Interim Report - 15 of 28

RNS Number : 9031L

HSBC Holdings PLC

16 August 2013

 



Risk

	Page
Risk profile ......................................................	102
Managing risk..................................................	103
Capital and liquidity ............................................	103
Areas of special interest .................................	103
Compliance ........................................................	103
Commercial real estate .......................................	103
Eurozone crisis ...................................................	104
Exposures to Egypt ............................................	104
Personal lending - US lending .............................	105
Top and emerging risks ..................................	105
Macroeconomic and geopolitical risk ..................	105
Macro-prudential, regulatory and legal risks to our business model ......................................	107
Risks related to our business operations, governance and internal control systems .........	109
Credit risk .......................................................	112
Liquidity and funding .....................................	156
Market risk ......................................................	164
Operational risk .............................................	172
Compliance risk ..................................................	173
Reputational risk ................................................	174
Risk management of insurance operations .	175

There have been no material changes to our policies and practices regarding risk management and governance as described in the Annual Report and Accounts 2012.

A description of the principal risks and uncertainties for the remaining six months of the financial year is on page 105.

A summary of our current policies and practices regarding risk is provided in the Appendix to Risk on page 252 of the Annual Report and Accounts 2012.

Risk profile

Managing our risk profile

·     A strong balance sheet is core to our philosophy.

·     Our portfolios remain aligned to our risk appetite and strategy.

·     Our risk management framework is supported by strong forward-looking risk identification.

Maintaining capital strength and strong liquidity position

·     Our core tier 1 capital ratio remains strong at 12.7%.

·     We have sustained our strong liquidity position throughout the first half of 2013.

·     The ratio of customer advances to deposits remains below 90%.

Strong governance

·     Robust risk governance and accountability is embedded across the Group.

·     The Board, advised by the Group Risk Committee, approves our risk appetite.

·     The Compliance control function is being restructured and expanded to improve focus on financial crime and regulatory compliance.

·     Our global risk operating model supports adherence to globally consistent standards and risk management policies across the Group.

Our top and emerging risks

·     Macroeconomic and geopolitical risk.

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

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

Managing risk

The growth in our business in the first half of 2013 was achieved while risks were assumed in a measured manner and in line with our risk appetite. Risks, particularly reputational and operational, were mitigated when they exceeded our risk appetite.

On a reported basis balance sheet assets decreased by 2% and our credit risk-weighted assets decreased by 3% during the period.

During the first six months of 2013, financial markets were dominated by concerns over sovereign debt default risk and its contagion effects, the continuing turmoil in the Middle East and the widely held perception that the world economic recovery remained fragile. This created volatility in financial markets. In the face of this changeable economic, political and financial environment, we maintained our conservative risk profile by reducing exposure to the most likely areas of stress. Stress tests were run regularly to evaluate the potential impact of emerging scenarios and, where necessary, we adjusted our risk appetite accordingly.

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

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

In the first half of 2013 we increased our gross loans and advances in Europe and Asia-Pacific. On a constant currency basis, our loan impairment charges and other credit risk provisions in the first half of 2013 were 34% below the first half of 2012, at US$3.1bn. The US accounted for a significant proportion of the decline, driven by favourable market value adjustments on loan collateral, a reduction in the CML portfolio and lower loan impairment charges following the sale of the CRS business in 2012.

Capital and liquidity

Preserving our strong capital position has long been, and will remain, a key priority for HSBC. We are well equipped to respond to the capital requirements imposed by Basel III, which are discussed further on page 186, and to sustain future growth. We utilise an enterprise-wide approach to testing the sensitivities of our capital plans against a number of scenarios; our approach to scenario stress testing analysis is discussed on page 192.

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

Areas of special interest

Compliance

In recent years, we have experienced increasing levels of compliance risk as regulators and other agencies pursued investigations into historical activities, and we continue to work with them in relation to existing issues. This has included the matters giving rise to the Deferred Prosecution Agreements reached with US authorities in relation to investigations regarding inadequate compliance with anti-money laundering and sanctions law, and the related undertaking with the FSA (now revised as a Direction from the Financial Conduct Authority ('FCA') following the UK regulatory restructuring in April 2013). We have responded to a number of investigations by the FCA into the mis-selling in the UK of certain products, including sales of payment protection insurance and of interest rate derivative products to SMEs. In addition we have been involved in investigations and reviews by various regulators and competition enforcement authorities related to certain past submissions made by panel banks and the process for making submissions in connection with the setting of Libor, Euribor and other benchmark interest and foreign exchange rates.

Further information about the Group's compliance risk management and the changes being made may be found on page 173.

Commercial real estate

Our exposure to commercial real estate lending continued to be concentrated in Hong Kong, the UK, Rest of Asia-Pacific and North America. The market in Hong Kong and most other Asian markets in which we conduct commercial real estate lending, after relative buoyancy in 2011, began to stabilise in late 2012, partly due to initiatives taken by various supervisory authorities which have extended into 2013. In the UK, many regions continued to be negatively affected by weak growth in the economy, though London and the South East, where more than 50% of our UK commercial real estate lending is based, continued to exhibit relative strength. In North America, the market remained stable, in part supported by the continued low levels of interest rates.

Refinance risk is discussed extensively on page 129 of the Annual Report and Accounts 2012. With the exception of the UK, in our material commercial real estate portfolios globally, the behaviour of the market and the quality of assets continues to cause no undue concerns. In the UK, economic conditions continue to prolong concerns regarding sensitivity to the risks of refinancing, although no deterioration in market conditions has been experienced in the first half of 2013.

There was a marginal reduction in UK commercial real estate balances compared with the end of 2012 with no significant changes in loans and advances due to be refinanced in the next 12 months.

Eurozone crisis

Eurozone countries are members of the EU and part of the euro single currency bloc. The peripheral eurozone countries are those that exhibit levels of market volatility that exceed other eurozone countries, demonstrating fiscal or political uncertainty which has persisted through the first half of 2013. Throughout 2012 and into 2013, in spite of austerity measures and structural reform, the peripheral eurozone countries of Greece, Ireland, Italy, Portugal, Spain and Cyprus continued to exhibit a high ratio of sovereign debt to GDP or short to medium-term maturity concentration of their liabilities. In March 2013, Cyprus sought assistance from the Troika (the European Commission, European Central Bank and the International Monetary Fund), which ultimately agreed a bailout under conditions requiring a consolidation of banking assets and the 'bail-in' of larger depositors' monies. Capital controls led to some minor disruption of payments from Cyprus. However, HSBC has limited exposure to the country and no impairments have been recorded as a result.

Our exposure to eurozone countries is analysed in the table on page 153.

Risk net exposure

At 30 June 2013, our net exposure to the peripheral eurozone countries was US$38bn, including net exposure to sovereign borrowers, agencies and banks of US$12bn, broadly unchanged compared with the end of 2012. This reflected a marginal increase in aggregate exposure to banks offset by a reduction in exposure to sovereign borrowers and agencies.

Our businesses in peripheral eurozone countries are funded from a mix of local deposits, local wholesale funding and intra-Group loans extended from HSBC operations with surplus funds. Intra-Group funding carries the risk that a member country might exit the eurozone and redenominate its national currency, which could result in a significant currency devaluation. A description of redenomination risk in the event of the exit of a eurozone member is provided on pages 131 and 201 of the Annual Report and Accounts 2012.

Risk management and contingency planning

Our framework for dealing with counterparty and systemic crisis situations is described on page 130 of the Annual Report and Accounts 2012. It continued to operate throughout the first half of 2013 to ensure that pre-crisis preparation remains apposite and robust. A Cyprus Major Incident Group was effective in dealing with the Group's response to the Cyprus sovereign debt crisis.

The main focus of eurozone contingency planning continues to be on Greece and Spain. Other scenarios including contagion risk to non-eurozone countries or the exit of a higher impact eurozone member remain under consideration.

Exposures to Egypt

At 30 June 2013, our total net lending exposure to Egypt was US$10.0bn. Over half of our exposure was to other financial institutions and corporates (US$5.5bn), almost all of which was onshore lending by HSBC in Egypt to corporate entities. Of this exposure US$3.1bn was off-balance sheet, principally undrawn committed facilities. This corporate exposure is diversified with almost half spread across a broad range of manufacturing activities and the remainder covering a range of other industry sectors.

The sovereign and agencies exposure, including exposure to the central bank, was US$3.0bn. This exposure was almost wholly in the form of local currency denominated treasury bills and central bank deposits.

Exposure to banks was US$0.5bn, largely comprising off-balance sheet commitments consisting of trade lines to Egyptian banks for the confirmation of their letters of credit.

Since the onset of the Arab Spring we have actively managed our exposure within Egypt. During the second quarter of 2013, our systemic crisis management processes were reinstigated in response to the unfolding constitutional crisis, and we continue to monitor developments closely. The most material risk to our overall portfolio in Egypt is the economic instability that would be caused by a further significant deterioration in the security situation.

Personal lending - US lending

Economic conditions in the US continued to improve in the first half of 2013, supported by improvements in the housing sector and increases in consumer spending. The unemployment rate has declined modestly since the start of the year amid signs that the labour market is more stable.

Total mortgage lending in the US was US$54bn at 30 June 2013, a decline of 5% compared with the end of 2012, mainly due to the continued run-off of the CML portfolio.

We remained focused on managing the run-off of balances in our HSBC Finance portfolio and completed the sale within our CML portfolio of US$4.3bn of personal unsecured loans and US$0.3bn of real estate loans. We transferred a further US$0.5bn of real estate loans to 'Assets held for sale' at 30 June 2013.

Total lending balances within HSBC Finance were US$36bn at 30 June 2013 including loans held for sale, a decline of US$6.6bn compared with the end of 2012. The rate at which balances in the CML portfolio are declining continues to be affected by the lack of refinancing opportunities available to customers. Foreclosure processing has now resumed in substantially all states, although there remains a backlog of loans which have not yet been referred to foreclosure. Our loan modification programmes, which are designed to improve cash collections and avoid foreclosure, continued to slow repayment rates.

Top and emerging risks

Identifying and monitoring top and emerging risks is integral to our approach to risk management. We define a 'top risk' as being a current, emerged risk which has arisen across any of our risk categories, regions or global businesses and has the potential to have a material impact on our financial results or our reputation and the sustainability of our long-term business model, and which may form and crystallise within a one-year horizon. We consider an 'emerging risk' to be one which has large uncertain outcomes that may form beyond a one-year horizon which, if they were to crystallise, could have a material effect on our long-term strategy. Our top and emerging risk framework enables us to focus on current and forward looking aspects of our risk exposures and ensure our risk profile remains in line with our risk appetite and that our appetite remains appropriate. Our current top and emerging risks have continued to evolve since those set out in the Annual Report and Accounts 2012 andare as follows:

Macroeconomic and geopolitical risk

·      Emerging markets slowdown

·      Increased geopolitical risk and changes in energy markets

·      Threats to the global economy from a disorderly exit from quantitative easing

Emerging markets slowdown

World growth is slowing as demand in mature economies is subdued and credit availability and investment activity remain very limited. Growth in a number of emerging markets has decelerated during the first half of 2013 and advanced economies are depending on stronger trade growth in emerging markets to help them through tough economic times domestically.

A number of mature economies are implementing austerity measures in order to reduce their deficits and public debt. This is expected to help resolve the sovereign and banking crisis in the medium term, but in the short term it is limiting growth, increasing unemployment and restricting taxation revenues severely. This is affecting the rest of the world through lower trade, reduced international financing as banks are deleveraging and potential disruption to capital flows.

Potential impact on HSBC

·     Trade and capital flows may contract as a result of weaker economic growth in some emerging markets, banks deleveraging, the introduction of protectionist measures in certain markets, the emergence of geopolitical risks or increasing redenomination risk, which in turn might curtail profitability.

·     Whilst growth in emerging markets as a whole is constrained by lower world demand and commodity prices, some countries are struggling more than others and could trigger a new crisis of confidence in emerging markets with the potential for increased volatility. In Egypt, the uncertain future is affecting the economy and the country's ability to attract the necessary financial support. In Brazil and Turkey, middle class protests have highlighted concerns regarding the political and economic choices made by the government authorities. In

Argentina, the unresolved dispute with 'hold out' bondholders is fuelling the risk of new defaults. Emerging markets have been supported during the last two years by significant capital inflows from advanced economies but a reverse of these capital flows would create difficulties for all countries having to finance current account deficits, public finance or both. Developments across all markets are closely watched by HSBC to ensure insights are shared and appropriate action is taken as circumstances evolve.

·     During the first half of 2013, we continued to manage closely our sovereign and financial institution counterparty credit positions in peripheral eurozone countries. In addition, we continued to monitor carefully exposures to counterparties domiciled in core European countries that had exposures to sovereigns and/or banks in peripheral eurozone countries of sufficient size to threaten their ongoing viability in the event of further unfavourable developments in the ongoing crisis.

Increased geopolitical risk and changes in energy markets

Weak global economic growth is intensifying the risk of protectionism and some countries may impose restrictions on trade or on capital flows to protect their domestic economies.

In Egypt, the political process remains in transition with a continuing risk of instability. In addition, the fighting in Syria may disrupt global international relations, with tensions between Israel and Iran adding to the risks in the region.

Continuing political instability and unrest in the Middle East increase the risk of higher oil prices, however, developments in global energy extraction increase the risk of lower energy prices affecting the dynamics of natural gas markets and our exposures. In other emerging markets such as Turkey and Brazil, the population is restive and increasingly critical of prevailing economic policies.

Potential impact on HSBC

·      Our results are subject to the risk of loss from unfavourable political developments, currency fluctuations, social instability and changes in government policies on matters such as expropriation, authorisations, international ownership, interest-rate caps, foreign exchange transferability and tax in the jurisdictions in
which we operate. Actual conflict could put our staff in harm's way and bring physical damage to our assets.

·      We have increased our monitoring of the geopolitical and economic outlook, in particular in countries where we have material exposures and a physical presence. Our internal credit risk rating of sovereign counterparties takes these factors into account and drives our appetite for conducting business in those countries. Where necessary, we adjust our country limits and exposures to reflect our appetite and mitigate these risks as appropriate.

·     Lower gas prices could increase political instability in the Middle East and affect market dynamics involving countries in the region to which HSBC is exposed.

Threats to the global economy from a disorderly exit from quantitative easing

The prolonged period of low interest rates caused by policy actions taken to address the economic crisis in mature economies continues to constrain the interest income we earn from investing our excess deposits, through spread compression and low returns on assets. However, an excessively rapid exit from quantitative easing ('QE') and a swift rise in interest rates could prove to be as detrimental, and fears of such actions are already creating significant volatility in the markets. An increase in real interest rates while economies remain weak could further limit the pace of recovery, fuel capital flows to safe havens and result in significant capital outflows from emerging markets.

Potential impact on HSBC

·     A scaling back of QE could have an adverse impact on global equity and bond prices, and create turbulence in global currency (foreign exchange) markets.

·     The pace and timing of QE cessation could heighten market instability. The indication from the Federal Reserve that further US QE will be tapered off depending on positive economic data, links the speed of scaling back to US economic growth. The speed of recovery in the US now suggests this could be an issue in the near future.

·     We have undertaken a review of our bond portfolios, carried out additional stress tests and managed our positions, to mitigate this risk.

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

·     Regulatory developments affecting our business model and Group profitability

·     Regulatory investigations and requirements relating to conduct of business and financial crime negatively affecting our results and brand

·     Dispute risk

Financial service providers face increasingly stringent and costly regulatory and supervisory requirements, particularly in the areas of capital and liquidity management, conduct of business, operational structures and the integrity of financial services delivery. Increased government intervention and control over financial institutions, together with measures to reduce systemic risk, may significantly alter the competitive landscape. These measures may be introduced as formal requirements in a supra-equivalent manner and to differing timetables across regulatory regimes.

Regulatory developments affecting our business model and Group profitability

Several regulatory changes are likely to affect our activities, both of the Group as a whole and of some or all of our principal subsidiaries. These changes include (i) publication, on 27 June, of the Capital Requirements Directive ('CRD IV'), which is the introduction of the Basel III measures in the EU, which comes into effect from 1 January 2014. The PRA will consult later this summer on the changes to the PRA's rules to reflect the new Regulation and to implement the Directive and relevant discretions provided in the Regulation; (ii) implementation of the new regulatory structure within the UK comprising the Financial Policy Committee ('FPC'), the Prudential Regulation Authority ('PRA') and the FCA and, in particular, the effects of the ability of the FPC to seek additional capital for lending to sectors perceived as higher risk, (iii) the designation of the Group by the Financial Stability Board as a global systemically important bank; (iv) proposed legislation in the UK to give effect to the recommendations of the Independent Commission on Banking ('ICB') in relation to 'ring-fencing' the UK retail banking from wholesale banking activities, the structural separation of other activities as envisaged in legislative proposals in the US (including the Volcker Rule proposed under the Dodd-Frank Act) and potential changes across the EU where initial proposals are expected later this year; (v) changes in the regime for the operation of capital markets with increasing standardisation, central clearing, reporting and margin requirements; (vi) requirements flowing from arrangements for the recovery and resolution of the Group and its main operating entities; and (vii) continued changes in the manner and standards for the conduct of business, including the effects of the recommendations now made by the Parliamentary Commission on Banking Standards. There is also the continued risk of further changes to regulation relating to remuneration and other taxes.

Potential impact on HSBC

·     Proposed changes relating to capital and liquidity requirements, remuneration and/or taxes could increase the Group's cost of doing business, reducing future profitability.

·     Proposed changes in and the implementation of regulations for derivatives and central counterparties, the ICB ring-fencing proposals, recovery and resolution plans, the Volcker Rule and the Foreign Account Tax Compliance Act ('FATCA') may affect the manner in which we conduct our activities and structure ourselves, with the potential both to increase the costs of doing business and curtail the types of business we can carry out, with the risk of decreased profitability as a result. Due to the fact that the development and implementation of many of these various regulations are in their early stages, it is not possible to estimate the effect, if any, on our operations.

·     We are closely engaged with the governments and regulators in the countries in which we operate to help ensure that the new requirements are properly considered and can be implemented in an effective manner. We are also ensuring that our capital and liquidity plans take into account the potential effects of the changes. Capital allocation and liquidity management disciplines have been expanded to incorporate future increased capital and liquidity requirements and drive appropriate risk management and mitigating actions.

Regulatory investigations and requirements relating to conduct of business and financial crime negatively affecting our results and brand

Financial service providers are at risk of regulatory sanctions or fines related to conduct of business and financial crime. The incidence of regulatory proceedings and other adversarial proceedings against financial service firms is increasing.

In December 2012, HSBC Holdings, HSBC North America Holdings, Inc, and HSBC Bank USA entered into agreements with US and UK authorities in relation to investigations regarding past inadequate compliance with anti-money laundering and sanctions laws. Among other agreements, HSBC Holdings and HSBC Bank USA entered into a five-year Deferred Prosecution Agreement ('US DPA') with the US Department of Justice ('DoJ') and HSBC Holdings entered into an undertaking with the FSA (the 'FCA Direction') to comply with certain forward-looking obligations with respect to anti-money laundering and sanctions requirements. In addition, HSBC Holdings entered into a two-year Deferred Prosecution Agreement with the New York County District Attorney (the 'DANY DPA').

Under the settlement agreements, HSBC Holdings and HSBC Bank USA made payments totalling US$1,921m to US authorities and undertook to continue cooperating fully with US and UK regulatory and law enforcement authorities and take further action to strengthen our compliance policies and procedures. The agreements with the DoJ and the US Federal Reserve, and the FCA Direction require us to retain an independent monitor (who is, for FCA purposes, a 'skilled person' under section 166 of the Financial Services and Markets Act) to evaluate our progress in implementing our obligations under the agreements and FCA Direction and to produce regular assessments of the effectiveness of our Compliance function. Michael Cherkasky has been selected as the independent monitor and, on 1 July 2013, the US District Court for the Eastern District of New York approved the US DPA and retained authority to oversee implementation of the same.

As reflected in the agreement entered into with the Office of the Comptroller of the Currency ('OCC') in December 2012 ('the Gramm-Leach-Bliley Act ('GLBA') Agreement'), the OCC has determined that HSBC Bank USA is not in compliance with the requirements which provide that a national bank and each depository institution affiliate of the national bank must be both well capitalised and well managed in order to own or control a financial subsidiary. As a result, HSBC Bank USA and its parent holding companies, including HSBC, no longer meet the requirements for financial holding company status, and may not engage in any new types of financial activities without the prior approval of the Federal Reserve Board. HSBC Bank USA may not directly or indirectly acquire control of, or hold an interest in, any new financial subsidiary, nor commence a new activity in its existing financial subsidiary, unless it receives prior approval from the OCC. HSBC Bank USA also entered into a separate consent order with the OCC requiring it to adopt an enterprise wide compliance programme. In addition, HSBC Bank USA is subject to the oversight from the Consumer Financial Protection Bureau, which is a federal agency that is primarily responsible for regulating consumer protection with regards to financial products and services.

In the UK, the FCA has continued to increase its focus on 'conduct risk' including attention to sales processes and incentives, product and investment suitability and conduct of business concerns more generally. These measures are concerned principally, but not exclusively, with the conduct of business with retail customers and in conjunction with this focus, the UK regulators are making increasing use of existing and new powers of intervention and enforcement, including powers to consider past business undertaken and implement customer compensation and redress schemes or other, potentially significant, remedial work. Additionally, the UK and other regulators increasingly take actions in response to customer complaints either specific to an institution or more generally in relation to a particular product. We have seen recent examples of this approach in the context of the possible mis-selling of PPI and of interest rate hedging products to SMEs.

The Group also continues to be subject to a number of other regulatory proceedings, including investigations and reviews by various regulators and competition and enforcement authorities around the world, including in the UK, the US, Canada, the EU, Switzerland and Asia, who are conducting investigations and reviews related to certain past submissions made by panel banks and the process for making submissions in connection with the setting of Libor, Euribor and other benchmark interest and foreign exchange rates. As certain HSBC entities are members of such panels, HSBC and/or its subsidiaries have been the subject of regulatory demands for information and are cooperating with those investigations and reviews. In addition, HSBC Holdings, HSBC Bank plc, HSBC Bank USA and other panel banks have been named as defendants in private lawsuits filed in the US with respect to the setting of Libor, including putative class action lawsuits which have been consolidated before the US District Court for the Southern District of New York. HSBC and other panel banks have also been named as defendants in putative class action lawsuits in New York and Chicago relating to credit default swap pricing. The complaints in those actions assert claims against HSBC and other panel banks under various US laws including US antitrust laws, the US Commodities Exchange Act and state law (see Note 24 on the Financial Statements for further information).

Potential impact on HSBC

·     It is difficult to predict the outcome of the regulatory proceedings involving our businesses. Unfavourable outcomes may have a material adverse effect on our reputation, brand and results, including loss of business and withdrawal of funding.

·     In relation to the US DPA, HSBC Holdings and HSBC Bank USA have committed to take or continue to adhere to a number of remedial measures. Breach of the US DPA at any time during its term may allow the DoJ to prosecute HSBC Holdings or HSBC Bank USA in relation to the matters which are the subject of the US DPA. Breach of the DANY DPA may allow the New York County District Attorney's Office to prosecute HSBC Holdings in relation to the matters which are the subject of that DPA.

·     In relation to the GLBA Agreement, if all of our affiliate depository institutions are not in compliance with these requirements within the time periods specified therein, as they may be extended, HSBC could be required either to divest HSBC Bank USA or to divest or terminate any financial activities conducted in reliance on the GLBA. Similar consequences under the GLBA Agreement could result for subsidiaries of HSBC Bank USA that engage in financial activities in reliance on expanded powers provided for in the GLBA. Any such divestiture or termination of activities would have an adverse material effect on the consolidated results and operation of HSBC. The GLBA Agreement requires HSBC Bank USA to take all steps necessary to correct the circumstances and conditions resulting from non‑compliance with the requirements referred to above. We have initiated steps to satisfy the requirements of the GLBA Agreement.

·     The UK and other regulators may identify future industry-wide mis-selling or other issues that could affect the Group. This may lead from time to time to: (i) significant direct costs or liabilities (including in relation to mis-selling); and (ii) changes in the practices of such businesses which benefit customers at a cost to shareholders. Further, decisions taken in the UK by the Financial Ombudsman Service in relation
to customer complaints (or any overseas equivalent that has jurisdiction) could, if applied to a wider class or grouping of customers, have a material adverse effect on the operating results, financial condition and prospects of the Group.

Steps to address many of the requirements of the DPAs, the FCA Direction and the GLBA Agreement have either already been taken or are under way. These include simplifying the Group's control structure, strengthening the governance structure with new leadership appointments, revising key policies and establishing bodies to implement single Global Standards shaped by the highest or most effective standards available in any location where the Group operates, as well as substantially increasing spending and staffing in the anti-money laundering and regulatory compliance areas in the past few years. There can be no assurance that these steps will be effective or that HSBC will not have to take additional remedial measures in the future to comply with the terms of the DPAs or the GLBA Agreement.

Dispute risk

The current economic environment has increased our exposure to actual and potential litigation. Further details are provided in Note 24 on the Financial Statements.

Potential impact on HSBC

·     Dispute risk gives rise to potential financial loss and significant reputational damage which could adversely affect customer and investor confidence.

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

·      Regulatory commitments and consent orders including under the Deferred Prosecution Agreements

·      Internet crime and fraud

·      Data management

·      Disposals

·      Level of change in the Compliance function

·      Information security risk

·      Model risk

Regulatory commitments and consent orders including under the Deferred Prosecution Agreements

There is a risk that we fail to meet our deadlines or we are judged to have material gaps in our plans or implementation compared with the requirements of the DPAs and other orders. Further details of this risk are provided on page 128 of the Annual Report and Accounts 2012.

Potential impact on HSBC

·     If, during the term of the US DPA, HSBC Holdings or HSBC Bank USA are determined to have breached the agreement, the DoJ may prosecute HSBC Holdings or HSBC Bank USA in relation to the matters which are the subject of the US DPA. Similarly, if, during the term of the DANY DPA, HSBC Holdings is determined to have breached that agreement, the New York County District Attorney may prosecute HSBC Holdings in relation to the matters which are subject to that DPA. The FCA may, in a similar vein, take enforcement action as a result of a breach of the FCA Direction.

Internet crime and fraud

With the ever-growing acceptance of, and demand for, internet and mobile services by customers, HSBC is increasingly exposed to fraudulent and criminal activities via these channels. Internet crime could result in financial loss and/or customer data and sensitive information being compromised. Along with internet fraud, the overall threat of external fraud may increase during adverse economic conditions, particularly in retail and commercial banking.

We also face the risk of breakdowns in processes or procedures and systems failure or unavailability, and our business is subject to disruption from events that are wholly or partially beyond our control, such as internet crime and acts of terrorism.

Potential impact on HSBC

·     Internet crime and fraud may give rise to losses in service to customers and/or economic loss to HSBC. The same threats apply equally when we rely on external suppliers or vendors to provide services to us and our customers.

·     We have increased our defences through enhanced monitoring and have implemented additional controls, such as two-factor authentication, to reduce the possibility of losses from fraud. We continually assess these threats as they evolve and adapt our controls to mitigate them.

Data management

HSBC has received feedback from external stakeholders that it needs a clear data strategy to meet the increasingly frequent regulatory reporting requirements as well as other internal and external information demands.

Potential impact on HSBC

·     Regulators are evaluating the industry on its ability to provide accurate information and may use the industry-developed Data Maturity Model to assess financial services firms.

·     A Group-level Data Strategy Board has been established to define our data strategy to ensure consistent data management across the Group. Vision, governance and quality frameworks of the data strategy have been completed and the policy and standards are due to be formulated by the third quarter of 2013. Any required action would follow.

Disposals

The implementation of our strategy to simplify our business, which involves withdrawing from certain markets, presents disposal risks which must be carefully managed. Implementing organisational changes to support the Group's strategy also requires close management oversight.

Potential impact on HSBC

·     The potential effects of disposal risks include regulatory breaches, industrial action, loss of key personnel and interruption to systems and processes during business transformation, and they can have both financial and reputational implications.

·     Steps taken to manage these risks proactively include maintaining a close dialogue with regulators and customers and involve HR, Legal, Compliance and other functional experts. Some disposals also involve Transitional Service Agreements, where there are ongoing risks, which are subject to close management oversight.

Level of change in the Compliance function

The Compliance function is undergoing a significant restructuring to increase its efficiency and effectiveness (see page 173).

Potential impact on HSBC

·     The size and scope of the change could generate heightened execution and people risk (including significant resourcing demands).

·     Global organisation structures and global management teams have been agreed. Implementation in the regions, global business teams and countries has been split into phases, with key hubs targeted in the first instance.

Information security risk

The security of our information and technology infrastructure is crucial for maintaining our banking applications and processes while protecting our customers and the HSBC brand.

Potential impact on HSBC

·     These risks give rise to potential financial loss and reputational damage which could adversely affect customer and investor confidence. Loss of customer data would also result in regulatory breaches which would result in fines and penalties being incurred.

·    
We have invested significantly in addressing this risk through increased training to raise staff awareness of the requirements, enhanced controls around data access and heightened monitoring of information flows.

Model risk

More stringent regulatory requirements governing the development of parameters applied to and controls around models used for measuring risk can give rise to changes, including increases in capital requirements. Furthermore, the changing external economic and legislative environment and changes in customer behaviour can lead to the assumptions we have made in our models becoming invalid.

Potential impact on HSBC

·     Model risks can result in a potentially increased and volatile capital requirement.

·     We continue to address these risks through enhanced model development, independent review and model oversight to ensure our models remain fit for purpose.

Credit risk

	Page		Tables	Page
Credit risk in the first half of 2013.......................	113		Loans and advances excluding held for sale: total exposure, impairment allowances and charges ........	113
Credit exposure ......................................................	114
Maximum exposure to credit risk ...............................	114		Maximum exposure to credit risk .................................	115
Personal lending .....................................................	116		Total personal lending .................................................	116
Mortgage lending ........................................................	117		Mortgage lending products ..........................................	117
Mortgage lending in the US ........................................	118		HSBC Finance US CML - residential mortgages .........	118
			HSBC Finance: foreclosed properties in the US ...........	119
			Trends in two months and over contractual delinquency in the US ..................................................................	120
Non-US mortgage lending............................................	120
Other personal lending................................................	120
Wholesale lending .................................................	121		Total wholesale lending ...............................................	121
Corporate and commercial .........................................	123
Financial (non-bank) ..................................................	123
Loans and advances to banks ......................................	124
Credit quality of financial instruments ..............	124		Distribution of financial instruments by credit quality ..	124
Past due but not impaired gross financial instruments .	127		Past due but not impaired loans and advances to customers and banks by geographical region ..........	127
			Ageing analysis of days past due but not impaired gross financial instruments ................................................	128
Renegotiated loans and forbearance ............................	129		Renegotiated loans and advances to customers ...........	129
			Renegotiated loans and advances to customers by geographical region ................................................	130
HSBC Finance loan modifications and re-ageing..........	131		Gross loan portfolio of HSBC Finance real estate secured balances ......................................................	132
			Movement in HSBC Finance renegotiated real estate balances ..................................................................	132
			Number of renegotiated real estate secured accounts remaining in HSBC Finance's portfolio ...................	133
Corporate and commercial forbearance ......................	133
Impaired loans ............................................................	133		Impaired loans and advances to customers and banks by industry sector ..........................................................	134
Impairment of loans and advances .......................	134		Impairment allowances on loans and advances to customers by geographical region ...........................	135
			Net loan impairment charge to the income statement by geographical region ................................................	136
			LICs by geographical region .......................................	136
Loan impairment charges in the first half of 2013 .......	136
			LICs by industry ...........................................................	136
			Movement in impairment allowances on loans and advances to customers and banks ............................	138
			Charge for impairment losses as a percentage of average gross loans and advances to customers by geographical region ................................................	139
			Reconciliation of reported and constant currency changes by geographical region ............................................	139
Concentration of exposure ....................................	140		Trading assets ..............................................................	140
			Gross loans and advances by industry sector ...............	141
			Gross loans and advances to customers by industry sector and by geographical region ...........................	142
			Loans and advances to banks by geographical region .	143
			Gross loans and advances to customers by country ......	144

	Page		Tables	Page
Securitisation exposures and other structured products ................................................................	146
Business model ...........................................................	146
Exposure in the first half of 2013 ..............................	146		Overall exposure of HSBC ...........................................	146
			Movement in the available-for-sale reserve ..................	147
Securities investment conduits ....................................	147		Available-for-sale reserve and economic first loss protection in SICs, excluding Solitaire .....................	147
Impairment methodologies .........................................	147		Carrying amount of HSBC's consolidated holdings of ABSs, and direct lending held at fair value through profit or loss	148
Exposures and significant movements ........................	151
Transactions with monoline insurers ..........................	151		HSBC's exposure to derivative transactions entered into directly with monoline insurers .................................	152
Leveraged finance transactions ...................................	152		HSBC's exposure to leveraged finance transactions .....	153
Representations and warranties related to mortgage sales and securitisation activities ..............	153
Exposures to countries in the eurozone ...............	153		Summary of exposures to eurozone countries ...............	154
Redenomination risk ..................................................	154		In-country funding exposure ........................................	155

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 other products such as guarantees and credit derivatives and from holding assets in the form of debt securities.

There have been no material changes to our policies and practices for the management of credit risk as described in the Annual Report and Accounts 2012.

During the first half of 2013, we reviewed the impairment allowance methodology used for retail banking and small business portfolios across the Group to ensure that the assumptions used in our collective assessment models continue to appropriately reflect the period of time between a loss event occurring and the account proceeding to delinquency and eventual write off.

In Brazil, we reviewed and modified the impairment allowance methodology and the underlying assumptions used for the same portfolios to reflect the level of restructuring that is taking place and the performance of these restructured accounts. This review resulted in an increase of US$242m in collective impairment allowances, mainly in Brazil's retail and small business restructured portfolios. A number of measures are under way to address these portfolios.

A summary of our current policies and practices regarding credit risk is provided in the Appendix to Risk on page 252 of the Annual Report and Accounts 2012.

Credit risk in the first half of 2013

Total exposure to credit risk remained broadly unchanged in the first half of 2013 with gross loans and advances of US$1,170bn reported at 30 June 2013, compared with US$1,166bn at 31 December 2012.

During the first half of 2013, we continued to monitor events in the eurozone, weathering the imposition of capital controls in Cyprus successfully. We also continued to monitor our portfolio in Egypt as the constitutional crisis unfolded. More details of the specific political and macroeconomic risks associated with these countries, and our management response, are provided on page 104.

Loans and advances excluding held for sale: total exposure, impairment allowances and charges

	30 Jun      2013		30 Jun      2012		31 Dec      2012
	US$bn		US$bn		US$bn
At end of period:
Total gross loans and advances (A) ...............	1,170.1		1,174.4		1,166.3
Impairment allowances ...	15.6		17.3		16.2
- as a percentage of (A) ................................	1.33%		1.47%		1.39%
Loans and advances net of impairment allowances ....................................	1,154.5		1,157.1		1,150.2
For period ended:
Impairment charges ........	3.2		4.5		8.2

The following commentary is on a constant currency basis.

Total personal lending decreased slightly to US$395bn in the first half of 2013 from US$401bn at the end of 2012. This was driven by a decrease in lending in North America due to the continued

 

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