Annual Report and Accounts -

RNS Number : 7241P

HSBC Holdings PLC

31 March 2009

	Page
Regulation and supervision1	188
Risk management1	191
Credit risk	192
Credit risk management2	192
Credit exposure3	197
Areas of special interest1	208
Renegotiated loans2	216
Credit quality of financial instruments3	217
Impaired loans and advances3	220
Impairment allowances and charges3	223
HSBC Holdings2	232
Risk elements in the loan portfolio1	233
Liquidity and funding	235
Policies and procedures2	235
Primary sources of funding2	235
HSBC Holdings2	240
Market risk	241
Value at risk3	241
Impact of market turmoil3	242
Trading portfolios2	244
Non-trading portfolios2	245
Defined benefit pension schemes2	246
Sensitivity of net interest income1	246
Structural foreign exchange exposures1	248
HSBC Holdings3	249
Residual value risk1	252
Operational risk1	252
Legal risk1	252
Global security and fraud1	253
Pension risk1	253
Reputational risk1	254
Sustainability risk1	254
Risk management of insurance operations2	255
Life insurance business2	255
Non-life insurance business2	256
Insurance risk2	256
Financial risks2	262
Present value of in-force long-term insurance business2	272
Capital management and allocation	274
Capital management2	274
Capital measurement and allocation3	275
Risk-weighted assets by principal subsidiary1	280

1 Unaudited.

2 Audited.

3 Audited where indicated.

Regulation and supervision

(Unaudited)

With listings of its ordinary shares in London, Hong Kong, New York, Paris and Bermuda, HSBC Holdings complies with the relevant requirements for listing and trading on each of these exchanges. In the UK, these are the Listing Rules of the Financial Services Authority ('FSA'); in Hong Kong, The Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited ('HKSE'); in the US, where the shares are traded in the form of ADSs, HSBC Holdings' shares are registered with the US Securities and Exchange Commission ('SEC'). As a consequence of its US listing, HSBC Holdings is also subject to the reporting and other requirements of the US Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, and the New York Stock Exchange's ('NYSE') Listed Company Manual, in each case as applied to foreign private issuers. In France and Bermuda, HSBC Holdings is subject to the listing rules of Euronext, Paris and the Bermuda Stock Exchange respectively, applicable to companies with secondary listings.

A statement of HSBC's compliance with the code provisions of the Combined Code on Corporate Governance issued by the Financial Reporting Council and with the Code on Corporate Governance Practices in Appendix 14 to the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited is set out in the 'Report of the Directors: Governance' on page 281.

HSBC's operations throughout the world are regulated and supervised by approximately 540 different central banks and regulatory authorities in those jurisdictions in which HSBC has offices, branches or subsidiaries. These authorities impose a variety of requirements and controls designed to improve financial stability and the transparency of financial markets and their contribution to economic growth. These regulations and controls cover, inter alia, capital adequacy, depositor protection, market liquidity, governance standards, customer protection (for example, fair lending practices, product design, and marketing and documentation standards), and social responsibility obligations (for example, anti-money laundering and anti-terrorist financing measures). In addition, a number of countries in which HSBC operates impose rules that affect, or place limitations on, foreign or foreign-owned or controlled banks and financial institutions. The rules include restrictions on the opening of local offices, branches or subsidiaries and the types of banking and non-banking activities that may be conducted by those local offices, branches or subsidiaries; restrictions on the acquisition of local banks or regulations requiring a specified percentage of local ownership; and restrictions on investment and other financial flows entering or leaving the country. The supervisory and regulatory regimes of the countries where HSBC operates will determine to some degree HSBC's ability to expand into new markets, the services and products that HSBC will be able to offer in those markets and how HSBC structures specific operations. As a result of the recent government interventions in response to recent global economic conditions - it is widely anticipated that there will be a substantial increase in government regulation and supervision of the financial services industry, including the imposition of higher capital requirements, heightened disclosure standards and restrictions on certain types of transaction structures.

In June 2006, the Basel Committee on Banking Supervision introduced a new capital adequacy framework to replace the 1988 Basel Capital Accord in the form of a new Accord (commonly known as 'Basel II'). Details of the way in which Basel II has been implemented by the FSA, the timing of the change and the impact on HSBC are set out on page 275.

The FSA supervises HSBC on a consolidated basis. In addition, each operating bank, finance company or insurance operation within HSBC is regulated by local supervisors. The primary regulatory authorities are those in the UK, Hong Kong and the US, the Group's principal areas of operation.

UK regulation and supervision

UK banking and financial services institutions are subject to multiple regulations. The primary UK statute is the Financial Services and Markets Act 2000 ('FSMA'). Additionally, data privacy is regulated by the Data Protection Act 1998. Other UK financial services legislation is derived from EU directives relating to banking, securities, insurance, investments and sales of personal financial services.

In addition to its role as HSBC's lead regulator, the FSA is responsible for authorising and supervising all HSBC's businesses in the UK which require authorisation under FSMA. These include deposit-taking, retail banking, life and general insurance, pensions, investments, mortgages, custody and share dealing businesses, and treasury and capital markets activity. HSBC Bank plc is HSBC's principal authorised institution in the UK.

FSA rules establish the minimum criteria for authorisation for banks and financial services businesses in the UK. They also set out reporting (and, as applicable, consent) requirements with regard to large individual exposures and large exposures to related borrowers. In its capacity as supervisor of HSBC on a consolidated basis, the FSA receives information on the capital adequacy of, and sets requirements for, HSBC as a whole. Further details on capital measurement are included in 'Capital management and allocation' on pages 274 to 280. The FSA's approach to capital requirements for UK insurers is to require minimum capital to be calculated on two bases. First, firms must calculate their liabilities on a prudent basis and add a statutory solvency margin ('pillar 1'). Secondly, firms must calculate their liabilities on a realistic basis then add to this their own calculation of risk-based capital. The sum of realistic reserves and risk-based capital ('pillar 2') is agreed with the FSA. Insurers are required to maintain capital equal to the higher of pillars 1 and 2. The FSA has the right to object, on prudential grounds, to persons who hold, or intend to hold, 10 per cent or more of the voting power of a financial institution.

The regulatory framework of the UK financial services system has traditionally been based on coߛoperation between the FSA and authorised institutions. The FSA monitors authorised institutions through ongoing supervision and the review of routine and ad hoc reports relating to financial and prudential matters. The FSA may periodically obtain independent reports, usually from the auditors of the authorised institution, as to the adequacy of internal control procedures and systems as well as procedures and systems governing records and accounting. The FSA meets regularly with HSBC's senior executives to discuss HSBC's adherence to the FSA's prudential guidelines. They also regularly discuss fundamental matters relating to HSBC's business in the UK and internationally, including areas such as strategic and operating plans, risk control, loan portfolio composition and organisational changes, including succession planning. In light of current conditions, HSBC has experienced an increased level of ongoing interaction with the FSA.

Hong Kong regulation and supervision

Banking in Hong Kong is subject to the provisions of the Banking Ordinance and to the powers, functions and duties ascribed by the Banking Ordinance to the Hong Kong Monetary Authority (the 'HKMA'). The principal function of the HKMA is to promote the general stability and effective working of the banking system in Hong Kong. The HKMA is responsible for supervising compliance with the provisions of the Banking Ordinance. The Banking Ordinance gives power to the Chief Executive of Hong Kong to give directions to the HKMA and the Financial Secretary with respect to the exercise of their respective functions under the Banking Ordinance.

The HKMA has responsibility for authorising banks, and has discretion to attach conditions to its authorisation. The HKMA requires that banks or their holding companies file regular prudential returns, and holds regular discussions with the management of the banks to review their operations. The HKMA may also conduct 'on-site' examinations of banks and, in the case of banks incorporated in Hong Kong, of any local and overseas branches and subsidiaries. The HKMA requires all authorised institutions to have adequate systems of internal control and requires the institutions' external auditors, upon request, to report on those systems and other matters such as the accuracy of information provided to the HKMA. In addition, the HKMA may from time to time conduct tripartite discussions with banks and their external auditors.

The HKMA has the power to divest controlling interests in a bank from persons if they are no longer deemed to be fit and proper, if they may otherwise threaten the interests of depositors or potential depositors, or if they have contravened any conditions specified by the HKMA. The HKMA may revoke authorisation in the event of an institution's nonߛcompliance with the provisions of the Banking Ordinance. These provisions require, among other things, the furnishing of accurate reports.

The HKMA implemented Basel II with effect from 1 January 2007 for all Authorised Institutions incorporated in Hong Kong.

The marketing of, dealing in and provision of advice and asset management services in relation to securities in Hong Kong are subject to the provisions of the Securities and Futures Ordinance of Hong Kong ('Securities and Futures Ordinance'). Entities engaging in activities regulated by the Securities and Futures Ordinance are required to be licensed. The HKMA is the primary regulator for banks involved in the securities business, while the Securities and Futures Commission is the regulator for non-banking entities.

US regulation and supervision

HSBC is subject to extensive federal and state supervision and regulation in the US. Banking laws and regulations of the Board of Governors of the Federal Reserve System (the 'Federal Reserve Board'), the Office of the Comptroller of the Currency (the 'OCC') and the Federal Deposit Insurance Corporation (the 'FDIC') govern many aspects of HSBC's US business.

HSBC and its US operations are subject to supervision, regulation and examination by the Federal Reserve Board because HSBC is a 'bank holding company' under the US Bank Holding Company Act of 1956 ('BHCA'), as a result of its control of HSBC Bank USA, N.A., Mclean, Virginia ('HBUS'); HSBC Trust Company (Delaware), N.A., Wilmington, Delaware ('HTCD'); and Wells Fargo Trade Bank, N.A., San Francisco, California ('WFTB'). HSBC North America Holdings Inc. ('HNAH'), formed to hold HSBC's US and Canadian operations is also a 'bank holding company'. Both HSBC and HNAH are registered as financial holding companies ('FHC's) under the BHCA, and, accordingly, may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature or incidental or complementary to activities that are financial in nature. The ability of HSBC and HNAH to engage in expanded financial activities as FHCs depends upon HSBC and HNAH continuing to meet certain criteria set forth in the BHCA, including requirements that their US depository institution subsidiaries be 'well capitalised' and 'well managed', and that such institutions have achieved at least a satisfactory record in meeting community credit needs during their most recent examinations pursuant to the Community Reinvestment Act.

In general, under the BHCA, an FHC would be required, upon notice by the Federal Reserve Board, to enter into an agreement with the Federal Reserve Board to correct any failure to comply with the requirements to maintain FHC status. Until such deficiencies are corrected, the Federal Reserve Board may impose limitations on the US activities of an FHC and depository institutions under its control. If such deficiencies are not corrected, the Federal Reserve Board may require an FHC to divest its control of any subsidiary depository institution or to desist from certain financial activities in the US.

The three US banks, HBUS, HTCD, and WFTB are subject to regulation and examination primarily by the OCC, secondarily by the FDIC, and by the Federal Reserve Board. Banking laws and regulations restrict many aspects of their operations and administration, including the establishment and maintenance of branch offices, capital and reserve requirements, deposits and borrowings, investment and lending activities, payment of dividends and numerous other matters.

In December 2007, US regulators published a final rule regarding Risk-Based Capital Standards: Advanced Capital Adequacy Framework - Basel II. This final rule represents the US adoption of the Basel II International Capital Accord ('Basel II'). The final rule became effective on 1 April 2008, and requires large bank holding companies, including HNAH, to adopt its provisions no later than 1 April 2011. HNAH has established comprehensive Basel II implementation project teams comprised of risk management specialists representing all risk disciplines. In addition, US banking authorities have adopted 'leverage' capital requirements that generally require US banks and bank holding companies to maintain a minimum amount of capital in relation to their balance sheet assets (measured on a non-risk-weighted basis).

HBUS and HTCD are subject to risk-based assessments from the FDIC, which insures deposits generally to a maximum of US$100,000 per domestic depositor. In October 2008, the FDIC raised the maximum amount of insured deposits to US$250,000 per domestic depositor until 31 December 2009, after which the limit will return to US$100,000. The FDIC bases assessments on supervisory ratings, financial ratios and long-term debt issuer ratings, with those banks in the highest rated categories paying lower assessments.

In October 2008, the FDIC announced its Temporary Liquidity Guarantee Programme ('TLGP'), under which the FDIC will guarantee (i) newly-issued senior unsecured debt issued by eligible, participating institutions, and (ii) certain non-interest bearing transaction accounts. HNAH and its subsidiary banks and bank holding companies elected to participate in both components of the TLGP, as applicable.

HSBC's US consumer finance operations are subject to extensive state-by-state regulation in the US, and to laws relating to consumer protection (both in general, and in respect of sub-prime lending operations, which have been subject to enhanced regulatory scrutiny); discrimination in extending credit; use of credit reports; privacy matters; disclosure of credit terms; and correction of billing errors. They also are subject to regulations and legislation that limit operations in certain jurisdictions.

Risk management

(Unaudited)

Introduction

All HSBC's activities involve, to varying degrees, the analysis, evaluation, acceptance and management of risks or combinations of risks. The most important categories of risk that the Group is exposed to are credit risk (including cross-border country risk), market risk, operational risks in various forms, liquidity risk, insurance risk, pension risk, residual value risk, reputational risk and sustainability (environmental and social) risks. Market risk includes foreign exchange, interest rate and equity price risks.

The management of these various risk categories is discussed below. Insurance risk is managed by the Group's insurance businesses together with their own credit, liquidity and market risk functions, distinct from those covering the rest of HSBC due to the different nature of their activities. They remain under risk oversight at Group level.

The risk profiles of HSBC Group and of individual operating entities change constantly under the influence of a wide range of factors. The risk management framework established by the Group fosters the continuous monitoring of the risk environment and an integrated evaluation of risks and their interdependencies.

Risk governance and ownership

A well-established risk governance and ownership structure ensures oversight of, and accountability for, the effective management of risk at Group, regional, customer group and operating entity levels.

The Board approves the Group's risk appetite framework, plans and performance targets for the Group and its principal operating subsidiaries, the appointment of senior officers, the delegation of authorities for credit and other risks and the establishment of effective control procedures. Under authority delegated by the Board, the Group Management Board ('GMB') through its separately convened Risk Management Meeting ('RMM') formulates high-level Group risk management policy, exercises delegated risk authorities and oversees the implementation of risk appetite and controls. It monitors all categories of risk, receives reports on actual performance and emerging issues, determines action to be taken and reviews the efficacy of HSBC's risk management framework.

Primary responsibility for managing risk at operating entity level lies with the respective boards and Chief Executive Officers, as custodians of their balance sheets. In their oversight and stewardship of risk management at Group level, GMB and RMM are supported by a dedicated Global Risk function headed by the Group Chief Risk Officer ('GCRO'), who is a member of both bodies and reports to the Group Finance Director within the integrated Finance and

Risk function, which the Group Finance Director represents on the Board.

Global Risk has functional responsibility for the principal financial risk types, namely retail and wholesale credit, market, operational, security and fraud risks. For these it establishes Group policy, exercises Group-wide oversight and provides reporting and analysis of portfolio composition on a global and a regional basis to senior management. Accountability and consistent control across the Global Risk function is provided through the Global Risk Management Board, chaired by the GCRO, the membership of which includes the Chief Risk Officers of HSBC's regions and the heads of risk disciplines within GMO. Global Risk also coߛordinates the continued development of the Group's risk appetite, economic capital and stress testing frameworks. In addition, the GCRO is a member of the Group Portfolio Oversight Committee, chaired by the Group Treasurer, which governs the Group's portfolio management activities for the wholesale business sector.

Risk appetite

HSBC's risk appetite framework describes the quantum and types of risk that HSBC is prepared to take in executing its strategy. It is central to an integrated approach to risk, capital and business management and supports the Group in achieving its return on equity objectives, as well as being a key element in meeting the Group's obligations under pillar 2 of Basel II.

The formulation of risk appetite considers HSBC's risk capacity, its financial position, the strength of its core earnings and the resilience of its reputation and brand. It is expressed both qualitatively, describing which risks are taken and why, and quantitatively. HSBC senior management attaches quantitative metrics to individual risk types to ensure that:

underlying business activity may be guided and controlled, so that it continues to be aligned to the risk appetite framework;
key assumptions underpinning risk appetite can be monitored and, as necessary, adjusted through subsequent business planning cycles; and
business decisions anticipated to be necessary to mitigate risk are flagged and acted upon promptly.

The risk appetite framework, governed by the Board and overseen in its implementation on an ongoing basis by GMB and RMM, is also maintained at regional and customer group levels. It operates through two key mechanisms:

the framework itself defines the governance bodies, processes, metrics and other features of how HSBC addresses risk appetite as part of its ongoing business;
periodic risk appetite statements define, at various levels in the business, the desired level of risk commensurate with return and growth targets and in line with the corporate strategy and stakeholder objectives.

The risk appetite framework covers both the beneficial and adverse aspects of risk. Within it, economic capital is the common currency through which risk is measured and used as the basis for risk evaluation, capital allocation and performance measurement across regions and customer groups. Risk appetite is executed through the operational limits that control the levels of risk run by the Group, regions and customer groups and is measured using risk-adjusted performance metrics.

Risk control culture

HSBC's risk management policies are encapsulated in the Group Standards Manual and cascaded in a hierarchy of policy manuals throughout the Group and communicate standards, instructions and guidance to employees. They support the formulation of risk appetite and establish procedures for monitoring and controlling risks, with timely and reliable reporting to management. HSBC regularly reviews and updates its risk management policies, systems and methodologies to reflect changes in law, regulation, markets, products and emerging best practice.

It is the responsibility of all Group officers to identify, assess and manage risk within the scope of their assigned responsibilities. Personal accountability, reinforced by the Group's governance structure and instilled by training and experience, helps to foster throughout the Group a disciplined and constructive culture of risk management and control.

Credit risk

Credit risk management

(Audited)

Credit risk is the risk of financial loss if a customer or counterparty fails to meet an obligation under a contract. It arises principally from direct lending, trade finance and leasing business, but also from certain off-balance sheet products such as guarantees and credit derivatives, and from the Group's holdings of assets in the form of debt securities. HSBC has standards, policies and procedures dedicated to monitoring and managing risk from such activities.

The credit risk governance structures and control frameworks implemented by the Group are designed for all stages of economic and financial cycles, including the current economic environment. No material changes were initiated to HSBC's risk management objectives, policies or procedures as a direct result of market turmoil. Certain measures already undertaken, however, are helping the Group to manage the effects of that turmoil. Such measures, for example the reinforcement of central credit risk oversight and independent review activities, continue to be implemented within a common operating model for the responsibilities and interaction of GMO Risk, regionally integrated risk functions and country-based management. In addition, certain operational processes have been invoked and applied in order to manage risks more intensively.

Credit Risk is part of the Global Risk function, and the heads of its Retail and Wholesale risk disciplines within GMO, as well as regional Chief Risk Officers, certain country Chief Credit Officers and the Head of Risk Strategy, report to the GCRO. The regional governance bodies for key risk matters reflect those in place at the centre. Functional units at the entity and regional levels report to GMO Risk. GMO helps build the Group's credit risk management capacity through staff selection, training, development, performance assessment and remuneration - the GCRO is jointly responsible with business heads for setting the performance goals of senior Global Risk officers.

Across the Group, Credit Risk fulfils the role of an independent credit control unit, while engaging in dialogue with business teams to set priorities, refine risk appetite, and monitor and report higher-risk exposures. Credit risk and risk capital management policies and methodologies, including analytical model development/review and management information, are enhanced in the light of experience gained, for instance through the roll-out of the Group's advanced internal ratings-based ('IRB') approach to Basel II. See also 'Capital Management' on page 274.

The Credit Risk function within GMO provides high-level oversight and management of credit risk for HSBC worldwide. Its responsibilities include:

Formulating Group credit policy. Compliance, subject to approved dispensations, is mandatory for all HSBC's operating companies, which must develop and record in local instruction manuals their detailed credit policies and procedures, consistent with Group policy.
Guiding HSBC's operating companies on the Group's appetite for credit risk exposure to specified market sectors, activities and banking products. GMO Risk controls exposures to certain higher-risk sectors and closely monitors exposure to others, including real estate, the automotive sector, certain non-bank financial institutions, structured products and leveraged finance transactions. When necessary, restrictions are imposed on new business or exposures, which may be capped at Group and/or entity level.
Undertaking independent review and objective assessment of risk. GMO Risk assesses all commercial non-bank credit facilities and exposures - including those embedded in derivatives - that are originated or renewed by HSBC's operating companies over designated limits, prior to the facilities being committed to customers or transactions being undertaken. Operating companies may not confirm credit approval without this concurrence.
Monitoring the performance and management of retail portfolios across the Group. GMO Risk tracks emerging trends and conducts in-depth portfolio reviews, overseeing the effective management of any adverse characteristics.
Controlling centrally exposures to sovereign entities, banks and other financial institutions. HSBC's credit and settlement risk limits to counterparties in these sectors are approved and managed by GMO Risk to optimise the use of credit availability and avoid excessive risk concentration.
Controlling exposure for all debt securities held; where a security is not held solely for the purpose of trading, a formal issuer risk limit is established.
Establishing and maintaining HSBC's policy on large credit exposures, ensuring that concentrations of exposure by counterparty, sector or geography do not become excessive in relation to the Group's capital base and remain within internal and regulatory limits. The approach is designed to be more conservative than internationally accepted regulatory standards. GMO Risk also monitors HSBC's intra-Group exposures to ensure they are maintained within regulatory limits. Plans are being developed to adopt the FSA's new 'Integrated Groups' regime in accordance with the published transition timetable.
Controlling cross-border exposures, through the imposition of country limits with sub-limits by maturity and type of business. Country limits are determined by taking into account economic and political factors, and applying local business knowledge. Transactions with countries deemed to be higher risk are considered on a case by case basis.
Maintaining and developing HSBC's risk rating framework and systems, to classify exposures meaningfully and enable focused management of the risks involved. The GCRO chairs the Credit Risk Analytics Oversight Committee, which reports to the RMM and oversees risk rating model governance for both wholesale and retail business. Rating methodologies, based upon a wide range of analytics and market data-based tools, are core inputs to the assessment of customer risk. For larger facilities, while full use is made of automated risk-rating processes, the ultimate responsibility for setting risk ratings rests with the final approving executive.
Assisting the Risk Strategy unit in the development of stress-testing scenarios, economic capital measurement and the refinement of key risk indicators and their reporting, the tools for this being increasingly embedded within the Group's business planning processes.
Reporting on aspects of the HSBC credit risk portfolio to the RMM, the Group Audit Committee and the Board of Directors of HSBC Holdings by way of a variety of regular and ad hoc reports covering:

risk concentrations;
retail portfolio performance at Group entity, regional and overall Group levels;
specific higher-risk portfolio segments;
a Risk Map of the status of key risk topics, with associated preventive and mitigating actions;
individual large impaired accounts, and impairment allowances/charges for all customer segments;
country limits, cross-border exposures and related impairment allowances;
portfolio and analytical model performance data; and
stress-testing results and recommendations.

Managing and directing credit risk management systems initiatives. HSBC has constructed a centralised database covering substantially all the Group's direct lending exposures, to deliver an increasingly granular level of management reporting. A uniform credit application process for banks is operational throughout the Group and a similar corporate credit application system covers almost all Group corporate business by value.
Providing advice and guidance to HSBC's operating companies, to promote best practice throughout the Group on credit-related matters such as sustainability risk, new products and training.

Acting on behalf of HSBC Holdings as the primary interface, for credit-related issues, with external parties including the Bank of England, the FSA, rating agencies, corporate analysts, trade associations and counterparts in the world's major banks and non-bank financial institutions.

Each HSBC operating company is required to implement credit policies, procedures and lending guidelines that meet local requirements while conforming to Group standards. Credit approval authorities are delegated by the Board of Directors of HSBC Holdings to the most senior Chief Executive Officers, who receive commensurate delegations from their own boards. In each major subsidiary, a Chief Risk Officer or Chief Credit Officer reports to the local Chief Executive Officer or Chief Operating Officer on credit-related issues, while maintaining a direct functional reporting line to the GCRO.

Each operating company is responsible for the quality and performance of its credit portfolios and for monitoring and controlling all credit risks in them, including those subject to central approval by Group Risk. This includes managing its own risk concentrations by market sector, geography and product. Local systems are in place throughout the Group to enable operating companies to control and monitor exposures by customer and retail product segments.

Special attention is paid to problem exposures, which are subject to more frequent and intensive review and reporting, in order to accelerate remedial action. Where appropriate, HSBC's local operating companies maintain or establish specialist units to provide customers with support in order to help them avoid default wherever possible.

Periodic risk-based audits of operating companies' credit processes and portfolios are undertaken by HSBC's Internal Audit function. Audits include consideration of the adequacy and clarity of credit policy/procedure manuals; an inߛdepth analysis of a representative sample of accounts; an overview of homogeneous portfolios of similar assets to assess the quality of the loan book and other exposures; consideration of any oversight or review work performed by credit risk management functions and the adequacy of impairment calculations; a review of analytical model governance and implementation; a review of management objectives and a check that Group and local standards and policies are adhered to in the approval and management of credit facilities.

Individually significant accounts are reviewed on a sample basis to ensure that risk ratings are appropriate, that credit and collection procedures have been properly followed and that, when an account or portfolio evidences deterioration, impairment allowances are raised in accordance with the Group's established procedures. Internal Audit discusses with management any risk ratings it considers to be inappropriate; after discussion, its final recommendations for revised ratings must then be adopted.

Credit quality

(Audited)

HSBC's credit risk rating systems and processes differentiate exposures in order to highlight those with greater risk factors and higher potential severity of loss. In the case of individually significant accounts, risk ratings are reviewed regularly and any amendments are implemented promptly. Within the Group's retail businesses, risk is assessed and managed using a wide range of risk and pricing models to generate portfolio data.

HSBC's historical, seven-grade risk rating system based on a judgemental assessment of the likelihood and impact of delinquency was superseded in 2008 for financial reporting purposes, as for those of all significant risk management decisions employing credit risk ratings, by a more risk-sensitive and granular methodology. This facilitates the IRB approach under Basel II adopted by the Group to support calculation of its minimum credit regulatory capital requirement.

The integration of this methodology into HSBC's risk processes and structures is well advanced and supports reporting on the new basis to senior management in line with the Group's IRB obligations. For further details, please see 'Credit quality of financial instruments' on page 217.

Impairment assessment

(Audited)

When impairment losses occur, HSBC reduces the carrying amount of loans and advances through the use of an allowance account. When impairment of available-for-sale financial assets and held-to-maturity financial investments occurs, the carrying amount of the asset is reduced directly. For further details on the accounting policy for impairment of available-for-sale debt and equity securities, see 'Accounting policies' on page 350.

Impairment allowances may be assessed and created either for individually significant accounts or, on a collective basis, for groups of individually significant accounts for which no evidence of impairment has been individually identified or for high-volume groups of homogeneous loans that are not considered individually significant.

It is HSBC's policy that each operating company creates allowances for impaired loans promptly and consistently.

Management regularly evaluates the adequacy of the established allowances for impaired loans by conducting a detailed review of the loan portfolio, comparing performance and delinquency statistics with historical trends and assessing the impact of current economic conditions.

Individually assessed impairment allowances

These are determined by evaluating exposure to loss, case by case, on all individually significant accounts and all other accounts that do not qualify for the collective assessment approach outlined below. Loans are treated as impaired as soon as there is objective evidence that an impairment loss has been incurred. The criteria used by HSBC to determine that there is such objective evidence include:

known cash flow difficulties experienced by the borrower;
past due contractual payments of either principal or interest;
breach of loan covenants or conditions;
the probability that the borrower will enter bankruptcy or other financial realisation; and
a significant downgrading in credit rating by an external credit rating agency.

In determining the level of allowances on such accounts, the following factors are typically considered:

HSBC's aggregate exposure to the customer;
the viability of the customer's business model and their capacity to trade successfully out of financial difficulties, generating sufficient cash flow to service debt obligations;
the ability of the borrower to obtain, and make payments in, the currency of the loan if not denominated in local currency;
the amount and timing of expected receipts and recoveries;
the extent of other creditors' commitments ranking ahead of, or pari passu with, HSBC and the likelihood of other creditors continuing to support the company;
the complexity of determining the aggregate amount and ranking of all creditor claims and the extent to which legal and insurance uncertainties are evident;
the value of security and likelihood of successfully realising it;
the existence of other credit mitigants and the ability of the providers of such credit mitigants to deliver as contractually committed; and
when available, the secondary market price of the debt.

The level of impairment allowances on individually significant accounts that are above defined materiality thresholds is reviewed at least semi-annually, and more regularly when circumstances require. This normally encompasses re-assessment of the enforceability of any collateral held and of actual and anticipated receipts. For significant commercial and corporate debts, specialised loan 'work-out' teams with experience in insolvency and specific market sectors are used to manage the lending and assess likely losses.

Individually assessed impairment allowances are only released when there is reasonable and objective evidence of a reduction in the established loss estimate.

Collectively assessed impairment allowances

Impairment is assessed on a collective basis in two circumstances:

to cover losses that have been incurred but have not yet been identified on loans subject to individual assessment; and
for homogeneous groups of loans that are not considered individually significant.

Incurred but not yet identified impairment

Individually assessed loans for which no evidence of impairment has been specifically identified on an individual basis are grouped together according to their credit risk characteristics. A collective impairment allowance is calculated to reflect impairment losses incurred at the balance sheet date which will only be individually identified in the future.

The collective impairment allowance is determined having taken into account:

historical loss experience in portfolios of similar credit risk characteristics (for example, by industry sector, risk rating or product segment);
the estimated period between impairment occurring and the loss being identified and evidenced by the establishment of an appropriate allowance against the individual loan; and
management's experienced judgement as to whether current economic and credit conditions are such that the actual level of inherent losses is likely to be greater or less than that suggested by historical experience.

The period between a loss occurring and its identification is estimated by local management for each relevant portfolio. In general, the periods used vary between four and twelve months although, in exceptional cases, longer periods are warranted.

The basis on which impairment allowances for incurred but not yet identified losses is established in each reporting entity is documented and reviewed by senior Finance and Credit Risk management to ensure conformity with Group policy.

Homogeneous groups of loans

Two methodologies are used to calculate impairment allowances where large numbers of relatively low-value assets are managed using a portfolio approach, typically:

low-value, homogeneous small business accounts in certain countries or territories;
residential mortgages that have not been individually assessed;
credit cards and other unsecured consumer lending products; and
motor vehicle financing.

When appropriate empirical information is available, the Group uses roll rate methodology. This employs a statistical analysis of historical trends of default and the amount of consequential loss, based on the delinquency of accounts within a portfolio of homogeneous accounts. Other historical data and current economic conditions are also evaluated when calculating the appropriate level of impairment allowance required to cover inherent loss. In certain highly developed markets, models also take into account behavioural and account management trends revealed in, for example, bankruptcy and rescheduling statistics.

When the portfolio size is small, or when information is insufficient or not reliable enough to adopt a roll rate methodology, a formulaic approach is used that allocates progressively higher percentage loss rates the longer a customer's loan is overdue. Loss rates reflect the discounted expected future cash flows for a portfolio.

Generally, historical experience is the most objective and relevant information from which to begin to assess inherent loss within each portfolio. In circumstances where historical loss experience provides less relevant information about the inherent loss in a given portfolio at the balance sheet date - for example, where there have been changes in economic conditions or regulations - management considers the more recent trends in the portfolio risk factors which may not be adequately reflected in its statistical models and, subject to guidance from Group Finance and GMO Risk, adjusts impairment allowances accordingly.

Roll rates, loss rates and the expected timing of future recoveries are regularly benchmarked against actual outcomes to ensure they remain appropriate.

Write-off of loans and advances

Loans are normally written off, either partially or in full, when there is no realistic prospect of further recovery. Where loans are secured, this is generally after receipt of any proceeds from the realisation of security. In the case of residential mortgages and second lien loans in HSBC Finance, loan carrying amounts in excess of net realisable value are written off at or before the time foreclosure is completed or when settlement is reached with the borrower. If there is no reasonable expectation of recovery, and foreclosure is pursued, unconstrained by delays required by law or regulation, the loan is normally written off no later than the end of the month in which the loan becomes 240 days contractually past due.

Unsecured personal facilities, including credit cards, are generally written off at between 150 and 210 days past due, the standard period being the end of the month in which the account becomes 180 days contractually delinquent. This period may be extended, generally to 300 days past due but in no event exceeding 360 days past due, in the case of HSBC Finance's unsecured personal facilities other than credit cards.

Cases of write-off periods exceeding 360 days past due are few but arise, for example, in a few countries where local regulation or legislation constrain earlier write-off, or where the realisation of collateral for secured real estate lending extends beyond this time.

In the event of bankruptcy or analogous proceedings, write-off may occur earlier than at the periods stated above. Collections procedures may continue after write-off.

Cross-border exposures

Management assesses the vulnerability of countries to foreign currency payment restrictions when considering impairment allowances on cross-border exposures. This assessment includes an analysis of the economic and political factors existing at the time. Economic factors include the level of external indebtedness, the debt service burden and access to external sources of funds to meet the debtor country's financing requirements. Political factors taken into account include the stability of the country and its government, threats to security, and the quality and independence of the legal system.

Impairment allowances are assessed in respect of all qualifying exposures within these countries unless these exposures and the inherent risks are:

performing, trade-related and of less than one year's maturity;
mitigated by acceptable security cover which is, other than in exceptional cases, held outside the country concerned;
in the form of securities held for trading purposes for which a liquid and active market exists, and which are measured at fair value daily;
performing facilities with a principal (excluding security) of US$1 million or below; or
performing facilities with maturity dates shorter than three months.

Credit exposure

Maximum exposure to credit risk

(Audited)

HSBC's exposure to credit risk is spread over several asset classes, including derivatives, trading assets, loans and advances to customers, loans and advances to banks, and financial investments. The balance of exposure at 31 December 2008 represented a change in risk profile compared with a year ago as HSBC repositioned its balance sheet in the face of unprecedented turmoil in financial markets. The following commentary is on a constant currency basis.

Derivative asset balances rose significantly as the financial turmoil of 2008 led to heightened levels of volatility in the underlying markets to which the derivatives are referenced. The rise in asset balances was primarily driven by interest rate derivatives as the global fall in interest reference rates created significant gaps between the fixed and floating components of interest rate swaps, which in turn led to substantial mark-to-market increases in the value of interest rate swap positions. The widening credit spreads and significant volatility in credit and foreign exchange markets created the environment in which credit derivative positions and foreign exchange derivative assets increased.

HSBC reduced exposure to banks as it tightened lending limits in response to declining credit quality. Much of this lending was instead placed into government issued or guaranteed debt, which contributed to an increase in financial investments.

Loans and advances to customers in the commercial sector grew while personal lending declined, primarily due to the continued run-off of parts of the portfolio in North America. Amounts due from non-bank financial institutions increased due to the expansion of reverse repo lending with the London Clearing House in the UK and a reclassification of cash collateral in the US.

Within trading assets, debt securities and treasury and other bills increased, primarily due to the consolidation on 30 September 2008 of five Constant Net Asset Value funds containing assets upon consolidation of around US$40 billion held for trading. For further details see pages 180 to 181.

As a consequence of the significant increase in derivative balances, there was a decline in the proportion of total assets represented by most other asset classes. On a reported basis, the proportion of total assets represented by derivative assets increased by 12 percentage points while that deployed in loans and advances to customers declined by 5 percentage points and the proportion of trading assets declined by 2 percentage points. Loans and advances to banks as a proportion of total assets declined by 4 percentage points.

The most significant factor affecting HSBC's exposure to credit risk during 2008 was the continuing deterioration in credit conditions in the US mortgage market. HSBC also experienced deterioration in credit quality in the commercial real estate sector. Loss experience remained concentrated in the personal lending portfolios, primarily in the US with 85 per cent of loan impairment charges and other credit risk provisions arising in Personal Financial Services in 2008 compared with 94 per cent in 2007. In 2008, 9 per cent of loan impairment charges and other credit risk provisions arose in Commercial Banking, compared with 6 per cent in 2007. In the UK, despite significant declines in house prices and activity in the housing market as a whole, the credit quality of HSBC's mortgage business remained materially stable in 2008.

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

Maximum exposure to credit risk

(Audited)

	At 31 December 2008			At 31 December 2007
	Maximum exposure	Offset	Net exposure to credit risk	Maximum exposure	Offset	Net exposure to credit risk
	US$m	US$m	US$m	US$m	US$m	US$m

Items in the course of collection from other banks	6,003	–	6,003	9,777	–	9,777

Trading assets	405,451	(13,227)	392,224	394,492	(12,220)	382,272
– treasury and other eligible bills	32,458	–	32,458	16,439	–	16,439
– debt securities	199,619	–	199,619	178,834	(1,417)	177,417
– loans and advances to banks	73,055	–	73,055	100,440	(994)	99,446
– loans and advances to customers	100,319	(13,227)	87,092	98,779	(9,809)	88,970

Financial assets designated at fair value	17,540	–	17,540	21,517	–	21,517
– treasury and other eligible bills	235	–	235	181	–	181
– debt securities	16,349	–	16,349	21,150	–	21,150
– loans and advances to banks	230	–	230	178	–	178
– loans and advances to customers	726	–	726	8	–	8

Derivatives	494,876	(383,308)	111,568	187,854	(121,709)	66,145

Loans and advances held at amortised cost	1,086,634	(83,398)	1,003,236	1,218,914	(66,983)	1,151,931
– loans and advances to banks	153,766	(126)	153,640	237,366	(278)	237,088
– loans and advances to customers	932,868	(83,272)	849,596	981,548	(66,705)	914,843

Financial investments	292,984	–	292,984	270,406	–	270,406
– treasury and other similar bills	41,027	–	41,027	30,104	–	30,104
– debt securities	251,957	–	251,957	240,302	–	240,302

Other assets	40,859	(5)	40,854	43,245	(226)	43,019
– endorsements and acceptances	10,482	(5)	10,477	12,248	(226)	12,022
– accrued income and other	30,377	–	30,377	30,997	–	30,997

Financial guarantees	52,318	–	52,318	56,440	–	56,440
Loan commitments and other credit-related commitments¹	604,022	–	604,022	764,457	–	764,457

	3,000,687	(479,938)	2,520,749	2,967,102	(201,138)	2,765,964

1 The amount of the loan commitments reflects, where relevant, the expected level of take-up of pre-approved loan offers made by mailshots to personal customers. In addition to those amounts, there is a further maximum possible exposure to credit risk of US$35,849 million (2007: US$317,834 million), reflecting the full take-up of such irrevocable loan commitments.

Collateral and other credit enhancements

(Audited)

Collateral held against financial instruments presented in the 'Maximum exposure to credit risk' table above is described in more detail below.

Items in the course of collection from other banks

Settlement risk arises in any situation where a payment in cash, securities or equities is made in the expectation of a corresponding receipt of cash, securities or equities. Daily settlement limits are established for counterparties to cover the aggregate of HSBC's transactions with each one on any single day. Settlement risk on many transactions, particularly those involving securities and equities, is substantially mitigated by settling through assured payment systems or on a delivery-versus-payment basis.

Treasury, other eligible bills and debt securities

Collateral held as security for financial assets other than loans and advances is determined by the nature of the instrument. Debt securities, treasury and other eligible bills are generally unsecured, except for ABSs and similar instruments, which are secured by pools of financial assets.

Derivatives

The ISDA Master Agreement is HSBC's preferred agreement for documenting derivatives activity. It provides the contractual framework within which dealing activity across a full range of over-the-counter products is conducted, and contractually binds both parties to apply close-out netting across all outstanding transactions covered by an agreement if either party defaults or other pre-agreed termination events occur. It is common, and HSBC's preferred practice, for the parties to execute a Credit Support Annex ('CSA') in conjunction with the ISDA Master Agreement. Under a CSA, collateral is passed between the parties to mitigate the market-contingent counterparty risk inherent in the outstanding positions.

Loans and advances

It is HSBC's policy, when lending, to do so on the basis of the customer's capacity to repay, rather than rely primarily on the value of security offered. Depending on the customer's standing and the type of product, facilities may be provided unsecured. Whenever available, collateral can be an important mitigant of credit risk.

The guidelines applied by operating companies in respect of the acceptability of specific classes of collateral or credit risk mitigation, and the determination of valuation parameters are subject to regular review to ensure that they are supported by empirical evidence and continue to fulfil their intended purpose. The principal collateral types employed by HSBC are as follows:

in the personal sector, mortgages over residential properties;
in the commercial and industrial sector, charges over business assets such as premises, stock and debtors;
in the commercial real estate sector, charges over the properties being financed; and
in the financial sector, charges over financial instruments such as cash, debt securities and equities in support of trading facilities.

In addition, credit derivatives, including credit default swaps and structured credit notes, and securitisation structures are used to manage credit risk in the Group's loan portfolio.

HSBC does not disclose the fair value of collateral held as security or other credit enhancements on loans and advances past due but not impaired, or on individually assessed impaired loans and advances, as it is not practicable to do so.

Concentration of exposure

(Audited)

Concentrations of credit risk arise when a number of counterparties or exposures have comparable economic characteristics, or such counterparties are engaged in similar activities or operate in the same geographical areas or industry sectors, so that their collective ability to meet contractual obligations is uniformly affected by changes in economic, political or other conditions.

Securities held for trading

(Unaudited)

Total securities held for trading within trading assets were US$254 billion at 31 December 2008 (2007: US$247 billion). The largest concentration of these assets was government and government agency securities, which amounted to US$143 billion, or 56 per cent of overall trading securities (2007: US$115 billion, 46 per cent). This included US$32 billion (2007: US$16 billion) of treasury and other eligible bills. Corporate debt and other securities were US$82 billion or 32 per cent of overall trading securities, 8 percentage points higher than 2007's level of 24 per cent at US$60 billion. Included within total securities held for trading were US$50 billion (2007: US$70 billion) of debt securities issued by banks and other financial institutions.

A more detailed analysis of securities held for trading is set out in Note 16 on the Financial Statements and an analysis of credit quality is provided on page 218.

Debt securities, treasury and other eligible bills

(Unaudited)

At US$293 billion, total financial investments excluding equity securities were 8 per cent higher at 31 December 2008 than at the end of 2007. Debt securities, at US$252 billion, represented the largest concentration of financial investments at 86 per cent of the total, compared with US$240 billion (89 per cent) at 31 December 2007. HSBC's holdings of corporate debt, ABSs and other securities were spread across a wide range of issuers and geographical regions, with 48 per cent invested in securities issued by banks and other financial institutions. In total, holdings in ABSs decreased by US$24 billion due to a combination of movements in fair values, principal amortisations and write-downs.

Investments in securities of governments and government agencies of US$114 billion were 38 per cent of overall financial investments, 5 percentage points higher than in 2007. US$41 billion of these investments comprised treasury and other eligible bills.

A more detailed analysis of financial investments is set out in Note 19 on the Financial Statements and an analysis by credit quality is provided on page 218.

The insurance businesses held diversified portfolios of debt and equity securities designated at fair value (2008: US$20 billion; 2007: US$34 billion) and debt securities classified as financial investments (2008: US$28 billion; 2007: US$23 billion). A more detailed analysis of securities held by the insurance businesses is set out on page 262.

Derivatives

(Unaudited)

Derivative assets at 31 December 2008 were US$495 billion, a rise of 163 per cent from 31 December 2007, primarily foreign exchange, interest rate and credit derivatives. The main drivers of growth were mark-to-market movements across the entire portfolio arising from volatility and movements in interest rates and credit spreads.

Loans and advances

(Unaudited)

Loans and advances were well diversified across industry sectors and jurisdictions.

At constant exchange rates, gross loans and advances to customers (excluding the financial sector settlement accounts and reclassified ABSs) at 31 December 2008 rose by US$54 billion or 7 per cent from 31 December 2007.

Personal lending represented 46 per cent of total loans and advances to customers including the financial sector settlement accounts and reclassified ABSs. Residential mortgages of US$243 billion represented 25 per cent of total advances to customers, the Group's largest concentration in a single exposure type.

Corporate, commercial and financial lending, including settlement accounts, amounted to 53 per cent of total loans and advances to customers at 31 December 2008. The largest industry concentrations were in non-bank financial institutions and commercial real estate lending at 10 per cent and 7 per cent, respectively, of total gross lending to customers.

Exposure to non-bank financial institutions principally comprised secured lending on trading accounts, primarily through repo facilities. During 2008, HSBC reduced unsecured exposure to hedge

fund trading accounts. HSBC had no material exposure to hedge funds affected by the administration of Lehman Brothers International (Europe).

HSBC managed its exposure to insurance institutions closely within existing limits and experienced no material loss during 2008.

Commercial, industrial and international trade lending rose strongly during 2008, increasing its proportion of total lending by 2 percentage points to 22 per cent of total gross loans and advances to customers on a reported basis. Within this category, the largest concentration of lending was to the service sector, which amounted to 6 per cent of total gross lending to customers.

Loans and advances to banks were widely distributed across major institutions.

Lending to banks was managed downwards during 2008. HSBC reduced limits to this sector in response to a deterioration in credit quality which was most visible in the collapse of a number of US and Icelandic banks to which the Group had advanced funds. The expansion of sovereign guarantees for some bank issuance increased appetite for these counterparties.

2008 compared with 2007

(Unaudited)

The commentary below analyses, on a constant currency basis, the changes in lending noted in the table below, compared with the position at 31 December 2007. On this basis, loans and advances to personal, corporate and commercial customers increased by 7 per cent, and total gross loans and advances rose by 1 per cent.

Total lending to personal customers was concentrated in North America (US$196 billion), the UK (US$108 billion) and Hong Kong (US$46 billion). Collectively, these regions accounted for 79 per cent of total personal lending, a decline of 1 percentage point from the level reported at 31 December 2007. Total lending to personal customers declined by 3 per cent to US$440 billion at 31 December 2008.

Gross loans and advances by industry sector

(Unaudited)


	At 31 December 2007	Constant currency effect	Movement on a constant currency basis	At 31 December 2008
	US$m	US$m	US$m	US$m
Gross loans and advances to customers
Personal	500,834	(47,831)	(12,776)	440,227
Residential mortgages1	269,068	(30,164)	4,433	243,337
Other personal2	231,766	(17,667)	(17,209)	196,890

Corporate and commercial	400,771	(59,671)	66,374	407,474
Commercial, industrial and international trade	202,038	(31,953)	39,755	209,840
Commercial real estate	72,345	(9,224)	7,848	70,969
Other property-related	33,907	(4,188)	1,020	30,739
Government	5,708	(650)	1,486	6,544
Other commercial3	86,773	(13,656)	16,265	89,382

Financial	99,148	(11,391)	13,328	101,085
Non-bank financial institutions	96,781	(11,146)	13,901	99,536
Settlement accounts	2,367	(245)	(573)	1,549

Asset-backed securities reclassified	-	-	7,991	7,991

Gross loans and advances to customers	1,000,753	(118,893)	74,917	956,777

Gross loans and advances to banks	237,373	(20,125)	(63,419)	153,829

	1,238,126	(139,018)	11,498	1,110,606
	At 31 December 2007	Constant currency effect	Movement on a constant currency basis	At 31 December 2008
	US$m	US$m	US$m	US$m
Gross loans and advances to customers
Personal	500,834	(47,831)	(12,776)	440,227
Residential mortgages1	269,068	(30,164)	4,433	243,337
Other personal2	231,766	(17,667)	(17,209)	196,890

Corporate and commercial	400,771	(59,671)	66,374	407,474
Commercial, industrial and international trade	202,038	(31,953)	39,755	209,840
Commercial real estate	72,345	(9,224)	7,848	70,969
Other property-related	33,907	(4,188)	1,020	30,739
Government	5,708	(650)	1,486	6,544
Other commercial3	86,773	(13,656)	16,265	89,382

Financial	99,148	(11,391)	13,328	101,085
Non-bank financial institutions	96,781	(11,146)	13,901	99,536
Settlement accounts	2,367	(245)	(573)	1,549

Asset-backed securities reclassified	-	-	7,991	7,991

Gross loans and advances to customers	1,000,753	(118,893)	74,917	956,777

Gross loans and advances to banks	237,373	(20,125)	(63,419)	153,829

	1,238,126	(139,018)	11,498	1,110,606

1 Including Hong Kong Government Home Ownership Scheme loans of US$3,882 million at 31 December 2008 (2007: US$3,942 million).

2 Other personal loans and advances include second lien mortgages and other property-related lending.

3 Other commercial loans and advances include advances in respect of agriculture, transport, energy and utilities.

Residential mortgages rose slightly to US$243 billion at 31 December 2008, comprising 25 per cent of total loans and advances to customers (including the financial sector and settlement accounts). A significant increase in mortgage lending in the UK, combined with more modest increases in Hong Kong, Rest of Asia-Pacific and Latin America, more than offset a 15 per cent decrease in the value of mortgage lending in North America.

In Europe, residential mortgage lending rose by 22 per cent to US$87 billion. Mortgage lending rose by 26 per cent in the UK, driven by the successful launch of the RateMatcher campaign in April 2008, and a similarly successful campaign in First Direct. This was partly offset by a decline in France due to the sale of the regional banks in July 2008.

In Hong Kong, residential mortgage lending rose by 11 per cent due to successful repricing initiatives which allowed HSBC to become the market leader for new mortgage lending during the year. In response to the weakening local economy and declining house prices in the second half of 2008, HSBC tightened lending criteria and increased pricing on new loans.

In Rest of Asia-Pacific, mortgage lending rose by 11 per cent, driven by continued business expansion in the Middle East. Balances in mainland China grew strongly as the branch network expanded.

In North America, mortgage lending declined by 15 per cent. In the US, total mortgage lending amounted to US$81 billion at 31 December 2008, a decline of 18 per cent since 31 December 2007. In the mortgage services business, balances declined by 21 per cent as there were no new originations and the portfolio continued to run-off. In consumer lending, balances declined by 7 per cent as a result of management actions taken to reduce risk in the portfolio, including further tightening underwriting criteria and increasing collateral requirements for new originations. In HSBC USA, balances declined by 32 per cent, primarily due to the sale of US$7.0 billion of mortgage portfolios during 2008 and the fact that the majority of loan originations continued to be sold in the secondary markets. In line with HSBC's reduced risk appetite, the wholesale and third-party correspondent prime mortgage business of HSBC USA was closed in November 2008.

In Latin America, residential mortgage lending increased, driven by continued growth in fixed rate mortgage lending in Mexico.

Other personal lending declined by 8 per cent to US$197 billion at 31 December 2008, representing 21 per cent of total loans and advances to customers (including the financial sector and settlement accounts).

In Europe, other personal lending declined by 11 per cent from the end of 2007 to US$54 billion. The decrease was primarily attributable to the UK as a stronger focus on secured lending restricted originations in the unsecured portfolio. The sale of certain non-core credit card portfolios in the first half of 2008 also contributed to the decrease in the UK. In France, balances declined due to the sale of the regional banks in the second half of 2008. In Turkey, continued expansion of the branch network during 2008 resulted in higher balances, particularly in credit cards and overdrafts.

In Hong Kong, other personal lending declined by 2 per cent to US$13 billion. HSBC remained the market leader for credit cards in Hong Kong based on cards in circulation, cardholder spending and balances.

In Rest of Asia-Pacific, other personal lending rose by 12 per cent, primarily due to strong growth in the Middle East. Elsewhere in the region, balances rose in Malaysia and Indonesia.

In North America, other personal lending balances declined by 12 per cent to US$97 billion. In the US, consumer finance business and credit card lending fell due to the combined effect of tighter underwriting criteria and lower marketing expenditure. A reduction in non-credit card personal lending reflected the decision to cease new business in guaranteed direct mail loans and personal home-owner loans in the second half of 2007, and tighter underwriting criteria applied to originations in the remainder of the portfolio. In the mortgage services business, second lien balances declined due to the continued run-off of the portfolio following the cessation of originations in 2007. Lower vehicle finance lending at HSBC Finance reflected the discontinuation of certain product offerings and the cessation of new vehicle loan originations from the dealer and direct-to-consumer channels in July 2008. HSBC USA also discontinued originations of indirect vehicle finance loans, but second lien loans increased following a promotional campaign channelled through the branch network in the first half of 2008. In Canada, lower balances were attributable to the disposal of the vehicle finance businesses during the year.

In Latin America, other personal lending rose by 9 per cent to US$15 billion. Lending growth was primarily concentrated in Brazil and reflected strong demand for payroll loans and vehicle lending. In Mexico, balances were broadly in line with 31 December 2007 and the mix was adjusted towards customers of higher credit quality. Further growth was restricted as risk appetite was adjusted by closing certain products to new originations and tightening underwriting criteria on cards, leading to a sharp reduction in the number of cards issued in 2008.

Loans and advances to corporate and commercial customers rose by 19 per cent to US$407 billion, with strong growth across all regions. Lending was primarily concentrated in Europe, where it accounted for 54 per cent of advances to this sector, of which more than 40 per cent were in the UK.

In Europe, corporate and commercial advances rose by 24 per cent. In the UK, lending rose by 35 per cent, driven by growth in lending to large corporates. Balances declined in France due to the sale of the regional banks in July 2008.

In Hong Kong, corporate and commercial lending rose by 19 per cent, driven by higher lending in commercial, industrial and international trade, commercial real estate and other property-related sectors.

In Rest of Asia-Pacific, strong corporate and commercial lending growth was experienced in the Middle East and Singapore, which rose by 26 per cent and 50 per cent respectively and, to a lesser extent, in Malaysia, India and Taiwan, the latter due to the acquisition of the assets and liabilities of The Chinese Bank in March 2008. In the Middle East, the corporate and commercial loan book continued to grow, owing to an expansion of lending in UAE, particularly for trade and investment projects, in addition to general business growth. In Singapore, higher lending was driven by strong demand from the international trade sector. Lending in Japan declined due to the closure of inactive and unprofitable accounts, and lending in mainland China fell as a result of tightened government regulations and tighter lending criteria in response to the weakening local economy. This partly offset the strong growth elsewhere in the region.

In North America, corporate and commercial lending increased by 7 per cent, driven by growth in HSBC USA and, to a lesser extent, in Canada. In HSBC USA, higher lending to corporate and commercial clients reflected the targeted expansion of middle market activities and the drawdown of existing credit facilities, partly offset by a decline in commercial real estate activity as the bank managed down its lending exposures in light of lower risk appetite and a deterioration in market conditions. In Canada, corporate and commercial lending rose by 9 per cent, particularly in Western Canada, as demand remained strong for commercial loans.

In Latin America, corporate and commercial lending rose by 20 per cent, driven by higher lending in Brazil as a result of strong growth in the trade loans portfolio and working capital products.

Loans and advances to the financial sector rose by 15 per cent with strong growth in the UK and North America, largely in collateralised lending. Lending balance were 46 per cent higher in the UK due to the increased use of secured funding facilities through the London Clearing House in the form of repos. In North America, higher lending was driven by HSBC USA due to the reclassification from 'Other assets' of cash collateral held with other institutions.

Loans and advances to banks fell by 29 per cent to US$154 billion due to a significant decline in placement activity in Hong Kong and Europe. This was driven by a reduction in money market and inter-bank placements in favour of treasury bills and bank securities. In the UK, a higher proportion of assets were invested in government and government-guaranteed debt. Elsewhere, growth in Latin America was primarily in Brazil, due to higher reverse repo balances.

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

Gross loans and advances to customers by industry sector

(Audited: 2008 to 2005; Unaudited: 2004)

	2008	2007	2006	2005	2004
	US$m	US$m	US$m	US$m	US$m

Personal	440,227	500,834	476,146	420,476	387,852
Residential mortgages1	243,337	269,068	265,337	238,546	227,847
Other personal	196,890	231,766	210,809	181,930	160,005

Corporate and commercial	407,474	400,771	343,107	278,709	231,772
Commercial, industrial and international trade	209,840	202,038	162,109	130,802	101,876
Commercial real estate	70,969	72,345	60,366	51,815	43,469
Other property-related	30,739	33,907	27,165	22,196	20,749
Government	6,544	5,708	8,990	8,218	10,527
Other commercial2	89,382	86,773	84,477	65,678	55,151

Financial	101,085	99,148	62,458	52,174	66,148
Non-bank financial institutions	99,536	96,781	59,204	50,032	52,329
Settlement accounts	1,549	2,367	3,254	2,142	13,819

Asset-backed securities reclassified	7,991	-	-	-	-

Total gross loans and advances to customers3	956,777	1,000,753	881,711	751,359	685,772

Impaired loans4,6	25,352	19,582	15,071	12,338	13,031
- as a percentage of gross loans and advances to customers4	2.6%	2.0%	1.7%	1.6%	1.9%

Total impairment allowances5	23,909	19,205	13,578	11,357	12,542
- as a percentage of total gross loans and advances	2.5%	1.9%	1.5%	1.5%	1.8%

1 Residential mortgages include Hong Kong Government Home Ownership Scheme loans of US$3,882 million (2007: US$3,942 million; 2006: US$4,078 million; 2005: US$4,680 million; 2004: US$5,383 million).

2 Other commercial loans and advances include advances in respect of agriculture, transport, energy and utilities.

3 Included within this total is credit card lending of US$75,266 million (2007: US$82,854 million; 2006: US$74,518 million; 2005: US$66,020 million; 2004: US$56,222 million).

4 The figures for 2004 are net of suspended interest.

5 2004: Specific provisions on impaired loans.

6 Impaired loans for 2004-2007 have been restated as a result of the reclassification of an element of a credit card portfolio as impaired. There has been no effect on impairment allowances.

Loans and advances to customers by industry sector and by geographical region

(Audited)

	Europe	Hong Kong	Rest of Asia- Pacific	North America	Latin America	Gross loans and advances to customers	Gross loans by industry sector as a % of total gross loans
	US$m	US$m	US$m	US$m	US$m	US$m	%
At 31 December 2008
Personal	141,532	46,087	37,411	195,534	19,663	440,227	46.0
Residential mortgages1	87,267	33,014	20,185	98,383	4,488	243,337	25.4
Other personal	54,265	13,073	17,226	97,151	15,175	196,890	20.6

Corporate and commercial	219,640	52,186	66,126	47,291	22,231	407,474	42.5
Commercial, industrial and international trade	121,047	20,186	40,147	15,178	13,282	209,840	21.9
Commercial real estate	32,704	14,233	8,144	13,504	2,384	70,969	7.4
Other property-related	7,666	10,296	5,128	7,234	415	30,739	3.2
Government	1,864	951	1,760	352	1,617	6,544	0.7
Other commercial2	56,359	6,520	10,947	11,023	4,533	89,382	9.3

Financial	62,620	2,680	5,646	27,746	2,393	101,085	10.6
Non-bank financial institutions	61,823	2,402	5,387	27,560	2,364	99,536	10.4
Settlement accounts	797	278	259	186	29	1,549	0.2

Asset-backed securities reclassified	6,258	-	-	1,733	-	7,991	0.9

Total gross loans and advances to customers3	430,050	100,953	109,183	272,304	44,287	956,777	100.0

Percentage of loans and advances by geographical region	44.9%	10.6%	11.4%	28.5%	4.6%	100.0%

Impaired loans	6,774	852	1,114	14,285	2,327	25,352
- as a percentage of gross loans and advances to customers	1.6%	0.8%	1.0%	5.2%	5.3%	2.6%

Total impairment allowances	3,859	733	1,227	16,090	2,000	23,909
- as a percentage of total gross loans and advances	0.9%	0.7%	1.1%	5.9%	4.5%	2.5%

At 31 December 2007
Personal	168,549	43,033	36,910	230,562	21,780	500,834	50.1
Residential mortgages1	95,665	29,689	20,397	118,993	4,324	269,068	26.9
Other personal	72,884	13,344	16,513	111,569	17,456	231,766	23.2

Corporate and commercial	225,282	43,716	60,442	48,898	22,433	400,771	40.0
Commercial, industrial and international trade	120,359	17,740	36,461	13,937	13,541	202,038	20.1
Commercial real estate	36,672	12,301	7,592	14,561	1,219	72,345	7.2
Other property-related	11,275	8,168	4,664	8,000	1,800	33,907	3.4
Government	2,299	332	1,667	248	1,162	5,708	0.6
Other commercial2	54,677	5,175	10,058	12,152	4,711	86,773	8.7

Financial	62,375	3,265	5,426	22,380	5,702	99,148	9.9
Non-bank financial institutions	61,216	2,483	5,191	22,252	5,639	96,781	9.7
Settlement accounts	1,159	782	235	128	63	2,367	0.2

Total gross loans and advances to customers3	456,206	90,014	102,778	301,840	49,915	1,000,753	100 .0

Percentage of loans and advances by geographical region	45.6%	9.0%	10.2%	30.2%	5.0%	100.0%

Impaired loans4	6,254	433	1,088	9,662	2,145	19,582
- as a percentage of gross loans and advances to customers	1.4%	0.5%	1.1%	3.2%	4.3%	2.0%

Total impairment allowances	3,931	376	926	11,980	1,992	19,205
- as a percentage of total gross loans and advances	0.9%	0.4%	0.9%	4.0%	4.0%	1.9%

1 Residential mortgages in Hong Kong include Hong Kong Government Home Ownership Scheme loans of US$3,882 million (2007: US$3,942 million).

2 Other commercial loans and advances include advances in respect of agriculture, transport, energy and utilities.

3 Included within this total is credit card lending of US$75,266 million (2007: US$82,854 million).

4 The 2007 impaired loans for North America have been restated as a result of the reclassification of an element of a credit card portfolio as impaired. There has been no effect on impairment allowances.

Gross loans and advances to customers by principal country within Rest of Asia-Pacific and Latin America

(Audited)


	Residential mortgages US$m	Other personal US$m	Property- related US$m	Commercial, international trade and other US$m	Total US$m
At 31 December 2008
Rest of Asia-Pacific
Australia	3,598	783	1,621	3,350	9,352
India	1,112	1,482	493	3,332	6,419
Indonesia	27	527	26	1,410	1,990
Japan	57	160	808	4,818	5,843
Mainland China	1,303	12	2,784	7,423	11,522
Malaysia	2,699	1,624	941	4,263	9,527
Middle East (excluding Saudi Arabia)	1,941	5,583	3,018	17,167	27,709
Egypt	-	275	125	2,106	2,506
United Arab Emirates	1,693	3,748	2,118	10,214	17,773
Other Middle East	248	1,560	775	4,847	7,430

Singapore	4,209	3,301	2,448	3,521	13,479
South Korea	2,153	682	34	2,497	5,366
Taiwan	2,217	705	14	1,497	4,433
Other	869	2,367	1,085	9,222	13,543

	20,185	17,226	13,272	58,500	109,183

Latin America
Argentina	41	707	60	1,648	2,456
Brazil	376	8,585	694	9,578	19,233
Mexico	2,150	3,665	1,024	6,094	12,933
Panama	1,105	1,076	569	1,877	4,627
Other	816	1,142	452	2,628	5,038

	4,488	15,175	2,799	21,825	44,287

At 31 December 2007
Rest of Asia-Pacific
Australia	4,376	922	2,065	3,998	11,361
India	1,545	1,721	339	3,723	7,328
Indonesia	24	497	12	1,171	1,704
Japan	29	126	566	3,541	4,262
Mainland China	500	6	1,746	9,443	11,695
Malaysia	2,632	1,508	787	4,024	8,951
Middle East (excluding Saudi Arabia)	1,036	4,441	2,870	13,536	21,883
Egypt	-	196	126	1,575	1,897
United Arab Emirates	895	2,936	2,159	8,222	14,212
Other Middle East	141	1,309	585	3,739	5,774

Singapore	3,946	3,403	1,712	2,471	11,532
South Korea	2,596	880	61	3,608	7,145
Taiwan	2,061	648	-	1,072	3,781
Other	1,652	2,361	2,098	7,025	13,136

	20,397	16,513	12,256	53,612	102,778

Latin America
Argentina	47	611	75	1,841	2,574
Brazil	329	10,110	426	8,601	19,466
Mexico	2,208	4,696	1,434	10,476	18,814
Panama	1,098	963	593	1,585	4,239
Other	642	1,076	491	2,613	4,822

	4,324	17,456	3,019	25,116	49,915
	Residential mortgages US$m	Other personal US$m	Property- related US$m	Commercial, international trade and other US$m	Total US$m
At 31 December 2008
Rest of Asia-Pacific
Australia	3,598	783	1,621	3,350	9,352
India	1,112	1,482	493	3,332	6,419
Indonesia	27	527	26	1,410	1,990
Japan	57	160	808	4,818	5,843
Mainland China	1,303	12	2,784	7,423	11,522
Malaysia	2,699	1,624	941	4,263	9,527
Middle East (excluding Saudi Arabia)	1,941	5,583	3,018	17,167	27,709
Egypt	-	275	125	2,106	2,506
United Arab Emirates	1,693	3,748	2,118	10,214	17,773
Other Middle East	248	1,560	775	4,847	7,430

Singapore	4,209	3,301	2,448	3,521	13,479
South Korea	2,153	682	34	2,497	5,366
Taiwan	2,217	705	14	1,497	4,433
Other	869	2,367	1,085	9,222	13,543

	20,185	17,226	13,272	58,500	109,183

Latin America
Argentina	41	707	60	1,648	2,456
Brazil	376	8,585	694	9,578	19,233
Mexico	2,150	3,665	1,024	6,094	12,933
Panama	1,105	1,076	569	1,877	4,627
Other	816	1,142	452	2,628	5,038

	4,488	15,175	2,799	21,825	44,287

At 31 December 2007
Rest of Asia-Pacific
Australia	4,376	922	2,065	3,998	11,361
India	1,545	1,721	339	3,723	7,328
Indonesia	24	497	12	1,171	1,704
Japan	29	126	566	3,541	4,262
Mainland China	500	6	1,746	9,443	11,695
Malaysia	2,632	1,508	787	4,024	8,951
Middle East (excluding Saudi Arabia)	1,036	4,441	2,870	13,536	21,883
Egypt	-	196	126	1,575	1,897
United Arab Emirates	895	2,936	2,159	8,222	14,212
Other Middle East	141	1,309	585	3,739	5,774

Singapore	3,946	3,403	1,712	2,471	11,532
South Korea	2,596	880	61	3,608	7,145
Taiwan	2,061	648	-	1,072	3,781
Other	1,652	2,361	2,098	7,025	13,136

	20,397	16,513	12,256	53,612	102,778

Latin America
Argentina	47	611	75	1,841	2,574
Brazil	329	10,110	426	8,601	19,466
Mexico	2,208	4,696	1,434	10,476	18,814
Panama	1,098	963	593	1,585	4,239
Other	642	1,076	491	2,613	4,822

	4,324	17,456	3,019	25,116	49,915

Loans and advances to banks by geographical region

(Audited: 2008 to 2005; Unaudited: 2004)

	Europe	Hong Kong	Rest of Asia- Pacific	North America	Latin America	Gross loans and advances to banks	Impairment allowances1
	US$m	US$m	US$m	US$m	US$m	US$m	US$m

At 31 December 2008	62,012	29,646	36,141	11,458	14,572	153,829	(63)
At 31 December 2007	104,534	63,737	39,861	16,566	12,675	237,373	(7)
At 31 December 2006	76,837	50,359	27,517	17,865	12,634	185,212	(7)
At 31 December 2005	44,369	42,751	19,559	10,331	8,964	125,974	(9)
At 31 December 2004	56,063	45,710	14,890	20,911	5,892	143,466	(17)

1 2004: provisions for bad and doubtful debts.

Country distribution of outstandings and cross-border exposures

(Unaudited)

HSBC controls the risk associated with cross-border lending, essentially that foreign currency will not be made available to local residents to make payments, through a centralised structure of internal country limits which are determined by taking into account relevant economic and political factors. Exposures to individual countries and cross-border exposure in aggregate are kept under continual review.

The following table summarises the aggregate of in-country foreign currency and cross-border outstandings by type of borrower to countries which individually represent in excess of 1 per cent of HSBC's total assets. The classification is based on the country of residence of the borrower but also recognises the transfer of country risk in respect of third-party guarantees, eligible collateral held and residence of the head office when the borrower is a branch. In accordance with the Bank of England Country Exposure Report (Form CE) guidelines, outstandings comprise loans and advances (excluding settlement accounts), amounts receivable under finance leases, acceptances, commercial bills, CDs and debt and equity securities (net of short positions), and exclude accrued interest and intraߛHSBC exposures.

In-country foreign currency and cross-border amounts outstanding

(Unaudited)

	Banks	Government and official institutions	Other	Total
	US$bn	US$bn	US$bn	US$bn
At 31 December 2008
UK	38.4	7.1	33.8	79.3
US	13.6	26.4	34.1	74.1
Germany	19.9	12.1	7.9	39.9
France	18.9	8.0	6.7	33.6
The Netherlands	14.1	1.9	10.3	26.3

At 31 December 2007
UK	32.3	2.2	47.5	82.0
US	14.0	11.4	29.5	54.9
France	38.8	1.7	1.9	42.4
Germany	30.3	5.9	5.6	41.8
The Netherlands	21.4	0.2	4.2	25.8

At 31 December 2006
UK	24.8	-	33.5	58.3
Germany	23.7	18.9	2.0	44.6
US	9.5	12.7	16.2	38.4
France	22.1	2.4	6.1	30.6
The Netherlands	14.4	2.1	3.9	20.4
Italy	4.7	12.5	1.4	18.6

At 31 December 2008, HSBC had in-country foreign currency and cross-border amounts outstanding to counterparties in Japan of between 0.75 per cent and 1.0 per cent of total assets; in aggregate, US$24.4 billion.

At 31 December 2007, HSBC had in-country foreign currency and cross-border amounts outstanding to counterparties in Hong Kong, Belgium and Ireland of between 0.75 per cent and 1.0 per cent of total assets. The aggregate in-country foreign currency and cross-border amounts outstanding were Hong Kong, US$19.7 billion, Belgium, US$19.3 billion and Ireland, US$19.3 billion.

At 31 December 2006, HSBC had in-country foreign currency and cross-border amounts outstanding to counterparties in Australia and Hong Kong of between 0.75 per cent and 1 per cent of total assets. The aggregate in-country foreign currency and cross-border amounts outstanding were Australia, US$17.1 billion, Hong Kong, US$13.9 billion.

Areas of special interest

Personal lending

(Unaudited)

HSBC provides a broad range of secured and unsecured personal lending products to meet customer needs. Given the diverse nature of the markets in which HSBC operates, the range is not standardised across all countries but is tailored to meet the demands of individual markets while using appropriate distribution channels and, wherever possible, common global IT platforms.

Personal lending includes advances to customers for asset purchase, such as residential property and motor vehicles, where the loans are typically secured on the assets being acquired. HSBC also offers loans secured on existing assets, such as first and second liens on residential property; unsecured lending products such as overdrafts, credit cards and payroll loans; and debt consolidation loans which may be secured or unsecured. At the end of February 2009, HSBC authorised the discontinuation as soon as

practicable of all new receivable originations of all products by the branch-based consumer lending business of HSBC Finance in North America (see page 70).

Various underwriting controls are applied before a loan is issued, and delinquency is managed through collection and customer management procedures. The expected occurrence and degree of delinquency varies according to the type of loan and the customer segment. Delinquency levels tend to increase in the normal course of portfolio ageing. As a result, loan impairment charges usually relate to lending originated in earlier accounting periods.

As discussed in 'Challenges and uncertainties' on page 12, rising unemployment has been the major factor in the deterioration in credit quality of personal lending portfolios in 2008. Further weakening in consumers' confidence and capacity to service financial commitments may result in deteriorating payment patterns and increased delinquencies and default rates and, as a consequence, higher loan impairment allowances and write-offs. HSBC monitors the effect of these factors on its personal lending portfolios and keeps under review a range of measures designed to limit the Group's exposure and mitigate the effect on customers.

Loan impairment allowances are sensitive to changes in the level of unemployment, particularly at the current time in North America, which affects customers' future ability to repay their loans. For example, had there been an additional 1 per cent increase in unemployment in North America, loan impairment allowances could have been higher by between US$0.7 billion and US$1.5 billion as at 31 December 2008. The relationship between changes in unemployment and loan impairment charges cannot be predicted with any degree of certainty. For example, sharp increases in unemployment may not have a linear impact on the level of increase in loan impairment charges.

Please refer to page 205 for further analysis of gross loans and advances by region and pages 34 and 229 for discussion of loan impairment charges and other credit risk provisions.

This information is provided by RNS

The company news service from the London Stock Exchange

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