Pestel Analysis of Hsbc

FINANCIAL SERVICES UK Banks: Performance Benchmarking Report Full Year Results 2012 kpmg. co. uk/banking Basis of preparation This report summarises the 2012 full year results of Barclays, HSBC, Lloyds Banking Group (Lloyds), Royal Bank of Scotland (RBS) and Standard Chartered1. Whilst progressively more information has been given in results announcements in recent years, not all statutory accounts or Pillar 3 reports have been published at the date of this report, and therefore analysis is constrained in certain respects.

Where total numbers are presented it is the total of the ? ve banks in the review. As an example, total assets is the sum of the total assets of the ? ve banks, expressed in sterling. Similarly, if an average number is presented, it is the average of the ? ve banks in the review. We have used simple headline numbers in our analysis unless stated otherwise; each bank has its own way of reporting performance and this has proved to be the most consistent method of presenting their results. HSBC and Standard Chartered present their results in US dollars ($).

These have been translated into sterling using the relevant period end or period average rate. Where percentage changes are presented for HSBC or Standard Chartered, these percentages are based on the dollar amounts disclosed by the banks, rather than on the sterling translation of those amounts. Note that any discussion of ’underlying’ results (or, in the case of Lloyds, of ‘management basis’) re? ects a number of adjustments to statutory ? gures, as determined by management. Underlying results will therefore not be comparable from bank to bank.

Management reporting in the bank results focuses on underlying ? gures. Adjustments commonly include: gains and losses losses on acquisitions and disposals of subsidiaries and businesses or fair value changes on own debt and jointly controlled entities within underlying non-interest income one-off items. 1. The ‘Focus on UK retail banking’ section also includes the results of Clydesdale Bank, Nationwide Building Society and Santander. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ?

rm of the KPMG , network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. All rights reserved. Contents Chapter 1 Chapter 2 Chapter 3 At a glance Summary Financial performance Pro? tability Bank cost cutting has barely scratched the surface Sector commentary Focus on UK retail banking Investment banking insights Investment banking – towards a new industry model Derivatives market shakeup starts to settle Restoring customer trust Real cultural change demands more than lip service Conduct counts Fighting ?

nancial crime comes at a cost IT security under new attack Financial position Balance sheet Non-core disposals gather pace Asset quality Capital adequacy Funding The future landscape 2013 Economic outlook: another disappointment or a sustained recovery? Banking outlook 1 2 4 4 15 17 17 22 27 29 31 31 33 35 37 39 39 43 45 49 51 53 53 55 Chapter 4 Chapter 5 Chapter 6 Chapter 7 © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved.

Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. 1 UK Banks: Performance Benchmarking Report | Full Year Results 2012 1. At a glance Barclays 2011 2012 20112 RBS 2012 Lloyds 2011 2012 HSBC1 2011 2012 Std. Chtrd. 1 2011 2012 Ranking By pro ts before tax By total assets By net assets Statutory pro t before tax (? million) Net interest margin (basis points) Cost to income ratio3 Impairment charge (? million) Return on equity4 Impaired loans to loans and advances to customers Impairment cover Total assets (?

million) Net assets (? million) Core Tier 1 ratio 2 2 3 3 2 3 4 3 2 5 3 2 5 4 4 4 4 4 1 1 1 1 1 1 3 5 5 2 5 5 5,879 246 (1,190) (5,165) (3,542) (570) 13,637 13,030 4,224 4,339 203 185 192 193 207 193 251 232 230 230 67. 0% 64. 0% 63. 0% 63. 0% 50. 3% 54. 8% 57. 5% 62. 8% 56. 5% 53. 8% 5,602 3,596 8,707 5,279 8,094 5,149 7,561 5,244 582 755 5. 8% (1. 9)% 10. 4% 9. 8% – – 10. 9% 8. 4% 12. 2% 12. 8% 4. 8% 4. 3% 8. 6% 9. 1% 10. 1% 8. 6% 4. 4% 3. 9% 1. 6% 2. 0% 49. 7% 52. 1% 48. 8% 51. 7% 46. 0%5 47. 0%5 42. 3% 41. 7% 59. 7% 53. 7% 1,563,527 1,490,321 1,506,867 1,312,295

970,546 924,552 1,653,460 1,665,335 387,598 393,686 65,196 62,957 76,053 70,448 46,594 44,684 107,462 113,265 26,770 28,485 11. 0% 10. 9% 10. 6% 10. 3% 10. 8% 12. 0% 10. 1% 12. 3% 11. 8% 11. 7% 1. HSBC’s and Standard Chartered’s numbers are reported in US dollars, converted to sterling so as to present the data in the same currency. The exchange rates used were obtained from www. oanda. com, using year-end rates, for balance sheet items and average rates for income statement items. 2. Restated ? gures. For an explanation see page 6 of RBS’ full announcement. 3.

Cost to income ratio as published in the ? nancial statements. 4. Lloyds did not report return on equity. RBS’ return on equity is for ‘Core’ only. 5. Lloyds disclose impairment coverage ratio excluding Retail unsecured loans in recoveries giving ? gures of 48. 2 percent for 2012 and 46. 9 percent for 2011. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom.

The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. UK Banks: Performance Benchmarking Report | Full Year Results 2012 2 2. Summary Reputational issues dominated 2012. Libor manipulation, interest rate swap mis-selling, escalating Payment Protection Insurance (PPI) provisions, and money laundering and sanctions-busting revelations have had a massive cumulative impact on public trust in the banking industry – as well as blowing a sizeable hole in the banks’ accounts. Yet aside from the resulting core charges, in a pure ?

nancial sense the banking sector fared relatively well. All the institutions covered in our report increased their core pro? ts for the year, as well as seeing marked share price gains. With banks adopting a more customer-centric focus, balance sheet restructurings well under way and the macroeconomic environment showing signs of recovery, in many ways banks have reached the ‘end of the middle’ with a rosier outlook ahead. There is a big ‘but’ though, in the shape of a tsunami of regulatory changes that are poised to strike. Pro? tability Statutory pro? t results across the industry were mixed.

The ? gures were impacted to varying degrees by huge one-off provisions for ? nes and customer redress, as well as accounting adjustments, most notably on the revaluation of own debt. This last item was caused by the credit markets’ more positive view on bank issues and interest rate movements. However, once these elements are stripped out, core performance has improved, due to: Better credit performance – impairment charges have continued to fall, while continued low interest rates are enabling the majority of people to pay their mortgages and even delever their credit exposures.

Stronger investment banking results – revenues are generally up, especially in rates businesses, helped in large part by more positive sentiment surrounding the future of the Eurozone. Against this improvement, margins are ? at or declining across the banking groups, which will remain a feature so long as interest rates are kept at their historic lows. A signi? cant amount of pro? t is earned overseas. John Hughes, UK Head of Banking Bill Michael, EMA Head of Financial Services Stronger balance sheets

Banks continued to make progress in strengthening their balance sheets as they prepare to meet looming regulatory obligations and better position themselves to withstand economic shocks. Wholesale funding is being progressively replaced by retail funding and, where wholesale funding remains, the tenors have been lengthened. Meanwhile, the delay in implementing the latest Capital Requirements Directive (CRD4) has left banks holding surplus liquidity. Banks also made strides during the year to bolster their capital positions. The actual impact of CRD4, once in force, depends on the ?

nal requirements and related technical standards, regulatory approvals and the bank’s further actions prior to implementation. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. 3 UK Banks: Performance Benchmarking Report | Full Year Results 2012

At Lloyds and RBS, the multiyear balance sheet management programmes aimed at slashing risk weighted assets, primarily through asset disposals, are nearing completion. Lloyds expect to reduce the non-core portfolio to ? 70 billion or less by the end of 2014, with more than half of this being retail. RBS is now four years into its ? ve-year recovery plan. The bank has announced that 2013 will be the last big year of restructuring and says it is much closer to reaching a state where the government can start selling its stake. Clouds on the horizon

In one sense, many of the fundamentals that have weighed on the industry and wider economic environment remain unchanged: for example, weakness in the European economies and the threat of budget sequestration (i. e. deep automatic government spending cuts) in the United States continue to pose a risk to the health of the global economy. Nevertheless, the outlook as we head through 2013 is brighter. Various uncertainties, not least concerns about the future of the Euro project and political succession in the United States and China, have been removed or tempered.

As a result, business sentiment – that intangible and yet all-important factor – is becoming more positive. As recent events in Cyprus have demonstrated, however, such sentiment is fragile. Once business con? dence returns, and with it demand for credit, banks have shown they are ready to lend, thus helping to fuel the UK’s economic recovery. Barclays, Lloyds and RBS reported that they participated in the Funding for Lending Scheme (FLS) that was launched in 2012 to boost lending to UK households and non-? nancial companies. We are also seeing the emergence of challenger banks, together with the disposal of branches by Lloyds and RBS.

Yet overshadowing the nascent banking and wider economic recovery hangs the spectre of regulatory overhaul. Certain aspects of regulatory change – such as the incoming Financial Conduct Authority’s focus on conduct across the whole market and strengthened powers to prevent the development and sale of inappropriate products or services – are both welcome and necessary in addressing conduct risk and behaviour failings, but will come at signi? cant cost. More worrying is the gathering storm of structural changes heading banks’ way such as ring-fence electri?

cation in the UK, the Liikanen proposals on mandatory trading separation, the Fed’s Intermediate Holding Company proposals, global derivatives market reform, CRD4, regulatory challenge on risk-weights and the EU’s plans for a ? nancial transaction tax and cap on bankers’ bonuses. These will continue to require considerable management time and effort. While many are necessary changes to right the wrongs of the past, more could be done to streamline them and make sure they are consistent, thereby increasing the time and resource available to the most important banking objective of all: driving economic growth.

© 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. UK Banks: Performance Benchmarking Report | Full Year Results 2012 4 3. Financial performance The statutory results are a mixed bag, and there has been a huge amount of

media attention on remuneration, PPI, Libor ? xing and interest rate swap (IRS) mis-selling. However, once we cut through the regulatory ? nes and costs of customer redress, and the paradox of booking losses when the market perceives a bank’s creditworthiness to be better, we actually ? nd an improved core ? nancial performance across all the banks. One source is not a surprise – an improved credit performance – as the problems from the 2008 crisis abate and the continued low interest rate environment supports affordability.

The other is from a less likely source – the banks’ investment banking arms – where revenues have been well in excess of 2011’s poor performance. Given the regulatory headwinds impacting investment banking, and the inevitable rise in interest rates in due course, how sustainable these positive features will prove to be is subject to debate. Mike Peck, Partner, Banking Audit In this chapter Pro? tability Bank cost cutting has barely scratched the surface 4 15 Pro? tability The key themes emerging are as follows: Net interest margins at best are ? at and fell at three of the ?

ve banks This, combined with shrinking balance sheets, meant that net interest income fell in absolute terms at four of the ? ve banks Improved investment banking results, predominantly in rates businesses Quite substantial Asset and Liability Management (ALM) gains, either through the sale of gilts or liability management exercises Non-interest income varied signi? cantly by bank, re? ecting their individual circumstances Signi? cant costs of regulatory ? nes and customer redress, amounting to ? 12. 1 billion in aggregate A signi? cant amount of pro?

t is earned overseas Banks have been able to control costs through targeted disposals or closures, reduced remuneration costs, and the re-engineering of systems and processes Signi? cant fair value losses on the revaluation of own debt Improved credit performance, with losses on loans reducing by ? 6. 9 billion or 25. 9 percent in aggregate. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity.

, All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. 5 UK Banks: Performance Benchmarking Report | Full Year Results 2012 Exceptional items and one-off adjustments The banks’ statutory results include a number of exceptional or unusual items that have had a signi? cant impact on the reported pro? ts but do not form part of the core results. In addition, each bank makes adjustments to arrive at its own underlying pro?

t measure and it can be challenging to achieve a consistent measure for purposes of comparisons. The table below shows adjustments of the statutory pro? t and loss for these items to derive a theoretical ‘core’ pro? t measure. This year, for the ? rst time, banks have linked ? nes or redress directly to remuneration but this has not been consistently applied, and the impact on reported remuneration and costs will be spread over a number of periods. As a result of this, and inconsistency between banks, we have not sought to strip out this effect from the core result?.

As in previous reports, we have treated sovereign debt impairment as part of the core result. Barclays ? billion RBS 2011 (0. 8) (0. 1) – Lloyds 2011 (3. 5) – – HSBC 2011 13. 6 (2. 3) – Std. Chtrd 2011 4. 2 – – 2011 5. 9 0. 1 1. 9 2012 0. 2 – (0. 2) 2012 (5. 2) (0. 1) – 2012 (0. 6) – – 2012 13. 0 (6. 0) – 2012 4. 3 – – Statutory pro t / (loss) before tax on continuing operations Impact from (pro ts) / losses on sale / acquisition of businesses (Gain) / loss on disposal and impairment on investment in BlackRock, Inc.

Other one-off items Impairment of associates Integration and restructuring costs Gain from gilt and bond sales (Gain) / loss on revaluation on own debt Pro t on debt buy back and extinguishments Government Asset Protection Scheme fee Volatility in insurance businesses Pension scheme adjustments Goodwill impairment and amortisation of intangible assets purchased upon acquisition UK Bank Levy Fines and customer redress PPI costs Provision for interest rate hedging products redress Fines and penalties from regulators ‘Core’ pro t / (loss) before tax and exceptional items – – – (2. 7) (1. 1) – – – 1. 0 0. 3 – – – 4. 6 – – – – 0. 4 0. 3 – 1.

1 (0. 5) (1. 9) (0. 3) 0. 9 – – 0. 2 0. 3 – 1. 6 (0. 9) 4. 6 (0. 5) – – – 0. 7 0. 2 – 1. 5 (0. 2) (0. 2) (1. 3) – 0. 8 – 0. 6 0. 2 – 1. 2 (3. 2) 0. 3 0. 2 – (0. 3) (0. 3) 0. 5 0. 2 – 0. 7 – (2. 5) – – – (0. 4) – 0. 4 – 0. 6 – 3. 3 – – – – – 0. 3 – – – – – – – – – 0. 1 0. 1 – – – (0. 1) – – – 0. 1 0. 1 1. 0 – – 6. 4 1. 6 0. 9 0. 3 8. 1 0. 9 – – (0. 2) 1. 1 0. 7 0. 4 2. 6 3. 2 – – 1. 1 3. 6 0. 4 – 2. 0 0. 6 – – 10. 1 1. 1 0. 4 1. 2 13. 9 – – – 4. 3 – – 0. 4 4. 9 1. Barclays does not disclose amounts relating to integration and restructuring costs, volatility in insurance businesses (only disclosed by Lloyds) and pension scheme adjustments.

2. HSBC’s and Standard Chartered’s numbers are reported in US dollars, converted to sterling so as to present the data in the same currency. The exchange rates used were obtained from www. oanda. com, using year-end rates, for balance sheet items and average rates for income statement items. 3 The ‘core’ pro? t measure is a theoretical pro? t measure that is calculated by adjusting statutory results for a number of exceptional or unusual items and does not refer to core/non-core business that some banks report on. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ?

rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. UK Banks: Performance Benchmarking Report | Full Year Results 2012 6 The notable positive message is that all ? ve banks delivered a core pro? t and also improved their year on year core results. These improving core results were to a large extent driven by decreases in loan impairment charges and the banks’ investment banking arms.

The total credit impairment charges on loans for Barclays, RBS, Lloyds and HSBC have fallen by ? 6. 9 billion, while only Standard Chartered has seen an increase. “ The notable positive message is that all ? ve banks delivered a core pro? t and also improved their year on year core results. Cost control has continued to be a priority. Compared to 2011, RBS, Lloyds and Barclays reported decreases in underlying operating costs of 5. 5, 5. 1 and 3. 3 percent respectively. The UK retail performance was mixed with generally declining interest  margins, ?

nes and customer redress partially offset by improved retail credit performance (except when commercial real estate has been included in the segment). In contrast to the improved core results, in terms of statutory results, HSBC, Barclays and Standard Chartered posted a pro? t, whereas RBS and Lloyds reported a loss. HSBC reported a 5. 6 percent ($1. 2 billion) reduction from 2011 in statutory pro? t before tax to $20. 6 billion. However, this included $5. 2 billion of adverse movements in the fair value of own debt compared with favourable movements of $3. 9 billion in 2011. This variance of $9.

1 billion was partially offset by $7 . 5 billion gains on sales of businesses, notably the disposal of non-strategic branches, the US Card and Retail Services business and their associate Ping An. Although reported results bear the burden of US regulatory ? nes and customer redress provisions in the UK, HSBC’s underlying pro? ts increased, mainly due to higher underlying revenues and lower loan impairment charges. Commercial Banking recorded revenue growth as customer loans and advances increased in all regions, with over half of this growth coming from the faster growing regions of Hong Kong, Rest of Asia Paci?

c and Latin America, driven by higher trade related lending. In addition, Global Banking and Markets results in Europe experienced a signi? cant turnaround following increased market con? dence about Eurozone recovery. Loan impairment charges in the US were signi? cantly lower re? ecting the continued reduction of portfolios in run-off. HSBC reported that Balance Sheet Management revenues rose by $324 million (on a constant currency basis), which includes gains on the disposal of available-forsale debt securities as part of structural interest rate risk management of the balance sheet, notably in Europe.

Standard Chartered’s statutory pro? t before tax increased by $101 million or 1. 5 percent. Hong Kong remained the largest pro? t generator, growing pro? t before tax by 7 . 0 percent, and pro? t before tax in Africa grew strongly, up 22. 8 percent. This helped offset lower pro? ts across a number of other geographies, with the Americas, UK and Europe in particular impacted by the settlements with the US authorities amounting to $667 million. Impairment losses and other credit risk provisions were up 34. 5 percent ($313 million). $140 million or 44.

7 percent of this increase came from the Wholesale Banking business and relates to a small number of large exposures in India and UAE. The remaining $173 million is attributable to Consumer Banking and relates to the seasoning impact of growth in the unsecured loan book coupled with pockets of localised stress. ” © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved.

Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. 7 UK Banks: Performance Benchmarking Report | Full Year Results 2012 In line with HSBC, Standard Chartered’s core pro? t growth was driven to a large extent by emerging market economies, notably Hong Kong. At Standard Chartered, Asia and the Middle East made up 86. 5 percent of operating pro? ts. At Barclays, exceptional items reduced pro? t before tax to ? 246 million compared to a ‘core’ pro? t of ? 8. 1 billion. A charge of ?

4. 6 billion relating to movements in the fair value of own debt reduced statutory pro? t before tax signi? cantly, especially when compared with favourable movements of ? 2. 7 billion in 2011. A ? 1. 6 billion provision for PPI redress and a ? 850 million provision for Interest Rate Hedging Products (IRHP) redress ate into pro? ts. The increase in core pro? t resulted mostly from an increase in the investment banking pro? t before tax of ? 1. 1 billion, driven by income growth of 13. 4 percent and reduced operating expenses due to lower employee incentive awards.

RBS has been impacted signi? cantly by exceptional items which have led to a ? 5. 2 billion operating loss before tax. This is, to a large extent, attributable to a ? 4. 6 billion charge for movements in the fair value of own debt due to improved creditworthiness (2011 saw a credit of ? 1. 9 billion). In addition, provisions have increased for strategic restructuring costs, PPI and IRHP redress costs and a penalty for Libor and Euribor ? xing misconduct. RBS’ core pro? t measure increased, partly because of investment banking’s contribution of ? 1. 5 billion operating pro?

t, an improvement of 67 percent. This was due to a 1. 5 percent . 9 income growth and a 19. 7 percent reduction in direct costs. RBS’ pro? t was positively impacted by gains on available-for-sale bond disposals amounting to ? 880 million, compared with ? 516 million in 2011, as active management of the liquid assets portfolio and favourable market conditions enabled the Group to crystallise gains. Lloyds’ statutory results were also dominated by exceptional items. PPI mis-selling redress, IRHP redress and restructuring costs meant that a statutory loss was reported. Despite a 12.

6 percent decrease in total underlying income net of insurance claims, underlying pro? t increased from ? 2. 0 billion to ? 2. 6 billion. This was the result of a 5. 1 percent reduction in costs and a 41. 8 percent reduction in the impairment charge to ? 5. 7 billion. The statutory pro? t includes a gain on asset sales of ? 2. 5 billion that primarily relates to ? 3. 2 billion gains from sales of centrally held government securities. Also included are losses from asset disposals of ? 1. 3 billion, principally relating to the run down of the non-core portfolios. The costs of its ‘Simpli?

cation’ programme and the retail business disposal costs mandated by the European Commission amounted together to ? 1. 2 billion. “ … factors that had an effect on the net interest margin for multiple banks include: the ongoing low interest rates notably in the UK and most Western economies, continued deleveraging of balance sheets, placements of greater portions of liquidity with central banks, reduction of wholesale funding and a highly competitive customer deposit market. Net interest margin The speci? c factors that in? uenced the net interest margin for each individual bank were different.

However, factors that had an effect on the net interest margin for multiple banks include: the ongoing low interest rates notably in the UK and most Western economies, continued deleveraging of balance sheets, placements of greater portions of liquidity with central banks, reduction of wholesale funding and a highly competitive customer deposit market. The overall impact of these factors resulted in the average net interest margin of the ? ve banks falling to 207 basis points (bps), which was 10 bps lower than the average of 217 bps in 2011. During 2012, three of the ?

ve banks (Barclays, Lloyds and HSBC) experienced a reduction in their net interest margin, whilst RBS and Standard Chartered both had stable net interest margins. ” © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International.

UK Banks: Performance Benchmarking Report | Full Year Results 2012 8 Net interest margin (bps) 300 250 200 150 100 50 0 A B C A B RBS C A B Lloyds C A B HSBC C A B C Barclays* A: 2010 B: 2011 C: 2012 Std. Chtrd *Barclays only provides margin information for RBB, Corporate Banking and Wealth and Investment Management. Source: KPMG LLP (UK) 2013 Barclays’ net interest margin is down 18 bps to 1. 85 percent. Its net interest income for the year reduced by ? 562 million to ? 11. 6 billion. Although customer interest income was relatively stable, non-customer interest income decreased signi?

cantly, re? ecting a reduction in the contribution from structural interest rate hedges to mitigate the impact of the low interest rate environment. RBS’ net interest margin remained stable at 1. 93 percent compared to 1. 92 percent in 2011. However, net interest income was down 7 . 0 percent, or ? 901 million, to ? 11. 4 billion. This was largely the result of a reduction in average interest-earning assets re? ecting strong progress in the run-down of non-core and targeted asset reductions in International Banking. Unsecured balances in UK Retail also declined.

RBS Retail and Commercial’s net interest margin fell by 5 bps mainly due to weaker deposit margins and lower asset yields. Lloyds’ net interest margin fell to 1. 93 percent from 2. 07 percent in 2011. Net interest income on a management basis was down 15. 4 percent to ? 10. 3 billion. This was largely due to lower asset balances as a result of further non-core asset reductions and continued low interest rates. The competitive deposit markets combined with higher wholesale funding costs also had a negative impact on net interest income. The average cost of new wholesale funding was higher than the matured funds it replaced.

For HSBC, net interest margin fell from 2. 51 percent to 2. 32 percent. This was attributable to signi? cantly lower yields on customer lending and on surplus liquidity, partly offset by a reduction in the cost of funds, notably on customer accounts. Disposals in 2012 led to a loss of interest income as well as a change in the composition of the lending book as higher yielding card balances were replaced by volume growth in relatively lower yielding products such as residential mortgages and term lending. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ?

rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. 9 UK Banks: Performance Benchmarking Report | Full Year Results 2012 “ Movements in underlying noninterest income varied signi? cantly by bank, re? ecting their individual circumstances. Barclays, RBS and Lloyds recorded a year on year decrease while HSBC and Standard Chartered reported increases.

Standard Chartered’s net interest margin remained constant at 2. 30 percent as asset margin pressure was offset by widening liability margins. Net interest income increased by 8. 4 percent and grew to $11. 0 billion. The increase in average interest earning assets was offset by the increase in average interest bearing liabilities. There was growth in several business areas – most notably in cards, personal loans, unsecured lending and current and savings accounts in Consumer Banking and trade and cash balances in Wholesale Banking. Non-interest income Movements in underlying non-interest income varied signi? cantly by bank, re?

ecting their individual circumstances. Barclays, RBS and Lloyds recorded a year on year decrease while HSBC and Standard Chartered reported increases. Although total adjusted non-interest income in the Investment Bank increased 21. 2 percent to ? 11. 1 billion, Barclays’ non-interest income was down 34. 5 percent to ? 13. 7 billion. The increase in the Investment Bank revenues was mainly driven by increases in ? xed income, currency and commodities, equities and prime services, and investment banking, particularly in the Americas. These increases were more than offset by fair value losses on own credit amounting to ?

4. 6 billion (2011: ? 2. 7 billion gain), lower net insurance income in the UK, lower commissions on Italian mortgage sales, lower European sales of investment products, and adverse currency movements in Africa. For RBS, non-interest income as reported on a management basis ? excluding insurance net premium income ? was down 3. 6 percent to ? 14. 1 billion. The largest drivers of this reduction were a decline in UK Retail fees as a result of weaker consumer spending volumes and lower rental income as a result of the disposal of RBS Aviation Capital. Despite the signi?

cant reduction in trading assets as a result of balance sheet management and optimisation, trading income in the Markets division was sustained. Lloyds’ underlying non-interest income was down 8. 3 percent to ? 8. 4 billion. The decrease was driven by lower expected returns in the insurance business and low customer con? dence affecting sales of insurance products. In addition, fee income in Asset Finance and International was lower, whilst managed reduction of the balance sheet also reduced fees and income. For HSBC, reported non-interest income decreased by 3. 0 percent to $30. 7 billion in 2012.

This was primarily due to adverse fair value movements on own debt attributable to credit spreads of $5. 2 billion, compared with favourable movements of $3. 9 billion in 2011. HSBC’s reported non-interest income was positively affected by gains amounting to $7 . 5 billion resulting from disposals including those of non-strategic branches, the US Card and Retail Services business and their associate Ping An. The increase in net trading income was more than offset by the decrease in net fee income. Net trading income increased mainly due to lower adverse fair value movements on non-qualifying hedges.

The reduction in net fee and commission income was mainly due to the sale of the Card and Retail Services business, which led to a reduction in cards and insurance fee income and fee expenses. In addition, broking income fell, most notably in Hong Kong and Europe, due to reduced transaction volumes re? ecting investor sentiment. ” © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom.

The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. UK Banks: Performance Benchmarking Report | Full Year Results 2012 10 Standard Chartered’s reported non-interest income increased to $8. 1 billion, which represented growth of 7 . 7 percent. Net fee and commission income grew by $577 million or 1. 9 percent as Standard Chartered increased participation in the Mortgage Purchase Program in Korea. Higher sales of bancassurance products also contributed positively to the increase. Net trading income increased by ? 103 million or 3.

9 percent as growth in Rates offset lower ? ow FX and Commodities income. Other operating income increased by $399 million, or 50. 3 percent, driven by higher operating lease rental income, increased realisations in the available-for-sale securities portfolio, a gain on the repurchase of subordinated debt and a gain on a property sale in Korea. Credit provisions Combined loan impairment charges of all the banks continued to decline this year, reducing 25. 9 percent to ? 19. 9 billion for 2012, compared to ? 26. 8 billion during 2011, which declined 22. 9 percent compared to 2010.

Lloyds continued to top the list with a decline of 36. 1 percent, followed by HSBC with 29. 1 percent. All banks reduced their impairment charges during 2012 compared to 2011, with the exception of Standard Chartered, which reported a marginal increase, albeit at far lower levels. The banks were able to decrease impairment charges by actively reducing higher risk portfolios, such as exposures in Spain, Greece and Ireland, and managing down non-core assets. The banks’ impairment charges also bene? ted from the low interest environment, facilitating customer affordability. Barclays’ loan impairment charge of ? 3.

6 billion was 6. 1 percent lower than in 2011. This reduction is mainly attributable to a decrease in retail impairment charges of ? 402 million to ? 2. 1 billion in 2012 with higher recoveries from PPI refunds in the UK and improved delinquency and recovery rates on Barclaycard. Wholesale loan impairment charges increased ? 171 million to ? 1. 5 billion compared to last year’s 41. 3 percent reduction, resulting from increased charges in positions in the Investment Bank partially offset by a decrease in Corporate Banking, principally in Spain where property and construction exposures are continuing to be reduced.

The increased impairment charges in the Investment Bank are mainly due to charges on ABS CDO Super Senior positions and losses on a small number of single name exposures. Additionally, there was a non-recurring release of ? 223 million in 2011. RBS reported a 26. 6 percent decrease in loan impairment charges of ? 5. 3 billion for 2012 compared to ? 7 . 2 billion in 2011, mainly due to a reduction in the non-core book charge of ? 1. 5 billion. Most of this reduction arose within Ulster Bank from planned run-off of assets in its commercial real estate portfolio. Additionally, in 2011, an impairment charge within the Core book of ?

1. 3 billion was recognised in respect of RBS’ holding of Greek sovereign bonds and related interest rate hedges; this was not repeated in 2012 as RBS reduced its exposure to Greek government debt, and values stabilised. Loan impairment charges at Lloyds were 36. 1 percent lower than 2011 at ? 5. 1 billion. The 2012 impairment charge bene? ted from a reduction in balance sheet exposure, alongside the low interest rate environment helping to maintain defaults at a lower level and broadly stable UK retail property prices, despite the weak commercial real estate market and weaker consumer con?

dence in a number of sectors. On a management basis, all divisions experienced impairment charge reductions of over 30 percent compared to 2011, including Wealth and International, which decreased 59 percent primarily driven by Commercial Real Estate and Corporate loans in Ireland. “ Combined loan impairment charges of all the banks continued to decline this year… ” © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved.

Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. 11 UK Banks: Performance Benchmarking Report | Full Year Results 2012 A 29. 1 percent decrease in loan impairment charges was reported by HSBC ($8. 2 billion). The effect of a fall in both collectively assessed allowances and credit risk provisions was partly offset by higher individually assessed impairment charges. The decrease in collectively assessed impairment allowances was primarily driven by North America where impairment losses decreased $3. 6 billion.

This was a result of lower US Consumer and Mortgage Lending balances due to continued run-off, lower delinquency rates and the sale of the Card and Retail Services business. In Europe, there were lower loan impairment charges in Retail Banking and Wealth Management as a result of focussed lending growth in higher quality assets and continued monitoring of customers facing ? nancial hardship. However, these decreases were partly offset by higher loan impairment charges and credit risk provisions in Latin America and higher individually assessed loan impairments on a small number of customers in Asia-Paci?

c. Net loan impairment charges (billion GBP) 12 10 8 6 4 2 0 A B C Barclays A B RBS C A B C Lloyds A B C HSBC A B C Std. Chtrd A: 2010 B: 2011 C: 2012 Source: KPMG LLP (UK) 2013 Loan impairment charges of $1. 2 billion were 34. 5 percent higher at Standard Chartered for the year ended 31 December 2012 compared to the prior year. Impairments in Consumer Banking increased due to a growth of the unsecured loan book coupled with some pockets of localised pressure. Wholesale Banking also experienced an increase which related to a small number of large exposures in India and UAE.

However, asset quality remained solid. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. UK Banks: Performance Benchmarking Report | Full Year Results 2012 12 Costs To improve returns, banks have continued to employ cost control measures in 2012.

Banks have been able to control costs through targeted disposals or closures, reduced remuneration costs and the re-engineering of systems and processes. Factors that had an upward effect on reported operating costs include in? ation and continued investments in strategic priorities. Two banks reported operating costs increases, whilst Barclays, RBS and Lloyds reported reduced underlying total operating costs. Cost to income ratio (percentage) 70 60 50 40 30 20 10 0 A B Barclays C A B RBS C A B Lloyds C A B HSBC C A B Std. Chtrd C

A: 2010 B: 2011 C: 2012 Items considered as costs in arriving at cost to income ratios are not consistent in all banks. Cost to income ratios are as reported by the respective banks. PPI, IRHP, fines and penalties, and bank levy are part of costs for HSBC, whereas for RBS and Lloyds these costs are not included in the table above. Barclays and Standard Chartered include fines and penalties, and Bank Levy. Source: KPMG LLP (UK) 2013 “ Cost to income ratios were to a large extent impacted by reported income ? gures. HSBC and Lloyds have seen a decline in their reported income ?

gures which contributed to the increase in their cost to income ratios. RBS has seen a slight decline in its reported income, but a similar reduction in operating costs has meant that its cost to income ratio has remained stable. Barclays and Standard Chartered have seen an increase in their reported income which has contributed to the improvement in their reported cost to income ratios. The banks have continued to employ cost reduction measures throughout the period with varying degrees of success. HSBC reports that the streamlining of various processes has resulted in achieving an additional $2.

0 billion in sustainable cost savings. This takes total annualised savings to $3. 6 billion, surpassing its cumulative target of annualised savings of $2. 5 to $3. 5 billion. However, operating expenses also increased due to in? ationary pressures, for example, on wages and salaries in Latin America and Asia. RBS reported operating expenses fell ? 859 million or 5. 5 percent in the period, broadly in line with income at 5. 6 percent, were largely driven by non-core run down, discontinued businesses in Markets and International Banking and the continuing bene?

ts from the cost reduction programme that was launched in 2009. Cumulative cost reduction programme savings amount to ? 3. 6 billion and are well ahead of the ? 1. 1 billion that was envisaged in the original plan. The banks have continued to employ cost reduction measures throughout the period with varying degrees of success. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom.

The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. ” 13 UK Banks: Performance Benchmarking Report | Full Year Results 2012 Lloyds saw a reduction in total reported costs of 5. 1 percent to ? 10. 1 billion. This was achieved through a number of cost cutting initiatives, including the consolidation of back of? ce operations, implementation of IT programmes, and outsourcing of property facilities and asset management services. Due to the progress made, Lloyds has revised its original operational cost target from ?

10 billion in 2014 to ? 9. 8 billion in 2013. Although recurring operating expenses increased by 3 percent, Standard Chartered has continued to manage expenses tightly despite in? ationary pressures. Whilst costs have increased compared with the prior period, these have increased proportionately less than the increase in income. Barclays’ European Retail and Business Banking division’s operating expenses decreased by ? 372 million to ? 839 million as a result of the nonrecurrence of restructuring charges and related ongoing cost savings. “ All banks reported lower levels of variable compensation.

” All banks reported lower levels of variable compensation. RBS noted that Markets reduced its staff expenses by 26. 0 percent, re? ecting lower headcounts and lower levels of variable compensation, including reductions and claw-backs following the Libor settlements. In addition, Barclays and Lloyds have seen staff costs decrease over the period due to a decline in staff numbers. HSBC has seen a decrease in staff costs, re? ecting the fall in average staff numbers as a result of organisational effectiveness initiatives and business disposals. HSBC’s variable pay pool decreased by 12.

6 percent compared to 2011. Lloyds reports that bonus awards are subject to deferral and adjustment, and that in 2012 total discretionary awards were approximately 3 percent lower than in 2011. Also, salary rewards have been limited, and frozen at more senior levels for the second year running, to re? ect the continuing challenging economic environment. Standard Chartered’s staff costs, excluding the non-recurring early retirement programme charge in Korea, have increased by 2 percent in line with staff numbers. Despite an increase in the charge for bonuses deferred from prior years to ? 1.

2 billion from ? 995 million in 2011, Barclays’ total incentive awards declined 16 percent for the group and 20 percent for the investment bank. Despite these cost pressures, HSBC, Lloyds, RBS and Standard Chartered made continued investments as part of their longer term strategies. HSBC reports that the increase in costs arose partly due to investment in strategic initiatives including certain business expansion projects, enhanced processes and technology capabilities and increased investment in regulatory and compliance infrastructure primarily in the US. Lloyds has re-invested a third of the Simpli?

cation programme savings to strengthen its core business. Standard Chartered has continued to invest in branches and increased investment in mobile and online technology in Consumer Banking and Transaction Banking in Wholesale Banking. There has been a signi? cant cost impact in 2012 in relation to a number of legacy practices such as the Payment Protection Insurance (PPI) redress and Interest Rate Hedging Products (IRHP) as well as ? nes from regulators. Fines mainly related to the setting of Libor and other rates, anti-money laundering and sanctions failings. Barclays increased its PPI redress provision by ?

1. 6 billion (2011: ? 1. 0 billion) and made a provision for IRHP products redress of ? 850 million. Barclays also paid ? 290 million of regulatory ? nes regarding its misconduct in relation to Libor and Euribor. HSBC’s underlying costs include payments of $1. 9 billion made as part of the settlement of the investigations into past inadequate compliance with antimoney laundering and sanction laws. Its additional provisions in respect of PPI and IRHP redress amount to $1. 7 billion and $598 million respectively. RBS’ numbers include PPI costs of ? 1. 1 billion, IRHP redress of ? 0.

7 billion, redress on the IT incident of ? 175 million and regulatory ? nes of ? 381 million relating to the setting of Libor and other rates. “ There has been a signi? cant cost impact in 2012 in relation to a number of legacy practices such as the Payment Protection Insurance (PPI) redress and Interest Rate Hedging Products (IRHP) as well as ? nes from regulators. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved.

Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. ” UK Banks: Performance Benchmarking Report | Full Year Results 2012 14 Lloyds increased its provision for PPI claims by ? 3. 6 billion and also made a ? 400 million provision for IRHPs. Standard Chartered Bank’s operating costs include the impact of the $667 million settlement with the US authorities regarding issues related to past compliance with US sanctions. “ Tax All ? ve banks’ effective tax rates were higher than the UK statutory rate of 24. 5 percent… All ?

ve banks’ effective tax rates were higher than the UK statutory rate of 24. 5 percent and Lloyds, HSBC and Standard Chartered saw increased tax charges. Factors that contributed to the increase in effective rate include the effect of non-deductible expenses such as regulatory ? nes and customer redress provisions, the impact of increased foreign taxes on pro? ts arising in overseas jurisdictions and a change in the UK corporation tax rate, adversely impacting deferred tax asset measurement. Barclays’ tax charge of ? 482 million on pro? ts before tax of ? 246 million resulted in an effective tax rate of 195.

9 percent. The high effective tax rate in 2012 is a result of the combination of losses in the UK, primarily relating to the own credit charge of ? 4. 6 billion and pro? ts in foreign jurisdictions that are taxed at higher rates. Despite a loss for the year, RBS incurred a tax charge of ? 469 million. This charge re? ects pro? ts in high tax regimes – principally the US – and losses in low tax regimes – principally Ireland. It also includes losses in overseas subsidiaries for which no deferred tax asset was recognised – principally Ireland – and reductions in the carrying value of deferred tax assets.

Lloyds incurred a tax charge of ? 773 million on a loss of ? 570 million. This charge is primarily due to a policyholder tax charge of ? 583 million arising from the revaluation of policyholder tax credits and recent changes to the taxation of life insurance companies. Additionally, ? 308 million of the tax charge resulted from the impact of the announced reduction in UK corporation tax rate to 23 percent on the net deferred tax asset. HSBC’s tax charge of $5. 3 billion in 2012 resulted in an effective tax rate of 25. 7 percent compared with 18. 0 percent in the previous year.

The 2012 tax charge re? ected the non-tax deductible effect of ? nes and penalties together with the non-recognition of the tax bene? t in respect of the accounting charge associated with negative fair value movements on own debt. The 2011 charge included the bene? t of US deferred tax recognised in respect of foreign tax credits. For Standard Chartered, the tax charge increased marginally in 2012, resulting in a higher effective tax rate that was up 0. 3 percent to 27 . 5 percent, primarily due to a change in pro? t mix offset by an increase in non-deductible expenses. ”

© 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. 15 UK Banks: Performance Benchmarking Report | Full Year Results 2012 Bank cost cutting has barely scratched the surface Consensus within the industry is that bank cost bases need to come down signi? cantly from their pre-credit crunch peak.

Yet there is still a long way to go. Around the world, many banks have announced plans to reduce costs by between 9 percent and 12 percent on average, but to date many have only taken out between 4 percent and 6 percent?. As shown on page 12, the cost income ratios are further impacted as total income is falling in some cases. “ Adrian Harkin, Partner Financial Services Management Consulting After ? ve years of post-crisis austerity, there is also a real need to galvanise programmes by focusing on the positives, such as how cost optimisation can drive improvements in customer experience and staff engagement.

” Banks should be seeking to view their expenses in a fresh way. Instead of focusing on cost centres and functional cost lines, it is important to look across the organisation and understand their overheads per customer or per employee, and whether their IT, HR, risk costs, etc. are high or low on a benchmarked basis … and why. 2. Buy in Unless there is a conversation about how the cost optimisation programme is set up, and the journey to achieve it is made aspirational, it will be dif? cult to succeed. The people within the organisation who own the costs usually are not the ones running the cost programmes.

Therefore, it is important to engage in enterprise-wide discussions to get buy-in from the relevant stakeholders on the bank’s cost optimisation objectives, the type of journey it plans to undertake and the limitations of different approaches – whether it is centralised or decentralised, strategic or tactical, top down or bottom up. After ? ve years of post-crisis austerity, there is also a real need to galvanise programmes by focusing on the positives, such as how cost optimisation can drive improvements in customer experience and staff engagement. Execution dif? culties

Part of the reason banks are falling short of their cost cutting goals – let alone taking out what is actually needed – is that the programmes are dif? cult to execute, requiring tough decisions to be made over extended timeframes of three years or so. As a result, many banks have tended to target ‘low-hanging fruit’ – such as functional restructurings, procurement and the targeting of discretionary spend – in the hope that the market changes and revenues grow. However, for many banks the ‘low-hanging fruit’ has now been picked, while the need to slash costs remains.

Keys to cost-cutting success There are four crucial elements banks should have in place if they are to achieve the degree of cost optimisation so desperately needed: 1. Cost transparency It is essential banks properly understand their costs and cost drivers, something that seems to have been lacking traditionally. A large percentage is typically recharged costs (e. g. IT and Head Of? ce). In addition, it is dif? cult to secure a ‘clean’ baseline of expenditure. It will be dif? cult to tackle ongoing costs without getting real transparency in these areas.

1. KPMG Analysis July 2012. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. UK Banks: Performance Benchmarking Report | Full Year Results 2012 16 3.

Deep dive Common cost-cutting levers many banks identify include operating model change, lean process transformation and automation, workforce pay changes, property consolidation and sourcing changes. However, not every organisation knows how to pull those levers effectively. To take costs out, it is vital banks dig down to a micro level across all parts of the group to lay bare the operations environment and operating model, to understand what staff are actually doing and how they are working. The desire to achieve quick results cheaply means many banks often fail to go into this level of detail.

4. Discipline Cost optimisation programmes must be underpinned by real discipline if they are to effect a cultural transformation in the way costs are viewed and managed. Banks need clear cost base lines, transparency around performance, and strong governance frameworks so that everyone understands what returns they get for what level of spend. Without implementation of a cost conscious culture, the programme is unlikely to be both successful and sustainable. Bold action Many banks have been talking about eliminating costs for years, but with mixed success.

Much of the focus to date has been on persistent trimming, an approach that ultimately takes a toll on institutional energy and morale. Instead, now is the time to be bold, to galvanise the organisation with a ? nal push. Cost optimisation is not about big ideas. It is about effective set up and execution. By managing the operation in a structured, systematic way, by removing errors and redundant processes, and engaging staff, it can be aspirational too – resulting in happy customers, happy staff and an industry-leading cost income ratio. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ?

rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. 17 UK Banks: Performance Benchmarking Report | Full Year Results 2012 4. Sector commentary In this chapter Focus on UK retail banking Investment banking insights Investment banking – towards a new industry model Derivatives market shakeup starts to settle 17 22 27 29

Mike Peck, Partner, UK Banking Audit Focus on UK retail banking With the persistent subdued economic environment the recent results of the major participants? in the UK retail banking market continue to highlight the ongoing challenges of operating in a low interest rate environment. Additionally, the regulatory ‘cost’ of operating in the UK marketplace remains apparent with redress for past conduct issues continuing to dominate the bottom line, and a drag on interest margin as required liquidity levels are maintained and stable retail deposits chased in the marketplace.

The key themes are consistent with those observed during previous reporting periods: Contraction at interest margin level re? ecting deposit margin compression offset by widening asset margins on new business Continued signi? cant decline in overall impairment charges as customers pay down debt – particularly unsecured balances – offset by higher commercial real estate impairment (where commercial real estate is classi? ed within this segment) Signi? cant costs for customer redress associated with past sales of Payment Protection Insurance (PPI).

The consensus outlook for a prolonged low interest rate environment, combined with the spectre of increased focus on conduct matters under the supervision of the Financial Conduct Authority from 1 April 2013, represent signi? cant ongoing challenges for participants in the UK retail banking marketplace. Against this backdrop, the focus remains on driving deeper customer relationships, lower risk premium business and operational ef? ciency to capture competitive advantage. Richard Gabbertas, Partner, Financial Services 1. Standard Chartered does not have signi? cant UK presence and is therefore excluded from the analysis.

© 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. UK Banks: Performance Benchmarking Report | Full Year Results 2012 18 Composition of UK retail banking Retail banking activities are de? ned differently by the various entities concerned, complicating attempts at direct comparisons between the businesses.

However, when referring to UK retail banking, we use the following classi? cations for the purpose of our analysis: Barclays: UK Retail and Business Banking (excludes Barclaycard) HSBC: UK Retail Banking (HSBC Bank plc) RBS: UK Retail Lloyds: Retail Nationwide Building Society2 (Nationwide) National Australia Bank (NAB): Clydesdale Bank Plc3 consolidated accounts Santander: Santander UK plc4 Overall trends The full year results have again been dominated by the scale of the charges taken for customer remediation for the potential mis-selling of PPI – Barclays ? 1. 6 billion (?

1. 2 billion within UK Retail and Business Banking); HSBC ? 938 million; RBS ? 1. 1 billion; Lloyds ? 3. 6 billion; NAB ? 120 million; Nationwide ? 133 million. Only Santander UK bucks this trend with no current year charge for PPI redress (2011: ? 751 million). Our analysis of UK retail performance below excludes the one-off distortions caused by the magnitude of these charges in respect of PPI. Whilst compression in interest margins is a recurrent theme across the marketplace, Nationwide bucks this trend having increased its net interest margin from 2011 levels.

The pressure on margins is being driven by the competitive nature of the retail deposit marketplace where increasing rates can be a necessity to preserve existing retail funding and attract new balances. Total customer deposits grew by ? 37 . 2 billion. 2. Half year results for the 6 months to 30 September 2012 combined with computed half year results to 4 April 2012. 3. Annual results for the year ended 30 September 2012. 4. Quarterly Management Statement for the year ended 31 December 2012. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ?

rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. 19 UK Banks: Performance Benchmarking Report | Full Year Results 2012 UK retail banking performance – profit before tax pre charges for PPI (million GBP) 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 -500 A B C Barclays A B C RBS A B C Lloyds A B C HSBC A B C Nationwide* A B C NAB A B C Santander

A: 2010 B: 2011 C: 2012 *Nationwide profit before tax is based on underlying profit which excludes costs in respect of the Bank Levy, FSCS, certain restructuring costs and fair value movements on derivatives and hedge accounting. “ Source: KPMG LLP (UK) 2013 The paydown of unsecured portfolios, as people continue to reduce their personal indebtedness in the low interest rate environment, and lower levels of delinquencies has driven the favourable unsecured impairment charges experienced in the year. The total impairment charge of ? 5. 0 billion reported by the participants was ? 0. 3 billion (5. 8 percent) lower than the 2011 equivalent.

Asset mix continues to be a key driver of impairment charges with signi? cant reductions in unsecured impairment experienced by both Lloyds (40. 7 percent) and RBS (27 percent) . 9 during 2012. The paydown of unsecured portfolios, as people continue to reduce their personal indebtedness in the low interest rate environment, and lower levels of delinquencies, have driven the favourable unsecured impairment charges experienced in the year. This has been mirrored in secured impairment charges where modest house price increases and a more optimistic house price outlook combined with stable arrears levels saw a reduction.

Individual banks’ roundup Lloyds once again maintains its position as the largest of the retail banks in terms of pro? t for the year (? 3,670 million), broadly ? at on the previous year. Net interest income decreased by 4. 0 percent (? 302 million), due to a combination of themes from previous periods being overall muted demand for credit, the impact of portfolio de-risking and higher funding costs. Interest margin was stable at 2. 08 percent against a backdrop of growth in customer deposits (excluding repos) of ? 13. 7 billion (5. 5 percent) to ? 260. 8 billion.

Lloyds did bene? t from a further decline in the impairment charge for the period with a reduction of ? 700 million (35. 5 percent). This reduction was driven by a ? 614 million decline in the unsecured charge and a ? 86 million reduction in the secured impairment charge to ? 377 million. This re? ects a combination of a sustainable approach to risk, focus on lending to existing customers plus the bene? t of the low interest rate environment. Fair value unwinds continue to play a role in boosting Lloyds pro? ts with a contribution of ? 482 million (2011: ?

839 million), although this impact is expected to continue its downward trend in future years. ” © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. UK Banks: Performance Benchmarking Report | Full Year Results 2012 20 RBS experienced a slight decrease in pro? t of ?

130 million (6. 4 percent) to ? 1,891 million. Net interest income was down 7 . 3 percent, with a decline in net interest margin of 37 bps. This re? ected weaker deposit margins and reductions in higher yielding unsecured balances partly offset by mortgage growth. Customer deposits grew by ? 1. 7 billion (5. 6 percent) to ? 107 . 6 billion. Impairment losses fell 32. 9 percent (? 259 million) during 2012, a result of signi? cant reductions in both the unsecured impairment charge (27 percent) to ? 437 million, and the secured . 9 impairment charge (49. 5 percent) to ? 92 million. RBS also bene?

ted from a reduction in costs as a result of simpli? cation of processes and lower headcount with operating costs decreasing by 5. 6 percent to ? 2,549 million. HSBC saw a decline in pro? ts of 15. 1 percent to ? 1,744 million5; however, 2011 pro? ts included a ? 292 million accounting gain arising from legislative changes to the measurement of de? ned bene? t pension obligations. HSBC was one of the few banks to show a growth in net interest income, with a 3. 8 percent increase to ? 3,738 million. Like the other banks, HSBC experienced further reductions in the loan impairment charge of 18.

2 percent to ? 651 million. This was driven by lower levels of delinquencies across both the unsecured and secured portfolios arising from a continued focus on improving collections performance and the quality of new business written in recent years. Barclays saw a growth in earnings of ? 52 million (3. 7 percent) to ? 1,472 million with the increase again driven by impairment reductions offset by a fall in net interest income. A 14 bps decrease in net interest margin to 1. 37 percent contributed to a ? 186 million reduction in net interest income. Impairment charges showed a signi?

cant decline of 49. 8 percent to ? 269 million re? ecting improvements across all portfolios, but principally in unsecured lending. Operating expenses, excluding the PPI provision, were broadly ? at at ? 2,684 million. On an underlying basis, Nationwide’s results showed an increase of 20. 4 percent to ? 407 million (adjusted for PPI). The impairment charge was ? 504 million, an increase of ? 180 million (55. 6 percent). This was driven by conditions in the commercial property sector and an increase in the consumer ? nance charge re? ecting the change in size and maturity of the book.

Net interest income at ? 1,755 million was ? 200 million higher as the interest margin increased by 12 bps to 93 bps. This re? ects the continued margin growth in core trading with strong new business asset margins, the positive impact of repricing at deal maturity, as customers either revert to Base or Standard Mortgage Rate or opt to take a new mortgage product, along with growth in the personal and consumer portfolios. 5. The 2011 comparative ? gure used for HSBC is pre the charge of ? 507 million for total customer redress as the charge for PPI was not separately disclosed for 2011.

© 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. 21 UK Banks: Performance Benchmarking Report | Full Year Results 2012 NAB experienced a decline in earnings during the period reporting a loss of ? 494 million (2011: ? 137 million pro? t).

This was the result of a substantial increase in impairment provisions for commercial real estate exposures, the majority of which were subsequently transferred to the parent. In addition, increased funding costs, following the credit rating downgrade in December 2011, had an adverse impact on margin. Net interest income fell 11. 6 percent to ? 869 million with the interest margin falling by 30 bps to 2. 07 percent. This re? ected lower margin money market and retail deposits being replaced by more expensive longer term wholesale funding and retail term deposits. Average retail deposit balances increased by ?

1. 2 billion as a result of NAB’s campaign to attract term deposits. Impairment losses were up ? 440 million to ? 737 million driven by business lending losses as a result of prolonged market and economic uncertainty, particularly in the commercial real estate market. These losses were partly offset by continued improvement in unsecured delinquencies and a reduction in mortgage losses. Operating costs were 19. 2 percent (? 141 million) higher at ? 874 million, although this included ? 149 million of restructuring costs; excluding these, there was a slight reduction in costs.

Santander UK experienced a decline in earnings (38. 8 percent) to ? 1,231 million. This was driven by a 23. 9 percent decline in net interest income to ? 2,915 million, re? ecting a reduction in margin of 44 bps to 1. 44 percent with structural market conditions and increased customer deposit funding costs contributing to this decline. Retail customer deposits increased by 4. 8 percent to ? 127 billion. Impairment losses increased by ? 444 million (78. 6 percent), largely in? uenced by a ? 335 million charge for non-core and legacy portfolios combined with what is described as a prudent view on the economic outlook.

Operating costs were 9. 0 percent lower than 2011 at ? 2,222 million, re? ecting the impairment of intangible assets in 2011 which has not been repeated in 2012. “ Outlook The regulatory and legislative landscape for ? nancial services in the UK continues to evolve at a pace and there seems no end in sight to this trend. Conduct risk matters have dominated the results of the UK retail participants for the past few reporting periods and could well continue to do so. The Financial Policy Committee warned in November 2012 that the growing scale and scope of conduct issues faced by banks could lead to

considerable costs in the future and that a realistic assessment of future conduct redress was needed. With the reorganisation of the regulatory bodies, there are multiple concurrent areas of focus in both conduct and prudential risk which bring with them stringent and costly regulatory and supervisory requirements. Against this backdrop, the subdued economic outlook looks set to continue where real term incomes are likely to continue to be squeezed by in? ationary pressures and, with interest rates expected to remain low, the pressure will remain on interest margin and the ability to drive bottom line growth.

The focus is clearly turning to driving deeper customer relationships which is intrinsically linked to restoring the public’s perception of the wider ? nancial services industry. The regulatory and legislative landscape for ? nancial services in the UK continues to evolve at a pace and there seems no end in sight to this trend. ” © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom.

The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. UK Banks: Performance Benchmarking Report | Full Year Results 2012 22 Investment banking insights Investment banks enjoyed improved performance across the board in 2012. Decisive European Central Bank intervention was a major factor in containing fears about the Eurozone, which had weighed so heavily on the previous year’s results. Nevertheless, fundamental challenges – not least unresolved Eurozone frictions and regulatory-mandated structural reforms – will continue to test investment banks’ pro?

tability prospects. Zaffar Khakoo, Director, Banking Audit De? ning investment banking Investment banking activities are de? ned differently by the various entities concerned, complicating attempts at direct comparisons. When referring to investment banking, we use the following classi? cations: Barclays: ‘Investment Bank’ as given in the ? nancial statements HSBC: Global Markets (disclosed as part of GB&M), Balance Sheet Management (BSM), Principal Investments and the Debit Valuation Adjustment (DVA).

This is attributed separately for HSBC’s results, rather than incorporated into product-lines RBS: Markets division Standard Chartered: Global Markets business line within the Wholesale bank. The incorporation of Lloyds’ investment banking results to other business lines means we have not included its results in our analysis. Lloyds’ investment banking operations do not form a signi? cant part of their overall results. The commentary in relation to expenses is at a divisional level at each bank, as it is not always possible to analyse expenses on a basis consistent with the de? nition above. Revenue of investment banking is de?

ned as ‘operating income’ for HSBC and Standard Chartered, ‘income’ for RBS, and ‘total income’ for Barclays. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. 23 UK Banks: Performance Benchmarking Report | Full Year Results 2012 “ Increased revenues at all banks was somewhat of a surprise.

Changing fortunes As the chart below shows, investment banking revenues in 2012 were up on the previous year. While the ? gures remain below the strong performance seen in 2009 and 2010 (with the exception of Standard Chartered), the results are encouraging. Investment banking revenue (billion GBP) 15 ” 12 9 6 3 0 A B C Barclays A B RBS C A B HSBC C A B C Std. Chtrd A: 2010 B: 2011 C: 2012 Source: KPMG LLP (UK) 2013 Barclays Total investment banking revenue grew from ? 10. 3 billion in 2011 to ? 11. 7 billion. With the exception of Principal Investments, all business lines posted higher income, with return on average equity jumping from 10.

4 percent to 13. 7 percent. Fixed Income, Currency and Commodities (FICC) was the main income driver, rising 17 . 0 percent to ? 7 . 4 billion on the back of increased liquidity and higher volumes, particularly in the rates world. Equities and Prime Services income also increased (13. 7 percent) thanks to higher market share despite overall subdued market volumes. “ While the ? gures remain below the strong performance seen in 2009 and 2010, the results are encouraging. ” HSBC Investment banking revenue grew from $11. 8 billion to $13. 1 billion. In 2012, HSBC booked a DVA for the ? rst time.

This is an adjustment to the valuation of Over the Counter (OTC) derivative contracts to re? ect within fair value the institution’s own credit risk. DVA generated a credit of $0. 5 billion, though this was more than offset by the charge resulting from changes to the Credit Valuation Adjustment (CVA) estimation methodology, which resulted in a charge of $0. 9 billion. Rates (up 32. 1 percent) and Credit (up 132. 5 percent) drove the increase at a product level, accounting for $2. 6 billion of total income, despite adverse fair value movements from own credit spreads on structured liabilities and the additional CVA charge as described above.

Tightening spreads and improved investor sentiment – helped by central bank stimuli – were key to the improvement. © 2013 KPMG LLP a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member ? rm of the KPMG network of independent member ? rms af? liated with KPMG International Cooperative, a Swiss entity. , All rights reserved. Printed in the United Kingdom. The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPM G International. UK Banks: Performance Benchmarking Report | Full Year Results 2012 24

Foreign Exchange (FX), the single largest contributor to Global Markets revenues at $3. 2 billion, was broadly ? at, while Equities revenue fell 29. 3 percent due to lower client appetite and volumes. Balance Sheet Management generated $3. 7 billion, a 7 . 2 percent increase, mainly due to disposals of available for sale debt securities. However, net interest income on the desk’s holdings declined, as higher yielding assets matured and proceeds were reinvested in a depressed interest rate environment. RBS Investment banking revenue totalled ? 4. 5 billion, up from ? 4. 4 billion the previous year1.

Gains mostly came from Rates products, which grew 36. 1 percent to ? 2. 0 billion. Performance was helped by having no repeat of the losses incurred in 2011 in managing CVA exposure. FX suffered from weak currencies volumes, whilst Credit Markets bene? ted from improved credit ? ow pro? tability offset by weaker earnings in credit origination. Asset Backed Products posted gains following investors search for yield. Standard Chartered Global Markets income of $7 . 2 billion was up from $6. 8 billion in 2011. Corporate Finance was the biggest contributor, generating $2. 2 billion (a 18.

6 percent rise) on the back of increased client demand, notably in Structured Trade Finance. Financial Markets activity, which fell slightly on 2011, accounted for roughly half the Global Markets income. Improved Rates and Credit income offset lower FX ? ow business. Common themes Income improvement Across the board, the selected banks posted income increases. Higher revenue was largely driven by Rates businesses, and to some extent Credit. While the gains were offset in part by reduced FX and Equities volumes, the impact of market-wide reductions was not uniform, with Barclays bene? ting from an increase in equities’ market share. “