Cautionary statement regarding forward-looking statements

The Capital and Risk Management Pillar 3 Disclosures at 31 December 2011 (‘Pillar 3 Disclosures 2011’) contains certain forward-looking statements with respect to HSBC’s financial condition, results of operations and business.

Statements that are not historical facts, including statements about HSBC’s beliefs and expectations, are forward-looking statements. Words such as ‘expects’, ‘anticipates’, ‘intends’, ‘plans’, ‘believes’, ‘seeks’, ‘estimates’, ‘potential’ and ‘reasonably possible’, variations of these words and similar expressions are intended to identify forward-looking statements. These statements are based on current plans, estimates and projections, and therefore undue reliance should not be placed on them. Forward-looking statements speak only as of the date they are made. HSBC makes no commitment to revise or update any forward-looking statements to reflect events or circumstances occurring or existing after the date of any forward-looking statements.

Written and/or oral forward-looking statements may also be made in the periodic reports to the US Securities and Exchange Commission, summary financial statements to shareholders, proxy statements, offering circulars and prospectuses, press releases and other written materials, and in oral statements made by HSBC’s Directors, officers or employees to third parties, including financial analysts.

Forward-looking statements involve inherent risks and uncertainties. Readers are cautioned that a number of factors could cause actual results to differ, in some instances materially, from those anticipated or implied in any forward-looking statement. These factors include changes in general economic conditions in the markets in which we operate, changes in government policy and regulation and factors specific to HSBC.

Contents

Introduction

HSBC is one of the world’s largest banking and financial services organisations. We serve around 89 million customers through our four global businesses: Retail Banking and Wealth Management, Commercial Banking, Global Banking and Markets, and Global Private Banking.

Our network of around 7,200 offices covers 85 countries and territories in six geographical regions: Europe, Hong Kong, Rest of Asia-Pacific, Middle East and North Africa (‘MENA’), North America and Latin America.

Listed on the London, Hong Kong, New York, Paris and Bermuda stock exchanges, shares in HSBC Holdings plc are held by over 220,000 shareholders in 132 countries and territories.

		Details of the Group’s principal activities, business and operating models and strategic direction may be found on page 10 of the Annual Report and Accounts 2011.

Basel II

The United Kingdom (‘UK’) Financial Services Authority (‘FSA’) supervises HSBC on a consolidated basis, and therefore receives information on the capital adequacy of, and sets capital requirements for, the Group as a whole. Individual banking subsidiaries are directly regulated by their local banking supervisors, who set and monitor their capital adequacy requirements.

We calculate capital at a Group level using the Basel II framework of the Basel Committee on Banking Supervision (‘Basel Committee’) as implemented by the FSA. However, local regulators are at different stages of implementation and local reporting may still be on a Basel I basis, notably in the United States (‘US’). In most jurisdictions, non-banking financial subsidiaries are also subject to the supervision and capital requirements of local regulatory authorities.

Basel II is structured around three ‘pillars’: minimum capital requirements, supervisory review process and market discipline. The Capital Requirements Directive (‘CRD’) implemented Basel II in the European Union (‘EU’) and the FSA then gave effect to the CRD by including the requirements of the CRD in its own rulebooks.

Pillar 3 disclosures 2011

Pillar 3, market discipline, complements the minimum capital requirements and the supervisory review process. Its aim is to develop disclosures by banks which allow market participants to assess the

scope of application of Basel II, capital, particular risk exposures and risk assessment processes, and hence the capital adequacy of the institution. Under the Pillar 3 framework all material risks must be disclosed, enabling a comprehensive view of the institution’s risk profile.

All material and non-proprietary information required by Pillar 3 is included in the Pillar 3 Disclosures 2011, which comprise both quantitative and qualitative information and are provided at the HSBC Group consolidated level. The FSA permits certain Pillar 3 requirements to be satisfied by inclusion within the financial statements.

		Where we adopt this approach, references are provided to the relevant pages of the Annual Report and Accounts 2011.

Principal changes to disclosures

The principal changes to our Pillar 3 Disclosures 2011, compared with the previous year, are those commonly known as Basel 2.5, implemented in the EU via CRD III, which increased the capital and disclosure requirements for re-securitisation exposures and market risk with effect from 31 December 2011. Further details are set out from page 34. In addition, we have replaced a table of counterparty sector exposures with a more granular industry sector analysis (page 18), and further developed our disclosures on remuneration (page 45).

Movement in risk-weighted assets in 2011

RWAs increased by US$106.4bn or 10% in 2011. Exchange rate differences caused a net reduction in RWAs of around US$9bn in the year, and the remaining increase in RWAs of US$115bn arose mainly in credit risk and market risk.

RWAs increased by approximately US$50bn as a result of the introduction of Basel 2.5, net of mitigating actions undertaken by management. Of this increase, around US$40bn was in market risk, of which the largest component was stressed VAR. Higher risk weights on re-securitisations increased credit risk RWAs by around US$10bn, primarily impacting the GB&M legacy portfolios.

The remaining increase in credit risk RWAs largely reflected growth in our global businesses, notably in Commercial Banking, and also included an increase in loan balances in our mainland China associates. Further details of the movement in our RWAs in 2011 may be found on page 211 of the Annual Report and Accounts 2011.

Future developments

The regulation of financial institutions continues to undergo significant change. In the areas of risk and capital management, considerable progress has been made in implementing the G20 governments’ agenda to increase the stability and resilience of the financial system, and further major changes in regulation are foreseen.

Following Basel Committee issuance in December 2010 of ‘Basel III’ rules, the European Commission issued in July 2011 its related implementing proposals, known as CRD IV,

comprising a Directive and Regulation which together will supersede earlier Directives. These proposals are currently under review within the European legislative process, which is expected to conclude in 2012.

Significant regulatory matters within the scope of CRD IV include quality and quantity of capital, counterparty credit risk, liquidity and funding, capital buffers and leverage. The new requirements will be phased in from 1 January 2013, as shown in the table below, with many areas subject to development of technical standards by the European Banking Authority and full implementation required by 1 January 2019.

In September 2011, the UK Independent Commission on Banking published its final Report, to which the Government responded before year end. At a global level, in November, the Basel Committee issued its final rules for the enhanced supervision of institutions designated global systemically important banks (‘G-SIBs’). The capital requirements of HSBC, as a G-SIB, could be significantly affected by these measures, which are in addition to those expected under CRD IV.

An overview of the above, together with related developments on the G20 agenda for financial sector regulation, may be found in the discussion of macro-prudential and regulatory risks on page 100 of the Annual Report and Accounts 2011. An assessment of the impact of Basel III, measures for G-SIBs and various mitigating actions by management on our capital position and our target core tier 1 ratio may be found in the ‘Capital’ section on page 212 of the Annual Report and Accounts 2011.

Frequency

We publish comprehensive Pillar 3 disclosures annually on the HSBC internet site, with summarised regulatory capital information provided in our interim reports and management statements.

Comparison with the Annual Report and Accounts 2011

The Pillar 3 Disclosures 2011 have been prepared in accordance with regulatory capital adequacy concepts and rules, rather than in accordance with International Financial Reporting Standards (‘IFRS’s). Therefore, some information in the Pillar 3 Disclosures 2011 is not directly comparable with the financial information in the Annual Report and Accounts 2011. This is most pronounced for the credit risk disclosures, where credit exposure is defined as the amount at risk that is estimated by the Group under specified Basel II parameters. This differs from similar information in the Annual Report and Accounts 2011, which is mainly reported at the balance sheet date and therefore does not reflect the likelihood of future drawings of committed credit lines.

Verification

The Pillar 3 Disclosures 2011 have been appropriately verified internally, but have not been audited by the Group’s external auditor.

Significant subsidiaries

Links to the financial information of significant subsidiaries, including capital resources and requirements, are available on our investor relations website page www.hsbc.com/investor-relations/financial-results/hsbc-group-companies.

Consolidation basis

The basis of consolidation for financial accounting purposes is described on page 292 of the Annual Report and Accounts 2011 and differs from that used for regulatory purposes. Investments in banking associates are equity accounted in the financial accounting consolidation, whereas their exposures are proportionally consolidated for regulatory purposes. Subsidiaries and associates engaged in insurance and non-financial activities are excluded from the regulatory consolidation and are deducted from regulatory capital. The regulatory consolidation does not include special purpose entities (‘SPE’s) where significant risk has been transferred to third parties. Exposures to these SPEs are risk-weighted as securitisation positions for regulatory purposes.

Scope of Basel II permissions

Credit risk capital requirements

Basel II applies three approaches of increasing sophistication to the calculation of Pillar 1 credit risk capital requirements. The most basic level, the standardised approach, requires banks to use external credit ratings to determine the risk weightings applied to rated counterparties. Other counterparties are grouped into broad categories and standardised risk weightings are applied to these categories. The next level, the internal ratings-based (‘IRB’) foundation approach, allows banks to calculate their credit risk capital requirements on the basis of their internal assessment of a counterparty’s probability of default (‘PD’), but subjects their quantified estimates of exposure at default (‘EAD’) and loss given default (‘LGD’) to standard supervisory parameters. Finally, the IRB advanced approach allows banks to use their own internal assessment in both determining PD and quantifying EAD and LGD.

The capital resources requirement, which is intended to cover unexpected losses, is derived from a formula specified in the regulatory rules, which incorporates PD, LGD, EAD and other variables such as maturity and correlation. Expected losses under the IRB approaches are calculated by multiplying PD by EAD and LGD. Expected losses are deducted from capital to the extent that they exceed total accounting impairment allowances.

For consolidated Group reporting, we have adopted the IRB advanced approach for the majority of our business. A number of Group companies and portfolios are in transition to IRB advanced from standardised or IRB foundation approaches, pending definition of local regulations or model development and approval; others will remain on standardised

under exemptions from IRB treatment. Approaches used for securitisation exposures are described on page 36.

Counterparty credit risk capital requirement

Counterparty credit risk, in both the trading and non-trading books, is the risk that the counterparty to a transaction may default before completing the satisfactory settlement of the transaction. Three approaches to calculating counterparty credit risk and determining exposure values are defined by Basel II: standardised, mark-to-market and internal model method (‘IMM’). These exposure values are used to determine capital requirements under one of the credit risk approaches; standardised, IRB foundation and IRB advanced.

We use the mark-to-market and IMM approaches for counterparty credit risk. Our longer-term aim is to migrate more positions from the mark-to-market to the IMM approach.

Market risk capital requirement

Market risk is the risk that movements in market risk factors, including foreign exchange, commodity prices, interest rates, credit spread and equity prices will reduce our income or the value of our portfolios.

The market risk capital requirement is measured using internal market risk models, where approved by the FSA, or the FSA standard rules. Following the implementation of Basel 2.5, our internal market risk models comprise VAR, stressed VAR, incremental risk charge and correlation trading under the comprehensive risk measure.

The majority of our market risk is subject to internal models, and we continue to increase the proportion that is assessed this way.

Operational risk capital requirement

Basel II includes capital requirements for operational risk, again utilising three levels of sophistication. The capital required under the basic indicator approach is a simple percentage of gross revenues, whereas under the standardised approach, it is one of three different percentages of gross revenues allocated to each of eight defined business lines. Both these approaches use an average of the last three financial years’ revenues. Finally, the advanced measurement approach uses banks’ own statistical analysis and modelling of operational risk data to determine capital requirements.

We have adopted the standardised approach in determining our operational risk capital requirement.

Capital management and allocation

Our approach to capital management is driven by our strategic and organisational requirements, taking into account the regulatory, economic and commercial environment in which we operate.

It is our objective to maintain a strong capital base to support the development of our business and to meet regulatory capital requirements at all times. To achieve this, our policy is to hold capital in a range of different forms and from diverse sources.

Our policy on capital management is underpinned by a capital management framework, which enables us to manage our capital in a consistent and aligned manner. The framework, which is approved by the Group Management Board (‘GMB’) annually, incorporates a number of different capital measures including market capitalisation, invested capital, economic capital and regulatory capital.

The responsibility for global capital allocation principles and decisions rests with GMB. Through our structured internal governance processes, we maintain discipline over our investment and capital allocation decisions and seek to ensure that returns on investment are adequate after taking account of capital costs. Our strategy is to allocate capital to businesses on the basis of their economic profit generation, regulatory and economic capital requirements and cost of capital.

Transferability of capital within the Group

Our capital management process is articulated in the annual Group capital plan which is approved by the Board. The plan is drawn up with the objective of maintaining both an appropriate amount of capital and an optimal mix between the different components of capital. HSBC Holdings and its major subsidiaries raise non-equity tier 1 capital and subordinated debt in accordance with our guidelines on market and investor concentration, cost, market conditions, timing, capital composition and maturity profile. Each of our subsidiaries manages its own capital to support its planned business growth and meet its local regulatory requirements within the context of the approved annual Group capital plan. In accordance with our capital management framework, capital generated by subsidiaries in excess of planned requirements is returned to HSBC Holdings, normally by way of dividends.

HSBC Holdings is the primary provider of equity capital to its subsidiaries and also provides non-equity capital to subsidiaries where necessary. These investments are substantially funded by HSBC

Holdings’ own capital issuance and profit retention. As part of its capital management process, HSBC Holdings seeks to maintain a prudent balance between the composition of its capital and that of its investment in subsidiaries.

During 2011 and 2010, none of the Group’s subsidiaries experienced significant restrictions on paying dividends or repaying loans and advances.

Internal assessment of capital adequacy

We assess the adequacy of our capital by considering the resources necessary to cover unexpected losses arising from discretionary risks, such as credit risk and market risk, or non-discretionary risks, such as operational risk and reputational risk. The framework, together with related policies define the Internal Capital Adequacy Assessment Process (‘ICAAP’) by which GMB examines our risk profile from both regulatory and economic capital viewpoints and ensures that our level of capital:

The regulatory and economic capital assessments rely upon the use of models that are integrated into our management of risk. Economic capital is the internally calculated capital requirement which we deem necessary to support the risks to which we are exposed. The minimum regulatory capital that we are required to hold is determined by the rules established by the FSA for the consolidated Group and by local regulators for individual Group companies. The economic capital assessment is the more risk-sensitive measure, as it covers a wider range of risks and takes account of the substantial diversification of risk accruing from our operations. Our economic capital models are calibrated to quantify the level of capital that is sufficient to absorb potential losses over a one-year time horizon to a 99.95% level of confidence for our banking activities and to a 99.5% level of confidence for our insurance activities and pension risks. Our approach to capital management is aligned to our corporate structure, business model and strategic direction. Our discipline around capital allocation is maintained within established processes and benchmarks, further details of which can be found

on page 215 of the Annual Report and Accounts 2011.

Economic capital is the metric by which risk is measured and linked to capital within our risk appetite framework. The risk appetite statement, which describes the quantum and types of risks that we are prepared to take in executing our strategy, is approved annually by the Board of Directors of HSBC Holdings (‘the Board’), advised by the Group Risk Committee (‘GRC’). Its implementation is overseen by GMB.

Our risk management framework fosters the continuous monitoring of the risk environment and an integrated evaluation of risks and their interactions. Certain of these risks are assessed and managed via the capital planning process. Risks that are measured through economic capital and those that are not are compared below.

		Further details on the risk appetite framework may be found on page 234 of the Annual Report and Accounts 2011.

Risks assessed via capital

Credit (including counterparty credit), market and operational risk

We assess economic capital requirements for these risk types by utilising the embedded operational infrastructure used for the pillar 1 capital calculation, together with an additional suite of models that take into account, in particular:

Our economic capital assessment operates alongside our regulatory capital process and consistently demonstrates a substantially lower overall capital requirement for credit risk than the regulatory equivalent, reflecting the empirical evidence of the benefits of global diversification. However, we maintain a prudent stance on capital coverage, ensuring that any model risk is mitigated.

Interest rate risk in the banking book

Interest rate risk in the banking book (‘IRRBB’) is defined as the exposure of our non-trading products to interest rates.

This risk arises in such portfolios principally from mismatches between the future yield on assets and their funding costs, as a result of interest rate changes. Analysis of this risk is complicated by

having to make assumptions on embedded optionality within certain product areas such as the incidence of mortgage prepayments, and from behavioural assumptions regarding the economic duration of liabilities which are contractually repayable on demand such as current accounts. IRRBB economic capital is measured as the amount of capital necessary to cover an unexpected loss in the value of our non-trading assets over one year to a 99.95% level of confidence.

Insurance risk

We operate a bancassurance model which provides insurance products for customers with whom we have a banking relationship. Many of these insurance products are manufactured by our subsidiaries but, where we consider it operationally more effective, third parties are engaged to manufacture insurance products for sale through our banking network. We work with a limited number of market-leading partners to provide such products. When manufacturing products ourselves, we underwrite the insurance risk and retain the risks and rewards associated with writing insurance contracts.

We continue to make progress in the implementation of a risk-based capital methodology for our insurance businesses. During 2011, we developed the use of risk-based capital metrics in the risk appetite statement, introduced internal economic capital reporting and enhanced the risk-based capital disclosure in the ICAAP.

Pension risk

We operate a number of pension plans throughout the world. Some of them are defined benefit plans, of which the largest is the HSBC Bank (UK) Pension Scheme. In order to fund the benefits associated with these plans, sponsoring Group companies (and in some instances, employees) make regular contributions in accordance with advice from actuaries and in consultation with the scheme’s trustees (where relevant). In situations where a funding deficit emerges, sponsoring Group companies agree to make additional contributions to the plans, to address the deficit over an appropriate repayment period.

		Further details of such payments may be found in Note 7 on page 316 of the Annual Report and Accounts 2011.

The defined benefit plans invest these contributions in a range of investments designed to meet their long-term liabilities.

Pension risk arises from the potential for a deficit in a defined benefit plan to arise from a number of factors, including:

Pension risk is assessed by way of an economic capital model that takes into account potential variations in these factors, using VAR methodology.

Residual risk

Residual risk is, primarily, the risk that mitigation techniques prove less effective than expected. This category also includes risks that arise from specific reputational or business events that give rise to exposures not deemed to be included in the major risk categories. We conduct economic capital assessments of such risks on a regular, forward-looking basis to ensure that their impact is adequately covered by our capital base.

Risks not explicitly assessed via capital

Liquidity risk

We use cash-flow stress testing as part of our control processes to assess liquidity risk. We do not manage liquidity through the explicit allocation of capital as, in common with standard industry practice, this is not considered to be an appropriate or adequate mechanism for managing these risks. However, we recognise that a strong capital base can help to mitigate liquidity risk both by providing a capital buffer to allow an entity to raise funds and deploy them in liquid positions, and by serving to reduce the credit risk taken by providers of funds to the Group.

Structural foreign exchange risk

Structural foreign exchange risks arise from our net investments in subsidiaries, branches and associates,

the functional currencies of which are other than the US dollar. Unrealised gains or losses due to revaluations of structural foreign exchange exposures are reflected in reserves, whereas other unrealised gains or losses arising from revaluations of foreign exchange positions are reflected in the income statement.

Our structural foreign exchange exposures are managed with the primary objective of ensuring, where practical, that our consolidated capital ratios and the capital ratios of the individual banking subsidiaries are largely protected from the effect of changes in exchange rates. This is usually achieved by ensuring that, for each subsidiary bank, the ratio of structural exposures in a given currency to RWAs denominated in that currency is broadly equal to the capital ratio of the subsidiary in question. We evaluate residual structural foreign exchange exposures using a VAR model, but typically do not assign any economic capital for these since they are managed within appropriate economic capital buffers.

Reputational risk

As a banking group, our good reputation depends upon the way in which we conduct our business, but it can also be affected by the way in which clients, to whom we provide financial services, conduct themselves. The safeguarding of our reputation is paramount and is the responsibility of all members of staff, supported by a global risk management structure, underpinned by relevant policies and practices, readily available guidance and regular training. A fresh emphasis in 2011 on values made these more explicit, to ensure we meet the expectations of society, customers, regulators and investors.

Sustainability risk

Sustainability risks arise from the provision of financial services to companies or projects which run counter to the needs of sustainable development; in effect, this risk arises when the environmental and social effects outweigh economic benefits. Sustainability risk is implicitly covered for economic capital purposes in credit risk, where risks associated with lending to certain categories of customers and industries are embedded.

Business risk

The FSA specifies that banks, as part of their internal assessment of capital adequacy process, should review their exposure to business risk.

Business risk is the potential negative impact on profits and capital from the Group not meeting our strategic objectives, as a result of unforeseen

changes in the business and regulatory environment, exposure to economic cycles and technological changes.

We manage and mitigate business risk through our business planning and stress testing processes, so that our business model and planned activities are resourced and capitalised consistent with the commercial, economic and risk environment in which the Group operates, and that any potential vulnerabilities of our business plans are identified at an early stage so that mitigating actions can be taken.

		Details of our management of these risks may be found on the following pages of the Annual Report and Accounts 2011: liquidity and funding 157, structural foreign exchange 166, reputational 183 and sustainability 184.

Risk management

Overview

All our activities – whether lending, payment transmission, trading business to support clients and markets, or maintenance of our infrastructure for delivering financial services – involve to varying degrees the measurement, evaluation, acceptance and management of risks.

The objective of risk management, shared across the organisation, is to support Group strategies to build sustainably profitable business in the best long-term interests of our shareholders and other stakeholders. We aim to ensure that risk management is firmly embedded in how we run our business through:

Risk culture

Our risk culture is a major strength of the Group, and fostering it is a key responsibility of senior executives assisted by the Global Risk function. All employees are held accountable for identifying, assessing and managing risks within the scope of their assigned responsibilities. A primary duty of the senior management in each country in which we

operate is to implement and maintain an effective risk strategy to address all risks in the business they manage, and we have a system of personal, not collective, authorities for lending decisions. Personal accountability, reinforced by learning and development, helps sustain a disciplined and constructive culture of risk management and control throughout HSBC.

Risk governance and risk appetite

Our risk governance structure and approach to risk appetite are set out in the description of the responsibilities of the GRC on page 233 of the Annual Report and Accounts 2011. Strong risk management and internal control systems are evidenced in an established framework of risk ownership and documented standards, policy and procedures.

Risk management objectives are integrated into the performance scorecards of the heads of regions, global businesses and key functions from the GMB down, and cascaded through the organisation. The objectives of the Global Risk function are also fully aligned in this process with strategic business objectives.

Risk appetite is a key component of our management of risk. Our approach is designed to reinforce the integration of risk considerations into key business goals and planning processes. Preserving our strong capital position remains a key priority for HSBC, and the level of integration of our risk and capital management helps to optimise our response to business demand for regulatory and economic capital.

Global Risk

As risk is not static, our risk profile continually alters as a result of change in the scope and impact of a wide range of factors, from geopolitical to transactional. The risk environment requires continual monitoring and holistic assessment in order to understand and manage its complex interactions across the Group.

The Global Risk function, headed by the Group Chief Risk Officer (‘GCRO’), provides an expert, integrated and independent assessment of risks across the Group:

In addition to ‘business as usual’ operations, the Global Risk function engages fully with business development activities such as new product approval and post-implementation review, and acquisition due diligence.

Diversification

Diversification is an important aspect of our management of risk. The diversification of our lending portfolio across the regions, together with our broad range of global businesses and products, ensures that we are not overly dependent on a few countries or markets to generate income and growth. Our geographical diversification also supports our strategies for growth in faster-growing markets and those with international connectivity. Diversification models are developed, together with the business, within the Global Risk function’s quantitative analytics discipline.

Stress testing

Global Risk leads work on stress scenario development, testing and analysis, the outcomes of which are used to assess the potential impact of relevant scenarios on the demand for regulatory capital, compared with its supply. Integrated with our risk appetite, planning and capital management processes, stress scenario analysis highlights any vulnerabilities of our business and capital plans to the adverse effects of extreme but plausible events. It is central to the monitoring of our top and emerging risks including among others: macro-economic and geopolitical risks such as that of sovereign and counterparty default in the eurozone; macro-prudential and regulatory change risks to our business model; and risks to our business operations including internet crime and information security risk.

		The Group’s top and emerging risks and areas of special interest are described on pages 235 and 112 respectively of the Annual Report and Accounts 2011.

Risk measurement and reporting systems

The purpose of our risk measurement and reporting systems is to ensure that, as far as possible, risks are

comprehensively captured with all the attributes necessary to support well-founded decisions, that those attributes are accurately assessed and that information is delivered in a timely way to the right points in the organisation for those risks to be successfully managed and mitigated.

Risk measurement and reporting systems are also subject to a robust governance framework, to ensure that their design is fit for purpose and that they are functioning properly. Group risk information technology (‘IT’) systems development is a key responsibility of the GCRO, while the operation and development of risk rating and management systems and processes are ultimately subject to the oversight of the Board.

We invest significant resources in IT systems and processes in order to maintain and improve our risk management capabilities. Group policy promotes the deployment of preferred technology where practicable. Group standards govern the procurement and operation of systems used in our subsidiaries, processing risk information within business lines and risk functions. The measurement and monitoring of the major risks we encounter, including credit, market and operational risks, are increasingly delivered by central systems or, where this is not the case for sound business reasons, through structures and processes that support comprehensive oversight by senior management.

Risk measurement, monitoring and reporting structures deployed at Group Head Office level are replicated in global businesses and subsidiaries through a common operating model for integrated risk management and control. This model sets out the respective responsibilities of Group Risk, regional and country Risk functions in respect of such matters as risk governance and oversight, approval authorities and lending guidelines, global and local scorecards, management information and reporting, and relations with third parties including regulators, rating agencies and auditors.

In May 2011, we revised this model to further embed Compliance within Global Risk, to establish specific Chief Risk Officer roles for Retail Banking and Wealth Management (‘RBWM’) and Commercial Banking (‘CMB’) in alignment with other global businesses, and to broaden the responsibility of Security and Fraud Risk. The new global model is designed to enable the end-to-end management of risk to be carried out in a consistent manner.

Credit risk

Overview and objectives

Credit risk is the risk of financial loss if a customer or counterparty fails to meet a payment obligation under a contract. It arises principally from direct lending, trade finance and leasing business, but also from off-balance sheet products such as guarantees and derivatives, and from the Group’s holdings of debt and other securities. Credit risk generates the largest regulatory capital requirement of the risks we incur. This includes a capital requirement for counterparty credit risk in the banking and trading books. Further details regarding our management of counterparty credit risk can be found on page 31.

The principal objectives of our credit risk management are:

Organisation and responsibilities

The credit risk functions within Wholesale Credit and Market Risk and Global Retail Risk Management are the constituent parts of Group Risk that support the GCRO in overseeing credit risks at the highest level. For this, their major duties comprise: undertaking independent reviews of larger and higher-risk credit proposals, large exposure policy and reporting oversight of our wholesale and retail credit risk management disciplines, ownership of our credit policy and credit systems programmes, and reporting on risk matters to senior executive management and to regulators. These credit risk functions work closely with other parts of the Global Risk function, for example: with Security and Fraud Risk on enhancement of protection against retail product fraud, with Market Risk on complex transactions, with Operational Risk on the internal control framework and with Risk Strategy on developing our economic capital model, risk appetite process and stress testing.

		The credit responsibilities of Group Risk are described on page189 of the Annual Report and Accounts 2011.

Group-wide, the credit risk functions comprise a network of credit risk management offices reporting

within regional, integrated risk functions. They fulfil an essential role as independent risk control units distinct from business line management in providing an objective scrutiny of risk rating assessments, credit proposals for approval and other risk matters.

For wholesale credit risk management, we operate through a hierarchy of personal credit limit approval authorities, not committee structures. Risk officers of individual operating companies, acting under authorities delegated by their boards and executive bodies within local and Group standards, are accountable for their recommendations and credit approval decisions. Each operating company is responsible for the quality and performance of its credit portfolios, and for monitoring and controlling all credit risks in those portfolios in accordance with Group standards.

Above certain risk-based thresholds established in line with authorities delegated by the Board, Group Risk concurrence must be sought for locally-approved facilities before they are extended to the customer. Moreover, risk proposals in certain portfolios – sovereign obligors, banks, some non-bank financial institutions and intra-Group exposures – are approved centrally in Group Risk to facilitate efficient control and the reporting of regulatory large and cross-border exposures.

Risk analytics

Group Risk manages credit risk analytics activities among a number of analytics disciplines supporting rating and scoring models, economic capital and stress testing. It formulates technical responses to industry developments and regulatory policy in the field of credit risk analytics, develops HSBC’s global credit risk models, and oversees local model development and use around the Group in progress toward our implementation targets for the IRB advanced approach.

The risk analytics models are governed by the Group Credit Risk Analytics Oversight Committee (‘CRAOC’) which meets monthly and reports to Risk Management Meeting (‘RMM’). Group CRAOC is chaired by the risk function, and its membership is drawn from Risk and global businesses. Its primary responsibilities are to oversee the governance of our risk rating models for both wholesale and retail business, to manage the development of global models and through its oversight of local CRAOCs, to monitor the development of local models.

Similarly structured model governance and decision-making arrangements are in place in the