The Group’s main business activities are retail and commercial banking, general insurance and long-term savings, provided through well recognised brands including Lloyds Bank, Halifax, Bank of Scotland and Scottish Widows.
Our reporting We aim to report in an integrated way to reflect the way we operate. As well as reporting our financial results, we also report on our strategy and approach to operating responsibly and take into account relevant economic, political, social, regulatory and environmental factors.
Within this year’s report we have also sought to address the additional reporting requirements arising from Section 172 of the Companies Act 2006 and the 2018 UK Corporate Governance Code.
Helping Britain Prosper Plan targets achieved including the new sustainability KPI
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During 2019, we’ve lent £13.8 billion to support people to buy their first home, helped over 350,000 more people save for their future and supported more than 100,000 businesses across the UK to start up and grow. Given our customer focused strategy, ambitious transformation programme and digital strength, the Group remains well placed to continue to support its customers, Help Britain Prosper and deliver long-term sustainable success.
Given our unique position at the heart of the UK economy, the successful transition to a more sustainable, lower-carbon economy is of strategic importance to us. In response to the global issue of climate change, the Group reached a new milestone with the development of a new goal, working with customers, Government and the market to help reduce emissions we finance by more than 50 per cent by 2030. We have made sustainability a focus area in our Helping Britain Prosper Plan and throughout 2019 we have continued to build on this by developing the new reporting framework, which can be found on pages 28 to 31.
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I am delighted that we have been named as a top 10 employer for working families, and also retained our place on both the Stonewall Top 100 Employers list for the fifth year in a row and The Times’ Top 50 Employers for Women for the eighth consecutive year. This great news demonstrates our clear commitment to ensuring all colleagues can feel confident in bringing their true selves to work and reach their full potential.
The results from the Group’s 2019 colleague survey, which can be found on page 9, acknowledge the positive work that has been completed. Transforming our culture with colleagues, empowered to speak out and drive their personal development, is critical to the successful delivery of our current strategy.
Remuneration There has been a substantial focus on remuneration throughout 2019. The Remuneration Committee has engaged extensively with our shareholders and other key stakeholders to develop the proposed 2020 Directors’ Remuneration Policy. The changes proposed within the new policy have been designed in the interests of our stakeholders and take on board feedback for a more simplified remuneration structure with a clear alignment to the purpose and strategy of the Group, whilst appropriately rewarding performance. The changes also support the long-term goal to narrow the gap between executive and wider colleague remuneration.
Full details of the proposed Policy and rationale for the proposed changes can be found within the Directors’ Report on Remuneration on pages 98 to 102. The policy will be subject to shareholder approval at the AGM in May.
Despite facing a challenging external environment, we have delivered a solid financial performance for the year. The additional PPI charge has however significantly impacted our statutory results. As a result of this and other performance factors, the total Group Performance Share (GPS) outcome for the Group decreased 33 per cent to £310.1 million.
Biggest mortgage lender in UK with c.£289 billion portfolio £18 billion lending commitment to UK businesses
Suppliers £5.9 billion paid in 2019 >95 per cent of direct suppliers located in the UK
I am pleased to welcome William Chalmers, who formally took the reins as the Group’s Chief Financial Officer in August 2019. We are pleased to have been able to attract a candidate of William’s calibre to the Board. He brings a wealth of experience that will be of significant benefit to the Group.
In June 2019, the Board and the senior management team took part in an intensive two-day strategy meeting to revisit our expectations of the current strategy and review the key trends that have emerged since. As part of this, the Board debated the transformation required to meet these evolving expectations and obligations to the Society of the Future.
In February 2018 we announced an ambitious plan to transform the Group for success in a digital world, supported by over £3 billion of strategic investment. We are now two-thirds of the way through the plan and have made significant progress in further digitising the Group, enhancing customer experience, maximising our capabilities as an integrated financial services provider and transforming the way we work.
We have made significant progress in our customer proposition. For example, our unique Single Customer View capability provides customers with the ability to view their pensions and long-term savings products alongside their banking products. Insurance and Wealth has seen strong growth in life and pensions sales, driven by new members in existing workplace schemes, increased auto enrolment workplace contributions and bulk annuities. In partnership with Schroders, during the third quarter of 2019 we launched Schroders Personal Wealth, with the ambition of becoming a top three financial planning business by the end of 2023. Also in the third quarter, the Group announced the acquisition of Tesco Bank’s prime UK residential mortgage portfolio, which complements our organic strategy.
Historic conduct issues remain disappointing but we continue to be focused on doing the right thing for our customers. The Group is fully committed to implementing all of the recommendations contained within Sir Ross Cranston's report relating to HBOS
We have made significant strategic progress and our performance continues to demonstrate the competitive advantage of our business model. António Horta-Osório Group Chief Executive
The Group’s ambitious three year strategic plan was launched in February 2018 and we are on track to achieve our targeted strategic outcomes. We have made significant progress in transforming the Group for success in a digital world and, in line with our commitment to invest more than £3 billion over the period, have invested £2 billion to date across our four strategic pillars.
We are using our deep understanding of our diverse customer base to deliver tailored propositions such as Club Lloyds and the Halifax Prize Draw
Having introduced automation for repetitive tasks, we have created over 1 million cumulative hours of colleague capacity and our transformation has covered around 55 per cent of the Group’s cost base
Virtual assistants are currently managing up to 5,000 customer conversations daily, with satisfaction increasing by more than 10 points. Around 25 per cent of queries are handled without being passed to a colleague and we expect this to increase
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We are working hard to help people save for the future and in 2019 in partnership with Schroders, we launched Schroders Personal Wealth. Our open book assets under administration have increased by £37 billion since the start of the current strategic plan. More generally, our banking savings range operates transparent pricing for all, with customers able to upgrade their accounts online with one click when better products become available.
The Group is committed to helping the UK transition to a sustainable, low carbon economy. Over the last five years we have raised over £2.8 billion in green bonds for UK corporate issuers, more than any other UK financial services company. We have also supported renewable energy projects that power the equivalent of 5.1 million homes.
As we look forward, we want to play our part in tackling climate change and we have targeted working with our customers, government and the market to help reduce the emissions we finance by more than 50 per cent by 2030, in line with the UK’s Net Zero Goal and the Paris Agreement. We are one of the first organisations in the world to commit to all three of The Climate Group’s ambitious sustainability initiatives, which aim to speed up the transition to a low carbon economy by committing to source 100 per cent of our electricity from renewable sources, improve energy productivity and transition to electric vehicles.
The Group was the first FTSE100 company to establish targets for championing diversity within its business and we now have 36.8 per cent of senior roles held by women, up almost 8 percentage points since 2014 and we continue to aim to meet our target of 40 per cent by the end of 2020. With 10.2 per cent of roles across the Group held by Black, Asian and Minority Ethnic (BAME) colleagues, we have exceeded our 2020 target of 10 per cent.
We have issued a separate presentation on our approach to environmental, social and governance issues, which can be found on the Group's external website.
Outlook Over 2019, UK economic performance has remained resilient in the face of significant political and economic uncertainty, supported by record employment, low interest rates and rising real wages. Although uncertainty remains given the ongoing negotiation of international trade agreements and the rate outlook remains challenging, there is now a clearer sense of direction and we remain well placed to Help Britain Prosper, support our customers and deliver strong and sustainable returns for shareholders. The Group’s confidence in the business model and future performance is reflected in our guidance for 2020: Net interest margin of 2.75 to 2.80 per cent
Operating costs to be less than £7.7 billion with the cost:income ratio lower than in 2019
Capital build expected to be within the Group’s ongoing guidance range of 170 to 200 basis points per year and risk-weighted assets to be broadly in line with 2019
Expect increased statutory return on tangible equity of 12 to 13 per cent, driven by resilient underlying profit and lower below the line charges
In January 2020, the Group announced its new ambitious goal to work with customers, government and the market to help reduce the carbon emissions we finance by more than 50 per cent by 2030.
Underlying profit before tax was lower in 2019, reflecting lower net income and higher impairment charges, partly offset by the Group’s continued progress in cost reductions. 1 Restated to include remediation.
Statutory profit after tax was lower in 2019, largely due to the additional PPI charge. The tax expense was £1.4 billion.
CURRENT TARGET Ongoing CET1 capital ratio target of c.12.5 per cent plus a management buffer of c.1 per cent 1 Pro forma, reflecting insurance dividends paid in the subsequent reporting period. 2018 also includes share buyback and 2016 reflects MBNA.
The statutory return on tangible equity was lower in 2019 given the lower statutory profit, largely due to additional PPI charges.
From a strategic perspective achievement of these targets helps us to learn what progress we are making in across all areas of our strategy.
Highlights Given our focus on UK customers, the Group’s prospects are closely linked to the fortunes of the UK economy
Our low risk business model and focus on efficiency positions us well irrespective of macro conditions. Nevertheless, if the economy was to be impacted significantly by crystallisation of either domestic or international risks, Group financial performance would be impacted
The UK market, to which our performance is inextricably linked, continues to evolve
The economic outlook appears to be improving. Nevertheless, in a long-term context growth is expected to remain subdued and interest rates low - core to that is the low rate of productivity growth, with the recent weakness of businesses’ investment spending suggesting a significant improvement is unlikely near-term. Uncertainty for some UK companies may persist in 2020 and drag on investment as the UK attempts to negotiate a comprehensive trade deal with the EU to a tight timescale. However, improved pay growth is likely to support households’ spending, and the likely fiscal stimulus is expected to provide some boost to the economy.
The fundamental drivers behind the subdued trends in the housing market are expected to remain in place - the high level of prices relative to incomes that constrains first-timebuyer demand, and expectations that interest rates could rise from their current low level.
There are, or course, significant risks to this outlook. The growth-cycle in both of the world’s largest economies - US and China - is in its mature stage, and the coronavirus outbreak and ongoing trade war could complicate the task of policymakers in guiding growth towards a stable and sustainable level. Conversely, high asset prices and corporate debt levels in some countries could be vulnerabilities if an improvement in global economic growth and a resulting rise in interest rates causes unexpected shifts in currencies or herd behaviour in financial markets as shareholders change their appetite between different types of investments. Domestically, the future trading relationship with the EU remains uncertain, as does businesses’ response to that uncertainty.
This picture of subdued but broadly stable growth is likely to be reflected across our markets. Consumer credit growth has slowed significantly over the past couple of years after a prior period of strong growth, but we expect that the slowdown has now run its course.
While customers want to be in control of their finances through digital channels, human interaction is still valued for more complex financial needs
CUSTOMER We are also investing in our branch and telephony channels to ensure that these are able to address our customers’ more complex needs more effectively, and continue to provide access to banking services for our more vulnerable customers.
Highlights The UK financial services sector is expected to remain highly regulated
LIBOR transition The transition from LIBOR to alternative reference rates will mean changes to products and funding structures.
The use of new technologies is increasing efficiency within the financial services sector and delivering meaningful improvements to the customer experience
Cyber security and the protection and appropriate use of customer data remain important factors in retaining customer trust
In response, a number of traditional competitors have attempted to replicate the success of neo-banks by developing their own digital-only offerings, often under separate and newly created brand names. A number of international peers have also entered the UK market through digital only challengers, taking advantage of the supportive regulatory environment and increasing similarity in customer behaviours across multiple geographies.
We are a simple, low-risk, customer focused UK financial services provider with distinctive and sustainable competitive strengths: Multi-brand, multi-channel proposition with data driven customer experience Operating in an integrated way through a range of distribution channels and brands ensures our customers can interact with us when and how they want and enables us to address the needs of different customer segments more effectively.
UK’s largest digital bank, branch network and customer franchise with leading integrated propositions Our scale and reach across the UK means that our franchise extends to around 26 million customers, with 16.4 million digitally active. We are uniquely positioned to deal with customers’ banking and investment needs.
As a large, UK focused financial services provider we face several external and internal challenges: The main external challenges we face are as previously discussed on pages 10 to 13
We also face a number of internal challenges: Operating as efficiently as possible, while remaining the best bank for customers
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In order to be the best bank for customers, we recognise that we must continue to adapt to changes in customer behaviour, technology-driven competition and regulation. Our propositions must be reflective of heightened customer expectations for ease of access, personalisation and relevance, as well as the needs created by changing life patterns.
Building a market leading digital experience We are the largest digital bank in the UK, with 16.4 million digitally active and 10.7 million mobile app customers. During the year, we have seen increased customer engagement with the enhanced digital features introduced in 2018 and have launched a range of new features that enable our customers to be more in control of their finances. These include the ability to change address via the mobile app and app statement searches, the latter of which is being used c.1.2 million times per month on average and is helping us to reduce our use of paper.
I can see my pension alongside my banking now which is great, really useful Lloyds Banking Group customer
The scaling of our use of machine learning is also delivering improved customer outcomes. For example, virtual assistants managed up to 5,000 customer conversations daily in 2019, with customer satisfaction increasing by more than 10 points. In addition, around 25 per cent of queries are handled without being passed to a colleague, a trend that is expected to increase further.
The Group has also significantly increased its adoption of private cloud, with more than 650 applications now migrated. These investments deliver a more efficient, scalable and flexible infrastructure and underpin the continuous improvement of our products and services for our customers’ benefit.
Progress in 2019 In 2019 we have continued to enhance and leverage the Group’s capabilities and unique business model to meet our customers’ banking and insurance needs more effectively.
Leveraging our partnership with Schroders to accelerate our Wealth strategy In 2019 we formally launched Schroders Personal Wealth, a market-leading wealth proposition, which combines the investment capabilities and innovative product offering of Schroders with our distribution footprint and digital reach. This allows us to better serve our customers’ financial planning and retirement needs, and underpins this joint-venture’s target of becoming a top three UK financial planning business by the end of 2023. In addition, as part of our broader strategic partnership, we are developing a full service offering for our customers, including access to a leading wealth and investment management business and a mass market direct offering that is due to launch in 2020.
Building skills for the future To deliver our significant transformation, we are continuing to make our biggest ever investment in our people during the course of the current strategic plan. In 2019, we delivered 5.5 million of total training hours, an increase of 28 per cent compared to 2018. We have also now delivered more than 3.2 million of cumulative training hours to develop the skills for the future since the end of 2017, and are well positioned to deliver our target of 4.4 million cumulative training hours by the end of 2020.
To enable and ensure stakeholder considerations are at the heart of all corporate decision making, a wide range of papers relating to different stakeholder groups are presented and discussed regularly by the Board. In addition all papers submitted to the Board are required to consider the impact of proposals on key stakeholder groups.
This section (pages 20 to 27) acts as our Section 172(1) statement; however, given the importance of stakeholder focus, long-term strategy and reputation, these are integrated throughout the report.
With around 26 million customers, we strive to treat them fairly, making it easy for them to find, understand and access products that are right for them, whatever their circumstances.
Having identified the need to upgrade the skills of small businesses in technology, productivity and export opportunities, we have been engaging with government and other organisations to provide additional support.
Indirect engagement The Board reviews the customer dashboard, which provides a detailed insight into the Group’s performance in respect of delivering on our customer related ambitions and agreed improvements in the dashboard’s construct during the course of the year. The Board also approves the annual customer plans, which set out the customer related priorities for the Group’s divisions for the coming year.
The Board also looks to benchmark performance among customers and uses insight from a range of internal and external research, including net promoter scores and other customer indices, to improve services.
The Board receives insight and guidance in relation to the competitive environment and market shares, providing strategic insight and generating good discussion among the Board, resulting in either actions or key learnings taken in the Group.
The focus on customers is not just evidenced by the regularity of presentations to Board, but also by the existence of the Group Customer First Committee. This Committee is composed of members of senior management and regularly reports to the Board. The Committee acts as the custodian of Group wide customer experience and has responsibility for monitoring, reviewing and challenging the divisions to make changes to support the delivery of the Group’s aim and customer-centric culture.
In accordance with the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (as amended by the Companies (Miscellaneous Reporting) Regulations 2018), this statement also provides details of how the Directors have engaged with and had regard to the interest of our key stakeholders.
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Given the Group's significant retail shareholder base, we have actively looked to increase engagement in the past twelve months and will continue to do so in 2020. We aim to build a sustainable communications infrastructure, including an enhanced corporate website, to ensure improvements deliver better insight for all our shareholders.
Our 2020 Remuneration policy Read more on pages 115 to 126
Direct engagement The Group understands the need to effectively communicate with existing and potential shareholders, briefing them on strategic and financial progress and attaining feedback. The Group therefore undertakes c.500 shareholder meetings a year, with the Group Chief Executive and Chief Financial Officer undertaking more than 80 meetings in 2019.
In addition, various Non-Executive Directors have engaged with shareholders through the year, including the Chairman and the Remuneration Committee Chair. The Chairman’s meetings were largely focused on corporate strategy, governance and sustainability, whilst the Remuneration Committee Chair has been consulting widely on the new remuneration policy. In total, NonExecutive Board members have engaged directly with shareholders representing around 30 per cent of our issued share capital during the year.
The AGM is an opportunity for shareholders to hear directly from the Board on the Group’s performance and strategic direction, and importantly, to ask questions. In 2019: – around 200 shareholders attended – over 67 per cent of total voting rights voted
The Board is accountable to shareholders and aims to ensure that a good dialogue is maintained
The management team consulted with external advisors, with payment approaches by other large corporates considered, and engaged with the regulators
A workplan was discussed and agreed in February 2019 and as a result, the Board now receives a quarterly Workforce Engagement report which comprises two component parts: A summary of the Board’s engagement activity with colleagues
Key themes raised by colleagues and trends on people matters, including, for example absence or attrition
The Board are committed to improving the transparency of workforce disclosure, and the Group participates in the Workforce Disclosure Initiative.
Colleague priorities Customer and value led culture Investment in training and IT Compelling colleague proposition Attractive reward structure
The Group held its biggest signature annual event, Helping Britain Prosper LIVE, which was attended by over 5,000 colleagues and was broadcast live to all colleagues. This event, hosted by the Group Chief Executive with support from key members of the executive leadership team, provided the opportunity for our colleagues to hear and see first-hand how we are progressing our strategy and Helping Britain Prosper every day.
The Group believes that a diverse workforce is critical to performance and regular progress updates are provided to the Board.
The Group’s Remuneration Policy was last approved by shareholders at the AGM in 2017 and has been in operation for the last three years. We have published our proposed revised Remuneration Policy within the Directors’ Remuneration Report on pages 98 to 123.
Our engagement process Proactive engagement took place throughout 2019 with key stakeholders including shareholders, colleagues and the regulator to understand some of the drivers for change
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The Board supports the Group’s 10 regional ambassadors that cover the home nations of Scotland, Wales and Northern Ireland, and the seven regions of England. Through the programme we have established strong relationships with politicians, the media, local councils and other community institutions to offer our insight on the major economic and social debates the country faces.
As the largest retail and commercial financial services provider in the UK, we have a presence across the country. We specifically invest in local communities across Britain to help them prosper economically and build social cohesion by tackling disadvantage.
Community and environmental priorities Helping the transition to a sustainable low carbon economy
The Responsible Business Committee, a subcommittee of the Board, provides oversight and support for the Group’s Helping Britain Prosper Plan, and the plans for delivering the aspiration to be seen as a trusted and responsible business.
During 2019, the Board reviewed responses from the Responsible Business materiality study which outlined a wide range of views on the Group. These responses then informed and guided our responsible business strategy and reporting.
The Board undertook various related deep dives throughout 2019, including key areas of strategic focus such as ESG, cyber security and inclusion and diversity within the Group, with specific focus on BAME colleagues. This highlighted a number of strengths but also identified opportunities for the Group to further improve its behaviours and approach.
Direct Engagement During 2019 we had regular meetings with our various regulators at different levels of the organisation from Board to senior management.
Our decision process The Group’s EU exit contingency plans continue to be monitored closely by the Board via specific regular updates, covering both operational status and external developments, a suite of early warning indicators and corresponding risk mitigation plans.
Tax is also covered in our Code of Responsibility, a code that applies to every colleague, team and business in our Group – day in, day out. The code makes tax a personal responsibility for every colleague in the Group.
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Given the size of our organisation, we are reliant on external suppliers for a number of key services. As well as being important for future success, we believe that dealing with suppliers in the right way is the right thing to do.
Supplier priorities Being treated fairly and professionally during the sourcing process
Supporting suppliers in meeting our requirements for cybersecurity in our supply chain
The Board Risk Committee oversees our detailed process to assess the cybersecurity of suppliers and help them meet our security requirements.
All potential acquisitions are assessed to ensure alignment with strategy and that they deliver appropriate returns
Detailed analysis of the transaction was undertaken by senior management before attaining Board approval including consultation with regulators
The transaction is consistent with Group strategy and value accretive to shareholders
Following this transaction, the Group’s open mortgage book assets at the year end were ahead of the year end 2018 balance
With the Group’s unique position at the heart of the British economy, we embrace our responsibility to help address some of the economic, social and environmental challenges the UK faces. We have been Helping Britain Prosper for the past 250 years, by delivering for our customers and communities, as a responsible, sustainable and inclusive business.
The Group understands that engagement is a two way process, so each year we ask colleagues to share their views via our independently run colleague survey, and participate in the annual Banking Standards Board Culture Assessment.
All Group colleagues receive a competitive and fair reward package. To encourage ownership, colleagues are eligible to participate in HMRC approved share plans. Further information can be found on page 116.
We embrace our economic, social and environmental responsibilities to Help Britain Prosper by operating as a responsible, sustainable and inclusive Group. Sara Weller Non-Executive Director and Chair, Responsible Business Committee
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Helping the transition to a sustainable low carbon economy Average number of homes that could be powered as a result of our support of UK renewable energy projects 5.1m2 5m
Helping Britain get a home Amount of lending committed to help people buy their first home £13.8bn £30bn
Helping people save for the future Growth in assets that we hold on behalf of customers in retirement and investment products3 £37.1bn2 £50bn
Tackling social disadvantage across Britain Number of charities we support as a result of our £100 million commitment to the Group’s independent charitable Foundations
Percentage of senior roles held by Black, Asian and Minority Ethnic colleagues 1 Figures are all cumulative 2018 to 2020 excluding Tackling social disadvantage across Britain and Championing Britain’s diversity.
We support the aims of the 2015 Paris Agreement and the UK Government’s Clean Growth Strategy, which will require a radical reinvention of ways of working, living and doing business including new Government policies and sustainable finance solutions. In 2018 we set out our Sustainability Strategy and when reporting on our progress, we support the Taskforce on Climate-Related Financial Disclosure (TCFD) framework, and currently plan to achieve full disclosure by 2022 in line with the TCFD recommendations and the UK Government’s Green Finance Strategy.
Pensions and investments: be a leading UK pension provider that offers our customers and colleagues sustainable investment choices, and challenge the companies we invest in to behave more sustainably and responsibly
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2019 29 £2.3bn greenfield offshore wind farm in Scotland
In November, Lloyds Banking Group provided funding and risk management services to the £2.3 billion Neart na Gaoithe (Strength of the Wind) offshore wind farm, a joint venture between EDF Energy Renewables and ESB Group. Located 15km off the coast of Fife, with the potential to power c.375,000 Scottish homes and offsetting 400,000 tonnes of CO2 emissions annually.
Metrics and targets In 2018, we committed to develop a reporting framework to track performance against our sustainability strategy. This includes measures for our energy use, emissions, water and waste; Group and portfolio metrics that drive emission reductions related to our financing activity; the amount of green finance we provide; and metrics that track climate change risk (including exposure to high carbon sectors and sectors at high risk from climate change).
The complexity of accessing robust data has prevented us from setting a full suite of targets in 2019. We intend, however, to set appropriate targets during 2020 for material sectors. Our new goal to reduce the emissions we finance by more than 50 per cent by 2030 will frame the level of ambition across our targets and metrics.
Extending our own carbon footprint measurement We met our 2030 carbon reduction target in 2019, having reduced emissions by 63 per cent since 2009. We also expanded our Scope 3 emissions measurement to include additional categories of emissions from business travel and colleague commuting. We continue to pursue our targets to reduce emissions by 80 per cent by 2050, operational waste by 80 per cent by 2025 (compared to 2014/15) and water consumption by 40 per cent by 2030 (compared to 2009). We will be developing new carbon, energy and travel targets in 2020. See Directors' report, page 97 for Group Emissions data.
Se le ct ed o th er s ec to rs s ub je ct to tr an si tio n ris ks
Teemill Tech is an ambitious firm, which operates with sustainability at its core. The rapid growth of Teemill’s customer base speaks for itself, with customers across the UK valuing the quality of its products.
In 2019, we included commentary on climate change risk within our Internal Capital Capacity Adequacy Assessment Process (ICAAP) submission, and in 2020 we are building on this through our analysis of initial scenarios to assess the impact on capital requirements. We are also engaged in the industry response to the Bank of England Discussion Paper to identify the best approach to explore the financial risks posed by climate change within its 2021 Biennial Exploratory Scenario (BES).
We have updated our external sector statements to include positions on six new sectors including manufacturing, automotive, agriculture, animal welfare, fisheries and UNESCO World Heritage Sites. This is in addition to the existing statements on power, coal, mining, oil and gas, forestry and defence. www.lloydsbankinggroup.com/Our-Group/ responsible-business/reporting-centre/. Our statement on coal has been updated and made more ambitious. We continue with our policy of not financing new coal fired power stations. We have now tightened our requirements for providing general banking or funding, and now require new clients to have less than 30 per cent of their revenue from the operation of coal fired power stations and/or coal mines (previously less than 50 per cent).
In line with TCFD, we are also developing forward-looking scenario analysis, incorporating physical and transition risks, to help us identify risks and opportunities over the short, medium and long-term. For example, Commercial Banking are conducting analysis on the real estate sector for business as usual and low carbon transition scenarios and our Insurance business has conducted an initial climate stress test. We are working with external consultants to enhance scenario analysis across our divisions and will use the outputs to support our scenario analysis assessments and inform our credit risk appetite decisions and future disclosures.
One in 14 electric cars in the UK was supplied by Group subsidiary Lex Autolease in 2019, supported by a £1 million cashback offer on pure electric vehicle (EV) orders, reducing future carbon dioxide emissions by an estimated 28 kilotonnes
University of Cambridge Banking Environment Initiative (BEI) – Bank 2030 We have been working with 12 leading banks to develop a roadmap for how the industry can direct capital towards environmentally and socially sustainable economic development.
EV100 – a commitment to accelerate the transition to Electric Vehicles by 2030
Climate Financial Risk Forum In 2019, we joined the PRA and FCA’s joint Climate Financial Risk Forum, participating in the Risk Management Working Group that aims to deliver a UK best practice handbook on implementation of the TCFD recommendations.
We also continue to support The Housing Growth Partnership, which provides help and mentoring to small and mid-sized house builders, who have built 1,636 new homes across the UK since 2018. In June, Vanessa Murden, Chief Operating Officer, Retail, joined the Board of Homes England, the UK Government’s vehicle supporting the delivery of affordable housing.
We continually look at ways of widening access to savings for everyone. For example, our Next Generation Text service supports customers with hearing difficulties. And we are currently the only UK bank to offer EasyRead statements for savings accounts, where pictures are used to support the meaning of the text. Our Banking savings range operates with transparent pricing for all, and customers can upgrade their accounts online with one click when better products become available.
Company Shop Group is the largest commercial redistributor of surplus food and household products in the UK, enabling some of the biggest retailers, manufacturers, food service and logistics providers to unlock value from surplus, which may have otherwise gone to waste. Supported by a £4.2 million funding package from the Lloyds Bank Clean Growth Financing Initiative (CGFI), Company Shop Group, whose head office is in South Yorkshire, opened three new stores in 2019, handled over 75 million units, saved over 25,000 tonnes of good food from going to waste and diversified into more non-food categories.
Small businesses without essential digital skills are nearly two and a half times more likely to close in the next two years, than those with full digital skills. The Group is part of the Department of Digital Culture Media and Sport’s Digital Skills Partnership, working with organisations like Google, Be the Business and Tata Consultancy Services to deliver impactful solutions. The Group also helped found future.now – a coalition led by organisations such as the City of London, Accenture, BT and Nominet, with over 60 partners all seeking to close the digital divide.
In addition, over 20,000 colleagues have volunteered to become Digital Champions supporting their local communities. Our Digital Knowhow workshops have helped thousands of organisations learn how to avoid fraud and take advantage of digital marketing techniques, read more online www.lloydsbankacademy.co.uk/
Externally, we have committed £9 million over three years to help SMEs to develop apprenticeships through our Levy Transfer initiative. And our investment of £10 million over 10 years in the Lloyds Bank Advanced Manufacturing Training Centre in Coventry will support 3,500 apprentices, graduates and engineers to be trained by 2024. We also work with the National Autistic Society to recruit and train young people with autism, with Business in the Community to recruit and train ex-offenders, and with the National Apprenticeship Service as active members of the Apprenticeship Diversity Champions Network.
In August, our Resilient Leader training course received a Princess Royal Training Award, recognising its lasting impact. Over 40,000 colleagues have completed our Mental Health e-learning and we’re training 2,500 colleagues to become Mental Health Advocates by 2020. In July, Lloyds Bank was the first organisation to sign up to the Mental Health Accessibility Standards, which were developed to help companies support customers with mental health problems.
Disability Percentage of colleagues who disclose they have a disability 2.8% 1.7%
Environmental matters Environmental (TCFD) statement – Reflecting the needs of our stakeholders, pages 20 and 26
– Reflecting the needs of our stakeholders, pages 20 and 26
1 Certain Group Policies, internal standards and guidelines are not published externally.
The Group’s balance sheet remains strong with lending growth in the open mortgage book as well as targeted segments, including SME and UK Motor Finance. This was more than offset by lower balances in Mid Markets and Global Corporates, primarily as a result of the optimisation of the Commercial portfolio, as well as continued reductions in the closed mortgage book. The Group’s capital position remains strong with a pro forma CET1 ratio of 15.0 per cent pre dividend accrual and 13.8 per cent post dividend.
2 Excludes reverse repos of £54.6 billion (31 December 2018: £40.5 billion).
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Retail operates a multi-brand and multi-channel strategy. It continues to simplify its business and provide more transparent products, helping to improve service levels and reduce conduct risks, whilst working within a prudent risk appetite.
Branch net promoter score up 5 points with around 50 per cent of customer facing time being spent on complex needs
Reduced complaints (excluding PPI) by 13 per cent in 2019 and mobile app NPS increased 3 per cent since 2017
Completed the integration of MBNA, realising a return on investment of 18 per cent, ahead of original target
Risk-weighted assets increased by 5 per cent mainly driven by mortgage model refinements and the Tesco acquisition 1 Subject to contract.
Through its segmented client coverage model, it provides clients with a range of products and services such as lending, transaction banking, working capital management, risk management and debt capital markets.
Awarded ‘Business Bank of the Year’ at the FDs’ Excellence Awards for the 15th consecutive year
Digitising the Group Cash management and payments API launched, allowing clients to send faster payments directly from their systems without human intervention and reducing payment times to 1.5 seconds
Beat the sustainability target of supporting energy efficient improvements for a further one million square feet of commercial real estate in 2019 and have supported renewable energy projects capable of powering 5 million homes by the end of 2019
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2019 39
Our wealth management joint venture with Schroders harnesses the unique strengths of two of the UK’s strongest financial services businesses.
Scottish Widows now offers its standard annuities on the open market allowing a wider range of customers to access the product and secure income for retirement. Aiming to achieve a 15 per cent market share by end of 2020
Maximising Group capabilities Schroders Personal Wealth launched with ambition of becoming a top 3 financial planning business by end of 2023
Wealth income and operating costs impacted by the transfer of assets to Schroders Personal Wealth in October 2019
In September 2019, Scottish Widows launched its standard annuity into the open market enabling a wider range of customers to access the product.
Provide colleagues and stakeholders with a single point of reference for risk management understanding, and supporting reference sources
The governance framework supports a consistent approach to enterprise-wide behaviour and decision-making.
Effective risk analysis, management and reporting Regular close monitoring and comprehensive reporting to all levels of management and the Board ensures appetite limits are maintained and subject to stress analysis at a risk type and portfolio level, as appropriate
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2019 41
Accountability Risk management is a team effort with all colleagues playing their part and taking full individual responsibility for their actions.
The Group continues its drive to deliver a leading customer experience whilst managing a varied change portfolio. Focus on improvements to the control environment and managing within risk appetite has enabled the safe delivery of change.
The need to protect existing processes and minimise adverse impact on colleagues and clients will support the delivery of a leading customer experience.
Managing risk means making the right decisions and doing the right thing for customers. It is at the heart of our Code of Responsibility and supports our aim to be the best bank for customers António Horta-Osório Group Chief Executive
Example Ineffective risk management could lead to vital services not being available to customers and stakeholders.
Mitigation The Group has increased its focus on operational resilience and has updated its strategy to reflect changing priorities of both customers and regulators
The risk that parties with whom we have contracted fail to meet their financial obligations (both on or off balance sheet).
Stage 3 loans and advances as a % of total 2018: 1.9%
The risk that we fail to provide an appropriate colleague and customer-centric culture, supported by robust reward and wellbeing policies and processes; effective leadership to manage colleague resources; effective talent and succession management; and robust control to ensure all colleague-related requirements are met.
Mitigation General Insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements broadly spread over different reinsurers
Risk Appetite We maintain a prudent liquidity profile and a balance sheet structure that limits our reliance on potentially volatile sources of funding.
Mitigation The Group manages and monitors liquidity risks and ensures that liquidity risk management systems and arrangements are adequate with regard to the internal risk appetite, Group strategy and regulatory requirements
We maintain a strong funding position in line with our low risk strategy, and the loan to deposit ratio remains within our target range
Risk Appetite We maintain capital levels commensurate with a prudent level of solvency and aim to deliver consistent and high quality returns to shareholders.
The Group maintains a recovery plan which sets out a range of potential mitigating actions that could be taken in response to a stress
The risk of financial loss, regulatory censure, reputational damage or customer detriment, as a result of deficiencies in the development, application and ongoing operation of Models and Rating Systems.
We actively manage our exposure to movements in market rates, to drive lower volatility earnings and offer a comprehensive customer proposition with hedging strategies to support strategic aims. Mitigating actions are implemented to reduce the impact of market movements, resulting in a more stable capital position Effective interest rate and inflation hedging has kept volatility in the Group’s defined benefit pension schemes low. This combined with improved market conditions has helped keep the schemes in IAS 19 surplus in 2019. This allows us to more efficiently utilise available capital resources
Trading surplus was resilient at £8,822 million (2018: £9,003 million) with lower net income partly offset by the Group’s continued progress in delivering cost reductions. Underlying profit was £7,531 million compared to £8,066 million in 2018, reflecting lower net income and higher impairment charges, partly offset by the Group’s strong cost performance. The Group’s market-leading underlying return on tangible equity was 14.8 per cent.
1 Net of profits on disposal of operating lease assets of £41 million (2018: £60 million).
The Group manages the risk to its earnings and capital from movements in interest rates centrally by hedging the net liabilities which are stable or less sensitive to movements in rates. As at 31 December 2019 the Group’s structural hedge had a nominal balance of £179 billion (31 December 2018: £180 billion) and an average duration of around three years (31 December 2018: around four years). The Group generated £2.7 billion of income from the structural hedge balances in 2019 (2018: £2.7 billion). Within this, the benefit from the hedge in the year was £1.1 billion over LIBOR (2018: £1.4 billion) with a fixed earnings rate of approximately 0.7 per cent over LIBOR (2018: 0.7 per cent).
Operating lease depreciation increased by 1 per cent reflecting some weakening in used car prices through the first three quarters of 2019, partly offset by a lower fleet size.
Total costs of £8,320 million were 5 per cent lower than in 2018, driven by the reduction in both operating costs and remediation charges.
The Group expects operating costs in 2020 to be less than £7.7 billion with the cost:income ratio lower than in 2019.
Overall credit performance in the secured book remains strong with the average mortgage loan to value increasing slightly to 44.9 per cent (31 December 2018: 44.3 per cent). New business average loan to value was 64.3 per cent and 88 per cent of the portfolio has a loan to value ratio of less than 80 per cent. New to arrears as a proportion of the total book remains low in both the secured and unsecured books. In Commercial Banking, the book continues to benefit from low interest rates and effective risk management, including a prudent approach to vulnerable sectors.
The PPI provision charge of £2,450 million was largely due to the significant increase in PPI information requests (PIRs) leading up to the deadline for submission of claims on 29 August 2019, and also reflects costs relating to complaints received from the Official Receiver as well as administration costs. An initial review of around 60 per cent of the five million PIRs received in the run-up to the PPI deadline has been undertaken, with the conversion rate remaining low, and consistent with the provision assumption of around 10 per cent. The Group has also reached final agreement with the Official Receiver. The unutilised provision at 31 December 2019 was £1,578 million.
In 2020, the Group expects an increased statutory return on tangible equity of 12 to 13 per cent, driven by resilient underlying profit and lower below the line charges.
Capital used for the acquisition of the Tesco Bank’s mortgage portfolio (bps) (9) Ordinary dividend accrual (bps) (123)
The transitional total capital ratio reduced to 21.5 per cent on a pro forma basis (31 December 2018: 23.1 per cent) and the Group’s transitional minimum requirement for own funds and eligible liabilities (MREL), which came into force on 1 January 2020, is 32.6 per cent on pro forma basis (31 December 2018: 32.6 per cent). The UK leverage ratio remains strong at 5.2 per cent on a pro forma basis.
Tangible net assets per share reduced by 2.2 pence in 2019 to 50.8 pence (31 December 2018: 53.0 pence) with the effects of the Group’s statutory profit after tax and positive cash flow hedge movements being more than offset by dividends paid in 2019, the revaluation of the Group’s retirement benefit obligations, the effects of the share buyback and other reserve movements.
Dividend The Group has a progressive and sustainable ordinary dividend policy whilst maintaining the flexibility to return surplus capital through buybacks or special dividends.
Final date for joining or leaving the dividend reinvestment plan 20 November 2020
Lloyds Banking Group Annual Report and Accounts 2019 53 Strateg ic rep ort
3 Excludes repos of £9.5 billion (31 December 2018: £1.8 billion).
4 Capital build is reported on a pro forma basis, reflecting the dividend paid up by the Insurance business in the subsequent first quarter period and is also reported before accruing for ordinary dividends, the cancellation of the remaining 2019 share buyback and the acquisition of Tesco Bank’s UK prime residential mortgage portfolio.
Statutory profit (loss) after tax1 1,019 (238) 1,025 1,200 766 1,423 1,146 1,171
Underlying return on tangible equity 12.2% 14.3% 15.6% 17.0% 13.6% 15.9% 17.3% 15.4%
Pro forma risk-weighted assets4 £203bn £209bn £207bn £208bn £206bn £207bn £207bn £211bn
Lloyds Banking Group Annual Report and Accounts 2019 55 Strateg ic rep ort
Risk-weighted assets £93.5bn £86.5bn £1.2bn £25.2bn £206.4bn 1 Excludes reverse repos.
3 Prior period segmental comparatives restated to reflect the transfer of the Cardnet business from Retail into Commercial Banking and certain equities business from Commercial Banking into Central items.
Underlying basis In order to allow a comparison of the Group’s underlying performance, the results are adjusted for certain items including restructuring, severance related costs, the rationalisation of the non-branch property portfolio, the establishment of the Schroders partnership, the integration of MBNA and Zurich’s UK workplace pensions and savings business, volatility and other items, which includes the effects of certain asset sales, the volatility relating to the Group’s hedging arrangements and that arising in the insurance businesses, insurance gross up, the unwind of acquisition related fair value adjustments and the amortisation of purchased intangible assets and payment protection insurance provisions.
Lloyds Banking Group Annual Report and Accounts 2019 57 Strateg ic rep ort
Risk-weighted assets 98.4 93.5 5 1 Prior period comparatives restated to reflect the transfer of the Cardnet business from Retail into Commercial Banking.
1 Prior period segmental comparatives restated to reflect the transfer of the Cardnet business from Retail into Commercial Banking and certain equities business from Commercial Banking into Central items.
Lloyds Banking Group Annual Report and Accounts 2019 59 Strateg ic rep ort
3 Equivalent regulatory view of ratio (including With Profits funds) at 31 December 2019 was 154 per cent (31 December 2018: 156 per cent).
During 2019, impairment included releases relating to the reassessment of credit risk associated with debt instruments held within the Group’s equity investments business.
Lloyds Banking Group Annual Report and Accounts 2019 61 Strateg ic rep ort
Lloyds Banking Group Annual Report and Accounts 2019 63 Strateg ic rep ort
Add back amortisation of intangible assets (post tax) (£m) 364 296
Add back amortisation of purchased intangible assets (post tax) (£m) 74 111
Share buyback During 2019, the Group completed £1.1 billion of the announced up to £1.75 billion share buyback programme, with an average price paid of 57.89 pence per share. Through a reduction in the weighted average number of ordinary shares in issue, share buybacks have the effect of increasing earnings per share and, depending on the average price paid per share, can either increase or decrease the tangible net assets per share. The 2019 share buyback had the effect of increasing the earnings per share by 0.1 pence and decreasing the tangible net assets per share by 0.2 pence.
Total number of employees 63,069 64,927 1 2018 figures restated to reflect the Group’s current structure.
Board and Committee changes Succession planning and the composition of the Board and its committees are important components of good governance. There were a number of changes to the Board and Committees during the year. George Culmer retired as Chief Financial Officer and Executive Director of the Group on 1 August 2019 and was succeeded by William Chalmers, who brought a wealth of experience to the Group. George was a crucial member of the team that helped turn Lloyds around and left with our thanks and best wishes for the future.
3. Alan Dickinson Senior Independent Director Appointed: September 2014 (Board), December 2019 (Senior Independent Director) Skills, experience and contribution: Highly regarded retail and commercial banker Strong strategic, risk and core banking experience Regulatory and public policy experience Alan has 37 years’ experience with the Royal Bank of Scotland, most notably as Chief Executive of RBS UK. Alan was a Non-Executive Director of Willis Limited and Chairman of its Risk Committee. He was formerly Chairman of Brown, Shipley & Co. Limited, a Non-Executive Director of Nationwide Building Society, where he was Chairman of its Risk Committee and a Governor of Motability. External appointments: Chairman of Urban&Civic plc and Non-Executive Director of England and Wales Cricket Board.
Group Plc as well as Chairman of the Financial Services Practitioner Panel and the Financial Conduct Authority’s Financial Advice Working Group. He was previously a Member of the BBC Trust and Chairman of the BrittenPears Foundation. External appointments: Chairman of Reach plc (formerly Trinity Mirror plc) and of their Nomination Committee. He is also Chairman of the Royal Northern College of Music and a member of the Board of Opera Ventures.
9. Stuart Sinclair Independent Director Appointed: January 2016 Skills, experience and contribution: Extensive experience in retail banking, insurance and consumer finance Governance and regulatory experience Significant experience in strategic planning and implementation Experience in consumer analysis, marketing and distribution Stuart is a former Non-Executive Director of TSB Banking Group plc, TSB Bank plc, LV Group, Virgin Direct and Vitality Health (formerly Prudential Health). He was previously the Interim Chairman of Provident Financial plc and a former Senior Independent Director of Swinton Group Limited. In his executive career, he was President and Chief Operating Officer of Aspen Insurance after spending nine years with General Electric as Chief Executive Officer of the UK Consumer Finance business then President of GE Capital China. Before that he was Chief Executive Officer of Tesco Personal Finance and Director of UK Retail Banking at the Royal Bank of Scotland. He was a Council member of The Royal Institute for International Affairs (Chatham House). External appointments: Senior Independent Director and Chair of the Risk & Capital Committee at QBE UK Limited (formerly QBE Insurance (Europe) Limited).
13. Juan Colombás Executive Director and Chief Operating Officer Appointed: November 2013 (Board), January 2011 to September 2017 (Chief Risk Officer), September 2017 (Chief Operating Officer) Skills, experience and contribution: Significant banking and risk management experience International business and management experience Juan is responsible for leading a number of critical Group functions and driving the transformation activities across the Group in order to build the Bank of the Future. He was previously the Chief Risk Officer and an Executive Director of Santander’s UK business. Prior to this, he held a number of senior risk, control and business management roles across the Corporate, Investment, Retail and Risk Divisions of the Santander Group. He was previously the Vice Chairman of the International Financial Risk Institute. External appointments: Member of the FCA Practitioner Panel.
Group Executive Committee Delivering our vision and managing a more agile organisation 1. Carla Antunes da Silva Group Strategy, Corporate Development and Investor Relations Director Appointed: June 2018 (GEC attendee) Skills and experience: Carla joined the Group in October 2015 and led the 2018 to 2020 Group Strategic Review and, prior to that, the work on the Bank of the Future. Carla is responsible for supporting senior management with strategic decision making such as recommendations on mergers, acquisitions/disposals and corporate ventures, and also manages the Group’s relationships with shareholders, analysts and the wider investment community. Prior to that Carla spent 18 years as an equity analyst leading the European Banks research team, with coverage of UK banks at Credit Suisse, JPMorgan and Deutsche Bank. Carla currently serves as a Non-Executive Director of Lloyds Bank Corporate Markets plc.
2. John Chambers Group Chief Information Officer Appointed: June 2018 (GEC attendee) Skills and experience: John joined the Group in February 2015 as Chief Information Officer for Group Operations, Functions and Enterprise and was appointed as the Group’s Chief Information Officer in September 2017. During the course of his career, John has been responsible for delivering large scale IT solutions, building teams that can operate at scale and working as part of global operating environments such as Barclays, Capita and Indian headquartered IT and business process outsourcing firms.
Kate joined the Group in 2005 from Linklaters, where she was a corporate lawyer specialising in mergers and acquisitions transactions. Before her current role, Kate held a number of senior positions including Deputy Group General Counsel and General Counsel for Group Legal. Kate is a trustee of the Lloyds Bank Foundation for England and Wales and is a Non-Executive Director of Scottish Widows.
7. Zak Mian Group Director, Transformation Appointed: August 2016 (GEC) Skills and experience: Zak joined the Group in 1989 as a Business Analyst in IT and has carried out multiple roles involving Retail CIO, Head of IT Architecture and leading the Digital Transformation programme. He was appointed Group Director, Digital and Transformation in 2016 and his responsibilities increased in September 2017 as the Group Director, Transformation. He is responsible for the digital transformation of the Group, including all IT and business change, and ensuring we are ready to meet the future expectations of our customers.
8. David Oldfield Group Director, Commercial Banking Appointed: May 2014 (GEC) Skills and experience: David was appointed as Group Director for the Commercial Banking division in September 2017 responsible for supporting corporate clients from SMEs and Mid Corporates through to Large Corporates and Financial Institutions. David started his career with Lloyds Bank in 1986 on the graduate entrant programme and has held a number of key leadership roles across all Divisions of the Group since that time. Immediately prior to his current role he was
9. Janet Pope Chief of Staff and Group Director, Responsible Business and Inclusion Appointed: January 2015 (GEC) Skills and experience: Janet joined the Group in 2008 to run the Savings business. She was previously Chief Executive at Alliance Trust Savings, prior to which she was EVP Global Strategy at Visa International. Janet spent 10 years at Standard Chartered Bank where she held a variety of roles including Retail Banking MD for Africa and non-executive directorships at Standard Chartered Bank Zimbabwe, Kenya, Zambia and Botswana. Janet is Chair of the Charities Aid Foundation Bank and a Non-Executive Director of the Banking Standards Board. She is also the Group’s Executive Sponsor for Sexual Orientation and Gender Identity.
13. Andrew Walton Group Corporate Affairs Director Appointed: September 2018 (GEC) Skills and experience: Andrew joined the Group in September 2018, as Group Corporate Affairs Director, with responsibility for internal and external communications, reputation management and public affairs. Prior to joining the Group, Andrew was Senior Managing Director and Global Head of Financial Services for the strategic communications segment of FTI Consulting.
Board and Committee composition and attendance at scheduled meetings in 20196
3 Sarah Legg joined the Board and respective Committees on 1 December 2019. There were no meetings in December 2019.
6 Where a Director is unable to attend a meeting s/he receives papers in advance and has the opportunity to provide comments to the Chairman of the Board or to the relevant Committee Chairman.
The Board is supported by its Committees which make recommendations on matters delegated to them under the Corporate Governance Framework, in particular in relation to Board appointments, internal control risk, financial reporting, governance and remuneration issues.
The Non-Executive Directors also receive regular updates from the Group Chief Executive’s office including a weekly email which gives context to current issues. In-depth and background materials are regularly provided via a designated area on the secure electronic Board portal.
Board venues are agreed and colleagues in the areas that the Board will visit are engaged at both senior management and operational level
Templates and guidelines are included within targeted training for authors of papers to ensure consistency and high quality of information
Meeting packs are uploaded and communicated to all Directors via a secure electronic Board portal typically a week in advance of the meeting to ensure sufficient time to review the matters which are to be discussed and seek clarification or any additional information
Topics for deep dives or additional items are discussed when required and include business, governance and regulatory updates
The Board makes full use of technology such as video conferencing, teleconferencing, a Board portal and tablets/devices in its meeting arrangements. This leads to greater flexibility, security and efficiency in Board paper distribution and meeting arrangements
This page 72 and page 73 show the key focus areas of the Board during the year and highlight the link between those focus areas and our strategic objectives. Also listed are stakeholder groups central to the matters considered and decisions taken.
Discussed conduct, culture and values – culture dashboard and change management
Received reports on responsible business including on climate change matters and sustainability
Link to strategic priorities: Link to stakeholder groups: Colleagues; Regulatory and Government; Shareholders
Discussed the annual review of customer conduct framework and risk Link to stakeholder groups: Customers; Regulatory and Government
Approved the payment of final and interim dividends Link to stakeholder groups: Shareholders
Approved the launch of a share buyback programme and its subsequent curtailment as conditions changed Link to stakeholder groups: Shareholders
Received an annual update on pension scheme valuations Link to stakeholder groups: Customers
Reviewed and approved the corporate governance framework Link to stakeholder groups: Shareholders
Reviewed and approved various Group policies including the signing authorities, and Board and GEC dealing policy Link to stakeholder groups: Colleagues; Regulatory and Government
Approved attestation of ring-fencing compliance Link to stakeholder groups: Customers; Regulatory and Government
Considered whistleblowing updates Link to stakeholder groups: Colleagues; Customers; Regulatory and Government
Held discussions with the PRA Link to stakeholder groups: Regulatory and Government
Two strategy away days to review the progress in implementing the Group’s strategy
Link to strategic priorities: Link to stakeholder groups: Customers; Shareholders; Colleagues; Community and Environment; Regulatory and Government; Suppliers
Link to strategic priorities: Link to stakeholder groups: Customers; Colleagues; Regulatory and Government
Link to strategic priorities: Link to stakeholder groups: Customers; Shareholders; Suppliers
Simplifying and improving our ways of working, through focusing on key colleague journeys
ther inform ation 2020 marks the beginning of a new policy period that must remain relevant for three years. This offered the opportunity for a fresh look. Stuart Sinclair Non-Executive Director and Chairman, Remuneration Committee
Customer insight sessions with workstream teams in research labs and other locations (see page 79 for more information)
Insurance sub-group under Scottish Widows Group Limited (including Scottish Widows Limited)
The Credit Disputes team shared with António the success it has had in improving the customer journey for credit card disputes. António was able to see the difference this transformation has made for customers by dialling into a live credit dispute call.
October 2019 Detailed questionnaire issued to all Directors by the Company Secretary
January 2020 Draft report discussed by the Company Secretary with the Chairman.
Subsequently the Board will consider the recommendations and agree an action plan.
Progress against the 2018 external Board effectiveness review During the year, work focused particularly on the Board becoming more outwardly focused and ensuring that the Board agenda was less rooted in regulatory compliance and risk mitigation. A summary of the Board’s progress against the actions arising from the 2018 effectiveness review are set out below.
Executive Director performance reports continue to evolve towards flagging issues and priorities
Regular competition reports to include more on the activities of new competitors
Requirement for Board and Committee Chairmen to be more directive when required
Further streamline meeting papers and agendas to enable more expansive discussion
Look at ways to better leverage individual Non-Executive Director skills and experience
Lord Blackwell was joined all day on this visit by Kendall Akhurst, a colleague from Group Transformation. As a strong advocate for, and member of, the Group’s Access network, which supports colleagues with disabilities, Kendall was particularly interested in the visit to the Birmingham Disability Resource Centre (BDRC). The BDRC is one of the many charities the Group supports through its charitable Foundations and provides support for people with all kinds of disabilities. Lord Blackwell spent time hearing about the wide range of support BDRC has received from the Group and also from people who use the centre and their experience of the Journey to Work scheme, which aims to help people turn their lives around by building up their confidence and self-esteem to get back into work.
The visit ended with a recognition dinner for 25 colleagues to celebrate how they have truly lived the Group’s values and what they have done to embody the Group’s purpose of Helping Britain Prosper.
The UK Corporate Governance Code 2018 (the ‘Code’) applied to the financial year ended 31 December 2019. The Group confirms that it applied the principles and complied with all the provisions of the Code throughout the year except in relation to that part of provision 36 that provides that the remuneration committee should develop a formal policy for post-employment shareholding requirements encompassing both unvested and vested shares. Whilst the Remuneration Committee has not introduced a formal post-employment shareholding policy, the existing reward structure ensures that Executive Directors will continue to meet the Group’s shareholding requirements for a minimum of two years after leaving the Group. On this basis, the Group believes that it already complies with best practice and with the spirit of provision 36 notwithstanding the fact that a specific formal policy has not been introduced. Please refer to pages 100 and 108 for a more detailed explanation of the Group’s approach to post-employment shareholding requirements. The Code is publicly available at www.frc.org.uk. This page and the following page explain how we have applied the principles and related provisions of the Code during the year. The alphabetical references in the paragraphs below correspond to the principles, and related provisions, of the Code. The Group has adopted the UK Finance Code for Financial Reporting Disclosure and its 2019 financial statements have been prepared in compliance with its principles.
António Horta-Osório manages and leads the Group on a day-to-day basis, making decisions on matters affecting the operation and performance of the Group’s business and the delivery of the Board’s approved strategy. He delegates aspects of his authority, as permitted under the Corporate Governance Framework, to other members of the Group Executive Committee.
The Non-Executive Directors challenge management constructively and help develop and set the Group’s strategy. They actively participate in Board decision-making and scrutinise management performance.
2 Sarah Legg joined the Board with effect from 1 December 2019.
Dear Shareholder I am pleased to report on the activity of the Nomination and Governance Committee (the ‘Committee’) during 2019.
At an Executive level, the Committee considered the overall health of the Executive talent pipeline, together with detailed Executive succession planning aimed at supporting the development of executives for the Bank of the Future. Further detail on succession planning can be found on page 84.
As part of the decision to appoint Sarah Legg and Catherine Woods to the Board, diversity was considered in its broadest sense. These appointments bring strong banking and asset management experience to the Group.
As noted, the Board places high emphasis on ensuring the development of diversity in senior management roles within the Group and supports and oversees the Group’s objectives of achieving 40 per cent of senior roles held by female executives by 2020, and of 8 per cent of senior roles being held by BAME executives by 2020. This is underpinned by a range of policies within the Group to help provide mentoring and development opportunities for female and BAME executives and to ensure unbiased career progression opportunities. Progress on this objective is monitored by the Board and built into its assessment of executive performance. As at 31 December 2019, female representation within senior management and their direct reports was 31.1 per cent in total (29.4 per cent and 31.3 per cent respectively). Female representation across all senior roles was 36.8 per cent, and BAME representation in senior roles was 6.7 per cent.
The role of succession planning in promoting diversity is recognised and the Group has a range of policies which promote the engagement of underrepresented groups within the business in order to build a diverse talent pipeline.
During the year, the Committee also considered the adequacy of succession arrangements for key senior management roles, also taking into consideration the changing opportunities as the shape of the Group continues to evolve through delivery of the Group’s strategy. The Chairman is responsible for developing and maintaining a succession plan for the Group Chief Executive who is, in turn, primarily responsible for developing and maintaining succession plans for key leadership positions in the senior executive team.
In establishing criteria for the new appointments, the Committee considered a number of factors including the collective Board’s technical and governance skill set, anticipated retirements in 2020 and 2021 based on current FRC Code guidance, and support for the Group’s diversity objectives.
Further meetings for selected candidates were held with other members of the Board.
Dear Shareholder I am pleased to report on how the Group Audit Committee (the ‘Committee‘) has discharged its responsibilities throughout 2019.
Reports from management were considered on the ongoing application of IFRS 9, including challenge of management judgements underpinning credit impairment provisions. The Committee also oversaw the successful implementation of IFRS 16, which was adopted by the Group on 1 January 2019, and received updates from the project to implement IFRS 17, which is expected to be effective for the 2022 financial year.
The Committee continued to oversee the role of Group Internal Audit, with particular focus on the key risk themes across the Group, including the transformation programmes, which continue to play an increasingly important role in the Group’s strategy.
During the course of the year, the Committee held separate sessions with the internal and external audit teams, without members of the executive management present. For details of how the Committee was run, see page 71.
Whilst the Committee’s membership comprises the Non-Executive Directors noted on page 70, all Non-Executive Directors may attend meetings as agreed with the Chairman of the Committee. The Group Financial Controller, Chief Internal Auditor, the external auditor, the Group Chief Executive, the Chief Financial Officer, the Chief Risk Officer and the Chief Operating Officer also attend meetings as appropriate. Details of Committee membership and meeting attendance can be found on page 70.
The Committee reviewed management’s assumptions used to calculate the Group’s provision for PPI redress and associated administration costs. The overall cost remains uncertain and the Committee considered management’s use of sensitivities used to evaluate this uncertainty.
The Committee’s consideration of PPI is discussed further on page 87.
The Committee reviewed the process used by management to determine an appropriate discount rate and considered the other critical assumptions underlying the calculation of the defined benefit liabilities, including those in respect of inflation and mortality.
The Committee agreed with management’s judgement that the deferred tax assets were appropriately supported by forecast taxable profits, taking into account the Group’s long-term financial and strategic plans. The disclosures relating to deferred tax are set out in note 37: ‘Deferred tax’ of the financial statements. The Group’s net deferred tax asset at 31 December 2019 was £2,622 million (31 December 2018: £2,453 million).
The Committee was satisfied that the provisions and disclosures made in respect of uncertain tax positions were appropriate. The relevant disclosures are set out in note 48: ‘Contingent liabilities, commitments and guarantees’ of the financial statements.
Lloyds Banking Group Annual Report and Accounts 2019 87 Lloyds Banking Group Annual Report and Accounts 2019 87 Strateg ic rep ort
Determining the appropriate accounting for certain oneoff transactions requires management to assess the facts and circumstances specific to each transaction.
The relevant disclosures are set out in note 23 of the financial statements.
The Committee noted that the principal impact of the standard on the Group was to recognise property leases ‘on-balance sheet’ rather than as operating leases. The Committee was satisfied that the disclosures made in respect of IFRS 16 in the Group’s financial statements were appropriate.
The Committee received an update on the Group’s IFRS 17 implementation project, which noted that, whilst the effective date of the standard is expected to be deferred, the Group will broadly maintain its existing timetable for elements of the programme that will improve processes. The Committee also noted the progress made to date on the IT development and actuarial models. The Committee was satisfied with the Group’s progress and its disclosure included in note 56 to the financial statements setting out the impact of accounting standards that were not effective for the Group at 31 December 2019.
The Directors are required to confirm whether they have a reasonable expectation that the Company and the Group will be able to continue to operate and meet their liabilities as they fall due for a specified period. The viability statement must also disclose the basis for the Directors’ conclusions and explain why the period chosen is appropriate.
The extent of the work undertaken by the Finance teams across the Group to ensure that the control environment continued to operate effectively
Approved the annual audit plan and budget, including resource and reviewed progress against the plan through the year
Statutory Audit Services compliance The Company and the Group confirm compliance with the provisions of The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014 (the Order) for the year to 31 December 2019. PwC has been auditor to the Company and the Group since 1995, and will continue as auditor until the year ending 31 December 2020.
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All Non-Executive Directors are members of the Committee. The Chief Risk Officer has full access to the Committee and attends all meetings. The Chief Internal Auditor and members of the Executive also attend meetings, as appropriate.
CiFD The Committee continues to focus closely on the Group’s management of conduct risks and issues associated with customers in financial difficulty.
During 2019, the Committee considered reports on the ongoing activity to improve the way we support customers experiencing financial difficulty.
The Committee continues to focus on ensuring the Group has an effective framework for managing complaints including root cause analysis to establish lessons learned and help prevent similar issues in the future. Consideration has been given to complaint metric performance via Board Risk Appetites and quality as measured by the Financial Ombudsman Service.
The Committee noted the actions in train, including defining solutions to allow vulnerability information to be recorded and shared, the continued development of vulnerability dashboards and enhancements to the control framework along with the proposals for an enhanced approach to investment prioritisation for vulnerability initiatives.
Conclusion: The Committee will continue to closely monitor climate change and sustainability risks, looking at the impact on both the Group and our customers, and the delivery of TCFD and other commitments.
Detailed reviews allowed the Committee to assess the overall quality of the portfolio and new business written. Risk levels and credit exposure, including to material individual names, were monitored with reference to management information and risk appetite limits, as appropriate.
Conclusion: Overall Commercial Banking credit quality remained broadly stable. Origination quality has been maintained, supported by a consistent through-the-cycle approach to risk appetite. The portfolio continues to be monitored closely with consideration given to the macroeconomic outlook and emerging trends.
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Data risk The Committee continues to focus on data governance, privacy and data ethics risks including oversight of the Group’s compliance with the General Data Protection Regulation (GDPR), and the associated risks and controls.
Throughout 2019, the Committee has continued to focus on the People risk profile, recognising the challenges faced with successfully delivering the Group’s strategic agenda, alongside the regulatory change agenda. The Group recognises the increasing demands on colleagues and is focusing on the ongoing monitoring of colleague wellbeing and engagement, and on developing colleague skills to achieve capability enhancement for a digital era. Particular consideration is given to critical populations and high performing individuals to support the Group’s core commitments. The Group has also made significant progress in evolving and refining the compliance control environment for the Senior Manager and Certification Regime (SMCR) and delivery of the SMCR extension was completed in 2019.
Conclusion: Regular monitoring continues to confirm that the People risk profile is managed effectively. The Committee ensures the necessary risk oversight as the Group continues to deliver simplified colleague processes and maximises colleague skills and potential to achieve the workforce of the future.
The Group has matured in its ability to define, measure and report execution risk. The articulation and quantification of this risk continues to embed through regular reviews of the execution risk dashboard and its metrics, as well as the implementation of the change and execution risk library.
An area of focus has been on increasing understanding of the wider risk impacts of the initiatives that are driving investment funding decisions and the impact of GSR3 on the Group’s risk profile. For instance, as GSR3 is transforming both ways of working and colleague journeys, there is a deeper understanding of the impact of those changes on People risk.
The key risks for the Group include volatility and possible discontinuities in financial markets, impact on our customers’ trading performance, financial position and credit profile, and ability to continue to operate in line with current practice across borders.
Financial Crime is a priority for the UK Government, law enforcement and regulators. The Committee continues to monitor the Group’s management of financial crime risk in light of continued legislative change and regulatory scrutiny.
Additionally, the Committee acknowledged the leading role the Group has played in the development of an industry code for authorised push payment fraud. The code was implemented in May 2019 and the Group has demonstrated compliance and good customer outcomes. Some operational improvements, expectations from the Financial Ombudsman’s Service regarding the provision of warnings and the issue of funding cases where neither the financial institution nor the customer is to blame continue to be addressed.
The Committee has continued focus on ensuring effective controls and oversight to comply with existing regulatory obligations, as well as receiving regular updates on emerging regulatory and legal risks. There have been ongoing significant regulatory change and oversight programmes in which the Board has placed increased focus to ensure successful execution, including the Basel Committee on Banking Supervision (BCBS 239), IBOR Transition, EU Exit, product pricing, customers in financial difficulty, HBOS Reading and climate change.
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The Group made good progress against targets in the Helping Britain Prosper Plan. Some examples, set out later on this page, include the launch of a unique Resilience portal to support colleagues mental health.
The Group continued to support its UK-wide Charitable Foundations, showcasing the work they do, including with domestic abuse and mental health charities.
The Committee regularly reviewed progress on our aim to have more women in senior roles. It also discussed the Group’s opportunity and plans to advance the representation of colleagues from BAME backgrounds at all levels.
The following report gives more examples of our activity to Help Britain Prosper in 2019. I hope you find it both interesting and informative.
The Committee’s Chair reviews the forward agenda regularly to ensure that the focus of the Committee’s work is on its key priorities and members have sufficient time at meetings to raise issues of concern and to engage in constructive dialogue with colleagues.
Directors’ and Officers’ liability insurance Throughout 2019 the Group had appropriate insurance cover in place to protect Directors, including the Director who retired during the year, from liabilities that may arise against them personally in connection with the performance of their role.
Change of control The Company is not party to any significant agreements which take effect, alter or terminate upon a change of control of the Company following a takeover bid. There are no agreements between the Company and its Directors or employees providing compensation for loss of office or employment that occurs because of a takeover bid.
The Company undertook an ordinary share buyback programme, which was launched on 1 March 2019, until it was cancelled in September 2019 as a result of the additional PPI charges announced in September. The programme repurchased in aggregate 1,886,917,377 ordinary shares for an aggregate consideration of c.£1.1 billion (aggregate nominal value of the ordinary shares £188,691,737.70) as a means by which to return capital to shareholders, given the amount of surplus capital. The 2019 ordinary share buyback also assisted in the normalisation of ordinary dividends. All of the repurchased ordinary shares were cancelled, and together represented 2.69 per cent of the called up share capital of the Company at completion of the programme. Further information in relation to the 2019 ordinary share buyback programme is provided on page 63.
Share capital and restrictions on the transfer of shares or voting rights
In addition, the Board obtains independent assurance from Risk Division over the alignment of the plan with Group strategy and the Board’s risk appetite. This assessment performed by Risk Division also identifies the key risks to delivery of the Group’s operating plan
The planning process is also underpinned by a robust capital and funding stress testing framework. This framework allows the Group to assess compliance of the operating plan with the Group’s risk appetite
The scenarios used for stress testing are designed to be severe but plausible, and take account of the availability and likely effectiveness of mitigating actions that could be taken by management to avoid or reduce the impact or occurrence of the underlying risks. In considering the likely effectiveness of such actions, the conclusions of the Board’s regular monitoring and review of risk and internal control systems, as discussed on page 79, is taken into account. Further information on stress testing and reverse stress testing is provided on page 137 to 138
The principal risks, including the Group’s objectives, policies and processes for managing credit, capital, liquidity and funding, are provided in the risk management section on pages 129 to 187
GHG emissions (CO2e) per £m of underlying income (Market Based)1 5.6 6.2 16.4
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Emissions in tonnes CO2e in line with the GHG Protocol Corporate Standard (2004) including revised Scope 2 guidance (2015) which discloses a Market Based figure in addition to the Location Based figure.
The measure and reporting criteria for Scope 1, 2, 3 emissions is provided in the Lloyds Banking Group Reporting Criteria available online at www.lloydsbankinggroup.com/our-group/responsible-business
Omissions Emissions associated with joint ventures and investments are not included in this disclosure as they fall outside the scope of our operational boundary. The Group does not have any emissions associated with imported heat, steam or imported cooling and is not aware of any other material sources of omissions from our reporting.
A copy of the financial statements is placed on our website at www.lloydsbankinggroup.com/investors/financial-performance. The Directors are responsible for the maintenance and integrity of the Company’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
The management report contained in the strategic report and the Directors’ report includes a fair review of the development and performance of the business and the position of the Company and the Group together with a description of the principal risks and uncertainties they face
Remuneration Content Chairman’s statement and remuneration policy overview pages 98 to 102
This represents a significant investment of approximately £20 million per annum in our colleagues and aligns the employer contributions available to the wider workforce with those of Executive Directors. At the same time, the Group supports the third largest private sector defined benefit (DB) scheme accruing benefits for a further 16,000 current colleagues.
Clarity Remuneration should be easy to explain and be viewed as fair
As a result of the new Policy, the Group Chief Executive’s fixed pay will reduce by 8 per cent and his maximum total remuneration opportunity by 29 per cent
How we have responded to your feedback Executive remuneration should be re-evaluated in the context of colleagues as a whole.
The proposed Policy for 2020 reduces the maximum total compensation opportunity for the Group Chief Executive by 29 per cent
Variable pay should be truly variable and not managed within a corridor without being closely aligned with outcomes.
The information below summarises Executive Director remuneration for the 2018 and 2019 performance years. Full details are provided in the Single total figure of remuneration table on page 103.
George Culmer Former Chief Financial Officer 1 Jan-1 Aug 2019 £3.43m £1.95m –
What: – We are changing the release schedule from five to three years.
– No award can be made if threshold performance is not met by the Group or the individual.
What: – There will be no change in maximum opportunities, however expected value for performance in line with target will change to 50 per cent of maximum. Why: – We believe the GPS award is an effective short term variable reward opportunity.
– Vesting will be subject to the achievement of performance conditions measured over a period of three years.
Why: – The proposed structure provides greater alignment to the delivery of the strategic aims for the Group. Please see our Policy FAQs on pages 101 to 102 for further understanding of our rationale for the LTSP and how it is structured.
Q Why did the Committee decide that the three underpins chosen for the plan are the most appropriate?
Our new variable reward structure The Group’s purpose is to support our customers, colleagues and communities and to Help Britain Prosper. The Group’s business model is to be a low risk UK bank and rewards for the executive management team in that business should reflect and encourage the steady creation of shareholder value over the long-term, best measured through the share price. The long-term sustainable success of the business is driven by meeting the needs of different stakeholders and our proposed move to Long Term (restricted) Share awards within our revised variable reward structure supports these strategic aims. We have set out why we believe the implementation of this new approach is now appropriate for the Group and aligns to our business model in our Policy FAQs on page 101.
In light of the Chief Operating Officer, Juan Colombás’ retirement announcement in 2020, an illustration has not been provided here.
Actual ordinary dividend payments do not fall below stated progressive policy in any year of the vesting period
1 William Chalmers was awarded a full year Group Performance Share award of £195,528 which has been pro-rated to reflect five months as an Executive Director for the purpose of the table above. Awards for William Chalmers and George Culmer will be made in March 2020 in a combination of cash and shares. 40 per cent will be released in the first year following the award with £2,000 paid in cash, and the balance of the upfront 40 per cent delivered in shares; 50 per cent of which will be subject to holding until March 2021. The remaining 60 per cent is deferred into shares with 40 per cent vesting in 2021 and 20 per cent in 2022. 50 per cent of each release will be subject to a further 12-month holding in line with regulatory requirements.
2 The 2017 Group Ownership Share (GOS) vesting (see page 106) at 49.7 per cent and dividend equivalents awarded in shares were confirmed by the Remuneration Committee at its meeting on 18 February 2020. The total number of shares vesting were 2,643,386 and 425,413 shares delivered in respect of dividend equivalents for António Horta-Osório, 1,467,137 shares vesting and 236,113 shares delivered in respect of dividend equivalents for Juan Colombás and 1,322,490 shares vesting and 212,834 shares delivered in respect of dividend equivalents for George Culmer. This award was pro-rated to reflect George’s leave date. William Chalmers was not granted a 2017 GOS award. The average share price between 1 October 2019 and 31 December 2019 (59.34 pence) has been used to indicate the value. The shares were awarded in 2017 based on a share price of 68.814 pence and as such no part of the reported value is attributable to share price appreciation.
The awards are subject to a vesting schedule and retention periods that match the vesting schedule and retention periods of the awards forfeited and as a result, the awards vest in tranches until January 2022. The awards were granted pursuant to Listing Rule 9.4.2, and in accordance with the regulatory requirements for buy-outs and are subject to clawback. Clawback will also apply to any awards exercised prior to the first anniversary of employment.
Cash allowance in lieu of pension contribution 418,865 198,735 82,806 129,892
Change Execution Risk 92.2% green and 6.4% red Green <75% and Red >15% Green >92.5% and Red <5%
Application of adjustments for risk, conduct and other factors. The overall pool was reduced by £107.3 million to reflect the impact of conduct-related provisions and regulatory fines received during 2019. £107.3m Overall GPS pool £310.1m
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Further investment and improvements delivered in the Group’s operational resilience, resulting in a c.30% reduction in critical incident occurrences in 2019
Juan Colombás Chief Operating Office – – – 100% – –
1 The overall GPS pool of £310.1 million was 28.1 per cent below the target pool of £431.2 million. Therefore, a downward adjustment of 28.1 per cent was applied to the award recommendations of William Chalmers and George Culmer.
Payments for loss of office (audited) George Culmer retired as Chief Financial Officer and an Executive Director with effect from 1 August 2019 and retired from the Group on 2 August 2019.
No other Executive Director served as a Non-Executive Director in 2019.
Comparison of returns to shareholders and GCE total remuneration The chart below shows the historical total shareholder return (TSR) of Lloyds Banking Group plc compared with the FTSE 100 as required by the regulations.
António Horta-Osório – – 62% 71% 54% 57% 77% 77% 67.60% –
Amanda Mackenzie OBE 63,567 – – – – 63,567 63,567 n/a
Shareholding requirements (audited) Executives are expected to build and maintain a company shareholding in direct proportion to their remuneration in order to align their interests to those of shareholders. The minimum shareholding requirements Executive Directors are expected to meet are as follows: 350 per cent of base salary for the GCE and 250 per cent of base salary for other Executive Directors. Newly appointed individuals will have three years from appointment to achieve the shareholding requirement. In the event that exceptional individual circumstances exist resulting in an Executive not being able to comply with the Policy, the Remuneration Committee will consider whether an exception should apply.
2. 2016 LTIP award was eligible to receive an amount equal in value to any dividends paid during the performance period. Dividend equivalents have been paid based on the number of shares vested and have been paid in shares. The dividend equivalent shares were paid on 7 March 2019. The closing market price of the Group’s ordinary shares on that date was 62.15 pence. The dividend equivalent shares are not subject to any holding period.
5. The number of Shares in respect of the 2017 and 2018 GOS Awards are stated in full and will be reduced to reflect the period from the start of the Performance Period to the date of leaving (2 August 2019) at the point of vest in accordance with the appropriate plan rules.
Statutory economic profit3 Set relative to 2021 targets Threshold: £2,210m Maximum: £3,315m
Cost:income ratio Set relative to 2021 targets Threshold: 45.9% Maximum: 43.4%
Threshold: +5% vs. 2021 UK Norm Maximum: +2% vs. 2021 UK High Performing Norm 1 FCA reportable complaints per 1,000 accounts.
The Committee considers the specific targets that apply to 2020 to be commercially sensitive but will provide information on the level of payout relative to the performance achieved in next year’s annual report on remuneration.
For the 2020 performance year, any Group Performance Share opportunity will be awarded in March 2021 in a combination of cash (up to 50 per cent) and shares. 40 per cent will be released in the first year following the award with £2,000 paid in cash, and the balance of the upfront 40 per cent delivered in shares; 50 per cent of which will be subject to holding until March 2022. The remaining 60 per cent is deferred into shares with 40 per cent vesting in 2022 and 20 per cent in 2023. 50 per cent of each release will be subject to a further 12-month holding in line with regulatory requirements.
The maximum Group Ownership Share award for Executive Directors is 300 per cent of salary and the Remuneration Committee has the ability to grant an award up to 400 per cent of salary for exceptional circumstances for the Group Chief Executive. Following confirmation that the Chief Operating Officer (COO) is due to retire in 2020, no award will be made.
Awards will be subject to a three-year performance period with vesting between the third and seventh anniversary of award, on a prorata basis. Any shares released are subject to a further holding period in line with regulatory requirements and market practice. Meeting threshold performance will result in 25 per cent vesting of each metric, relative to each weighting.
Statutory economic profit1 Set relative to 2022 targets Threshold: £1,965m Maximum: £2,948
Threshold: +5% vs UK norm Maximum: +2% vs UK High Performing Norm 1 A measure of profit taking into account expected losses, tax and a charge for equity utilisation.
The reduction in the pay gap can be attributed to an improvement in female representation across the Bank, with an increase in the proportion of female colleagues in senior roles. The proportion of women in the upper pay quartile for the Group has increased. We are pleased to see that our efforts have started to decrease our gender pay gap, however we are aware that there continue to be more men in senior roles. Addressing female representation across the Bank will take time and we are committed to achieving our gender targets that will have an impact on our pay gaps in future years. Further information is available at: www.lloydsbankinggroup.com/globalassets/our-group/responsible-business/reporting-centre/lloydsbanking -group-gender-pay-gap-report-2019.pdf
2019 A 179:1 128:1 71:1 114:1 82:1 47:1 2018 A 237:1 169:1 93:1 113:1 81:1 48:1 2017 A 245:1 177:1 97:1 113:1 82:1 48:1
Notes to the calculation: The 2019 total remuneration for the colleagues identified at P25, P50 and P75 are as follows: £26,419, £36,975, £66,944
All other data has been calculated in line with the methodology for the single total figure of remuneration for the Group Chief Executive
Statement of voting at Annual General Meeting The table below sets out the voting outcome at the Annual General Meeting in May 2019 in relation to the annual report on remuneration and the Remuneration Policy, last voted on in 2017.
Directors’ remuneration policy (binding vote in 2017) 47,673 98.03% 959 1.97% 535
Comfortable that the Directors’ Remuneration Policy worked effectively in 2019, ensuring that there was true alignment between pay and performance notwithstanding that there were areas of development to consider when designing the new Policy
Key highlights: Delivery of the Group’s new performance management approach ‘Your Best’ and colleague understanding of the link between performance and reward.
Oversight 2020 Colleague Pension Policy and how the changes support the Group’s culture.
It is intended that approval of the Remuneration Policy will be sought at three-year intervals, unless amendments to the Policy are required, in which case further shareholder approval will be sought. Information on how the Policy will be implemented in 2020 is included in the annual report on remuneration.
The objective of the Policy is to align individual reward with the Group’s performance, the interests of its shareholders and a prudent approach to risk management. In this way, the requirements of the major stakeholders are balanced: customers, shareholders, employees, and regulators.
The policy is based on principles which are applicable to all employees within the Group and, in particular, the principle that the reward package should support the delivery of the Group’s purpose of Helping Britain Prosper and the strategic aim of becoming the best bank for customers whilst delivering long-term superior and sustainable returns to shareholders. It fosters performance in line with the Group’s values and behaviours, encourages effective risk disciplines and is in line with relevant regulations and codes of best practice.
Decision making process for determining the Policy and consideration of stakeholder views In formulating the Policy, the Remuneration Committee has consulted extensively with a number of stakeholders including institutional shareholders and the Group’s main regulators, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). A formal consultation on the remuneration of Executive Directors was not undertaken with colleagues. However, constructive engagement with the Group's recognised Unions took place on key elements of the reward package and the unions continue to play a valuable role in representing colleagues across the Group. The Committee also increased its level of oversight on remuneration matters for colleagues and the wider workforce in 2019, receiving overviews and analysis on key reward matters on a quarterly basis to support decisions in relation to executive remuneration.
Operation Base salaries are typically reviewed annually with any increases normally taking effect from 1 January for existing Executive Directors and 1 April for future appointments. When determining and reviewing base salary levels, the Committee takes into account base salary increases for employees throughout the Group and ensures that decisions are made within the following two parameters: – An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective job-sizing methodologies.
Salary may be paid in sterling or other currency and at an exchange rate determined by the Committee.
Operation Executive Directors are entitled to participate in the Group’s defined contribution scheme with company contributions set as a percentage of salary. An individual may elect to receive some or all of their pension allowance as cash in lieu of pension contribution.
Measures consist of both financial and non-financial measures and the weighting of these measures will be determined annually by the Committee. The weightings of the performance measures for the 2020 financial year are set out for 2019 on page 110. All assessments of performance are ultimately subject to the Committee’s judgement, but no award will be made if threshold performance (as determined by the Committee) is not met for financial measures or the individual receives a score of 2.6 out of 5 or below. The normal ‘target’ level of the Group Performance Share is 50 per cent of maximum opportunity.
Changes The normal ‘target’ level of the Group Performance Share has changed to 50 per cent of maximum opportunity from 30 per cent.
Maximum potential The maximum Long Term Share Plan opportunity is 200 per cent of base salary for all Executive Directors including the GCE.
Performance measures An award may be granted by the Remuneration Committee taking into account an assessment of performance of the Company, any Member of the Group or business unit or team, and/or the performance, conduct or capability of the Participant, on such basis as the Committee determine. The normal ‘target’ level of the Long Term Share award is 150 per cent of base salary.
No further performance conditions will apply. However vesting will be subject to the underpins and Remuneration Committee discretion as described above.
To exercise discretion in accordance with the rules, including in relation to whether or not malus or clawback provisions would apply, in connection with recruitment, or terminations of employment, or corporate events affecting the Company
Legacy awards and restrictions on payments Awards in respect of the Group Performance Share and under the long-term incentive Group Ownership share will be granted in 2020 under the terms of the Directors’ remuneration policy approved by shareholders on 11 May 2017 (the “2017 Policy”). No further awards would be made under the long-term incentive Group Ownership share (or the terms of the 2017 Policy) unless the new Long Term Share Plan 2020 was not approved by shareholders. The Committee reserves the right to make any remuneration payments/awards and any payments/awards for loss of office, notwithstanding that they are not in line with the policy set out above where the terms of the payment/award were agreed (i) before the 2017 policy came into effect; (ii) pursuant to the 2017 policy; or (iii) at a time when the relevant individual was not a Director of the Group and, in the opinion of the Committee, the payment/award was not in consideration for the individual becoming a Director of the Group. Such payments/awards will have been set out in the annual report on remuneration for the relevant year. They include awards and payments made under previous approved remuneration policy and payments in relation to deferred Group Performance Share awards and long-term incentive’ Group Ownership share awards granted in 2018, 2019 and, as referred to above, 2020.
Illustration of application of remuneration policy The charts below illustrate possible remuneration outcomes under the following three scenarios: 1. The maximum that may be paid, assuming full Group Performance Share payout and full vesting under the new Long Term Share plan. For the Long Term Share Plan, an indication of the maximum remuneration receivable assumes a share price appreciation of 50 per cent during the period in which the award is subject to underpins. The basis of the calculation of the share price appreciation is that the share price embedded in the calculation for the ‘maximum’ bar chart is assumed to increase by 50 per cent across the performance period.
Transitional arrangements for overseas hires, which might include relocation expenses and accommodation
Under terms agreed when joining the Group, Juan Colombás is entitled to a conditional lump sum benefit, payable either (i) on reaching normal retirement age unless he voluntarily resigns or is dismissed for cause, or (ii) on leaving due to long-term sickness or death, as described further in the annual report on remuneration.
At any time, at its absolute discretion, the Group may elect to terminate the individual’s employment by paying to the Executive Director, in lieu of the notice period, an amount equivalent to base salary, subject to mitigation as described more fully in the termination payments section of this report
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Awards vest on the original vesting date (or exceptionally on the date of leaving). Vesting is subject to the underpins and time pro-rating (for months worked in underpin period). Malus and clawback will apply.
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Remuneration policy table for Chairman and Non-Executive Directors The table below sets out the remuneration policy for Non-Executive Directors (NEDs).
The Group has applied the EBA Delegated Regulation (EU) No 604/2014 to determine which colleagues should be identified as MRTs. MRTs are colleagues who are considered to have a material impact on the Group’s risk profile, and include, but are not limited to: Senior management, Executive Directors, members and attendees of the Group Executive Committee (GEC) and their respective executive level direct reports
Further detail can be found in the DRR and the DRP. In particular, see pages 104 to 106, 110 to 111 and 117.
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attendees of the GEC and their respective direct reports – Approved Persons performing SIFs and/or all colleagues performing a Senior Management Function – Other MRTs – Non-MRTs 1 Eligibility based on seniority, grade and role.
Further information on deferral, vesting and performance adjustment can be found in the DRR on pages 110 and 111 and 118 of the DRP.
Takers4 1 Converted to Euros using the exchange rate €1 = £0.8518 (average exchange rate 1 December 2019 – 31 December 2019 based on the European Commission Budget exchange rates). The exchange rate used for 2018 was €1 = £0.89135.
2 Values for LTIP/Group Ownership Share awards based on expected value at grant pre the application of the EBA discount factor. (50 per cent of granted LTIP/GOS before apply EBA discount required Inclusive of uplift in response to prohibition of dividend equivalents).
3 Values for LTIP/Group Ownership Share awards based on expected value at the date of grant pre the application of the EBA discount factor.
Table 5 Other payments awarded in relation to the 2019 performance year Guaranteed bonuses Sign-on awards Severance payments
3 Reference to the ‘Management Body’ relates to Executive Directors only. Non-Executive Directors are not eligible to receive variable remuneration.
The Group's approach to risk 130 Emerging risks 133 Risk governance 135 Capital stress testing 137 Full analysis of risk categories 138
Further information on risk management can be found: Risk overview 40 Note 53: Financial risk management 289 Pillar 3 report: www.lloydsbankinggroup.com
Green Resource Engineering A designer and manufacturer of cooling systems has delivered a £1.1 million export order to South Korea thanks to support from Lloyds Bank. Green Resource Engineering (GRE) in Devon, won the contract to supply the country’s largest smart energy supplier, marking the first time GRE has exported directly to South Korea.
This full risk management section provides a more in-depth picture of how risk is managed within the Group, detailing the Group’s emerging risks, approach to stress testing, risk governance, committee structure, appetite for risk and a full analysis of the principal risk categories (pages 138 to 187), the framework by which risks are identified, managed, mitigated and monitored.
Governance is maintained through delegation of authority from the Board to individuals through the management hierarchy. Senior executives are supported by a committee based structure which is designed to ensure open challenge and support effective decision-making.
The Group’s risk appetite, principles, policies, procedures, controls and reporting are regularly reviewed and updated where needed to ensure they remain fully in-line with regulation, law, corporate governance and industry good practice.
The process for risk identification, measurement and control is integrated into the overall framework for risk governance. Risk identification processes are forward-looking to ensure emerging risks are identified. Risks are captured and measured using robust and consistent quantification methodologies. The measurement of risks includes the application of stress testing and scenario analysis, and considers whether relevant controls are in place before risks are incurred.
Identified risks are reported on a monthly basis or as frequently as necessary to the appropriate committee. The extent of the risk is compared to the overall risk appetite as well as specific limits or triggers. When thresholds are breached, committee minutes are clear on the actions and timeframes required to resolve the breach and bring risk within tolerances. There is a clear process for escalation of risks and risk events.
All business areas complete a Control Effectiveness Review (CER) annually, reviewing the effectiveness of their internal controls and putting in place a programme of enhancements where appropriate. The CER reports are approved at divisional risk committees or directly by the relevant member of the Group Executive Committee to confirm the accuracy of the assessment. This key process is overseen and independently challenged by Risk division, reviewed by Group Internal Audit against the findings of its assurance activities, and reported to the Board. No significant failings or weaknesses were identified during the 2019 review.
Risk culture Based on the Group’s conservative business model, prudent approach to risk management, and guided by the Board, the senior management articulates the core risk values to which the Group aspires, and sets the tone at the top, with a strong focus on building and sustaining long-term relationships with customers, through the economic cycle. The Group’s Code of Responsibility reinforces colleagues’ accountability for the risks they take and their responsibility to prioritise their customers’ needs.
Table 1.1: Exposure to risk arising from the business activities of the Group The table below provides a high level guide to how the Group’s business activities are reflected through its risk-weighted assets. Details of the business activities for each division are provided in the Financial Performance Overview on pages 37 to 39.
Principal risks The Group’s principal risks are shown in the risk overview (pages 42 to 46). The Group’s emerging risks are shown overleaf. Full analysis of the Group’s risk categories is on pages 138 to 187.
Regulatory and legal: The financial sector continues to experience increasing regulation from various bodies, including government and regulators.
Regulatory rules and laws from both the UK and overseas may affect the Group’s operation, placing pressure on expert resource and investment priorities.
– The Group Chief Risk Officer (CRO) has assumed responsibility for identifying and managing the risks arising from climate change, alongside the CROs for key legal entities. – We are integrating risk management of financial risks posed by climate change in our existing enterprise risk management framework, including our policies, risk appetite and controls. – We continue to support customers and clients in managing the financial risks from the UK’s transition to a low carbon economy.
Increases in geopolitical tensions increase the indirect threat of a sophisticated attack on the Group. The capability of organised crime groups is growing rapidly, which along with the commoditisation of cyber-crime increases the likelihood that the Group or one of its suppliers will be the direct target of a sophisticated attack. This increases the risk of the Group’s exposure through its supply chain.
Political uncertainties including EU trade deal: Following the UK’s exit from the EU, significant negotiation is now required on the terms of the future trade agreement. As a result, the possibility of a limited or no deal at the end of the transition period remains and could manifest in prolonged business uncertainty across the UK, including in the financial services sector. This continued lack of clarity over the UK’s relationship with the EU and other foreign countries, and ongoing challenges in the Eurozone, including weak growth, raise additional uncertainty for the UK’s economic outlook. There also remains the possibility of a further referendum on Scottish independence.
– Entities established in the EU ensure continuity of certain business activities; contingency planning in relation to wider areas of impact.
Operational complexity has the potential to restrict our speed of response to market trends. Inability to leverage data and innovate could lead to loss of market share as challengers capitalise on Open Banking. Timely delivery of GSR3 objectives remains key to addressing the competitive challenges facing the Group.
– The Group is transforming the business to improve customer experience by digitising customer journeys and leveraging branches for complex needs, in response to customers’ evolving needs and expectations.
– The Group is responsive to changing customer behaviour/business models and adjusts its risk management approach as appropriate.
– GSR3 is designed to support the Group to strengthen its competitive position.
– The Group has implemented Open Banking and actively monitors implications for our customers, including protection from fraud.
– High levels of liquidity provided by central banks has boosted asset values and reduced spreads across a wide range of assets, but creates vulnerability to a sharp correction if the global economy turns down. – Wide array of risks considered in setting strategic plans. – Capital and liquidity are reviewed regularly through committees, ensuring compliance with risk appetite and regulatory requirements. – The Group has a robust through the cycle credit risk appetite, including appropriate product, sector and single name concentration parameters, robust sector appetite statements and policies, as well as affordability and indebtedness controls at origination. In addition to ongoing focused monitoring, portfolio deep dives are conducted and regular larger exposure reviews. Enhancements have been made to our use of early warning indicators, including sector-specific indicators.
– Risk appetite criteria limit single counterparty exposures complemented by a UK-focused strategy.
– The Chief Security Office develops and maintains a framework for external incidents, including financial stability, to ensure the incident response team convenes and acts as a rapid reaction group, should an external crisis occur.
The increase in execution only propositions due to digitisation may lead to increased conduct risk where customers (including vulnerable customers) choose unsuitable products. Our approach to customer segmentation will need to ensure conduct and reputational risks are well managed.
– Digital principles are being agreed across the Group, primarily aimed at preventing material conduct residual risk and giving customers an optimal, informative and fair buying journey to mitigate the increased risks.
– Technology risks, including those related to machine learning, are escalated and discussed through governance to ensure ongoing monitoring of any emerging unintended consequences.
– The Group is working closely with the Bank of England initiated Working Group on Sterling Risk-Free Reference Rates on the transition away from LIBOR in the UK.
– Maintaining close engagement with the FCA on potential impacts. – Working closely with industry bodies to understand and manage the impact of benchmark transition in other geographies.
– Implementing an internal communication strategy to ensure that all staff are aware and have the tools and training required.
Table 1.3: Executive and Risk Committees The Group Chief Executive is supported by the following: Committees Risk focus
Provides a Group-wide perspective of customer experience and the governing body of customer plans and targets including governing targets and plans, oversight of customer outcomes and experience, and learning through best practice externally and leveraging Group memberships and partnerships.
Recommends and implements the strategy and plans for delivering the Group’s aspiration to be viewed as a trusted responsible business as part of the purpose of Helping Britain Prosper.
Responsible for monitoring the progress of transformation across the Group, acting as a clearing house to resolve issues and facilitate resolution of issues where necessary and to drive the execution of the Group’s transformation agenda as agreed by the Group Chief Executive.
Group Model Governance Committee Responsible for approving the model governance framework, the associated policy and related principles and procedures; reviewing and approving models, model changes, model extensions and capital post model adjustments; recommending those models which require GRC approval to GRC; approving summary of model performance, approving any appropriate corrective actions; and supporting approval of risk appetite performance and escalating as required.
Support the Internal Capital Adequacy Assessment Process (ICAAP) by demonstrating capital adequacy, and meet the requirements of regulatory stress tests that are used to inform the setting of the Prudential Regulation Authority (PRA) and management buffers (see capital risk on pages 166 to 175) of the Group and its separately regulated legal entities
Risk Mitigation: Drive the development of potential actions and contingency plans to mitigate the impact of adverse scenarios. Stress testing also links directly to the recovery planning process of the Group and its legal entities
The Group Financial Risk Committee (GFRC), chaired by the Chief Risk Officer and attended by the Chief Financial Officer and other senior Risk and Finance colleagues, is the committee that has primary responsibility for overseeing the development and execution of the Group’s and RingFenced Bank’s stress tests. Lloyds Bank Corporate Markets (LBCM) Risk Committee performs a similar function within the scope of LBCM.
Risk categories recognised by the Group are periodically reviewed to ensure that they reflect the Group risk profile in light of internal and external factors, such as the Group strategy and the regulatory environment in which it operates. There have been no changes to the risk categories during 2019.
The implementation of effective governance and control frameworks to ensure adequate controls are in place to manage the change activity and act to mitigate the change and execution risks identified. These controls are monitored in line with the Change policy and any additional monitoring that is deemed necessary
When personal data is not gathered legally, for a legitimate purpose, or is not managed/protected from misuse and/or processed in a way that complies with General Data Protection Regulations (GDPR) and other data privacy regulatory obligations
When data records are not created, retained, protected and destroyed appropriately and when data records cannot be retrieved in a timely manner
Delivering increased level of data maturity against the Data Management Capability Assessment Model
The Group failing to upgrade its IT systems and leaving them vulnerable to failure
Effective operational resilience ensures the Group designs resilience into its systems, is able to withstand and/or recover from a significant unexpected event occurring and can continue to provide services to its customers. A significant outage could result in customers being unable to access accounts or conduct transactions, which as well as presenting significant reputational risk for the Group would negatively impact the Group’s purpose of Helping Britain Prosper. Operational resilience is also an area of continued regulatory and industry focus, similar in importance to financial resilience.
Conduct risk – an operational resilience failure may render the Group liable to fines from the FCA for poor conduct
People: the Group acknowledges the risks associated to the failure to maintain appropriately skilled and available colleagues. The Group continues to optimise its approach to ensure that where applicable, colleagues are capable of supporting a critical business process. Key controls and processes are regularly reported to committee(s) and alignment to the Group Strategic Review is closely monitored
Measurement The Group assesses and monitors the impact of the strategic risk implications of new business, product entries and other strategic initiatives, as part of the business planning processes and stress testing scenarios.
Continued focus on increasing the efficiency of the Group’s operations to ensure investment capacity, responsiveness and effectiveness to respond to external trends
Development of a compelling colleague proposition to continue to attract talent to the Group
Exposures The principal sources of credit risk within the Group arise from loans and advances, contingent liabilities, commitments, debt securities and derivatives to customers, financial institutions and sovereigns. The credit risk exposures of the Group are set out in note 53 on page 289.
Additionally, credit risk arises from leasing arrangements where the Group is the lessor. Note 2(J) on page 210 provides details on the Group’s approach to the treatment of leases.
The investments held in the Group’s defined benefit pension schemes also expose the Group to credit risk. Note 36 on page 253 provides further information on the defined benefit pension schemes’ assets and liabilities.
Credit risk is measured from different perspectives using a range of appropriate modelling and scoring techniques at a number of levels of granularity, including total balance sheet, individual portfolio, pertinent concentrations and individual customer – for both new business and existing lending. Key metrics, such as total exposure, risk-weighted assets, new business quality, concentration risk and portfolio performance, are reported monthly to Risk Committees.
As the third line of defence, Group Internal Audit undertakes regular risk-based reviews to assess the effectiveness of Credit risk management and controls.
Mitigation The Group uses a range of approaches to mitigate Credit risk.
Specialist expertise: credit quality is managed and controlled by a number of specialist units within the business and Risk division, which provide for example: intensive management and control; security perfection; maintenance of customer and facility records; expertise in documentation for lending and associated products; sector-specific expertise; and legal services applicable to the particular market segments and product ranges offered by the Group.
Stress testing: the Group’s credit portfolios are subject to regular stress testing. In addition to the Group led, PRA, EBA and other regulatory stress tests, exercises focused on individual divisions and portfolios are also performed. For further information on stress testing process, methodology and governance see page 137.
The requirement for collateral and the type to be taken at origination will be based upon the nature of the transaction and the credit quality, size and structure of the borrower. For non-retail exposures if required, the Group will often seek that any collateral include a first charge over land and buildings owned and occupied by the business, a debenture over the assets of a company or limited liability partnership, personal guarantees, limited in amount, from the directors of a company or limited liability partnership and key man insurance. The Group maintains policies setting out which types of collateral valuation are acceptable, maximum loan to value (LTV) ratios and other criteria that are to be considered when reviewing an application. Other than for project finance, object finance and income-producing real estate where charges over the subject assets are required, the provision of collateral will not determine the outcome of an application. Notwithstanding this, the fundamental business proposition must evidence the ability of the business to generate funds from normal business sources to repay a customer or counterparty’s financial commitment, rather than reliance on the disposal of any security provided.
The Group requires collateral to be realistically valued by an appropriately qualified source, independent of both the credit decision process and the customer, at the time of borrowing. In certain circumstances, for Retail residential mortgages this may include the use of automated valuation models based on market data, subject to accuracy criteria and LTV limits. Where third-parties are used for collateral valuations, they are subject to regular monitoring and review. Collateral values are subject to review, which will vary according to the type of lending, collateral involved and account performance. Such reviews are undertaken to confirm that the value recorded remains appropriate and whether revaluation is required, considering for example, account performance, market conditions and any information available that may indicate that the value of the collateral has materially declined. In such instances, the Group may seek additional collateral and/or other amendments to the terms of the facility. The Group adjusts estimated market values to take account of the costs of realisation and any discount associated with the realisation of the collateral when estimating credit losses.
Refer to note 53 on page 289 for further information on collateral.
The Group also assesses the affordability and sustainability of lending for each borrower. For secured lending this includes use of an appropriate
Where credit acceptance scorecards are used, new models, model changes and monitoring of model effectiveness are independently reviewed and approved in accordance with the governance framework set by the Group Model Governance Committee.
Additional mitigation for Commercial customers Individual credit assessment and independent sanction of customer and bank limits: with the exception of small exposures to SME customers where certain relationship managers have limited delegated sanctioning authority, credit risk in commercial customer portfolios is subject to sanction by the independent Risk division, which considers the strengths and weaknesses of individual transactions, the balance of risk and reward, and how credit risk aligns to the Group and Divisional risk appetite. Exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities and risk based recommended maximum limit parameters. Approval requirements for each decision are based on a number of factors including, but not limited to, the transaction amount, the customer’s aggregate facilities, credit policy, risk appetite, credit risk ratings and the nature and term of the risk. The Group’s credit risk appetite criteria for counterparty and customer loan Underwriting is generally the same as that for loans intended to be held to maturity. All hard loan/bond Underwriting must be sanctioned by Risk division. A pre-approved credit matrix may be used for ‘best efforts’ underwriting.
Counterparty credit limits: limits are set against all types of exposure in a counterparty name, in accordance with an agreed methodology for each exposure type. This includes credit risk exposure on individual derivatives and securities financing transactions, which incorporates potential future exposures from market movements against agreed confidence intervals. Aggregate facility levels by counterparty are set and limit breaches are subject to escalation procedures.
Daily settlement limits: settlement risk arises in any situation where a payment in cash, securities or equities is made in the expectation of a corresponding receipt in cash, securities or equities. Daily settlement limits are established for each relevant counterparty to cover the aggregate of all settlement risk arising from the Group’s market transactions on any single day. Where possible, the Group uses Continuous Linked Settlement in order to reduce FX settlement risk.
Other credit risk transfers The Group also undertakes asset sales, credit derivative based transactions, securitisations (including Significant Risk Transfer transactions), purchases of credit default swaps and purchase of credit insurance as a means of mitigating or reducing credit risk and/or risk concentration, taking into account the nature of assets and the prevailing market conditions.
The Group classifies accounts as forborne at the time a customer in financial difficulty is granted a concession. Non-performing exposures can be reclassified as Performing Forborne after a minimum 12 month cure period, providing there are no past due amounts or concerns regarding the full repayment of the exposure. A minimum of a further 24 months must pass from the date the forborne exposure was reclassified as Performing Forborne before the account can exit forbearance. If conditions to exit forbearance are not met at the end of this probation period, the exposure shall continue to be identified as forborne until all the conditions are met.
The Group’s treatment of loan renegotiations is included in the impairment policy in note 2(H) on page 209.
Stage 2 loans as a proportion of total loans and advances to customers reduced by 0.1 percentage points to 7.7 per cent (31 December 2018: 7.8 per cent). Stage 2 loans and advances were broadly flat at £38.4 billion
Stage 2 expected credit loss allowances as a percentage of drawn balances (coverage) decreased to 3.7 per cent (31 December 2018: 4.1 per cent), largely driven by a reduction in expected credit loss (ECL) allowances in SME due to an enhanced approach to loan amortisation within the IFRS 9 model and a number of other model refinements
Stage 3 loans as a proportion of total loans and advances to customers fell to 1.8 per cent (31 December 2018: 1.9 per cent), with Stage 3 loans and advances down £0.5 billion to £8.8 billion. Coverage of Stage 3 assets reduced by 1.8 percentage points to 22.5 per cent, largely as a result of a the improved performance of mortgage cases in longterm default , and a change in the mix of Commercial assets due to a combination of write-offs and the transfer in of cases with lower likelihood of net loss
Expected credit loss allowance on drawn balances (3,259) (675) (995) (1,447) (142)
Expected credit loss allowances (drawn and undrawn) as a percentage of gross lending (%)2 0.8 0.2 3.7 22.5
Table 1.11: Group expected credit loss allowances (drawn and undrawn) as a percentage of loans and advances to customers (statutory basis)
Retail The credit quality of the Retail portfolios remains strong and continues to benefit from robust credit risk management, including affordability and indebtedness controls at origination and a prudent approach to risk appetite. The economic environment continues to benefit from high employment rates, positive real wage growth and household indebtedness remaining below pre-crisis levels
Loans and advances increased to £345 billion (31 December 2018: £343 billion)
The impairment charge increased to £1,038 million in 2019 compared to £861 million in the same period in 2018, driven by a number of items including some weakening in used car prices, provisioning methodology refinements and lower cash recoveries following prior year debt sales, partially offset by releases following a reassessment of cases in long-term default and repossession and improvements in the Secured portfolio
ECL allowance as a percentage of drawn balances for Stage 3 decreased to 19.1 per cent (31 December 2018: 19.7 per cent) following a reassessment of Secured cases in long-term default. Coverage for Stage 2 is also broadly stable at 3.6 per cent (31 December 2018: 3.9 per cent)
The average indexed loan to value (LTV) remained broadly stable at 44.9 per cent (31 December 2018: 44.3 per cent) and the proportion of balances with an LTV of greater than 90 per cent remained broadly flat at 2.5 per cent (31 December 2018: 2.4 per cent). The average LTV of new business increased to 64.3 per cent (31 December 2018: 62.5 per cent). The Group entered into a risk transfer transaction of £1 billion worth of higher LTV new business in 2019, which was awarded Transaction of the Year at the 2019 SCI Capital Relief Trades Awards
The motor finance portfolio continued to grow in 2019, with loans and advances increasing by 7.0 per cent to £16.0 billion (31 December 2018: £14.9 billion). The portfolio continues to benefit from a prudent approach to residual values at origination and provisions through the loan lifecycle. Residual value provisions, which are included in ECL allowances for Stage 1 and Stage 2, have increased to £201 million at 31 December 2019 (31 December 2018: £99 million). This is due to an anticipated increase in residual value deficits following some weakening in used car prices, a change in approach relating to the recognition of voluntary terminations and book growth. As a result of this, the impairment charge increased to £203 million for 2019 (2018: £113 million) and coverage for the portfolio increased to 2.4 per cent (31 December 2018: 1.9 per cent)
Asset quality ratio 0.30% 0.25% 5bp 1 Unsecured includes Credit cards, Loans and Overdrafts.
Expected credit loss allowance on drawn balances (1,961) (563) (766) (490) (142)
3 Stage 3 ECL allowances as a percentage of drawn balances are calculated excluding loans in recoveries for unsecured of £184 million (31 December 2018: £233 million) and £21 million (31 December 2018: £17 million) for Business Banking in Other.
Expected credit loss allowances (drawn and undrawn) as a percentage of gross lending (%)4 0.8 0.2 3.6 19.1
3 UK Motor Finance for Stages 1 and 2 include £201 million (31 December 2018: £99 million) relating to provisions against residual values of vehicles subject to finance leasing agreements. These provisions are included within the calculation of coverage ratios.
Table 1.21: Retail expected credit loss allowances (drawn and undrawn) as a percentage of loans and advances to customers (underlying basis)
2 These balances exclude the impact of the HBOS and MBNA acquisition related adjustments.
Table 1.25: Mortgages greater than three months in arrears (excluding repossessions, underlying basis)
The stock of repossessions increased to approximately 1,150 cases at 31 December 2019 compared to approximately 750 cases at 31 December 2018.
2 Average loan to value is calculated as total loans and advances as a percentage of the total indexed collateral of these loans and advances; the balances exclude the impact of the HBOS acquisition adjustments.
For existing interest only mortgages, a contact strategy is in place during the term of the mortgage to ensure that customers are aware of their obligations to repay the principal upon maturity of the loan.
As a percentage of loans and advances, forbearance loans improved to 1.9 per cent at 31 December 2019 (31 December 2018: 2.2 per cent).
3 2019 balances include MBNA, 2018 balances have been restated on the same basis.
Expected credit loss allowances (drawn and undrawn) as a percentage of gross lending (%) 1.4 0.1 4.2 27.4
Table 1.32: Commercial Banking expected credit loss allowances (drawn and undrawn) as a percentage of loans and advances to customers
At 31 December 2018 1 Includes client-specific indicators not reflected within quantitative PD assessments.
Approximately 60 per cent of loans and advances to UK Direct Real Estate relate to commercial real estate with the remainder related to residential real estate. The portfolio continues to be heavily weighted towards investment real estate (c.90 per cent) over development
We provide colleague training on environmental risk management as part of the standard suite of Commercial Banking credit risk courses. To support this training, a range of online resources are available to colleagues, including environmental risk theory, procedural guidance, and information on environmental legislation and sector-specific environmental impacts. We also continue to partner with the Cambridge Institute for Sustainability Leadership to provide high quality training to executives and colleagues focused on risk management, product development and in clientfacing roles.
Risk department conducts thematic reviews of regulatory compliance and provides oversight of regulatory compliance assessments across businesses and divisions where appropriate
Exposures The Group faces significant conduct risks, which affect all aspects of the Group’s operations and all types of customers.
Conduct risks can impact directly or indirectly on our customers and could materialise from a number of areas across the Group, including: Business and strategic planning that does not sufficiently consider customer needs
Due to the level of enhanced focus on conduct, there is a risk that certain aspects of the Group’s current or legacy business may be determined by the Financial Conduct Authority, other regulatory bodies or the courts as not being conducted in accordance with applicable laws or regulations, in a manner that fails to deliver fair and reasonable customer treatment, or is inconsistent with market integrity or competition requirements.
Continuous embedding of the customer vulnerability framework. Development and continued oversight of the implementation of the vulnerability strategy continues through the Group Customer Vulnerability Committee (GCVC) operating at a senior level to prioritise change, drive implementation and ensure consistency across the Group. The Group is also in the third year of its partnership with Macmillan to support customers with cancer, has launched specialist support for those impacted by financial and domestic abuse and has signed up to standards supporting customers with mental health problems
Monitoring and testing of customer outcomes to ensure the Group delivers fair outcomes for customers whilst making continuous improvements to products, services and processes
Continued focus on proactive identification and mitigation of conduct risk in the GSR3
Failure of IT systems, due to volume of change, and/or aged infrastructure
Execution, delivery and process management 18.04 21.21 20.60 25.96 1 2018 breakdowns have been restated to reflect a number of events that have been reclassified following an internal review.
The Group adopts a risk based approach to mitigate the internal and external fraud risks it faces, reflecting the current and emerging fraud risks within the market. Fraud risk appetite metrics holistically cover the impacts of fraud in terms of losses to the Group, costs of fraud systems and operations, and customer experience of actual and attempted fraud. Oversight of the appropriateness and performance of these metrics is undertaken regularly through business area and Group-level committees. This approach drives a continual programme of prioritised enhancements to the Group’s technology, process and people related controls, with an emphasis on preventative controls supported by real time detective controls wherever feasible. Group-wide policies and operational control frameworks are maintained and designed to provide customer confidence, protect the Group’s commercial interests and reputation, comply with legal requirements and meet regulatory requirements. The Group’s fraud awareness programme remains a key component of its fraud control environment, and awareness of fraud risk is supported by mandatory training for all colleagues. The Group also plays an active role with other financial institutions, industry bodies, and enforcement agencies in identifying and combatting fraud
The Group has adopted policies and procedures designed to detect and prevent the use of its banking network for money laundering, terrorist financing, bribery, tax evasion, human trafficking, modern-day slavery and wildlife trafficking, and activities prohibited by legal and regulatory sanctions. Against a background of increasingly complex and detailed laws and regulations, and of increased criminal and terrorist activity, the Group regularly reviews and assesses its policies, procedures and organisational arrangements to keep them current, effective and consistent across markets and jurisdictions. The Group requires mandatory training on these topics for all employees. Specifically, the anti-money laundering procedures include ‘know-your-customer’ requirements, transaction monitoring technologies, reporting of suspicions of money laundering or terrorist financing to the applicable regulatory authorities, and interaction between the Group’s Financial Intelligence Unit and external agencies and other financial institutions. The Anti-Bribery Policy prohibits the payment, offer, acceptance or request of a bribe, including ‘facilitation payments’ by any employee
Lloyds Banking Group Annual Report and Accounts 2019 165 or agent and provides a confidential reporting service for anonymous reporting of suspected or actual bribery activity. The Sanctions and the Related Prohibitions Policy sets out a framework of controls for compliance with legal and regulatory sanctions
Monitoring Monitoring and reporting of operational risk is undertaken at Board, Group, entity and divisional committees. Each committee monitors key risks, control effectiveness, key risk and control indicators, events, operational losses, risk appetite metrics and the results of independent testing conducted by Risk and/or Internal Audit.
The insurance programme is monitored and reviewed regularly, with recommendations being made to the Group’s senior management annually prior to each renewal. Insurers are monitored on an ongoing basis, to ensure counterparty risk is minimised. A process is in place to manage any insurer rating changes or insolvencies.
Colleague engagement may continue to be challenged by ongoing media attention on culture within the banking sector, conduct and ethical considerations
Inadequately designed people processes that are not resilient to withstand unexpected events
Maintain effective remuneration arrangements to ensure they promote an appropriate culture and colleague behaviours that meet customer needs and regulatory expectations
Ensuring colleague wellbeing strategies and support are in place to meet colleague needs, and that the skills and capability growth required to build a workforce for the ‘Bank of the Future’ are achieved
Ongoing consultation with the Group’s recognised unions on changes which impact their members
Monitoring Insurance underwriting risks in the Insurance business are monitored by Insurance senior executive committees and ultimately the Insurance Board. Significant risks from the Insurance business and the defined benefit pension schemes are reviewed by the Group Executive and Group Risk Committees and Board.
The countercyclical capital buffer (CCYB) is time-varying and is designed to require banks to hold additional capital to remove or reduce the build-up of systemic risk in times of credit boom, providing additional loss absorbing capacity and acting as an incentive for banks to constrain further credit growth. The amount of the buffer is determined by reference to buffer rates applied by the Bank of England’s Financial Policy Committee (FPC) for the individual countries where the Group has relevant credit exposures. The CCYB rate for the UK is currently set at 1.0 per cent and will increase to 2.0 per cent from December 2020 following a review by the FPC of the appropriate level to set in the current standard risk environment. As a result of this change the PRA will consult in 2020 on a reduction in Pillar 2A capital requirements by 50 per cent of the relevant bank specific increase in the CCYB, which would leave overall loss absorbing capacity (MREL) broadly unchanged, but increase the Group’s requirement plus buffers for CET1 by c.65 basis points.
In addition to the risk-based capital framework outlined above, the Group is also subject to minimum capital requirements under the UK Leverage Ratio Framework. The leverage ratio is calculated by dividing fully loaded tier 1 capital resources by the leverage exposure which is a defined measure of on-balance sheet assets and off-balance sheet items.
The Group’s capital plan also considers the impact of IFRS 9 which has the potential to increase bank capital volatility. Under stress this is primarily a result of provisioning for assets that are not in default at an earlier stage than would have been the case under IAS 39.
Regular reporting of actual and base case and stress scenario projected ratios for Group, the Ring-Fenced Bank sub-group and key legal entities is undertaken, including submissions to the Group Capital Risk Committee (GCRC), Group Financial Risk Committee (GFRC), Group Asset and Liability Committee (GALCO), Group Risk Committee (GRC), Board Risk Committee (BRC) and the Board. Capital policies and procedures are well established and subject to independent oversight.
the Ring-Fenced Bank sub-group’s systemic risk buffer (SRB) of 2.0 per cent of risk-weighted assets, which equates to 1.7 per cent of risk weighted assets at Group level
168 Lloyds Banking Group Annual Report and Accounts 2019 the Group’s PRA Buffer, which the PRA sets after taking account of the results of the annual PRA stress test and other information, as well as outputs from the Group’s internal stress tests. The PRA requires the PRA Buffer itself to remain confidential between the Group and the PRA
At EU level, G-SIBs are subject to the minimum requirements for own funds and eligible liabilities (MREL) that came into force in June 2019 following the implementation of CRR II. The MREL framework reflects the European implementation of the global TLAC standard. The purpose of MREL is to require firms to maintain sufficient own funds and eligible liabilities that are capable of credibly bearing losses or recapitalising a bank whilst in resolution. MREL requirements can be satisfied by a combination of regulatory capital and certain unsecured liabilities (which must be subordinate to a firm’s operating liabilities).
As the Group is not classified as a G-SIB it is not directly subject to the CRR II MREL requirements. However the Group is subject to the Bank of England’s MREL SoP and must therefore maintain a minimum level of MREL resources from 1 January 2020. The Group operates a single point of entry (SPE) resolution strategy, with Lloyds Banking Group plc as the designated resolution entity.
From 1 January 2022, the higher of 2 times Pillar 1 plus 2 times Pillar 2A, equivalent to 25.2 per cent of risk-weighted assets, or 6.5 per cent of the UK leverage ratio exposure measure
Internal MREL requirements will also apply to the Group’s material sub-groups and entities, including the RFB sub-group, Lloyds Bank plc, Bank of Scotland plc and Lloyds Bank Corporate Markets plc, from 1 January 2020.
The Group’s capital position also benefitted by 34 basis points as a result of the cancellation of the remaining c.£650 million of the 2019 buyback programme, as announced in September 2019. The Group used 9 basis points of capital for the acquisition of the Tesco UK prime residential mortgage portfolio.
Total capital requirement The Group’s total capital requirement (TCR) as at 31 December 2019, being the aggregate of the Group’s Pillar 1 and current Pillar 2A capital requirements, was £25,608 million (31 December 2018: £26,124 million).
Excess of expected losses over impairment provisions and value adjustments (243) (27) (243) (27)
Dividends paid out on ordinary shares during the year (2,312) – – (2,312)
Excess of expected losses over impairment provisions and value adjustments (216) – – (216)
AT1 capital resources have reduced by £1,124 million over the year, primarily reflecting a redemption during the year and the annual reduction in the transitional limit applied to grandfathered AT1 capital instruments, offset in part by the issuance of new capital instruments.
During 2019, the Group issued externally £3.5 billion (sterling equivalent) of senior unsecured securities from Lloyds Banking Group plc which, while not included in total capital, are eligible to meet MREL requirements. Combined with previous issuances made over the last few years the Group remains comfortably positioned to meet MREL requirements from 1 January 2020 and, as at 31 December 2019, had a transitional MREL ratio of 32.5 per cent of risk-weighted assets.
On a pro forma basis the UK leverage ratio reduced to 5.2 per cent from 5.6 per cent pro forma at 31 December 2018.
4 The UK leverage ratio is 5.2 per cent on a pro forma basis upon recognition of the dividend paid up by the Insurance business in February 2020 in relation to its 2019 earnings (31 December 2018: 5.6 per cent pro forma).
176 Lloyds Banking Group Annual Report and Accounts 2019 of England’s Discount Window Facility which can be used to access additional liquidity in a time of stress. The Group considers diversification across geography, currency, markets and tenor when assessing appropriate holdings of liquid assets. The Group’s liquid asset buffer is available for deployment at immediate notice, subject to complying with regulatory requirements.
The Group carries out internal stress testing of its liquidity and potential cash flow mismatch position over both short (up to one month) and longer-term horizons against a range of scenarios forming an important part of the internal risk appetite. The scenarios and assumptions are reviewed at least annually to ensure that they continue to be relevant to the nature of the business including reflecting emerging horizon risks to the Group. For further information on the Group’s 2019 liquidity stress testing results refer to page 179.
Cash and balances at central bank – non-LCR eligible4 5.7 5.8 (2)
Trading and fair value through profit and loss 4.0 11.9 (66)
2 Excludes £0.1 billion (31 December 2018: £nil) of loans and advances to banks within the Insurance business and £1.6 billion (31 December 2018: £0.4 billion) of reverse repurchase agreements.
Table 1.47 Reconciliation of Group funding to the balance sheet (audited)
The disclosure is not designed to identify assets that would be available in the event of a resolution or bankruptcy.
Trading and other financial assets at fair value through profit or loss 54 – 2,646 2,700 – 5,190 – 150,639 155,829 158,529
Financial assets at amortised cost: Loans and advances to banks – – 12 12 – 1,223 2,555 2,493 6,271 6,283
Exposures The internal and corporate governance arrangements of major financial institutions continue to be subject to a high level of regulatory and public scrutiny. The Group’s exposure to governance risk is also reflective of the significant volume of existing and proposed legislation and regulation, both within the UK and across the multiple jurisdictions within which it operates, with which it must comply.
Balance sheet linkages The information provided in table 1.54 aims to facilitate the understanding of linkages between banking, trading, and insurance balance sheet items and the positions disclosed in the Group’s market risk disclosures.
Cash and balances at central banks 55,130 – 55,130 – Interest rate
Debt securities in issue 97,689 – 97,689 – Interest rate, credit spread
Foreign exchange risk Economic foreign exchange exposure arises from the Group’s investment in its overseas operations (net investment exposures are disclosed in note 53 on page 289). In addition, the Group incurs foreign exchange risk through non-functional currency flows from services provided by customer-facing divisions, the Group’s debt and capital management programmes and is exposed to volatility in its CET1 ratio, due to the impact of changes in foreign exchange rates on the retranslation of non-sterlingdenominated RWAs.
The Group has an integrated Asset and Liability Management (ALM) system which supports non-traded asset and liability management of the Group. This provides a single consolidated tool to measure and manage interest rate repricing profiles (including behavioural assumptions), perform stress testing and produce forecast outputs. The Group is aware that any assumptions based model is open to challenge. A full behavioural review is performed annually, or in response to changing market conditions, to ensure the assumptions remain appropriate and the model itself is subject to annual re-validation, as required under the Group Model Governance Policy. The key behavioural assumptions are: embedded optionality within products the duration of balances that are contractually repayable on demand, such as current accounts and overdrafts, together with net free reserves of the Group the re-pricing behaviour of managed rate liabilities namely variable rate savings
Table 1.55 below shows, split by material currency, the Group’s market value sensitivities to an instantaneous parallel up and down 25 and 100 basis points change to all interest rates.
Client facing activity and associated hedges 109.4 (147.9) 430.8 (702.8) 76.2 (125.4) 341.6 (538.6)
Credit spread risk mainly arises from annuities where policyholders’ future cash flows are guaranteed at retirement. Exposure arises if the market value of the assets which are held to back these liabilities, mainly corporate bonds and loans, do not perform in line with expectations
One of the consequences of preparations for the formation of the Ring Fenced Bank was to reduce the impact of some stresses within the Insurance business, though Group exposures may not have materially changed. Examples of this include centralisation of defined benefit pension schemes, and the transfer of specific hedging programmes from the corporate centre to the business unit where the exposure emanated.
Mitigation Equity and credit spread risks are closely monitored and, where appropriate, asset liability matching is undertaken to mitigate risk. Unit matching has been used since 2018 to reduce the sensitivity of equity movements by matching unit-linked liabilities on a best-estimate view. Hedging strategies are also in place to reduce exposure from unit-linked funds and the with-profit funds.
All trading activities are performed within the Commercial Banking division. While the trading positions taken are generally small, any extreme moves in the main risk factors and other related risk factors could cause significant losses in the trading book depending on the positions at the time. The average 95 per cent 1-day trading VaR (Value at Risk; diversified across risk factors) was £0.9 million for 31 December 2019 compared to £0.8 million for 31 December 2018.
Table 1.59 shows some relevant statistics for the Group’s 1-day 95 per cent confidence level VaR that are based on 300 historical consecutive business days to year end 2019 and year end 2018.
Definition Model risk is defined as the risk of financial loss, regulatory censure, reputational damage or customer detriment, as a result of deficiencies in the development, application or ongoing operation of models and rating systems.
Mitigation The model risk management framework, established by and with continued oversight from an independent team in the Risk division, provides the foundation for managing and mitigating model risk within the Group. Accountability is cascaded from the Board and senior management via the Group enterprise risk management framework.
To the best of our knowledge and belief, we declare that non-audit services prohibited by the FRC’s Ethical Standard were not provided to the Group or the parent company.
Our audit approach Overview – Overall Group materiality: £360 million (2018: £360 million), based on 5 per cent of profit adjusted to remove the effects of certain items which were considered to have a disproportionate impact. – Overall parent company materiality: £360 million (2018: £360 million), based on 1 per cent of total assets but limited to the overall Group materiality. – The scope of our audit and the nature, timing and extent of audit procedures performed were determined by our risk assessment, the financial significance of components and other qualitative factors (including history of misstatement through fraud or error). – We performed audit procedures over components considered financially significant in the context of the Group (full scope audit) or in the context of individual primary statement account balances (audit of specific account balances). We performed other procedures including testing entity level controls, information technology general controls and analytical review procedures to address the risk of material misstatement in the residual components.
These items were discussed with the Audit Committee as part of our audit plan communicated in May 2019 and supplemented with updates in January 2020. These were the key audit matters for discussion at the conclusion of our audit.
Capability of the audit in detecting irregularities, including fraud Based on our understanding of the Group and industry, we identified that the principal risks of non-compliance with laws and regulations related to breaches of banking laws and regulations such as, but not limited to, regulations relating to consumer credit and unethical and prohibited business practices, and we considered the extent to which non-compliance might have a material effect on the financial statements. We also considered those laws and regulations that have a direct impact on the preparation of the financial statements such as the Companies Act 2006, Consumer Credit Act 1974 and Banking Reform Act 2013. We evaluated management’s incentives and opportunities for fraudulent manipulation of the financial statements (including the risk of override of controls), and determined that the principal risks were related to posting manual journal entries to manipulate financial performance, management bias through judgements and assumptions in significant accounting estimates and significant one-off or unusual transactions. The Group engagement team shared this risk assessment with the component auditors so that they could include appropriate audit procedures in response to such risks in their work. Audit procedures performed by the Group engagement team and/or component auditors included: – Discussions with management and those charged with governance including consideration of known or suspected instances of non-compliance with laws and regulation and fraud; – Evaluation and testing of the operating effectiveness of management’s entity level controls designed to prevent and detect irregularities, in particular their code of conduct and whistleblowing helpline; – Assessment of matters reported on the Group’s whistleblowing helpline and the results of management’s investigation of such matters; – Performing testing over period end adjustments; – Incorporating unpredictability into the nature, timing and/or extent of our testing; – Reviewing key correspondence with the FCA and PRA; – Challenging assumptions and judgements made by management in their significant accounting estimates, in particular in relation to the allowance for ECL; the provision for PPI; insurance actuarial assumptions; the defined benefit obligation; the valuation of certain level 3 financial instruments; and hedge accounting (see related key audit matters below); and – Identifying and testing journal entries, in particular any manual journal entries posted by infrequent users or senior management, posted on unusual days, posted with descriptions indicating a higher level of risk, or posted late with a favourable impact on financial performance.
Key audit matters Key audit matters are those matters that, in the auditors’ professional judgement, were of most significance in the audit of the financial statements of the current period and include the most significant assessed risks of material misstatement (whether or not due to fraud) identified by the auditors, including those which had the greatest effect on: the overall audit strategy; the allocation of resources in the audit; and directing the efforts of the engagement team. These matters, and any comments we make on the results of our procedures thereon, were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. This is not a complete list of all risks identified by our audit.
The determination of the allowance for ECL is a judgemental area. A number of judgements and assumptions are outlined in the financial statements, including the definition of significant increases in credit risk and the application of forward looking information.
We understood management’s process and tested key controls relating to the generation, selection and weighting of economic scenarios. We engaged our internal economic experts and actuarial modelling specialists to assist us as we considered: – The approach to the determination of the base case economic scenario; – The identification and use of appropriate external economic data; – The approach to the generation and selection of economic scenarios representing the upside, downside and severe downside; – The operation of the Group’s internally developed statistical model; and – The review, challenge and approval of the economic scenarios by the Group’s governance processes.
We independently re-performed the Group’s model and performed testing to evaluate the level of non-linearity captured in the allowance for ECL. We also assessed the appropriateness of the weightings adopted.
We understood management’s process and tested key controls around the determination of the allowance for ECL, including controls relating to: – Appropriateness of modelling methodologies and monitoring of model performance; – Periodic model review, validation and approval; – The identification of credit impairment events; and – The review, challenge and approval of the allowances for ECL, including the impairment model outputs, key management judgements and overlays applied.
We tested the completeness and accuracy of key data inputs, sourced from underlying systems that are applied in the calculation. We tested the reconciliation of loans and advances between underlying source systems and the ECL models.
Based on our knowledge and understanding of the weaknesses and limitations in management’s models and industry emerging risks, we critically assessed the completeness of the overlays proposed by management.
Commercial Banking We understood management’s process and evaluated and tested key controls around the determination of the allowance for ECL.
We performed the following procedures over the Stage 1 and 2 allowance for ECL: – We critically assessed whether the methodology applied in the calculation is compliant with IFRS 9; – We tested the formulae applied within the calculation, including the appropriateness, and application of, the quantitative and qualitative criteria used to assess significant increases in credit risk; – We tested the completeness and accuracy of key data inputs, sourced from underlying systems that are applied in the calculation; – We tested the reconciliation of loans and advances between underlying source systems and the allowance models; and – We critically assessed the impact of identified model limitations and the completeness of overlays applied by management.
We performed the following procedures to test the completeness of credit impaired assets requiring a Stage 3 allowance for ECL: – We critically assessed the criteria for determining whether a credit impairment event had occurred; and – We tested a risk based sample of Stage 1 and 2 loans, utilising industry and insolvency specialists to support the audit team in identifying sectors or types of borrowers with an elevated risk of weaker financial performance or distress. For each risk based sample, as well as an additional haphazardly selected sample of Stage 1 and 2 loans, we independently assessed whether there was evidence indicating a credit impairment event (e.g. a customer experiencing financial difficulty or in breach of covenant) and therefore whether they were appropriately categorised.
We found that these key controls were designed, implemented and operated effectively, and therefore determined that we could place reliance on these key controls for the purposes of our audit.
Refer to page 85 (Audit Committee report), page 206 (Note 2: Accounting policies), page 214 (Note 3: Critical accounting judgments and estimates) and pages 243, 249 and 252 (Notes 25, 32 and 33).
A number of significant assumptions about future experience contribute as key inputs into the valuation of the Group’s insurance contracts, participating investment contracts (‘insurance contract liabilities’) and the value of in-force business asset.
Refer to page 85 (Audit Committee report), page 206 (Note 2: Accounting policies), page 214 (Note 3: Critical accounting judgements and estimates) and page 253 (Note 36: Retirement benefit obligations).
We understood and tested key controls over the pensions process involving the use of members data, formulation of assumptions and the financial reporting process. We tested the controls for determining the actuarial assumptions and the approval of those assumptions by senior management.
We engaged our actuarial experts, met with management and communicated with their actuaries to understand the judgements made in determining key economic assumptions used in the calculation of the liability. We assessed the reasonableness of those assumptions by comparing to our own independently determined benchmarks and concluded that the assumptions used by management were appropriate.
However, because not all future events or conditions can be predicted, this statement is not a guarantee as to the Group’s and parent company’s ability to continue as a going concern. For example, the terms of the United Kingdom’s withdrawal from the European Union are not clear, and it is difficult to evaluate all of the potential implications on the Group’s trade, customers, suppliers and the wider economy.
We are required to report if the directors’ statement relating to Going Concern in accordance with Listing Rule 9.8.6R(3) is materially inconsistent with our knowledge obtained in the audit.
Strategic report and Directors’ report In our opinion, based on the work undertaken in the course of the audit, the information given in the Strategic Report and Directors’ Report for the year ended 31 December 2019 is consistent with the financial statements and has been prepared in accordance with applicable legal requirements. (CA06)
Mark Hannam (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London 19 February 2020
Consolidated income statement for the year ended 31 December 198 Lloyds Banking Group Annual Report and Accounts 2019
Financial liabilities at fair value through profit or loss 29 21,486 30,547
Consolidated statement of changes in equity for the year ended 31 December 202 Lloyds Banking Group Annual Report and Accounts 2019
Currency translation differences (tax: £nil) – (12) – (12) – – (12)
Issue of other equity instruments (note 44) – – (3) (3) 896 – 893
Distributions on other equity instruments1 – – (433) (433) – – (433)
Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax – (74) – (74) – – (74)
Gains and losses attributable to own credit risk, net of tax – – (40) (40) – – (40)
Distributions on other equity instruments1 – – (415) (415) – – (415)
The Group has early adopted the hedge accounting amendments Interest Rate Benchmark Reform, issued by the IASB as a response to issues arising from the planned replacement of interest rate benchmarks in a number of jurisdictions. The amendments confirm that entities applying hedge accounting can continue to assume that the interest rate benchmark on which the hedged cash flows and cash flows of the hedging instrument are based is not altered as a result of the uncertainties of the interest rate benchmark reform. Comparatives have not been restated. Further details are provided in note 53.
(A) Consolidation The assets, liabilities and results of Group undertakings (including structured entities) are included in the financial statements on the basis of accounts made up to the reporting date. Group undertakings include subsidiaries, associates and joint ventures. Details of the Group’s subsidiaries and related undertakings are given on pages 332 to 337.
Note 2: Accounting policies continued value; the gain or loss that is recognised in profit or loss on the partial disposal of the subsidiary includes the gain or loss on the remeasurement of the retained interest.
The assets backing the insurance and investment contracts issued by the Group do not meet the criteria to be measured at amortised cost or fair value through other comprehensive income as they are managed on a fair value basis and accordingly are measured at fair value through profit or loss. Similarly, trading securities, which are debt securities and equity shares acquired principally for the purpose of selling in the short term or which are part of a portfolio which is managed for short-term gains, do not meet these criteria and are also measured at fair value through profit or loss. Financial assets measured at fair value through profit or loss are recognised in the balance sheet at their fair value. Fair value gains and losses together with interest coupons and dividend income are recognised in the income statement within net trading income.
An assessment of whether credit risk has increased significantly since initial recognition considers the change in the risk of default occurring over the remaining expected life of the financial instrument. The assessment is unbiased, probability-weighted and uses forward-looking information consistent with that used in the measurement of expected credit losses. In determining whether there has been a significant increase in credit risk, the Group uses quantitative tests based on relative and absolute probability of default (PD) movements linked to internal credit ratings together with qualitative indicators such as watchlists and other indicators of historical delinquency, credit weakness or financial difficulty. However, unless identified at an earlier stage, the
A loan or advance is normally written off, either partially or in full, against the related allowance when the proceeds from realising any available security have been received or there is no realistic prospect of recovery and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off decrease the amount of impairment losses recorded in the income statement. For both secured and unsecured retail balances, the write-off takes place only once an extensive set of collections processes has been completed, or the status of the account reaches a point where policy dictates that continuing attempts to recover are no longer appropriate. For commercial lending, a write-off occurs if the loan facility with the customer is restructured, the asset is under administration and the only monies that can be received are the amounts estimated by the administrator, the underlying assets are disposed and a decision is made that no further settlement monies will be received, or external evidence (for example, third party valuations) is available that there has been an irreversible decline in expected cash flows.
Note 2: Accounting policies continued (1) Pension schemes The Group operates a number of post-retirement benefit schemes for its employees including both defined benefit and defined contribution pension plans. A defined benefit scheme is a pension plan that defines an amount of pension benefit that an employee will receive on retirement, dependent on one or more factors such as age, years of service and salary. A defined contribution plan is a pension plan into which the Group pays fixed contributions; there is no legal or constructive obligation to pay further contributions.
Deferred tax liabilities are generally recognised for all taxable temporary differences but not recognised for taxable temporary differences arising on investments in subsidiaries where the reversal of the temporary difference can be controlled and it is probable that the difference will not reverse in the foreseeable future. Deferred tax liabilities are not recognised on temporary differences that arise from goodwill which is not deductible for tax purposes.
Products sold by the life insurance business are classified into three categories:
– Insurance contracts – these contracts transfer significant insurance risk and may also transfer financial risk. The Group defines significant insurance risk as the possibility of having to pay benefits on the occurrence of an insured event which are significantly more than the benefits payable if the insured event were not to occur. These contracts may or may not include discretionary participation features. – Investment contracts containing a discretionary participation feature (participating investment contracts) – these contracts do not transfer significant insurance risk, but contain a contractual right which gives the holder the right to receive, in addition to the guaranteed benefits, further additional discretionary benefits or bonuses that are likely to be a significant proportion of the total contractual benefits and the amount and timing of which is at the discretion of the Group, within the constraints of the terms and conditions of the instrument and based upon the performance of specified assets.
– Insurance and participating investment contracts which are unit-linked Liabilities for unit-linked insurance contracts and participating investment contracts are stated at the bid value of units plus an additional allowance where appropriate (such as for any excess of future expenses over charges) . The liability is increased or reduced by the change in the unit prices and is reduced by policy administration fees, mortality and surrender charges and any withdrawals. Benefit claims in excess of the account balances incurred in the period are also charged through insurance claims. Revenue consists of fees deducted for mortality, policy administration and surrender charges.
(N) Foreign currency translation Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (the functional currency) . Foreign currency transactions are translated into the appropriate functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement, except when recognised in other comprehensive income as qualifying cash flow or net investment hedges. Non-monetary assets that are measured at fair value are translated using the exchange rate at the date that the fair value was determined. Translation differences on equities and similar non-monetary items held at fair value through profit and loss are recognised in profit or loss as part of the fair value gain or loss. Translation differences on non-monetary financial assets measured at fair value through other comprehensive income, such as equity shares, are included in the fair value reserve in equity unless the asset is a hedged item in a fair value hedge.
Provision is made for expected credit losses in respect of irrevocable undrawn loan commitments and financial guarantee contracts (see (H) above) .
The Group uses a quantitative test together with qualitative indicators to determine whether there has been a SICR for an asset. For retail, a deterioration in the Retail Master Scale of four grades for credit cards, personal loans or overdrafts, three grades for personal mortgages, or two grades for UK motor finance accounts is treated as a SICR. For Commercial a doubling of PD with a minimum increase in PD of 1 per cent and a resulting change in the underlying grade is treated as a SICR. All financial assets are assumed to have suffered a SICR if they are more than 30 days past due.
Post-model adjustments Limitations in the Group’s impairment models or input data may be identified through the on-going assessment and validation of the output of the models. In these circumstances, management make appropriate adjustments to the Group’s allowance for impairment losses to ensure the overall provision adequately reflects all material risks. These adjustments are generally determined taking into account the particular attributes of the exposure which have not been adequately captured by the primary impairment models.
Forward looking information The measurement of expected credit losses is required to reflect an unbiased probability-weighted range of possible future outcomes. In order to do this, the Group has developed an economic model to project a wide range of key impairment drivers using information derived mainly from external sources. These drivers include factors such as the unemployment rate, the house price index, commercial property prices and corporate credit spreads. The modelgenerated economic scenarios for the six years beyond 2019 are mapped to industry-wide historical loss data by portfolio. Combined losses across portfolios are used to rank the scenarios by severity of loss. Alongside a defined central scenario three further scenarios are generated by averaging a group of individual scenarios around specified points along the loss distribution to reflect the range of outcomes. The central scenario reflects the Group’s base case assumptions used for medium-term planning purposes, an upside and a downside scenario are also produced together with a severe downside scenario. Rare occurrences of adverse economic events can lead to relatively large credit losses which means that typically the most likely outcome is less than the probability-weighted outcome of the range of possible future events. To allow for this a relatively unlikely severe downside scenario is therefore included. At 31 December 2018 and 2019, the base case, upside and downside scenarios each carry a 30 per cent weighting; the severe downside scenario is weighted
At 31 December 2019 At 31 December 2018 10pp increase in HPI
At 31 December 2019 At 31 December 2018 1pp increase in unemployment 1pp decrease in unemployment 1pp increase in unemployment 1pp decrease in unemployment
Valuation of assets and liabilities arising from insurance business At 31 December 2019, the Group recognised a value of in-force business asset of £5,311 million (2018: £4,491 million) and an acquired value of in-force business asset of £247 million (2018: £271 million) .
Estimation of income taxes includes the assessment of recoverability of deferred tax assets. Deferred tax assets are only recognised to the extent they are considered more likely than not to be recoverable based on existing tax laws and forecasts of future taxable profits against which the underlying tax deductions can be utilised. The Group has recognised a deferred tax asset of £3,611 million (2018: £3,778 million) in respect of UK trading losses carried forward. Substantially all of these losses have arisen in Bank of Scotland plc and Lloyds Bank plc, and they will be utilised as taxable profits arise in those legal entities in future periods.
The Group’s expectations as to the level of future taxable profits take into account the Group’s long-term financial and strategic plans, and anticipated future tax-adjusting items. In making this assessment, account is taken of business plans, the Board-approved operating plan and the expected future economic outlook as set out in the strategic report, as well as the risks associated with future regulatory change. Under current law there is no expiry date for UK trading losses not yet utilised, although (since Finance Act 2016) banking losses that arose before 1 April 2015 can only be used against 25 per cent of taxable profits arising after 1 April 2016, and they cannot be used to reduce the surcharge on banking profits. This restriction in utilisation means that the value of the deferred tax asset is only expected to be fully recovered by 2039. It is possible that future tax law changes could materially affect the value of these losses ultimately realised by the Group.
Note 3: Critical accounting judgements and estimates continued Regulatory provisions At 31 December 2019, the Group carried provisions of £2,408 million (2018: £2,385 million) against the cost of making redress payments to customers and the related administration costs in connection with historical regulatory breaches.
The segmental results and comparatives are presented on an underlying basis, the basis reviewed by the chief operating decision maker. The effects of the following are excluded in arriving at underlying profit: – market volatility and asset sales, including the effects of certain asset sales, the volatility relating to the Group’s own debt and hedging arrangements and that arising in the insurance businesses; – the unwind of acquisition-related fair value adjustments and the amortisation of purchased intangible assets; – restructuring costs, principally comprising severance costs, the costs of integrating newly acquired businesses, the costs of regulatory reform and the rationalisation of the non-branch property portfolio; and – payment protection insurance.
Commercial Banking provides a range of products and services such as lending, transactional banking, working capital management, risk management and debt capital markets services to SMEs, corporates and financial institutions. Insurance and Wealth offers insurance, investment and wealth management products and services.
Segment underlying income, net of insurance claims 10,821 4,340 2,133 815 18,109
Analysis of segment underlying other income, net of insurance claims: Credit and debit card fees 652 330 – – 982
Insurance and other, net of insurance claims 206 72 2,216 (954) 1,540
Other external income, net of insurance claims 1,478 916 2,407 (475) 4,326
Segment other income, net of insurance claims 2,014 1,422 2,021 275 5,732
Total underlying income, net of insurance claims 11,157 4,683 1,988 896 18,724
Segment underlying income, net of insurance claims 11,157 4,683 1,988 896 18,724
Other segment items: Investments in joint ventures and associates at end of year 4 – – 87 91 1 Restated, see page 217.
Segment other income, net of insurance claims 2,150 1,803 1,846 406 6,205
4 Comprises the effects of asset sales (loss of £145 million) ; volatility and other items (gains of £95 million) ; the amortisation of purchased intangibles (£108 million) ; restructuring (£879 million, comprising severance related costs, the rationalisation of the non-branch property portfolio, the work on implementing the ring-fencing requirements and the integration of MBNA and Zurich’s UK workplace pensions and savings business) ; and the fair value unwind and other items (losses of £319 million) .
Interest and similar expense: Deposits from banks, excluding liabilities under sale and repurchase transactions 0.86 1.39 1.18 (96) (117) (80)
Liabilities under sale and repurchase agreements 1.12 0.96 0.58 (301) (245) (110)
Interest payable on liabilities held at amortised cost 0.98 0.79 0.79 (4,859) (3,797) (3,659)
2 The impact of the Group’s hedging arrangements is included on this line; excluding this impact the weighted average effective interest rate in respect of debt securities in issue would be 2.57 per cent (2018: 2.68 per cent; 2017: 2.43 per cent) .
Fee and commission income: Credit and debit card fees 982 993 953
At 31 December 2019, the Group held on its balance sheet £293 million (31 December 2018: £282 million) in respect of services provided to customers and £140 million (31 December 2018: £168 million) in respect of amounts received from customers for services to be provided after the balance sheet date. Current unsatisfied performance obligations amount to £270 million (31 December 2018: £314 million) ; the Group expects to receive substantially all of this revenue by 2022.
Income recognised during the year ended 31 December 2019 included £54 million in respect of amounts included in the contract liability balance at 31 December 2018 and £9 million in respect of amounts from performance obligations satisfied in previous years.
For commercial customers, alongside its provision of current accounts, the Group provides other corporate banking services including factoring and commitments to provide loan financing. Loan commitment fees are included in fees and commissions where the loan is not expected to be drawn down by the customer.
Change in insurance and participating investment contracts (note 32) (12,633) 4,565 (9,067)
Depreciation and amortisation: Depreciation of property, plant and equipment (note 27) 2,064 1,852 1,944
Performance-based compensation expense comprises: Awards made in respect of the year ended 31 December 244 362 334
Performance-based compensation expense deferred until later years comprises: Awards made in respect of the year ended 31 December 113 152 127
Average headcount The average number of persons on a headcount basis employed by the Group during the year was as follows: Note 12: Auditors’ remuneration Fees payable to the Company’s auditors by the Group are as follows: 2019 £m 2018 £m 2017 £m
Other non-audit fees: Services relating to corporate finance transactions – – 1.2
Other non-audit fees: This category includes due diligence relating to corporate finance, including venture capital transactions and other assurance services. The auditors are not engaged to provide tax services.
Acquisition due diligence and other work performed in respect of potential venture capital investments – – 0.1
Financial assets at fair value through other comprehensive income (1) – – – (1)
Impairment losses on loans and receivables: Loans and advances to customers 697
Note 14: Tax expense (A) Analysis of tax expense for the year 2019 £m 20181 £m 20171 £m
For amounts included above which are subject to repurchase and reverse repurchase agreements see note 53.
Derivatives designated as fair value hedges: Derivatives designated as cash flow hedges: Total derivative assets/liabilities – hedging 619,812 1,236 1,105 718,984 1,563 1,108
The notional amount of the contract does not represent the Group’s exposure to credit risk which is limited to the current cost of replacing contracts with a positive value to the Group should the counterparty default. To reduce credit risk the Group uses a variety of credit enhancement techniques such as netting and collateralisation, where security is provided against the exposure; a large proportion of the Group's derivatives are held through exchanges such as London Clearing House and are collateralised through those exchanges. Further details are provided in note 53 Credit risk.
The carrying amounts of the Group’s hedging instruments are as follows: Carrying amount of the hedging instrument
2 Acquisition of portfolios in 2019 relates to the purchase, completed in September 2019, of Tesco Bank's UK residential mortgage portfolio.
Later than 2 years and not later than 3 years 181 456
Later than 4 years and not later than 5 years 171 130
Other items charged to the income statement 153 (73) 827 (193) 714
Other items charged to the income statement (25) 8 (4) – (21)
Charge to the income statement (note 13) (28) 14 (1) – (15)
Expected credit loss in respect of financial assets at fair value through other comprehensive income (memorandum item) – – – – –
Loans and advances to customers: Debt securities – – 6 – 6
Share of other comprehensive income – 8 – – – – – 8 –
Establishment of joint venture (note 23) 208 – – – 208 –
Note 23: Acquisitions Acquisition of workplace pensions business On 1 July 2019, following the receipt of regulatory and legal approvals, the Group completed the acquisition of the UK workplace pensions and savings business of the Zurich Insurance Group. The total fair value of the purchase consideration in the year was £20 million, settled in cash.
Financial assets at fair value through profit or loss 7,350 – 7,350
Note 23: Acquisitions continued The post-acquisition total income of the acquired business, which is included in the Group statutory consolidated income statement for the year ended 31 December 2019, is £22 million; the business also contributed profit before tax of £2 million for the same period.
Wealth management partnership Following agreement with Schroders to enter into a partnership to create a new wealth management proposition, during 2019 the Group transferred approximately £13 billion of assets under management from its UK wealth management business and £12 billion of investment funds administered by its existing Authorised Corporate Director business into Scottish Widows Schroder Wealth Holdings Limited.
The recoverable amount of the goodwill relating to Motor Finance has also been based on a value-in-use calculation using pre-tax cash flow projections based on financial budgets and plans approved by management covering a four-year period and a discount rate of 14 per cent. The cash flows beyond the four-year period are extrapolated using a growth rate of 0.5 per cent which does not exceed the long-term average growth rates for the markets in which Motor Finance participates. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of Motor Finance to fall below the balance sheet carrying value.
The recoverable amount of the goodwill relating to the Cards business has been based on a value-in-use calculation using pre-tax cash flow projections based on financial budgets and plans approved by management covering a five-year period and a discount rate of 10 per cent. The cash flows beyond the five year period assume no growth. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of the Cards business to fall below the balance sheet carrying value.
Note 25: Value of in-force business Key assumptions The impact of reasonably possible changes in the key assumptions made in respect of the Group's life insurance business, which include the impact on the value of in force business, are disclosed in note 33.
The principal features of the methodology and process used for determining key assumptions used in the calculation of the value of in-force business are set out below: Economic assumptions Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. In practice, to achieve the same result, where the cash flows are either independent of or move linearly with market movements, a method has been applied known as the ‘certainty equivalent’ approach whereby it is assumed that all assets earn a risk-free rate and all cash flows are discounted at a risk-free rate. The certainty equivalent approach covers all investment assets relating to insurance and participating investment contracts, other than the annuity business (where an illiquidity premium is included, see below) .
Risk-free rate (value of in-force non-annuity business) 1 0.00 to 3.90 0.00 to 4.05
Risk-free rate (value of in-force annuity business) 1 0.91 to 4.81 1.28 to 5.33
Expense inflation 3.41 3.75 1 All risk-free rates are quoted as the range of rates implied by the relevant forward swap curve.
The movement in the acquired value of in-force non-participating investment contracts over the year is as follows: 2019 £m 2018 £m
Cost or valuation: Exchange and other adjustments – – (6) 11 5