Notes to the consolidated financial statements

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49 Financial risk management

As a bancassurer, financial instruments are fundamental to the Group's activities and, as a consequence, the risks associated with financial instruments represent a significant component of the risks faced by the Group.

The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk; and liquidity risk. Information about the Group's exposure to each of the above risks, the Group's objectives, policies and processes for measuring and managing risk and the Group's management of capital can be found in the Risk Management section. The following additional disclosures, which provide quantitative information about the risks within financial instruments held or issued by the Group, should be read in conjunction with that earlier information.

Measurement basis of financial assets and liabilities

The accounting policies in note 2 describe how different classes of financial instruments are measured, and how income and expenses, including fair value gains and losses, are recognised. The following table analyses the carrying amounts of the financial assets and liabilities by category and by balance sheet heading.

			At fair value through profit or loss
	Derivatives designated as hedging instruments £m		Held for trading £m	Designated upon initial recognition £m	Available- for-sale £m	Loans and receivables £m	Held at amortised cost £m	Insurance contracts £m	Total £m
As at 31 December 2008
Financial assets
Cash and balances at central banks	–		–	–	–	–	5,008	–	5,008
Items in the course of collection from banks	–		–	–	–	–	946	–	946
Trading and other financial assets at fair value through profit or loss	–		857	44,207	–	–	–	–	45,064
Derivative financial instruments	435		28,449	–	–	–	–	–	28,884
Loans and advances to banks	–		–	–	–	40,758	–	–	40,758
Loans and advances to customers	–		–	–	–	242,735	–	–	242,735
Available-for-sale financial assets	–		–	–	55,707	–	–	–	55,707
Total financial assets	435		29,306	44,207	55,707	283,493	5,954	–	419,102
Financial liabilities
Deposits from banks	–		–	–	–	–	66,514	–	66,514
Customer accounts	–		–	–	–	–	170,938	–	170,938
Items in course of transmission to banks	–		–	–	–	–	508	–	508
Trading and other liabilities at fair value through profit or loss	–		6	6,748	–	–	–	–	6,754
Derivative financial instruments	4,169		22,723	–	–	–	–	–	26,892
Debt securities in issue	–		–	–	–	–	75,710	–	75,710
Liabilities arising from insurance contracts and participating investment contracts	–		–	–	–	–	–	33,792	33,792
Liabilities arising from non-participating investment contracts	–		–	–	–	–	–	14,243	14,243
Unallocated surplus within insurance businesses	–		–	–	–	–	–	270	270
Subordinated liabilities	–		–	–	–	–	17,256	–	17,256
Total financial liabilities	4,169		22,729	6,748	–	–	330,926	48,305	412,877

			At fair value through profit or loss
	Derivatives designated as hedging instruments £m		Held for trading £m	Designated upon initial recognition £m	Available- for-sale £m	Loans and receivables £m	Held at amortised cost £m	Insurance contracts £m	Total £m
As at 31 December 2007
Financial assets
Cash and balances at central banks	–		–	–	–	–	4,330	–	4,330
Items in the course of collection from banks	–		–	–	–	–	1,242	–	1,242
Trading and other financial assets at fair value through profit or loss	–		4,663	53,248	–	–	–	–	57,911
Derivative financial instruments	264		8,395	–	–	–	–	–	8,659
Loans and advances to banks	–		–	–	–	34,845	–	–	34,845
Loans and advances to customers	–		–	–	–	209,814	–	–	209,814
Available-for-sale financial assets	–		–	–	20,196	–	–	–	20,196
Total financial assets	264		13,058	53,248	20,196	244,659	5,572	–	336,997
Financial liabilities
Deposits from banks	–		–	–	–	–	39,091	–	39,091
Customer accounts	–		–	–	–	–	156,555	–	156,555
Items in course of transmission to banks	–		–	–	–	–	668	–	668
Trading and other liabilities at fair value through profit or loss	–		99	3,107	–	–	–	–	3,206
Derivative financial instruments	800		6,782	–	–	–	–	–	7,582
Debt securities in issue	–		–	–	–	–	51,572	–	51,572
Liabilities arising from insurance contracts and participating investment contracts	–		–	–	–	–	–	38,063	38,063
Liabilities arising from non-participating investment contracts	–		–	–	–	–	–	18,197	18,197
Unallocated surplus within insurance businesses	–		–	–	–	–	–	554	554
Subordinated liabilities	–		–	–	–	–	11,958	–	11,958
Total financial liabilities	800		6,881	3,107	–	–	259,844	56,814	327,446

Reclassification of financial assets

In accordance with the amendment to lAS 39 as disclosed in note 2, the Group reviewed the categorisation of its assets classified as held for trading and available-for-sale financial assets. On the basis that there was no longer an active market for some of those assets, which are therefore more appropriately managed as loans, the Group reclassified £2,993 million of assets classified as held for trading (measured at fair value through profit or loss immediately prior to reclassification) to loans and receivables with effect from 1 July 2008 and £437 million of assets classified as available-for-sale financial assets (measured at fair value through equity) to loans and receivables with effect from 1 November 2008. At the time of these transfers, the Group had the intention and ability to hold them for the foreseeable future or until maturity.

Held for trading to loans and receivables

In respect of the £2,993 million of assets transferred with effect from 1 July 2008, a loss of £172 million was recognised in the income statement for the six months to 30 June 2008 (year to 31 December 2007: £132 million) while they were classified as held for trading. If the assets had not been transferred and had been kept as held for trading, a loss of £347 million would have been recognised in the income statement for the six months to 31 December 2008 within net trading income.

Since their reclassification to loans and receivables, a net credit of £31 million has been recognised in the income statement for the six months to 31 December 2008 within net interest income and a charge of £158 million within impairment. The weighted average effective interest rate of the assets transferred was 6.3 per cent with expected recoverable cash flows of £3,524 million.

Available-for-sale financial assets to loans and receivables

In respect of the £437 million of assets transferred with effect from 1 November 2008, a negative valuation movement of £261 million, including exchange movements, was recognised in the revaluation reserve in respect of available-for-sale financial assets for the ten months to 31 October 2008 while they were classified as available-for-sale financial assets. If the assets had not been transferred and had been kept as available-for-sale financial assets £3 million would have been recognised in interest income and £209 million would have been recognised in impairment in the income statement for the two months to 31 December 2008.

Since their reclassification to loans and receivables, an amount of £3 million has been recognised in the income statement for the two months to 31 December 2008 within interest income and a further £23 million within impairment. The weighted average effective interest rate of the assets transferred was 10.9 per cent with expected recoverable cash flows of £837 million.

For the year ended 31 December 2007, a negative valuation movement of £34 million, including exchange movements, was recognised in the revaluation reserve in respect of available-for-sale financial assets and £32 million was recognised in interest income.

Interest rate risk

In the Group's retail banking business interest rate risk arises from the different repricing characteristics of the assets and liabilities. Liabilities are either insensitive to interest rate movements, for example interest free or very low interest customer deposits, or are sensitive to interest rate changes but bear rates which may be varied at the Group's discretion and that for competitive reasons generally reflect changes in the Bank of England's base rate. There are a relatively small volume of deposits whose rate is contractually fixed for their term to maturity.

Many banking assets are sensitive to interest rate movements; there is a large volume of managed rate assets such as variable rate mortgages which may be considered as a natural offset to the interest rate risk arising from the managed rate liabilities. However a significant proportion of the Group's lending assets, for example personal loans and mortgages, bear interest rates which are contractually fixed for periods of up to five years or longer.

The Group establishes two types of hedge accounting relationships for interest rate risk: fair value hedges and cash flow hedges. The Group is exposed to fair value interest rate risk on its fixed rate customer loans, its fixed rate customer deposits and the majority of its subordinated debt, and to cash flow interest rate risk on its variable rate loans and deposits together with its floating rate subordinated debt. The majority of the Group's hedge accounting relationships are fair value hedges where interest rate swaps are used to hedge the interest rate risk inherent in the fixed rate mortgage portfolio. At 31 December 2008 the aggregate notional principal of interest rate swaps designated as fair value hedges was £37,243 million (2007: £50,734 million) with a net fair value liability of £1,231 million (2007: £197 million) (see note 17). The losses on the hedging instruments were £584 million (2007: losses of £233 million). The gains on the hedged items attributable to the hedged risk were £426 million (2007: gains of £211 million).

In addition the Group has a small number of cash flow hedges which are primarily used to hedge the variability in the cost of funding within the wholesale business. These cash flows are expected to occur over the next six years and the hedge accounting adjustments will be reported in the income statement as the cash flows arise. The notional principal of the interest rate swaps designated as cash flow hedges at 31 December 2008 was £867 million (2007: £630 million) with a net fair value liability of £90 million (2007: £23 million) (see note 17). In 2008, there is no ineffectiveness recognised in the income statement that arises from cash flow hedges (2007: nil). There were no transactions for which cash flow hedge accounting had to be ceased in 2008 or 2007 as a result of the highly probable cash flows no longer being expected to occur.

Currency risk

Foreign exchange exposures comprise those originating in treasury trading activities and structural foreign exchange exposures, which arise from investment in the Group's overseas operations.

The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to Wholesale and International Banking Market and Liquidity Risk. Associated VaR and the closing, average, maximum and minimum for 2007 and 2008 are disclosed within Risk Management.

Risk arises from the Group's investments in its overseas operations. The Group's structural foreign currency exposure is represented by the net asset value of the foreign currency equity and subordinated debt investments in its subsidiaries and branches. Gains or losses on structural foreign currency exposures are taken to reserves.

The Group hedges part of the currency translation risk of the net investment in certain foreign operations using cross currency swaps. At 31 December 2008 the aggregate notional principal of these cross currency swaps was £6,318 million (2007: £5,302 million) with a net fair value liability of £2,413 million (2007: liability of £316 million) (see note 17) and they were designated on an after-tax basis as hedges of net investments in foreign operations. In 2008, ineffectiveness of £14 million before tax and £10 million after tax (2007: nil) was recognised in the income statement arising from net investment hedges.

The Group's main overseas operations are in the Americas, Asia and Europe. Details of the Group's structural foreign currency exposures, after net investment hedges, are as follows:

	2008 £m		2007 £m
Functional currency of Group operations
Euro	133		95
US dollar	(907)		7
Swiss franc:
Gross exposure	2,784		1,945
Net investment hedge	(2,663)		(1,875)
	121		70
Japanese yen:
Gross exposure	3,667		2,148
Net investment hedge	(3,645)		(2,136)
	22		12
Other non-sterling	296		196
	(335)		380

Credit risk

The Group's credit risk exposure arises predominantly in the United Kingdom and the European Union.

The maximum credit risk exposure of the Group in the event of other parties failing to perform their obligations is detailed below. No account is taken of any collateral held and the maximum exposure to loss is considered to be the balance sheet carrying amount or, for non-derivative off-balance sheet transactions and financial guarantees, their contractual nominal amounts.

	2008 £m		2007 £m
Loans and advances to banks	40,916		34,845
Loans and advances to customers	246,304		212,222
Deposit amounts available for offset1	(4,837)		(6,206)
Impairment losses	(3,727)		(2,408)
	278,656		238,453
Available-for-sale debt securities and treasury and other bills	55,666		20,167
Trading and other financial assets at fair value through profit or loss	21,790		26,165
Derivative assets, before netting	28,884		8,659
Amounts available for offset under master netting arrangements1	(10,598)		(3,287)
	18,286		5,372
Assets arising from reinsurance contracts held	385		350
Financial guarantees	10,382		9,753
Irrevocable loan commitments and other credit-related contingencies2	51,659		56,600
Maximum credit risk exposure	436,824		356,860
Maximum credit risk exposure before offset items	452,259		366,353

¹Deposit amounts available for offset and amounts available for offset under master netting arrangements do not meet the criteria under IAS 32 to enable loans and advances and derivative assets respectively to be presented net of these balances in the financial statements.

²See note 48 – Contingent liabilities and commitments for further information.

A general description of collateral held in respect of financial instruments is disclosed within Risk Management.

Loans and advances to banks – the Group may require collateral before entering into a credit commitment with another bank, depending on the type of the financial product and the counterparty involved, and netting agreements are obtained whenever possible and to the extent that such agreements are legally enforceable.

Available-for-sale debt securities, treasury and other bills, and trading and other financial assets at fair value through profit or loss – the credit quality of the Group's available-for-sale debt securities, treasury and other bills, and the majority of the Group's trading and other financial assets at fair value through profit or loss held is set out below. An analysis of trading and other financial assets at fair value through profit or loss is included in note 16 and a similar analysis for available-for-sale financial assets is included in note 21. The Group's non-participating investment contracts are all unit-linked. Movements in the fair values of trading and other financial assets at fair value through profit or loss which back those investment contracts, including movements arising from credit risk, are borne by the contract holders.

Derivative assets – the Group reduces exposure to credit risk by using master netting agreements and by obtaining cash collateral. An analysis of derivative assets is given in note 17. Of the net derivative assets of £18,286 million (2007 £5,372 million), cash collateral of £2,970 million (2007: £2,004 million) was held and a further £5,840 million was due from OECD banks (2007: £1,459 million).

Assets arising from reinsurance contracts held – of the assets arising from reinsurance contracts held at 31 December 2008 of £385 million (2007: £350 million), £380 million (2007: £341 million) were due from insurers with a credit rating of AA or above.

Financial guarantees – these represent undertakings that the Group will meet a customer's obligation to third parties if the customer fails to do so. Commitments to extend credit represent unused portions of authorisations to extend credit in the form of loans, guarantees or letters of credit. The Group is theoretically exposed to loss in an amount equal to the total guarantees or unused commitments, however, the likely amount of loss is expected to be significantly less; most commitments to extend credit are contingent upon customers maintaining specific credit standards.

Reverse repo and repo transactions – for reverse repo transactions which are accounted for as collateralised loans, it is the Group's policy to seek collateral which is at least equal to the amount loaned. At 31 December 2008, the fair value of collateral accepted under reverse repo transactions that the Group is permitted by contract or custom to sell or repledge was £5,858 million (2007: £10,300 million). Of this, £5,855 million (2007: £10,299 million) was sold or repledged as at 31 December 2008. The fair value of collateral pledged in respect of repo transactions, accounted for as secured borrowings, where the secured party is permitted by contract or custom to repledge was £5,734 million (2007: £768 million).

Loans and advances

	Loans and advances to customers				Loans and advances designated at fair value through profit or loss £m	Loans and advances to banks £m
	Retail – mortgages £m	Retail – other £m	Wholesale £m	Total £m
31 December 2008
Neither past due nor impaired	110,148	33,571	89,208	232,927	608	40,741
Past due but not impaired	3,134	1,146	555	4,835	–	17
Impaired – no provision required	479	150	1,253	1,882	–	–
– provision held	882	4,327	1,451	6,660	–	158
Gross	114,643	39,194	92,467	246,304	608	40,916
Allowance for impairment losses (note 20)	(186)	(2,345)	(1,038)	(3,569)	–	(158)
Net	114,457	36,849	91,429	242,735	608	40,758
31 December 2007
Neither past due nor impaired	99,828	29,850	73,475	203,153	1,189	34,845
Past due but not impaired	2,153	966	639	3,758	–	–
Impaired – no provision required	415	100	293	808	–	–
– provision held	343	3,600	560	4,503	–	–
Gross	102,739	34,516	74,967	212,222	1,189	34,845
Allowance for impairment losses (note 20)	(37)	(2,029)	(342)	(2,408)	–	–
Net	102,702	32,487	74,625	209,814	1,189	34,845

The analysis of lending between retail and wholesale has been prepared based upon the type of exposure and not the business segment in which the exposure is recorded. Included within retail are exposures to personal customers and small businesses, whilst included within wholesale are exposures to corporate customers and other large institutions.

Loans and advances which are neither past due nor impaired

	Loans and advances to customers				Loans and advances designated at fair value through profit or loss £m	Loans and advances to banks £m
	Retail – mortgages £m	Retail – other £m	Wholesale £m	Total £m
31 December 2008
Good quality	109,437	21,251	50,718		129	40,295
Satisfactory quality	643	9,305	34,559		411	192
Lower quality	–	900	3,444		56	240
Below standard, but not impaired	68	2,115	487		12	14
Total	110,148	33,571	89,208	232,927	608	40,741
31 December 2007
Good quality	99,407	18,157	46,240		191	34,647
Satisfactory quality	378	8,964	25,013		670	190
Lower quality	1	665	2,034		327	7
Below standard, but not impaired	42	2,064	188		1	1
Total	99,828	29,850	73,475	203,153	1,189	34,845

The definitions of good quality, satisfactory quality, lower quality and below standard, but not impaired applying to retail and wholesale are not the same, reflecting the different characteristics of these exposures and the way they are managed internally, and consequently totals are not provided. Wholesale lending has been classified using internal probability of default rating models mapped so that they are comparable to external credit ratings. Good quality lending comprises the lower assessed default probabilities, with other classifications reflecting progressively higher default risk. Classifications of retail lending incorporate expected recovery levels for mortgages, as well as probabilities of default assessed using internal rating models. Good quality lending includes the lower assessed default probabilities and all loans with low expected losses in the event of default, with other categories reflecting progressively higher risks and lower expected recoveries.

Loans and advances which are past due but not impaired

	Loans and advances to customers				Loans and advances designated at fair value through profit or loss £m	Loans and advances to banks £m
	Retail – mortgages £m	Retail – other £m	Wholesale £m	Total £m
31 December 2008
0-30 days	1,527	853	289	2,669	–	–
30-60 days	633	259	90	982	–	–
60-90 days	424	32	70	526	–	17
90-180 days	549	2	77	628	–	–
Over 180 days	1	–	29	30	–	–
Total	3,134	1,146	555	4,835	–	17
Fair value of collateral held	2,637	n/a	n/a	n/a	–	–
31 December 2007
0-30 days	1,123	781	266	2,170	–	–
30-60 days	445	155	107	707	–	–
60-90 days	260	29	129	418	–	–
90-180 days	325	1	67	393	–	–
Over 180 days	–	–	70	70	–	–
Total	2,153	966	639	3,758	–	–
Fair value of collateral held	2,111	n/a	n/a	n/a	–	–

A financial asset is 'past due' if a counterparty has failed to make a payment when contractually due.

Collateral held against retail mortgage lending is principally comprised of residential properties; their fair value has been estimated based upon the last actual valuation, adjusted to take into account subsequent movements in house prices, after making allowance for indexation error and dilapidations. The resulting valuation has been limited to the principal amount of the outstanding advance in order to provide a clearer representation of the Group's credit exposure.

Lending decisions are based on an obligor's ability to repay from normal business operations rather than reliance on the disposal of any security provided. Collateral values for non-mortgage lending are assessed more rigorously at the time of loan origination or when taking enforcement action and may fluctuate, as in the case of floating charges, according to the level of assets held by the customer. Whilst collateral is reviewed on a regular basis in accordance with business unit credit policy, this varies according to the type of lending and collateral involved. It is therefore not practicable to estimate and aggregate current fair values of collateral for non-mortgage lending.

Renegotiated loans and advances

Loans and advances that were renegotiated during the year and that would otherwise have been past due or impaired at 31 December 2008 totalled £144 million (2007: £579 million).

Repossessed collateral

	2008 £m	2007 £m
Residential property	221	73
Other	26	9
Total	247	82

The Group does not take physical possession of properties or other assets held as collateral and uses external agents to realise the value as soon as practicable, generally at auction, to settle indebtedness. Any surplus funds are returned to the borrower or are otherwise dealt with in accordance with appropriate insolvency regulations.

Loan to value ratio of mortgage lending

	2008 £m	2007 £m
Analysis by loan to value ratio of the Group's residential mortgage lending which is neither past due nor impaired:
Less than 70 per cent	55,040	66,716
70 per cent to 80 per cent	15,812	15,690
80 per cent to 90 per cent	15,954	12,102
Greater than 90 per cent	23,342	5,320
Total	110,148	99,828

Debt securities, treasury and other bills – analysis by credit rating:

	AAA £m	AA £m	A £m	BBB £m	Rated BB or lower £m	Not rated £m	Total £m
As at 31 December 2008
Debt securities held at fair value through profit or loss
Trading assets:
Government securities	38	–	–	–	–	–	38
Corporate and other debt securities	76	187	38	68	87	80	536
Total held as trading assets	114	187	38	68	87	80	574
Other assets held at fair value through profit or loss:
Government securities	7,025	45	138	1	–	117	7,326
Other public sector securities	–	–	–	–	–	18	18
Bank and building society certificates of deposit	96	337	–	–	–	–	433
Mortgage backed securities	207	108	23	16	–	15	369
Other asset backed securities	206	362	391	277	105	1	1,342
Corporate and other debt securities	3,194	864	2,911	2,142	599	1,410	11,120
Total held at fair value through profit or loss	10,842	1,903	3,501	2,504	791	1,641	21,182
Available-for-sale financial assets
Debt securities:
Government securities	851	–	1	–	–	16	868
Other public sector securities	–	–	–	–	–	12	12
Bank and building society certificates of deposit	–	9,418	166	–	18	–	9,602
Mortgage backed securities	4,388	6	21	–	14	–	4,429
Other asset backed securities	4,604	121	60	20	98	53	4,956
Corporate and other debt securities	4,111	1,424	304	71	113	567	6,590
Total debt securities	13,954	10,969	552	91	243	648	26,457
Treasury bills and other bills	26,858	2,351	–	–	–	–	29,209
Total held as available-for-sale assets	40,812	13,320	552	91	243	648	55,666
	AAA £m	AA £m	A £m	BBB £m	Rated BB or lower £m	Not rated £m	Total £m
As at 31 December 2007 Debt securities held at fair value through profit or loss
Trading assets:
Government securities	62	–	–	–	–	–	62
Mortgage backed securities	–	28	51	8	–	–	87
Other asset backed securities	–	15	61	38	3	5	122
Corporate and other debt securities	268	1,268	1,390	103	59	519	3,607
Total held as trading assets	330	1,311	1,502	149	62	524	3,878
Other assets held at fair value through profit or loss:
Government securities	4,808	6	15	1	–	18	4,848
Bank and building society certificates of deposit	42	548	53	–	–	168	811
Mortgage backed securities	61	–	–	–	–	9	70
Other asset backed securities	1,367	214	153	71	–	–	1,805
Corporate and other debt securities	5,118	1,606	2,868	2,528	340	1,104	13,564
Total held at fair value through profit or loss	11,726	3,685	4,591	2,749	402	1,823	24,976
Available-for-sale financial assets
Debt securities:
Government securities	310	–	–	–	–	9	319
Other public sector securities	–	–	–	–	–	5	5
Bank and building society certificates of deposit	–	1,683	125	–	15	2	1,825
Mortgage backed securities	5,880	14	10	–	–	146	6,050
Other asset backed securities	3,895	37	27	–	–	112	4,071
Corporate and other debt securities	3,822	1,170	186	–	–	1,092	6,270
Total debt securities	13,907	2,904	348	–	15	1,366	18,540
Treasury bills and other bills	31	1,596	–	–	–	–	1,627
Total held as available-for-sale assets	13,938	4,500	348	–	15	1,366	20,167

There are no material amounts for debt securities, treasury and other bills which are past due but not impaired.

Liquidity risk

The table below analyses financial instrument liabilities of the Group, excluding those arising from insurance and participating investment contracts, on an undiscounted future cash flow basis according to contractual maturity, into relevant maturity groupings based on the remaining period at the balance sheet date; balances with no fixed maturity are included in the over 5 years category.

	Up to 1 month £m	1-3 months £m	3-12 months £m	1-5 years £m	Over 5 years £m	Total £m
As at 31 December 2008
Deposits from banks	49,620	13,617	1,480	1,986	5	66,708
Customer accounts	151,164	8,258	9,675	2,303	697	172,097
Derivative financial instruments, trading and other liabilities at fair value through profit or loss	29,479	1,077	5,295	7,203	3,818	46,872
Debt securities in issue	24,381	26,944	9,192	13,643	3,489	77,649
Liabilities arising from non-participating investment contracts	14,243	–	–	–	–	14,243
Subordinated liabilities	34	130	563	5,382	20,516	26,625
Total	268,921	50,026	26,205	30,517	28,525	404,194
As at 31 December 2007
Deposits from banks	35,466	2,218	1,480	26	–	39,190
Customer accounts	144,213	4,800	7,578	2,002	447	159,040
Derivative financial instruments, trading and other liabilities at fair value through profit or loss	10,286	2,176	3,607	1,589	1,851	19,509
Debt securities in issue	20,307	6,047	9,529	13,202	6,197	55,282
Liabilities arising from non-participating investment contracts	18,197	–	–	–	–	18,197
Subordinated liabilities	27	210	1,067	6,371	14,292	21,967
Total	228,496	15,451	23,261	23,190	22,787	313,185

Trading derivatives (other than those in the insurance companies) and trading liabilities are included in the up to 1 month column at their fair value. Liquidity risk on these items is not managed on the basis of contractual maturity as they are frequently settled on demand at fair value and therefore this is considered a better presentation of the Group's liquidity risk. Derivatives used in a hedging relationship are included according to their contractual maturity.

Cash flows for undated subordinated liabilities whose terms give the Group the option to redeem at a future date are included within the table on the basis that the Group will exercise its option to redeem.

The principal amount for undated subordinated liabilities with no redemption option is included within the over 5 years column; interest of approximately £412 million (2007: £223 million) per annum which is payable in respect of those instruments for as long as they remain in issue is not included beyond 5 years.

Further information on the Group's liquidity exposures is provided within Risk Management.

Liabilities arising from insurance and participating investment contracts are analysed on a behavioural basis, as permitted by IFRS 4, as follows:

	Up to 1 month £m	1-3 months £m	3-12 months £m	1-5 years £m	Over 5 years £m	Total £m
As at 31 December 2008	340	927	2,626	7,030	22,869	33,792
As at 31 December 2007	238	651	1,570	9,548	26,056	38,063

The following tables set out the amounts and residual maturities of Lloyds Banking Group's off balance sheet contingent liabilities and commitments.

	Within 1 year £m		1-3 years £m		3-5 years £m		Over 5 years £m		Total £m
31 December 2008
Acceptances	49		–		–		–		49
Other contingent liabilities	1,722		1,525		402		1,071		4,720
Total contingent liabilities	1,771		1,525		402		1,071		4,769
Lending commitments	54,155		15,029		8,014		3,625		80,823
Other commitments	572		181		80		99		932
Total commitments	54,727		15,210		8,094		3,724		81,755
Total contingents and commitments	56,498		16,735		8,496		4,795		86,524
	Within 1 year £m		1-3 years £m		3-5 years £m		Over 5 years £m		Total £m
31 December 2007
Acceptances	39		1		–		–		40
Other contingent liabilities	1,441		1,032		255		796		3,524
Total contingent liabilities	1,480		1,033		255		796		3,564
Lending commitments	60,981		13,759		10,634		4,221		89,595
Other commitments	466		78		108		117		769
Total commitments	61,447		13,837		10,742		4,338		90,364
Total contingents and commitments	62,927		14,870		10,997		5,134		93,928

Fair values of financial assets and liabilities

Financial instruments include financial assets, financial liabilities and derivatives. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.

Wherever possible, fair values have been estimated using market prices for instruments held by the Group. Where market prices are not available, or are unreliable because of poor liquidity, fair values have been determined using valuation techniques which, to the extent possible, use market observable inputs. Valuation techniques used include discounted cash flow analysis and pricing models and, where appropriate, comparison to instruments with characteristics either identical or similar to those of the instruments held by the Group. These estimation techniques are necessarily subjective in nature and involve several assumptions.

The fair values presented in the following table are at a specific date and may be significantly different from the amounts which will actually be paid or received on the maturity or settlement date.

Because a variety of estimation techniques are employed and significant estimates made, comparisons of fair values between financial institutions may not be meaningful. Readers of these financial statements are thus advised to use caution when using this data to evaluate the Group's financial position.

Fair value information is not provided for items that do not meet the definition of a financial instrument. These items include intangible assets, such as the value of the Group's branch network, the long-term relationships with depositors and credit card relationships; premises and equipment; and shareholders' equity. These items are material and accordingly the Group believes that the fair value information presented does not represent the underlying value of the Group.

The valuation technique for each major category of financial instrument and, where valuation models are used, significant inputs into valuation models, are discussed below.

Where referred to within the major categories listed, the Group's use of lead manager quotes and market standard consensus pricing services are as described below:

Lead manager quotes for illiquid assets in the current markets do not represent binding levels and are validated for consistency across the same asset class and by reference to discounted cash flow models that use expected loss and discount assumptions.

Market standard consensus pricing services aggregate price and other market data inputs from leading participants in the relevant markets and provide average mid-level outputs adjusted to exclude prices that are clearly out of line with other prices observed; these levels do not represent binding quotes.

Trading and other financial assets at fair value through profit or loss

The fair values of financial instruments quoted in active markets are based on quoted prices. The fair values of financial instruments that are not quoted in active markets are determined using valuation techniques including cash flow models which, to the extent practicable, use observable market inputs such as interest rate yield curves, equities and commodities prices, option volatilities and currency rates that are either directly observable or are implied from instrument prices. The fair values of bonds classified as trading assets are determined predominantly from lead manager quotes and, where these are not available, by reference to market standard consensus pricing services, broker quotes and other research data. Certain corporate bonds were valued using credit default swap (CDS) spreads and assumptions around the bond/CDS spread. The fair values of the Group's venture capital investments are determined using techniques which follow British Venture Capital Association (BVCA) guidelines.

The fair value movement on assets and liabilities held at fair value through profit or loss and gains in respect of instruments held for trading are disclosed in note 7.

At 31 December 2008, the Group had a portfolio of corporate bonds hedged by CDS. Prior to October 2008, the markets for both corporate bonds and CDS were relatively liquid and both sides of the above position were valued using market observable inputs. During October 2008 bid/offer spreads widened severely and, consequently, the cash market for corporate bonds became inactive. The above position is valued in part using assumptions around the bond/CDS spread. The effect of using reasonably possible alternative adverse assumptions for this valuation would reduce net trading income by up to £105 million.

Derivative financial instruments

All derivatives are recognised at their fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and using valuation techniques, including discounted cash flow and options pricing models, as appropriate. Derivatives are carried in the balance sheet as assets when their fair value is positive and as liabilities when their fair value is negative.

Interest rate swaps are valued using discounted cash flow models; the most significant inputs into those models are interest rate yield curves which are developed from publicly quoted rates. Foreign exchange derivatives that do not contain options are priced using rates available from publicly quoted sources. Credit derivatives, except for the items noted below, are valued using publicly available yield and CDS curves; the Group uses standard models with observable inputs. Less complex interest rate and foreign exchange option products are valued using volatility surfaces developed from publicly available interest rate cap, interest rate swaption and other option volatilities; option volatility skew information is derived from a market standard consensus pricing service. For more complex option products, the Group calibrates its models using observable at-the-money data; where necessary, the Group adjusts for out-of-the-money positions using a market standard consensus pricing service.

An analysis of derivatives including fair values by contract type is given in note 17.

At 31 December 2008, the Group had a senior synthetic position in a structured corporate collateralised debt obligation (CDO) that is valued in part using assumptions around recovery levels. The effect of using reasonably possible alternative favourable or adverse assumptions for recovery levels would increase or reduce net trading income by up to £80 million respectively.

At 31 December 2008, the Group had a credit valuation reserve on its derivative positions that is valued in part using assumptions around credit spreads and recovery risks. The effect of using reasonably possible alternative adverse combinations of assumptions for these risks would reduce net trading income by up to £70 million.

Loans and advances to banks and customers

The Group provides loans and advances to commercial, corporate and personal customers at both fixed and variable rates. The carrying value of the variable rate loans and those relating to lease financing is assumed to be their fair value. For fixed rate lending, several different techniques are used to estimate fair value, as considered appropriate. For commercial and personal customers, fair value is principally estimated by discounting anticipated cash flows (including interest at contractual rates) at market rates for similar loans offered by the Group and other financial institutions. The fair value for corporate loans is estimated by discounting anticipated cash flows at a rate which reflects the effects of interest rate changes, adjusted for changes in credit risk. Certain loans secured on residential properties are made at a fixed rate for a limited period, typically two to five years, after which the loans revert to the relevant variable rate. The fair value of such loans is estimated by reference to the market rates for similar loans of maturity equal to the remaining fixed interest rate period. The fair values of asset backed securities (ABS) and secondary loans, which were previously within assets held for trading and were reclassified to loans and receivables (see Held for trading to loans and receivables), are determined predominantly from lead manager quotes and, where these are not available, by alternative techniques including reference to credit spreads on similar assets with the same obligor, market standard consensus pricing services, broker quotes and other research data.

Available-for-sale financial assets

Listed securities are valued at current bid prices. Unlisted securities and other financial assets are valued based on discounted cash flows, market prices of similar instruments and other appropriate valuation techniques. The fair values of bonds classified as available-for-sale financial assets, including ABS, are determined predominantly from lead manager quotes and, where these are not available, by alternative techniques including reference to credit spreads on similar assets with the same obligor, market standard consensus pricing services, broker quotes and other research data.

At 31 December 2008, the Group's available-for-sale financial assets included ABS of £13,938 million. In respect of these assets, the effect of a 100 basis point shift in credit spreads would result in a pre-tax movement of £590 million which would be recognised, net of tax, in the revaluation reserve in respect of available-for-sale assets.

Deposits from banks and customer accounts

The fair value of deposits repayable on demand is considered to be equal to their carrying value. The fair value for all other deposits and customer accounts is estimated using discounted cash flows applying either market rates, where applicable, or current rates for deposits of similar remaining maturities.

Debt securities in issue and subordinated liabilities

The fair value of short-term debt securities in issue is approximately equal to their carrying value. Fair value for other debt securities and for subordinated liabilities is estimated using quoted market prices.

Trading and other liabilities at fair value through profit or loss

The fair values of financial instruments quoted in active markets are based on quoted prices. The fair values of financial instruments that are not quoted in active markets are determined using valuation techniques including cash flow models which, to the extent practicable, use observable market inputs such as interest rate yield curves, equities and commodities prices, option volatilities and currency rates that are either directly observable or are implied from instrument prices.

Liabilities arising from non-participating investment contracts

The value of the Group's non-participating investment contracts, all of which are unit-linked, is contractually linked to the fair values of financial assets within the Group's unitised investment funds and is determined using current unit prices multiplied by the number of units attributed to the contract holders at the balance sheet date. Their value is never less than the amount payable on surrender, discounted for the required notice period where applicable.

Financial commitments and contingent liabilities

Financial guarantees are valued on the basis of cash premiums receivable. The Group considers that it is not meaningful or practical to provide an estimate of the fair value of other contingent liabilities and financial commitments, given the lack of an established market, the diversity of fee structures and the difficulty of separating the value of the instruments from the value of the overall transaction. Therefore only financial guarantees are included in the following table.

	Carrying value 2008 £m	Carrying value 2007 £m	Fair value 2008 £m	Fair value 2007 £m
Financial assets
Trading and other financial assets at fair value through profit or loss	45,064	57,911	45,064	57,911
Derivative financial instruments	28,884	8,659	28,884	8,659
Loans and advances to banks	40,758	34,845	40,425	34,832
Loans and advances to customers	242,735	209,814	237,079	209,066
Available-for-sale financial assets	55,707	20,196	55,707	20,196
Financial liabilities
Deposits from banks	66,514	39,091	66,504	39,063
Customer accounts	170,938	156,555	171,119	156,608
Trading and other liabilities at fair value through profit or loss	6,754	3,206	6,754	3,206
Derivative financial instruments	26,892	7,582	26,892	7,582
Debt securities in issue	75,710	51,572	76,291	51,312
Liabilities arising from non-participating investment contracts	14,243	18,197	14,243	18,197
Financial guarantees	35	26	35	26
Subordinated liabilities	17,256	11,958	11,199	12,128