Risk management

Market Dislocation

During 2008, the global dislocation in financial markets has resulted in exceptional instability and volatility impacting upon market and investor confidence which has been characterised by a marked reduction in liquidity. This crisis in the financial markets led the UK Government to inject liquidity into the financial system and to require (and participate in) recapitalisation of the banking sector to restore confidence to the market.

During October 2008, as part of the co-ordinated package of capital and funding measures for the UK banking sector, implemented by HM Treasury, the Group participated in the Government Funding Package and thereby facilitated access to the UK Government backed provision of liquidity.

There can be no assurance that the measures so far announced by the Government, will be sufficient to prevent any future strain on the Group's ability to meet its financial obligations as they fall due. The recovery of wholesale and capital markets will depend upon renewed confidence in the UK banking system particularly if market conditions revert to the reduced levels of wholesale market liquidity, and the availability of traditional sources of funding become more limited.

The key dependencies on successfully funding the Group's balance sheet include the continued functioning of the money and capital markets at their current levels; the continued access of the Group to central bank and Government sponsored liquidity facilities, including issuance under HMT's credit guarantee scheme (CGS) and access to the Bank of England's various facilities; limited further deterioration in the Group's credit ratings; and no significant or sudden withdrawal of deposits resulting in increased reliance on money markets or Government support schemes.

Based upon projections by management, which take into account the acquisition on the 16 January 2009 of HBOS plc, and assume the availability of the existing and announced Government Funding Package, the Group believes it has adequate resources to continue in business for the foreseeable future.

Responses to market dislocation and banking crisis

During the market dislocation there has been even more rigorous focus on the governance, accountabilities and execution capabilities to ensure adherence to an even lower risk profile. It is part of the Lloyds TSB approach to learn from adverse situations – regardless of whether there has been any direct business impact. Accordingly, ‘lessons learned' exercises form part of normal activity and have been carried out during this turbulent period. The Lloyds TSB risk culture has manifested itself in some clear and critical pre crunch wholesale and capital markets policy actions that served to limit exposure.

The Group has developed its credit, liquidity and market risk control frameworks. Particular focus has been placed on the control of credit spread risk, associated stress testing and modelling. The Group during the year has further strengthened its oversight of liquidity, funding, capital and asset liability management issues with the upgrading of membership of the group asset and liability committee. Membership consists of group executive committee members and the treasurer, and it is chaired by the chief executive. A senior asset and liability committee has been created to support the group asset and liability committee. There have also been a number of further developments to our liquidity control frameworks that have been instituted including further developments of stress testing. During the height of the crisis, daily meetings with the group chief executive were held to assess the Group's position which has held up well during the worst aspects of the market dislocation.

In respect of credit risk, Lloyds TSB has reduced exposure via timely exit or scaling back of positions. In wholesale and capital market exposure, the Group has restricted investment policy for the Lloyds TSB conduit ‘Cancara' (for example: no CDOs of asset backed securities); restricted exposure to monolines and leveraged loans; reviewed liquidity risk appetite and enhanced liquidity reporting; reduced holdings of equities in the insurance companies; progressed its pension scheme de-risking strategy and tightened policy parameters for US sub-prime mortgages. Also, all exposures were sanctioned on the basis of Lloyds TSB being content to hold the risk to maturity. In retail banking, risk mitigation activities and a prudent lending stance were maintained in the context of the changing environment: tightening of maximum loan to value criteria on all mortgage books; withdrawal of higher risk mortgage products; tightening of credit card eligibility criteria and tightening of policy rules and scorecard cut offs across all retail portfolios.

Consistent with our ‘through the cycle' approach, Lloyds TSB has a proactive and supportive approach to assist customers through difficult periods. We have also invested significantly in our highly successful collections and recoveries and business support units.