16. Fair values of financial assets and liabilities

The valuations of financial instruments have been classified into three levels according to the quality and reliability of information used to determine those fair values. Note 50 to the Group’s 2019 financial statements describes the definitions of the three levels in the fair value hierarchy.

Valuation control framework

Key elements of the valuation control framework, which covers processes for all levels in the fair value hierarchy including level 3 portfolios, include model validation (incorporating pre-trade and post-trade testing), product implementation review and independent price verification. Formal committees meet quarterly to discuss and approve valuations in more judgemental areas.

Transfers into and out of level 3 portfolios

Transfers out of level 3 portfolios arise when inputs that could have a significant impact on the instrument’s valuation become market observable; conversely, transfers into the portfolios arise when sources of data cease to be observable.

Valuation methodology

For level 2 and level 3 portfolios, there is no significant change to the valuation methodology (techniques and inputs) disclosed in the Group’s 2019 Annual Report on Form 20-F applied to these portfolios.

The table below summarises the carrying values of financial assets and liabilities presented on the Group’s balance sheet. The fair values presented in the table are at a specific date and may be significantly different from the amounts which will actually be paid or received on the maturity or settlement date.


	At 30 June 2020		At 31 December 2019
	Carrying	Fair	Carrying	Fair
	value	value	value	value
	£m	£m	£m	£m
Financial assets
Financial assets at fair value through profit or loss	157,113	157,113	160,189	160,189
Derivative financial instruments	32,978	32,978	26,369	26,369

Loans and advances to banks	11,202	11,211	9,775	9,773
Loans and advances to customers	501,508	501,494	494,988	495,804
Debt securities	5,604	5,597	5,544	5,537
Financial assets at amortised cost	518,314	518,302	510,307	511,114
Financial assets at fair value through other comprehensive income	27,211	27,211	25,092	25,092
Financial liabilities
Deposits from banks	34,124	34,190	28,179	28,079
Customer deposits	453,446	453,773	421,320	421,728
Financial liabilities at fair value through profit or loss	21,474	21,474	21,486	21,486
Derivative financial instruments	28,631	28,631	25,779	25,779
Debt securities in issue	99,931	105,211	97,689	100,443
Liabilities arising from non-participating investment contracts	34,927	34,927	37,459	37,459
Subordinated liabilities	17,717	22,368	17,130	19,783

The carrying amount of the following financial instruments is a reasonable approximation of fair value: cash and balances at central banks, items in the course of collection from banks, items in course of transmission to banks and notes in circulation.

The Group manages valuation adjustments for its derivative exposures on a net basis; the Group determines their fair values on the basis of their net exposures. In all other cases, fair values of financial assets and liabilities measured at fair value are determined on the basis of their gross exposures.

The following tables provide an analysis of the financial assets and liabilities of the Group that are carried at fair value in the Group’s consolidated balance sheet, grouped into levels 1 to 3 based on the degree to which the fair value is observable.

Financial assets


	Level 1	Level 2	Level 3	Total
	£m	£m	£m	£m
At 30 June 2020
Financial assets at fair value through profit or loss:
Loans and advances to customers	—	11,232	11,264	22,496
Loans and advances to banks	—	4,075	—	4,075
Debt securities	20,747	23,610	1,841	46,198
Treasury and other bills	20	—	—	20
Equity shares	82,086	356	1,882	84,324
Total financial assets at fair value through profit or loss	102,853	39,273	14,987	157,113
Financial assets at fair value through other comprehensive income:
Debt securities	14,142	12,644	181	26,967
Treasury and other bills	80	—	—	80
Equity shares	—	—	164	164
Total financial assets at fair value through other comprehensive income	14,222	12,644	345	27,211
Derivative financial instruments	99	31,995	884	32,978
Total financial assets carried at fair value	117,174	83,912	16,216	217,302

At 31 December 2019
Financial assets at fair value through profit or loss:
Loans and advances to customers	—	10,164	10,912	21,076
Loans and advances to banks	18	2,381	—	2,399
Debt securities	18,670	20,246	1,990	40,906
Treasury and other bills	19	—	—	19
Equity shares	93,766	17	2,006	95,789
Total financial assets at fair value through profit or loss	112,473	32,808	14,908	160,189
Financial assets at fair value through other comprehensive income:
Debt securities	12,876	11,273	181	24,330
Treasury and other bills	535	—	—	535
Equity shares	—	—	227	227
Total financial assets at fair value through other comprehensive income	13,411	11,273	408	25,092
Derivative financial instruments	50	25,456	863	26,369
Total financial assets carried at fair value	125,934	69,537	16,179	211,650

Financial liabilities



	Level 1	Level 2	Level 3	Total
	£m	£m	£m	£m

At 30 June 2020
Financial liabilities at fair value through profit or loss:
Liabilities held at fair value through profit or loss	—	7,644	47	7,691
Trading liabilities	1,963	11,820	—	13,783
Total financial liabilities at fair value through profit or loss	1,963	19,464	47	21,474
Derivative financial instruments	63	27,101	1,467	28,631
Total financial liabilities carried at fair value	2,026	46,565	1,514	50,105

At 31 December 2019
Financial liabilities at fair value through profit or loss:
Liabilities held at fair value through profit or loss	—	7,483	48	7,531
Trading liabilities	2,781	11,174	—	13,955
Total financial liabilities at fair value through profit or loss	2,781	18,657	48	21,486
Derivative financial instruments	54	24,358	1,367	25,779
Total financial liabilities carried at fair value	2,835	43,015	1,415	47,265

Movements in level 3 portfolio

The tables below analyse movements in the level 3 financial assets portfolio.



		Financial
	Financial	assets at		Total
	assets at	fair value		financial
	fair value	through other		assets
	through profit	comprehensive	Derivative	carried at
	or loss	income	assets	fair value
	£m	£m	£m	£m


At 1 January 2020	14,908	408	863	16,179
Exchange and other adjustments	106	11	19	136
Gains recognised in the income statement within other income	135	—	124	259
Losses recognised in other comprehensive income within the revaluation reserve in respect of financial assets carried at fair value through other comprehensive income	—	(67)	—	(67)
Purchases/ increases to customer loans	851	—	2	853
Sales/ repayments	(839)	(7)	(81)	(927)
Transfers into the level 3 portfolio	73	—	41	114
Transfers out of the level 3 portfolio	(247)	—	(84)	(331)
At 30 June 2020	14,987	345	884	16,216
Gains recognised in the income statement within other income relating to those assets held at 30 June 2020	141	—	132	273


		Financial
	Financial	assets		Total
	assets at	at fair value		financial
	fair value	through other		assets
	through profit	comprehensive	Derivative	carried at
	or loss	income	assets	fair value
	£m	£m	£m	£m

At 1 January 2019	13,917	267	927	15,111
Exchange and other adjustments	3	1	—	4
Gains recognised in the income statement within other income	489	—	251	740
Gains recognised in other comprehensive income within the revaluation reserve in respect of financial assets held at fair value through other comprehensive income	—	8	—	8
Purchases/ increases to customer loans	1,511	—	2	1,513
Sales/ repayments	(1,522)	(80)	(16)	(1,618)
Transfers into the level 3 portfolio	563	—	22	585
Transfers out of the level 3 portfolio	(98)	—	(2)	(100)
At 30 June 2019	14,863	196	1,184	16,243
Gains recognised in the income statement within other income relating to those assets held at 30 June 2019	189	—	285	474

The tables below analyse movements in the level 3 financial liabilities portfolio.


	Financial		Total
	liabilities at		financial
	fair value		liabilities
	through	Derivative	carried at
	profit or loss	liabilities	fair value
	£m	£m	£m

At 1 January 2020	48	1,367	1,415
Exchange and other adjustments	—	20	20
Losses recognised in the income statement within other income	1	194	195
Additions	—	2	2
Redemptions	(2)	(8)	(10)
Transfers into the level 3 portfolio	—	51	51
Transfers out of the level 3 portfolio	—	(159)	(159)
At 30 June 2020	47	1,467	1,514
Losses recognised in the income statement within other income relating to those liabilities held at 30 June 2020	—	195	195


	Financial		Total
	liabilities at		financial
	fair value		liabilities
	through	Derivative	carried at
	profit or loss	liabilities	fair value
	£m	£m	£m

At 1 January 2019	11	716	727
Exchange and other adjustments	—	—	—
Losses recognised in the income statement within other income	—	204	204
Additions	—	1	1
Redemptions	(1)	(12)	(13)
Transfers into the level 3 portfolio	53	364	417
Transfers out of the level 3 portfolio	(11)	—	(11)
At 30 June 2019	52	1,273	1,325
Losses recognised in the income statement within other income relating to those liabilities held at 30 June 2019	—	249	249

The tables below set out the effects of reasonably possible alternative assumptions for categories of level 3 financial assets and financial liabilities which have an aggregated carrying value greater than £500 million.

At 30 June 2020

Effect of reasonably

possible alternative

Significant

assumptions1

Valuation

unobservable

Carrying

Favourable

Unfavourable

technique(s)

inputs

Range2

value

changes

£m

Financial assets at fair value through profit or loss

Loans and advances to customers

Discounted cash flows

Interest rate spreads (bps)

50 bps /
256 bps

11,264

541

(503)

Equity and venture capital investments

Market approach

Earnings multiple

1.1 /
14.6

1,886

(30)

Equity and venture capital investments

Underlying asset/net asset value (incl. property prices)³

n/a

961

124

(146)

Unlisted equities, debt securities and property partnerships in the life funds

Underlying asset/net asset value (incl. property prices)³

n/a

867

(44)

Other

14,987

Financial assets at fair value through other comprehensive income

345

(9)

Derivative financial assets

Interest rate derivatives

Option pricing model

Interest rate volatility

0% /
176%

884

(7)

884

Financial assets carried at fair value

16,216

Financial liabilities at fair value through profit or loss

Derivative financial liabilities

Interest rate derivatives

Option pricing model

Interest rate volatility

0% /
176%

1,467

—

Financial liabilities carried at fair value

1,514

Where the exposure to an unobservable input is managed on a net basis, only the net impact is shown in the table.

The range represents the highest and lowest inputs used in the level 3 valuations.

Underlying asset/net asset values represent fair value.

At 31 December 2019

Effect of reasonably

possible alternative

Significant

assumptions1

Valuation

unobservable

Carrying

Favourable

Unfavourable

technique(s)

inputs

Range2

value

changes

£m

Financial assets at fair value through profit or loss:

Loans and advances to customers

Discounted cash flows

Interest rate spreads (bps)

47bps / 108bps

10,912

401

(384)

Equity and venture capital investments

Market approach

Earnings multiple

1.5 /15.4

1,948

(89)

Underlying assets/net asset value (incl. property prices)³

935

(113)

Unlisted equities, debt securities and property partnerships in the life funds

Underlying asset/net asset value (incl. property prices, broker quotes or discounted cash flows)3

n/a

1,052

(41)

Other

(1)

14,908

Financial assets at fair value through other comprehensive income

408

Derivative financial assets:

Interest rate derivatives

Option pricing model

Interest rate volatility

14% / 115%

863

(6)

863

Financial assets carried at fair value

16,179

Financial liabilities at fair value through profit or loss

Derivative financial liabilities:

Interest rate derivatives

Option pricing model

Interest rate volatility

14% / 115%

1,367

—

1,367

Financial liabilities carried at fair value

1,415

Where the exposure to an unobservable input is managed on a net basis, only the net impact is shown in the table.

The range represents the highest and lowest inputs used in the level 3 valuations.

Underlying asset/net asset values represent fair value.

Unobservable inputs

Significant unobservable inputs affecting the valuation of debt securities, unlisted equity investments and derivatives are unchanged from those described in the Group’s 2019 financial statements.

Reasonably possible alternative assumptions

Valuation techniques applied to many of the Group’s level 3 instruments often involve the use of two or more inputs whose relationship is interdependent. The calculation of the effect of reasonably possible alternative assumptions included in the table above reflects such relationships and are unchanged from those described in note 50 to the Group’s 2019 financial statements.