Interim Report - 4 of 25

Summary income statement

Reported profit before tax of US$12.7bn in the first half of 2012 was US$1.3bn, or 11%, higher than in the first half of 2011. This was primarily due to a US$3.1bn gain on the sale of the US Card and Retail Services business and a US$661m gain from the sale of 138 branches in the US (a further 57 branches are expected to be sold in the third quarter). These gains were partially offset by adverse fair value movements on own debt attributable to credit spreads of US$2.2bn, compared with adverse movements of US$143m in the first half of 2011. On an underlying basis, profit before tax was 3% lower, primarily due to higher operating expenses reflecting an increase in notable cost items, particularly provisions for customer redress in the UK of US$1.3bn (compared with US$611m in the first half of 2011) and US anti-money laundering, Bank Secrecy Act ('BSA') and Office of Foreign Asset Control ('OFAC') investigations of US$0.7bn.

We expect the sale of US Card and Retail Services to have a significant impact on both revenue and profitability in North America for the foreseeable future.

The following commentary is on an underlying basis, except where otherwise stated. The difference between reported and underlying results is explained and reconciled on page 16.

Net operating income before loan impairment charges and other credit risk provisions ('revenue') was US$1.4bn, or 4% higher than the first half of 2011. This was mainly due to higher revenue in GB&M and Commercial Banking ('CMB'). The increase in GB&M revenue included higher disposal gains on available-for-sale securities in Balance Sheet Management and continued growth in Foreign Exchange earnings. GB&M also recorded higher Rates income as market sentiment improved considerably during the first quarter of 2012. In CMB, revenue growth reflected increased net interest income derived from strong lending growth, notably during the first half of 2011, higher deposit spreads following interest rate rises in certain Asian markets during 2011, and growth in average customer account balances. In RBWM, we continued to manage down our Consumer and Mortgage Lending ('CML') run-off portfolio in North America and, as a consequence, revenue fell. This was partly offset by revenue growth in Hong Kong and Latin America.

Loan impairment charges and other credit risk provisions were in line with the first half of 2011. This reflected a decrease, primarily in North America and, to a lesser extent, in Europe, which was broadly offset by an increase in Latin America and Rest of Asia-Pacific. In North America, the reduction was mainly due to the continued decline in lending balances in the CML portfolio and the effect of the delays in foreclosure processing was less pronounced. In Europe, credit quality improved in our RBWM business, mainly in the UK, as we continued to focus on higher quality assets. This resulted in lower delinquency rates across both the secured and unsecured lending portfolios. This was broadly offset by increased loan impairment charges and other credit risk provisions in Latin America, notably in Brazil, due to higher delinquency rates following strong growth in lending balances in previous periods, and in Rest of Asia-Pacific due to higher individually assessed loan impairments and a charge on available-for-sale debt securities.

Operating expenses were higher than in the first half of 2011. This increase resulted from a number of notable items, which included a provision of US$700m in respect of US anti-money laundering, BSA and OFAC investigations, as well as restructuring costs of US$563m and provisions relating to customer redress programmes in the UK of US$1.3bn, compared with US$477m and US$611m, respectively, in the first half of 2011. Notable items in the first half of 2011 also included a credit of US$587m relating to pension obligations in the UK.

The provisions for customer redress programmes include estimates in respect of possible mis-selling of PPI policies and interest rate protection products in previous years. The additional provision in the first half of 2012 relating to PPI

sales reflects the refinement of our assumptions in the light of our recent claims experience. The provision in relation to certain US law enforcement and regulatory matters represents an estimate of the amount of penalties and/or fines that are likely to be imposed in connection with the anti-money laundering, OFAC and BSA investigations currently underway. See page 105 for further information about the possible adverse consequences which could arise from these regulatory investigations. There are many factors which affect the estimates on which these provisions are based and there remains a high degree of uncertainty as to the costs that will be eventually incurred.

Excluding the items above, operating expenses were marginally lower, reflecting our sustainable cost saving initiatives, partly offset by wage inflation, investment in compliance infrastructure and business expansion projects. During the first half of 2012, full-time equivalent staff numbers ('FTE's) reduced by more than 16,700. Our organisational effectiveness programmes led to a decrease of around 9,500, while business disposals accounted for the majority of the remaining reduction. Our operational effectiveness programmes led to sustainable savings of US$0.8bn.

On a constant currency basis, income from associates increased, mainly driven by strong results in our mainland China associates. The contribution from Bank of Communications Co., Limited ('BoCom') rose due to wider spreads. Our share of profits from Industrial Bank Co. Limited ('Industrial Bank') increased due to continued strong lending growth.

The reported profit after tax was US$0.7bn or 7% lower than in the first half of 2011, reflecting a higher tax charge in the first half of 2012. This arose from higher taxed profits on the disposal of the US branches and Card and Retail Services business combined with a non-deductible provision in respect of the US law enforcement and regulatory matters. The lower tax charge in the first half of 2011 included the benefit of deferred tax recognised in respect of foreign tax credits. As a result of these factors, the effective tax rate for the first half of 2012 was 28.5% compared with 14.9% in 2011.

The following commentaries are on a constant currency basis, unless stated otherwise.

Net interest income

For footnotes, see page 100.

Reported net interest income decreased by 4%. On a constant currency basis, it declined by 1%.

On an underlying basis, in which the comparable period of 2011 has been adjusted by US$669m relating to constant currency and US$709m to reflect the completion of the sales of the Card and Retail Services business and 138 non-strategic branches, net interest income rose by 3%.

On a constant currency basis, interest income earned on interest-earning assets fell. This was driven mainly by a significant decline in Balance Sheet Management in Europe as yield curves continued to flatten and interest rates remained low, together with a reduction in the available-for-sale debt security portfolio as a result of disposals, notably in the first quarter of 2012. During the second half of 2011 and the first half of 2012, we placed a greater portion of our excess liquidity with central banks in line with our conservative risk profile; the lower yield on these placements relative to other financial investments also contributed to the decline in interest income. This was partly offset by higher Balance Sheet Management revenues in Hong Kong and Rest of Asia-Pacific, notably mainland China, resulting from growth in the size of the investment portfolio and higher interest rates.

Average customer lending balances, including those classified within 'Assets held for sale', rose significantly compared with the first half of 2011. This reflected the targeted lending growth throughout 2011 and in the first half of 2012 in CMB and GB&M, as well as strong residential mortgage lending growth in RBWM in the UK, Hong Kong and Rest of Asia-Pacific. However, the benefit to interest income of the growth in average balances was offset in income terms by a decline in the overallyield on customer lending as a result of a change in the composition of our lending book. This was driven by significant growth in relatively lower yielding term lending in CMB and GB&M and higher quality secured lending, particularly residential mortgages, as we continued to reduce higher yielding unsecured lending in RBWM.

The decline in interest income was partly offset by lower interest expense, notably in relation to debt issued by the Group. This reflected a net reduction in average balances outstanding, largely in the US, as funding requirements fell following the business disposals and in Europe, where short-term funding was not replaced in line with the rise in deposit funding.

Interest expense on customer accounts, including those reported within 'Other liabilities held for sale', was broadly in line with the first half of 2011. There was a significant rise in average balances in Hong Kong, Rest of Asia-Pacific and Europe as a result of targeted campaigns; however, the effect of this growth was largely offset by a reduction in the cost of funds, driven by downward movement in interest rates in Latin America and re-pricing activities in the US.

The decrease in the net interest spread compared with the first half of 2011 was attributable to lower yields on our excess liquidity and customer lending partly offset by a reduction in the cost of funds on customer accounts. Our net interest margin also fell, but by a lesser amount, due to the benefit from net free funds, which rose as a result of customers holding more funds in liquid non-interest bearing current accounts and higher third-party funding of our trading book.

Net fee income

Net fee income decreased by US$500m on a reported basis, and by US$235m on a constant currency basis.

US$184m of the decrease on a constant currency basis was driven by the sale of the Card and Retail Services business which, in particular, led to a reduction in income relating to cards and insurance as well as fee expenses. As part of the transaction, we also entered into a transition service agreement with the purchaser to support certain account servicing operations until such time as these are integrated into the purchaser's infrastructure. We will receive fees for providing these services and the associated costs will be reported in 'Operating expenses'.

Broking income was lower, notably in Hong Kong and Europe, reflecting reduced transaction volumes as a result of weaker investor sentiment amidst uncertain market conditions.

Income from funds under management ('FuM') was also lower, mainly in Europe and Rest of Asia-Pacific, reflecting adverse movements in equity markets and muted investor sentiment, particularly in the second half of 2011. Europe was also affected by net new money outflows and a fall in client numbers within GPB. In addition, income from FuM was lower in North America due to the sale of the private client services business in Canada.

Partly offsetting these reductions was an increase in trade-related income, notably in Europe, Hong Kong and Rest of Asia-Pacific, which benefited from export-led lending growth as we continued to capitalise on our position as the world's leading trade finance bank, as reported in the Oliver Wyman Global Transaction Banking Survey 2011.

Underwriting fees also increased in GB&M, mainly in North America and Hong Kong, reflecting our participation in a higher number of debt capital markets transactions in the first half of 2012.

Net trading income

For footnotes, see page 100.

Reported net trading income of US$4.5bn was 6% lower than in the first half of 2011. On a constant currency basis, it was 3% lower as a decline in net interest income from trading activities and higher adverse fair value movements on economic and non-qualifying hedges were only partly offset by a rise in income from trading activities.

Net interest income from trading activities declined due to lower average holdings of, and yields on, debt securities held for trading, partly offset by a reduction in funding costs.

There were adverse fair value movements on non-qualifying hedges. These hedges are derivatives entered into as part of a documented interest rate management strategy for which hedge accounting was not, nor could not be, applied. They are principally cross-currency and interest rate swaps used to economically hedge fixed rate debt issued by HSBC Holdings and floating rate debt issued by HSBC Finance Corporation ('HSBC Finance'). The size and direction of the changes in fair value of non-qualifying hedges that are recognised in the income statement can be volatile from year to year, but do not alter the cash flows expected as part of the documented interest rate management strategy for both the instruments and the underlying economically hedged assets and liabilities. In North America, the effects of falling US long-term interest rates were more pronounced than in the first half of 2011, resulting in higher adverse fair value movements. In Europe, there were adverse movements on non-qualifying hedges in European operating entities driven in part by a decline in interest rates. This was partly offset by lower adverse movements in HSBC Holdings, also in Europe, which were driven by a less pronounced decline in long-term US interest rates relative to sterling and euro interest rates than in the first half of 2011.

Income from trading activities increased. Our Foreign Exchange business benefited from increased client revenues, driven in part by GB&M's ongoing collaboration with CMB, coupled with a favourable trading environment for foreign exchange, particularly in Europe. Rates revenues increased in Europe with higher revenues attributable to the tightening of spreads on eurozone bonds, notably in the first quarter of 2012 following the announcement of the long-term refinancing operation ('LTRO'). Rates revenues in Hong Kong and Rest of Asia-Pacific also benefited from tightening spreads.

These strong performances in Foreign Exchange and Rates were also partly offset by a reduction in Equities trading revenues, which reflected a less favourable trading environment. Net trading income from our legacy credit portfolio (see page 284) also declined as a result of write-downs compared with net releases of write-downs in the first half of 2011. There were also adverse fair value movements on structured liabilities of US$330m, mainly in Rates, as credit spreads tightened at the beginning of 2012 compared with a reported favourable fair value movement of US$60m in the first half of the previous year.

In addition, there were adverse foreign exchange movements on trading assets held as economic hedges of foreign currency debt held at fair value compared with favourable fair value movements reported in the first half of 2011. These offset favourable foreign exchange movements on the foreign currency debt which are reported in 'Net expense from financial instruments designated at fair value'.

Net income/(expense) from financial instruments designated at fair value

Assets and liabilities from which net income/(expense) from financial instruments designated at fair value arose

For footnotes, see page 100.

Most of the financial liabilities designated at fair value relate to certain fixed-rate long-term debt issued and managed in conjunction with interest rate swaps as part of a documented interest rate management strategy. The movement in fair value of these long-term debt issues includes the effect of our credit spread changes and any ineffectiveness in the economic relationship between the related swaps and own debt. As credit spreads widen or narrow, accounting profits or losses are booked. The size and direction of the changes in the credit spread on our debt and ineffectiveness, which are recognised in the income statement, can be volatile from period to period, but do not alter the cash flows envisaged as part of the documented interest rate management strategy. As a consequence, fair value movements arising from changes in our own credit spread on long-term debt and other fair value movements on the debt and related derivatives are not regarded internally as part of managed performance and are therefore not allocated to global businesses, but are reported in 'Other'. Credit spread movements on own debt are excluded from underlying results, and related fair value movements are not included in the calculation of regulatory capital.

We reported net expense from financial instruments designated at fair value of US$1.2bn in the first half of 2012 compared with US$100m in the same period in 2011. This included the credit spread-related movements in the fair value of our own long-term debt, on which we reported adverse fair value movements of US$2.2bn and US$143m in the respective periods. The adverse fair value movements arose in the first half of 2012 as credit spreads tightened in Europe and North America, compared with lower adverse fair value movements in the first half of 2011.

Net income arising from financial assets held to meet liabilities under insurance and investment contracts reflected higher net investment gains in 2012 as market conditions improved, compared with the first half of 2011. This predominantly affected the value of assets held to support unit-linked contracts in the UK and Hong Kong, insurance contracts with discretionary participation features ('DPF') in Hong Kong, and investment contracts with DPF in France.

The investment gains arising from equity markets resulted in a corresponding movement in liabilities to customers, reflecting the extent to which unit-linked policyholders, in particular, participate in the investment performance of the associated asset portfolio. Where these relate to assets held to back investment contracts, the corresponding movement in liabilities to customers is also recorded under 'Net income from financial instruments designated at fair value'. This is in contrast to gains or losses related to assets held to back insurance contracts or investment contracts with DPF, where the corresponding movement in liabilities to customers is recorded under 'Net insurance claims incurred and movement in liabilities to policyholders'.

Within net income from financial instruments designated at fair value were favourable foreign exchange movements in the first half of the year, compared with adverse movements in the same period in 2011 on foreign currency debt designated at fair value issued as part of our overall funding strategy. An offset from trading assets held as economic hedges was reported in 'Net trading income'.

Gains less losses from financial investments

In the first half of 2012, gains less losses from financial investments rose by US$538m and US$555m on a reported and a constant currency basis, respectively.

This was principally driven by higher gains generated from the disposal of available-for-sale government debt securities in Europe, notably in the first quarter of 2012 and, to a lesser extent, in North and Latin America, as part of Balance Sheet Management's structural interest rate risk management activities. These gains were offset in part by the non-recurrence of gains in Hong Kong in the first half of 2011.

Net gains on the disposal of equity securities rose significantly in Hong Kong as a result of the sale of our shares in two non-strategic investments in India, Axis Bank Limited and Yes Bank Limited. They were offset in part by lower net gains on the disposal of equity securities in Europe and the non-recurrence of a gain in GB&M on the sale of shares in a Mexican listed company in the first half of 2011.

Higher impairments in equity investments were driven by the financial restructuring of an equity investment in the renewable energy sector.

Net earned insurance premiums

Net earned insurance premiums remained broadly unchanged on a reported basis, but increased by 4% on a constant currency basis. This rise was primarily driven by strong sales of life insurance products in Hong Kong and Rest of Asia-Pacific, and unit-linked, term life and credit protection products in Latin America.

In Hong Kong, sales of insurance contracts with DPF increased, supported by product launches and marketing campaigns. Renewal premiums from unit-linked contracts also increased as a result of strong sales in previous periods.

In Latin America, net earned premiums grew due to a rise in sales volumes of unit-linked, term life and credit protection products in Brazil. This was partly offset in Argentina, as premiums decreased as a result of the sale of the general insurance business in May 2012.

In Europe, net earned premiums decreased in France on investment contracts with DPF as a result of the adverse economic environment and increased product competition. In addition, there was a reduction in premiums due to the non-renewal and transfer to third parties of certain contracts in our Irish business.

Other operating income

Change in present value of in-force long-term insurance business

For footnote, see page 100.

Reported other operating income of US$1.0bn decreased by 20% in the first half of 2012 and by 17% on a constant currency basis.

Reported other operating income in the first half of 2012 included gains on selling businesses as we rationalised our portfolio in non-strategic markets. These included gains of US$83m on the sale of the Private Client Services business in Canada, US$108m on the sale of our RBWM operations in Thailand, US$67m on the sale of our Global Private Banking ('GPB') business in Japan, US$130m on the sale of our shareholding in a property company in the Philippines, and US$102m following the completion of the sale of our general insurance manufacturing business in Argentina.

In the first half of 2011, reported other operating income included a gain of US$181m arising from a further dilution of our holding in Ping An following its issue of share capital to a third party.

On an underlying basis, excluding the items listed above, other operating income decreased largely due to the non-recurrence of a gain of US$237m (US$243m as reported) recognised upon refinement of the calculation of the present value of in-force ('PVIF') long-term insurance business in the first half of 2011. The increase in the PVIF asset attributable to the value of new business, in line with the rise in premiums, was largely offset by the net movement in expected return and experience and assumption updates.

Losses were also recognised on the sale of syndicated loans in Europe and on the reclassification of certain businesses to held-for-sale in Latin America. The non-recurrence of the gain on sale and leaseback of branches in Mexico in the first half of 2011 also contributed to the decrease in other operating income.

Net insurance claims incurred and movement in liabilities to policyholders

For footnote, see page 100.

Net insurance claims incurred and movement in liabilities to policyholders increased by 2% on a reported basis, and by 7% on a constant currency basis. The increase was driven by the continued growth of the business, notably in Hong Kong and Latin America, and from higher investment returns allocated to policyholders compared with the same period in 2011.

The increase in liabilities to policyholders was primarily driven by additional liabilities established for new business written, notably in Hong Kong and Brazil, which was consistent with increases in net earned premiums. In addition, the strong renewal premium in Hong Kong also contributed to additional reserves.

Further increases in the movement in liabilities to policyholders resulted from gains on the fair value of the assets held to support policyholder contracts where the policyholder bears investment risk. This particularly related to unit-linked insurance contracts and investment and insurance contracts with DPF. The higher investment returns were the result of favourable equity market movements compared with the same period in 2011. The gains or losses experienced on the financial assets designated at fair value held to support these insurance and investment contract liabilities are reported in 'Net income from financial instruments designated at fair value'.

Loan impairment charges and other credit risk provisions

On a reported basis, loan impairment charges and other credit risk provisions decreased from US$5.3bn to US$4.8bn, a decline of 9% compared with the first half of 2011 and 6% on a constant currency basis. Within this, collectively assessed allowances fell by 19% and individually assessed impairment allowances increased by 78% on a constant currency basis.

An improvement in loan impairment charges and other credit risk provisions was recorded, primarily in our CML portfolio in North America and, to a lesser extent, in Europe. This was partly offset by increased loan impairment charges and other credit risk provisions in Latin America, mainly in Brazil, as well as in Rest of Asia‑Pacific and the Middle East and North Africa.

Impairments on available-for-sale debt securities were US$56m lower than in the first half of 2011, primarily in Europe due to lower charges on available-for-sale ABSs on legacy credit and lower impairment charges on available-for-sale Greek sovereign debt in GB&M.

Loan impairment charges and other credit risk provisions in North America fell by 29% compared with the first half of 2011 to US$2.2bn, reflecting a reduction in CML, as well as the sale of the Card and Retail Services business in May 2012.

Loan impairment charges in our CML business in the US fell by 28% to US$1.6bn, driven by lower lending balances, an improvement in two-months-and-over contractual delinquency on balances less than 180 days past due as the portfolios continued to run off. Loan impairment charges were adversely affected by delays in expected cash flows from mortgage loans as a result of delays in foreclosure processing, though the effect was less pronounced than in the first half of 2011. Additionally, in the first half of 2012 we increased our loan impairment allowances having updated our assumptions regarding the timing of expected cash flows received from customers with modified loans.

In Europe, loan impairment charges and other credit risk provisions decreased by 9% to US$1.0bn, primarily in the UK. This reduction was mainly in RBWM, due to improved delinquency trends across both the secured and unsecured portfolios where we continued to focus our lending growth on higher quality assets. In GB&M, loan impairment charges increased because of a small number of individually assessed provisions in the UK and a rise in charges in our legacy credit business. This was partly offset by lower credit risk provisions, primarily driven by reduced impairments on available-for-sale ABSs in legacy credit as the losses arising in the underlying collateral pools generated lower charges, coupled with a lower impairment charge on Greek sovereign debt. Further information on our exposures to countries in the eurozone is provided in 'Areas of special interest - Eurozone exposures' on page 121. In CMB, loan impairment charges and other credit risk provisions increased by US$58m, driven by a rise in individually assessed loan impairment allowances, reflecting the challenging economic conditions.

Loan impairment charges and other credit risk provisions in Latin America increased by 57% to US$1.1bn, primarily in RBWM and CMB. In RBWM, this was mainly due to increased delinquency rates in Brazil, following strong balance sheet growth in previous periods which was driven by increased marketing, a focus on acquiring customers and strong customer demand in buoyant economic conditions which subsequently weakened. In CMB, loan impairment charges and other credit risk provisions almost doubled to US$315m, mainly in Brazil following strong balance sheet growth, primarily in Business Banking, which resulted in increased delinquencies as well as a rise in individually assessed loan impairment charges. We took a number of steps to address the increase in delinquencies in RBWM and CMB, including improving our collections capabilities reducing third-party originations and lowering credit limits where appropriate.

In Rest of Asia-Pacific, loan impairment charges and other credit risk provisions increased by US$197m, due to higher individually assessed impairment charges relating to a small number of corporate exposures in the region and a charge on available-for-sale debt securities.

In the Middle East and North Africa, loan impairment charges and other credit risk provisions increased by 38% to US$135m, primarily in GB&M, as we incurred a small number of significant individually assessed loan impairment charges in the first half of 2012. Loan impairment charges were 36% lower in RBWM due to an improvement in credit quality which reflected the repositioning of the book towards higher quality lending. Loan impairment charges were also lower in CMB due to the non-recurrence of loan impairment charges in the first half of 2011, relating to a small number of corporate names as we worked closely with our customers through the credit cycle.

In Hong Kong, loan impairment charges and other credit risk provisions remained broadly unchanged as the credit environment remained stable and we maintained our focus on high levels of asset quality.

Operating expenses

Staff numbers (full-time equivalent)

Operating expenses of US$21.2bn increased by 3% on a reported basis and by US$1.4bn or 7% on a constant currency basis compared with the first half of 2011. On an underlying basis, costs increased by 10%.

The rise in operating expenses on a constant currency basis resulted from a number of notable items.

In the first half of 2012, additional provisions of US$1.3bn were raised in respect of customer redress provisions in the UK, taking the balance sheet provision at 30 June 2012 to US$1.7bn (see Note 17 on the Financial Statements). These provisions include the estimated redress for the possible mis‑selling in previous years of PPI policies (US$1.0bn) and interest rate protection products (US$237m). With regard to the latter, we are working with customers and the Financial Services Authority ('FSA') to assess the need for redress for smaller companies. The additional provision relating to PPI sales reflects the refinement of our assumptions in the light of our recent claims

experience. There are many factors which affect the estimated liability and there remains a high degree of uncertainty as to the eventual cost of redress for these matters.

Operating expenses included a provision of US$700m which represents management's best estimate of the amount of penalties and fines related to US anti-money laundering, BSA and OFAC investigations as described in Note 25 on the Financial Statements. There is a high degree of uncertainty in making this estimate and it is possible that the amounts when finally determined could be higher, possibly significantly higher. A change to this estimate could adversely affect operating expenses in the future. On page 107, we discuss the possible adverse consequences which could arise from regulatory investigations.

Costs also rose due to the non-recurrence of a credit in 2011 of US$570m (US$587m as reported) following a change in the inflation measure used to calculate the defined benefit obligation in the UK for deferred pensions.

In the first half of 2012, we continued in our efforts to simplify the Group through our organisational effectiveness programmes. This resulted in an increase in restructuring costs of US$112m compared with the first half of 2011.

During the period we achieved a further US$0.8bn of sustainable cost savings through our organisational effectiveness programmes. The savings achieved by delivering on these programmes enabled the funding of investment in strategic initiatives including business expansion projects, primarily in Rest of Asia-Pacific, and the strengthening of our regulatory control and compliance infrastructure.

During the first half of the year our average staff numbers (expressed in FTEs) fell by 5%, compared with the first half of 2011. We recorded a net reduction of more than 16,700 FTEs compared with the end of 2011 through our organisational effectiveness programmes and the sale of the Card and Retail Services portfolio and the non-strategic branches in the US. The resulting savings in staff costs, however, were more than offset by restructuring costs, the non-recurrence of the UK pension credit and wage inflation in Latin America, Hong Kong and Rest of Asia-Pacific.

General and administrative expenses increased due to the notable items referred to above. Excluding notable items, costs fell, primarily in North America reflecting reduced marketing programmes in Card and Retail Services during the first half of 2012 and the lower cost of holding foreclosed properties, as inventory diminished following the slowing of foreclosure processing activities. Offsetting this decline were higher compliance costs in the US, along with business growth and general inflationary pressures particularly in Latin America and Rest of Asia-Pacific.

Cost efficiency ratios

Share of profit in associates and joint ventures

The reported share of profit in associates and joint ventures was US$1.8bn, an increase of 18% compared with the first half of 2011. On a constant currency basis, this increased by 15%, driven primarily by higher contributions from our mainland China associates.

Our share of profits from BoCom rose, driven by loan growth and wider spreads. Fee income also increased from settlements and credit cards. Profits from Industrial Bank increased due to continued strong lending growth and a rise in fee based revenue, partly offset by a rise in operating expenses.

Profits from The Saudi British Bank rose, driven by higher revenues, lower loan impairment charges and good cost control.

Profits from Ping An were lower, as increased income from the banking business following the consolidation of Shenzhen Development Bank and stable insurance income were more than offset by lower securities broking and underwriting income.

On 6 March 2012, Industrial Bank announced a proposal for the private placement of additional share capital. The proposal is subject to regulatory approvals and, if it proceeds, will dilute our interest in Industrial Bank and lead to a reassessment of the current accounting treatment of the investment.

Tax expense

The tax charge in the first half of 2012 was US$1.9bn higher than in the first half of 2011 on a reported basis.

The higher tax charge in the first half of 2012 reflected the effect of higher taxed profits arising on the disposal of the Card and Retail Services business and the US branches, as well as the non-deductible provision in respect of US anti-money laundering,

BSA and OFAC investigations. The lower tax charge in the first half of 2011 included the benefit of US deferred tax recognised in 2011 in respect of foreign tax credits.

As a result of these factors, the reported effective tax rate for the first half of 2012 was 28.5% compared with 14.9% for the first half of 2011.

Summary consolidated balance sheet

For footnotes, see page 100.

A more detailed consolidated balance sheet is contained in the Financial Statements on page 213.

Movement from 31 December 2011 to 30 June 2012

Total reported assets were US$2.7 trillion, 4% higher than at 31 December 2011 on both a reported and constant currency basis.

Our conservative approach to managing the Group balance sheet and strong excess liquidity position, partly due to the growth in deposits in the first half of 2012, enabled us to continue to support our customers' borrowing requirements, resulting in growth in term and trade-related lending and residential mortgages. Trading assets grew due to increased client activity in the first half of 2012, and the fair value of derivative contracts rose due to downward movements of yield curves in major currencies. A number of the business disposals announced previously were completed, including the sale of the Card and Retail Services business and 138 non-strategic branches in the US, as we continued to reshape our balance sheet and improve our capital deployment.

The following commentary is based on a comparison with the balance sheet at 31 December 2011.

Assets

Cash and balances at central banks increased by 14%. Financial markets continued to be dominated by concerns about eurozone sovereign debt levels and their possible contagion effects in the first half of 2012. As a result, we maintained our conservative risk profile by placing a greater portion of our excess liquidity with central banks, particularly in Europe. In North America, balances at central banks declined as liquidity was redeployed into government debt securities and reverse repos and to repay debt.

Trading assets rose by 18%, as client activity increased from the subdued levels seen in the second half of 2011. This resulted in higher reverse repo and equity securities balances, as well as a rise in settlement account balances which vary significantly in proportion to the level of trading activity. In addition, the increase in cash collateral posted with external counterparties reflected the increase in the fair value of derivative liabilities.

Financial assets designated at fair value increased by 6%. This was driven by the consolidation of a fund in our insurance business in France, which invests primarily in debt securities, following an increase in our holding in the first half of the year.

Derivative assets increased by 3%. This was driven by a significant rise in the fair value of interest rate contracts, notably in Europe, due to downward movements of yield curves in major currencies reflecting the ongoing monetary response to the economic weakness and turmoil in the eurozone. This was offset in part by higher netting, which rose in line with the increase in fair values.

Loans and advances to banks remained in line with December 2011 levels.

Loans and advances to customers increased by 4%. Lending grew in the second quarter of 2012, notably in CMB in Hong Kong, Rest of Asia-Pacific and the UK and in GB&M in Rest of Asia-Pacific as we captured international trade and capital flows and demand for credit rose. Overdraft balances in the UK which did not meet netting criteria under current accounting rules also increased, with a corresponding rise in customer accounts. Reverse repo balances rose, largely due to the deployment of the proceeds from the US disposals. In addition, residential mortgage balances continued to grow strongly, notably in the UK reflecting the success of our competitive offerings and marketing campaigns and, to a lesser extent, in Hong Kong where housing market activity remained relatively subdued compared with the previous year. The rise was also attributable to the completion of the merger of our operations in Oman ('HSBC Oman') with Oman International Bank S.A.O.G. ('OIB'). This was partly offset by a reduction in residential mortgage balances in the US due to repayments on the run-off portfolio closed to new business.

During the first half of 2012, loans and advances to customers relating to the planned disposals of non-strategic RBWM banking operations in Rest of Asia-Pacific and businesses in Latin America were reclassified from 'Loans and advances to customers' to 'Assets held-for-sale' as we continued to reshape the Group using our five filters framework. A combined view of customer lending, which includes loans and advances to customers classified as held for sale is shown on page 36. The combined view of lending remained in line with December 2011 levels as growth in mortgage balances and term lending was broadly offset by the completion of the sale of the US Card and Retail Services business and the disposal of 138 non-strategic branches in the US in the first half of 2012.

Financial investments were broadly in line with December 2011 levels as Balance Sheet Management continued to hold large portfolios of highly liquid assets while managing selectively our exposure to sovereign debt. In Europe, financial investments declined as we redeployed the liquidity from the disposal of available-for-sale securities to central banks as part of portfolio management activities. This was largely offset by a rise in North America where excess liquidity was redeployed into government debt securities.

Assets held for sale declined by 69% as a result of the completion of the US disposals. This was partly offset by reclassification of assets of disposal groups to 'Assets held for sale', notably the loans and advances to customers associated with the non-strategic operations in Latin America and Rest of Asia-Pacific.

Other assets remained in line with December 2011 levels.

Liabilities

Deposits by banks increased by 10%. The continued turmoil in sovereign debt markets led to a rise in placements by other financial institutions with HSBC, notably in Europe.

Customer accounts grew by 2%, driven by growth in Europe across all global businesses, and in Hong Kong across RBWM and CMB, reflecting the success of deposit gathering initiatives. The rise was also attributable to the completion of the merger of HSBC Oman with OIB. This was partly offset by lower repo balances and declines in Latin America due to a managed reduction in term deposits in Brazil, together with a fall in North America as short-term institutional placements at the end of 2011 returned to more normal levels in a competitive market.

In the first half of 2012, we reclassified deposit balances of non-strategic businesses in Rest of Asia-Pacific and Latin America from 'Customer accounts' to 'Liabilities held for sale'. A combined view of customer deposits with customer accounts classified as held for sale is shown on page 36. The rise in the combined view of deposits reflected the growth in customer accounts, offset in part by the completion of the sale of the non-strategic branches in the US.

Trading liabilities increased by 16% as a result of higher repo activity to fund the rise in trading assets resulting from the increase in client activity. Cash collateral posted by third parties also rose in line with the fair value of derivative assets, notably in Europe. Settlement account balances, which vary significantly in proportion to the level of trading activity, also increased.

Financial liabilities designated at fair value remained in line with December 2011 levels. A net increase in Europe as a result of new issuances was broadly offset by a net reduction in North America, where maturities were not replaced as funding requirements fell, driven by the business disposals and the continued reduction of the consumer finance portfolios in run-off in the US.

Derivative businesses are managed within market risk limits and, as a consequence, the increase in the value of Derivative liabilities broadly matched that of 'Derivative assets'.

Debt securities in issue decreased by 4%. As noted above, funding requirements declined in North America and therefore maturing debt issuances were not replaced.

Liabilities under insurance contracts increased by 4%. This reflected reserves established for new business written, notably in Hong Kong and Europe, together with higher investment returns which resulted in a rise in the fair value of assets held to support unit-linked and investment and insurance contracts with DPF and the related liabilities to policyholders. This was partly offset by a reduction in insurance liabilities following the completion of the sale of the general insurance business in Argentina and reclassification of insurance liabilities in the US to liabilities of disposal groups held for sale.

Liabilities of disposal groups held for sale decreased by 43% following the completion of the disposal of 138 branches in the US. This was partly offset by the reclassification of liabilities relating to the non-strategic businesses in Latin America and Rest of Asia-Pacific together with insurance liabilities in the US to 'Liabilities of disposal groups held for sale' following the five filters review.

Other liabilities rose by 11%, reflecting the rise in provisions relating to certain US law enforcement and regulatory matters and customer redress provisions, a rise in current tax liabilities and higher balances owed to bondholders and investors in consolidated funds.

Equity

Total shareholders' equity rose by 5%, driven by profits generated in the period and a reduction in the negative balance on the available-for-sale reserve from US$3.4bn at 31 December 2011 to US$1.8bn at 30 June 2012 reflecting an improvement in the fair value of these assets.

Reconciliation of constant currency changes in assets and liabilities

For footnote, see page 100.

In implementing our strategy, we have agreed to sell a number of businesses across the Group. Assets and liabilities of businesses, the sale of which is highly probable, are reported in held-for-sale categories on the balance sheet until the sale is closed. We include loans and advances to customers

and customer account balances reported in held-for-sale categories in our combined view of customer lending and customer accounts. We consider the combined view more accurately reflects the size of our lending and deposit books and growth thereof.

Customer accounts by country