Reporting Just as we operate in an integrated way, we aim to report in an integrated way.
Strategic report Group highlights 01 Chairman’s statement 02 Group Chief Executive’s review 04 Key performance indicators 06 Our external environment 08 Our business model 10 Our strategic priorities 12 Refl ecting the needs of our stakeholders 16 Responsible Business 19 Helping Britain Prosper Plan 20 Divisional overview 27 Risk overview 30
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 01 3.21p +5% Ordinary dividend per share including interim and final dividend. In addition the Group intends to implement a share buyback of up to £1.75bn
(2.5)pp Cost:income ratio including remediation further improved 15.7m Digitally active customers, the largest digital bank in the UK
£6.0bn +13% Statutory profit before tax increased significantly, further closing the gap between statutory and underlying profit £8.1bn +6% Underlying profit increased, driven by higher income, and lower costs 5.5p +27% Earnings per share increased in the year, largely due to the significant increase in statutory profit >£3bn Strategic investment spend over the three year plan period (2018 to 2020), significant increase on prior plan
Helping Britain get a home £12.4bn in lending to first time buyers
Overview and strategy The Group once again delivered strong financial performance in 2018 while making major strides in executing our strategic transformation. Nevertheless I am conscious it was a frustrating year for shareholders, with a disappointing share price performance despite this progress. While external factors affecting UK investments are outside of our control, the Board are determined to continue building value for shareholders by maintaining our focus on delivering continued improvement in our results whilst simultaneously investing in the transformation required to serve our customers and operate effectively in a digital world. We are committed to building a successful and sustainable Group we can all be proud of.
The Board has been actively involved in the development and ongoing review of the strategy and last year we announced the next phase of our strategic plan. We outlined our four transformation priorities focused on the financial needs and behaviours of the customer of the future: further enhancing our leading customer experience; further digitising the Group; maximising Group capabilities; and transforming ways of working. This programme of change and renewal is all embracing, and our strong capital build is enabling us to invest more than £3 billion in these strategic initiatives over the current three year plan period (2018 to 2020), a significant increase over the prior period.
One important component of this opportunity is the potential to provide a deeper range of financial planning, wealth management and retirement solutions to our bank customers, drawing on the capabilities and expertise within Scottish Widows. During 2018, as well as completing the acquisition of the UK workplace pensions and savings business from Zurich Financial Services, we were delighted to announce a strategic partnership with Schroders in October with the aim of creating a market leading wealth management proposition.
In October, Amanda Mackenzie joined the Board as a Non-Executive Director, and will serve as a member of the Board Risk Committee, Remuneration Committee and Responsible Business Committee. Further biography details can be found on page 53. At the end of December 2018, Deborah McWhinney stepped down as a Non-Executive Director of the Group for personal reasons and Stuart Sinclair succeeded Anita Frew as Chairman of the Board Remuneration Committee. Anita will continue to be a member of the Committee, alongside her roles as the Group’s Deputy Chairman and Senior Independent Director.
In October George Culmer announced that he would be retiring in the third quarter of 2019, having served the Group so well since joining in 2012. I want to pay tribute to George’s tremendous contribution and to thank him on behalf of the Board, our colleagues and our shareholders.
Remuneration During the year we were disappointed to receive a 20.78 per cent advisory vote against our remuneration report, having previously had 98 per cent of votes support the Directors' remuneration policy in 2017. We have listened carefully to our shareholders and other key stakeholders and have made a number of changes to simplify our process for determining bonus awards for Executive Directors and to enhance our disclosures.
Outlook As we look ahead to 2019, the UK continues to face uncertainty around the near-term outlook for the economy reflecting both EU exit negotiations and wider global economic risks. However we have a strong and resilient business and, as we accelerate into the second year of our strategic transformation, we believe that our customer focus and simple business model with its multi-brand, multichannel proposition will continue to provide the best opportunities for competitive advantage and future success.
We believe that our customer focus and simple business model will continue to provide the best opportunities for competitive advantage and future success.
As the UK’s leading financial services provider we are making a significant positive impact on the UK economy
Investment More than £3 billion strategic investment spend over the plan period
Group Chief Executive’s review Another year of strong strategic and financial performance
The success of our multi-channel, multi-brand approach is reflected in our net promoter score which increased to 62 in the year and is up c.50 per cent from 2011.
We have increased investment in technology which now represents 16 per cent of operating costs, with over two-thirds relating to enhancing existing capabilities and creating new ones. This has driven operational efficiencies and improved the experience of customers and colleagues.
We are adopting new technologies, introducing machine learning and creating approximately 780,000 hours of additional colleague capacity through the use of robotics for simple repetitive tasks. We have also made targeted investments in public and private cloud solutions, which will deliver more efficient and scalable infrastructure going forward, whilst collaborating with fintechs to accelerate the digital transformation of the business, as part of our broader innovation strategy.
In 2018 we launched Single Customer View; a unique capability already enabling over 3 million customers to view in one place the pension and insurance products they hold with the Group alongside their banking products. We have expanded our workplace pensions and savings offering to over 2 million customers and have seen net inflows of £13 billion into our financial planning and retirement propositions.
In 2018, the Group became the first FTSE 100 company to set a public target to increase representation of Black, Asian and Minority Ethnic (BAME) colleagues, committing to 8 per cent of senior management and to 10 per cent of the total workforce by 2020. At the end of the year 6.4 per cent of senior management and 9.5 per cent of all colleagues were from BAME backgrounds. In recognition of the importance the Group places on helping the UK transition to a low carbon economy, in 2019 we have included a specific sustainability metric in our Plan. This signals our commitment and is supported by a detailed sustainability strategy. More information on the sustainability strategy is provided on pages 24 and 25.
Our market leading efficiency continues to be a competitive advantage and we now expect operating costs to be less than £8 billion in 2019, a year ahead of the original target. We also continue to expect a cost:income ratio, including remediation costs, in the low 40s as we exit 2020, with improvements in this ratio every year
Credit quality remains strong and, given our low risk business model and the significant portfolio improvements in recent years, we expect an asset quality ratio of less than 30 basis points in 2019 and the rest of the plan period
Year-on-year increase in technology spend >1m of future skills training hours delivered >3m customers with access to Single Customer View
Underlying profit increased in 2018, largely due to higher income, and lower costs whilst asset quality remains strong. 1 Restated to include remediation.
Statutory profit before tax increased significantly, largely driven by strong underlying performance and lower charges below the line.
As a result of significant strategic progress in 2018, we have reported increased statutory and underlying profits, strong capital generation and have announced an increased ordinary dividend and our intention to implement a share buyback.
Pay for performance across the Group Key performance indicators that are directly linked to remuneration are marked with this symbol. To ensure our employees act in the best interests of customers and shareholders, remuneration at all levels of the organisation is aligned to the strategic priorities and financial performance of the business and also takes into account specific risk management controls. The remuneration awarded to Executive Directors is heavily weighted towards the delivery of long-term, sustainable performance that aligns with shareholder experience. For the variable awards made under the Group Performance Share and Group Ownership Share plans in respect of performance in 2018, over 95 per cent is awarded in shares, and 70 per cent is subject to performance conditions applying over three years.
Our common equity tier 1 ratio remains strong. The Board's view of the level of capital required to grow the business, meet regulatory requirements and cover uncertainties remains around 13 per cent plus a management buffer of around 1 per cent. In the last two years we have reduced this to 13.9 per cent through dividend payments and buybacks.
Since we launched the Plan in 2014 we have made strong progress. In 2018, we achieved 20 out of 22 targets, helping to address some of the social, economic and environmental challenges the UK faces. Find out more on page 20.
Our net promoter score is the measure of customer service at key touch points and the likelihood of customers recommending us. Customer satisfaction slightly increased in 2018.
Link to strategic priorities Leading customer experience 1 New baseline score introduced to tie in with new
Despite the strong financial performance our share price fell by 24 per cent in 2018 in line with many other financial services companies. After including dividends paid in the year, total shareholder return was (20) per cent.
Economic profit, a measure of profit taking into account expected losses, tax and a charge for equity utilisation. In 2018, the equity charge and tax charge increased.
Given our UK focus, the Group’s prospects are closely linked to the fortunes of the UK economy
The economy faces significant uncertainty around the UK’s departure from the EU. With the expectation that the UK leaves in an orderly fashion, the economy should be able to grow in 2019 at a similar pace to 2018
Market dynamics Households’ spending power has been improving in recent months as pay growth has begun to pick up and outpace inflation, which is falling back towards the medium term target of 2 per cent. Inflation adjusted pay is now slightly above its previous peak in early 2016. This improvement is expected to continue through 2019, supported by a reduction in planned fiscal tightening announced in the 2018 Budget in November and the end of the cap to public sector pay growth. The improvement in spending power should help support growth in consumer spending and borrowing, whilst also increasing growth in households’ savings.
There is increasing clarity on impending regulation although new regulation and market reviews continue to be issued
Other A number of other regulatory initiatives are currently in the pipeline, which seek to address, among other things, vulnerability, access to services, customer treatment and choice, and competition.
As we continue to see in a number of other industries, incumbents who do not respond to changing customer preferences and behaviours are at the greatest risk.
Market dynamics Our competitive landscape continues to evolve. A number of domestic incumbents are intensifying their focus on the UK market, as a result of restructuring post-financial crisis and ongoing regulatory changes. In addition we are seeing increasing competition from smaller non traditional and technology focused companies, some of whom are partnering with large, traditional banks to build scale and drive efficiency. Tech giants also remain a future threat to the financial services sector, given strong brand loyalty, access to significant customer data and a focus on delivering great customer experiences.
Our leading cost position, combined with our simple business model, provides us with the operational flexibility to compete effectively. However, we are going further to respond to these threats and our current strategic plan should equip us well to combat these challenges.
Our business model How we create value, and what sets us apart
OUR PRODUCTS Our product range is driven by our customers’ needs and is informed through comprehensive customer analysis and insight.
OUR BUSINESS AREAS Our business areas are structured according to the products and the services we provide to best serve our customers' financial needs. We currently have three business areas: Retail
We also face a number of internal challenges: Operating as efficiently as possible while remaining the best bank for customers
Building a market leading digital experience In a year in which we met more of our customers’ simple needs via mobile than any other channel for the first time, we have made a number of functionality enhancements designed to put customers more in control of their finances digitally.
We have also launched enhanced security and anti-fraud features including location based transaction searches and the ability to freeze and unfreeze cards via mobile, with other functionality enhancements including improved statement searches, smart alerts and upcoming payment notifications.
Progress in 2018 We have made a strong start against our strategic objectives of driving additional operational efficiencies that will make banking simpler and easier for customers. We have embraced technology developments, with increasing levels of investment underpinning the progress made in modernising our IT and data architecture and improving processes for the benefit of both customers and colleagues.
Focus for 2019 We will further embrace technology while continuing to build our innovation pipeline and collaborate with fintechs to accelerate our transformation. We will also make better use of our extensive customer data, creating a single record for each of our customers that allow us to deliver better insight driven propositions. As a result, we will make ongoing improvements to our customer offering, leveraging our mobile app to deliver new functionality to customers in a timely manner and providing greater control and insight to customers than ever before.
Our market leading cost position and customer franchise are sources of competitive advantage. However, we must not be complacent and must further digitise the Group to drive additional operational efficiencies, improve the experience of our customers and colleagues and allow us to invest more for the future. In addition, we must continue to simplify and progressively transform our IT architecture in order to use data more efficiently, enhance our multi-channel customer engagement and create a scalable and resilient infrastructure.
+£50 billion growth in financial planning and retirement open book assets under administration >1 million new pensions customers
Leveraging our partnership with Schroders to accelerate our Wealth strategy In October, we announced a strategic partnership with Schroders to create a market leading wealth proposition that will better serve customer needs and accelerate the development of our financial planning and retirement business. We are excited by the potential that the combination of our significant customer base, multi-channel distribution and digital capabilities with Schroders’ investment and wealth management expertise and technology brings and have consequently set an ambitious target of becoming a top three UK financial planning business within five years.
Progress in 2018 We recognise that our colleagues play a critical role in our transformation and have made significant progress in providing them with the skills they will need in the future as well as an improved working environment and tools to deliver change more effectively. At the same time, we are simplifying and improving our colleague proposition, responding to changing expectations towards employers.
We are also reducing complexity to allow our colleagues to spend more time focusing on decisions that really matter. Consistent with this focus, we have started the migration of 60 people processes and systems onto a single HR platform, leveraging cloud based technology, and completely redesigned our performance management process, one of our key colleague journeys, reducing management time, bureaucracy and process, and focusing on meaningful colleague feedback and development.
We engage with stakeholders in many different ways and this section outlines the key stakeholder Groups, how we are interacting with them and how they inform strategic decision making.
The real focus on customers is not just evidenced by the regularity of presentations but also by the existence of the Group Customer First Committee. This is a sub-committee of the Group Executive Committee which focuses on Group customer experience, customer targets and plans and best practice externally
During 2018 senior management increased their investor engagement with over 300 investors seen during the year. In addition to the Group Chief Executive and Chief Financial Officer, an increasing number of other executive committee members undertook investor meetings in the year
We are committed to making the Group a great place to work and believe that our colleagues are crucial to the long-term success of our business. We believe it is important that the Board engages actively with colleagues and understands the views of the Group’s diverse workforce and does this in a variety of ways, as outlined below
Members of the Board visited several Group offices, including our new Halifax flagship branch in London, and the MBNA offices in Chester, providing the opportunity to meet key functions in our supply chain supporting our IT and transformation labs and customer call handling
We are committed to improving the transparency of workforce disclosure and for the first time in 2018 participated in the Workforce Disclosure Initiative
During 2018, the Board discussed how best to engage with the wider workforce; permanent employees, contingent workers and third party suppliers that work on the Group’s premises. From the second quarter of 2019, the Board will receive quarterly insight into workforce related activity and support key decision making
We offer a competitive and fair reward package. Colleagues are eligible to participate in HMRC approved share plans which promote share ownership by giving employees an opportunity to invest in Group shares. Further information can be found on page 98 in the Directors’ Remuneration Report.
The Group supports the UN Declaration of Human Rights, and the International Labour Organisation (ILO) Fundamental Conventions, whilst complying with all relevant laws. We also support several voluntary standards, including the UN Guiding Principles on Business and Human Rights
This year we made further enhancements to address the risk of Modern Slavery in our supply chain and provided training on human trafficking and modern slavery for specialist colleagues
Board members are directly involved with our considerable community engagement and environmental focus. Our Responsible Business Committee, a committee of the Board, provides oversight and support for the Group’s Helping Britain Prosper Plan, and the plans for delivering the aspirations to be seen as a trusted and responsible business
The Group’s Helping Britain Prosper Plan is reviewed and approved annually by the Board to ensure it focuses on what matters most to people, businesses and communities in the UK
We recognise that we have a responsibility to help address the economic, social and environmental challenges that the UK faces.
Responsible business of the year Lloyds Banking Group has been voted Responsible Business of the Year 2018 by Business in The Community, which highlighted our Helping Britain Prosper Plan, commitment to delivering social benefits through digital transformation and support for the lower carbon economy. Euromoney magazine has also ranked us Best Bank in Western Europe for Corporate Responsibility 2018.
Percentage of senior roles held by Black, Asian and Minority Ethnic colleagues
Responsible Business Helping Britain Prosper Plan As part of Helping Britain Prosper, we believe we have a responsibility to help address some of the social, economic and environmental challenges that the UK faces. We manage this through our Helping Britain Prosper Plan.
António Horta-Osório Group Chief Executive visit lloydsbankinggroup.com/ prosperplan 1 Figures are all cumulative excluding tackling social disadvantage across Britain and championing Britain's diversity.
Our total community investment in 2018 was £56 million . This includes our colleagues’ time, direct donations, and the money we give to our Foundations, which receive a share of the Group’s profits annually. The Foundations supported over 3,000 charities in 2018, providing help for some of the most disadvantaged and vulnerable people in Britain.
Indicator is subject to Limited ISAE3000 (revised) assurance by Deloitte LLP for the 2018 Annual Responsible Business Reporting. Deloitte’s 2018 assurance statement and the 2018 Reporting Criteria are available online at www.lloydsbankinggroup.com/our-group/responsiblebusiness /
Disability Percentage of colleagues who disclose they have a disability4 1.7% 2.6%
2. Data as at 31 December 2018. Amanda Mackenzie joined the Board on 1 October 2018, and Deborah McWhinney retired from the Board on 31 December 2018.
Our approach To meet our commitment, we will: Take a strategic approach to identifying new opportunities to support our customers and clients and to finance the UK transition to a sustainable low carbon economy, embedding sustainability into Group strategy across all activities
Use our scale and reach to help drive progress towards a sustainable and resilient UK economy, environment and society through our engagement with industry, Government, investors, suppliers and customers
Embed sustainability into the way we do business and manage our own operations in a more sustainable way
Responsible business continued 2010. To ensure this plan supports the UK’s climate change priorities and our long term strategy, we have a set of market leading targets to improve the sustainability of our own operations and supply chain. These include reducing our operational waste by 70 per cent by 2020 and 80 per cent by 2025 (compared to 2014/15), and reducing our CO2e emissions by 60 per cent by 2030 and 80 per cent by 2050 (compared to 2009) www.lloydsbankinggroup. com/our-group/responsible-business/ sustainability-in-lloyds-banking-group. We anticipate achievement of the 2050 target well before this date, driven by both our energy efficiency improvements, direct investment in renewable energy on our sites and through purchasing Renewable Energy Guarantees of Origin (REGOs) to cover our UK electricity consumption. We are now able to state that 100 per cent of our UK electricity comes from renewable sources and to show our commitment to supporting the transition to the low carbon economy, we have joined the RE100 campaign, a collaborative, global initiative uniting businesses committed to 100 per cent renewable energy.
We have created a Group sustainability team, supported by divisional Governance Forums and working groups led by divisional Managing Directors. This enables us to have a coordinated approach to oversight, delivery and reporting of the Group sustainability strategy to the GESC, along with a mechanism for keeping management and the Board updated on climate related issues impacting the Group.
Our ambition Our goal is to be a leader in supporting the UK to successfully transition to a more sustainable, low carbon economy. We have set ourselves seven ambitions anchored to the goals laid out in the UK Government’s Clean Growth Strategy, as these align closely to our business priorities: Business: become a leading UK commercial bank for sustainable growth, supporting our clients to transition to sustainable business models and operations, and to pursue new clean growth opportunities
Pensions & investments: be a leading UK pension provider that offers our customers and colleagues sustainable investment choices, and challenges companies we invest in to behave more sustainably and responsibly
For each ambition we will consider the Government’s targets and current plans. We will use forward looking scenarios to identify risks and opportunities over short, medium and long term time horizons and assess how they impact the resilience of our strategy. We are developing a series of propositions against each ambition and have defined an implementation plan to achieve a leadership position within three years. We will work with Government and other stakeholders on thought leadership to help inform the creation of the policies and market conditions required for large scale investment in the transition to a sustainable, low carbon economy. To support these propositions, we are equipping our business relationship managers and other colleagues with training and tools to have more informed conversations on climate related issues. As part of our TCFD implementation plan, we will also develop a forward looking approach to systematically reporting material financial risk and opportunity aggregated across the Group.
In 2018 we launched a £2 billion Clean Growth Finance Initiative (CGFI) to help British businesses reduce their environmental impacts and benefit from the transition to a low carbon economy. The CGFI aims to be the most inclusive UK green funding proposition available, incentivising all types of businesses to invest in low carbon projects by providing discounted financing for capital expenditure or investment with a green purpose.
2 Note our market based emissions are equal to location based for 2016/15. This is in accordance with GHG protocol guidelines in absence of appropriate residual factors.
We have made sustainability a focus area in our Helping Britain Prosper Plan and have defined metrics for it. We disclose our inhouse greenhouse gas emissions, as shown below, with supporting commentary detailed in the directors report Environmental section within Directors’ Report see page 81 and our set of in house environmental targets on our website www.lloydsbankinggroup.com/ourgroup /responsible-business/sustainability-inlloyds -banking-group.
Find out more about our set of in-house environmental targets at www.lloydsbanking. com/our-group/responsible-business/ sustainabilityinlloyds-banking-group
Leading customer experience Launched API-enabled Open Banking aggregation capability, providing customers with more control and the ability to view in one place the current accounts they hold with us alongside those held outside the Group Maintained position as UK’s largest digital bank with 15.7 million digitally active customers Maintained the UK’s largest branch network, while tailoring it to meet customers’ complex needs more effectively. Opened a new flagship Halifax branch and 41 micro branches, while also introducing 16 new mobile branches, with the enlarged fleet helping serve customers in more remote and rural communities across more than 210 locations Expanded Remote Advice video service, with approximately 38,000 customers having already discussed their mortgage needs with remote advisers in one of the 270 branches that offer this service or from their own homes Increased personalisation, with the recent launch of Lend a Hand mortgage expanding support to first time buyers Reduced complaints (excluding PPI) by 10 per cent in 2018
Taking a prime position on London’s busy Oxford Street, and with 13,500 square feet of floor space, the Halifax Flagship branch is one of the largest in the UK. It offers a relaxed, comfortable space open to everyone. Customers and non-customers alike are encouraged to explore at their leisure.
Funding for UK manufacturers £bn £3bn growth in net lending to start-ups, SMEs and Mid Market clients
Insurance and Wealth offers insurance, investment and wealth management products and services. It supports around 10 million customers with assets under administration of £141 billion and annualised annuity payments in retirement of over £1 billion. The Group continues to invest significantly in the development of the business, with the aims of capturing considerable opportunities in pensions and financial planning, offering customers a single home for their banking and insurance needs, and driving growth across intermediary and relationship channels through a strong distribution model.
Digitising the Group Successful pilot allowing customers to register and manage home insurance claims online now being followed up with introduction of new technology, enabling customers to upload digital media to accelerate settlement
Ongoing collaboration with Commercial Banking to provide long duration loans primarily to finance housing, infrastructure and education while backing the growing annuity portfolio, with £1.1 billion new loans written in 2018
1 Underlying customer net inflows £5 billion and Zurich transfer £8 billion.
Strong control framework The Group’s Risk Management Framework is the foundation for the delivery of effective risk control and ensures that the Group risk appetite is continually developed and controlled.
2018 themes Our priorities for risk management have continued to evolve, alongside progression of the Group’s strategy and development of external factors. Our principal risks are outlined over the next few pages but a number of themes have been particularly prevalent in 2018.
Observed or anticipated changes in the economic environment could impact profitability due to an increase in delinquency, defaults, write-downs and/or expected credit losses
Effective, well-established governance process supported by independent credit risk oversight and assurance
We are committed to operating sustainably and responsibly, and commit significant resource and expense to ensure we meet our legal and regulatory obligations.
We seek to support sustainable growth in our targeted segments. We have a conservative and well-balanced credit portfolio, managed through the economic cycle and supported by strong credit portfolio management.
Conduct The risk of customer detriment due to poor design, distribution and execution of products and services or other activities which could undermine the integrity of the market or distort competition leading to unfair customer outcomes, regulatory censure and financial and reputational loss.
Operational We face significant operational risks which may disrupt services to customers, cause reputational damage, and result in financial loss. These include the availability, resilience and security of our core IT systems, unlawful or inappropriate use of customer data, theft of sensitive data, fraud and financial crime threats, and the potential for failings in our customer processes.
Investing in enhanced cyber controls to protect against external threats to the confidentiality or integrity of electronic data, or the availability of systems, and to ensure effective third-party assurance
Focused action to attract, retain and develop high calibre people. Delivering initiatives to reinforce behaviours which generate the best outcomes for customers and colleagues
Uncertain property insurance claims impact Insurance earnings and capital, e.g. extreme weather conditions, such as flooding, can result in high property damage claims
Processes for underwriting, claims management, pricing and product design seek to control exposure. Experts in demographic risk (for example longevity) support the propositions
Reinsurance and other risk transfer arrangements are actively reviewed for their efficacy, including monitoring the strength of third-parties with whom the risk is shared
Read more pages 138 to 139 £14,384m Insurance (Life and Pensions present value of new business premiums) 2017: £9,951m £690m General Insurance underwritten total gross written premiums 2017: £733m
Funding and liquidity Funding risk is the risk that we do not have sufficiently stable and diverse sources of funding. Liquidity risk is the risk that we have insufficient financial resources to meet our commitments as they fall due.
A deterioration in either the Group’s or the UK’s credit rating, or a sudden and significant withdrawal of customer deposits, would adversely impact our funding and liquidity position
Holding liquid assets to cover potential cash and collateral outflows and to meet regulatory requirements. In addition, maintaining a further pool of assets that can be used to access central bank liquidity facilities
Governance Against a background of increased regulatory focus on governance and risk management, the most significant challenges arise from ensuring that the Group continues to demonstrate compliance with the requirements to ring-fence core UK financial services and activities, the potential impact of EU exit and further requirements under the Senior Manager & Certification Regime (SM&CR).
To meet ring-fencing requirements, core UK financial services and activities have been ring-fenced from other activities of the Group and an appropriate control environment and governance structures are in place to ensure compliance
Equity and credit spread risks are closely monitored and, where appropriate, asset and liability matching is undertaken
The consequences of inadequate models could include: inappropriate levels of capital or impairments; inappropriate credit or pricing decisions; and adverse impacts on funding or liquidity, or the Group’s earnings and profits
Since its inception in 2011, nearly 900 students have benefited from our Lloyds Scholars programme, which provides the financial support they need to study at university along with a package of support, including mentoring and internships. Oxford University has welcomed 94 Lloyds Scholars so far, and those who have taken the programme are very positive about the experience. To encourage school pupils to consider applying to top universities, whatever their background and financial circumstances, Lloyds Banking Group has also supported the IntoOxford project. This gives Year 10 students the chance to spend a day at an Oxford college, develop their study skills for GCSEs in a workshop and get help with university background information. Our Lloyds Scholars programme has recently been awarded ‘Highest Impact Employer Initiative’ in the 2018 upReach Student Social Mobility Awards.
Net interest income of £12,714 million increased by 3 per cent compared to 2017, reflecting an improved net interest margin and slightly higher average interest-earning banking assets of £436 billion. The net interest margin increased to 2.93 per cent with lower deposit costs and an increased contribution from the structural hedge, again more than offsetting continued pressure on asset margins. In line with previous guidance, the Group expects a net interest margin of c.2.90 per cent in 2019 and for the margin to be resilient through the plan period.
Total costs of £8,765 million were 3 per cent lower than in 2017, driven by the reduction in operating costs and remediation charges.
The Group’s statutory profit after tax of £4,400 million was 24 per cent higher than in 2017, driven by increased underlying profit, a reduction in the payment protection insurance charge and a lower effective tax rate. Earnings per share was 5.5p, 27 per cent higher than 2017 driven by increased statutory profit and lower share count.
The payment protection insurance charge of £750 million included an additional £200 million charged in the fourth quarter. The additional charge was largely driven by an increase in average redress per case, additional operational costs to deal with potential complaint volatility and continued improvements in data interrogation and the Group’s ability to identify valid claims, partly offset by lower reactive complaints which have been 12,000 per week in the second half of 2018, compared with the Group’s assumption of 13,000 per week. The outstanding balance sheet provision at 31 December 2018 was £1.3 billion and continues to assume around 13,000 complaints per week until the timebar in August 2019.
Liquidity coverage ratio 130% 127% 3pp 1 Adjusted to reflect the impact of applying IFRS 9 from 1 January 2018.
The loan to deposit ratio was stable at 107 per cent. Wholesale funding increased by 22 per cent to £123 billion, compared to £101 billion at 31 December 2017, as the Group refinanced Bank of England Funding for Lending Scheme maturities and increased liquidity buffers.
The Group’s liquidity surplus continues to exceed the regulatory minimum and internal risk appetite with a liquidity coverage ratio (LCR) of 130 per cent (31 December 2017: 127 per cent) and LCR eligible assets of £129 billion (31 December 2017: £121 billion).
The Group continues to expect ongoing capital build of 170 to 200 basis points per year, after allowing for the impact of estimated RWA inflation and increased pension contributions.
Tangible net assets per share 53.0p 51.7p 1.3p 1 Adjusted to reflect the impact of applying IFRS 9 from 1 January 2018, with transitional arrangements applied for capital.
3 Adjusted to reflect the impact of applying IFRS 9 from 1 January 2018.
6 SME portfolio re-segmented in the first half of 2018 moving £1.0 billion of loans and advances to customers and £2.0 billion of customer deposits to Business Banking. Comparatives not restated.
SME including Retail Business Banking 31.8 31.0 3 31.6 1 1 Prior period restated to include run-off.
5 As part of the Lloyds Bank Corporate Markets launch c.£2 billion of loans and advances to customers moved to Group Corporate Treasury.
2 Present value of new business premiums. Further information on page 288.
The Group actively manages its exposures to interest rate, foreign currency exchange rate, inflation and market movements within the banking book through a comprehensive hedging strategy. This helps to mitigate earnings, volatility and reduces the impact of market movements on the capital position.
Add back amortisation of intangible assets (post tax) (£m) 296 219
Homelessness is a very real challenge facing all cities across the UK. The Lloyds Bank Flagship Branch on Manchester’s Market Street, in conjunction with Barnabus, the Booth Centre and other local charities, help individuals affected by homelessness to access banking products and services to support them in their journey to regaining financial independence.
Lloyds Banking Group Annual Report and Accounts 2018 51 Strateg ic rep ort
Experience across a range of sectors, including banking, asset and investment management, manufacturing and utilities Extensive experience as chairman in a range of industries Strong board governance experience, including investor relations and remuneration Anita was previously Chairman of Victrex plc, the Senior Independent Director of Aberdeen Asset Management and IMI plc, an Executive Director of Abbott Mead Vickers, a Non-Executive Director of Northumbrian Water and has held various investment and marketing roles at Scottish Provident and the Royal Bank of Scotland. External appointments: Chairman of Croda International Plc and a Non-Executive Director of BHP Billiton.
Lloyds Banking Group Annual Report and Accounts 2018 53 Strateg ic rep ort
13. Malcolm Wood Company Secretary Appointed: November 2014 Skills and experience: Malcolm was previously General Counsel and Company Secretary of Standard Life after a career as a corporate lawyer in private practice in London and Edinburgh. He has a wealth of experience in governance, policy and regulation. He is a Fellow of the Institute of Chartered Secretaries and Administrators and a Member of the Corporate Governance Council and the GC100. Malcolm is an attendee of the Group Executive Committee.
Skills and experience: John 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. His experience spans systems integration, large scale data analytics, enterprise application platforms, software product development, IT operations and infrastructure.
George joined the Board as an Executive Director in May 2012. Read his full biography on page 53.
Skills and experience: Jen was appointed as Group People and Productivity Director in July 2017 and is responsible for leading the people function, property, sourcing, divestment and development teams and managing the Group’s cost base. Prior to her current role, Jen held the roles of Group Customer Services Director and Managing Director, Retail Business Banking. Jen has enjoyed a career spanning multiple industries, including banking, engineering and the airline sector. Jen is a Non-Executive Director of Lloyds Bank Corporate Markets plc and a Non-Executive Director of the Kent Community NHS Foundation Trust.
Skills and experience: Andrew joined the Group as Group Corporate Affairs Director, taking on responsibility for internal and external communications, reputation management and public affairs. Prior to Lloyds, Andrew was Senior Managing Director and Global Head of Financial Services for the Strategic Communications segment of FTI Consulting.
2 Deborah McWhinney retired from the Board on 31 December 2018.
Strategic thinking 10 out of 10 10 out of 10 5 out of 10 7 out of 10 5 out of 10 8 out of 10 10 out of 10
Age 1 Data as at 31 December 2018. Amanda Mackenzie joined the Board on 1 October 2018, and Deborah McWhinney retired from the Board on 31 December 2018.
In 2018 deep dive sessions were held on the following topics: IT Architecture Strategy
Deep dives on customer propositions, including mortgage offerings and transforming customer journeys
Processes and outcomes for fair treatment of customer complaints and remediation
Establishment of the operational, organisational and governance structure for the Ring-Fenced Banks.
Review and approval of various Group policies including Signing Authorities, Group Statement on Modern Slavery, and Board and GEC Members’ Dealing Policy
Independent decision making by the Ring-Fenced Bank Boards – on any matters where there might be a conflict between the interests of the Ring-Fenced Banks and the interests of another part of the Group, ensuring that the Ring-Fenced Bank Boards act in the interests of the Ring-Fenced Banks.
Risks considered and managed from the Ring-Fenced Banks’ perspective – this includes maintenance of the capital adequacy and liquidity of the Ring-Fenced Banks.
Q: How do we remain focused on resolving legacy conduct, litigation and regulatory matters?
A: Even in the best of times, it is essential for banks to be aware of both inherent and emerging risks of which there are many. The inherent risks receive regular scrutiny, but emerging risks require special attention particularly with a banking group the size of Lloyds Banking Group.
Change also brings other risks. It is important to provide the ever more user friendly and sophisticated services that the banking customers of tomorrow increasingly require, and will obtain from other suppliers if we do not. Changing processes and systems that have been established over decades if not more and making the organisation agile and able to respond to demand, is a very material risk and will take up a great deal of the Board Risk Committee’s time for many years ahead.
A: Fortunately, I sleep pretty well. The comprehensive work programme undertaken by the Board Risk Committee means that most issues have been reviewed in detail and actions taken or accelerated where appropriate.
For the Group, as the Ring-Fenced Bank structure is now in place, I also liaise and collaborate with the Ring-Fenced Bank Senior Independent Director where appropriate.
A: My role as the Group’s whistleblowing Champion is to oversee the integrity, independence and effectiveness of the Group’s procedures for whistleblowing. There is a dedicated team within the Group that is responsible for managing whistleblowing concerns and as such I delegate much of the day-to-day activity to these trusted colleagues. I retain oversight over the team through regular catch up meetings and have a direct reporting line for matters that require escalation to me. On an annual basis, I am responsible for presenting to the Board on the effectiveness of the Group’s arrangements and this includes relevant case updates, industry perspective and whether the internal processes are effective to handle disclosures properly.
In addition, the Group has recently participated in a benchmarking exercise led by Protect. Protect (formerly known as Public Concern at Work) provide external confidential advice. Colleagues can contact the independent UK Whistleblowing charity, Protect who can talk you through your options and help you raise a concern about risk, malpractice or suspected wrongdoing at work. This exercise reviewed the governance, engagement and operational arrangements and compared these to other financial and non-financial companies. The Group scored positively with the results showing a favourable position.
Lloyds Banking Group Annual Report and Accounts 2018 61 Strateg ic rep ort
Non-Executive discussions and informal dinners are held prior to most Board meetings, some of which also include the Group Chief Executive.
Board meetings have certain standing items, such as a report from the Group Chief Executive and Chief Financial Officer on Group performance, reports from the Chairmen of Committees and principal subsidiaries and updates from GEC members.
Processes Controls and governance are very strong; Committees are broadly well chaired; The 2018 strategy review process was hailed as a great success in allowing for wideranging and free-flowing debate.
Board evaluation How the Board performs and is evaluated In accordance with the three-year cycle, the 2018 effectiveness review was facilitated externally by Egon Zehnder1, an external board evaluation specialist, between August 2018 and January 2019. The annual effectiveness review, which is facilitated externally at least once every three years, provides an opportunity to consider ways of identifying greater efficiencies, maximising strengths and highlighting areas of further development. The effectiveness review was commissioned by the Board, assisted by the Company Secretary and overseen by the Nomination and Governance Committee. Details of this effectiveness review are provided below.
The Board conducted internal effectiveness reviews in 2016 and 2017. These were led by the Chairman of the Board, and included a review of effectiveness of the Board, its Committees and individual Directors with the support of the Nomination and Governance Committee. Performance evaluation of the Chairman is carried out by the NonExecutive Directors, led by the Senior Independent Director, taking into account the views of the Executive Directors.
The effectiveness review findings focus on both evaluation of effectiveness of the Board as a whole, and of the individual Directors.
More concise reports, highlighting important points and avoiding unnecessary volume and repetition.
A review of the schedule of Board and Committee meetings took place, and a number of meetings have been removed after being considered unnecessary.
Enhanced video conferencing facilities have been installed in various Group locations to improve the quality of remote participation in meetings when attendance in person is not possible.
As part of the monthly report to the Board, the CFO now reports on the Bank of England’s ‘minimum requirements for own funds and eligible liabilities’ and will continue to highlight significant developments related to the Group’s debt funding.
Training modules were identified from a list of the topics used by Group colleagues, and following discussions between Group Secretariat, Risk and Group Learning, the following themes were identified as being the most relevant for Non-Executive Directors: Anti-Bribery
Delivery of training The training is delivered via an online training platform on the Group’s intranet. The Directors can access this at any time, and once the training is completed, it is recorded on the system to provide a full audit trail. The Directors have completed the modules for 2018.
The definition of the Group’s ‘workforce’ was considered and agreed as ‘our permanent employees, contingent workers and thirdparty suppliers that work on the Group’s premises delivering services to our customers and supporting key business operations.
The UK Corporate Governance Code 2016 (the ‘Code’) applied to the Lloyds Banking Group 2018 financial year. The Group confirms that it applied the main principles and complied with all the provisions of the Code throughout the year. The Group has been subject to the provisions of the UK Corporate Governance Code 2018 since January 2019, and will report on this next year. The Code is publicly available at www.frc.org.uk. The following two pages explain how we have applied the Main Principles and the provisions of the Code during the year.
António Horta-Osório manages and leads the Group on a day-to-day basis and makes decisions on matters affecting the operation, performance and strategy of the Group’s business. He delegates aspects of his own authority, as permitted under the Corporate Governance Framework, to other members of the Group Executive Committee.
Further information on meeting arrangements and the responsibilities of the Directors are given on pages 59 to 61 and 65 respectively.
More information about the work and focus of the Nomination and Governance Committee can be found on pages 67 to 69.
B4. Training and development The Chairman leads the training and development of Directors and the Board generally and regularly reviews and agrees with each Director their individual and combined training and development needs.
The Chairman personally ensures that on appointment each Director receives a full, formal and tailored induction. The emphasis is on ensuring the induction brings the business and its issues alive for the new Director, taking account of the specific role they have been appointed to fulfil and the skills/experience of the Director to date.
E2. Use of General Meetings The Board values the AGM as a key opportunity to meet shareholders. The 2019 AGM will be held on 16 May 2019. The whole Board is expected to attend and will be available to answer shareholders’ questions.
Board and GEC changes As reported in my introduction to the Governance Report on page 51, there have been a number of changes to the Board during the year, all of which have been overseen by the Nomination and Governance Committee (the ‘Committee’). The Committee conducted a rigorous process for identifying and assessing candidates to recruit both the Ring-Fenced Bank only Non-Executive Directors and an additional Group NonExecutive Director. Details of this selection process can be found on page 69. The Committee has also overseen the transition from Anita Frew to Stuart Sinclair as the Chair of the Remuneration Committee Chairman, and as part of the succession plan which is in place for senior management, have approved the appointment of Kate Cheetham as Company Secretary to replace Malcolm Wood when he retires from the Group in June 2019.
The outcome of this review provided a comprehensive view of the GEC role characteristics against which the current senior management layer below GEC can be assessed to ensure alignment of capability, aspiration and adequacy of current development plans. The identified characteristics are designed to represent the particular leadership requirements of those undertaking GEC-level roles within the Group as we build the Bank of the Future. Our ambition is to ensure an Executive team that embraces the diverse strengths of individual leaders and collectively exhibits the characteristics expected of a team leading the Group to succeed in a digital world. The GEC characteristics align to the leadership behaviours: inspire delivery; encourage simplicity; develop confidence; and build trust. Additional emphasis is placed upon key capabilities required to lead cultural transformation, including innovative strategic thinking; agile change management; digital technology; collaborative team working and insightful customer perspectives.
Individual assessment scores against the GEC characteristics have been shared with each GEC member and attendee for discussion with their line manager. Additional personal development interventions have been agreed as appropriate, with individual development plans continuing to be owned and driven by each Executive.
Overall, the results of the assessment evidence that the GEC collectively exhibit strong capabilities in the leadership characteristics required to deliver the Bank of the Future. As a team, their breadth of banking and governance experience provides the knowledge base required to enable robust decision-making. Personal characteristics around values, judgement and drive are aligned with the Group’s target culture.
The Committee has also overseen amendments to the Corporate Governance Framework to reflect the requirements of the New Code ahead of implementation in 2019.
During the year, the Committee, led by the Chairman, reviewed the succession plans and development plans for key senior management roles, and established the GEC characteristics as described on page 67.
Training Overseeing the roll out of training to all Non-Executive Directors
The Board diversity policy The Board Diversity Policy (the Policy) sets out the Board of Lloyds Banking Group’s approach to diversity and provides a high level indication of the Board’s approach to diversity in senior management roles which is governed in greater detail, through the Group’s policies, a summary of which is provided below.
Russell Reynolds Associates was appointed by the Committee and provided with a remit of what skills and experience the candidates should have, based on the existing skills matrix of the Board, and taking into account diversity in its broadest sense.
The Committee considered the shortlisted candidates, having been provided with an extensive report from Russell Reynolds Associates which was based on interviews with the candidates and included details of their background, skills, experience and a full evaluation. Interviews took place with various members of the Committee. The Committee recommended the appointments to the Board, which subsequently approved them, subject to regulatory approval where required.
A number of firms were invited by the Committee to tender for the external audit mandate. Our current auditor, PwC, did not participate. The process, overseen in the first instance by a Selection Committee comprised of members of the Committee, involved representatives meeting with senior management from across the Group. After careful consideration by the Committee, a recommendation was made to the Board for the appointment of Deloitte LLP, which the Board accepted. Subject to shareholders’ approval at the 2021 AGM, Deloitte LLP will therefore be appointed as external auditor in place of PwC, with effect from the year ending December 2021. Ensuring in the interim the continued effectiveness of the external auditor has also been a focus, with the Committee reviewing the plan for the external audit, and considering reports from the auditor on accounting and control matters.
The Committee considered the style and format of external disclosure for quarters one and three of 2018, and agreed a significant simplification of information provided. IFRS 9 was successfully implemented during the year, although the
During the year the Committee considered a number of issues relating to the Group’s financial reporting. These issues are summarised on the next page, including discussion of the conclusions the Committee reached, and the key factors considered by the Committee in reaching its conclusions.
Annually the Committee undertakes an effectiveness review. The review forms part of the Board evaluation process with Directors being asked to complete parts of the questionnaire relating to the Committees of which they were members. The findings of the review were considered by the Committee at its January 2019 meeting. On the basis of the evaluation the feedback was that the performance of the Committee continues to be effective.
The Committee has delivered on its responsibilities of ensuring the integrity of the financial statements and effectiveness of internal and external audit services.
During the year the Group provided a further £750 million for further operating costs and redress as claims volumes were higher than previously expected.
The Committee concluded that the provision for PPI redress and the Group’s external disclosures were appropriate. The disclosures relating to PPI are set out in note 37: ‘Other provisions’ of the financial statements.
The Committee was satisfied that the provisions for other conduct matters were appropriate. The disclosures relating to other conduct provisions are set out in note 37: ‘Other provisions’ of the financial statements.
The Group adopted IFRS 9 on 1 January 2018 and issued a transition document setting out the impact on the Group. IFRS 9 differs significantly from the previous impairment standard (IAS 39) as it requires impairment losses to be recognised on an expected loss (rather than incurred loss) basis. As a result, the Group’s impairment provision is dependent on management’s forward looking judgements on matters such as interest rates, house prices and unemployment rates, as well as its assessment of a customer’s current financial position and whether it has suffered a significant increase in credit risk.
The Committee reviewed the Group’s transition document and was satisfied that it was appropriate.
Ring-fencing In readiness for the ring-fencing regime, which came into force on 1 January 2019, the Group has transferred certain businesses, and assets and liabilities out of Lloyds Bank plc and Bank of Scotland plc (together, the ring-fenced bank) and their subsidiaries to other parts of the Group, including the Group’s non ring-fenced bank, Lloyds Bank Corporate Markets plc (LBCM). For each transfer, the principal accounting judgement considered by management was whether it involved the transfer of a business or a transfer of assets and liabilities.
During June 2018, the Group sold its 3.3 per cent stake in Standard Life Aberdeen for £344 million. The Committee reviewed management’s proposed accounting, which had no impact on the Group’s income statement as the investment was classified as ‘at fair value through other comprehensive income’. The Committee was satisfied that the accounting was appropriate.
Group Internal Audit In monitoring the activity, role and effectiveness of the internal audit function and their audit programme the Committee: monitored the effectiveness of Group Internal Audit and their audit programme through quarterly reports on the activities undertaken and a report from the Quality Assurance function within Group Internal Audit approved the annual audit plan and budget, including resource and reviewed progress against the plan through the year assessed Group Internal Audit’s resources and skills (supplemented by externally sourced subject matter experts as required) as adequate to fulfil its mandate oversaw Group Internal Audit’s progress against the 2017 External Quality Assessment considered the major findings of significant internal audits, and management’s response
Auditor independence and remuneration Both the Board and the external auditor have policies and procedures designed to protect the independence and objectivity of the external auditor. In 2018, the Committee amended its policy on business recovery services provided by the auditor in respect of the Group’s customers to reflect revisions made by the Financial Reporting Council (FRC) to its rules. To ensure that there is an appropriate level of oversight by the Committee, the policy sets a financial threshold above which all non-audit services provided by the external auditor must be approved in advance by the Committee; the policy permits senior management to approve certain engagements with fees for amounts below the threshold. The policy also details those services that the Committee prohibits the external auditor from providing to the Group; these are consistent with the non-audit services which the FRC considers to be prohibited. The total amount of fees paid to the auditor for both audit and non-audit related services in 2018 is disclosed in note 12 to the financial statements.
PwC was re-appointed as auditor with effect from 1 January 2016 following a tender process conducted in 2014 in respect of the audit contract for the 2016, and subsequent, financial years.
Committee composition, skills, experience and operation Alan Dickinson, Chairman of the Committee, is a highly regarded retail and commercial banker, having spent 37 years with the Royal Bank of Scotland, most notably as Chief Executive of RBS UK, overseeing the group’s Retail and Commercial operations in the UK. The Committee is composed of Non-Executive Directors, who provide core banking and risk knowledge, together with breadth of experience which brings knowledge from other sectors, and a clear awareness of the importance of putting the customer at the centre of all that the Group does.
Matters considered by the Committee Over the course of the year the Committee considered a wide range of risks facing the Group, both standing and emerging, across all key areas of risk management, in addition to risk culture and risk appetite, as noted above.
As part of this review, certain risks were identified which required further detailed consideration. Set out on the following pages is a summary of these risks, with an outline of the material factors considered by the Committee, and the conclusions which were ultimately reached.
A detailed review of the portfolio was conducted, which considered the quality of the overall portfolio as well as newly originated business. The Committee reviewed sectors that have been impacted by slower economic growth or structural change, notably those that are linked to discretionary consumer spending, for example, retail, as well as areas such as commercial real estate, agriculture and leveraged finance. Credit exposure and risk levels were monitored with reference to management information and risk appetite limits which included overall portfolio information as well as material individual exposures. The Committee also considered the Group’s approach to credit policies and individual transaction limits, and reviewed summary details of transactions and portfolio reviews that were assessed at the Group’s most senior credit committee. Conclusion: Overall Commercial Banking credit quality remained stable. Origination quality has been maintained, supported by a consistent through-the-cycle approach to risk appetite. The portfolio continues to be monitored closely with consideration given to the macroeconomic outlook and emerging trends.
The Committee reviewed the risks relating to consumer lending indebtedness, PRA guidance on managing affordability risk, new FCA rules on Persistent Debt for credit cards, and residual value risk in Motor Finance.
Consideration was given to regulatory feedback, the Group’s lending controls and risk appetite monitoring, new consumer lending indebtedness risk and the residual value risk profile in the Motor Finance portfolio. The Committee noted that lending controls and risk appetite metrics for both indebtedness and affordability assessment are in place, and acknowledged the Group’s actions to closely monitor and control higher risk and marginal indebtedness segments and reduce exposure over time. The Committee reviewed progress against implementation of new FCA rules on Persistent Debt in the cards portfolio. Persistent Debt has decreased and further treatments are being tested to encourage higher levels of repayment. The Committee reviewed the progress being made to strengthen risk appetite limits and controls on residual value risk in the Motor Finance portfolio. Conclusion: The Committee was satisfied that appropriate lending controls and monitoring are in place for affordability and indebtedness and noted progress made to strengthen these and improve visibility of customers’ debt positions, as well as ensure resilience in Motor Finance.
The Committee continues to consider key economic risks, particularly given the increasingly uncertain outlook.
Conclusion: The Group continues to review the impact of severe economic scenarios on our business model, whilst the Committee ensures the necessary risk oversight via review and challenge of the internal and regulatory stress tests.
Given the significance of the risk to the Group, the Committee has a sub-committee specifically focused on IT and cyber risks.
Data risk The Committee continues to focus on data governance and privacy risks including oversight of the Group’s compliance with the General Data Protection Regulation (GDPR), and the associated risks and controls.
The Committee continues to recognise risks associated with an extensive strategic change agenda, incorporating both discretionary and regulatory change. Focus areas include new execution risk metrics, effective change oversight and governance.
Recognising the extent of our transformation agenda, the Committee has received regular monitoring of key change and execution risk indicators. Metrics have been developed and refined throughout the year, alongside regular reporting.
Conclusion: There is significant work needed to transform how change is delivered, impacting both capacity and required change capability. This reorganisation is happening concurrently with change delivery. Further focus is required to manage dependencies and associated risks alongside refinement of execution risk metrics, and change/execution risk reporting.
Conclusion: The EU exit plans continue to be closely monitored by the Committee via specific regular updates, a suite of early warning indicators and corresponding risk mitigation plans.
Financial crime is a priority for the UK Government, law enforcement and regulators. The Committee continues to monitor the Group’s management of financial crime risk in light of significant regulatory change.
Conclusion: The Committee noted satisfaction with the standard of compliance documented in the MLRO report, and acknowledged the action plans in place across the Group to further enhance the Group’s position.
The Committee considered the challenging and evolving nature of the fraud risk environment influenced by factors such as an increasing sophistication of fraud typologies, third-party data breaches, and an uplift in social engineering fraud. The Group continues to invest in new and innovative controls, as well as working in collaboration with the public sector to prevent, detect, and respond to fraud risks. As such, the Committee was updated on strategic plans which will deliver enhanced controls enabling the Group to continue to manage fraud risk within appetite. Additionally, the Committee acknowledged the leading role the Group has played in the development of an industry code for authorised push payment fraud. The code will be agreed in early 2019 and the Group is well positioned to manage the impact.
During the year the Committee discussed the current model risk profile, with specific focus on the new IFRS 9 Impairment models, trends in performance and actions being taken to resolve material model issues. The Committee considered wider model issues such as the increase in automation and analytics required to support the Bank’s strategic aims, regulatory issues and the action being taken by the Group to address these, as well as benchmarking the Group’s approach to model risk management compared to the industry.
Conclusion: Whilst good progress was made in 2018, the demand for models and model related activity is expected to continue to increase, with key drivers being the Group strategy, and the need to meet new regulatory requirements in the longer-term.
Vulnerability Vulnerable customers represent a significant proportion of the Group’s customer base and continue to be an area of close focus.
Committee purpose and operation The Committee’s role is to support the Board in overseeing the Group’s performance as a responsible business by providing oversight of, and support for, the Group’s strategy and plans for delivering the aspiration, to be seen as a trusted, responsible business, as part of the Company’s purpose to Help Britain Prosper. This role is fulfilled by providing oversight and challenge on those activities which impact on the Company’s behaviour and reputation as a trusted, responsible business and by considering and recommending to the Board for approval the Responsible Business Report and Helping Britain Prosper Plan.
The Chairman of the Committee 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.
The Committee took a comprehensive deep dive to review the Company’s emerging sustainability strategy. The Group committed to supporting the country’s transition to a lower carbon economy, in line with the Government’s Clean Growth Plan, and directors from all business areas described how their activity contributed to the overall plan.
Further information on the activities which the Committee keeps under review are set out in the 2019 Helping Britain Prosper Plan on page 19. The Plan sets out how the Company seeks to help people, communities and businesses prosper.
The Board continues to give due consideration at each year end to the return of any surplus capital and for 2018, the Board intends to implement a share buyback of up to £1.75 billion, equivalent to up to 2.46 pence per share. This represents the return of capital over and above the Board’s view of the current level of capital required to grow the business, meet regulatory requirements and cover uncertainties.
The Company intends to use the authority for the repurchase of ordinary shares granted to it at the 2018 AGM to implement the proposed share buyback. Details of this existing authority are set out under ‘Power of Directors in relation to shares’.
Biographies of current Directors are set out on pages 52 to 53. Details of the Directors seeking election or re-election at the AGM are set out in the Notice of Meeting.
Directors’ and Officers’ liability insurance Throughout 2018 the Group had appropriate insurance cover in place to protect Directors, including the Directors who retired or resigned during the year, from liabilities that may arise against them personally in connection with the performance of their role.
The Company has also granted deeds of indemnity by deed poll and by way of entering into individual deeds, which constitute ‘qualifying third-party indemnity provisions’ to the Directors of the Group’s subsidiary companies, including to former Directors who retired during the year and since the year end, and to Group colleagues subject to the provisions of the Senior Managers and Certification Regime. Such deeds were in force during the financial year ended 31 December 2018 and remain in force as at the date of this report.
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.
Based upon this assessment, the Directors have a reasonable expectation that the Company and the Group will be able to continue in operation and meet its liabilities as they fall due over the next three years to 31 December 2021.
GHG emissions (CO2e) per £m of underlying income (Market Based) 6.2 16.4 19.4 1 Location based intensity levels have been restated for 2015-2016 and 2016-2017 to reflect changes to emissions data only, replacing estimated data with actuals; underlying income figures for those years have not changed.
Statement of directors’ responsibilities The Directors are responsible for preparing the annual report, the Directors’ remuneration report and the financial statements in accordance with applicable law and regulations. Company law requires the Directors to prepare financial statements for each financial year. Under that law, the Directors have prepared the Group and parent Company financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union. Under company law, the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and the Company and of the profit or loss of the Company and Group for that period. In preparing these financial statements, the Directors are required to: select suitable accounting policies and then apply them consistently; make judgements and accounting estimates that are reasonable and prudent; and state whether applicable IFRSs as adopted by the European Union have been followed. The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s transactions and disclose with reasonable accuracy at any time the financial position of the Company and the Group and enable them to ensure that the financial statements and the Directors’ remuneration report comply with the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation. They are also responsible for safeguarding the assets of the Company and the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. A copy of the financial statements is placed on our website at www.lloydsbankinggroup.com. 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.
Malcolm Wood Company Secretary 19 February 2019 Lloyds Banking Group plc Registered in Scotland Company number SC95000
Dear Shareholder On behalf of the Board, I am pleased to present our Directors’ remuneration report for the year ended 31 December 2018. This is my first report to you, and on behalf of the Board I would like to thank Anita Frew for her chairmanship of the Committee in the period to September 2018, when I took over. I hope to continue the excellent work Anita did in ensuring that remuneration is actively debated and transparent to all relevant stakeholders.
These principles underpin all our decisions and ensure that our remuneration approach and outcomes are aligned to the Group’s purpose and priorities.
Lloyds Banking Group Annual Report and Accounts 2018 83 Strateg ic rep ort
As in previous years, we believe any remuneration awarded to Executive Directors must be supported by strong performance achieved with the interests of all our stakeholders in mind.
The Group has also made progress in reducing the Gender Pay Gap by 1.3 per cent, with the median gap reducing from 32.8 per cent to 31.5 per cent, lower than the average for Financial Services, through a combination of targeting our salary increases and our efforts to increase female representation at senior levels in the Group.
Reflecting the Group’s performance in 2018, the Committee determined that the total Group Performance Share funding should be 3 per cent down year-on-year (adjusted for changes in eligible population). Individual awards for Executive Directors reduced on average by 12 per cent year-on-year. Awards for Executive Directors were determined at 67.6 per cent of maximum.
All colleagues, including Executive Directors, participate in the Group Performance Share plan. This single approach to bonus awards ensures there is a fair and transparent link between individual remuneration outcomes and Group performance.
Determination of Group Performance Share award: The performance assessment determines the maximum opportunity and the range that judgement can be applied within.
Total Remuneration for Executive Directors 2017 vs 2018 The charts below summarise the Executive Directors’ remuneration for the 2017 and 2018 performance years. Full details are provided on page 88.
Remuneration overview How we pay in line with performance and our strategic goals 1 2018 Group Performance Share, awarded in March 2019.
For 2019: GCE: £1,050,000 CFO: £504,000 COO: £497,000 Awards are released in shares in equal tranches over a five year period.
For 2018, the following awards were made: GCE: £1,177,700 CFO: £526,841 COO: £526,841 £2,000 is paid in cash in March 2019, with the balance of the upfront 40 per cent delivered in shares. Half of this is delivered in June 2019 and the remainder subject to holding until March 2020. The remaining 60 per cent is deferred into shares with 40 per cent vesting in 2020 and 20 per cent in 2021. Half of each deferral is also subject to holding for one year.2 See page 93.
1 yr hold 1 yr hold 1 yr hold 2 yr hold20%
Shareholding requirements are in line with FTSE 100 practice and actual Executive Director shareholdings are significantly above the required levels as can be seen on page 91.
How we performed against the key performance indicators which directly impact remuneration outcomes and support the delivery of our reward principles
47.3% or less 25% payout 3rd place 25% payout 8% p.a. or more 25% payout 13.4m 25% payout £2,507m 25% payout 25% payout
Long Term Variable Remuneration 1 Adjusted total costs, excluding remediation. 2 Excludes MBNA.
All metrics rated Good Under performance of ≥3 metrics Top performance in ≥4 metrics. No metrics at Good, Developing or Under.
Deliver Helping Britain Prosper targets 90.9% rated Green <Less than 50% of metrics rated Green ≥90% metrics rated Green, none Red
Timeline Process Calculation step 1 Target full year underlying profit agreed by Board, adjusted for conduct and target GPS expense. 2 On target increased year-on-year due to population change, including colleagues moving from incentives to Group Performance Share in 2018. 3 Underlying profit of £8,066m adjusted by £600m for conduct provision, £27m for year-on-year Prudential Value Adjustment in line with regulatory requirement and £461m for Group performance share expense in 2018.
Assessment of performance against Group Balanced Scorecard objectives agreed in Q1 2018. Balanced Scorecard
Overall pool £464.5m Final approved GPS funding for the Group was 4 per cent greater than the original target. £464.5m / £447.5m = 104% (Group Funding Modifier)
The Annual Group Performance Share outcome is calculated using the following steps.
Individual performance ratings are determined on the basis of whole job contribution taking account of both (i) what has been achieved against the balanced scorecard objectives for the area for which they have responsibility and (ii) personal performance that considers how performance has been achieved through their leadership approach. For the Group Chief Executive the relevant Balanced Scorecard is the Group Balanced Scorecard, for the Chief Financial Officer the Finance Division Scorecard, and for the Chief Operating Officer the Chief Operating Office Scorecard. Discretion may be applied in deciding whether personal performance rating should vary from the mechanical outcome provided by the Balanced Scorecard metrics. No discretion has been exercised for 2018.
Delivered customer complaint reductions which saw an 8.2 per cent year-on-year reduction to a close of 3.04 FCA complaints per thousand.
2 Other remuneration payments comprise income from all employee share plans, which arises through employer matching or discounting of employee purchases.
Pension and benefits (audited) Pension/Benefits £ António Horta-Osório George Culmer Juan Colombás
Defined benefit pension arrangements (audited) António Horta-Osório has a conditional unfunded pension commitment. This was a partial buy-out of a pension forfeited on joining from Santander Group. It is an Employer-Financed Retirement Benefits Scheme (EFRBS). The EFRBS provides benefits on a defined benefit basis at a normal retirement age of 65. The benefit in the EFRBS accrued during the six years following commencement of employment, therefore ceasing to accrue as of 31 December 2016. The EFRBS was subject to performance conditions. It provides a percentage of the GCE’s base salary or reference salary in the 12 months before retirement or leaving. No additional benefit is due in the event of early retirement. The rate of pension accrued in each year depended on share price conditions being met and the total pension due is 6 per cent of his base salary of £1,244,400 or £74,664. There are no other Executive Directors with defined benefit pension entitlements. Under terms agreed when joining the Group, Juan Colombás is entitled to a conditional lump sum benefit of £718,996 either (i) on reaching normal retirement age of 65 unless he voluntarily resigns or is dismissed for cause, or (ii) on leaving due to long-term sickness or death.
External appointments António Horta-Osório – During the year ended 31 December 2018, the GCE served as a Non-Executive Director of Exor, Fundação Champalimaud, Stichting INPAR Management/Enable and Sociedade Francisco Manuel dos Santos. The Group Chief Executive is entitled to retain the fees, which were £380,569 in total.
António Horta-Osório – – 1,765 3,398 7,475 11,540 8,704 5,791 6,434 6,270
António Horta-Osório – – 0% 0% 54% 97% 94.18% 55% 66.3% 68.7%
Directors’ interests (audited) Number of shares Number of options Total shareholding1 Value
2 Awards subject to performance under the LTIP had an expected value of 50 per cent of face value at grant (in line with the Remuneration Policy). Values are based on the 31 December 2018 closing price of 51.85 pence. Full face value of awards are £23,004,897 for António Horta-Osório, £13,007,279 for George Culmer and £10,314,767 for Juan Colombás.
Shareholding requirement (audited) Executives are expected to build and maintain a company shareholding in direct proportion to their remuneration in order to align their interests to those of shareholders. The minimum shareholding requirements Executive Directors are expected to meet are as follow: 350 per cent of base salary for the GCE and 250 per cent of base salary for other Executive Directors. Newly appointed individuals will have three years from appointment to achieve the shareholding requirement.
5 GPS is deferred into shares. The face value of the share awards in respect of GPS granted in March 2018 was £1,058,016 (1,555,288 shares) for António Horta-Osório; £479,200 (704,426 shares) for George Culmer; and £479,200 (704,426 shares) for Juan Colombás. The share price used to calculate the face value is the average price over the five days prior to grant (27 February to 5 March 2018), which was 68.027 pence.
Implementation of the policy in 2019 It is proposed to operate the policy in the following way in 2019: Base Salary
Salaries will therefore be as follows: GCE: £1,269,288 (with effect from 1 January 2019) CFO: £779,351 COO: £794,938 (with effect from 1 January 2019) CFO Designate1: £794,938
Individual award maxima for Executive Directors will remain unchanged from 2018 at 140 per cent of base salary for the GCE and 100 per cent of base salary for other Executive Directors. No award will be payable if an individual is rated below an expected level from a performance, regulatory or risk perspective.
The Committee may consider the application of malus and clawback as outlined in the performance adjustment section.
As regulations prohibit the payment of dividend equivalents on awards in 2019 and subsequent years, the number of shares subject to the award has been determined by applying a discount factor to the share price on grant, as previously disclosed. The Committee approved an adjustment of 29.8 per cent for colleagues who are senior managers, including the Executive Directors.
Percentage change in remuneration levels Figures for ‘All employees’ are calculated using figures for UK-based colleagues subject to the GPS plan. This population is considered to be the most appropriate group of employees for these purposes because its remuneration structure is consistent with that of the GCE. For 2018, 65,537 colleagues were included in this category.
In assessing the pay ratio for 2018, the Committee has considered likely ratios at industry and sector peers, and companies with a similar employee profile. The Remuneration Committee views pay ratios as a useful reference point to inform policy-setting, but also takes into consideration a number of other factors when considering remuneration levels, including direct engagement on pay with the Group’s recognised unions and shareholders. The Committee is confident that the Group’s policy on pay is fair and that improvements to pay progression will continue to ensure that lower paid colleagues receive a greater share of pay awards.
The median ratio has decreased 4 per cent year-on-year. The median ratio provides a fair reflection of the Group’s approach to pay as colleagues at this level make up approximately 70 per cent of the Group’s employee base, however, these colleagues do not receive long-term incentive plan awards which are more volatile. For the majority of colleagues, year-on-year changes in remuneration are principally driven by pay awards, which the Group directs to the lowest grades. For example, the P25 colleague in 2017 received a 5 per cent pay increase in 2018, meaning this colleague moved up in the percentile ranking to P25.5. The colleague who is now at P25 for 2018 received a 3 per cent pay increase which brought them up from P24.5 to that level. For 2019, the pay budget has been set at 2.6 per cent, but only 2 per cent for senior colleagues, including the Group Chief Executive. To support the Group’s policy of real wage growth and commitment to pay progression, there is a focus on ensuring higher pay awards for colleagues who are lower paid, or paid lower within their pay range. From April 2019, all full-time colleagues will be paid a minimum salary of £17,510. For some colleagues, this will result in an increase of up to 9.9 per cent. This salary level is 7 per cent above the National Living Wage.
The single total figure of remuneration calculated for each of the 65,537 UK colleagues includes full time equivalent base pay, Group Performance Share awards for the 2018 performance year, long term incentive plan payments (for eligible colleagues), core benefits, pension, overtime and shift payments, travel/relocation payments and private medical benefit.
Consideration of the revised UK Corporate Governance Code and how the Committee intends to ensure compliance moving into 2019 and beyond
We are not seeking to make any changes to our Directors Remuneration Policy for 2019 but the Committee will undertake a full review of the Policy in 2019 ahead of the 2020 AGM. During 2019, the Committee will increase its level of oversight on remuneration matters for the wider workforce to support with key decision making when setting the policy. This will include implementation of changes supporting the Group’s new performance management approach.
In light of the recent enhancements in corporate governance, the Committee will continue to focus on implementing the revised principles of the UK Corporate Governance Code. In addition to continuous engagement with stakeholders, the Committee intends to increase the level of engagement it has with the wider workforce on remuneration matters.
Statement of voting at Annual General Meeting The table below sets out the voting outcome at the Annual General Meeting in May 2018.
Directors’ remuneration policy (binding vote in 2017) 47,673 98.03% 959 1.97% 535 2018 annual report on remuneration (advisory vote) 39,664 79.22% 10,405 20.78% 645
The Group’s remuneration policy was approved at the AGM on 11 May 2017 and took effect from that date. 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; no changes are proposed for 2019. The full policy is set out in the 2016 annual report and accounts (pages 90–98) which is available at: The tables in this section provide a summary of the Directors’ remuneration policy. There is no significant difference between the policy for Executive Directors and that for other colleagues. Further information about the remuneration policy for other colleagues is set out in section ‘Other remuneration disclosures’.
Purpose and link to strategy To incentivise and reward Executive Directors and senior management to deliver against strategic objectives designed to support the long-term success of the Group and encourage working as a team. It ensures executives build an ownership interest in the Group and are motivated by delivering longterm superior and sustainable returns for shareholders.
Performance measures Measures and targets are set by the Committee annually and are set out in the annual report on remuneration each year.
A proportion of the aggregate variable remuneration may vest immediately on award. The remaining proportion of the variable remuneration is then deferred in line with regulatory requirements.
Further information on which performance measures were chosen and how performance targets are set are disclosed in the relevant sections throughout the report.
Maximum potential The Committee will make no increase in fees or benefits currently provided which it believes is inconsistent with the parameters above.
The overarching purpose of the Remuneration Committee is to consider, agree and recommend to the Board an overall remuneration policy and philosophy for the Group that is defined by, supports and is closely aligned to its long-term business strategy, business objectives, risk appetite and values and recognises the interests of relevant stakeholders. The remuneration policy governs all aspects of remuneration and applies in its entirety to all divisions, business units and companies in the Group, including wholly-owned overseas businesses and all colleagues, contractors and temporary staff. The Committee reviews the policy annually and Committee pays particular attention to the top management population, including the highest paid colleagues in each division, those colleagues who perform senior management functions for the Group and MRTs. Further details on the operation of the Remuneration Committee can be found on page 96 of the DRR.
The use of a balanced scorecard approach to measure performance enables the Remuneration Committee to assess the performance of the Group and its senior executives in a consistent and performancedriven way. The Group’s remuneration policy supports the business values and strategy, based on building long-term relationships with customers and colleagues and managing the financial consequences of business decisions across the entire economic cycle.
Further information on the GPS plan can be found on pages 93 and 98 of the DRR.
Any awards made to new hires to compensate them for unvested variable remuneration they forfeit on leaving their previous employment (‘buy-out awards’) will be subject to appropriate retention, deferral, performance and clawback arrangements in accordance with applicable regulatory requirements.
Approved Persons performing SIFs and/or all colleagues performing a Senior Management Function2
Executive Directors and GEC members: see page 96 of the 2016 DRR.
Approved Persons performing SIFs and/or all colleagues performing a Senior Management Function
2 Value of LTIP/Group Ownership Share awards based on expected value at grant pre the application of the EBA discount factor.
Services1 £m Total £m 1 Chief Operating Office comprises People and Productivity, Group Transformation, Chief Information Office and Chief Security Office. Group Functions comprises Risk, Finance, Legal, Strategy, Group Corporate Affairs, Group Internal Audit, Company Secretariat and Responsible Business.
Total amount of amendment during the year due to expost explicit adjustments
A new fleet of hybrid and electric buses is arriving on the streets of London, with funding provided through our Clean Growth Finance Initiative (CGFI). Metroline, one of the capital’s largest bus providers, has used a £50 million asset finance facility to fund its fleet renewal programme, in line with London Mayor Sadiq Khan’s plans to make London the world’s greenest global city. Targets have been set by Transport for London to operate low-emission transport across the city and reduce carbon dioxide emissions by 60 per cent before 2025. Metroline is one of a number of businesses that have accessed discounted funding to support low carbon projects through the CGFI.
Further information on risk management can be found: Risk overview 30 Note 52: Financial risk management 255 Pillar 3 report: www.lloydsbankinggroup.com The Group supports the recommendations made in the report ‘Enhancing the Risk Disclosures of Banks’ issued by the Enhanced Disclosure Task Force of the Financial Stability Board in October 2012.
This full risk management section provides a more in-depth picture of how risk is managed within the Group, detailing the Group’s emerging risks, approach to stress testing, risk governance, committee structure, appetite for risk (pages 106 to 114) and a full analysis of the primary risk categories (pages 114 to 159) – the framework by which risks are identified, managed, mitigated and monitored.
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 colleague accountability for the risks they take and their responsibility to prioritise their customers’ needs.
People – the Group leads responsibly and proficiently, manages its people resource effectively, supports and develops colleague talent, and meets legal and regulatory obligations related to its people.
Capital – the Group maintains capital levels commensurate with a prudent level of solvency, and aims to deliver consistent and high quality earnings.
Risk decision-making and reporting Risk analysis and reporting enables better understanding of risks and returns, supporting the identification of opportunities as well as better management of risks.
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 Divisional Results on pages 27 to 29.
2 Central Items include assets held outside the main operating divisions, including assets relating to Group Corporate Treasury which holds the Group’s liquidity portfolio, and other supporting functions.
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 cybercrime 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 the supply chain.
There is a risk of a no deal EU exit outcome or a delay to EU exit, which could result in continuing business uncertainty across the whole UK banking sector.
– Internal contingency plans recalibrated and regularly reviewed for potential strategic, operational and reputational impacts. – Engagement with politicians, officials, media, trade and other bodies to reassure our commitment to Helping Britain Prosper.
– 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.
Geopolitical shocks: Current uncertainties could further impede the global economic recovery. Global events, as well as terrorist activity including cyber-attacks, have the potential to trigger changes in the economic outlook, market risk pricing and funding conditions.
Climate change: The key risks associated with climate change are physical risks arising from climate and weather-related events, and transition risks, which are the financial risks resulting from the process of adjustment towards a lower carbon economy. Both of these risks may cause the impairment of asset values and impact the creditworthiness of our clients, which could result in currently profitable business deteriorating over the term of agreed facilities. Conversely propositions currently outside of appetite may constitute an acceptable opportunity in the future.
There is also a risk that campaign groups or other bodies could seek to take legal action (including indirect action) against the Group and/or the financial services industry for investing in or lending to organisations that they deem to be responsible for, or contributing to, climate change.
– We have embedded Sustainability in our Helping Britain Prosper Plan and Group Property Objectives. – We are taking a strategic approach to align with the UK Government’s Clean Growth Strategy and have committed to adopting the approach set out by the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD). – We are identifying new opportunities to support customers and clients and to finance the UK’s transition to a lower carbon economy. – We will embed sustainability into the way we do business and manage our own operations in a more sustainable way, identifying and managing material sustainability-related risks across the Group, and disclosing these in line with the TCFD recommendations. – We will ensure that appropriate training is provided to Relationship managers and Risk colleagues to enable them to have effective sustainability conversations with their clients.
Reverse stress testing Reverse stress testing is used to explore the vulnerabilities of the Group’s and its key legal entities’ strategies and plans to extreme adverse events that would cause the businesses to fail, in order to facilitate contingency planning. The scenarios used are those that would cause the businesses to be unable to carry on their activities. Where reverse stress testing reveals plausible scenarios with an unacceptably high risk when considered against the Group’s or its entities’ risk appetite, they will adopt measures to prevent or mitigate that risk, which are then reflected in strategic plans.
The engagement of all required business, Risk and Finance areas is built into the preparation process, so that the appropriate analysis of each risk category’s impact upon the business plans is understood and documented. The methodologies and modelling approach used for stress testing ensure that a clear link is shown between the macroeconomic scenarios, the business drivers for each area and the resultant stress testing outputs. All material assumptions used in modelling are documented and justified, with a clearly communicated review and sign-off process. Modelling is supported by expert judgement and is subject to the Group Model Governance Policy.
How risk is managed in Lloyds Banking Group The Group’s Risk Management Framework (RMF) (see risk overview, page 30) is structured around the following components which meet and align with the industry-accepted internal control framework standards.
Robust processes and controls to identify and report policy breaches are in place. These include clear materiality criteria and escalation procedures which ensure an appropriate level of visibility and prioritisation of remedial actions.
Insurance underwriting risk through the governance arrangements for Insurance Group (Insurance Group is a separate regulated entity with its own Board, governance structure and Chief Risk Officer)
Assisted by the Board Risk and Audit Committees, the Board approves the Group’s overall governance, risk and control frameworks and risk appetite. Refer to the Corporate Governance section on pages 56 to 78, for further information on Board committees.
The Group’s Corporate Governance Framework applies across Lloyds Banking Group plc, Lloyds Bank plc, Bank of Scotland plc and HBOS plc. It is tailored where needed to meet the entity specific needs of Lloyds Bank plc and Bank of Scotland plc, and supplementary Corporate Governance Frameworks are in place to address sub-group specific requirements of the other sub-groups (LBCM, Insurance and LBG Equity Investments).
The divisional and functional risk committees review and recommend divisional and functional risk appetite and monitor local risk profile and adherence to appetite.
Table 1.3: Executive and Risk Committees In relation to the operation of Lloyds Banking Group plc, the Group Chief Executive is supported by the following: Committees Risk focus
Conduct Review Committee Provides senior management oversight, challenge and accountability in connection with the Group’s engagement with conduct review matters as agreed with the Group Chief Executive.
Responsible for providing recommendations regarding performance adjustment, including the individual risk-adjustment process and risk-adjusted performance assessment, and making final decisions on behalf of the Group on the appropriate course of action relating to conduct breaches, under the formal scope of the SM&CR.
Group Strategic Review 3 Committee 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.
Ensures development and application of fraud and financial crime risk management complies with the Group’s strategic aims, Group Corporate Responsibility, Group Risk Appetite and Group Fraud and Financial Crime Policies. Provides direction and appropriate focus on priorities to enhance the Group’s fraud and financial crime risk management capabilities in line with business and customer objectives whilst aligning to the Group’s target operating model.
Definition Credit risk is defined as the risk that parties with whom the Group has contracted fail to meet their financial obligations (both on and offbalance sheet).
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 52 on page 255.
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 110.
Collateral The principal types of acceptable collateral include: residential and commercial properties; charges over business assets such as premises, inventory and accounts receivable; financial instruments such as debt securities; vehicles; cash; and guarantees received from third-parties.
For non-mortgage retail lending to small businesses, collateral may include second charges over residential property and the assignment of life cover.
Commercial lending decisions must be based on an obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. The 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 one or more of 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 acceptable collateral bases for valuation, 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.
The extent to which collateral values are actively managed will depend on the credit quality and other circumstances of the obligor and type of underlying transaction. Although lending decisions are based on expected cash flows, any collateral provided may impact the pricing and other terms of a loan or facility granted. This will have a financial impact on the amount of net interest income recognised and on internal loss given default estimates that contribute to the determination of asset quality and returns.
The gross asset quality ratio remains stable at 28 basis points, in line with 2017 and 2016
Stage 3 loans as a proportion of total loans and advances to customers have remained stable at 1.9 per cent, with Stage 3 loans and advances up £0.2 billion to £9.2 billion. Coverage of Stage 3 drawn balances increased to 24.3 per cent (1 January 2018: 24.0 per cent).
Credit portfolios are well positioned against an uncertain economic outlook and potential market volatility, including that related to the UK’s exit from the EU
Purchased or originated credit impaired assets (POCI) are those that have been originated or acquired in a credit impaired state. This includes within the definition of credit impaired the purchase of a financial asset at a deep discount that reflects impaired credit losses.
ECL allowance (drawn and undrawn) as a percentage of gross lending (%)2 0.8 0.2 3.4 29.8 1 Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances include the impact of the HBOS and MBNA acquisition related adjustments.
ECL allowance (drawn and undrawn) as a percentage of gross lending (%)2 1.0 0.2 3.5 24.0 1 Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances exclude the impact of the HBOS and MBNA acquisition related adjustments.
Table 1.6d: Reconciliation between statutory and underlying basis of Group expected credit loss allowances on drawn balances
Table 1.7: Group expected credit loss allowances (drawn and undrawn) as a percentage of loans and advances to customers (statutory basis)
Table 1.8: Group Stage 2 loans and advances to customers (statutory basis)
At 1 January 20181,2 1 Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances include the impact of the HBOS and MBNA acquisition related adjustments.
Expected credit loss (ECL) allowance as a percentage of drawn balances for Stage 3 increased to 19.7 per cent from 18.5 per cent relating to prudent provisioning in Secured. Coverage for Stage 2 has increased to 3.9 per cent from 3.2 per cent, largely due to model refinements to the Stage 2 transfer approach for Secured resulting in a reclassification of better quality Stage 2 assets into Stage 1.
5 Certain balances have been reallocated between segments. This includes the incorporation of International Wealth into Commercial Banking and the allocation of Run-off across Retail and Commercial Banking.
Table 1.11: Retail expected credit loss allowances (drawn and undrawn) as a percentage of loans and advances to customers (statutory basis)
At 1 January 20182,6 1 Total and Stage 3 ECL allowance as a percentage of drawn balances are calculated excluding loans in recoveries for Unsecured (31 December 2018: £233 million; 1 January 2018: £277 million), and Business Banking within Other (31 December 2018: £17 million; 1 January 2018: £14 million).
Table 1.11a: Retail expected credit loss allowances (drawn and undrawn) as a percentage of loans and advances to customers (underlying basis)
Up to date 1-30 days past due Over 30 days past due
Retail forbearance The basis of disclosure for forbearance has changed compared to previous years to be aligned to definitions used in the European Banking Authority’s FINREP reporting. The change leads to an increase in disclosed forbearance of £5.6 billion, with the main drivers being longer probation periods before a customer can return to order and the inclusion of Past Term Interest Only for Secured.
UK Motor Finance (Retail) 51 26 24 36.1 1 ECL as a percentage of total loans and advances which are forborne are calculated excluding loans in recoveries for Unsecured (31 December 2018: £107 million; 1 January 2018: £147 million).
Commercial Banking The overall credit quality of the portfolio and new business remains good with the portfolio benefiting from effective risk management, a through the cycle approach to risk appetite and continued low interest rates. Notwithstanding the current competitive market conditions, the Group is maintaining its prudent risk appetite.
Uncertainty persists around the UK and global economic outlook, including the outcome of EU exit negotiations, the sustainability of global economic growth, trade wars and geopolitical risks. Allied to this are headwinds in a number of sectors including construction, support services and consumerrelated sectors, such as retail. However, the portfolios remain well positioned and the Group’s through the cycle risk appetite approach is unchanged. Monitoring indicates no material deterioration in the credit quality of the portfolio.
Planning for any EU exit outcome is well advanced and continues to evolve in Commercial Banking to ensure portfolio quality is maintained whilst supporting the Group’s Helping Britain Prosper strategy.
The size and nature of the commercial portfolio results in some volatility as cases move between stages. Stage 3 loans as a proportion of total loans and advances to customers has increased to 3.2 per cent (1 January 2018: 2.7 per cent). Stage 3 expected credit loss (ECL) allowance as a percentage of Stage 3 drawn balances has reduced to 32.3 per cent (1 January 2018: 35.3 per cent) largely as a result of a transfer in of assets to impaired status on which lower ECL allowances are assessed.
Asset quality ratio 0.09% 0.10% (1)bp 1 Prior period comparatives are on an IAS 39 basis. Includes Run-off, previously reported as a separate segment.
Environmental risk management The Group ensures appropriate management of the environmental impact, including climate change, of its lending activities. The Group-wide credit risk principles require all credit risk to be incurred with due regard to environmental legislation and the Group’s code of responsibility.
Mitigation The Group undertakes a range of key mitigating actions to manage regulatory and legal risk. These include the following: The Board establishes a Group-wide risk appetite and metric for regulatory and legal risk.
Risk and Legal provide oversight, proactive support and constructive challenge to the business in identifying and managing regulatory and legal issues.
The Group engages with regulatory authorities and industry bodies on forthcoming regulatory changes, market reviews and investigations, ensuring programmes are established to deliver new regulation and legislation.
Definition The risk of customer detriment due to poor design, distribution and execution of products and services or other activities which could undermine the integrity of the market or distort competition, leading to unfair customer outcomes, regulatory censure and financial and reputational loss.
Conduct risks can impact directly or indirectly on our customers and can materialise from a number of areas across the Group, including: business and strategic planning that does not sufficiently consider customer needs; ineffective management and monitoring of products and their distribution (including the sales process); unclear, unfair, misleading or untimely customer communications; a culture that is not sufficiently customer-centric; poor governance of colleagues’ incentives and rewards and approval of schemes which drive unfair customer outcomes; ineffective management and oversight of legacy conduct issues; ineffective management of customers’ complaints or claims; and outsourcing of customer service and product delivery via third-parties that do not have the same level of control, oversight and culture as the Group. The Group is also exposed to the risk of engaging in or failing to manage conduct which could constitute market abuse, undermine the integrity of a market in which it is active, distort competition or create conflicts of interest.
Mitigation The Group takes a range of mitigating actions with respect to conduct risk. The Group’s ongoing commitment to good customer outcomes sets the tone from the top and supports the development of the right customer-centric culture – strengthening links between actions to support conduct, culture and customer and enabling more effective control management. Actions to enable good conduct include: Conduct risk appetite established at Group and business area level, with metrics included in the Group risk appetite to ensure ongoing focus.
Cultural transformation, supported by strong direction and tone from senior executives and the Board. This is underpinned by the Group’s values, behaviours and code of responsibility, to deliver the best bank for customers.
Continued embedding of the customer vulnerability framework. The Customer Vulnerability Cross Divisional Committee continues to operate at a senior level to prioritise change, drive implementation and ensure consistency across the Group. Significant partnership with Macmillan to support customers with cancer continues, alongside ongoing activities to support all vulnerable customers, including those experiencing financial and domestic abuse.
Continued embedding and evolving of the Group’s customer journey strategy and framework to support our focus on conduct from an end-to-end customer perspective.
Review and oversight of thematic conduct agenda items at GPGC, ensuring holistic consideration of key Group-wide conduct risks.
Ongoing engagement with third-parties involved in serving the Group’s customers to ensure consistent delivery.
Continued focus on market conduct through training and enhancements of procedures and controls, governed by the Market Steering Committee which also provides read-across for the Group on industry issues.
Implementation of enhanced change delivery methodology to enable prioritisation and delivery of initiatives to address conduct challenges.
Monitoring Monitoring and reporting is undertaken at Board, Group and business area committees. As part of the reporting of CRAMs, a robust outcomes testing regime is in place to determine whether the Group is delivering fair outcomes for customers.
GCFC acts as the guardian of customer experience and has responsibility for monitoring and reviewing plans and actions to improve it, including challenging divisions to make changes based on key learnings to support the delivery of the Group’s vision and foster a customer-centric culture.
Operational resilience and damage to physical assets including: terrorist acts, other acts of war or hostility, geopolitical, pandemic or other such events.
Mitigating actions to the principal operational risks are: The threat landscape associated with cyber risk continues to evolve and there is significant regulatory attention on this subject. The Board has defined a cyber risk appetite and continues to invest heavily to protect the Group from malicious cyber-attacks. Most recent investment has focused on improving the Group’s approach to identity and access management, improving capability to detect and respond to cyber-attacks and improved ability to manage vulnerabilities across the estate.
The Group has increased its focus on operational resilience and has updated its operational resilience strategy to reflect changing priorities of both customers and regulators. At the core of its approach to operational resilience are the Group’s Critical business processes which drive all activity, including further mapping of the processes to identify any additional resilience requirements such as impact tolerances in the event of a service outage. The Group continues to develop playbooks that address a range of interruptions from internal and external threats and tests these through scenario based testing and exercising.
Exposures The Group’s management of material people risks is critical to its capacity to deliver against its strategic objectives and to be the best bank for customers. The Group is exposed to the following key people risks: Maintaining organisational skills, capability, resilience and capacity levels in response to increasing volumes of organisational, political and external market change; Senior Managers and Certification Regime (SM&CR) and additional regulatory constraints on remuneration structures may impact the Group’s ability to attract and retain talent; The increasing digitisation of the business is changing the capability mix required and may impact our ability to attract and retain talent; The increasing demands on colleagues and consequential impact colleague wellbeing may impact on the Group’s ability to enhance colleague skills to achieve capability uplift for a digital era; and
Measurement The Group measures the amount of capital it requires and holds through applying the regulatory framework defined by the Capital Requirements Directive and Regulation (CRD IV) as implemented in the UK by the Prudential Regulation Authority (PRA) and supplemented through additional regulation under the PRA Rulebook. Further details of the Group’s regulatory capital and leverage frameworks, including the means by which its capital and leverage requirements and capital resources are calculated, will be provided in the Group’s Pillar 3 Report.
Additional minimum requirements under Pillar 2A are set by the PRA as a firm-specific Individual Capital Requirement (ICR) reflecting a point in time estimate, which may change over time, of the minimum amount of capital that is needed by the Group to cover risks that are not fully covered by Pillar 1, such as credit concentration and operational risk, and those risks not covered at all by Pillar 1, such as pensions and interest rate risk in the banking book (IRRBB).
As part of the capital planning process, forecast capital positions are subjected to extensive internal stress testing to determine the adequacy of the Group’s capital resources against the minimum requirements, including the ICR. The PRA considers outputs from both the Group’s internal stress tests and the annual Bank of England stress test, in conjunction with the Group’s other regulatory capital buffers, as part of the process for informing the setting of a bank-specific capital buffer for the Group, known as the PRA Buffer. The PRA requires this buffer to remain confidential between the Group and the PRA.
The minimum leverage ratio requirement under the UK Leverage Ratio Framework is 3.25 per cent. This is supplemented by a time-varying countercyclical leverage buffer (CCLB) which is determined by multiplying the leverage exposure measure by 35 per cent of the countercyclical capital buffer (CCYB) rate. As at 31 December 2018 the CCLB was 0.3 per cent (31 December 2017: nil). An additional leverage ratio buffer (ALRB) will apply from 2019 to the Group’s ring-fenced bank (RFB) sub-group, to
140 Lloyds Banking Group Annual Report and Accounts 2018 be determined by multiplying the RFB leverage exposure measure by 35 per cent of the SRB. An equivalent amount of capital, referred to as the Leverage Ratio Group Add-on, will be required to be held at Group level under the UK framework to cover the RFB’s ALRB.
The Group is able to accumulate additional capital through the retention of profits over time, which can be enhanced through reducing or cancelling dividend payments and share buybacks, by raising new equity via, for example, a rights issue or debt exchange and by raising additional tier 1 or tier 2 capital securities. The cost and availability of additional capital is dependent upon market conditions and perceptions at the time. The Group is also able to manage the demand for capital through management actions including adjusting its lending strategy, risk hedging strategies and through business disposals.
This takes into account, amongst other things: the minimum Pillar 1 CET1 capital requirement of 4.5 per cent of risk-weighted assets.
In November 2016 the Bank of England published a statement of policy on its approach for setting MREL in line with EU requirements.
During 2018, the Group issued £8.8 billion (sterling equivalent) of senior unsecured securities from Lloyds Banking Group plc which, while not included in total capital, are eligible to meet MREL. Combined with previous issuances made over the last two years the Group remains comfortably positioned to meet MREL requirements from 2020 and, as at 31 December 2018, had a transitional MREL ratio of 32.4 per cent of riskweighted assets.
Offset by a reduction of 0.38 per cent relating to PPI charges
3 The Group's common equity tier 1 ratio is 14.8 per cent reflecting the dividend paid by the Insurance business in February 2019 in relation to its 2018 earnings. The post share buyback common equity tier 1 ratio is 13.9 per cent on a pro forma basis (31 December 2017: 13.9 per cent).
Movement in treasury shares and employee share schemes 300 – – 300
Movements in subordinated debt: Repurchases, redemptions and other – (551) (824) (1,375)
3 The movement in eligible provisions reflects the adjustment made in respect of the application of the IFRS 9 transitional arrangements.
Movements in risk levels (market risk only) – – – – (901) – (901)
Risk-weighted assets as at 31 December 2018 135,743 25,757 161,500 7,250 2,085 25,505 196,340
The risk-weighted assets movement table provides analysis of the movement in risk-weighted assets in the period by risk type and an insight into the key drivers of the movements. The key driver analysis is compiled on a monthly basis through the identification and categorisation of riskweighted asset movements and is subject to management judgment.
Sterling foreign exchange movements, principally with Euro and US Dollar, contributed to an increase of £0.6 billion in credit risk-weighted assets
Counterparty credit risk, risk-weighted assets reduction of £0.6 billion was mainly driven by lower CVA risk-weighted assets, foreign exchange movements and yield movement.
Leverage ratio Analysis of leverage movements The Group’s fully loaded UK leverage ratio increased to 5.5 per cent reflecting the increase in tier 1 capital, partially offset by the £6.0 billion increase in the exposure measure. The latter largely reflects increases in both the derivatives exposure measure and securities financing transactions (SFT) exposure measure, offset in part by the reduction in financial assets at fair value through other comprehensive income and the reduction in off-balance sheet items.
The SFT exposure measure, representing SFT assets per the balance sheet net of deconsolidation and other SFT adjustments, increased by £21.8 billion during the period, largely reflecting a continued increase in customer volumes, partially offset by a small reduction in trading volumes.
The table below summarises the component parts of the Group’s leverage ratio. Further analysis will be provided in the Group’s Pillar 3 Report.
Stress testing The Group undertakes a wide ranging programme of stress testing providing a comprehensive view of the potential impacts arising from the risks to which the Group and its key legal entities are exposed. One of the most important uses of stress testing is to assess the resilience of the operational and strategic plans of the Group and its legal entities to adverse economic conditions and other key vulnerabilities. As part of this programme the Group conducts macroeconomic stress tests of the operating plans.
In 2018 the Group participated in both the concurrent UK stress test run by the Bank of England (BoE) and in the European Banking Authority’s (EBA) bi-annual EU-wide stress test. The EBA stress test did not contain a pass/ fail threshold and as announced in November, the Group demonstrated its ability to meet applicable capital requirements under stressed conditions. In the case of the BoE stress test, despite the severity of the scenario, the Group exceeded the capital and leverage hurdles after the application of management actions, and as a consequence was not required to take any capital actions.
All minimum regulatory requirements of the insurance companies have been met during the year.
Measurement Liquidity risk is managed through a series of measures, tests and reports that are primarily based on contractual maturities with behavioural overlays as appropriate. Note 52 on page 255 sets out an analysis of assets and liabilities by relevant maturity grouping. The Group undertakes quantitative and qualitative analysis of the behavioural aspects of its assets and liabilities in order to reflect their expected behaviour.
The Group can monetise liquid assets quickly, either through the repurchase agreements (repo) market or through outright sale. In addition, the Group has pre-positioned a substantial amount of assets at the Bank of England’s Discount Window Facility which can be used to access additional liquidity in a time of stress. The Group considers diversification across geography, currency, markets and tenor when assessing appropriate holdings of liquid assets. The Group’s liquid asset buffer is available for deployment at immediate notice, subject to complying with regulatory requirements.
Liquidity risk within the Insurance business may result from: the inability to sell financial assets quickly at their fair values; an insurance liability falling due for payment earlier than expected; the inability to generate cash inflows as anticipated; an unexpected large operational event; or from a general insurance catastrophe e.g. a significant weather event. Liquidity risk is actively managed and monitored within the Insurance business to ensure that it remains within approved risk appetite, so that even under stress conditions, there is sufficient liquidity to meet obligations.
Funding and liquidity management in 2018 The Group has maintained its strong funding and liquidity position with a stable loan to deposit ratio of 107 per cent.
The Group’s liquidity position remains strong and in excess of the regulatory minimum and internal risk appetite, with a LCR of 130 per cent as at 31 December 2018 based on the EU Delegated Act. Total LCR eligible liquid assets as at 31 December 2018 were £129.4 billion, up £8.5 billion in the year.
Financial assets at fair value through other comprehensive income 24.0 41.2 (42)
1 Adjusted to reflect the implementation of IFRS 9 and IFRS 15.
Of which issued by Lloyds Banking Group plc2 – 4.9 1.3 2.6 8.8 1 Private placements include structured bonds and term repurchase agreements (repos).
Liquidity Portfolio At 31 December 2018, the banking business had £129.4 billion of highly liquid unencumbered LCR eligible assets (31 December 2017: £120.9 billion), of which £128.6 billion is LCR level 1 eligible (31 December 2017: £120.2 billion) and £0.8 billion is LCR level 2 eligible (31 December 2017: £0.7 billion). These assets are available to meet cash and collateral outflows and PRA regulatory requirements. The Insurance business manages a separate liquidity portfolio to mitigate insurance liquidity risk. Total LCR eligible liquid assets represent just under 6.2 times the Group’s money market funding less than one year to maturity (excluding derivative collateral margins and settlement accounts) and exceed total wholesale funding, and thus provide a substantial buffer in the event of market dislocation.
Stress testing results Internal liquidity stress testing results at 31 December 2018 showed that the banking business had liquidity resources representing 167 per cent of modelled outflows from all wholesale funding sources, retail and corporate deposits, intraday requirements and rating dependent contracts under the Group’s most severe liquidity stress scenario.
Mitigation The Group’s Risk Management Framework (RMF) establishes robust arrangements for risk governance, in particular by: Defining individual and collective accountabilities for risk management, risk oversight and risk assurance through a three lines of defence model which supports the discharge of responsibilities to customers, shareholders and regulators; Outlining governance arrangements which articulate the enterprise-wide approach to risk management; and
Monitoring A review of the Group’s RMF, which includes the status of the Group’s principles and policy framework, and the design and operational effectiveness of key governance committees, is undertaken on an annual basis and the findings are reported to the Group Risk Committee, Board Risk Committee and the Board.
Balance sheet linkages The information provided in table 1.42 aims to facilitate the understanding of linkages between banking, trading, and insurance balance sheet items and the positions disclosed in the Group’s market risk disclosures.
Debt securities in issue 91,168 – 91,168 – Interest rate, credit spread
Monitoring GALCO and the GMRC regularly review high level market risk exposure as part of the wider risk management framework. They also make recommendations to the Board concerning overall market risk appetite and Group Market Risk Policy. Exposures at lower levels of delegation are monitored at various intervals according to their volatility, from daily in the case of trading portfolios to monthly or quarterly in the case of less volatile portfolios. Levels of exposures compared to approved limits and triggers are monitored by Risk and where appropriate, escalation procedures are in place.
Basis risk arises from the possible changes in spreads, for example where the bank lends with reference to a central bank rate but funds with reference to LIBOR, and the spread between these two rates widens or tightens.
Measurement Interest rate risk exposure is monitored monthly using, primarily: (i) Market value sensitivity: this methodology considers all repricing mismatches (behaviourally adjusted where appropriate) in the current balance sheet and calculates the change in market value that would result from an instantaneous 25, 100 and 200 basis points parallel rise or fall in the yield curve (subject to an appropriate floor). The market value sensitivities are calculated on a static balance sheet using principal cash flows excluding interest, commercial margins and other spread components and are therefore discounted at the risk free zero-coupon rate.
Table 1.44 below shows, split by material currency, the Group’s market value sensitivities to an instantaneous parallel up and down 25 and 100 basis points change to all interest rates.
Client facing activity and associated hedges 76.2 (125.4) 341.6 (538.6) 86.1 (54.0) 370.5 (186.9)
Mitigation The Group’s policy is to optimise reward whilst managing its market risk exposures within the risk appetite defined by the Board. The Group Market Risk Policy and procedures outlines the hedging process, and the centralisation of risk from divisions into GCT, e.g. via the transfer pricing framework. GCT is responsible for managing the centralised risk and does this through natural offsets of matching assets and liabilities, and appropriate hedging activity of the residual exposures, subject to the authorisation and mandate of GALCO within the Board risk appetite. The hedges are externalised to the market by derivative desks within GCT and Commercial Banking Markets. The Group has hedge accounting solutions in place, which reduce the accounting volatility arising from the Group’s economic hedging activities by utilising both LIBOR and bank base rate assets.
Whilst the bank faces margin compression in low rate environments, its exposure to pipeline and prepayment risk are not considered material, and are hedged in line with expected customer behaviour. These are appropriately monitored and controlled through divisional Asset and Liability Committees (ALCOs).
Longevity risk is measured using both 1-in-20 year stresses (risk appetite) and 1-in-200 year stresses (regulatory capital).
Equity risk arises indirectly through the value of future management charges on policyholder funds. These management charges form part of the value of in-force business (see note 24 on page 210). Equity risk also arises in the with-profits funds but is less material.
Credit spread risk mainly arises from annuities where policyholders’ future cash flows are guaranteed at retirement. Exposure arises if the market value of the assets which are held to back these liabilities, mainly corporate bonds and loans, do not perform in line with expectations.
Table 1.47 demonstrates the impact of the Group’s UK Recession scenario on Insurance’s portfolio (with no diversification benefit, but after the impact of Group consolidation on interest rate and credits spreads). For Insurance, this impact of this scenario is identical to the Eurozone Credit Crunch so no restatement of 2017 figures is required. The amounts include movements in assets, liabilities and the value of in-force business in respect of Insurance contracts and participating investment contracts. The impact of equity movements at 2018 has been mitigated by hedging actions in the year. The impact of interest rate and credit spread movements at 2018 has been impacted by the adoption of IFRS9.
Trading book VaR (1-day 99 per cent) is compared daily against both hypothetical and actual profit and loss. The 1-day 99 per cent VaR chart for Lloyds Banking Group can be found in the Group’s Pillar 3 Report
Report on the audit of the financial statements Opinion In our opinion, the financial statements of Lloyds Banking Group plc (the Group) and the parent company financial statements (the financial statements): – give a true and fair view of the state of the Group’s and of the parent company’s affairs as at 31 December 2018 and of the Group’s profit and the Group’s and parent company’s cash flows for the year then ended; – have been properly prepared in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union and, as regards the parent company’s financial statements, as applied in accordance with the provisions of the Companies Act 2006; and – have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation.
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.
These items were discussed with the Audit Committee as part of our audit plan communicated in April 2018 and supplemented with updates in January 2019. These were the key audit matters for discussion at the conclusion of our audit.
Independent auditors’ report to the members of Lloyds Banking Group plc continued 162 Lloyds Banking Group Annual Report and Accounts 2018
Materiality The scope of our audit was influenced by our application of materiality. We set certain quantitative thresholds for materiality. These, together with qualitative considerations, helped us to determine the scope of our audit and the nature, timing and extent of our audit procedures on the individual financial statement line items and disclosures, and in evaluating the effect of misstatements, both individually and in aggregate on the financial statements as a whole.
We agreed with the Audit Committee that we would report to them misstatements identified during our audit above £15 million (Group audit and parent company audit) (2017: £20 million) as well as misstatements below those amounts that, in our view, warranted reporting for qualitative reasons.
Any components which were considered individually financially significant in the context of the Group’s consolidated financial statements (defined as components that represent more than or equal to 10% of the total assets of the consolidated Group) were considered full scope components. We considered the individual financial significance of other components in relation to primary statement account balances. We considered the presence of any significant audit risks and other qualitative factors (including history of misstatements through fraud or error). Any component which was not already included as a full scope audit component but was identified as being individually financially significant in respect of one of more account balances was subject to specific audit procedures over those account balances. Inconsequential components (defined as components which, in our judgement, did not represent a reasonable possibility of a risk of material misstatement either individually or in aggregate) were eliminated from further consideration for specific audit procedures although they were subject to Group level analytical review procedures. All remaining components which were neither inconsequential nor individually financially significant were subject to procedures which mitigated the risk of material misstatement including testing of entity level controls, information technology general controls and Group and component level analytical review procedures.
Components within the scope of our audit contributed 92 per cent of Group total assets and 87 per cent of Group total income.
Group economics We understood management’s process and tested key controls relating to the generation, selection and weighting applied to economic scenarios. We engaged our internal economic experts as well as actuarial modelling specialists to assist us as we considered: – The identification and use of appropriate external economic data; – The operation of the Group’s internally developed statistical model; – The approach to selection of economic scenarios representing an upside, downside and severe downside in addition to the Group’s base case scenario used for internal planning; and
We critically assessed the assumptions adopted in the base case economic scenario and compared this both to our independent view of the economic outlook as well as market consensus, and investigated economic variables outside of our thresholds. We assessed the risk of bias in the forecasts, as well as the existence of contrary evidence. We considered the political uncertainties that existed at the year‑end and how these might impact on the economic scenarios selected by the Group.
Retail and Commercial Banking We understood management’s process and tested key controls around the determination of expected credit loss allowances, 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
Given the inherent uncertainty in the estimation of conduct, litigation and other regulatory provisions and their judgemental nature, we evaluated the disclosures made in the financial statements. In particular, we focused on challenging management around whether the disclosures were sufficiently clear in highlighting the exposures that remain, significant uncertainties that exist in respect of the provisions and the sensitivity of the provisions to changes in the underlying assumptions.
For credit default and illiquidity premium, we assessed the appropriateness of the methodology against our knowledge and experience of regulatory requirements and industry practice. We challenged whether the asset mix used in the illiquidity premium calculation remained an appropriate proxy to a market consistent portfolio by comparing the proportion of illiquid assets held to those held by other similar companies based on our understanding of the market and the most recent public information for other similar companies.
For persistency, we considered the appropriateness of assumptions set by management in light of actual experience and regulatory changes. For example, we considered how the assumptions reflected expected persistency experience from the removal of commission for qualifying pension schemes and the impact of increased options available to pension policyholders (Finance Act 2014).
Valuation of certain level 3 financial instruments Group Refer to page 70 (Audit Committee Report), page 177 (Accounting Policies) and pages 241 and 271 (Notes 49, 54 and Critical Accounting Estimates and Judgements). As part of the Group’s transition to IFRS 9, £10.2bn of financial assets have been transferred from amortised cost to fair value. These comprise two portfolios, each of which are concentrations of similar, non‑traded assets which are classified as level 3 instruments as their valuation is subjective and determined using bespoke models which rely on a range of unobservable inputs.
With the support of our valuations specialists, we performed the following testing: – evaluating the appropriateness of the valuation methodologies and testing their application; – evaluating key inputs and assumptions, with reference to matters including historic performance, market information and perspectives, servicer and trustee reports and investment prospectuses; and
We performed testing over the consensus and employee data used in calculating the obligation. Where material, we also considered the treatment of curtailments, settlements, past service costs, remeasurements, benefits paid, and any other amendments made to obligations during the year.
For the purposes of our audit, we validate the design and operating effectiveness of those automated and IT dependent controls that support the in‑scope financial statement line items. We also review the supporting IT General Computer Controls (ITGCs) that provide assurance over the effective operation of these controls as well as those controls that manage the integrity of relevant data repositories for the full financial reporting period.
We are required to report if we have anything material to add, or draw attention to, in respect of the directors’ statement in the financial statements about whether the directors considered it appropriate to adopt the going concern basis of accounting in preparing the financial statements, and the directors’ identification of any material uncertainties to the Group’s and the parent company’s ability to continue as a going concern over a period of at least twelve months from the date of approval of the financial statements.
We have nothing to report in respect of the above matters. 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.
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.
Based on the responsibilities described above and our work undertaken in the course of the audit, the Companies Act 2006 (CA06), ISAs (UK) and the Listing Rules of the Financial Conduct Authority (FCA) require us also to report certain opinions and matters as described below (required by ISAs (UK) unless otherwise stated).
Other Code Provisions We have nothing to report in respect of our responsibility to report when: – The statement given by the directors, on page 81, that they consider the Annual Report taken as a whole to be fair, balanced and understandable, and provides the information necessary for the members to assess the Group’s and parent company’s position and performance, business model and strategy is materially inconsistent with our knowledge of the Group and parent company obtained in the course of performing our audit. – The section of the Annual Report on page 70 describing the work of the Audit Committee does not appropriately address matters communicated by us to the Audit Committee. – The directors’ statement relating to the parent company’s compliance with the Code does not properly disclose a departure from a relevant provision of the Code specified, under the Listing Rules, for review by the auditors.
Movement in cash flow hedging reserve: Effective portion of changes in fair value taken to other comprehensive income 234 (363) 2,432
Consolidated statement of changes in equity for the year ended 31 December 174 Lloyds Banking Group Annual Report and Accounts 2018
Currency translation differences (tax: £nil) – (8) – (8) – – (8)
IFRS 9 replaces IAS 39 and addresses classification, measurement and derecognition of financial assets and liabilities, the impairment of financial assets measured at amortised cost or fair value through other comprehensive income, expected credit loss provisions for loan commitments and financial guarantee contracts and general hedge accounting.
Classification and measurement: IFRS 9 requires financial assets to be classified into one of the following measurement categories: fair value through profit or loss, fair value through other comprehensive income and amortised cost. Classification is made on the basis of the objectives of the entity’s business model for managing its financial assets and the contractual cash flow characteristics of the instruments. The requirements for derecognition are broadly unchanged from IAS 39. The standard also retains most of the IAS 39 requirements for financial liabilities except for those designated at fair value through profit or loss whereby that part of the fair value change attributable to the entity’s own credit risk is recorded in other comprehensive income. The Group early adopted this requirement with effect from 1 January 2017.
General hedge accounting: The new hedge accounting model aims to provide a better link between risk management strategy, the rationale for hedging and the impact of hedging on the financial statements. The standard does not explicitly address macro hedge accounting solutions, which are being considered in a separate IASB project – Accounting for Dynamic Risk Management. Until this project is finalised, the IASB has provided an accounting policy choice to retain IAS 39 hedge accounting in its entirety or choose to apply the IFRS 9 hedge accounting requirements. The Group has elected to continue applying hedge accounting as set out in IAS 39.
Details of the impact of adoption of IFRS 9 and IFRS 15 are provided in note 54.
The Group consolidates collective investment vehicles if its beneficial ownership interests give it substantive rights to remove the external fund manager over the investment activities of the fund. Where a subsidiary of the Group is the fund manager of a collective investment vehicle, the Group considers a number of factors in determining whether it acts as principal, and therefore controls the collective investment vehicle, including: an assessment of the scope of the Group’s decision making authority over the investment vehicle; the rights held by other parties including substantive removal rights without cause over the Group acting as fund manager; the remuneration to which the Group is entitled in its capacity as decision maker; and the Group’s exposure to variable returns from the beneficial interest it holds in the investment vehicle. Consolidation may be appropriate in circumstances where the Group has
Financial liabilities are measured at fair value through profit or loss where they are trading liabilities or where they are designated at fair value through profit or loss in order to reduce an accounting mismatch; where the liabilities are part of a group of liabilities (or assets and liabilities) which is managed, and its performance evaluated, on a fair value basis; or where the liabilities contain one or more embedded derivatives that significantly modify the cash flows arising under the contract and would otherwise need to be separately accounted for. Financial liabilities measured at fair value through profit or loss are recognised in the balance sheet at their fair value. Fair value gains and losses are recognised in the income statement within net trading income in the period in which they occur, except that gains and losses attributable to changes in own credit risk are recognised in other comprehensive income.
When a financial liability is exchanged for an equity instrument, the new equity instrument is recognised at fair value and any difference between the carrying value of the liability and the fair value of the new equity is recognised in profit or loss.
Derivatives embedded in a financial asset are not considered separately; the financial asset is considered in its entirety when determining whether its cash flows are solely payments of principal and interest. Derivatives embedded in financial liabilities and insurance contracts (unless the embedded derivative is itself an insurance contract) are treated as separate derivatives when their economic characteristics and risks are not closely related to those of the host contract and the host contract is not carried at fair value through profit or loss. These embedded derivatives are measured at fair value with changes in fair value recognised in the income statement. In accordance with IFRS 4 Insurance Contracts, a policyholder’s option to surrender an insurance contract for a fixed amount is not treated as an embedded derivative.
(2) As lessor Assets leased to customers are classified as finance leases if the lease agreements transfer substantially all the risks and rewards of ownership to the lessee but not necessarily legal title. All other leases are classified as operating leases. When assets are subject to finance leases, the present value of the lease payments, together with any unguaranteed residual value, is recognised as a receivable, net of allowances for expected credit losses, within loans and advances to banks and customers. The difference between the gross receivable and the present value of the receivable is recognised as unearned finance lease income. Finance lease income is recognised in interest income over the term of the lease using the net investment method (before tax) so as to give a constant rate of return on the net investment in the leases. Unguaranteed residual values are reviewed regularly to identify any impairment.
(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.
Current tax is the amount of corporate income taxes expected to be payable or recoverable based on the profit for the period as adjusted for items that are not taxable or not deductible, and is calculated using tax rates and laws that were enacted or substantively enacted at the balance sheet date.
Current tax includes amounts provided in respect of uncertain tax positions when management expects that, upon examination of the uncertainty by Her Majesty’s Revenue and Customs (HMRC) or other relevant tax authority, it is more likely than not that an economic outflow will occur. Provisions reflect management’s best estimate of the ultimate liability based on their interpretation of tax law, precedent and guidance, informed by external tax advice as necessary. Changes in facts and circumstances underlying these provisions are reassessed at each balance sheet date, and the provisions are re‑measured as required to reflect current information.
Deferred tax assets are recognised to the extent it is probable that taxable profits will be available against which the deductible temporary differences can be utilised, and are reviewed at each balance sheet date and reduced to the extent that it is no longer probable that sufficient taxable profits will be available to allow all or part of the asset to be recovered.
Note 2: Accounting policies continued (M) Insurance The Group undertakes both life insurance and general insurance business. Insurance and participating investment contracts are accounted for under IFRS 4 Insurance Contracts, which permits (with certain exceptions) the continuation of accounting practices for measuring insurance and participating investment contracts that applied prior to the adoption of IFRS. The Group, therefore, continues to account for these products using UK GAAP and UK established practice.
Liabilities of the Group’s with‑profit funds, including guarantees and options embedded within products written by these funds, are stated at their realistic values in accordance with the Prudential Regulation Authority’s realistic capital regime, except that projected transfers out of the funds into other Group funds are recorded in the unallocated surplus (see below).
Costs which are directly attributable and incremental to securing new non‑participating investment contracts are deferred. This asset is subsequently amortised over the period of the provision of investment management services and its recoverability is reviewed in circumstances where its carrying amount may not be recoverable. If the asset is greater than its recoverable amount it is written down immediately through fee and commission expense in the income statement. All other costs are recognised as expenses when incurred.
Note 2: Accounting policies continued Contingent liabilities are possible obligations whose existence depends on the outcome of uncertain future events or those present obligations where the outflows of resources are uncertain or cannot be measured reliably. Contingent liabilities are not recognised in the financial statements but are disclosed unless they are remote.
(Q) Cash and cash equivalents For the purposes of the cash flow statement, cash and cash equivalents comprise cash and non‑mandatory balances with central banks and amounts due from banks with a maturity of less than three months.
Lifetime of an exposure The PD of a financial asset is dependent on its expected life. A range of approaches, segmented by product type, has been adopted by the Group to estimate a product’s expected life. These include using the full contractual life and taking into account behavioural factors such as early repayments and refinancing. For non‑revolving retail assets, the Group has assumed the expected life for each product to be the time taken for all significant losses to be observed and for a material proportion of the assets to fully resolve through either closure or write‑off. For retail revolving products, the Group has considered the losses beyond the contractual term over which the Group is exposed to credit risk. For commercial overdraft facilities, the average behavioural life has been used. Changes to the assumed expected lives of the Group’s assets could have a material effect on the ECL allowance recognised by the Group.
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 in the Corporate Master Scale for UK motor finance accounts is treated as a SICR. For Commercial a doubling of PD with a minimum increase in PD of 1 per cent and a resulting change in the 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.
Valuation of assets and liabilities arising from insurance business At 31 December 2018, the Group recognised a value of in‑force business asset of £4,491 million (2017: £4,533 million) and an acquired value of in‑force business asset of £271 million (2017: £306 million).
Defined benefit pension scheme obligations The net asset recognised in the balance sheet at 31 December 2018 in respect of the Group’s defined benefit pension scheme obligations was £1,146 million (comprising an asset of £1,267 million and a liability of £121 million) (2017: a net asset of £509 million comprising an asset of £723 million and a liability of £214 million). The Group’s accounting policy for its defined benefit pension scheme obligations is set out in note 2(K).
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.
More detail on the nature of the assumptions that have been made and key sensitivities is set out in note 37.
In accordance with IFRS 13 Fair Value Measurement, the Group categorises financial instruments carried on the balance sheet at fair value using a three level hierarchy. Financial instruments categorised as level 1 are valued using quoted market prices and therefore there is minimal judgement applied in determining fair value. However, the fair value of financial instruments categorised as level 2 and, in particular, level 3 is determined using valuation techniques including discounted cash flow analysis and valuation models.
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.
Note 4: Segmental analysis continued Insurance and Wealth offers insurance, investment and wealth management products and services.
Other includes certain assets previously reported as outside of the Group’s risk appetite and income and expenditure not attributed to divisions, including the costs of certain central and head office functions and the Group’s private equity business, Lloyds Development Capital.
Total underlying income, net of insurance claims 11,237 4,657 1,988 842 18,724
Other external income, net of insurance claims 1,623 1,169 2,343 (587) 4,548
Segment other income, net of insurance claims 2,171 1,653 1,865 321 6,010
Other external income, net of insurance claims 1,313 684 2,432 193 4,622
Other segment items: Investments in joint ventures and associates at end of year 12 6 – 47 65 1 Restated see page 188.
Total underlying income, net of insurance claims 10,239 4,738 1,958 504 17,439
Segment underlying income, net of insurance claims 10,239 4,738 1,958 504 17,439
Other external income, net of insurance claims 1,186 1,413 1,838 (122) 4,315
Segment other income, net of insurance claims 2,165 1,875 1,878 86 6,004
4 Comprises the effects of asset sales (gain of £30 million) ; volatile items (gain of £263 million) ; liability management (loss of £14 million) ; the amortisation of purchased intangibles (£91 million) ; restructuring costs (£621 million, principally comprising costs relating to the Simplification programme; the rationalisation of the non‑branch property portfolio, the work on implementing the ring‑fencing requirements and the integration of MBNA) ; and the fair value unwind and other items (loss of £270 million) .
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 2.68 per cent (2017: 2.43 per cent; 2016: 2.70 per cent) .
Included within interest and similar income is £227 million (2017: £179 million; 2016: £205 million) in respect of impaired financial assets. Net interest income also includes a credit of £701 million (2017: credit of £651 million; 2016: credit of £557 million) transferred from the cash flow hedging reserve (see note 41).
The Group adopted IFRS 15 ’Revenue from Contracts with Customers’ on 1 January 2018, comparatives have not been restated. Further details on the impact of the new accounting standard, which was not significant, are set out in note 54. At 31 December 2018, the Group held on its balance sheet £282 million in respect of these services and £168 million in respect of amounts received from customers for services to be provided after the balance sheet date. Current unsatisfied performance obligations amount to £314 million at 31 December 2018; the Group expects to receive substantially all of this revenue by 2021.
Change in insurance and participating investment contracts (note 31) 4,565 (9,067) (14,160)
Performance‑based compensation expense comprises: Awards made in respect of the year ended 31 December 362 334 312
Performance‑based compensation expense deferred until later years comprises: Awards made in respect of the year ended 31 December 152 127 123
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: 2018 £m 2017 £m 2016 £m
Audit related fees: This category includes fees in respect of services for assurance and related services that are reasonably related to the performance of the audit or review of the financial statements, for example acting as reporting accountants in respect of debt prospectuses required by the listing rules.
Other changes in credit quality Changes in loss allowance as a result of movements in risk parameters that reflect changes in customer quality, but which have not resulted in a transfer to a different stage. This also contains the impact on the impairment charge as a result of write‑offs and recoveries, where the related loss allowances are reassessed to reflect ultimate realisable or recoverable value.
The income tax expense is made up as follows: £m £m £m
Profit attributable to equity shareholders – basic and diluted 3,869 3,042 2,001
Other financial assets mandatorily at fair value through profit or loss £m
Derivatives designated as fair value hedges: Derivatives designated as cash flow hedges: Total derivative assets/liabilities – hedging 718,984 1,563 1,108 741,357 1,881 1,613
The notional amount of the contract does not represent the Group’s real exposure to credit risk which is limited to the current cost of replacing contracts with a positive value to the Group should the counterparty default. To reduce credit risk the Group uses a variety of credit enhancement techniques such as netting and collateralisation, where security is provided against the exposure. Further details are provided in note 52 Credit risk.
The principal derivatives used by the Group are as follows: – Interest rate related contracts include interest rate swaps, forward rate agreements and options. An interest rate swap is an agreement between two parties to exchange fixed and floating interest payments, based upon interest rates defined in the contract, without the exchange of the underlying principal amounts. Forward rate agreements are contracts for the payment of the difference between a specified rate of interest and a reference rate, applied to a notional principal amount at a specific date in the future. An interest rate option gives the buyer, on payment of a premium, the right, but not the obligation, to fix the rate of interest on a future loan or deposit, for a specified period and commencing on a specified future date. – Exchange rate related contracts include forward foreign exchange contracts, currency swaps and options. A forward foreign exchange contract is an agreement to buy or sell a specified amount of foreign currency on a specified future date at an agreed rate. Currency swaps generally involve the exchange of interest payment obligations denominated in different currencies; the exchange of principal can be notional or actual. A currency option gives the buyer, on payment of a premium, the right, but not the obligation, to sell specified amounts of currency at agreed rates of exchange on or before a specified future date. – Credit derivatives, principally credit default swaps, are used by the Group as part of its trading activity and to manage its own exposure to credit risk. A credit default swap is a swap in which one counterparty receives a premium at pre‑set intervals in consideration for guaranteeing to make a specific payment should a negative credit event take place. – Equity derivatives are also used by the Group as part of its equity‑based retail product activity to eliminate the Group’s exposure to fluctuations in various international stock exchange indices. Index‑linked equity options are purchased which give the Group the right, but not the obligation, to buy or sell a specified amount of equities, or basket of equities, in the form of published indices on or before a specified future date.
Note 19: Finance lease receivables The Group's finance lease receivables are classified as loans and advances to customers and accounted for at amortised cost. The balance is analysed as follows: 2018 £m 2017 £m
Later than 1 year and not later than 5 years 1,351 1,106
Equipment leased to customers under finance leases primarily relates to structured financing transactions to fund the purchase of aircraft, ships and other large individual value items. During 2017 and 2018 no contingent rentals in respect of finance leases were recognised in the income statement. There was an allowance for uncollectable finance lease receivables included in the allowance for impairment losses of £1 million (2017: £nil).
Charge to the income statement (note 13) (65) (51) 1,140 – 1,024
Charge to the income statement (note 13) (19) (48) (6) – (73)
The recoverable amount of the goodwill relating to Scottish Widows has been based on a value‑in‑use calculation. The calculation uses pre‑tax projections of future cash flows based upon budgets and plans approved by management covering a three‑year period, the related run‑off of existing business in force and a discount rate of 9 per cent. The budgets and plans are based upon past experience adjusted to take into account anticipated changes in sales volumes, product mix and margins having regard to expected market conditions and competitor activity. The discount rate is determined with reference to internal measures and available industry information. New business cash flows beyond the three‑year period have been extrapolated using a steady 2 per cent growth rate which does not exceed the long‑term average growth rate for the life assurance market. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of Scottish Widows to fall below its balance sheet carrying value.
Note 24: Value of in-force business Key assumptions The impact of reasonably possible changes in the key assumptions made in respect of the Group's life insurance business, which include the impact on the value of in force business, are disclosed in note 32.
The principal features of the methodology and process used for determining key assumptions used in the calculation of the value of in‑force business are set out below: Economic assumptions Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. In practice, to achieve the same result, where the cash flows are either independent of or move linearly with market movements, a method has been applied known as the ‘certainty equivalent’ approach whereby it is assumed that all assets earn a risk‑free rate and all cash flows are discounted at a risk‑free rate. The certainty equivalent approach covers all investment assets relating to insurance and participating investment contracts, other than the annuity business (where an illiquidity premium is included, see below).
Expense inflation 3.75 3.67 1 All risk‑free rates are quoted as the range of rates implied by the relevant forward swap curve.
Non-market risk An allowance for non‑market risk is made through the choice of best estimate assumptions based upon experience, which generally will give the mean expected financial outcome for shareholders and hence no further allowance for non‑market risk is required. However, in the case of operational risk, reinsurer default and the with‑profit funds these can be asymmetric in the range of potential outcomes for which an explicit allowance is made.
The movement in the acquired value of in‑force non‑participating investment contracts over the year is as follows: 2018 £m 2017 £m
Movement in value of in‑force business The movement in the value of in‑force insurance and participating investment contracts over the year is as follows: 2018 £m 2017 £m
The purchased credit card relationships represent the benefit of recurring income generated from portfolios of credit cards purchased. The balance sheet amount at 31 Deceber 2018 is expected to be amortised over its remaining useful life of nine years.
Change in fair value of investment properties (note 7) 230 – – – 230
Change in fair value of investment properties (note 7) 139 – – – 139
Accumulated depreciation and impairment: Depreciation charge for the year – 125 734 1,085 1,944
Balance sheet amount at 31 December 2017 3,699 1,063 2,943 5,022 12,727
Assets arising from reinsurance contracts held (notes 31 and 33) 749 602
Liabilities designated at fair value through profit or loss primarily represent debt securities in issue which either contain substantive embedded derivatives which would otherwise need to be recognised and measured at fair value separately from the related debt securities, or which are accounted for at fair value to significantly reduce an accounting mismatch.
Life insurance (see (1) below) : Non‑life insurance contracts (see (2) below) : 1 During the year the Group has reviewed the classification of pre‑2007 unitised pension savings products and as a result these products have been reclassified from insurance contracts to participating investment contracts; comparatives have been restated accordingly.
(ii) Method of calculation of liabilities With‑profit liabilities are stated at their realistic value, the main components of which are: – With‑profit benefit reserve, the total asset shares for with‑profit policies; – Cost of options and guarantees (including guaranteed annuity options) ; – Deductions levied against asset shares; – Planned enhancements to with‑profits benefits reserve; and – Impact of the smoothing policy.
(iii) Assumptions Key assumptions used in the calculation of with‑profit liabilities, and the processes for determining these, are: Investment returns and discount rates With‑profit fund liabilities are valued on a market‑consistent basis, achieved by the use of a valuation model which values liabilities on a basis calibrated to tradable market option contracts and other observable market data. The with‑profit fund financial options and guarantees are valued using a stochastic simulation model where all assets are assumed to earn, on average, the risk‑free yield and all cash flows are discounted using the risk‑free yield. The risk‑free yield is defined as the spot yield derived from the relevant swap curve, adjusted for credit risk. Further information on significant options and guarantees is given below.
For those policies written in Scottish Widows pre‑demutualisation containing potentially valuable options and guarantees, under the terms of the Scheme a separate memorandum account was set up, within the With‑Profit Fund originally held in Scottish Widows plc and subsequently transferred into Scottish Widows Limited, called the Additional Account which is available, inter alia, to meet any additional costs of providing guaranteed benefits in respect of those policies. The Additional Account had a value at 31 December 2018 of £2.5 billion (2017: £2.8 billion). The eventual cost of providing benefits on policies written both pre and post demutualisation is dependent upon a large number of variables, including future interest rates and equity values, demographic factors, such as mortality, and the proportion of policyholders who seek to exercise their options. The ultimate cost will therefore not be known for many years.
Note 31: Liabilities arising from insurance contracts and participating investment contracts continued Interest rates The rates of interest used are determined by reference to a number of factors including the redemption yields on fixed interest assets at the valuation date.
(iv) Options and guarantees outside the With-Profit Funds A number of typical guarantees are provided outside the With‑Profit Funds such as guaranteed payments on death (e.g. term assurance) or guaranteed income for life (e.g. annuities). In addition, certain personal pension policyholders in Scottish Widows, for whom reinstatement to their occupational pension scheme was not an option, have been given a guarantee that their pension and other benefits will correspond in value to the benefits of the relevant occupational pension scheme. The key assumptions affecting the ultimate value of the guarantee are future salary growth, gilt yields at retirement, annuitant mortality at retirement, marital status at retirement and future investment returns. There is currently a provision, calculated on a deterministic basis, of £39 million (2017: £35 million) in respect of those guarantees.
Change in provision for unearned premiums charged to income statement (16) (46)
These provisions represent the liability for short‑term insurance contracts for which the Group’s obligations are not expired at the year end.
Note 32: Life insurance sensitivity analysis The following table demonstrates the effect of reasonably possible changes in key assumptions on profit before tax and equity disclosed in these financial statements assuming that the other assumptions remain unchanged. In practice this is unlikely to occur, and changes in some assumptions may be correlated. These amounts include movements in assets, liabilities and the value of the in‑force business in respect of insurance contracts and participating investment contracts. The impact is shown in one direction but can be assumed to be reasonably symmetrical.
Widening of credit default spreads on corporate bonds8 0.25% addition (364) (303) (235) (195)
5 This sensitivity shows the impact on the value of in‑force business, financial options and guarantee costs, statutory reserves and asset values of reducing the risk‑free rate by 25 basis points.
8 This sensitivity shows the impact of a 25 basis point increase in credit default spreads on corporate bonds and the corresponding reduction in market values. Swap curves, the risk‑free rate and illiquidity premia are all assumed to be unchanged.
The total amount recognised in the balance sheet relates to: 2018 £m 2017 £m
A valuation to determine the funding status of each scheme is carried out at least every three years, whereby scheme assets are measured at market value and liabilities (technical provisions) are measured using prudent assumptions. If a deficit is identified a recovery plan is agreed between the Group and the scheme Trustee and sent to the Pensions Regulator for review. The Group has not provided for these deficit contributions as the future economic benefits arising from these contributions are expected to be available to the Group. The Group’s overseas defined benefit pension schemes are subject to local regulatory arrangements.
The last funding valuations of other Group schemes were carried out on a number of different dates. In order to report the position under IAS 19 as at 31 December 2018 the most recent valuation results for all schemes have been updated by qualified independent actuaries. The main differences between the funding and IAS 19 valuations are different and more prudent approach to setting the discount rate and more conservative longevity assumptions used in the funding valuations.
Return on plan assets excluding amounts included in interest income (1,558) 1,267
Money market instruments, cash, derivatives and other assets and liabilities (283) (6,843) (7,126) 1,501 (5,190) (3,689)
Risk exposure of the defined benefit schemes Whilst the Group is not exposed to any unusual, entity specific or scheme specific risks in its defined benefit pension schemes, it is exposed to a number of significant risks, detailed below: Inflation rate risk: the majority of the plans’ benefit obligations are linked to inflation both in deferment and once in payment. Higher inflation will lead to higher liabilities although this will be materially offset by holdings of inflation‑linked gilts and, in most cases, caps on the level of inflationary increases are in place to protect against extreme inflation.
Asset at 31 December 2,453 2,284 Asset at 31 December 2,453 2,284
On 29 October 2018, the UK government announced its intention to restrict the use of capital tax losses to 50 per cent of any future gains arising. Had this restriction been substantively enacted at 31 December 2018, the effect would have been to reduce net deferred tax assets by £41 million.
In addition, no deferred tax asset is recognised in respect of unrelieved foreign tax credits of £46 million (2017: £46 million), as there are no expected future taxable profits against which the credits can be utilised. These credits can be carried forward indefinitely.
Packaged bank accounts The Group has provided a further £45 million in the year ended 31 December 2018 (£245 million was provided in the year ended 31 December 2017) in respect of complaints relating to alleged mis‑selling of packaged bank accounts, raising the total amount provided to £795 million. A number of risks and uncertainties remain particularly with respect to future volumes.
1 The repurchases and redemptions resulted in cash outflows of £2,256 million (2017: £1,008 million) .
Dated subordinated liabilities £m 1.75% Subordinated Fixed Rate Notes 2028 callable 2023 664 4.344% Subordinated Fixed Rate Notes callable 2048 1,065
Redesignation to ordinary shares (see below) – (80,921,051) – – (8) –
The directors have authority to allot and issue ordinary and preference shares and to make market purchases of ordinary and preference shares as granted at the annual general meeting on 24 May 2018. The authority to issue shares and the authority to make market purchases of shares will expire at the next annual general meeting. Shareholders will be asked, at the annual general meeting, to give similar authorities.
Redemption of preference shares1 – – 210 1 During the year ended 31 December 2016, the Company redeemed all of its outstanding 6.267% Non‑cumulative Fixed to Floating Rate Callable US Dollar Preference Shares at their combined sterling equivalent par value of £210 million. These preference shares had been accounted for as subordinated liabilities. On redemption an amount of £210 million was transferred from the distributable merger reserve to the share premium account.
Revaluation reserve in respect of debt securities held at fair value through other comprehensive income 279
The payment of dividends by subsidiaries and the ability of members of the Group to lend money to other members of the Group may be subject to regulatory or legal restrictions, the availability of reserves and the financial and operating performance of the entity. Details of such restrictions and the methods adopted by the Group to manage the capital of its subsidiaries are provided under Capital Risk on page 140.
The principal terms of the AT1 securities are described below: – The securities rank behind the claims against Lloyds Banking Group plc of (a) unsubordinated creditors, (b) claims which are, or are expressed to be, subordinated to the claims of unsubordinated creditors of Lloyds Banking Group plc but not further or otherwise or (c) whose claims are, or are expressed to be, junior to the claims of other creditors of Lloyds Banking Group, whether subordinated or unsubordinated, other than those whose claims rank, or are expressed to rank, pari passu with, or junior to, the claims of the holders of the AT1 Securities in a winding‑up occurring prior to the Conversion Trigger. – The securities bear a fixed rate of interest until the first call date. After the initial call date, in the event that they are not redeemed, the AT1 securities will bear interest at rates fixed periodically in advance for five year periods based on market rates. – Interest on the securities will be due and payable only at the sole discretion of Lloyds Banking Group plc, and Lloyds Banking Group plc may at any time elect to cancel any Interest Payment (or any part thereof) which would otherwise be payable on any Interest Payment Date. There are also certain restrictions on the payment of interest as specified in the terms. – The securities are undated and are repayable, at the option of Lloyds Banking Group plc, in whole at the first call date, or on any fifth anniversary after the first call date. In addition, the AT1 securities are repayable, at the option of Lloyds Banking Group plc, in whole for certain regulatory or tax reasons. Any repayments require the prior consent of the PRA. – The securities convert into ordinary shares of Lloyds Banking Group plc, at a pre‑determined price, should the fully loaded Common Equity Tier 1 ratio of the Group fall below 7.0 per cent.
Note 44: Dividends on ordinary shares The directors have recommended a final dividend, which is subject to approval by the shareholders at the Annual General Meeting, of 2.14 pence per share (2017: 2.05 pence per share; 2016: 1.7 pence per share) representing a total dividend of £1,523 million (2017: £1,475 million; 2016: £1,212 million), which will be paid on 21 May 2019. At 31 December 2016 the directors also recommended a special dividend of 0.5 pence per share representing a total dividend of £356 million. The financial statements do not reflect recommended dividends.
The cash cost of the dividends paid in the year was £2,240 million (2017: £2,284 million; 2016: £2,014 million), in 2017 and 2016 this was net of a credit in respect of unclaimed dividends written‑back in accordance with the Company's Articles of Association.
Note 45: Share-based payments Charge to the income statement The charge to the income statement is set out below: 2017 £m 2016 £m
Executive and SAYE plans: Options granted in the year 14 17 16
During the year ended 31 December 2018 the Group operated the following share‑based payment schemes, all of which are equity settled.
For the 2016 and 2017 plan participants may be entitled to any dividends paid during the vesting period if the performance conditions are met. An amount equal in value to any dividends paid between the award date and the date the Remuneration Committee determine that the performance conditions were met may be paid, based on the number of shares that vest. The Remuneration Committee will determine if any dividends are to be paid in cash or in shares. Details of the performance conditions for the plan are provided in the Directors’ remuneration report.
Awards in respect of the 2016 grant vested in 2019 at a rate of 68.7 per cent.
The table below details, on an aggregated basis, key management personnel compensation: 2018 £m 2017 £m 2016 £m
Granted, including certain adjustments (includes entitlements of appointed key management personnel) 39 37 29
Deposits placed by key management personnel attracted interest rates of up to 3.5 per cent (2017: 4.0 per cent; 2016: 4.0 per cent).
At 31 December 2018, the Group did not provide any guarantees in respect of key management personnel (2017 and 2016: none).
In addition to the above balances, the Group has a number of other associates held by its venture capital business that it accounts for at fair value through profit or loss. At 31 December 2018, these companies had total assets of approximately £4,091 million (2017: £4,661 million), total liabilities of approximately £4,616 million (2017: £5,228 million) and for the year ended 31 December 2018 had turnover of approximately £4,522 million (2017: £4,601 million) and made a loss of approximately £125 million (2017: net loss of £87 million). In addition, the Group has provided £1,141 million (2017: £1,226 million) of financing to these companies on which it received £49 million (2017: £81 million) of interest income in the year.
Certain Group companies are also named as defendants in (i) UK based claims; and (ii) in 2 Dutch class actions, raising LIBOR manipulation allegations. A number of the claims against the Group in relation to the alleged mis‑sale of interest rate hedging products also include allegations of LIBOR manipulation.
Undrawn formal standby facilities, credit lines and other commitments to lend: Less than 1 year original maturity: Mortgage offers made 11,594 11,156
Operating lease commitments Where a Group company is the lessee the future minimum lease payments under non‑cancellable premises operating leases are as follows: 2018 £m 2017 £m
All lending assets and debt securities held by the Group in Cancara are restricted in use, as they are held by the collateral agent for the benefit of the commercial paper investors and the liquidity providers only. The Group provides liquidity facilities to Cancara under terms that are usual and customary for standard lending activities in the normal course of the Group’s banking activities. During 2018 there have continued to be planned drawdowns on certain liquidity facilities for balance sheet management purposes, supporting the programme to provide funding alongside the proceeds of the asset‑backed commercial paper issuance. The Group could be asked to provide support under the contractual terms of these arrangements including, for example, if Cancara experienced a shortfall in external funding, which may occur in the event of market disruption.
(C) Unconsolidated collective investment vehicles and limited partnerships The Group’s direct interests in unconsolidated structured entities comprise investments in collective investment vehicles, such as Open‑Ended Investment Companies, and limited partnerships with a total carrying value of £26,028 million at 31 December 2018 (2017: £28,759 million), included within financial assets designated at fair value through profit and loss (see note 16). These investments include both those entities managed by third parties and those managed by the Group. At 31 December 2018, the total asset value of these unconsolidated structured entities, including the portion in which the Group has no interest, was £2,435 billion (2017: £2,338 billion).
Financial assets at fair value through profit or loss – 35,246 123,283 – – – – 158,529
Financial assets at fair value through other comprehensive income – – – – 24,815 – – 24,815
Financial liabilities at fair value through profit or loss – 23,451 – 7,096 – – – 30,547
Liabilities arising from insurance contracts and participating investment contracts – – – – – – 98,874 98,874
Liabilities arising from non‑participating investment contracts – – – – – – 13,853 13,853
Loans and advances to customers – – – – 472,498 – 472,498
Items in course of transmission to banks – – – – 584 – 584
Unallocated surplus within insurance businesses – – – – – 390 390
Total financial assets at fair value through other comprehensive income 19,182 5,366 267 24,815
Total trading and other financial assets at fair value through profit or loss 104,988 54,204 3,686 162,878
Movements in Level 3 portfolio The table below analyses movements in level 3 financial assets, excluding derivatives, carried at fair value (recurring measurement).
Adjustment on adoption of IFRS 9 (note 54) 10,466 302 (696) 10,072
Gains (losses) recognised in the income statement, within other income, relating to the change in fair value of those assets held at 31 December (104) – (104) 125 – 125
Debt securities Debt securities measured at fair value and classified as level 2 are valued by discounting expected cash flows using an observable credit spread applicable to the particular instrument.
(B) Financial liabilities, excluding derivatives Valuation hierarchy At 31 December 2018, the Group’s financial liabilities carried at fair value, excluding derivatives, comprised its financial liabilities at fair value through profit or loss and totalled £30,547 million (31 December 2017: £50,877 million). The table below analyses these financial liabilities by balance sheet classification and valuation methodology (level 1, 2 or 3, as described on page 243). The fair value measurement approach is recurring in nature. There were no significant transfers between level 1 and 2 during the year.
Losses (gains) recognised in the income statement within other income – (2)
(C) Derivatives All of the Group’s derivative assets and liabilities are carried at fair value. At 31 December 2018, such assets totalled £23,595 million (31 December 2017: £25,834 million) and liabilities totalled £21,373 million (31 December 2017: £26,124 million). The table below analyses these derivative balances by valuation methodology (level 1, 2 or 3, as described on page 243). The fair value measurement approach is recurring in nature. There were no significant transfers between level 1 and level 2 during the year.
Where the Group’s derivative assets and liabilities are not traded on an exchange, they are valued using valuation techniques, including discounted cash flow and options pricing models, as appropriate. The types of derivatives classified as level 2 and the valuation techniques used include: – Interest rate swaps which are valued using discounted cash flow models; the most significant inputs into those models are interest rate yield curves which are developed from publicly quoted rates. – Foreign exchange derivatives that do not contain options which are priced using rates available from publicly quoted sources. – Credit derivatives which are valued using standard models with observable inputs, except for the items classified as level 3, which are valued using publicly available yield and credit default swap (CDS) curves. – Less complex interest rate and foreign exchange option products which are valued using volatility surfaces developed from publicly available interest rate cap, interest rate swaption and other option volatilities; option volatility skew information is derived from a market standard consensus pricing service. For more complex option products, the Group calibrates its models using observable at‑the‑money data; where necessary, the Group adjusts for out‑of‑the‑ money positions using a market standard consensus pricing service.
Losses (gains) recognised in the income statement within other income (84) 49 (208) 215
Gains (losses) recognised in the income statement, within other income, relating to the change in fair value of those assets or liabilities held at 31 December (424) 82 (208) 213
The Group has also recognised a Funding Valuation Adjustment to adjust for the net cost of funding uncollateralised derivative positions. This adjustment is calculated on the expected future exposure discounted at a suitable cost of funds. A ten basis points increase in the cost of funds will increase the funding valuation adjustment by approximately £23 million.
At 31 December 2018, the Group’s derivative trading business held mid to bid‑offer valuation adjustments of £80 million (2017: £74 million).
Level 3 financial liabilities carried at fair value 727 804 1 Ranges are shown where appropriate and represent the highest and lowest inputs used in the level 3 valuations.
Note 50: Transfers of financial assets There were no significant transferred financial assets which were derecognised in their entirety, but with ongoing exposure. Details of transferred financial assets that continue to be recognised in full are as follows.
The Group enters into repurchase and securities lending transactions in the normal course of business that do not result in derecognition of the financial assets covered as substantially all of the risks and rewards, including credit, interest rate, prepayment and other price risks are retained by the Group. In all cases, the transferee has the right to sell or repledge the assets concerned.
Note 51: Offsetting of financial assets and liabilities The following information relates to financial assets and liabilities which have been offset in the balance sheet and those which have not been offset but for which the Group has enforceable master netting agreements or collateral arrangements in place with counterparties.
Market risk (A) Interest rate risk Interest rate risk arises from the different repricing characteristics of the assets and liabilities. Liabilities are either insensitive to interest rate movements, for example interest free or very low interest customer deposits, or are sensitive to interest rate changes but bear rates which may be varied at the Group’s discretion and that for competitive reasons generally reflect changes in the Bank of England’s base rate. The rates on the remaining deposits are contractually fixed for their term to maturity.
The Group’s risk management policy is to optimise reward whilst managing its market risk exposures within the risk appetite defined by the Board. The largest residual risk exposure arises from balances that are deemed to be insensitive to changes in market rates (including current accounts, a portion of variable rate deposits and investable equity), and is managed through the Group’s structural hedge. The structural hedge consists of longer‑term fixed rate assets or interest rate swaps and the amount and duration of the hedging activity is reviewed regularly by the Group Asset and Liability Committee. Further details on the Group market risk policy can be found on page 154.
The Group’s main overseas operations are in the Americas and Europe. Details of the Group’s structural foreign currency exposures, after net investment hedges, are as follows: (C) Functional currency of Group operations
Credit risk The Group’s credit risk exposure arises in respect of the instruments below and predominantly in the United Kingdom. Information about the Group’s exposure to credit risk, credit risk management, measurement and mitigation can be found on pages 115 to 135.
Loans and advances to banks, net1 6,283 – 6,283 6,611 – 6,611
Loans and advances to customers, net1 484,858 (3,241) 481,617 472,498 (7,030) 465,468
Debt securities, treasury and other bills 40,168 – 40,168 45,198 – 45,198
Assets arising from reinsurance contracts held 749 – 749 602 – 602
Stage 2 and Stage 3 assets with a carrying amount of approximately £1,000 million were modified during the year. No material gain or loss was recognised by the Group.
Loans and advances carried at fair value through profit or loss comprise £27,734 million (1 January 2018: £31,590 million) of trading assets of which £27,685 million (1 January 2018: £31,548 million) have a good quality rating and £49 million (1 January 2018: £42 million) have a satisfactory rating; and £13,142 million (1 January 2018: £14,016 million) of other assets mandatorily held at fair value through profit or loss of which £12,509 million (1 January 2018: £13,338 million) is viewed by the business as investment grade.
Debt securities held at amortised cost An analysis by credit rating of the Group’s debt securities held at amortised cost is provided below: Investment grade1 £m Other2 £m Total £m
Total debt securities held at amortised cost 5,238 3,314 1 Credit ratings equal to or better than ‘BBB’.
Financial assets at fair value through other comprehensive income/available-for-sale financial assets (excluding equity shares) An analysis of the Group’s financial assets at fair value through other comprehensive income (available‑for‑sale financial assets at 31 December 2017) is included in note 21. The credit quality of the Group’s financial assets at fair value through other comprehensive income (available‑for‑sale financial assets at 31 December 2017) (excluding equity shares) is set out below: Investment grade1 £m Other2 £m Total £m
Other assets held at fair value through profit or loss: Bank and building society certificates of deposit 1,105 – 1,105 222 – 222