severity on default of second lien loans has typically approached 100% of the amount outstanding, as any equity in the property is consumed through the repayment of the first lien loan.

Impairment allowances for these loans are determined by applying a roll-rate migration analysis which captures the propensity of these loans to default based on past experience. Once we believe that a second lien residential mortgage loan is likely to progress to write-off, the loss severity assumed in establishing our impairment allowance is close to 100% in the CML portfolios, and more than 80% in HSBC Bank USA.

HSBC Finance: foreclosed properties in the US

(Unaudited)

	Year ended 31 December 2012	Half-year ended		Year ended 2011
	Year ended 31 December 2012	31 December 2012	30 June 2012	Year ended 2011

Number of foreclosed properties at end of period .........................	2,973	2,973	2,836	3,511
Number of properties added to foreclosed inventory in the period	6,827	3,212	3,615	11,187
Average loss on sale of foreclosed properties⁷ ..............................	6%	6%	7%	8%
Average total loss on foreclosed properties⁸ .................................	54%	53%	55%	56%
Average time to sell foreclosed properties (days) .........................	172	166	179	185

For footnotes, see page 249.

In late 2010, we suspended all new foreclosure proceedings and, in early 2011, ceased foreclosures where judgement had yet to be entered while we enhanced our processes. We have now resumed the processing of suspended foreclosures in substantially all states, although there remains a significant backlog which will take time to resolve. Loss severities may be increased by any additional delays in the processing of foreclosures.

The number of foreclosed properties at HSBC Finance at 31 December 2012 decreased compared with the end of December 2011 as the rate at which properties were added to real estate owned inventory was slow as a result of the backlog in foreclosure activities and the continuing sales of these properties during 2012. We expect that the number of foreclosed

properties added to the inventory will increase and this will continue to be affected by ongoing refinements to our processes and extended foreclosure timelines.

The average total loss on foreclosed properties and the average loss on sale of foreclosed properties decreased compared with 2011. This reflected a greater proportion of properties sold where we had accepted a deed-in-lieu. Typically, losses on a deed-in-lieu are lower than losses from properties acquired through a standard foreclosure process. The decrease in the loss on sale also reflected a slowdown in the rate of decline in house prices during 2012 and, in some markets, improvements in pricing compared with 2011.

Valuation of foreclosed properties in the US

We obtain real estate by foreclosing on the collateral pledged as security for residential mortgages. Prior to foreclosure, carrying amounts of the loans in excess of fair value less costs to sell are written down to the discounted cash flows expected to be recovered, including from the sale of the property. Broker price opinions are obtained and updated every 180 days and real estate price trends are reviewed quarterly to reflect any improvement or additional deterioration. Our methodology is regularly validated by comparing the discounted cash flows expected to be recovered based on current market conditions (including estimated cash flows from the sale of the property) to the updated broker price opinion, adjusted for the estimated historical difference between interior and exterior appraisals. The fair values of foreclosed properties are initially determined based on broker price opinions. Within 90 days of foreclosure, a more detailed property valuation is performed reflecting information obtained from a physical interior inspection of the property and additional allowances or write-downs are recorded as appropriate. Updates to the valuation are performed no less than once every 45 days until the property is sold, with declines or increases recognised through changes to allowances.

Credit cards

In the first half of 2012 we completed the sale of our US Card and Retail Services business, transferring general and private label credit card lending balances to the purchaser. The residual balances in the US at 31 December 2012 were related to HSBC Bank USA's credit card programme.

Personal non-credit card lending

Personal non-credit card lending balances and two months and over delinquent balances in the US fell, largely due to the reclassification of non-real estate personal loan balances to 'Assets held for sale' and portfolio run-off, as this business is closed to new advances.

Trends in two months and over contractual delinquency in the US

(Unaudited)

	At 31 December
	2012	2011	2010
	US$m	US$m	US$m
In personal lending in the US
First lien residential mortgages .....................................................................	8,926	9,065	8,632
Consumer and Mortgage Lending ..............................................................	7,629	7,922	7,618
Other mortgage lending ............................................................................	1,297	1,143	1,014

Second lien residential mortgages ..................................................................	477	674	847
Consumer and Mortgage Lending ..............................................................	350	501	668
Other mortgage lending ............................................................................	127	173	179

Credit card ....................................................................................................	27	714	957
Private label .................................................................................................	-	316	404
Personal non-credit card ...............................................................................	335	513	811

Total ............................................................................................................	9,765	11,282	11,651

	%	%	%

As a percentage of the relevant loans and receivables balances
First lien residential mortgages .....................................................................	18.1	17.1	15.0
Second lien residential mortgages ..................................................................	8.0	8.5	9.1
Credit card ....................................................................................................	3.3	3.8	4.7
Private label .................................................................................................	-	2.5	3.0
Personal non-credit card ...............................................................................	7.4	8.3	9.5

Total ............................................................................................................	16.1	11.4	10.7

Wholesale lending

(Unaudited)

Wholesale lending covers the range of credit facilities granted to sovereign borrowers, banks, non‑bank financial institutions, corporate entities

and commercial borrowers. Our wholesale portfolios are well diversified across geographical and industry sectors, with certain exposures subject to specific portfolio controls.

Total wholesale lending

(Unaudited)

	Europe	Hong Kong	Rest of Asia- Pacific	MENA	North America	Latin America	Total
	US$m	US$m	US$m	US$m	US$m	US$m	US$m
At 31 December 2012
Corporate and commercial ..............	223,061	99,199	85,305	22,452	47,886	35,590	513,493
- Manufacturing ..........................	56,690	10,354	19,213	3,373	9,731	12,788	112,149
- International trade and services	70,954	33,832	32,317	9,115	13,419	9,752	169,389
- Commercial real estate .............	33,279	23,384	9,286	865	6,572	3,374	76,760
- Other property-related .............	7,402	16,399	6,641	2,103	7,607	380	40,532
- Government .............................	2,393	2,838	1,136	1,662	774	1,982	10,785
- Other commercial⁹ ...................	52,343	12,392	16,712	5,334	9,783	7,314	103,878

Financial (non-bank financial institutions).................................	55,732	4,546	4,255	1,196	13,935	1,594	81,258
Asset-backed securities reclassified...	3,694	-	-	-	197	-	3,891
Loans and advances to banks ..........	45,320	23,500	44,592	9,198	13,465	16,528	152,603

Total wholesale lending (A) ............	327,807	127,245	134,152	32,846	75,483	53,712	751,245

Impairment allowances on wholesale lending
Corporate and commercial ..............	3,537	383	526	1,312	732	856	7,346
- Manufacturing ..........................	611	86	129	210	84	287	1,407
- International trade and services	992	233	185	360	189	329	2,288
- Commercial real estate .............	1,011	5	62	156	214	103	1,551
- Other property-related .............	164	20	81	241	102	13	621
- Government .............................	15	-	-	42	2	-	59
- Other commercial ....................	744	39	69	303	141	124	1,420

Financial (non-bank financial institutions) ................................	318	29	11	157	37	2	554
Loans and advances to banks ..........	40	-	-	17	-	-	57

Total ..............................................	3,895	412	537	1,486	769	858	7,957

- as a percentage of A ................	1.19%	0.32%	0.40%	4.52%	1.02%	1.60%	1.06%

At 31 December 2011
Corporate and commercial ..............	204,984	91,592	77,887	21,152	41,271	35,930	472,816
- Manufacturing ..........................	45,632	9,004	16,909	3,517	7,888	13,104	96,054
- International trade and services	64,604	29,066	29,605	8,664	10,710	10,060	152,709
- Commercial real estate .............	32,099	20,828	9,537	1,002	7,069	3,406	73,941
- Other property-related .............	7,595	17,367	6,396	1,770	5,729	682	39,539
- Government .............................	3,143	2,918	962	1,563	656	1,837	11,079
- Other commercial⁹ ...................	51,911	12,409	14,478	4,636	9,219	6,841	99,494

Financial (non-bank financial institutions) ................................	63,671	3,473	3,183	1,168	12,817	1,907	86,219
Asset-backed securities reclassified...	4,776	-	-	-	504	-	5,280
Loans and advances to banks ..........	54,406	35,159	47,309	8,571	14,831	20,836	181,112

Total wholesale lending (B) .............	327,837	130,224	128,379	30,891	69,423	58,673	745,427

Impairment allowances on wholesale lending
Corporate and commercial ..............	3,256	492	576	1,242	756	729	7,051
- Manufacturing ..........................	571	107	287	202	95	243	1,505
- International trade and services	962	316	154	428	166	298	2,324
- Commercial real estate .............	892	4	39	159	179	83	1,356
- Other property-related .............	155	15	22	154	154	16	516
- Government .............................	4	-	-	28	1	-	33
- Other commercial ....................	672	50	74	271	161	89	1,317

Financial (non-bank financial institutions) ................................	435	26	11	149	76	3	700
Loans and advances to banks ..........	49	-	-	17	59	-	125

Total ..............................................	3,740	518	587	1,408	891	732	7,876

- as a percentage of B ................	1.14%	0.40%	0.46%	4.56%	1.28%	1.25%	1.06%

For footnote, see page 249.

Corporate and commercial

Corporate and commercial lending, excluding commercial real estate and other property-related lending, increased from US$365bn at 31 December 2011 to US$400bn at 31 December 2012.

At 31 December 2012, this represented 39% of total gross loans and advances to customers, compared with 38% at 31 December 2011. The growth was mainly in the international trade and services sector, where balances mainly increased in Europe despite muted demand for credit and, in Hong Kong, driven by growth in trade finance volumes as we capitalised on trade and capital flows. In the manufacturing sector, balances increased in Europe due to growth in the UK of overdraft balances and corresponding customer accounts which did not meet netting criteria under accounting rules.

The aggregate of our commercial real estate and other property-related lending was US$117bn at 31 December 2012, 3% higher than at 31 December 2011, representing 12% of total loans and advances to customers. This growth was mainly in Hong Kong, where demand for funds remained strong despite a degree of market stabilisation after a sustained period of buoyancy in the property investment and property development sectors. Commercial real estate and other property-related lending also grew in North America due to an increase in originations in commercial mortgages, which reflected our continued focus on expanding our core offering to gain a larger presence in key growth markets, including the West Coast, Southeast and Midwest of the US.

For information on refinancing in commercial real estate lending, see page 128.

Financial (non-bank)

Financial (non-bank) lending decreased from US$86bn at 31 December 2011 to US$81bn at 31 December 2012. This was mainly in Europe due to a decline in reverse repo activity, partly offset by higher balances in North America, due to an increase in reverse repo balances in Canada, and in Hong Kong and Rest of Asia-Pacific, driven by an increase in loans drawn by financial planning companies, leasing companies and insurance companies reflecting higher demand for funds from a small number of corporates.

Loans and advances to banks

Loans and advances to banks decreased from US$181bn at 31 December 2011 to US$153bn at 31 December 2012. This was mainly driven by maturities and repayments in Hong Kong together with a decline in reverse repos in Europe reflecting, in part, the redeployment of liquidity to central banks.

Credit quality of financial instruments

(Audited)

A summary of our current policies and practices regarding the credit quality of financial instruments is provided in the Appendix to Risk on page 253.

The five classifications describing the credit quality of our lending, debt securities portfolios and derivatives are defined on page 253. Additional credit quality information in respect of our consolidated holdings of ABSs is provided on page 259.

For the purpose of the following disclosure, retail loans which are past due up to 89 days and are not otherwise classified as impaired in accordance with our disclosure convention (see page 253), are not disclosed within the expected loss ('EL') grade to which they relate, but are separately classified as past due but not impaired.

2012 compared with 2011

(Unaudited)

We assess credit quality on all financial instruments which are subject to credit risk, as shown in the table on page 155. The balance of these financial instruments was US$2,516bn at 31 December 2012, an increase of 4% over 2011, of which US$1,690bn or 67% was classified as 'strong'. This percentage declined marginally compared with 68% at 31 December 2011. The proportion of financial instruments classified as 'good' remained broadly stable at 16% and the proportion of 'satisfactory' balances increased marginally from 12% to 14%. The proportion of 'sub-standard' financial instruments remained low at 2% in both 2012 and 2011.

The proportion of trading assets classified as 'strong' declined from 75% to 65%. Overall trading assets rose, largely in Europe, due to an increase in holdings of debt securities from 2011's subdued levels which, coupled with the downgrading of certain eurozone countries, resulted in an absolute and relative increase in debt securities classified as 'good'. In addition, holdings of 'strong' treasury and other eligible bills fell both absolutely and relative to the rest of trading assets primarily in Hong Kong due to maturities without replacement of government bonds, while increased levels of reverse repo and stock lending balances with customers increased the proportion of 'good' and 'satisfactory' classifications compared with 'strong'.

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