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Our purpose The strong motivation for all of us in Lloyds is the central role we play in Britain’s economy as the UK’s leading financial services provider. We are clear our purpose as a Group is to Help Britain Prosper. This means not only providing outstanding service to our customers, but also responding to the UK’s social and economic issues which we believe we are best placed to address.
Becoming simpler and more efficient Maintained the UK’s largest branch network, with 21 per cent market share. Responding to changing customer usage and preferences resulted in an overall net reduction in branches, the introduction of new branch formats in selected locations and an increase in mobile branches to 28, supporting 169 communities.
Net interest income increased 8 per cent (3 per cent excluding MBNA) reflecting a 14 basis points improvement in net interest margin, driven by deposit repricing offsetting mortgage margin pressures.
Customer deposits were down 1 per cent to £253.1 billion, with a continued reduction in tactical balances.
Exceeded the £4 billion Helping Britain Prosper funding commitment for manufacturing businesses, for the four years to 2017. In addition, continued to support the Lloyds Bank Advanced Manufacturing Training Centre, investing £1 million a year since 2014; and to date have trained over 500 manufacturing graduates, engineers and apprentices, building towards the target of 1,000 by 2020.
The risk appetite framework ensures our risks are managed in line with our risk appetite
Focused action to attract, retain and develop high calibre people. Delivering initiatives which reinforce behaviours to generate the best outcomes for customers and colleagues.
Leveraging our considerable change experience to meet ring-fencing requirements before the regulatory deadlines, and the continuing evolution of SM&CR.
The risk of financial loss, regulatory censure, reputational damage or customer detriment, as a result of deficiencies in the development, application and ongoing operation of financial models and rating systems.
IFRS 9 The Group implemented IFRS 9 (Financial Instruments) on 1 January 2018. The adoption of the new Standard resulted in a reduction in shareholders’ equity of £1.2 billion largely reflecting an increase in impairment provisions of £1.3 billion. The impact on the Group’s CET1 capital ratio before transitional relief at 1 January 2018 was a reduction of c.30 basis points after taking account of the offset against regulatory expected losses. After transitional relief the impact was c.1 basis point.
3 The CET1 and leverage ratios at 31 December 2017 and 2016 are reported on a pro forma basis, reflecting the dividends paid by the Insurance business in February 2018 and February 2017, respectively, in relation to prior year earnings. In addition the CET1 ratios at 31 December 2016 have been adjusted for the acquisition of MBNA.
Lloyds Banking Group Annual Report and Accounts 2017 55 Risk m anag em ent Financial statem ents O
Zak joined the Group in 1989 as a Business Analyst in IT and has carried out multiple roles involving Retail CIO, Head of IT Architecture and leading the Digital Transformation programme. He was appointed Group Director, Digital and Transformation in 2016 and his responsibilities increased in September 2017 as the Group Director, Transformation. He is responsible for the digital transformation of the Group, including all IT and business change, and ensuring we are ready to meet the future expectations of our customers. Zak has a Computer Science degree from York University.
IT Resilience and cyber security At the Board meeting in May 2017, the Board took part in an advanced scenario testing exercise to simulate real life cyber-attack scenarios. The purpose of this was to enhance the Board’s understanding of the processes and controls in place, and to rehearse the actions required from the Board at the different stages of an incident if such an event should occur in reality.
I am pleased to be able to report a successful conclusion to the planned transformation of the Group Internal Audit function, and during the year we carried out a thorough independent external quality assessment of the function. This review noted the scale and pace of improvement and also provided important recommendations on the application of best practice. These have been incorporated in the future audit plan and in providing a fit for purpose approach for audit in the rapidly changing environment.
The Committee also considered the effectiveness and performance of the auditor and the audit process.
The environment within which the Group operates continues to be subject to considerable change. Uncertainties, including the EU Exit and wider geo-political risks continue to provide challenges, and the Committee will continue to monitor developments and any associated impact on the Group’s risk profile.
Each of the current Directors who are in office as at the date of this report, and whose names and functions are listed on pages 54–55 of this annual report, confirm that, to the best of his or her knowledge: the Group financial statements, which have been prepared in accordance with IFRSs as adopted by the European Union, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and Group; and the management report contained in the strategic report and the Directors’ report includes a fair review of the development and performance of the business and the position of the Company and Group, together with a description of the principal risks and uncertainties that they face.
Contents Remuneration Committee Chairman’s statement 84 Remuneration at a glance 86 Annual report on remuneration 88 Directors’ remuneration policy 100
Collective performance adjustment The Committee considered the conduct-related provisions, including an additional PPI provision. This led to a downward adjustment of £109.6 million, or 21 per cent.
The levels of award set for 2018 remain unchanged and are as follows: GCE: £900,000
Failed the annual Prudential Regulation Authority (PRA) stress test due to the Group’s capital position and negative feedback on quality of submissions and ranked significantly below peers.
Restructured the business and reorganised the team ready for the next stage of the Group’s strategic journey.
Successful return of the Group to full private ownership, repaying the taxpayer £20.3 billion plus an additional £900 million.
When determining and reviewing the level of benefits provided, the Committee ensures that decisions are made within the following two parameters: – An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective job-sizing methodologies. – Benefits for comparable roles in comparable publicly listed financial services groups of a similar size.
The Group Ownership Share (GOS) plan is a core part of the reward strategy and an important tool for aligning the Group’s reward strategy to the long-term performance of the business. Through the application of carefully considered, stretching target measures, the Group can ensure that awards are forfeited or restricted where performance does not meet the desired level.
>708,000 individuals, small businesses and charities helped to improve their digital skills in 2017
Model – the Group has embedded a framework for the management of model risk to ensure effective control and oversight, compliance with all regulatory rules and standards, and to facilitate appropriate customer outcomes.
Group Fraud and Financial Crime Prevention Committee Reviews and challenges the management of fraud and financial crime risk including overall strategy and performance, Group-level risk appetite and broader corporate responsibilities, and engagement with relevant authorities and other external parties. The committee is accountable for ensuring that, at Group level, current and emerging fraud and financial crime risks are effectively identified and managed within appetite, and that strategies and investments to improve fraud and financial crime prevention are co-ordinated and implemented in relevant business areas.
The investments held in the Group’s defined benefit pension schemes also expose the Group to credit risk. Note 35 on page 206 provides further information on the defined benefit pension schemes’ assets and liabilities.
Retail customers The Group’s aim in offering forbearance and other assistance to customers in financial distress is to benefit both the customer and the Group by discharging the Group’s regulatory and social responsibilities to support its customers and act in their best long-term interests and by bringing customer facilities back into a sustainable position which, for owner occupier mortgages, also means keeping customers in their homes. The Group offers a range of tools and assistance to support customers who are encountering financial difficulties. Cases are managed on an individual basis, with the circumstances of each customer considered separately and the action taken judged as being affordable and sustainable for the customer. Operationally, the provision and review of such assistance is controlled through the application of an appropriate policy framework, controls around the execution of policy, regular review of the different treatments to confirm that they remain appropriate, monitoring of customers’ performance and the level of payments received, and management visibility of the nature and extent of assistance provided and the associated risk.
Forbearance A key factor in determining whether the Group treats a commercial customer as forborne is the granting of a concession which is outside the Group’s current risk appetite to a borrower who experiences, or is believed to be about to experience, financial difficulty. Where a concession is granted to a customer that is not in financial difficulty or the risk profile is considered within the Group’s current risk appetite, the concession would not be considered to be an act of forbearance. The Group does not believe forbearance reporting is appropriate for derivatives, available for sale assets and the trading book where assets are marked to market daily.
The table below sets out the largest unimpaired forborne loans and advances to Commercial Banking customers (exposures over £5 million) as at 31 December 2017 by type of forbearance: Table 1.21: Commercial Banking unimpaired forborne loans and advances1 (audited)
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 has completed a three year programme to deliver capability to meet that risk appetite. Given the nature of the threat, the Group continues to invest heavily in protecting against malicious cyber-attacks and is commencing further investment in enhancing the protection of its customers and their data, improving capability to detect and respond to attacks and protecting its most critical systems. – The Group continues to optimise its approach to IT and operational resilience by investing in technology improvements and enhancing the resilience of systems that support the Group’s critical business processes, primarily through the Technology Resilience Programme, with independent verification of progress on an annual basis. The Board recognises the role that resilient technology plays in achieving the Group’s strategy of becoming the best bank for customers and in maintaining banking services across the wider industry. As such, the Board dedicates considerable time and focus to this subject at both the Board and the Board Risk Committee, and continues to sponsor key investment programmes that enhance resilience. – The Group is making a significant investment to improve data privacy, including the security of data and oversight of third parties. The Group’s strategy is to introduce advanced data management practices, based on Group-wide standards, data-first culture and modern enterprise data platforms, supported by a simplified modern IT architecture. – The Group adopts a risk based approach to mitigate the internal and external fraud risks it faces, reflecting the current and emerging fraud risks within the market. Fraud risk appetite metrics have been defined, holistically covering the impacts of fraud in terms of losses to the Group, costs of fraud systems and operations, and customer experience of actual and attempted fraud. Oversight of the appropriateness and performance of these metrics is undertaken regularly through business area and Group-level committees. This approach drives a continual programme of prioritised enhancements to the Group’s technology, process and people related controls, with an emphasis on preventative controls supported by real time detective controls wherever feasible. Group-wide policies and operational control frameworks are maintained and designed to provide customer confidence, protect the Group’s commercial interests and reputation, comply with legal requirements and meet regulatory expectations. The Group’s fraud awareness programme remains a key component of its fraud control environment, and awareness of fraud risk is supported by mandatory training for all
Excess of expected losses over impairment provisions and value adjustments 104 – – 104
Total risk-weighted assets 210,919 215,534 1 Threshold risk-weighted assets reflect the element of significant investments and deferred tax assets that are permitted to be risk-weighted instead of being deducted from CET1 capital. Significant investments primarily arise from investment in the Group’s Insurance business.
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 is exposed. One of the most important uses of stress testing is to assess the resilience of the operational and strategic plans of the Group to adverse economic conditions and other key vulnerabilities. As part of this programme, and in line with previous years, the Group conducted macroeconomic stress tests of the operating plan.
The majority of debt issuance originates from the issuance, capital vehicles and medium term notes desks and the interest rate risk of the debt issued is hedged by swapping them into a floating rate.
1 Banking activities, Pensions and Insurance stresses; Interest rate -100 bps, Basis Risk 3 month London Interbank Offered Rate (LIBOR) +100bps/bank base rate -25bps, Foreign Exchange (FX) -15 per cent GBP, Credit Spread +100 per cent, Equity -30 per cent, Inflation +50 bps 2 Trading Portfolios; Interest rate +30bps, FX +5 per cent GBP, Credit Spread +20 per cent, Inflation +50bps.
Equity risk Equity risk arises primarily from three different sources: (i) the Group’s strategic equity holdings in Banco Sabadell, Aberdeen Asset Management, and Visa Europe; (ii) exposure to Lloyds Banking Group share price through deferred shares and deferred options granted to employees as part of their benefits package; and (iii) the Group’s private equity investments held by Lloyds Development Capital.
Table 1.46 below shows supplementary value sensitivity to a steepening and flattening (c. 100 basis points around the 3 year point) in the yield curve. This ensures there are no unintended consequences to managing risk to parallel shifts in rates.
Refer to page 73 (Audit Committee Report), page 173 (Accounting Policies) and pages 198, 202 and 205 (Notes 24, 31, 32 and Critical Accounting Estimates and Judgements).
We understood and tested key controls surrounding Group IT’s central process for the periodic recertification of user access entitlements across in-scope systems as well as reviewed the processes for managing privileged access to IT systems.
On 1 January 2018, the Group transitioned to financial instruments accounting standard IFRS 9 which replaced IAS 39. The estimated transition impact is disclosed in Note 54 to the Financial Statements in accordance with IAS 8. Disclosures in 2017 are intended to provide users with an understanding of the estimated impact of the new standard, and as a result are more limited than the disclosure to be included in the 2018 financial statements.
(4) Borrowings Borrowings (which include deposits from banks, customer deposits, debt securities in issue and subordinated liabilities) are recognised initially at fair value, being their issue proceeds net of transaction costs incurred. These instruments are subsequently stated at amortised cost using the effective interest method.
Fees payable for the audit of the Company’s current year annual report 1.5 1.5 1.2
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 2016 and 2017 no contingent rentals in respect of finance leases were recognised in the income statement. There was no allowance for uncollectable finance lease receivables included in the allowance for impairment losses (2016: £nil).
Collective impairment allowances are generally established for smaller balance homogenous portfolios such as the retail portfolios. For these portfolios the asset is included in a group of financial assets with similar risk characteristics and collectively assessed for impairment. Segmentation takes into account factors such as the type of asset, industry sector, geographical location, collateral type, past-due status and other relevant factors. These characteristics are relevant to the estimation of future cash flows for groups of such assets as they are indicative of the borrower’s ability to pay all amounts due according to the contractual terms of the assets being evaluated.
At acquisition date, the contractual amount of loans and advances receivable from customers was £7,628 million. The amount expected to be collected is not materially different from the book value recognised by MBNA at 1 June 2017 (£7,466 million).
At 31 December the future minimum rentals receivable under non-cancellable operating leases were as follows: 2017 £m 2016 £m
The amount contractually payable on maturity of the debt securities held at fair value through profit or loss at 31 December 2017 was £14,224 million, which was £6,412 million higher than the balance sheet carrying value (2016: £16,079 million, which was £6,656 million higher than the balance sheet carrying value). At 31 December 2017 there was a cumulative £147 million increase in the fair value of these liabilities attributable to changes in credit spread risk; this is determined by reference to the quoted credit spreads of Lloyds Bank plc, the issuing entity within the Group. Of the cumulative amount an increase of £52 million arose in 2017 and an increase of £28 million arose in 2016.
Total charge to the income statement (note 11) 625 555 548 2017 £m 2016 £m
More detail on the nature of the assumptions that have been made and key sensitivities is set out below.
Other legal actions and regulatory matters In addition, during the ordinary course of business the Group is subject to other complaints and threatened or actual legal proceedings (including class or group action claims) brought by or on behalf of current or former employees, customers, investors or other third parties, as well as legal and regulatory reviews, challenges, investigations and enforcement actions, both in the UK and overseas. All such material matters are periodically reassessed, with the assistance of external professional advisers where appropriate, to determine the likelihood of the Group incurring a liability. In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management's best estimate of the amount required at the relevant balance sheet date. In some cases it will not be possible to form a view, for example because the facts are unclear or because further time is needed properly to assess the merits of the case, and no provisions are held in relation to such matters. In these circumstances, specific disclosure in relation to a contingent liability will be made where material. However the Group does not currently expect the final outcome of any such case to have a material adverse effect on its financial position, operations or cash flows.
Liabilities arising from insurance contracts and participating investment contracts – – – – – – 103,413 103,413
(i) Uncollateralised derivative valuation adjustments, excluding monoline counterparties The following table summarises the movement on this valuation adjustment account during 2016 and 2017: £m 2016 £m
A CVA is taken where the Group has a positive future uncollateralised exposure (asset). A DVA is taken where the Group has a negative future uncollateralised exposure (liability). These adjustments reflect interest rates and expectations of counterparty creditworthiness and the Group’s own credit spread respectively.
Total debt securities classified as loans and receivables 3,643 3,397 1 Credit ratings equal to or better than ‘BBB’.
Change in derivative financial instruments, trading and other financial assets at fair value through profit or loss
IFRS 15 Revenue from Contracts with Customers IFRS 15 replaces IAS 18 ‘Revenue’ and IAS 11 ‘Construction Contracts’ and is effective for annual periods beginning on or after 1 January 2018.
Global Growth Fund 54.22% European Growth Fund 90.07% American Growth Fund 87.81% Pacific Growth Fund 76.54% Japan Growth Fund 98.62%
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