Interim Report - 14 of 25

Risk

Managing our risk profile

·; A strong balance sheet is core to our philosophy.

·; We ensure that our portfolios remain aligned to our risk appetite and strategy.

·; We actively manage our risks, supported by strong forward looking risk identification.

Maintaining capital strength and strong liquidity position

·; Our core tier 1 capital ratio remains strong at 11.3%.

·; We have sustained our strong liquidity position throughout the first half of 2012.

·; The ratio of customer advances to deposits remains below 90%.

Strong governance

·; Robust risk governance and accountability is embedded across the Group.

·; The Board, advised by the Group Risk Committee, approves our risk appetite.

·; Our global risk operating model supports adherence to globally consistent standards and risk management policies across the Group.

Our top and emerging risks

·; Macroeconomic and geopolitical risk.

·; Macro-prudential, regulatory and legal risks to our business model.

·; Risks related to our business operations, governance and internal control systems.

The continued growth in our business in the first half of 2012 was achieved while ensuring risks were assumed in a measured manner and in line with our risk appetite. Risks were mitigated when they exceeded our risk appetite, particularly reputational and operational risks.

Balance sheet assets grew by 4% and our credit risk-weighted assets decreased by 3% during the period.

During the first six months of 2012, financial markets were dominated by concerns over sovereign debt default risk and its contagion effects, the Middle East and the perception that the world economic recovery remained fragile. This created volatility in financial markets. In the face of this changeable economic and financial environment, we maintained our conservative risk profile by reducing exposure to the most likely areas of stress. Stress tests are run regularly to evaluate the potential impact of emerging scenarios and, where applicable and necessary, we adjusted our risk appetite accordingly.

We continued to manage selectively our exposure to sovereign debt and bank counterparties, with the overall quality of the portfolio remaining strong. We regularly updated our assessment of higher risk countries and adjusted our risk appetite and exposures to reflect the updates.

The diversification of our lending portfolio across the regions, together with our broad range of global businesses and products, ensured that we were not overly dependent on a few countries or markets to generate income and growth. Our geographical diversification also supported our strategies for growth in faster-growing markets and those with international connectivity.

In the first half of 2012 we increased our gross loans and advances in all regions except Latin America, where we classified certain lending balances to held for sale. On a constant currency basis, our loan impairment charges and other credit risk provisions in the first half of 2012 were 6% below the first half of 2011, at US$4.8bn. The US accounted for a significant proportion of the decline, with a reduction in the CML portfolio and the sale of the Card and Retail Services business on 1 May 2012.

Capital and liquidity

Preserving our strong capital position has long been, and will remain, a key priority for HSBC. We are well equipped to respond to the capital requirements imposed by Basel III, which are discussed further on page 198, and to sustain future growth. We utilise an enterprise-wide approach to testing the sensitivities of our capital plans against a number of scenarios; our approach to scenario stress testing analysis is discussed on page 183.

We continue to maintain a very strong liquidity position and are well positioned for the emerging new regulatory landscape.

Details of the top and emerging risks identified through our risk management processes are set out below:

Macroeconomic and geopolitical risk

Severe economic slowdown in mature economies impacting global growth

World growth is slowing as demand in mature economies is subdued and credit availability and investment activity remain very limited. A number of mature economies are implementing austerity measures in order to reduce their deficits and public debt. This is expected to help resolve the sovereign and banking crisis in the medium term, but in the short term it is limiting growth, increasing unemployment and restricting taxation revenues severely. This is affecting the rest of the world through lower trade, reduced international financing as banks are deleveraging and potential disruption to capital flows.

Potential impact on HSBC

·; Trade and capital flows may contract as a result of banks deleveraging, the introduction of protectionist measures in certain markets or the emergence of geopolitical risks, which in turn might curtail profitability.

·; A prolonged period of low interest rates due to policy actions taken to address the economic crisis in mature economies will constrain, through spread compression and low returns on assets, the interest income we earn from investing our excess deposits.

·; During the first half of 2012, we continued to reduce our sovereign and financial institution counterparty credit positions in peripheral eurozone countries. In addition, we actively sought to identify and reduce exposures to those counterparties domiciled in core European countries that had exposures to sovereigns and/or banks in peripheral eurozone countries of sufficient size to threaten their ongoing viability in the event of an unfavourable conclusion to the current crisis.

Eurozone member departing from the currency union or a split into two different monetary unions

Exposures to the eurozone have received increasing focus given the continued instability in the area and the potential for contagion from the peripheral to core eurozone countries, and beyond to trading partners.

There is a significant risk of one or more countries leaving the euro. This would place further pressure on banks within the core European countries through their exposures to banks in these countries. In the current context of very low growth due to austerity measures, this could further aggravate the economic crisis and could push European countries into a vicious circle of economic and sovereign debt defaults. Although our exposure to the peripheral eurozone countries is relatively limited, we are exposed to counterparties in the core European countries which could be affected by any sovereign or currency crisis. Our eurozone exposures are described in more detail on pages 121 to 131.

Potential impact on HSBC

·; We could incur significant losses stemming from the exit of one or more countries from the eurozone and the redenomination of their currencies.

·; Our exposures to European banks may come under stress, heightening the potential for credit and market risk losses, if the sovereign debt and banking system crisis in the region increases the need to recapitalise parts of the sector.

·; In the event of contagion from stress in the peripheral eurozone sovereign and financial sectors, our ability to borrow from other

·;

financial institutions or to engage in funding transactions may be adversely affected by market dislocation and tightening liquidity.

·; We have actively managed the risk of sovereign defaults during the first half of 2012 by reducing exposures and other measures.

In addition, should such an event happen without the co-ordinated intervention to protect the rest of the eurozone, it could trigger banking defaults in companies with which we do business and have a knock-on effect on the global banking system.

·; In seeking to manage and mitigate this risk, we have prepared and tested detailed operational contingency plans to deal with such a scenario.

Increased geopolitical risk in certain regions

We are subject to geopolitical risks in the countries in which we operate. During the first half of 2012, these risks remained heightened in the Middle East.

In Egypt, the political transition process is still ongoing with the risk of instability remaining. In addition the political instability in Syria could spread across the region and become very disruptive for global international relations.

Potential impact on HSBC

·; Our results are subject to the risk of loss from unfavourable political developments, currency fluctuations, social instability and changes in government policies on matters such as expropriation, authorisations, international ownership, interest-rate caps, foreign exchange transferability and tax in the jurisdictions in which we operate. Actual conflict could bring about loss of life among our staff and physical damage to our assets.

·; We have increased our monitoring of the geopolitical and economic outlook, in particular in countries where we have material exposures and a physical presence. Our internal credit risk rating of sovereign counterparties takes these factors into account and drives our appetite for conducting business in those countries. Where necessary, we adjust our country limits and exposures to reflect our appetite and mitigate these risks as appropriate.

Macro-prudential, regulatory and legal risks to our business model

Financial service providers face increasingly stringent and costly regulatory and supervisory requirements, particularly in the areas of capital and liquidity management, conduct of business, operational structures and the integrity of financial services delivery. Increased government intervention and control over financial institutions, together with measures to reduce systemic risk, may significantly alter the competitive landscape. These measures may be introduced as formal requirements in a supra-equivalent manner and to differing timetables across regulatory regimes.

Regulatory developments affecting our business model and Group profitability

There are several key regulatory changes which are likely to have an effect on our activities. These are set out below:

Basel III/CRD IV

- In December 2010, the Basel Committee issued two documents: A global regulatory framework for more resilient banks and banking systems and International framework for liquidity risk measurement, standards and monitoring, which together are commonly referred to as 'Basel III'.

- In June 2011, the Basel Committee issued a revision to the former document setting out the finalised capital treatment for counterparty credit risk in bilateral trades.

- In July 2011, the European Commission published proposals for a new Regulation and Directive, known collectively as CRD IV, to give effect to the Basel III framework in the EU.

- Quality of capital: CRD IV requires a further strengthening and harmonisation of the criteria for eligibility of capital instruments with an emphasis on common equity as the principal component of tier 1 capital.

- Capital levels: CRD IV proposals would require banks to hold common equity tier 1 capital equal to at least 4.5% of RWAs with an additional capital conservation buffer of 2.5%, which could be used in periods of stress, subject to certain restrictions, for example, on bonus payments and dividends. Banks may also be required to hold a further countercyclical capital buffer to protect against potential future losses, when excess credit growth in the financial system as a whole is associated with an increase in system-wide risk. The level of bank capital will also need to exceed a minimum leverage requirement of 3% of total assets, currently subject to supervisory monitoring and review, prior to becoming a binding requirement from 1 January 2018.

- Counterparty credit risk: requirements for managing and capitalising counterparty credit risk are to be strengthened. In particular, an additional capital charge for potential losses associated with the deterioration in the creditworthiness of individual counterparties, the credit valuation adjustment, will be introduced.

- Liquidity and funding: a new minimum standard, the liquidity coverage ratio, designed to improve the short-term resilience of a bank's liquidity risk profile, will be introduced after an observation and review period in 2015. To promote resilience by creating incentives for banks to fund their activities with more stable sources of funding, the European Commission will consider proposing a net stable funding ratio after an observation and review period in 2018.

- Derivatives and central counterparty clearing: measures have been introduced to give effect to the commitments from the G20 leading group of countries designed to reduce systemic risk and volatility relating to derivatives trading. The G20 agreed that all standardised over-the-counter ('OTC') derivatives were to be traded on exchanges or electronic trading platforms, where appropriate, and centrally cleared by the end of 2012. They are to be reported to trade repositories. Higher capital requirements under Basel III will be imposed for bilateral (uncleared) transactions to incentivise the use of clearing.

UK Independent Commission on Banking: the UK government issued its White Paper in June 2012 setting out its proposed implementation of the recommendations of the ICB. It is likely that we will be required to make major changes to our corporate structure and the business activities we conduct in the UK through our major banking subsidiary, HSBC Bank, as:

- at a minimum retail banking activities for most personal customers and smaller businesses currently carried out within that entity will have to be spun off into a ring-fenced retail bank. These changes will take some time to implement with a significant effect on costs from both implementing the changes and running the ongoing operations as restructured;

- significant banks, such as HSBC Bank, will be required to have core tier 1 capital of at least 10% of RWAs and over 3% of total assets, which is a leverage requirement; and

- UK-incorporated banks will be required to hold equity and debt capable of absorbing losses if the bank is non-viable, together with primary loss-absorbing capacity ('PLAC') of at least 17% of RWAs.

The framework for defining products, services and customers which are either required to be within the ring-fenced bank or prohibited from it are subject to a consultation, and will then be incorporated into draft legislation. Detailed rule making will also be required which will take place over an extended period, probably into 2015.

The 'Volcker Rule': the so called Volcker Rule proposed under section 619 of the Dodd-Frank Wall Street Reform & Consumer Protection Act (the 'Dodd-Frank Act') could affect HSBC in North America and across the Group. The Volcker Rule placed restrictions on proprietary trading activities and on investing in and sponsoring hedge fund and private equity funds. In October 2011, a proposed rule was published which generated extensive public comment including submissions from foreign governments and other bodies on, inter alia, the overall scope and extra-territorial effects of the proposed rule. As yet, revised rules to implement the provisions of the Volcker Rule have not been published. On 19 April 2012, the Federal Reserve Board ('FRB') clarified that banking entities covered by the Volcker Rule, have the full two-year period provided by the Volcker Rule until 21 July 2014 to fully conform their activities and investments, unless the FRB extends the period.

There is a continued risk of further changes to regulation relating to remuneration and other taxes.

G-SIBs: the capital impact of being designated a global systemically important bank ('G‑SIB') is discussed on page 200.

Potential impact on HSBC

·; The proposals relating to capital and liquidity are likely to result in increased minimum capital and liquidity requirements, although the nature, timing and effect of many of the changes remain unclear, as is the extent to which entities within the Group may already comply with these requirements. Higher requirements in capital and liquidity have an effect on our future financial condition and the results of our operations. There is also the risk of secondary effects as the overall flow of credit to the economy is constrained and economic activity and opportunities for banking income slows.

·; As an institution with a relatively low-risk portfolio, the proposed leverage ratio could cause HSBC to either accept lower returns on equity than competitors or constrain business activity in areas which are well collateralised or possess sufficient risk mitigants.

·; For a further description of the possible effects of the new Basel III/CRD IV rules on HSBC see page 198. We could be required to raise more capital or reduce our level of RWAs to meet the requirements. Such actions and any resulting transactions may not be within our operating plans and may not be conducted on the most favourable terms. This could lead to lower returns on equity and cause some business activities and products to be less profitable and, in some instances, to fail to cover their cost of equity.

·; Proposed changes relating to remuneration and taxes could increase the Group's cost of doing business in the regulatory regimes in which these changes are implemented, reducing future profitability. Proposed changes in regulations such as the rules relating to derivatives and central counterparties regulation, the UK ICB ring-fencing proposals, recovery and resolution plans, the Volcker Rule and the Foreign Account Tax Compliance Act ('FATCA') may affect the manner in which we conduct our activities and structure ourselves, with the potential to both increase the costs of doing business and curtail the types of business we can carry out, with the risk of decreased profitability as a result. Due to the stage of development and implementation of these various regulations, it is not possible to estimate the effect, if any, on our operations.

·; We are closely engaged with the governments and regulators in the countries in which we operate to help ensure that the new requirements are properly thought through and understood so that they can be implemented in an effective manner. We are also ensuring that our capital and liquidity plans take into account the potential effects of the changes. Capital allocation and liquidity management disciplines have been expanded to incorporate future increased capital and liquidity requirements and drive appropriate risk management and mitigating actions.

Regulatory investigations, fines, sanctions and requirements relating to conduct of business and financial crime negatively affecting our results and brand

Financial service providers are at risk of regulatory sanctions or fines related to conduct of business and financial crime. The incidence of regulatory proceedings and other adversarial proceedings against financial service firms is increasing.

HSBC Holdings and certain of its affiliates are the subject of ongoing investigations by bank regulatory and law enforcement agencies in the US relating to their compliance with anti-money laundering laws and regulations, the US Bank Secrecy Act and sanctions programmes administered by the US Office of Foreign Assets Control. In each of these US regulatory and law enforcement matters, HSBC Group companies have received Grand Jury subpoenas or other requests for information from US Government or other agencies, and HSBC is cooperating fully and engaging in efforts to resolve matters including through preliminary discussions with relevant authorities. The resolution of at least some of these matters is likely to involve the filing of corporate criminal as well as civil charges and the imposition of significant fines and penalties. The prosecution of corporate criminal charges in these types of cases has most often been deferred through an agreement with the relevant authorities; however, the US authorities have substantial discretion, and prior settlements can provide no assurance as to how the US authorities will proceed in these matters. In the event of a filing of criminal charges the prosecution of which is not deferred, there could be significant consequences to HSBC and its affiliates, including loss of business, withdrawal of funding and harm to our reputation, all of which could have a material adverse effect on our business, liquidity, financial condition, results of operations and prospects.

Various regulators and competition and enforcement authorities around the world including in the UK, the US, Canada, the EU, Switzerland and Asia are conducting investigations related to certain past submissions made by panel banks in connection with the setting of London interbank offered rates ('LIBOR'), European interbank offered rates ('EURIBOR') and other interest rates. As certain HSBC entities are members of such panels, HSBC and/or its subsidiaries have been the subject of regulatory demands for information and are cooperating with those investigations.

Potential impact on HSBC

·; We are subject to a number of regulatory actions and investigations, see Note 25 on the Financial Statements. It is inherently difficult to predict the outcome of the regulatory proceedings involving our businesses. Unfavourable outcomes are having and may continue to have a material adverse effect on our reputation, brand and results, including loss of business and withdrawal of funding.

·; In response to this risk, we are progressing a number of initiatives which seek to address the issues identified, including creating our new global management structure, enhancing our governance and oversight, increasing our compliance function resource, emphasising our values and designing and implementing new global standards as outlined elsewhere.

Dispute risk

The current economic environment has increased our exposure to actual and potential litigation against the Group. Further details are discussed in Note 25 on the Financial Statements.

Potential impact on HSBC

Dispute risk gives rise to potential financial loss and significant reputational damage which could adversely affect customer and investor confidence.

Risks related to our business operations, governance and internal control systems

Challenges to achieving our strategy in a downturn

The external environment remains challenging and the structural changes which the financial sector is going through are creating obstacles to the achievement of strategic objectives. This, combined with the prolonged global economic slowdown, could affect the achievement of our strategic targets for the Group as a whole and our global businesses.

Potential impact on HSBC

·; The downturn may put pressure on our ability to earn returns on equity in excess of our cost of equity while operating within the overall parameters of our risk appetite.

·; Through our strategic initiatives, which have heightened the focus on capital allocation and cost efficiency, we are actively seeking to manage and mitigate this risk.

Internet crime and fraud

We are exposed to potentially fraudulent and criminal activities, in particular a growing threat from internet crime which could result in the loss of customer data and sensitive information. The threat of external fraud may increase during adverse economic conditions, especially in retail and commercial banking.

We also face breakdowns in processes or procedures and systems failure or unavailability and are subject to the risk of disruption to our business arising from events that are wholly or partially beyond our control, such as internet crime and acts of terrorism.

Potential impact on HSBC

·; Internet crime and fraud may give rise to losses in service to customersand/or economic loss to HSBC. These risks equally apply when we rely on external suppliers or vendors to provide services to us and our customers.

·; We have increased our monitoring and have implemented additional controls such as two-factor authentication to mitigate the possibility of losses from these risks.

Social media risk

The scale and profile of social media networks ('SMN's) have grown both in terms of customer demographic and geographical reach to represent a significant potential reputational risk to our organisation, given that these networks can be used as powerful broadcasting tools which can reach large numbers of people in a very short time frame.

Potential impact on HSBC

·; SMNscan be used to exacerbate the effect of customer complaints and service failures, and provide a means for employees to unlawfully publicise confidential information. SMNs present significant risks to our reputation and brand.

·; In order to reduce our exposure to these risks, an HSBC presence has been created in several of the larger SMNs in order to provide an official point of contact for our customers and stake- holders. Monitoring has also been implemented in some entities to protect our brand and identity and to understand general sentiment towards us and, in some cases, our specific products and initiatives. We have invested significantly in addressing the risk through increased training to raise staff awareness.

Level of change creating operational complexity and heightened operational risk

There are many drivers of change across HSBC and the banking industry including change driven by new banking regulation, the increased globalisation of the economy and business needs, new products and delivery channels, and organisational change.

Operational complexity has the potential to heighten all types of operational risk across our activities. This includes the risk of process errors, systems failures and fraud. It can also increase operational costs.

The implementation of our strategy to simplify our business, involves the withdrawal from certain markets, which presents disposal risks which must be carefully managed. The implementation of organisational changes to support the Group's strategy also requires close management oversight.

Potential impact on HSBC

·; Critical systemsfailure and a prolonged loss of service availability could cause serious damage to our ability to serve our clients, breach regulations under which we operate and cause long-term damage to our business, reputation and brand. Systems and controls could be degraded as a result of organisational effectiveness initiatives unless there is strong governance and an oversight framework to monitor the risk and control environment. We seek to ensure that our critical systems infrastructure, including IT services, essential buildings, offshore processes and key vendors, is constantly monitored and properly resourced to mitigate against systems failures.

·; The potential effects of disposal risks include regulatory breaches, industrial action, loss of key personnel and interruption to systems and processes during business transformation, and they can have both financial and reputational implications. Steps taken to manage these risks proactively include a close dialogue with regulators and customers and the involvement of HR, legal, compliance and other functional experts.

Information security risk

The reliability and security of our information and technology infrastructure and customer databases and their ability to combat internet fraud are crucial to maintaining our banking applications and processes and to protecting the HSBC brand.

Potential impact on HSBC

·; These risks give rise to potential financial loss and reputational damage which could adversely affect customer and investor confidence. Loss of customer data would also result in regulatory breaches which would result in fines and penalties being incurred.

·; We have investedsignificantly in addressing this risk through increased training to raise staff awareness of the requirements, enhanced controls around data access and heightened monitoring of information flows.

Model risk

More stringent regulatory requirements governing the development, parameters applied to and controls around models used for measuring risk can give rise to changes, including increases in capital requirements. Furthermore, the changing external economic and legislative environment and changes in customer behaviour can lead to the assumptions we have made in our models becoming invalid.

Potential impact on HSBC

·; These model risks can result in a potentially increased and volatile capital requirement.

·; We continue to address these risks through enhanced model development, independent review and model oversight to ensure our models remain fit for purpose.

Credit risk is the risk of financial loss if a customer or counterparty fails to meet a payment obligation under a contract. It arises principally from direct lending, trade finance and leasing business, but also from off-balance sheet products such as guarantees and derivatives, and from the Group's holding of debt and other securities. Credit risk generates the largest regulatory capital requirement of the risks we incur.

There have been no material changes to our policies and practices for the management of credit risk as described in the Annual Report and Accounts 2011.

Credit risk in the first half of 2012

Exposure, impairment allowances and charges

Loan impairment charges and other credit risk provisions

The Group's total reported gross loans and advances, which excludes lending balances transferred to held for sale, were US$1,174bn at 30 June 2012, an increase of 3% compared with 31 December 2011.

The following commentary is on a constant currency basis.

Total gross loans and advances rose by 3%, compared with the end of 2011. The increase reflected growth in corporate and commercial lending, mainly in Hong Kong and Rest of Asia-Pacific, as well as a rise in overdraft balances in the UK which did not meet netting criteria under current accounting rules. Financial lending also increased, reflecting an increase in reverse repos, while personal lending growth was attributable to an increase in mortgage lending. During the first half of 2012, we reclassified certain lending balances to assets held for sale. At 30 June 2012, lending balances reported as held for sale were US$6.7bn. These included US$4.7bn of balances associated with the disposal of our operations in certain countries in Latin America.

In the first half of 2012, we continued to reduce our sovereign agency and bank credit risk exposure in peripheral eurozone countries. At 30 June 2012, our net exposure to the sovereign, agency and bank debt of Spain, Ireland, Italy, Greece, Portugal and Cyprus was US$11.6bn. At 30 June 2012 our sovereign and agency exposures to these countries were not considered to be impaired. For further details on our exposure to the eurozone, see page 121.

At 30 June 2012, our personal lending balances were US$401bn, an increase of 2% on 31 December 2011 as residential mortgage balances rose while other categories of personal lending declined.

First lien residential mortgage lending at 30 June 2012 was US$287bn, 2% higher than at the end of 2011. It represented 29% of our total gross lending to customers, in line with the end of 2011. Our most significant exposure to residential mortgages was in the UK, the US and Hong Kong.

In the first half of 2012, we continued to grow our residential mortgage portfolios in the UK and Hong Kong. Average loan-to-value ('LTV') ratios on new residential mortgage lending in the UK and Hong Kong were 58% and 50%, respectively, while LTV ratios on our total residential mortgage books were 51% in the UK and 34% in Hong Kong. Delinquency levels and loan impairment charges in our residential mortgage portfolios in both the UK and Hong Kong remained at low levels in the first half of 2012.

In the US, we continued to be affected by industry-wide foreclosure delays which have extended the period between when a loan goes 180‑days past due and the realisation of cash proceeds from selling the property. There remains a significant backlog of foreclosures which will take time to resolve.

Total personal lending in the US was US$63bn at 30 June 2012, representing 16% of the Group's total personal lending. Balances in the portfolio declined by 5% compared with 31 December 2011, reflecting continued run-off in the CML portfolio. At 30 June 2012, lending balances in the CML portfolio were US$46bn, a decline of 8% compared with 31 December 2011, of which 44% was due to the write-off of balances. During the first half of 2012, we completed the sale of our US Card and Retail Services business. The lending balances associated with this transaction were reported as held for sale at 31 December 2011.

In US dollar terms, lending balances in the CML portfolio that were two months or more delinquent were US$8.3bn compared with US$8.9bn at the end of 2011, with reductions in both the real estate secured and personal non-credit card sections of the portfolio. Reduced delinquency on real estate secured lending balances reflected a fall in early stage delinquency as the portfolio continued to run off, as well as seasonal improvements in collections, partly offset by higher late stage delinquency due to the temporary suspension of foreclosure activities.

In our Annual Report and Accounts 2011, we disclosed a quantification of the value of collateral we hold over a borrower's specific asset, in the event of the borrower failing to meet its contractual obligations. At 30 June 2012, there were no significant changes in the value of collateral compared with the end of 2011.

At 30 June 2012, renegotiated loan balances were US$46.2bn, broadly in line with the end of 2011. The majority of our renegotiated loan balances were in North America in the real estate secured portion of the CML portfolio, where 57% of the lending balances have been reaged, modified or reaged and modified.

Reclassification to assets held for sale

During the period, the decline in gross loans and advances was partly due to a reclassification of certain lending balances to assets held for sale. Disclosures relating to assets held for sale are provided in credit risk management tables, primarily where the disclosure is relevant to the measurement of these financial assets, as follows:

·; maximum exposure to credit risk (page 114);

·; distribution of financial instruments by credit quality (page 139); and

·; ageing analysis of days past due but not impaired gross financial instruments (page 143).

Although gross loans and advances and related impairment allowances are reclassified from 'Loans and advances to customers' and 'Loans and advances to banks' in the balance sheet, there is no equivalent income statement reclassification. As a result, charges for loan impairment losses shown in the credit risk disclosures include loan impairment charges relating to financial assets classified as assets held for sale.

The table below presents 'Loans and advances to customers' and 'Loans and advances to banks' as reported, and differentiates them from those classified as held for sale.

Comparative data at 30 June 2011 have not been separately presented as the amounts are insignificant.

Reported and held-for-sale loans1

For footnote, see page 180.

The table below analyses the amount of 'Loan impairment charges and other credit risk provisions' arising from assets held for sale and other assets not held for sale. They primarily relate to the US Card and Retail Services businesses classified as held for sale at 31 December 2011. These assets had been disposed of by 30 June 2012.

Loan impairment charges and other credit risk provisions ('LIC's)

Credit exposure

Maximum exposure to credit risk

Our credit exposure is well diversified across a broad range of asset classes.

Our maximum exposure to loans and advances at amortised cost increased compared with the end of 2011. The rise primarily reflected growth in corporate and commercial lending in Hong Kong and Rest of Asia-Pacific. In addition, lending in the manufacturing sector rose, mainly in the UK, reflecting a rise in overdraft balances which did not meet netting criteria under current accounting rules. Reverse repo balances also rose, largely reflecting the deployment of proceeds from the US disposals, while mortgage lending increased due to growth in the UK and Hong Kong, partly offset by continued run-off in the US.

The loans and advances offset adjustment in the table on page 114 primarily relates to customer loans and deposits, and balances arising from repo and reverse repo transactions. The offset relates to balances where there is a legally enforceable right of offset in the event of counterparty default and where,

as a result, there is a net exposure for credit risk management purposes. However, as there is no intention to settle these balances on a net basis under normal circumstances, they do not qualify for net presentation for accounting purposes.

Maximum exposure to financial investments decreased moderately compared with the end of 2011. This largely reflected the disposal of available-for-sale securities in Europe, broadly offset by a rise in North America where excess liquidity was used to purchase government debt securities.

In the first half of 2012, our exposure to trading assets rose reflecting increased client activity compared with the subdued levels seen in the second half of 2011. This resulted in higher reverse repo and settlement account balances which vary proportionately with levels of trading activity.

The Group's maximum exposure to cash and balances at central banks increased as we continued to place excess liquidity in Europe with central banks. In North America, we reduced balances at central banks as we repaid debt and increased our purchases of government debt securities.

Our maximum exposure to derivatives at 30 June 2012 increased compared with the end of 2011. This primarily reflected a rise in the fair value of interest rate and, to a lesser extent foreign exchange derivative contracts in Europe following movements in yield curves.

The derivative offset amount in the table overleaf relates to exposures where the counterparty has an offsetting derivative exposure with HSBC, a master netting arrangement is in place and the credit risk exposure is managed on a net basis, or the position is specifically collateralised, normally in the form of cash. At 30 June 2012, the total amount of such offsets was US$340bn (30 June 2011: US$208bn; 31 December 2011: US$306bn), of which US$301bn (30 June 2011: US$188bn; 31 December 2011: US$272bn) were offsets under a master netting arrangement, US$38.5bn (30 June 2011: US$20.1bn; 31 December 2011: US$33.0bn) was collateral received in cash and US$1.1bn (30 June 2011: US$0.2bn; 31 December 2011: US$0.7bn) was other collateral. These amounts do not qualify for net presentation for accounting purposes, as settlement may not actually be made on a net basis.

While not considered as offset in the table overleaf, other arrangements including short positions in securities and financial assets held as part of linked insurance/investment contracts where the risk is predominately borne by the policyholder, reduce our maximum exposure to credit risk. In addition, we hold collateral in respect of individual loans and advances.

Concentration of exposure

Concentrations of credit risk are described in the Appendix to Risk on page 183.

Securities held for trading

Total securities held for trading within trading assets were US$192bn at 30 June 2012 (30 June 2011: US$269bn; 31 December 2011: US$186bn). The largest concentration of these assets was in government and government agency securities. Our most significant exposures were to US Treasury and government agency securities (US$21bn) and UK (US$11bn) and Hong Kong (US$7bn) government securities. A detailed analysis of securities held for trading is set out in Note 7 on the Financial Statements and an analysis of credit quality is provided on page 139.

Debt securities, treasury and other eligible bills

Our holdings of corporate debt, ABSs and other securities were spread across a wide range of issuers and geographical regions, with 15% invested in securities issued by banks and other financial institutions. A more detailed analysis of financial investments is set out in Note 13 on the Financial Statements and an analysis by credit quality is provided on page 139.

At 30 June 2012, our insurance businesses held diversified portfolios of debt and equity securities designated at fair value of US$31.5bn (30 June 2011: US$31.3bn; 31 December 2011: US$28.9bn) and debt securities classified as financial investments of US$40.2bn (30 June 2011: US$41.7bn; 31 December 2011: US$40.1bn). A more detailed analysis of securities held by the insurance businesses is set out on page 178.

Derivatives

Derivative assets at 30 June 2012 were US$356bn, (30 June 2011: US$261bn; 31 December 2011: US$346bn) of which the largest concentrations of exposure were in interest rate and foreign exchange derivatives. For an analysis of derivatives see Note 12 on the Financial Statements.

Loans and advances

Gross loans and advances to customers (excluding the financial sector) at 30 June 2012 increased by US$26bn or 3% from 31 December 2011. On a constant currency basis the increase was 3%. In the first half of 2012, we increased our exposure to personal lending and most industry sectors, with growth in Asia and Europe.

Summary of gross loans and advances to customers

The following commentary is on a constant currency basis:

Personal lending of US$401bn in the first half of 2012 was higher than at 31 December 2011. At US$287bn, first lien residential mortgage lending continued to represent the Group's largest concentration in a single exposure type, the most significant balances being in the UK (41%), the US (18%) and Hong Kong (17%).

Corporate and commercial lending was 50% of gross lending to customers at 30 June 2012.

Maximum exposure to credit risk

For footnotes, see page 180.

International trade and services was the biggest portion of the corporate and commercial lending category, increasing by 3% compared with 31 December 2011. The most significant concentrations of international trade and services lending were in the UK, Hong Kong and Rest of Asia-Pacific.

Commercial real estate lending, which represented 8% of total gross lending to customers, was broadly in line with 31 December 2011. The main concentrations of commercial real estate lending were in the UK and Hong Kong. See 'Areas of special interest' for further discussion on commercial real estate lending.

Our exposure in the financial category was US$95bn, an increase of 10% compared with 31 December 2011, due to a redeployment of short-term liquidity in North America from central banks to reverse repos. The largest exposure was to non-bank financial institutions and was spread across a range of institutions, with the most significant concentration in France, the UK and the US.

Loans and advances to banks were US$182bn, broadly in line with the end of 2011, and remained widely dispersed across many countries.

The following tables analyse loans by industry sector and by the location of the principal operations of the lending subsidiary or, in the case of the operations of The Hongkong and Shanghai Banking Corporation Limited, HSBC Bank, HSBC Bank Middle East Limited and HSBC Bank USA, by the location of the lending branch.

Gross loans and advances by industry sector

For footnotes, see page 180.

Gross loans and advances to customers by industry sector and by geographical region