FINANCIAL RISK MANAGEMENT

12 Months Ended

Dec. 31, 2018

Disclosure of financial risk management [text block] [Abstract]

Disclosure of financial risk management [text block]

NOTE 52: FINANCIAL RISK MANAGEMENT

As a bancassurer, financial instruments are fundamental to the Group’s activities and, as a consequence, the risks associated with financial instruments represent a significant component of the risks faced by the Group.

The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk; liquidity risk; capital risk; and insurance risk. Information about the Group’s exposure to each of the above risks and capital can be found on pages 35–103. The following additional disclosures, which provide quantitative information about the risks within financial instruments held or issued by the Group, should be read in conjunction with that earlier information.

Market risk

(A) INTEREST RATE RISK

Interest rate risk arises from the different repricing characteristics of the assets and liabilities. Liabilities are either insensitive to interest rate movements, for example interest free or very low interest customer deposits, or are sensitive to interest rate changes but bear rates which may be varied at the Group’s discretion and that for competitive reasons generally reflect changes in the Bank of England’s base rate. The rates on the remaining deposits are contractually fixed for their term to maturity.

Many banking assets are sensitive to interest rate movements; there is a large volume of managed rate assets such as variable rate mortgages which may be considered as a natural offset to the interest rate risk arising from the managed rate liabilities. However, a significant proportion of the Group’s lending assets, for example many personal loans and mortgages, bear interest rates which are contractually fixed.

The Group’s risk management policy is to optimise reward whilst managing its market risk exposures within the risk appetite defined by the Board. The largest residual risk exposure arises from balances that are deemed to be insensitive to changes in market rates (including current accounts, a portion of variable rate deposits and investable equity), and is managed through the Group’s structural hedge. The structural hedge consists of longer-term fixed rate assets or interest rate swaps and the amount and duration of the hedging activity is reviewed regularly by the Group Asset and Liability Committee. Further details on the Group market risk policy can be found on page 96.

The Group establishes hedge accounting relationships for interest rate risk using cash flow hedges and fair value hedges. The Group is exposed to cash flow interest rate risk on its variable rate loans and deposits together with its floating rate subordinated debt. The derivatives used to manage the structural hedge may be designated into cash flow hedges to manage income statement volatility. The economic items related to the structural hedge, for example current accounts, are not suitable hedge items to be documented into accounting hedge relationships. The Group is exposed to fair value interest rate risk on its fixed rate customer loans, its fixed rate customer deposits and the majority of its subordinated debt, and to cash flow interest rate risk on its variable rate loans and deposits together with its floating rate subordinated debt. The Group applies netting between similar risks before applying hedge accounting.

Hedge ineffectiveness arises during the management of interest rate risk due to residual unhedged risk. Sources of ineffectiveness, which the Group may decide to not fully mitigate, can include basis differences, timing differences and notional amount differences. The effectiveness of accounting hedge relationships is assessed between the hedging derivatives and the documented hedged item, which can differ to the underlying economically hedged item.

At 31 December 2018 the aggregate notional principal of interest rate swaps designated as fair value hedges was £150,971 million (2017: £109,670 million) with a net fair value asset of £760 million (2017: asset of £738 million) (note 17). The gains on the hedging instruments were £94 million (2017: losses of £420 million). The losses on the hedged items attributable to the hedged risk were £32 million (2017: gains of £484 million). The gains and losses relating to the fair value hedges are recorded in net trading income.

In addition the Group has cash flow hedges which are primarily used to hedge the variability in the cost of funding within the commercial business. Note 17 shows when the hedged cash flows are expected to occur and when they will affect income for designated cash flow hedges. The notional principal of the interest rate swaps designated as cash flow hedges at 31 December 2018 was £556,945 million (2017: £549,099 million) with a net fair value liability of £486 million (2017: liability of £456 million) (note 17). In 2018, ineffectiveness recognised in the income statement that arises from cash flow hedges was a loss of £25 million (2017: loss of £21 million).

(B) CURRENCY RISK

The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to the market and liquidity risk function in London. Associated VaR and the closing, average, maximum and minimum are disclosed on page 102. The Group also manages foreign currency risk via cash flow hedge accounting, utilising currency swaps.

Risk arises from the Group’s investments in its overseas operations. The Group’s structural foreign currency exposure is represented by the net asset value of the foreign currency equity and subordinated debt investments in its subsidiaries and branches. Gains or losses on structural foreign currency exposures are taken to reserves.

The Group ceased all hedging of the currency translation risk of the net investment in foreign operations on 1 January 2018. At 31 December 2017 the Group used foreign currency borrowings with an aggregate principal of £41 million to hedge currency translation risk. In 2017, an ineffectiveness loss of £11 million before tax and £8 million after tax was recognised in the income statement arising from net investment hedges.

The Group’s main overseas operations are in the Americas and Europe. Details of the Group’s structural foreign currency exposures, after net investment hedges, are as follows:

(C) FUNCTIONAL CURRENCY OF GROUP OPERATIONS

	2018						2017
	Euro £m		US Dollar £m		Other non-sterling £m		Euro £m			US Dollar £m		Other non-sterling £m
Gross exposure		112		59		60		73			374		32
Net investment hedges		–		–		–		(41	)		–		–
Total structural foreign currency exposures, after net investment hedges		112		59		60		32			374		32

Credit risk

The Group’s credit risk exposure arises in respect of the instruments below and predominantly in the United Kingdom. Information about the Group’s exposure to credit risk, credit risk management, measurement and mitigation can be found on pages 51–65.

(A) MAXIMUM CREDIT EXPOSURE

The maximum credit risk exposure of the Group in the event of other parties failing to perform their obligations is detailed below. No account is taken of any collateral held and the maximum exposure to loss, which includes amounts held to cover unit-linked and With Profits funds liabilities, is considered to be the balance sheet carrying amount or, for non-derivative off-balance sheet transactions and financial guarantees, their contractual nominal amounts.

	At 31 December 2018							At 31 December 2017
	Maximum exposure £m		Offset2 £m			Net exposure £m		Maximum exposure £m		Offset2 £m			Net exposure £m
Loans and advances to banks, net1		6,283		–			6,283		6,611		–			6,611
Loans and advances to customers, net1		484,858		(3,241	)		481,617		472,498		(7,030	)		465,468
Debt securities, net1		5,238		–			5,238		3,643		–			3,643
Financial assets at amortised cost		496,379		(3,241	)		493,138		482,752		(7,030	)		475,722
Financial assets at fair value through other comprehensive income/available-for-sale financial assets3		24,794		–			24,794		40,901		–			40,901
Financial assets at fair value through profit or loss:3,4
Loans and advances		40,876		–			40,876		31,590		–			31,590
Debt securities, treasury and other bills		40,168		–			40,168		45,198		–			45,198
		81,044		–			81,044		76,788		–			76,788
Derivative assets		23,595		(14,327	)		9,268		25,834		(13,049	)		12,785
Assets arising from reinsurance contracts held		749		–			749		602		–			602
Off-balance sheet items:
Acceptances and endorsements		194		–			194		71		–			71
Other items serving as direct credit substitutes		632		–			632		740		–			740
Performance bonds and other transaction-related contingencies		2,425		–			2,425		2,300		–			2,300
Irrevocable commitments and guarantees		64,884		–			64,884		65,946		–			65,946
		68,135		–			68,135		69,057		–			69,057
		694,696		(17,568	)		677,128		695,934		(20,079	)		675,855

1	Amounts shown net of related impairment allowances.
2	Offset items comprise deposit amounts available for offset, and amounts available for offset under master netting arrangements, that do not meet the criteria under IAS 32 to enable loans and advances and derivative assets respectively to be presented net of these balances in the financial statements.
3	Excluding equity shares.
4	Includes assets within the Group’s unit-linked funds for which credit risk is borne by the policyholders and assets within the Group’s With-Profits funds for which credit risk is largely borne by the policyholders. Consequently, the Group has no significant exposure to credit risk for such assets which back related contract liabilities.

(B) CONCENTRATIONS OF EXPOSURE

The Group’s management of concentration risk includes single name, industry sector and country limits as well as controls over the Group’s overall exposure to certain products. Further information on the Group’s management of this risk is included within Credit risk mitigation, Risk management on page 51.

At 31 December 2018 the most significant concentrations of exposure were in mortgages (comprising 61 per cent of total loans and advances to customers) and to financial, business and other services (comprising 16 per cent of the total).

	31 December 2018 £m			1 January  2018 £m			31 December 2017 £m
Agriculture, forestry and fishing		7,314			7,074			7,461
Energy and water supply		1,517			1,384			1,609
Manufacturing		8,260			7,886			7,886
Construction		4,684			4,378			4,428
Transport, distribution and hotels		14,113			14,074			14,074
Postal and telecommunications		2,711			2,148			2,148
Property companies		28,451			27,631			30,980
Financial, business and other services		77,505			50,707			57,006
Personal:
Mortgages		297,498			304,515			304,665
Other		28,699			28,757			28,757
Lease financing		1,822			2,094			2,094
Hire purchase		15,434			13,591			13,591
Total loans and advances to customers before allowance for impairment losses		488,008			464,239			474,699
Allowance for impairment losses (note 20)		(3,150	)		(3,223	)		(2,201	)
Total loans and advances to customers		484,858			461,016			472,498

Following the reduction in the Group’s non-UK activities, an analysis of credit risk exposures by geographical region has not been provided.

(C) CREDIT QUALITY OF ASSETS

LOANS AND ADVANCES

The analysis of lending has been prepared based on the division in which the asset is held; with the business segment in which the exposure is recorded reflected in the ratings system applied. The internal credit ratings systems used by the Group differ between Retail and Commercial, reflecting the characteristics of these exposures and the way that they are managed internally; these credit ratings are set out below. All probabilities of default (PDs) include forward-looking information and are based on 12 month values, with the exception of credit impaired.

	Retail		Corporate
	Grade	IFRS 9 PD%	Grade	IFRS 9 PD%
Good quality	1–6	0.00–4.50	1–10	0.00–0.50
Satisfactory quality	7–9	4.51–14.00	11–14	0.51–3.00
Lower quality	10	14.01–20.00	15–18	3.01–20.00
Below standard	11–13	20.01–99.99	19	20.01–99.99
Credit impaired	14	100.00	20–23	100.00

			Loans and advances to customers
Gross carrying amount	Loans and advances to banks £m		Retail – mortgages £m		Retail – other £m		Commercial £m		Other £m		Total £m
At 31 December 2018
Stage 1
Good quality		6,177		257,740		44,314		65,089		44,369		411,512
Satisfactory quality		105		57		2,562		25,472		–		28,091
Lower quality		–		–		72		1,441		–		1,513
Below standard, but not credit-impaired		–		–		415		–		–		415
		6,282		257,797		47,363		92,002		44,369		441,531
Stage 2
Good quality		3		10,784		2,737		100		6		13,627
Satisfactory quality		–		1,709		1,158		3,450		6		6,323
Lower quality		–		262		285		2,988		–		3,535
Below standard, but not credit-impaired		–		899		907		54		–		1,860
		3		13,654		5,087		6,592		12		25,345
Stage 3
Credit-impaired		–		1,393		997		3,296		55		5,741
Purchased or originated credit-impaired
Credit-impaired		–		15,391		–		–		–		15,391
Total		6,285		288,235		53,447		101,890		44,436		488,008
Expected credit losses
Stage 1
Good quality		2		37		279		32		43		391
Satisfactory quality		–		–		65		50		–		115
Lower quality		–		–		4		11		–		15
Below standard, but not credit-impaired		–		–		4		–		–		4
		2		37		352		93		43		525
Stage 2
Good quality		–		141		89		1		1		232
Satisfactory quality		–		34		100		86		6		226
Lower quality		–		9		40		231		–		280
Below standard, but not credit-impaired		–		42		207		7		–		256
		–		226		436		325		7		994
Stage 3
Credit-impaired		–		118		366		1,058		11		1,553
Purchased or originated credit-impaired
Credit-impaired		–		78		–		–		–		78
Total		2		459		1,154		1,476		61		3,150

Stage 3 assets include balances of approximately £250 million (with outstanding amounts due of approximately £2,200 million) which have been subject to a partial write off and where the Group continues to enforce recovery action.

Stage 2 and Stage 3 assets with a carrying amount of approximately £1,000 million were modified during the year. No material gain or loss was recognised by the Group.

Loan commitments and financial guarantees	Retail – mortgages £m		Retail – other £m		Commercial £m		Other £m		Total £m
At 31 December 2018
Stage 1
Good quality		12,024		60,379		51,632		246		124,281
Satisfactory quality		2		532		6,501		–		7,035
Lower quality		–		10		126		–		136
Below standard, but not credit-impaired		–		363		31		–		394
		12,026		61,284		58,290		246		131,846
Stage 2
Good quality		19		1,858		–		–		1,877
Satisfactory quality		1		156		693		–		850
Lower quality		–		27		297		–		324
Below standard, but not credit-impaired		–		50		11		–		61
		20		2,091		1,001		–		3,112
Stage 3
Credit-impaired		5		39		6		–		50
Purchased or originated credit-impaired
Credit-impaired		90		–		–		–		90
Total		12,141		63,414		59,297		246		135,098
Expected credit losses
Stage 1
Good quality		1		98		9		1		109
Satisfactory quality		–		5		7		–		12
Lower quality		–		–		1		–		1
Below standard, but not credit-impaired		–		–		1		–		1
		1		103		18		1		123
Stage 2
Good quality		–		28		–		–		28
Satisfactory quality		–		10		7		–		17
Lower quality		–		3		5		–		8
Below standard, but not credit-impaired		–		10		1		–		11
		–		51		13		–		64
Stage 3
Credit-impaired		–		–		6		–		6
Total		1		154		37		1		193

			Loans and advances to customers
Gross carrying amount	Loans and advances to banks £m		Retail – mortgages £m		Retail – other £m		Commercial £m		Other £m		Total £m
At 1 January 2018
Stage 1
Good quality		4,245		251,663		40,951		64,207		17,276		374,097
Satisfactory quality		–		44		3,203		25,577		–		28,824
Lower quality		–		–		127		557		–		684
Below standard, but not credit-impaired		–		–		276		–		–		276
		4,245		251,707		44,557		90,341		17,276		403,881
Stage 2
Good quality		2		17,599		2,711		210		67		20,587
Satisfactory quality		–		1,359		1,377		4,470		4,094		11,300
Lower quality		–		290		299		2,616		–		3,205
Below standard, but not credit-impaired		–		861		823		469		–		2,153
		2		20,109		5,210		7,765		4,161		37,245
Stage 3
Credit-impaired		–		1,232		873		2,714		321		5,140
Purchased or originated credit-impaired
Credit-impaired		–		17,973		–		–		–		17,973
Total		4,247		291,021		50,640		100,820		21,758		464,239
Expected credit losses
Stage 1
Good quality		1		30		276		35		72		413
Satisfactory quality		–		–		104		60		–		164
Lower quality		–		–		9		6		–		15
Below standard, but not credit-impaired		–		–		5		–		–		5
		1		30		394		101		72		597
Stage 2
Good quality		–		169		92		1		16		278
Satisfactory quality		–		24		123		134		110		391
Lower quality		–		7		42		183		–		232
Below standard, but not credit-impaired		–		36		147		64		–		247
		–		236		404		382		126		1,148
Stage 3
Credit-impaired		–		86		313		957		90		1,446
Purchased or originated credit-impaired
Credit-impaired		–		32		–		–		–		32
Total		1		384		1,111		1,440		288		3,223

Loan commitments and financial guarantees	Retail – mortgages £m		Retail – other £m		Commercial £m		Other £m		Total £m
At 1 January 2018
Stage 1
Good quality		11,690		60,305		53,335		287		125,617
Satisfactory quality		–		801		5,463		–		6,264
Lower quality		–		26		226		–		252
Below standard, but not credit-impaired		–		7		–		–		7
		11,690		61,139		59,024		287		132,140
Stage 2
Good quality		50		1,908		59		–		2,017
Satisfactory quality		–		221		577		–		798
Lower quality		–		32		347		–		379
Below standard, but not credit-impaired		–		45		76		–		121
		50		2,206		1,059		–		3,315
Stage 3
Credit-impaired		–		61		–		–		61
Purchased or originated credit-impaired
Credit-impaired		113		–		–		–		113
Total		11,853		63,406		60,083		287		135,629
Expected credit losses
Stage 1
Good quality		1		91		11		2		105
Satisfactory quality		–		19		19		–		38
Lower quality		–		2		1		–		3
Below standard, but not credit-impaired		–		1		–		–		1
		1		113		31		2		147
Stage 2
Good quality		–		37		–		–		37
Satisfactory quality		–		15		28		–		43
Lower quality		–		4		14		–		18
Below standard, but not credit-impaired		–		20		8		–		28
		–		76		50		–		126
Total		1		189		81		2		273

Loans and advances carried at fair value through profit or loss comprise £27,734 million (1 January 2018: £31,590 million) of trading assets of which £27,685 million (1 January 2018: £31,548 million) have a good quality rating and £49 million (1 January 2018: £42 million) have a satisfactory rating; and £13,142 million (1 January 2018: £14,016 million) of other assets mandatorily held at fair value through profit or loss of which £12,509 million (1 January 2018: £13,338 million) is viewed by the business as investment grade.

DEBT SECURITIES HELD AT AMORTISED COST

An analysis by credit rating of the Group’s debt securities held at amortised cost is provided below:

	31 December 2018							1 January 2018
	Investment grade1 £m		Other2 £m		Total £m			Investment grade1 £m		Other2 £m		Total £m
Asset-backed securities:
Mortgage-backed securities		3,263		9		3,272			2,265		–		2,265
Other asset-backed securities		763		17		780			1,025		7		1,032
		4,026		26		4,052			3,290		7		3,297
Corporate and other debt securities		1,176		16		1,192			27		16		43
Gross exposure		5,202		42		5,244			3,317		23		3,340
Allowance for impairment losses						(6	)						(26	)
Total debt securities held at amortised cost						5,238							3,314

1	Credit ratings equal to or better than ‘BBB’.
2	Other comprises sub-investment grade (31 December 2018: £6 million; 1 January 2018: £nil) and not rated (31 December 2018: £36 million; 1 January 2018: £23 million).

FINANCIAL ASSETS AT FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME/AVAILABLE-FOR-SALE FINANCIAL ASSETS (EXCLUDING EQUITY SHARES)

An analysis of the Group’s financial assets at fair value through other comprehensive income (available-for-sale financial assets at 31 December 2017) is included in note 21. The credit quality of the Group’s financial assets at fair value through other comprehensive income (available-for-sale financial assets at 31 December 2017) (excluding equity shares) is set out below:

	31 December 2018						1 January 2018
	Investment grade1 £m		Other2 £m		Total £m		Investment grade1 £m		Other2 £m		Total £m
Debt securities:
Government securities		18,971		–		18,971		34,708		–		34,708
Bank and building society certificates of deposit		118		–		118		167		–		167
Asset-backed securities:
Mortgage-backed securities		120		–		120		2,381		–		2,381
Other asset-backed securities		–		131		131		358		109		467
		120		131		251		2,739		109		2,848
Corporate and other debt securities		4,934		217		5,151		4,250		365		4,615
Total debt securities		24,143		348		24,491		41,864		474		42,338
Treasury and other bills		303		–		303		–		–		–
Total financial assets at fair value through other comprehensive income/available-for-sale financial assets		24,446		348		24,794		41,864		474		42,338

1	Credit ratings equal to or better than ‘BBB’.
2	Other comprises sub-investment grade (31 December 2018: £85 million; 1 January 2018: £98 million) and not rated (31 December 2018: £263 million; 1 January 2018: £376 million).

DEBT SECURITIES, TREASURY AND OTHER BILLS HELD AT FAIR VALUE THROUGH PROFIT OR LOSS

An analysis of the Group’s financial assets at fair value through profit or loss is included in note 16. The credit quality of the Group’s debt securities, treasury and other bills held at fair value through profit or loss is set out below:

	2018						2017
	Investment grade1 £m		Other2 £m		Total £m		Investment grade1 £m		Other2 £m		Total £m
Debt securities, treasury and other bills held at fair value through profit or loss
Trading assets:
Government securities		7,192		–		7,192		9,833		–		9,833
Asset-backed securities:
Mortgage-backed securities		10		–		10		84		105		189
Other asset-backed securities		63		–		63		95		–		95
		73		–		73		179		105		284
Corporate and other debt securities		228		19		247		469		54		523
Total held as trading assets		7,493		19		7,512		10,481		159		10,640
Other assets held at fair value through profit or loss:
Government securities		10,903		–		10,903		12,180		7		12,187
Other public sector securities		2,059		5		2,064		1,519		8		1,527
Bank and building society certificates of deposit		1,105		–		1,105		222		–		222
Asset-backed securities:
Mortgage-backed securities		208		7		215		208		3		211
Other asset-backed securities		283		3		286		924		2		926
		491		10		501		1,132		5		1,137
Corporate and other debt securities		16,141		1,922		18,063		17,343		2,124		19,467
Total debt securities held at fair value through profit or loss		30,699		1,937		32,636		32,396		2,144		34,540
Treasury bills and other bills		20		–		20		18		–		18
Total other assets held at fair value through profit or loss		30,719		1,937		32,656		32,414		2,144		34,558
Total held at fair value through profit or loss		38,212		1,956		40,168		42,895		2,303		45,198

1	Credit ratings equal to or better than ‘BBB’.
2	Other comprises sub-investment grade (2018: £411 million; 2017: £331 million) and not rated (2018: £1,545 million; 2017: £1,972 million).

Credit risk in respect of trading and other financial assets at fair value through profit or loss held within the Group’s unit-linked funds is borne by the policyholders and credit risk in respect of with-profits funds is largely borne by the policyholders. Consequently, the Group has no significant exposure to credit risk for such assets which back those contract liabilities.

DERIVATIVE ASSETS

An analysis of derivative assets is given in note 17. The Group reduces exposure to credit risk by using master netting agreements and by obtaining collateral in the form of cash or highly liquid securities. In respect of the Group’s net credit risk relating to derivative assets of £9,268 million (2017: £12,785 million), cash collateral of £6,039 million (2017: £5,419 million) was held and a further 213 million was due from OECD banks (2017: £275 million).

	2018						2017
	Investment grade1 £m		Other2 £m		Total £m		Investment grade1 £m		Other2 £m		Total £m
Trading and other		19,797		2,235		22,032		21,742		2,211		23,953
Hedging		1,534		29		1,563		1,874		7		1,881
Total derivative financial instruments		21,331		2,264		23,595		23,616		2,218		25,834

1	Credit ratings equal to or better than ‘BBB’.
2	Other comprises sub-investment grade (2018: £1,920 million; 2017: £1,878 million) and not rated (2018: £344 million; 2017: £340 million).

FINANCIAL GUARANTEES AND IRREVOCABLE LOAN COMMITMENTS

Financial guarantees represent undertakings that the Group will meet a customer’s obligation to third parties if the customer fails to do so. Commitments to extend credit represent unused portions of authorisations to extend credit in the form of loans, guarantees or letters of credit. The Group is theoretically exposed to loss in an amount equal to the total guarantees or unused commitments, however, the likely amount of loss is expected to be significantly less; most commitments to extend credit are contingent upon customers maintaining specific credit standards.

(D) COLLATERAL HELD AS SECURITY FOR FINANCIAL ASSETS

A general description of collateral held as security in respect of financial instruments is provided on page 52. The Group holds collateral against loans and advances and irrevocable loan commitments; qualitative and, where appropriate, quantitative information is provided in respect of this collateral below. Collateral held as security for financial assets at fair value through profit or loss and for derivative assets is also shown below.

The Group holds collateral in respect of loans and advances to banks and customers as set out below. The Group does not hold collateral against debt securities, comprising asset-backed securities and corporate and other debt securities, which are classified as financial assets held at amortised cost.

LOANS AND ADVANCES TO BANKS

There were reverse repurchase agreements which are accounted for as collateralised loans within loans and advances to banks with a carrying value of £461 million (2017: £771 million), against which the Group held collateral with a fair value of £481 million (2017: £796 million).

These transactions were generally conducted under terms that are usual and customary for standard secured lending activities.

LOANS AND ADVANCES TO CUSTOMERS

Retail lending

Mortgages

An analysis by loan-to-value ratio of the Group’s residential mortgage lending is provided below. The value of collateral used in determining the loan-to-value ratios has been estimated based upon the last actual valuation, adjusted to take into account subsequent movements in house prices, after making allowances for indexation error and dilapidations.

In some circumstances, where the discounted value of the estimated net proceeds from the liquidation of collateral (i.e. net of costs, expected haircuts and anticipated changes in the value of the collateral to the point of sale) is greater than the estimated exposure at default, no credit losses are expected and no ECL allowance is recognised.

	Stage 1 £m		Stage 2 £m		Stage 3 £m		Purchased or originated credit-impaired £m		Total gross £m
At 31 December 2018
Less than 70 per cent		186,974		10,853		1,058		11,658		210,543
70 per cent to 80 per cent		38,865		1,704		176		1,864		42,609
80 per cent to 90 per cent		26,353		837		90		1,024		28,304
90 per cent to 100 per cent		5,136		154		33		349		5,672
Greater than 100 per cent		469		106		36		496		1,107
Total		257,797		13,654		1,393		15,391		288,235

	Neither past due nor impaired £m		Past due but not impaired £m		Impaired £m		Gross £m
At 31 December 2017
Less than 70 per cent		211,366		4,211		2,348		217,925
70 per cent to 80 per cent		41,323		754		544		42,621
80 per cent to 90 per cent		22,421		422		398		23,241
90 per cent to 100 per cent		5,036		145		209		5,390
Greater than 100 per cent		1,326		95		387		1,808
Total		281,472		5,627		3,886		290,985

Other

The majority of non-mortgage retail lending is unsecured. At 31 December 2018, Stage 3 non-mortgage lending amounted to £631 million, net of an impairment allowance of £366 million (2017: impaired non-mortgage lending amounted to £817 million, net of an impairment allowance of £542 million).

Stage 1 and Stage 2 non-mortgage retail lending amounted to £52,450 million (2017: unimpaired non-mortgage lending amounted to £49,482 million). Lending decisions are predominantly based on an obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. Collateral values are rigorously assessed at the time of loan origination and are thereafter monitored in accordance with business unit credit policy.

The Group credit risk disclosures for unimpaired non-mortgage retail lending report assets gross of collateral and therefore disclose the maximum loss exposure. The Group believes that this approach is appropriate.

Commercial lending

Reverse repurchase transactions

At 31 December 2018 there were reverse repurchase agreements which were accounted for as collateralised loans with a carrying value of £40,483 million (2017: £16,832 million), against which the Group held collateral with a fair value of £42,339 million (2017: £17,122 million), all of which the Group was able to repledge. Included in these amounts were collateral balances in the form of cash provided in respect of reverse repurchase agreements of £nil (2017: £nil). These transactions were generally conducted under terms that are usual and customary for standard secured lending activities.

Stage 3 secured lending

The value of collateral is re-evaluated and its legal soundness re-assessed if there is observable evidence of distress of the borrower; this evaluation is used to determine potential loss allowances and management’s strategy to try to either repair the business or recover the debt.

At 31 December 2018, Stage 3 secured commercial lending amounted to £658 million, net of an impairment allowance of £215 million (2017: impaired secured commercial lending amounted to £698 million, net of an impairment allowance of £242 million). The fair value of the collateral held in respect of impaired secured commercial lending was £590 million (2017: £797 million). In determining the fair value of collateral, no specific amounts have been attributed to the costs of realisation. For the purposes of determining the total collateral held by the Group in respect of impaired secured commercial lending, the value of collateral for each loan has been limited to the principal amount of the outstanding advance in order to eliminate the effects of any over-collateralisation and to provide a clearer representation of the Group’s exposure.

Stage 3 secured commercial lending and associated collateral relates to lending to property companies and to customers in the financial, business and other services; transport, distribution and hotels; and construction industries.

Stage 1 and Stage 2 secured lending

For Stage 1 and Stage 2 secured commercial lending, the Group reports assets gross of collateral and therefore discloses the maximum loss exposure. The Group believes that this approach is appropriate as collateral values at origination and during a period of good performance may not be representative of the value of collateral if the obligor enters a distressed state.

Stage 1 and Stage 2 secured commercial lending is predominantly managed on a cash flow basis. On occasion, it may include an assessment of underlying collateral, although, for Stage 3 lending, this will not always involve assessing it on a fair value basis. No aggregated collateral information for the entire unimpaired secured commercial lending portfolio is provided to key management personnel.

FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS (EXCLUDING EQUITY SHARES)

Included in financial assets at fair value through profit or loss are reverse repurchase agreements treated as collateralised loans with a carrying value of £28,356 million (2017: £31,590 million). Collateral is held with a fair value of £36,101 million (2017: £39,099 million), all of which the Group is able to repledge. At 31 December 2018, £31,013 million had been repledged (2017: £31,281 million).

In addition, securities held as collateral in the form of stock borrowed amounted to £51,202 million (2017: £61,469 million). Of this amount, £49,233 million (2017: £44,432 million) had been resold or repledged as collateral for the Group’s own transactions.

These transactions were generally conducted under terms that are usual and customary for standard secured lending activities.

DERIVATIVE ASSETS, AFTER OFFSETTING OF AMOUNTS UNDER MASTER NETTING ARRANGEMENTS

The Group reduces exposure to credit risk by using master netting agreements and by obtaining collateral in the form of cash or highly liquid securities. In respect of the net derivative assets after offsetting of amounts under master netting arrangements of £14,327 million (2017: £12,785 million), cash collateral of £6,039 million (2017: £5,419 million) was held.

IRREVOCABLE LOAN COMMITMENTS AND OTHER CREDIT-RELATED CONTINGENCIES

At 31 December 2018, the Group held irrevocable loan commitments and other credit-related contingencies of £62,640 million (2017: £63,237 million). Collateral is held as security, in the event that lending is drawn down, on £10,661 million (2017: £10,956 million) of these balances.

COLLATERAL REPOSSESSED

During the year, £245 million of collateral was repossessed (2017: £297 million), consisting primarily of residential property.

In respect of retail portfolios, the Group does not take physical possession of properties or other assets held as collateral and uses external agents to realise the value as soon as practicable, generally at auction, to settle indebtedness. Any surplus funds are returned to the borrower or are otherwise dealt with in accordance with appropriate insolvency regulations. In certain circumstances the Group takes physical possession of assets held as collateral against commercial lending. In such cases, the assets are carried on the Group’s balance sheet and are classified according to the Group’s accounting policies.

(E) COLLATERAL PLEDGED AS SECURITY

The Group pledges assets primarily for repurchase agreements and securities lending transactions which are generally conducted under terms that are usual and customary for standard securitised borrowing contracts.

REPURCHASE TRANSACTIONS

Deposits from banks

Included in deposits from banks are balances arising from repurchase transactions of £21,170 million (2017: £23,175 million); the fair value of the collateral provided under these agreements at 31 December 2018 was £19,615 million (2017: £23,082 million).

Customer deposits

Included in customer deposits are balances arising from repurchase transactions of £1,818 million (2017: £2,638 million); the fair value of the collateral provided under these agreements at 31 December 2018 was £1,710 million (2017: £2,640 million).

Financial liabilities at fair value through profit or loss

The fair value of collateral pledged in respect of repurchase transactions, accounted for as secured borrowing, where the secured party is permitted by contract or custom to repledge was £28,438 million (2017: £48,765 million).

SECURITIES LENDING TRANSACTIONS

The following on balance sheet financial assets have been lent to counterparties under securities lending transactions:

	2018 £m		2017 £m
Financial assets at fair value through profit or loss		5,837		6,622
Loans and advances to customers		–		197
Financial assets at fair value through other comprehensive income (2017: available-for-sale financial assets)		1,917		2,608
		7,754		9,427

SECURITISATIONS AND COVERED BONDS

In addition to the assets detailed above, the Group also holds assets that are encumbered through the Group’s asset-backed conduits and its securitisation and covered bond programmes. Further details of these assets are provided in notes 30 and 48.

Liquidity risk

Liquidity risk is defined as the risk that the Group has insufficient financial resources to meet its commitments as they fall due, or can only secure them at excessive cost. Liquidity risk is managed through a series of measures, tests and reports that are primarily based on contractual maturity. The Group carries out monthly stress testing of its liquidity position against a range of scenarios, including those prescribed by the PRA. The Group’s liquidity risk appetite is also calibrated against a number of stressed liquidity metrics.

The table below analyses assets and liabilities of the Group into relevant maturity groupings based on the remaining contractual period at the balance sheet date; balances with no fixed maturity are included in the over 5 years category. Certain balances, included in the table below on the basis of their residual maturity, are repayable on demand upon payment of a penalty.

(A) MATURITIES OF ASSETS AND LIABILITIES

	Up to 1 month £m		1-3 months £m		3-6 months £m		6-9 months £m		9-12 months £m		1-2 years £m		2-5 years £m		Over 5 years £m		Total £m
At 31 December 2018
Assets
Cash and balances at central banks		54,662		1		–		–		–		–		–		–		54,663
Financial assets at fair value through profit or loss		10,686		8,826		8,492		5,133		2,587		2,090		5,467		115,248		158,529
Derivative financial instruments		579		688		418		336		441		1,064		3,075		16,994		23,595
Loans and advances to banks		2,594		520		584		172		203		160		–		2,050		6,283
Loans and advances to customers		36,326		19,383		18,415		14,378		11,318		30,459		72,028		282,551		484,858
Debt securities held at amortised cost		7		–		–		521		–		–		2,262		2,448		5,238
Financial assets at fair value through other comprehensive income		166		453		249		800		1,685		2,536		11,496		7,430		24,815
Other assets		2,667		1,552		196		238		219		387		1,118		33,240		39,617
Total assets		107,687		31,423		28,354		21,578		16,453		36,696		95,446		459,961		797,598
Liabilities
Deposits from banks		2,793		1,688		748		54		45		4,758		16,052		4,182		30,320
Customer deposits		380,753		10,623		5,628		4,543		4,431		6,421		3,244		2,423		418,066
Derivative financial instruments and financial liabilities at fair value through profit or loss		5,160		11,877		5,048		1,663		522		1,104		4,108		22,438		51,920
Debt securities in issue		4,172		5,692		9,007		4,668		1,694		13,062		28,676		24,197		91,168
Liabilities arising from insurance and investment contracts		1,844		1,850		2,316		2,302		2,104		7,995		20,986		73,330		112,727
Other liabilities		4,403		3,201		733		1,182		1,383		756		232		13,652		25,542
Subordinated liabilities		85		145		95		251		–		2,600		2,559		11,921		17,656
Total liabilities		399,210		35,076		23,575		14,663		10,179		36,696		75,857		152,143		747,399
At 31 December 2017
Assets
Cash and balances at central banks		58,519		2		–		–		–		–		–		–		58,521
Financial assets at fair value through profit or loss		11,473		13,345		4,858		2,781		1,056		2,655		5,341		121,369		162,878
Derivative financial instruments		449		601		763		451		503		965		2,763		19,339		25,834
Loans and advances to banks		3,104		314		190		190		192		131		2,405		85		6,611
Loans and advances to customers		28,297		15,953		13,585		11,881		10,482		29,340		70,967		291,993		472,498
Debt securities held as loans and receivables		10		29		–		–		7		350		2,775		472		3,643
Available-for-sale financial assets		59		365		286		1,025		265		3,040		15,366		21,692		42,098
Other assets		3,807		897		414		1,170		854		725		5,618		26,541		40,026
Total assets		105,718		31,506		20,096		17,498		13,359		37,206		105,235		481,491		812,109
Liabilities
Deposits from banks		2,810		2,318		1,885		87		28		–		22,378		298		29,804
Customer deposits		366,778		18,821		10,615		5,524		5,074		7,823		2,986		503		418,124
Derivative financial instruments and financial liabilities at fair value through profit or loss		19,215		16,932		4,933		3,419		948		1,961		4,298		25,295		77,001
Debt securities in issue		3,248		6,014		4,431		3,506		2,902		6,333		25,669		20,347		72,450
Liabilities arising from insurance and investment contracts		1,898		2,003		2,484		2,466		2,425		8,532		21,842		77,210		118,860
Other liabilities		4,229		2,805		239		2,216		1,894		1,498		1,933		13,991		28,805
Subordinated liabilities		–		202		1,588		–		570		574		3,983		11,005		17,922
Total liabilities		398,178		49,095		26,175		17,218		13,841		26,721		83,089		148,649		762,966

The above tables are provided on a contractual basis. The Group’s assets and liabilities may be repaid or otherwise mature earlier or later than implied by their contractual terms and readers are, therefore, advised to use caution when using this data to evaluate the Group’s liquidity position. In particular, amounts in respect of customer deposits are usually contractually payable on demand or at short notice. However, in practice, these deposits are not usually withdrawn on their contractual maturity.

The table below analyses financial instrument liabilities of the Group, excluding those arising from insurance and participating investment contracts, on an undiscounted future cash flow basis according to contractual maturity, into relevant maturity groupings based on the remaining period at the balance sheet date; balances with no fixed maturity are included in the over 5 years category.

	Up to 1 month £m			1-3 months £m			3-12 months £m			1-5 years £m			Over 5 years £m			Total £m
At 31 December 2018
Deposits from banks		2,820			2,710			1,022			20,920			3,502			30,974
Customer deposits		380,985			10,584			14,169			11,634			1,554			418,926
Financial liabilities at fair value through profit or loss		9,693			10,984			7,553			930			10,771			39,931
Debt securities in issue		5,942			7,314			22,564			48,233			24,201			108,254
Liabilities arising from non-participating investment contracts		13,853			–			–			–			–			13,853
Subordinated liabilities		247			1,017			1,144			8,231			19,328			29,967
Total non-derivative financial liabilities		413,540			32,609			46,452			89,948			59,356			641,905
Derivative financial liabilities:
Gross settled derivatives – outflows		39,165			27,976			23,978			43,239			33,763			168,121
Gross settled derivatives – inflows		(38,301	)		(27,283	)		(23,134	)		(40,690	)		(28,933	)		(158,341	)
Gross settled derivatives – net flows		864			693			844			2,549			4,830			9,780
Net settled derivatives liabilities		13,511			103			209			782			2,193			16,798
Total derivative financial liabilities		14,375			796			1,053			3,331			7,023			26,578
At 31 December 2017
Deposits from banks		2,516			3,545			2,096			21,498			660			30,315
Customer deposits		367,103			18,854			21,308			11,198			2,375			420,838
Financial liabilities at fair value through profit or loss		21,286			14,424			6,499			4,251			13,044			59,504
Debt securities in issue		3,444			6,331			12,562			36,999			23,923			83,259
Liabilities arising from non-participating investment contracts		15,447			–			–			–			–			15,447
Subordinated liabilities		231			454			2,907			7,170			19,164			29,926
Total non-derivative financial liabilities		410,027			43,608			45,372			81,116			59,166			639,289
Derivative financial liabilities:
Gross settled derivatives – outflows		23,850			31,974			24,923			43,444			30,605			154,796
Gross settled derivatives – inflows		(23,028	)		(30,972	)		(23,886	)		(43,523	)		(32,065	)		(153,474	)
Gross settled derivatives – net flows		822			1,002			1,037			(79	)		(1,460	)		1,322
Net settled derivatives liabilities		17,425			128			776			974			2,795			22,098
Total derivative financial liabilities		18,247			1,130			1,813			895			1,335			23,420

The majority of the Group’s non-participating investment contract liabilities are unit-linked. These unit-linked products are invested in accordance with unit fund mandates. Clauses are included in policyholder contracts to permit the deferral of sales, where necessary, so that linked assets can be realised without being a forced seller.

The principal amount for undated subordinated liabilities with no redemption option is included within the over five years column; interest of approximately £27 million (2017: £24 million) per annum which is payable in respect of those instruments for as long as they remain in issue is not included beyond five years.

Further information on the Group’s liquidity exposures is provided on pages 88–94.

Liabilities arising from insurance and participating investment contracts are analysed on a behavioural basis, as permitted by IFRS 4, as follows:

	Up to 1 month £m		1-3 months £m		3-12 months £m		1-5 years £m		Over 5 years £m		Total £m
At 31 December 2018		1,667		1,624		5,925		25,414		64,244		98,874
At 31 December 2017		1,708		1,747		6,467		26,479		67,012		103,413

For insurance and participating investment contracts which are neither unit-linked nor in the Group’s with-profit funds, in particular annuity liabilities, the aim is to invest in assets such that the cash flows on investments match those on the projected future liabilities.

The following tables set out the amounts and residual maturities of the Group’s off balance sheet contingent liabilities and commitments.

	Up to 1 month £m		1-3 months £m		3-6 months £m		6-9 months £m		9-12 months £m		1-3 years £m		3-5 years £m		Over 5 years £m		Total £m
At 31 December 2018
Acceptances and endorsements		64		83		34		13		–		–		–		–		194
Other contingent liabilities		450		484		203		223		150		665		133		749		3,057
Total contingent liabilities		514		567		237		236		150		665		133		749		3,251
Lending commitments and guarantees		67,055		2,947		4,474		6,055		16,123		17,737		15,374		4,602		134,367
Other commitments		428		–		–		2		92		20		13		176		731
Total commitments and guarantees		67,483		2,947		4,474		6,057		16,215		17,757		15,387		4,778		135,098
Total contingents and commitments		67,997		3,514		4,711		6,293		16,365		18,422		15,520		5,527		138,349
At 31 December 2017
Acceptances and endorsements		12		51		4		–		–		4		–		–		71
Other contingent liabilities		392		669		210		131		205		506		271		656		3,040
Total contingent liabilities		404		720		214		131		205		510		271		656		3,111
Lending commitments and guarantees		66,964		3,137		5,966		5,525		14,572		18,001		16,577		4,503		135,245
Other commitments		19		–		–		38		–		46		71		210		384
Total commitments and guarantees		66,983		3,137		5,966		5,563		14,572		18,047		16,648		4,713		135,629
Total contingents and commitments		67,387		3,857		6,180		5,694		14,777		18,557		16,919		5,369		138,740