Interim Report 10 of 25

Economic background

Brent crude oil prices in excess of US$100 per barrel in the first half of 2012 helped support revenues and spending across much of the Middle East. Data from the HSBC Purchasing Managers Index, consumer indicators and credit growth all demonstrated a pick-up in economic activity driven by the expansionary government spending policies which were announced in the wake of protests in 2011. Saudi Arabia, Qatar and Oman showed the strongest signs of recovery, while the UAE economy was more subdued due to a cautious fiscal policy and lack of credit growth. Activity in Bahrain and, to a lesser extent, Kuwait, was held back by political instability. The non-oil producers were increasingly affected by exposure to the troubled eurozone economies in the first half of the year. Export and tourism activity slowed, which limited corporate investment spending. Despite electing its first president since the revolution, Egypt's economic activity remained subdued.

Review of performance

Our operations in the Middle East and North Africa reported a profit before tax of US$772m, an increase of 3% compared with the first half of 2011. On a constant currency basis, pre-tax profits increased by 4%, reflecting higher income from our associates, modest revenue growth in challenging market conditions and lower costs from the implementation of strategic restructuring programmes, partly offset by higher loan impairment charges.

We continued to make progress on our strategic programmes to improve capital deployment, using the Group's five filters framework to review our existing businesses and assess acquisitions. In the first half of 2012, we completed the merger of our operations in Oman with Oman International Bank S.A.O.G. ('OIB'), giving us a 51% ownership of the combined entity, HSBC Bank Oman S.A.O.G., now the third largest Bank in the Sultanate. We also entered into an agreement to acquire the onshore retail and commercial banking business of Lloyds Banking Group in the UAE, subject to regulatory approval. Lloyds' strong presence in expatriate retail banking and complementary commercial banking is a good strategic fit with our position as the leading international bank in the UAE.

We achieved strong growth in profit before tax in all of our priority markets, including Saudi Arabia through our associate, The Saudi British Bank, which won the Euromoney award for excellence as

Profit/(loss) before tax by country within global businesses

'The Best Bank in Saudi Arabia' and 'The Best Debt House in Saudi Arabia'. Strong performances were also reported in the UAE and Egypt. Despite signs of recovery, political and economic uncertainty continued in the region. The strength of the HSBC brand and resilience of the oil-based regional economies together with our international connectivity, position us well for future growth.

Delivery of sustainable cost savings is a key priority and we realised substantial benefits from the actions taken in 2011 to reduce our cost base. In the first half of 2012, we took further steps to improve our cost efficiency and drive additional sustainable cost savings through our organisational effectiveness initiatives, including a de-layering of our management structure and the transfer of additional operational processes to our global service centre.

In RBWM, we remained focused on growing Wealth Management revenues, launching a number of new investment funds, bonds and deposit products. We also entered into a ten-year strategic partnership with Zurich Life International to be the exclusive provider of their wealth insurance products in the region. We continued to roll out our digital solution for mobile banking in the region and launched an Arabic version of the HSBC website in the UAE, becoming the first international bank with a bilingual presence there.

In CMB, we continued to strengthen our position as the leading international trade and business bank. We launched our third International Trade SME Fund in the UAE, pledging US$272m to support SMEs engaged in cross-border trade, and added resources to enhance our international capabilities, particularly in respect of emerging trade corridors. Our Payments and Cash Management business was named 'Best Cash Management Bank in the Middle East 2012' in the Euromoney Awards for Excellence and continued to achieve success by growing deposit balances.

In GB&M, our customers benefited from dedicated coverage teams on our mainland China, South Korea and India desks in the UAE, Saudi Arabia and Oman, leveraging our 'South-South' connectivity to provide access to Asian investors for issuers in the region with funding requirements. We continued to focus on generating incremental revenues through the provision of risk management services to regional clients by leveraging our global expertise, including in equity and energy derivatives. We also completed a record number of bond issuances in the first half of 2012, which is indicative of continuing investor appetite for Middle East and North Africa debt. We won seven Euromoney awards for excellence including 'The Best Project Finance House in the Middle East' and 'The Best Equity House in the Middle East'. GB&M also won a number of EMEA Finance Achievement Awards, including 'Best Sukuk House 2011', and three of GB&M's customer deals were recognised by The Banker 'Deals of the Year 2012'.

The following commentary is on a constant currency basis.

Net interest income rose by 5%, driven by higher average deposit balances in RBWM as a result of targeted customer acquisition and successful marketing campaigns, together with wider spreads as we repriced our deposits and benefited from higher interest rates in Egypt. Deposit balance growth in our Payments and Cash Management business, reflecting targeted client growth, led to an increase in net interest income in GB&M, while Balance Sheet Management benefited from higher yields on the available-for-sale investment portfolios. This was partly offset by a low level of demand for corporate credit in CMB.

Net fee income decreased by 7% due to lower advisory revenues and Securities Services' fees in GB&M, both of which were affected by the continuing challenging political and economic environment. Fees also declined due to the repositioning of RBWM's cards portfolio towards higher quality lending, which resulted in a reduction in late and over-limit fees along with higher reward scheme charges following revisions to the agreement with our partner aimed at improving card utilisation. In addition, fees declined in private banking as we exited our domestic private banking operations in the UAE. This was partly offset by higher trade import fees in CMB which were driven by targeted sales activity.

Net trading income decreased by 8%, mainly from adverse credit valuation adjustments on certain trading positions relating to a small number of exposures in GB&M. This was partly offset by higher Rates trading income from increased client activity in the first half of 2012 and revaluation gains on certain equity holdings in Principal Investments.

Gains less losses from financial investments increased by US$11m, driven principally by the non-recurrence of adverse fair value movements on certain investments in 2011.

Loan impairment charges and other credit risk provisions increased by US$37m as significant loan impairment charges were recorded for a small number of large exposures in GB&M. This was partly offset by lower impairments in RBWM, due to an improvement in credit quality which reflected the repositioning of the book towards higher quality lending in previous periods, and in CMB as we worked closely with customers through the credit cycle.

Operating expenses decreased by 6%, as a result of the sustainable cost saving initiatives implemented in 2011 and the first half of 2012. These particularly affected staff costs as we reduced employee numbers by over 750 from their peak in March 2011, although staff numbers increased by more than 1,000 following the merger of our Oman operations with OIB. Performance-related costs rose as a result of the merger with OIB and legal costs increased in connection with the strategic transactions noted above.

Share of profits from associates and joint venturesincreased by 13%, mainly from The Saudi British Bank, driven by higher revenues due to growth in lending and a rise in trade, other lending and guarantee fees, good cost control and a decline in loan impairment charges as operating conditions improved.

Profit/(loss) before tax and balance sheet data - Middle East and North Africa

Profit/(loss) before tax and balance sheet data - Middle East and North Africa (continued)