HSBC 2004 Annual Report Download - page 176

HSBC HOLDINGS PLC
Financial Review (continued)
174
aspects of business are set for HSBC and for
individual subsidiaries, businesses and functions.
These are communicated through manuals and
statements of policy, and promulgated through
internal communications and training. The policies
set out operational procedures in all areas of
reputational risk, including treating customers fairly,
conflicts of interest, money laundering deterrence,
environmental impact, anti-corruption measures and
employee relations.
Management in all operating entities is required
to establish a strong internal control structure to
minimise the risk of operational and financial failure,
and to ensure that a full appraisal of reputational
implications is made before strategic decisions are
taken. The Group internal audit function monitors
compliance with policies and standards.
Capital management and allocation
Capital measurement and allocation
The FSA supervises HSBC on a consolidated basis
and, as such, receives information on the capital
adequacy of, and sets capital requirements for,
HSBC as a whole. Individual banking subsidiaries
are directly regulated by their local banking
supervisors, which set and monitor their capital
adequacy requirements. In some jurisdictions,
certain non-banking subsidiaries are subject to the
supervision and capital requirements of local
regulatory authorities. Since 1988, when the
governors of the Group of Ten central banks agreed
to guidelines for the international convergence of
capital measurement and standards, the banking
supervisors of HSBC’ s major banking subsidiaries
have exercised capital adequacy supervision in a
broadly similar framework. The guidelines agreed in
1988, referred to as the Basel Accord, are applied on
a consistent basis across the European Union
through directives, which are then implemented by
member states.
In implementing the EU’s Banking
Consolidation Directive, the FSA requires each bank
and banking group to maintain an individually
prescribed ratio of total capital to risk-weighted
assets taking into account both balance sheet assets
and off-balance sheet transactions. Under the EU’ s
Amending Directive to the Capital Adequacy
Directive, the FSA allows banks to calculate capital
requirements for market risk in the trading book
using VAR techniques.
HSBC’s capital is divided into two tiers: tier 1,
comprising shareholders’ funds, innovative tier 1
securities and minority interests in tier 1 capital, but
excluding revaluation reserves; and tier 2,
comprising general loan loss provisions, revaluation
reserves, qualifying subordinated loan capital and
minority and other interests in tier 2 capital. The
amount of innovative tier 1 securities cannot exceed
15 per cent of overall tier 1 capital, qualifying tier
2 capital cannot exceed tier 1 capital, and qualifying
term subordinated loan capital may not exceed
50 per cent of tier 1 capital. There are also
limitations on the amount of general provisions
which may be included in tier 2 capital. The book
values of goodwill, intangible assets and own shares
held are deducted in arriving at tier 1 capital. Total
capital is calculated by deducting the book values of
unconsolidated investments, investments in the
capital of banks, and certain regulatory items from
the total of tier 1 and tier 2 capital.
Banking operations are categorised as either
trading book (broadly, marked-to-market activities)
or banking book (all other activities) and risk-
weighted assets are determined accordingly. Banking
book risk-weighted assets are measured by means of
a hierarchy of risk weightings classified according to
the nature of each asset and counterparty, taking into
account any eligible collateral or guarantees.
Banking book off-balance-sheet items giving rise to
credit, foreign exchange or interest rate risk are
assigned weights appropriate to the category of the
counterparty, taking into account any eligible
collateral or guarantees. Trading book risk-weighted
assets are determined by taking into account market-
related risks such as foreign exchange, interest rate
and equity position risks, and counterparty risk.
Future developments
In October 2004, the FSA published a consultation
paper CP04/17 ‘Implications of a changing
accounting framework’ . This paper sets out the
FSA’ s proposed approach to assessing banks’ capital
adequacy after implementation of IFRS. In the
absence of the FSA’ s final rules on capital adequacy
reporting under IFRS, which may be different from
the proposals set out in CP04/17, HSBC will follow
its proposals with effect from 1 January 2005.
Under the consultation paper, there will be
changes to the measurement of banks’ capital
adequacy in a number of ways, the most significant
of which for HSBC are set out below.
• The capital treatment for collective impairment
provisions will be the same as previously for
general provisions, i.e. they will be included in
tier 2 capital. This is expected to have a positive
impact on HSBC’s total capital ratio.
• Transitional impacts of IFRS implementation,
such as the capitalisation of software costs, are