HSBC 2007 Annual Report Download - page 284

HSBC HOLDINGS PLC
Report of the Directors: The Management of Risk (continued)
Capital management and allocation > Capital measurement
282
Capital management and allocation
Capital management
(Audited)
HSBC’s capital management approach is driven by
its strategy and organisational requirements, taking
into account the regulatory and commercial
environment in which it operates. The Group’s
strategy underpins HSBC’s Capital Management
Framework which has been approved by the Group
Management Board. It is HSBC’s policy to maintain
a strong capital base to support the development of
its business and to meet regulatory capital
requirements at all times. It also maintains a strong
discipline over its investment decisions and where it
allocates its capital, seeking to ensure that returns on
investment are appropriate after taking account of
capital costs. In addition, the level of capital held by
HSBC Holdings and other major subsidiaries,
particularly HSBC Finance, is determined by its
rating targets.
HSBC’s strategic intention is to allocate capital
to businesses based on their economic profit
generation and, within this process, regulatory and
economic capital requirements and the cost of capital
are key factors. The responsibility for global capital
allocation principles and decisions rests with the
Group Management Board. Stress testing is used as
an important mechanism in understanding the
sensitivities of the core assumptions in the capital
plans to the adverse impact of extreme, but plausible,
events. Stress testing allows senior management to
formulate management action in advance of
conditions starting to reflect the stress scenarios
identified. The Group has identified the following as
being the material risks faced and managed through
the Capital Management Framework; credit, market,
operational, asset and liability management, pension,
and insurance risks.
In 2007, HSBC continued to manage its capital
against its benchmark minimum tier 1 capital ratio of
8.25 per cent, which it has used under the current
Basel Capital Accord (‘Basel I’) for the purposes of
its long-term capital planning. In 2008, as the Group
operates under the new framework for calculating
minimum capital requirements known as ‘Basel II’,
it will target a tier 1 capital ratio within the range
7.5 to 9.0 per cent, based on core tier 1 capital plus
innovative tier 1 capital, less deductions from tier 1
capital under the FSA’s Basel II disclosure rules.
HSBC recognises the effect on shareholder
returns of the level of equity capital employed within
the Group and seeks to maintain a prudent balance
between the advantages and flexibility afforded by a
strong capital position and the higher returns on
equity that are possible with greater leverage.
The Capital Management Framework covers the
different capital measures within which HSBC
manages its capital in a consistent and aligned
manner. These include the market capitalisation,
invested capital, economic capital and regulatory
capital. HSBC defines invested capital as the equity
capital invested in HSBC by its shareholders.
Economic capital is the capital requirement
calculated internally by HSBC to support the risks to
which it is exposed and is set at a confidence level
consistent with a ‘AA’ target credit rating.
Regulatory capital is the capital which HSBC is
required to hold as determined by the rules
established by the FSA for the consolidated Group
and by HSBC’s local regulators for individual Group
companies.
An annual Group capital plan is prepared and
approved by the Board with the objective of
maintaining both the optimal amount of capital and
the mix between the different components of capital.
The Group’s policy is to hold capital in a range of
different forms and from diverse sources and all
capital raising is agreed with major subsidiaries as
part of their individual and the Group’s capital
management processes. HSBC Holdings and its
major subsidiaries raise non-equity tier 1 capital and
subordinated debt in accordance with the Group’s
guidelines on market and investor concentration,
cost, market conditions, timing, effect on
composition and maturity profile. The subordinated
debt requirements of other HSBC companies are met
internally.
Each subsidiary manages its own capital
required to support planned business growth and
meet local regulatory requirements, within the
context of the approved annual Group capital plan.
As part of HSBC’s Capital Management Framework,
capital generated in excess of planned requirements
is returned to HSBC Holdings, normally by way of
dividends.
HSBC Holdings is primarily a provider of
equity capital to its subsidiaries. These investments
are substantially funded by HSBC Holdings’ own
capital issuance and profit retentions. HSBC
Holdings seeks to maintain a prudent balance
between the composition of its capital and that of its
investment in subsidiaries.
Capital measurement and allocation
(Audited)
The FSA supervises HSBC on a consolidated basis
and, as such, receives information on the capital
adequacy of, and sets capital requirements for,