Annual Financial Report - 29 of 48

Liquidity and funding

Liquidity risk is the risk that the Group does not have sufficient financial resources to meet its obligations as they fall due, or will have to do so at an excessive cost. The risk arises from mismatches in the timing of cash flows.

There were no material changes to our policies and practices for the management of liquidity and funding risks in 2012.

Liquidity and funding in 2012

(Unaudited)

The liquidity position of the Group strengthened in 2012, and we continued to enjoy strong inflows of customer deposits and maintained good access to wholesale markets. During 2012, customer accounts grew by 7% (US$86bn) while loans and advances to customers increased by 6% (US$57bn), leading to a small decrease in our advances to deposits ratio to 74% (2011: 75%).

HSBC UK (see footnote 40 on page 249) recorded an increase in its advances to core funding ratio to 106% at 31 December 2012 (2011: 100%). During 2012, HSBC UK continued to fund the majority of its growth in advances with growth in core deposits and remained within its advances to core funding limit.

The Hongkong and Shanghai Banking Corporation (see footnote 41 on page 249)

recorded a decrease in its advances to core funding ratio to 73% at 31 December 2012 (2011: 75%), mainly as a result of its core deposits increasing more than advances.

The completion of the sale of the US cards business and branch network during 2012 improved the liquidity and funding position of both HSBC Finance and HSBC USA (see footnote 42 on page 249), the latter recording a decrease in its advances to core funding ratio to 78% as at 31 December 2012 (2011: 86%).

Customer deposit markets

Customer accounts increased by 7% year on year. After excluding repo balances, the year-on-year increase was 7%.

Retail Banking and Wealth Management

We continued to grow our RBWM customer accounts, which increased by 6%, by providing differentiated products and services to different segments. The growth in retail deposits benefited from the wider macroeconomic trend of expanded money supply, customer deleveraging and weak loan growth, which partially offset the competitive pressure in some of our key markets for retail deposits and savers' reluctance to place funds into low-rate deposits.

Global Private Banking

As economic conditions remained subdued and interest rates continued to fall, part of the GPB customer base realigned its risk appetite and made use of the wide range of products available, with some asset reallocation to higher yielding off-balance sheet products including equities, funds and bonds. As a result, customer accounts decreased by 5% year on year.

Commercial Banking

Customer accounts increased by 11% year on year, with the majority of this increase resulting from increases in Payments and Cash Management accounts. The growth in these customer accounts and the strong growth in payment volumes demonstrated a funding source that is correlated to the operational services that HSBC provides to the CMB customer base.

Global Banking and Markets

Customer accounts increased by 8% year on year. After excluding repo balances with customers, GB&M deposits increased by 10% year on year, with the majority of this rise resulting from increases in Payments and Cash Management accounts. The growth in these customer accounts and the strong growth in payment volumes demonstrated a funding source that is strongly linked to the operational

services that HSBC provides to the GB&M customer base.

Wholesale funding markets

Wholesale funding markets gradually improved during 2012, although the volume of term debt issued by banks was low by recent standards, influenced to a significant extent by reduced bank funding requirements. Globally, market conditions across public wholesale funding markets were predominantly driven by sovereign-related and more general events in the eurozone.

HSBC continued to have good access to debt capital markets throughout 2012 with Group entities issuing US$10.5bn of public transactions of which US$9.8bn was senior unsecured debt.

In January 2013 the Group repaid €5bn (US$6.6bn) of funding raised through the ECB's Long Term Repo Operations ('LTRO'), leaving only €473m (US$624m) outstanding.

Management of liquidity and funding risk

(Audited)

Our liquidity and funding risk management framework ('LFRF') employs two key measures to define, monitor and control the liquidity and funding risk of each of our operating entities. The advances to core funding ratio is used to monitor the structural long-term funding position, and the stressed coverage ratio, incorporating Group-defined stress scenarios, is used to monitor the resilience to severe liquidity stresses.

The three principal entities listed in the tables below represented 62% (2011: 61%) of the Group's customer accounts (excluding repos). Including other principal entities, the percentage was 94% (2011: 96%).

Advances to core funding ratio

The table below shows the extent to which loans and advances to customers in our principal banking entities were financed by reliable and stable sources of funding.

Advances to core funding limits set for operating entities at 31 December 2012 ranged between 70% and 115%, except for one operating entity reported within the total of HSBC's other principal entities which operated with a limit of 125% during 2012. This limit has been reduced to 115% for 2013.

Advances to core funding ratios39

(Audited)

For footnotes, see page 249.

Stressed coverage ratios

The stressed coverage ratios tabulated below express stressed cash inflows as a percentage of stressed cash outflows over both one-month and three-month time horizons. Operating entities are required to maintain a ratio of 100% or greater out to three months.

Inflows included in the numerator of the stressed coverage ratio are those that are assumed to be generated from liquid assets net of assumed haircuts, and cash inflows related to assets contractually maturing within the time period.

In general, customer advances are assumed to be renewed and as a result do not generate a cash inflow.

Stressed one-month and three-month coverage ratios39

(Audited)

For footnotes, see page 249.

The stressed coverage ratios for HSBC UK remained broadly unchanged.

The stressed coverage ratios for The Hongkong and Shanghai Banking Corporation improved as the increase in core deposits exceeded the increase in loans and advances to customers. The resulting surplus was deployed in liquid assets, thereby improving the stressed coverage ratios.

The stressed coverage ratios for HSBC USA improved as a result of the net effect of selling the US Card and Retail Services business and non-strategic branches during 2012, which resulted in a reduction in core deposits that was lower than the reduction in loans and advances to customers. The resulting surplus was deployed in liquid assets, thereby improving the stressed coverage ratios.

The three-month stressed coverage ratio for the total of HSBC's other principal entities remained broadly unchanged. The one-month stressed coverage ratio improved as a result of an increase in contractual maturities between one month and three months.

Liquid assets of HSBC's principal operating entities

The table below shows the estimated liquidity value (before assumed haircuts) of assets categorised as liquid used for the purposes of calculating the three-month stressed coverage ratios, as defined under the LFRF.

Any unencumbered asset held as a consequence of a reverse repo transaction with a residual contractual maturity within the stressed coverage ratio time period and unsecured interbank loans maturing within three months are not included in liquid assets, as these assets are reflected as contractual cash inflows.

Liquid assets are held and managed on a standalone operating entity basis. Most of the liquid assets shown are held directly by each operating entity's Balance Sheet Management function, primarily for the purpose of managing liquidity risk, in line with the LFRF.

Liquid assets also include any unencumbered liquid assets held outside Balance Sheet Management for any other purpose. The LFRF gives ultimate control of all unencumbered assets and sources of liquidity to Balance Sheet Management.

Liquid assets of HSBC's principal entities

For footnotes, see page 249.

Our liquid asset policy was refined at 1 January 2012 to apply a more granular classification of liquid assets, as described in the Appendix to Risk on page 261. Under the previous framework, liquid assets were classified into two categories: central government, central bank and US agency MBS exposures; and all other non-government exposures. Central government, central bank and US agency MBS exposures qualify as Level 1 or Level 2 under the new policy and are shown as such in the comparatives.

All assets held within the liquid asset portfolio are unencumbered.

Liquid assets held by HSBC UK increased as a result of a rise in customer accounts, which led to an increase in the level of non-core deposits and, consequently, liquid assets.

Liquid assets held by The Hongkong and Shanghai Banking Corporation also rose as a result of an increase in customer accounts. As the growth in core deposits exceeded the increases in loans and advances to customers, the difference was deployed into liquid assets and the level of liquid assets held grew accordingly.

Liquid assets held by HSBC USA decreased as a result of the sale of the US Card and Retail Services business and non‑strategic branches during 2012.

Net contractual cash flows

The following table quantifies the contractual cash flows from interbank and intergroup loans and deposits, and reverse repo, repo (including intergroup transactions) and short positions for the principal entities shown. These contractual cash inflows and outflows are reflected gross in the numerator and denominator, respectively, of the one and three-month stressed coverage ratios and should be considered alongside the level of liquid assets.

Outflows included in the denominator of the stressed coverage ratios include the principal outflows associated with the contractual maturity of wholesale debt securities reported in the table headed 'Wholesale funding cash flows payable by HSBC under financial liabilities by remaining contractual maturities' on page 210.

Net cash inflows/(outflows) for interbank and intra-group loans and deposits and reverse repo, repo and short positions

(Audited)

For footnotes, see page 249.

Net cash flow arising from interbank and intra-group loans and deposits

Under the LFRF, a net cash inflow within three months arising from interbank and intra-group loans and deposits will give rise to a lower liquid asset requirement. Conversely, a net cash outflow within three months arising from interbank and intra-group loans and deposits will give rise to a higher liquid assets requirement.

Net cash flow arising from reverse repo, repo, stock borrowing, stock lending and outright short positions (including intra-group)

A net cash inflow represents additional liquid resources, in addition to liquid assets, because any unencumbered asset held as a consequence of a reverse repo transaction with a residual contractual maturity within the stressed coverage ratio time period is not reflected as a liquid asset.

The impact of net cash outflow depends on whether the underlying collateral encumbered as a result will qualify as a liquid asset when released at the maturity of the repo. The majority of the Group's repo transactions are collateralised by liquid assets and, as such, any net cash outflow shown is offset by the return of liquid assets, which are excluded from the liquid asset table above.

Contingent liquidity risk arising from

committed lending facilities

(Audited)

The Group's operating entities provide commitments to various counterparts. In terms of liquidity risk, the most significant risk relates to committed lending facilities which, whilst undrawn, give rise to contingent liquidity risk, as these could be drawn during a period of liquidity stress. Commitments are given to customers and committed lending facilities are provided to consolidated multi-seller conduits, established to enable clients to access a flexible market-based source of finance (see page 209), consolidated securities investment conduits and third‑party sponsored conduits.

The consolidated securities investment conduits primarily represent Solitaire and Mazarin (see pages 186). These conduits issue asset-backed commercial paper secured against the portfolio of securities held by these conduits. At 31 December 2012, HSBC UK had undrawn committed lending facilities to these conduits of US$18bn (2011: US$22bn), of which Solitaire represented US$13bn (2011: US$16bn) and the remaining US$5.1bn (2011: US$6.2bn) pertained to Mazarin. At 31 December 2012, the commercial paper issued by Solitaire and Mazarin was entirely held by HSBC

UK. Since HSBC controls the size of the portfolio of securities held by these conduits, no contingent liquidity risk exposure arises as a result of these undrawn committed lending facilities.

The table below shows the level of undrawn commitments to customers outstanding for the five largest single facilities and the largest market sector, and the extent to which they are undrawn.

The Group's contractual undrawn exposures at 31 December monitored under the contingent liquidity risk limit structure

(Audited)

For footnotes, see page 249.

Sources of funding

(Audited)

Our primary sources of funding are customer current accounts and customer savings deposits payable on demand or at short notice. We issue wholesale securities (secured and unsecured) to supplement our customer deposits and change the currency mix, maturity profile or location of our liabilities. 

The funding sources and uses table, which provides a consolidated view of how our balance sheet is funded, should be read in the light of the LFRF, which requires operating entities to manage liquidity and funding risk on a stand-alone basis.

The table analyses our consolidated balance sheet according to the assets that primarily arise from operating activities and the sources of funding primarily supporting these activities. The assets and liabilities that do not arise from operating activities are presented as a net balancing source or deployment of funds.

The level of customer accounts continued to exceed the level of loans and advances to customers. Excluding the effect of repos from customer accounts and reverse repos from loans and advances to customers, the adjusted advances to deposits ratio at 31 December 2012 was 73.4% (2011: 73.5%). The positive funding gap was predominantly deployed into liquid assets; cash and balances with central banks and financial investments, as required by the LFRF.

Loans and other receivables due from banks continued to exceed deposits taken from banks. The Group remained a net unsecured lender to the banking sector.

Funding sources and uses

(Audited)

Wholesale funding cash flows payable by HSBC under financial liabilities by remaining contractual maturities

(Unaudited)

The balances in the table above will not agree directly with those in our consolidated balance sheet as the table incorporates, on an undiscounted basis, all cash flows relating to principal and future coupon payments.

Funding of HSBC Finance

We do not expect the professional markets to be a source of funding for HSBC Finance in the future in view of the sale of the Card and Retail Services business and the run-off of its remaining portfolio. HSBC Finance expects to meet future funding needs by asset sales and affiliate funding. As a consequence, no new external third-party funding, including commercial paper, is being originated by HSBC Finance.

Encumbered and unencumbered assets

(Unaudited)

The objective of this disclosure is to facilitate an understanding of available and unrestricted assets that could be used to support potential future funding and collateral needs.

An asset is defined as encumbered if it has been pledged as collateral against an existing liability, and as a result is no longer available to the bank to secure funding, satisfy collateral needs or be sold to reduce the funding requirement. An asset is therefore categorised as unencumbered if it has not been pledged against an existing liability. Unencumbered assets are then further analysed into four separate sub-categories; 'readily realisable assets', 'other realisable assets', 'reverse repo/stock borrowing receivables and derivative assets' and 'cannot be pledged as collateral'.

The disclosure is not designed to identify assets which would be available to meet the claims of creditors or to predict assets that would be available to creditors in the event of a resolution or bankruptcy.

The table below summarises the total on and off-balance sheet assets that are capable of supporting future funding and collateral needs and shows the extent to which these assets are currently pledged for this purpose.

Summary of assets available to support potential future funding and collateral needs (on and off-balance sheet)

(Unaudited)

At 31 December 2012, the Group held US$1,749bn of unencumbered assets that could be used to support potential future funding and collateral needs, representing 80% of the total assets that can support funding and collateral needs (on and off-balance sheet). Of this amount, US$764bn (US$666bn on-balance sheet) were assessed to be readily realisable.

The effect of active collateral management

Collateral is managed on an operating entity basis, consistent with the operating entity management of liquidity and funding. The available collateral held by each operating entity is managed as a single collateral pool. In managing this collateral and deciding which collateral to pledge, each operating entity will seek to optimise the use of the available collateral pool, within the confines of the LFRF, irrespective of whether the collateral pledged is recognised on-balance sheet or was received in respect of reverse repo, stock borrowing or derivative transactions.

As a result of managing collateral in this manner, in terms of asset encumbrance presentation, we may encumber on-balance sheet holdings while maintaining available unencumbered off-balance sheet holdings, even though we are not seeking to directly finance the on-balance sheet holdings pledged.

In quantifying the level of encumbrance of negotiable securities, the encumbrance has been analysed on an individual security basis. In doing so where a particular security has been encumbered and HSBC has holdings of the security both on-balance sheet and off-balance sheet with the right to repledge, it is assumed for the purpose of this disclosure that the off-balance sheet holding is encumbered ahead of the on-balance sheet holding.

An on balance-sheet encumbered and off-balance sheet unencumbered asset will occur, for example, if we receive a specific security as a result of a reverse repo/stock borrow transaction, but finance the cash lent by pledging a generic collateral basket, even if the security received is eligible for the collateral basket pledged. This will also occur if we receive a generic collateral basket as a result of a reverse repo transaction but finance the cash lent by pledging specific securities, even if the securities pledged are eligible for the collateral basket.

Off-balance sheet collateral received and pledged for reverse repo and stock borrowing transactions

The fair value of assets accepted as collateral that HSBC is permitted to sell or repledge in the absence of default was US$296bn at 31 December 2012 (2011: US$302bn). The fair value of any such collateral that has been sold or repledged was US$203bn (2011: US$189bn). HSBC is obliged to return equivalent securities. These transactions are conducted under terms that are usual and customary to standard reverse repo and stock borrowing transactions.

The fair value of collateral received and repledged in relation to reverse repo and stock borrowing are reported on a gross basis. The related balance sheet receivables and payables are reported on a net basis where required under IFRS netting criteria.

As a result of reverse repo and stock borrowing transactions where the collateral received can be sold or re-pledged, but has not been sold or re-pledged, we held US$93bn of unencumbered collateral available to support potential future funding and collateral needs at 31 December 2012.

Off-balance sheet non-cash collateral received and pledged for derivative transactions

The fair value of assets accepted as collateral related to derivative transactions that we are permitted to sell or repledge in the absence of default was US$6.0bn. The fair value of any such collateral that has been sold or repledged was US$0.8bn. We are obliged to return equivalent securities. These transactions are conducted under terms that are usual and customary to derivative transactions.

Analysis of on-balance sheet encumbered and unencumbered assets

The table on page 213 presents an analysis of on‑balance sheet holdings only, and shows the amounts of balance sheet assets that are encumbered. The table therefore excludes any available off-balance sheet holdings received in respect of reverse repo, stock borrowing or derivatives.

Analysis of on-balance sheet encumbered and unencumbered assets

(Unaudited)