Annual Financial Report - 21 of 44

RNS Number : 1464A

HSBC Holdings PLC

27 March 2012

Risk

Risk profile¹ ..........................................................	98
Managing risk¹ ......................................................	98
Top and emerging risks¹ ........................................	99
Credit risk³ ............................................................	104
Liquidity and funding² ............................................	157
Market risk³ ..........................................................	163
Operational risk¹ ...................................................	170
Risk management of insurance operations² ............	171
Other material risks¹ .............................................	183
Appendix to Risk ..................................................	188

1 Unaudited. 2 Audited. 3 Audited where indicated.

Risk profile

(Unaudited)

Managing our risk profile

· A strong balance sheet is core to our philosophy.

· We ensured that our portfolios remain aligned to our risk appetite and strategy.

· We actively managed our risks, supported by strong forward looking risk identification.

Maintaining capital strength and strong liquidity position

· Our core tier 1 capital ratio remains strong at 10.1%.

· We have sustained our strong liquidity position throughout 2011.

· The 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.

· A new global operating model has been implemented across the global Risk function.

Our top and emerging risks

· Macro-economic and geopolitical risk.

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

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

For details of HSBC's policies and practices regarding risk management and governance
see the Appendix to Risk on page 188.

Managing risk

(Unaudited)

The continued growth in our business in 2011 was achieved while ensuring risks were assumed in a measured manner and in line with our appetite for such risks. This approach is encapsulated within our risk appetite framework.

Report of the Group Risk Committee

Further commentary on risk appetite, risk governance and stress testing can be found within the Report of the Group Risk Committee, on page 233 of the Corporate Governance section.

The diversification of our lending portfolio across the regions, together with our broad range of global businesses and products, ensured that we were not overly dependent on a few countries or markets to generate income and growth in 2011. Our geographical diversification also supported our strategies for growth in faster-growing markets and those with international connectivity.

During 2011 financial markets were dominated by concerns over sovereign debt default risk within the peripheral eurozone countries and the potential for contagion across core European countries. Middle East turmoil and the perception that the world economic recovery remained fragile continued to cause concerns. Within the challenging economic and financial environment, we maintained our conservative risk profile by reducing exposure to the most likely areas of stress. Our top and emerging risk framework supports our approach to forward‑looking risk identification and assists in providing focus on appropriate stress tests required to evaluate the potential impact of emerging scenarios. Where applicable and necessary, we have adjusted our risk appetite.

We continued to selectively manage our exposure to sovereign debt, with the overall quality of the portfolio remaining strong. We regularly updated our assessment of higher risk countries and adjusted our risk appetite and exposures to reflect the updates.

During 2011, credit quality improved in general terms and loan impairment charges and other credit risk provisions declined, most notably in the US reflecting lower lending balances in our consumer finance portfolios, partly offset by increases in new collectively assessed loan impairment allowances in both Latin America and Hong Kong on the back of strong lending growth. On a constant currency basis, our loan impairment charges and other credit risk provisions in 2011 were US$12.1bn, 15% lower than in 2010.

Capital and liquidity

Preserving our strong capital position has long been, and will remain, a key priority for HSBC. We are well equipped to respond to the capital requirements imposed by Basel III, which are discussed further on page 212, and to sustain future growth. We utilise an enterprise-wide approach to testing the sensitivities of our capital plans against a number of scenarios; our approach to scenario stress testing analysis is discussed on page 188.

We continue to maintain a very strong liquidity position and are well positioned for the emerging new regulatory landscape.

Top and emerging risks

(Unaudited)

Details of the top and emerging risks identified through our risk management processes are set out below:

Macro-economic and geopolitical risk

· Eurozone - risk of sovereign default

· Eurozone member departing from the currency union

· Increased geopolitical risk in certain regions

Eurozone - risk of sovereign and counterparty defaults

Exposures to the eurozone have received increasing focus given the continued instability in the area and the potential for contagion from the peripheral to core eurozone countries.

There is an increasing risk of sovereign defaults by the peripheral eurozone countries which would place further pressure on banks within the core European countries that are exposed to these sovereigns. 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 crisis. Our eurozone exposures are described in more detail on pages 113 to 118.

Potential impact on HSBC

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

·
Trade and capital flows may contract as a result of banks deleveraging, protectionist measures being introduced 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 eurozone crisis will constrain, through spread compression and low returns on assets, the interest income we earn from investing our excess deposits.

· 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.

· We have actively managed the risk of sovereign defaults during 2011 by reducing exposures and other measures.

Eurozone member departing from the currency union

The risk of a eurozone member departing from the currency union is a plausible scenario. Should it materialise it would have a significant impact on the entire financial sector and the wider economy. It would crystallise sovereign risks and those to the bank and corporate sectors, and the disruption caused would affect consumer activity.

Potential impact on HSBC

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

· In addition, should such an event happen in a disorderly manner, it could trigger banking defaults in companies with which we do business and have a knock-on effect on the global banking system.

· In seeking to manage and mitigate this risk, we have prepared and tested detailed operational contingency plans to deal with such a scenario. We are keeping these plans under close review as events develop.

Increased geopolitical risk in certain regions

We are subject to geopolitical risks in the countries in which we operate. During 2011, these were particularly heightened in the Middle East and in certain parts of Asia.

In the Middle East, the 'Arab Spring' has spread across the region, leading to political instability in a number of countries. In Asia, tensions persist in certain areas following leadership and regime changes which pose a threat of instability and potential conflict.

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 amongst our staff and physical damage to our assets.

· We have increased our monitoring of the geopolitical and macro-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 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

There are several key regulatory changes which are likely to have an effect on our activities. These are set out below:

Basel III/CRD IV

- Derivatives and central counterparty clearing: measures have been introduced to give effect to the G20 commitments designed to reduce systemic risk and volatility relating to derivatives trading. The G20 agreed that all standardised over-the-counter ('OTC') derivatives were to be exchange traded where appropriate, reported to trade repositories and centrally cleared by the end of 2012. Higher capital requirements under Basel III will be imposed for bilateral (uncleared) transactions to incentivise the use of clearing.

- Quality of capital: The Capital Requirement Directive ('CRD IV') requires a further strengthening and harmonisation of the criteria for eligibility of capital instruments with an emphasis on common equity as the principal component of tier 1 capital.

- Capital buffers: CRD IV proposals comprise a capital conservation buffer of 2.5% of RWAs to be built up during periods of economic growth, aimed at ensuring the capacity to absorb losses in stressed periods that may span a number of years, and a countercyclical capital buffer of up to an additional 2.5% to be built up in periods in which credit growth exceeds GDP growth.

- Counterparty credit risk: requirements for managing and capitalising counterparty credit risk are to be strengthened. In particular, an additional capital charge for potential losses associated with the deterioration in the creditworthiness of individual counterparties, the capital valuation adjustment, will be introduced.

- Liquidity and funding: a new minimum standard, the liquidity coverage ratio, designed to improve the short-term resilience of a bank's liquidity risk profile, will be introduced after an observation and review period in 2015. To promote resilience by creating incentives for banks to fund their activities with more stable sources of funding, the European Commission will consider proposing a net stable funding

ratio after an observation and review period in 2018.

In addition, the Basel Committee on Banking Supervision will monitor a leverage ratio based on a minimum 3% tier 1 capital ratio over the period beginning in 2013.

UK Independent Commission on Banking: the forthcoming legislation in relation to the report of the Independent Commission on Banking ('ICB') is likely to require us to make major changes to our corporate structure and the business activities we conduct in the UK through our major banking subsidiary, HSBC Bank, arising from:

- the likelihood that the retail banking activities currentlycarried out within that entity may have to be spun-off into a ring-fenced retail bank. These changes would take an extended period to implement with a significant effect on costs to both implement the changes and run the ongoing operations as restructured;

- the call for banks to hold a specified level of primary loss-absorbing capital ('PLAC') up to 20% of their respective risk-weighted loans and investment assets. Many of the areas which could affect our business are precisely those areas where changes to the proposals appear likely or where consultation is being undertaken by the UK government. The government has indicated that it may modify the recommendations in the report and is proposing to undertake extensive consultation in two stages during 2012;

- introduction of a non-risk based leverage ratio, not as a binding prudential requirement but as an instrument for supervisory review (pillar 2).

Bank levy:legislation in respect of the UK bank levy was enacted on 19 July 2011. A charge of US$570m for the UK bank levy has been recognised in operating expenses in 2011. The UK levy is based on the consolidated balance sheet at the year-end. Bank levies have also been introduced, most notably in France, Germany and South Korea. The overall cost in 2011 was US$587m.

The 'Volcker Rule': while we do not have segregated proprietary trading desks, the so called Volcker Rule proposed under the Dodd-Frank Wall Street Reform & Consumer Protection Act (the 'Dodd-Frank Act') could affect HSBC in North America and across the Group. On 11 October 2011, a proposed rule was published which generated extensive public comment. A number of foreign governments and other bodies have made public submissions to the US authorities on, inter alia, the overall scope and extra-territorial effects of the proposed rule. However, rulemaking to implement the provisions of the Volcker Rule has not been completed.

G-SIBs: the capital impact of being designated a Global systemically important bank ('G‑SIB') is discussed on page 213.

Potential impact on HSBC

· The proposals relating to capital and liquidity will affect the capital adequacy and liquidity frameworks under which financial institutions operate and result in increased capital and liquidity requirements, although the nature, timing and effect of many of the changes remain unclear. Increases in capital and liquidity requirements could have a material effect on our future financial condition or the results of our operations. There is also the risk of second and third order impacts of regulation which could constrain the flow of credit within the economy.

· The proposed leverage ratio could cause HSBC, as an institution with a relatively low‑risk portfolio overall, to constrain business activity in areas which are well collateralised or possess sufficient risk mitigants.

· For a further description of the possible effects of the new Basel III/CRD IV rules on HSBC see page 213. If either the quality or amount of the Group's capital were to fall outside the proposed regulations, we could be required to raise more capital or reduce our level of RWAs to meet the requirements. Such actions and any resulting transactions may not be within our operating plans and may not be conducted on the most favourable terms. This could lead to lower returns on equity and cause some business activities and products to be less profitable and, in some instances, to fail to cover their cost of equity.

· The proposed changes relating to remuneration, bank levies and other taxes could increase the Group's cost of doing business in the regulatory regimes in which these changes are implemented, reducing future profitability. Proposed changes in regulations such as the rules relating to derivatives and central counterparties regulation, the UK ICB ring-fencing proposals, recovery and resolution plans and the Volcker Rule may affect the manner in which we conduct our activities and structure ourselves, with the potential to both 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 stage of development and implementation of these various regulations, 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 thought through and understood so that they 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 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.

Potential impact on HSBC

· We are subject to a number of regulatory actions and investigations. See Note 44 on the Financial Statements. It is inherently difficult to predict the outcome of the regulatory proceedings involving our businesses. An unfavourable outcome could have a material adverse effect on our results and brand.

· In response to this risk, we are progressing a number of initiatives which seek to address the issues identified and enhance our governance and oversight.

Dispute risk

The current economic environment has increased our exposure to actual and potential litigation against the Group. Further details are discussed in Note 44 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

· Challenges to achieving our strategy in a downturn

· Internet crime and fraud

· Social media risk

· Level of change creating operational complexity and heightened operational risk

· Information security risk

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 macroeconomic slowdown, could affect the achievement of our strategic targets for the Group as a whole and our global businesses.

Potential impact on HSBC

· The downturn 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

We are exposed to potentially fraudulent and criminal activities, in particular from a growing threat from internet crime which could result in the loss of customer data and sensitive information. The threat of external fraud may increase during adverse economic conditions, especially in retail and commercial banking.

We also face breakdowns in processes or procedures and systems failure or unavailability and are subject to the risk of disruption to our business arising 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. These risks equally apply when we rely on external suppliers or vendors to provide services to us and our customers.

· We have increased our monitoring and have implemented additional controls such as two-factor authentication to mitigate the possibility of losses from these risks.

Social media risk

The scale and profile of social media networks ('SMN's) have grown both in terms of customer demographic and geographical reach to represent a significant potential reputational risk to our organisation, given that these networks can be used as powerful broadcasting tools with the capability to reach large numbers of people in a very short time frame.

Potential impact on HSBC

· SMNs can be used to exacerbate the effect of customer complaints and service failures, and provide a means for employees to publicise confidential information. SMNs present significant risks to our reputation and brand.

· In order to reduce our exposure to these risks, an HSBC presence has been created in several of the larger SMNs in order to provide an official point of contact for our customers and stakeholders. Monitoring has also been implemented in some entities to protect our brand and identity and to understand general sentiment towards us and, in some cases, our specific products and initiatives.

Level of change creating operational complexity and heightened operational risk

There are many drivers of change across HSBC and the banking industry including change driven by new banking regulation, the increased globalisation of the economy and business needs, new products and delivery channels, and organisational change.

Operational complexity has the potential to heighten all types of operational risk across our activities. This includes the risk of process errors, systems failures and fraud. It can also increase operational costs.

The implementation of our strategy, based on the application of our five filters methodology (see page 11), may involve the withdrawal from certain markets, which presents disposal risks which must be carefully managed.

Potential impact on HSBC

· Critical systems failure and a prolonged loss of service availability could cause serious damage to our ability to serve our clients, breach regulations under which we operate and cause long-term damage to our business, reputation and brand. We seek to ensure that our critical systems infrastructure is constantly monitored and properly resourced to mitigate against systems failures.

· 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. Management actions to manage these risks proactively include a close dialogue with regulators and customers and the involvement of HR, legal, compliance and other functional experts.

Information security risk

The reliability and security of our information and technology infrastructure and customer databases and their ability to combat internet fraud are crucial to maintaining our banking applications and processes and to protecting 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 result in regulatory breaches which would 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, enhanced controls around data access and heightened monitoring of information flows.

Credit risk

Credit risk in 2011 ................................................	104
Credit exposure .....................................................	105
Areas of special interest ........................................	112
Wholesale lending ..............................................	112
Personal lending ...............................................	119
US personal lending ..........................................	124
Credit quality of financial instruments ...................	126
Past due but not impaired gross financial instruments ....................................................	128
Renegotiated loans and forbearance .................	129
Impaired loans disclosure ..................................	133
Impairment of loans and advances .........................	134
Collateral ..............................................................	144
Securitisation exposures and other structured products .............................................................	149

Credit risk is the risk of financial loss if a customer or counterparty fails to meet a payment obligation under a contract. It arises principally from direct lending, trade finance and leasing business, but also from off-balance sheet products such as guarantees and derivatives, and from the Group's holdings of debt and other securities. Credit risk generates the largest regulatory capital requirement of the risks we incur.

· Total gross loans and advances decreased by 2% to US$1,139bn reflecting the reclassification of assets to held for sale.

· Balance sheet exposure to the sovereign and agency debt of Greece, Ireland, Italy, Portugal and Spain was US$4.7bn at 31 December 2011.

We have amended our presentation of impaired loans as described on page 133. Other than that, there were no material changes to our policies and practices for the management of credit risk in 2011.

A summary of our current policies and practices regarding credit risk is provided in the Appendix to Risk on page 188.

Credit risk in 2011

(Unaudited)

Exposure, impairment allowances and charges

(Audited)

	2011	2010
	US$bn	US$bn
At 31 December
Total gross loans and advances (A) .........................................	1,139.1	1,186.9
Impairment allowances ..............	17.6	20.2
- as a percentage of A ............	1.55%	1.70%

Year ended 31 December
Impairment charges¹ ..................	11.5	13.5

For footnote, see page 185.

Loan impairment charges and other credit risk provisions

(Audited)

	2011	2010
	US$m	US$m

At 31 December ........................	12,127	14,039

	%	%
Personal ....................................	77	80
Corporate and commercial .........	17	16
Financial ....................................	1	1
Impairment of available-for-sale debt securities .........................	5	3
of which: Greek Government..	2	-


	100	100

In 2011, loans and advances to customers continued to represent the Group's most significant exposure to credit risk. At 31 December 2011, total gross loans and advances were US$1,139bn, a decrease of 2% on a constant currency basis compared with 31 December 2010. The decline reflected the reclassification to assets held for sale of balances relating to the pending sale of our US Card and Retail Services business and 195 branches in upstate New York. For further detail on assets held for sale see page 105.

During 2011, we reduced our exposure to sovereigns and banks in the peripheral European countries. We also reduced our exposure to risk from sovereign and financial institution counterparty positions across the broader eurozone and from specific financial institutions in other countries. At 31 December 2011, our on-balance sheet exposure to the sovereign and agency debt of Greece, Ireland, Italy, Portugal and Spain was US$4.7bn. In 2011, we recognised an impairment charge of US$212m in respect of Greek sovereign and agency exposures classified as available for sale. Our sovereign exposures to Ireland, Italy, Portugal, and Spain are not considered to be impaired at 31 December 2011.

On a constant currency basis, our personal lending book was US$394bn, 6% lower than at 31 December 2010 following the reclassification referred to above. Excluding the reclassification, total personal lending grew, primarily in the UK due to growth in mortgage balances, driven by successful marketing campaigns, and also in Hong Kong, as we continued to provide competitive mortgage products for our customers, partly offset by the continued run-off of the CML portfolio in the US.

At US$279bn, residential mortgage lending continued to comprise the Group's largest concentration in a single exposure type at 31 December 2011. The Group's most significant exposure to mortgage lending was in the UK, the US and Hong Kong. Our UK mortgage portfolio remained of high quality with an average loan to value ('LTV') ratio for new business of 53%, while in Hong Kong the average LTV ratio on new mortgage originations was 49%. The average LTV ratio of our mortgage books in the UK and Hong Kong remained low at 52% and 37%, respectively.

The Group's exposure to personal lending in the US remained significant. At 31 December 2011, total personal lending balances were US$67bn, a decline of 39% compared with 31 December 2010, largely due to the reclassification of certain lending balances to held for sale. In 2011, we continued to make progress in running off the CML portfolio as balances declined by 15% to US$49.5bn. The rate at which balances declined during 2011 was slowed by the industry-wide examination of foreclosure practices.

In dollar terms, lending balances that were two months or more delinquent in the CML portfolio decreased modestly in 2011 reflecting the continued run-off, partly offset by the temporary suspension of foreclosure activities. In our held-for-sale Card and Retail Services portfolio, two months or more delinquency rates improved as the credit quality of the overall portfolio improved.

In 2011, we conducted a review of loan portfolios with significant levels of forbearance. The review resulted in no significant change in our loan impairment allowances, though we amended our presentation of impaired loans to provide more relevant information on the effects of forbearance on the credit risk of loans and advances (see page 133). Our balance of impaired loans increased significantly under the revised presentation, reducing the ratio of total impairment allowances to impaired loans. On a restated basis, this ratio was 42.3% (2010: 43% instead of 71.6% under the previous presentation).

Reclassification to assets held for sale

During 2011, the decline in gross loans and advances was partly due to a reclassification of certain lending balances to assets held for sale. Disclosures relating to assets held for sale are provided in certain credit risk management tables, primarily where the disclosure is relevant to the measurement of these financial assets, as follows:

· Maximum exposure to credit risk (page 107);

· Distribution of financial instruments by credit quality (page 127); and

· Ageing analysis of days past due but not impaired gross financial instruments (page 129).

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.

The table below presents 'Loans and advances to customers' and 'Loans and advances to banks' as reported, and those classified as held for sale:

Reported and held-for-sale loans

	At 31 December 2011
	Total gross loans and advances	Impairment allowances on loans and advances
	US$m	US$m

As reported .........................	1,139,052	17,636
Assets held for sale ..............	37,273	1,614

Total reported and held for sale ............................	1,176,325	19,250

2010 comparative data have not been separately presented for the credit risk management disclosures as the amounts are insignificant.

Credit exposure

Maximum exposure to credit risk

(Audited)

Our credit exposure is spread across a broad range of asset classes, including derivatives, trading assets, loans and advances to customers, loans and advances to banks and financial investments.

In 2011, our exposure to credit risk remained well diversified across asset classes. During the year, we reduced our exposure to the peripheral eurozone countries and to countries across the broader European economic area, in particular by transferring our excess liquidity away from sovereign and bank-issued debt securities and from money market placements with banks to placements with central banks in the most highly-rated countries. Despite this, we increased our overall exposure to credit risk in 2011.

'Maximum exposure to credit risk' table (page 107)

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 to customers represent our largest exposure to credit risk; however, this balance reduced at the end of 2011, compared with the end of 2010 as certain lending balances were reclassified as 'Assets held for sale'. We were able to successfully grow our residential mortgage portfolios in many other markets, notably in Hong Kong and the UK where credit quality remained high and LTV ratios were low.

Our exposure to loans and advances to banks decreased in 2011, mainly in Europe as funds from maturing term loans and reverse repo balances were redeployed to 'Cash and balances at central banks'. This was offset in part by higher central bank lending in Rest of Asia-Pacific, reflecting strong deposit growth in the region. Our net exposure to loans and advances to banks also decreased.

The loans and advances offset adjustment primarily relates to customer loans and deposits and balances arising from repo and reverse repo transactions. The offset relates to balances 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.

We increased our exposure to cash and balances at central banks in 2011, as discussed above, reflecting the placement of excess liquidity with central banks in Europe and North America.

Our exposure to derivatives increased in 2011, mainly in Europe reflecting an increase in the fair value of interest rate contracts. This was compounded by an increase in the notional value of outstanding contracts, partly offset by higher netting which rose in line with the increase in fair values. Despite the increase in maximum exposure, our net exposure to derivatives in 2011 decreased due to a rise in the derivative offset.

The derivative offset amount in the table on page 107 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 2011, the total amount of such offsets was US$306bn (2010: US$198bn), of which US$272bn (2010: US$178bn) were offsets under a master netting arrangement, US$33.0bn (2010: US$19.1bn) were collateral received in cash and US$0.7bn (2010: US$0.2bn) were other collateral. These amounts do not qualify for net presentation for accounting purposes as settlement may not actually be made on a net basis.

During 2011, we decreased our exposure to trading assets. This reflected a reduction in our holdings of government and highly-rated corporate debt securities and equity positions, notably in Europe. In addition, our reverse repo exposure declined in North America as we did not replace maturities.

In 2011, our loss experience continued to be dominated by the personal lending portfolios, with some 77% of our loan impairment charges related to this lending category of which 56% was related to US personal lending. This compared with 80% in 2010, of which 57% was related to US personal lending.

While not considered as offset in the table below, 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 144).

Maximum exposure to credit risk

(Audited)

	At 31 December 2011			At 31 December 2010
	Maximum exposure	Offset	Exposure to credit risk (net)	Maximum exposure	Offset	Exposure to credit risk (net)
	US$m	US$m	US$m	US$m	US$m	US$m

Cash and balances at central banks ...............	129,902	-	129,902	57,383	-	57,383
Items in the course of collection from other banks .......................................................	8,208	-	8,208	6,072	-	6,072
Hong Kong Government certificates of indebtedness .............................................	20,922	-	20,922	19,057	-	19,057

Trading assets ..............................................	309,449	(4,656)	304,793	343,966	(4,189)	339,777
Treasury and other eligible bills ................	34,309	-	34,309	25,620	-	25,620
Debt securities .........................................	130,487	-	130,487	168,268	-	168,268
Loans and advances to banks ...................	75,525	-	75,525	70,456	-	70,456
Loans and advances to customers .............	69,128	(4,656)	64,472	79,622	(4,189)	75,433

Financial assets designated at fair value ........	12,926	-	12,926	19,593	-	19,593
Treasury and other eligible bills ................	123	-	123	159	-	159
Debt securities .........................................	11,834	-	11,834	18,248	-	18,248
Loans and advances to banks ...................	119	-	119	315	-	315
Loans and advances to customers .............	850	-	850	871	-	871

Derivatives ..................................................	346,379	(305,616)	40,763	260,757	(197,501)	63,256

Loans and advances held at amortised cost ..	1,121,416	(87,978)	1,033,438	1,166,637	(91,966)	1,074,671
- to banks ................................................	180,987	(3,066)	177,921	208,271	(3,099)	205,172
- to customers .........................................	940,429	(84,912)	855,517	958,366	(88,867)	869,499

Financial investments ..................................	392,834	-	392,834	392,772	-	392,772
Treasury and other similar bills ................	65,223	-	65,223	57,129	-	57,129
Debt securities .........................................	327,611	-	327,611	335,643	-	335,643

Assets held for sale² .....................................	37,808	(204)	37,604	-	-	-
- disposal groups ......................................	37,746	(204)	37,542	-	-	-
- non-current assets held for sale .............	62	-	62	-	-	-

Other assets .................................................	32,992	-	32,992	30,371	(29)	30,342
Endorsements and acceptances ................	11,010	-	11,010	10,116	(29)	10,087
Other .......................................................	21,982	-	21,982	20,255	-	20,255

Financial guarantees and similar contracts ...	39,324	-	39,324	49,436	-	49,436
Loan and other credit-related commitments³	654,904	-	654,904	602,513	-	602,513

	3,107,064	(398,454)	2,708,610	2,948,557	(293,685)	2,654,872

For footnotes, see page 185.

Concentration of exposure

Concentrations of credit risk are described in the Appendix to Risk on page 188.

Securities held for trading

(Unaudited)

Total securities held for trading within trading assets were US$186bn at 31 December 2011 (2010: US$235bn). The largest concentration of these assets was to government and government agency debt securities. A detailed analysis of securities held for trading is provided in Note 15 on the Financial Statements and an analysis of credit quality on page 127.

Debt securities, treasury and other eligible bills

(Unaudited)

Our holdings of corporate debt, ABSs and other securities were spread across a wide range of issuers and geographical regions, with 17% invested in securities issued by banks and other financial institutions. A detailed analysis of financial investments is provided in Note 21 on the Financial Statements and an analysis by credit quality on page 127.

At 31 December 2011, our insurance businesses held diversified portfolios of debt and equity securities designated at fair value of US$28.9bn (2010: US$28.3bn) and debt securities classified as financial investments of US$40.1bn (2010: US$38.5bn). For an analysis of securities held by the insurance businesses, see page 178.

Derivatives

(Unaudited)

Derivative assets were US$346bn at 31 December 2011 (2010: US$261bn), of which the largest concentrations were interest rate and foreign exchange derivatives. For an analysis of derivatives, see Note 20 on the Financial Statements.

Loans and advances

(Unaudited)

On a reported basis, gross loans and advances to customers (excluding the financial sector) at 31 December 2011 were US$872bn, a decrease of US$5.0bn or 1% from 31 December 2010.

Summary of gross loans and advances to customers

(Unaudited)

The following commentary is on a constant currency basis:

Personal lending balances of US$394bn in 2011 were 6% lower than at 31 December 2010 following the reclassification of balances to held for sale, and the continued run-off of the CML portfolio, partly offset by growth in residential mortgage lending in the UK and Hong Kong. For more information on Personal lending, see 'Areas of special interest - personal lending' on page 119.

Corporate and commercial lending was 49% of gross lending to customers at 31 December 2011, representing our largest lending category. International trade and services was the biggest portion of this category, increasing by 6% compared with 31 December 2010 following economic growth, particularly in Asia. Commercial real estate lending, which represented 8% of total gross lending to customers, increased by 4% in 2011, as the demand for funds in property investment and development remained strong in Hong Kong and certain countries in the Rest of Asia-Pacific region.

In the financial category, our largest exposure was to non-bank financial institutions which decreased by 13% to US$85.3bn; this was mainly in North America and related to lower reverse repos as we increased our placements of excess liquidity with central banks.

Loans and advances to banks were widely distributed across many countries in 2011 and decreased by 11% as funds from maturing term loans and reverse repo balances were redeployed into central banks, mainly in Europe.

The following tables analyse loans by industry sector and by the location of the principal operations of the lending subsidiary or, in the case of the operations of The Hongkong and Shanghai Banking Corporation, HSBC Bank, HSBC Bank Middle East and HSBC Bank USA, by the location of the lending branch.

Gross loans and advances by industry sector

(Audited)

	2011	Currency effect	Move- ment	2010	2009	2008	2007
	US$m	US$m	US$m	US$m	US$m	US$m	US$m

Personal .........................................	393,625	(4,735)	(26,960)	425,320	434,206	440,227	500,834
Residential mortgages⁴ ................	278,963	(1,825)	12,107	268,681	260,669	243,337	269,068
Other personal⁵ ...........................	114,662	(2,910)	(39,067)	156,639	173,537	196,890	231,766

Corporate and commercial ..............	472,816	(6,329)	33,633	445,512	383,090	407,474	400,771
Manufacturing⁶ ...........................	96,054	(1,765)	6,698	91,121	80,487	81,103	72,895
International trade and services⁶ .	152,709	(2,074)	8,210	146,573	115,641	128,737	129,143
Commercial real estate ................	73,941	(598)	2,659	71,880	69,389	70,969	72,345
Other property-related ................	39,539	(245)	4,946	34,838	30,520	30,739	33,907
Government ................................	11,079	(258)	2,743	8,594	6,689	6,544	5,708
Other commercial⁷ ......................	99,494	(1,389)	8,377	92,506	80,364	89,382	86,773

Financial .........................................	86,219	(1,874)	(13,632)	101,725	96,650	101,085	99,148
Non-bank financial institutions ...	85,275	(1,818)	(13,070)	100,163	95,237	99,536	96,781
Settlement accounts ....................	944	(56)	(562)	1,562	1,413	1,549	2,367

Asset-backed securities reclassified ..	5,280	(14)	(598)	5,892	7,827	7,991	-

Total gross loans and advances to customers ('TGLAC') .................	957,940	(12,952)	(7,557)	978,449	921,773	956,777	1,000,753

Gross loans and advances to banks ..	181,112	(5,669)	(21,648)	208,429	179,888	153,829	237,373

Total gross loans and advances .......	1,139,052	(18,621)	(29,205)	1,186,878	1,101,661	1,110,606	1,238,126

Impaired loans and advances to customers⁸...............................	41,584	(575)	(4,712)	46,871	30,606	25,352	19,582
- as a percentage of TGLAC ......	4.3%			4.8%	3.3%	2.6%	2.0%

Impairment allowances on loans and advances to customers .................	17,511	(396)	(2,176)	20,083	25,542	23,909	19,205
- as a percentage of TGLAC ......	1.8%			2.1%	2.8%	2.5%	1.9%

Charge for impairment losses ..........	11,505	185	(2,228)	13,548	24,942	24,131	17,177
New allowances net of allowance releases ...................................	12,931	210	(1,847)	14,568	25,832	24,965	18,182
Recoveries ..................................	(1,426)	(25)	(381)	(1,020)	(890)	(834)	(1,005)

For footnotes, see page 185.

Movements in the above table attributed to the reclassification of certain loans and advances to held for sale were: US$33.2bn of other personal lending, US$1.3bn of residential mortgages, US$1.3bn of

manufacturing international trade and services, and US$0.4bn of commercial real estate, US$0.5bn of loans and advances to banks and US$0.6bn related to other industry sectors.

Gross loans and advances to customers by industry sector and by geographical region

(Audited)

	Europe	Hong Kong	Rest of Asia- Pacific	MENA	North America	Latin America	Total	As a % of total gross
	US$m	US$m	US$m	US$m	US$m	US$m	US$m		loans
At 31 December 2011
Personal .......................................	166,147	63,181	43,580	5,269	95,336	20,112	393,625		41.1
Residential mortgages⁴...............	119,902	46,817	32,136	1,837	73,278	4,993	278,963		29.1
Other personal⁵ ........................	46,245	16,364	11,444	3,432	22,058	15,119	114,662		12.0

Corporate and commercial ...........	204,984	91,592	77,887	21,152	41,271	35,930	472,816		49.3
Manufacturing⁶ .........................	45,632	9,004	16,909	3,517	7,888	13,104	96,054		10.0
International trade and services⁶ ..............................................	64,604	29,066	29,605	8,664	10,710	10,060	152,709		15.9
Commercial real estate .............	32,099	20,828	9,537	1,002	7,069	3,406	73,941		7.7
Other property-related .............	7,595	17,367	6,396	1,770	5,729	682	39,539		4.1
Government .............................	3,143	2,918	962	1,563	656	1,837	11,079		1.2
Other commercial⁷ ...................	51,911	12,409	14,478	4,636	9,219	6,841	99,494		10.4

Financial ......................................	63,671	3,473	3,183	1,168	12,817	1,907	86,219		9.0
Non-bank financial institutions .	63,313	3,192	2,937	1,162	12,817	1,854	85,275		8.9
Settlement accounts ..................	358	281	246	6	-	53	944		0.1

Asset-backed securities reclassified	4,776	-	-	-	504	-	5,280		0.6

TGLAC ........................................	439,578	158,246	124,650	27,589	149,928	57,949	957,940		100.0

Percentage of TGLAC by geographical region ...................	45.9%	16.5%	13.0%	2.9%	15.7%	6.0%	100.0%

Impaired loans⁸ ............................	11,751	604	1,069	2,425	22,696	3,039	41,584
- as a percentage of TGLAC ....	2.7%	0.4%	0.9%	8.8%	15.1%	5.2%	4.3%

Total impairment allowances .......	5,242	581	782	1,714	7,181	2,011	17,511
- as a percentage of TGLAC ....	1.2%	0.4%	0.6%	6.2%	4.8%	3.5%	1.8%

At 31 December 2010
Personal .......................................	161,717	57,308	40,184	5,371	139,117	21,623	425,320		43.4
Residential mortgages⁴ ..............	111,618	42,488	28,724	1,751	78,842	5,258	268,681		27.4
Other personal⁵ ........................	50,099	14,820	11,460	3,620	60,275	16,365	156,639		16.0

Corporate and commercial ...........	203,804	80,823	67,247	19,560	38,707	35,371	445,512		45.6
Manufacturing⁶ .........................	46,890	8,171	15,050	3,074	5,748	12,188	91,121		9.3
International trade and services⁶ ..............................................	65,090	25,280	26,224	8,099	10,989	10,891	146,573		15.0
Commercial real estate .............	30,629	19,678	8,732	1,085	8,768	2,988	71,880		7.3
Other property-related .............	6,401	15,232	5,426	1,785	5,109	885	34,838		3.6
Government .............................	2,289	2,339	415	1,345	89	2,117	8,594		0.9
Other commercial⁷ ...................	52,505	10,123	11,400	4,172	8,004	6,302	92,506		9.5

Financial ......................................	70,725	3,189	2,259	1,347	21,202	3,003	101,725		10.4
Non-bank financial institutions .	70,019	2,824	2,058	1,335	21,109	2,818	100,163		10.2
Settlement accounts ..................	706	365	201	12	93	185	1,562		0.2

Asset-backed securities reclassified	5,216	-	-	-	676	-	5,892		0.6

TGLAC ........................................	441,462	141,320	109,690	26,278	199,702	59,997	978,449		100.0

Percentage of TGLAC by geographical region ...................	45.2%	14.4%	11.2%	2.7%	20.4%	6.1%	100.0%

Impaired loans⁸ ............................	11,394	660	1,324	2,529	27,840	3,124	46,871
- as a percentage of TGLAC ....	2.6%	0.5%	1.2%	9.6%	13.9%	5.2%	4.8%

Total impairment allowances .......	5,663	629	959	1,652	9,170	2,010	20,083
- as a percentage of TGLAC ....	1.3%	0.4%	0.9%	6.3%	4.6%	3.4%	2.1%

For footnotes, see page 185.

Loans and advances to banks by geographical region

(Audited)

	Europe	Hong Kong	Rest of Asia- Pacific	MENA	North America	Latin America	Loans and advances to banks	Impair- ment allowances
	US$m	US$m	US$m	US$m	US$m	US$m	US$m		US$m

At 31 December 2011⁹ ......	54,406	35,159	47,309	8,571	14,831	20,836	181,112		(125)
At 31 December 2010¹⁰ ......	78,239	33,585	40,437	9,335	19,479	27,354	208,429		(158)
At 31 December 2009 .........	65,614	36,197	35,648	8,435	15,386	18,608	179,888		(107)
At 31 December 2008 .........	62,012	29,646	28,665	7,476	11,458	14,572	153,829		(63)
At 31 December 2007 .........	104,534	63,737	32,373	7,488	16,566	12,675	237,373		(7)

For footnote, see page 185.

Gross loans and advances to customers by country

(Audited)

	Residential mortgages US$m	Other personal US$m	Property- related US$m	Commercial, international trade and other US$m	Total US$m
At 31 December 2011
Europe ....................................................	119,902	46,245	39,694	233,737	439,578
UK ..........................................................	111,224	22,218	29,191	160,236	322,869
France .....................................................	3,353	9,305	8,160	49,572	70,390
Germany ..................................................	10	343	112	4,518	4,983
Malta .......................................................	1,708	567	520	1,591	4,386
Switzerland ..............................................	1,803	10,684	156	1,918	14,561
Turkey ....................................................	767	2,797	255	3,652	7,471
Other .......................................................	1,037	331	1,300	12,250	14,918

Hong Kong ............................................	46,817	16,364	38,195	56,870	158,246

Rest of Asia-Pacific ..............................	32,136	11,444	15,933	65,137	124,650
Australia ..................................................	9,251	1,327	2,357	6,073	19,008
India ........................................................	830	461	809	3,914	6,014
Indonesia .................................................	81	463	97	4,577	5,218
Mainland China .......................................	2,769	317	5,078	15,665	23,829
Malaysia ..................................................	4,329	2,166	1,351	5,898	13,744
Singapore .................................................	7,919	4,108	3,690	9,433	25,150
Taiwan ....................................................	3,062	550	139	4,555	8,306
Vietnam ...................................................	42	184	42	1,397	1,665
Other .......................................................	3,853	1,868	2,370	13,625	21,716

Middle East and North Africa (excluding Saudi Arabia) .......................	1,837	3,432	2,772	19,548	27,589
Egypt ......................................................	2	441	100	2,775	3,318
Qatar .......................................................	9	445	354	1,098	1,906
UAE ........................................................	1,520	1,882	1,464	12,070	16,936
Other .......................................................	306	664	854	3,605	5,429

North America ......................................	73,278	22,058	12,798	41,794	149,928
US ...........................................................	52,484	14,087	7,850	27,307	101,728
Canada .....................................................	19,045	7,518	4,391	13,600	44,554
Bermuda ..................................................	1,749	453	557	887	3,646

Latin America .......................................	4,993	15,119	4,088	33,749	57,949
Argentina ................................................	32	1,379	114	2,331	3,856
Brazil .......................................................	1,657	9,802	1,660	18,638	31,757
Mexico ....................................................	1,847	2,261	1,284	8,210	13,602
Panama ...................................................	1,240	1,014	923	2,537	5,714
Other .......................................................	217	663	107	2,033	3,020


Total .......................................................	278,963	114,662	113,480	450,835	957,940

Gross loans and advances to customers by country (continued)

	Residential mortgages US$m	Other personal US$m	Property- related US$m	Commercial, international trade and other US$m	Total US$m
At 31 December 2010
Europe .....................................................	111,618	50,099	37,030	242,715	441,462
UK ..........................................................	103,037	25,636	26,002	165,283	319,958
France .....................................................	3,749	9,550	8,737	56,613	78,649
Germany ..................................................	11	356	79	4,015	4,461
Malta .......................................................	1,656	599	563	1,643	4,461
Switzerland ..............................................	1,358	10,708	114	1,837	14,017
Turkey ....................................................	809	2,817	210	2,783	6,619
Other .......................................................	998	433	1,325	10,541	13,297

Hong Kong ..............................................	42,488	14,820	34,910	49,102	141,320

Rest of Asia-Pacific .................................	28,724	11,460	14,158	55,348	109,690
Australia ..................................................	8,405	1,267	2,346	4,867	16,885
India ........................................................	920	526	680	4,583	6,709
Indonesia .................................................	74	531	115	3,374	4,094
Mainland China .......................................	2,046	310	3,836	12,932	19,124
Malaysia ..................................................	3,833	2,053	1,361	4,845	12,092
Singapore .................................................	6,571	3,661	3,262	7,846	21,340
Taiwan ....................................................	3,002	527	135	2,832	6,496
Vietnam ...................................................	35	162	59	1,255	1,511
Other .......................................................	3,838	2,423	2,364	12,814	21,439

Middle East and North Africa (excluding Saudi Arabia) .......................	1,751	3,620	2,870	18,037	26,278
Egypt ......................................................	3	396	111	2,484	2,994
Qatar .......................................................	8	491	404	918	1,821
UAE ........................................................	1,477	2,099	1,359	11,043	15,978
Other .......................................................	263	634	996	3,592	5,485

North America ........................................	78,842	60,275	13,877	46,708	199,702
US ...........................................................	57,630	51,686	8,269	31,496	149,081
Canada .....................................................	19,505	8,070	5,079	14,711	47,365
Bermuda ..................................................	1,707	519	529	501	3,256

Latin America .........................................	5,258	16,365	3,873	34,501	59,997
Argentina ................................................	30	918	103	2,172	3,223
Brazil .......................................................	1,111	10,979	1,816	17,093	30,999
Mexico ....................................................	2,097	2,365	1,146	8,622	14,230
Panama ...................................................	1,155	982	489	3,794	6,420
Other .......................................................	865	1,121	319	2,820	5,125


Total .......................................................	268,681	156,639	106,718	446,411	978,449

Areas of special interest

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.

During the year, we continued to reduce our sovereign and financial institution counterparty credit risk positions in peripheral eurozone countries. We also reduced our exposure to risk from financial institution counterparty positions across the broader eurozone and from specific financial institutions in other countries. This process was particularly focused on our surplus liquidity, which resulted in significant placements directly with central banks in the most highly rated countries.

We actively sought to identify 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 on-going viability in the event of an unfavourable conclusion to the current crisis.

This was undertaken through the analysis of publicly available information, reviews of external analyst reports and meetings with the counterparties'

This information is provided by RNS

The company news service from the London Stock Exchange

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