HSBC 2011 Annual Report Download - page 40

HSBC HOLDINGS PLC
Report of the Directors: Operating and Financial Review (continued)
Financial summary > Critical accounting policies
38
Critical accounting policies
(Audited)
Introduction
The results of HSBC are sensitive to the accounting
policies, assumptions and estimates that underlie the
preparation of our consolidated financial statements.
The significant accounting policies are described in
Note 2 on the Financial Statements.
When preparing the financial statements, it is
the Directors’ responsibility under UK company law
to select suitable accounting policies and to make
judgements and estimates that are reasonable and
prudent. The accounting policies that are deemed
critical to our results and financial position, in terms
of the materiality of the items to which the policies
are applied and the high degree of judgement
involved, including the use of assumptions and
estimation, are discussed below.
Impairment of loans and advances
Our accounting policy for losses arising from the
impairment of customer loans and advances is
described in Note 2g on the Financial Statements.
Loan impairment allowances represent
management’s best estimate of losses incurred
in the loan portfolios at the balance sheet date.
Management is required to exercise judgement
in making assumptions and estimates when
calculating loan impairment allowances on both
individually and collectively assessed loans and
advances. Of the Group’s total loans and advances
to customers before impairment allowances of
US$958bn (2010: US$978bn), US$17bn or 2%
(2010: US$16bn; 2%) were individually assessed
for impairment, and US$941bn or 98% (2010:
US$962bn; 98%) were collectively assessed for
impairment.
The most significant judgemental area is the
calculation of collective impairment allowances. The
geographical area with most exposure subject to this
judgement is North America. Collective impairment
allowances in North America were US$7bn,
representing 62% (2010: US$9bn; 64%) of the total
collectively assessed loan impairment allowance.
The methods used to calculate collective
impairment allowances on homogeneous groups
of loans and advances that are not considered
individually significant are disclosed in Note 2g
on the Financial Statements. They are subject to
estimation uncertainty, in part because it is not
practicable to identify losses on an individual loan
basis because of the large number of individually
insignificant loans in the portfolio.
The methods involve the use of statistically
assessed historical information which is
supplemented with significant management
judgement to assess whether current economic and
credit conditions are such that the actual level of
inherent losses is likely to be greater or less than
that suggested by historical experience. In normal
circumstances, historical experience provides the
most objective and relevant information from which
to assess inherent loss within each portfolio.
Sometimes, however, it provides less relevant
information about the inherent loss in a given
portfolio at the balance sheet date, for example,
when there have been changes in economic,
regulatory or behavioural conditions which result in
the most recent trends in portfolio risk factors being
not fully reflected in the statistical models. In these
circumstances, the risk factors are taken into account
by adjusting the impairment allowances derived
solely from historical loss experience.
Risk factors include loan portfolio growth,
product mix, unemployment rates, bankruptcy trends,
geographical concentrations, loan product features,
economic conditions such as national and local
trends in housing markets, the level of interest rates,
portfolio seasoning, account management policies
and practices, changes in laws and regulations, and
other influences on customer payment patterns.
Different factors are applied in different regions
and countries to reflect local economic conditions,
laws and regulations. The methodology and the
assumptions used in calculating impairment losses
are reviewed regularly in the light of differences
between loss estimates and actual loss experience.
For example, roll rates, loss rates and the expected
timing of future recoveries are regularly
benchmarked against actual outcomes to ensure
they remain appropriate.
Under certain specified conditions, the Group
provides loan forbearance to borrowers experiencing
financial difficulties by agreeing to modify the
contractual payment terms of loans in order to
improve the management of customer relationships,
maximise collection opportunities and, if possible,
avoid default or repossession. Where forbearance
activities are significant, higher levels of judgement
and estimation uncertainty are involved in
determining their effects on loan impairment
allowances. Forbearance activities take place in both
retail and wholesale loan portfolios, but the Group’s
largest concentration is in the US, in HSBC
Finance’s CML portfolio. A detailed review of the
CML portfolio was carried out during 2011 to
improve the risk differentiation in the segmentation
of the portfolio. The review involved extensive