PILLAR 3 Disclosures For the nine months ended 31 December 2009

Transcription

1 PILLAR 3 Disclosures For the nine months ended 31 December 2009

2 Forward-Looking Statement This document contains certain forward looking statements within the meaning of Section 21E of the US Securities Exchange Act of 1934 and Section 27A of the US Securities Act of 1933 with respect to certain of the Bank of Ireland Group s (the Group) plans and its current goals and expectations relating to its future financial condition and performance and the markets in which it operates. These forward looking statements can be identified by the fact that they do not relate only to historical or current facts. Forward looking statements sometimes use words such as aim, anticipate, target, expect, estimate, intend, plan, goal, believe, or other words of similar meaning. Examples of forward looking statements include among others, statements regarding the Group s future financial position, income growth, business strategy, projected costs, projected impairment losses, capital ratios, margins, future payment of dividends, the outcome of the current review of the Group s defined benefit pension schemes, estimates of capital expenditures, discussions with Irish, European and other regulators and plans and objectives for future operations. Because such statements are inherently subject to risks and uncertainties, actual results may differ materially from those expressed or implied by such forward looking statements. Such risks and uncertainties include, but are not limited to, risks and uncertainties relating to the performance of the Irish and UK economies, property market conditions in Ireland and the UK, costs of funding, the performance and volatility of international capital markets, the expected level of credit defaults, the impact of the National Asset Management Agency, the outcome from the review by the European Commission under EU state aid rules of the restructuring plan submitted by the Group, the Group s ability to expand certain of its activities, development and implementation of the Group s strategy, including the ability to achieve estimated cost reductions, competition, the Group s ability to address information technology issues, and the availability of funding sources. Any forward looking statements speak only as at the date they are made. The Group does not undertake to release publicly any revision to these forward looking statements to reflect events, circumstances or unanticipated events occurring after the date hereof. The reader should however, consult any additional disclosures that the Group has made or may make in documents filed or submitted or may file or submit to the US Securities and Exchange Commission. 2

3 Capital Requirements Directive PILLAR 3 Risk Management Disclosures Contents Executive Summary Introduction Capital Risk Management Credit Risk Counterparty Credit Risk Equity Holdings not in the Trading Book Securitisation Market Risk Operational Risk Glossary

4 Executive Summary Basel II The Basel Capital Accord (Basel II) is a capital adequacy framework which aims to improve the way regulatory capital requirements reflect credit institutions underlying risks. Basel II was introduced into EU law through the Capital Requirements Directive (CRD). Basel II is based around three complementary elements or pillars. Pillar 1 contains mechanisms and requirements for the calculation by financial institutions of their minimum capital requirements for credit risk, market risk and operational risk. Pillar 2 is concerned with the supervisory review process. It is intended to ensure that each financial institution has sound internal processes in place to assess the adequacy of its capital, based on a thorough evaluation of its risks. Supervisors (for the Bank of Ireland Group ( the Group ), this is the Irish Financial Regulator (the Financial Regulator )) are tasked with evaluating how well financial institutions are assessing their capital adequacy needs relative to their risks. Pillar 3 requires financial institutions to publicly disclose detailed information on their Basel II risk management processes and risk measures. The Group s Pillar 3 document is a technical paper which should be read in conjunction with the Group s Annual Report for the nine months ended 31 December 2009 (hereafter referred to as the Group s Annual Report 31 December 2009 ), which contains some Pillar 3 qualitative information. The Group s Pillar 3 disclosures have been prepared in accordance with the CRD as implemented into Irish law. Areas Covered In accordance with Pillar 3 requirements, the areas covered by the Group s Pillar 3 disclosures include the Group s capital requirements and resources, credit risk, market risk, operational risk and information on the Group s securitisation activity. The topics covered are also dealt with in the Group s Annual Report 31 December 2009 and cross-referencing to relevant sections is provided throughout this document. In some areas more detail is provided in these Pillar 3 disclosures. For instance, the section on capital requirements includes additional information on the amount of capital held against various risks, and significantly more detail on loan data is provided. It should be noted that while some quantitative information in this document is based on financial data in the Group s Annual Report 31 December 2009 and the Group s Form 20-F December 31, 2009, other quantitative data is sourced from the Group s Basel II system and is calculated according to a different set of rules. The difference between the financial statement data and that sourced from the Group s Basel II system is most evident for credit risk disclosures where credit exposure under Basel II (referred to as exposure at default ) is defined as the expected amount of exposure at default and is estimated under specified Basel II parameters and, unlike financial statement information, includes potential future drawings of committed credit lines. Pillar 3 quantitative data is thus not always comparable with the quantitative data contained in the Group s Annual Report 31 December 2009 or the Group s Form 20-F December 31, Meeting Capital Requirements The Group s total capital position at 31 December 2009 was 13.2 billion ( 16.0 billion at 31 March 2009). Compared to a capital requirement of 7.9 billion ( 8.4 billion at 31 March 2009), which equates to 8% of risk weighted assets (8% being the minimum total capital ratio required by the Financial Regulator), this represented coverage of 167% (189% at 31 March 2009). The Group s core tier 1 capital position was 8.8 billion at 31 December 2009 ( 10.0 billion at 31 March 2009). The Group s equity tier 1, core tier 1, tier 1 and total capital ratios at 31 December 2009 were 5.3%, 8.9%, 9.8% and 13.4% respectively. Since 31 March 2009, the Group has undertaken a number of measures, including the following, to strengthen its capital position: 4

5 In June 2009 the Group announced the successful completion of a debt re-purchase programme of 1.7 billion of euro, sterling and US dollar denominated non core tier 1 securities. This initiative increased the Group s equity tier 1 by 1 billion. In February 2010 the Group successfully completed a lower tier 2 debt-for-debt exchange, which yielded a gain to equity and core tier 1 capital of 405 million, whilst leaving the total capital position unchanged. In February 2010 the Group issued 184 million units of Ordinary Stock to the National Pension Reserve Fund Commission (NPRFC) in lieu of the 250 million cash dividend otherwise due on the 2009 Preference Stock (for information on the 2009 Preference Stock, refer to Note 55 of the Group s Annual Report 31 December 2009). The Financial Regulator has completed a Prudential Capital Assessment Review (PCAR) on the Group in order to assess its capital requirements. This review, which was completed on 30 March 2010, has taken into account both expected base and potential stressed case loan losses, together with other financial developments, over a 3 year time horizon to 31 December The PCAR has been undertaken with reference to: A target core tier 1 ratio level of 8% in the base case. As a further prudent requirement, the capital to meet the base case target must be principally in the form of equity to meet a targeted equity tier 1 ratio of 7%. A target level of 4% core tier 1 capital should be maintained in a stress scenario. As announced by the Financial Regulator on 30 March 2010, the outcome of this review determined that the Group would need to raise 2.66 billion of equity capital by 31 December 2010 to comply with the PCAR. This outcome is aligned with previously held views within the Group and the Group has raised additional capital in excess of the Financial Regulator s requirements. In conjunction with these plans and to support them, the State (NPRFC) committed to converting part of its holding ( 3.5 billion Preference Stock) into ordinary equity. On 26 April 2010, the Group announced its intention to strengthen capital by 3.4 billion gross / 2.8 billion net (subject to shareholder approval), by way of the Institutional Placing 0.5 billion, the NPRFC Placing billion (through the conversion of part of the 3.5 billion Preference Stock), the Rights Issue (including NPRFC Rights Issue Undertaking) of up to billion and the Debt for Equity Offers. Shareholder approval was obtained at the EGC meeting of 19 May On 9 June 2010 the Group announced the successful completion of all the elements of the capital raise, which resulted in the Group strengthening capital by 3.56 billion gross / 2.94 billion net. The Group transferred Tranche 1 of its National Asset Management Agency (NAMA) bound assets on 2 April The loans that are expected to transfer to NAMA of approximately 12.2 billion, had impairment provisions of 2.8 billion at 31 December 2009 which together with accrued interest and related derivatives of 0.2 billion, will give rise to an expected net transfer of 9.6 billion of Bank of Ireland Eligible Bank Assets to NAMA. The loans are expected to comprise 8.5 billion of land and development loans and 3.7 billion of associated loans. Tranche 1 NAMA Assets of 1.9 billion (before impairment provisions), comprised 0.9 billion of land and development loans and 1.0 billion of associated loans. The consideration received for these assets amounted to 1.2 billion in Government guaranteed bonds and non-guaranteed subordinated bonds resulting in a discount to gross loan value of approximately 36%. The Group has developed a model which it believes replicates the NAMA valuation methodology and has put a sample of 6 billion (approximately 50% of the loans which the Group expects to transfer to NAMA, including Tranche 1 NAMA Assets) through this model. The model indicates that on this sample, the level of discount would be similar to that pertaining to Tranche 1 NAMA Assets. The loss on disposal of Bank of Ireland Eligible Bank Assets to NAMA will be a function of three factors: the quantum of those assets, the mix of those assets as between land and development and associated loans, and the discount that would apply to those assets. 5

6 While the limited number and nature of loans involved in Tranche 1 NAMA Assets may not be representative of the total portfolio, applying the level of discount (approximately 36%) on the disposal of the Tranche 1 NAMA Assets to the portfolio of 12.2 billion of loans would result in a loss of 4.4billion (before taking account of impairment provisions of 2.8 billion at 31 December 2009). The Bank estimates that the disposal of loans to NAMA of 12.2 billion will reduce the Risk Weighted Assets of the Group by approximately 11 billion. The pro forma impact on capital ratios is outlined in Part XV, page 153 (Unaudited Pro Forma Financial Information) of the Prospectus for the Rights Issue dated 26 April 2010 available on the Group s website. 1 Risk Management The Group s risk management structure has been reinforced by changes put in place since 31 March An internal reorganisation has been implemented, which includes a split of the role of the Chief Risk Officer into two functions Chief Credit & Market Risk Officer (CCMRO) and Chief Governance Risk Officer (CGRO) both of whom report directly to the Group Chief Executive Officer. The restructure was designed to enhance the status of risk at executive level and give greater line of sight on accountability and responsibility for risk. In addition, since 31 March 2009, a new committee the Court Risk Committee (CRC) has been established. The Committee comprises non-executive directors of the Court and its primary responsibilities are to assist the Court in discharging its responsibilities in overseeing risk management in the Group. To that end it forms a view on the key risks facing the Group, on the quality and effectiveness of risk identification assessment, control and reporting, reviews the extent to which strategy is informed by and aligned with the Group s risk appetite, and reports its findings to the Court. The CRC meets at least quarterly; it met 4 times during the second half of 2009 and is scheduled to meet 6 times in Credit Risk The Group uses Foundation Internal Ratings Based approach (IRB), IRB Retail and Standardised approaches for the calculation of its credit risk capital requirements. The Standardised approach involves the application of prescribed regulatory formulae to credit exposures to calculate the capital requirement. The IRB approaches (Advanced, Foundation and Retail) allow banks, subject to the approval of their regulator, to use their internal credit risk measurement models combined, where appropriate, with regulatory rules, to calculate their capital needs. At 31 December 2009, the Group applied the Foundation IRB and IRB Retail approaches to 66% (61.5% at 31 March 2009) of its exposures which resulted in 44% of credit risk weighted assets (RWA) being based on IRB approaches (41% at 31 March 2009). In May 2010 the Group received IRB model approval for three further models. Had approval for these models been in place as at 31 December 2009, 81% of the Group s exposures and 66% of credit RWA would have been based on IRB approaches. Subject to regulatory approval, the Group anticipates extending the usage of Foundation IRB and IRB Retail in due course. In addition, circa 12.2 billion of the Group s higher risk loan exposures consisting of performing and nonperforming land and development loans, together with associated loans (primarily investment property loans), are in the process of being transitioned to the National Asset Management Agency (NAMA). 1.9 billion of exposures have been transferred to date. The credit risk information disclosed includes a breakdown of the Group s exposures by Basel exposure class, by location, sector and asset quality. Information on past due and impaired financial assets and provisions is also provided. The Group s approach to management of balances in arrears and impaired loans is rigorous, with a focus on early intervention and active management of accounts. The Group has redeployed significant resources from loan origination into remedial management of existing loans which has further strengthened its management of past due and impaired loans

7 Market Risk The Group generates market risk in the normal course of its banking business and this risk is substantially mitigated with external counterparties. The Group engages to a limited extent in proprietary risk-taking, but does not seek to generate a material proportion of its earnings from this activity and has a low tolerance for earnings volatility arising from trading risk. The management of market risk in the Group is governed by high level principles approved by the Court and a detailed statement of policy approved by the Group Risk Policy Committee. Discretionary market risk is subject to strict controls which set out the markets and instruments in which risk can be assumed, the types of positions which can be taken and the limits which must be complied with. The Group employs a VaR approach to measure, and set limits for, proprietary market risk-taking in Bank of Ireland Global Markets. This is supplemented by a range of other measures including stress tests. The Group uses the Standardised approach for its assessment of capital requirements for market risk, using the prescribed regulatory calculation method. Operational Risk The Group's operational risk framework is implemented by business units, supported by the Group Regulatory, Compliance and Operational Risk function (GRCOR function). Implementation of the operational risk framework is monitored by the Group Risk Policy Committee, the Group Audit Committee and the Group Regulatory, Compliance and Operational Risk Committee. Group and business risk exposures are assessed and appropriate controls and mitigants are put in place; appropriate loss tolerances are set and monitored. This strategy is further supported by risk transfer mechanisms such as the Group s insurance programme. The Group uses the Standardised approach for its assessment of capital requirements for operational risk, using the prescribed regulatory calculation method. 7

8 1. Introduction The Basel Capital Accord ( Basel II ), which has been implemented into EU law by the Capital Requirements Directive (CRD), consists of three Pillars. Pillar 1 contains mechanisms and requirements for the calculation by financial institutions of their minimum capital requirements for credit risk, market risk and operational risk. Pillar 2 is concerned with the supervisory review process. Pillar 3 is intended to complement Pillar 1 and Pillar 2. It requires that financial institutions disclose information annually on the scope of application of the Basel II requirements, capital requirements and resources, risk exposures and risk assessment processes. The CRD was implemented into Irish law in The Bank of Ireland Group ( the Group ) is required to comply with its disclosure requirements. For ease of reference, the requirements are referred to as Pillar 3 in this document. Pillar 3 contains both qualitative and quantitative disclosure requirements. The Group s qualitative disclosure requirements are largely met in the Operating and Financial Review and the Risk Management sections of the Group s Annual Report 31 December 2009 and the Group s Form 20-F December 31, This document contains the Group s Pillar 3 quantitative disclosure requirements and the remainder of the qualitative disclosure requirements. This document should therefore be read in conjunction with the Group s Annual Report 31 December Copies of the Group s Annual Report 31 December 2009 and the Group s Form 20-F December 31, 2009 can be obtained from the Group s website at or from the Group Secretary s Office, Bank of Ireland, 40 Mespil Road, Dublin 4, Ireland. The Group s Pillar 3 disclosures have been produced in accordance with the Group s Pillar 3 Disclosure Policy. Supervision The Bank of Ireland Group is regulated by the Financial Regulator. As at 31 December 2009, the Group held 4 separate banking licences. These are held by the Governor and Company of the Bank of Ireland, ICS Building Society, Bank of Ireland Mortgage Bank and Bank of Ireland (IOM) Limited. All of these entities are regulated by the Financial Regulator with the exception of Bank of Ireland (IOM) Limited which is regulated by the Isle of Man Financial Supervision Commission. Each individual licence holder and regulatory entity is required to comply with its local regulatory requirements. The Group has included within certain licences (principally the Governor and Company of the Bank of Ireland bank licence) the capital, assets and liabilities of a range of non regulated subsidiaries domiciled in both Ireland and overseas. These included subsidiaries are not (i) credit institutions (ii) investment firms or (iii) other regulated entities that have a capital requirement driven by business activity levels. Preparation and Basis of Consolidation The Group s Pillar 3 disclosures are published on a consolidated basis for the nine months ended 31 December The Group is availing of the discretion provided for in Article 70 of the CRD to report on a solo consolidation basis which allows for the treatment of subsidiaries as if they were, in effect, branches of the parent in their own right. Not all legal entities are within the scope of Pillar 3. Table 1.1 below illustrates differences between the basis of consolidation for accounting purposes and the Basel II regulatory treatment. 8

9 Table 1.1 Basis of Consolidation Entity Statutory Accounting Treatment Basel II Regulatory Treatment BOI Life Fully Consolidated 90% of investment taken as a deduction to Total Capital. Balance of investment added to RWA. Joint Ventures Equity Accounting For holdings >10% of Joint Venture s Total Capital, deduction to Total Capital for investment in excess of 10% of the Total Capital of the Joint Venture (50% from tier 1, 50% from tier 2). Balance of investment added to RWA. Associates Equity Accounting For holdings >10% of the Associate s Total Capital, deduction to Total Capital for investment in excess of 10% of the Total Capital of the Associate (50% from tier 1, 50% from tier 2). Balance of investment added to RWA. Securitisation Vehicles Fully Consolidated 1st Loss deduction taken 50% from tier 1 & 50% from tier 2. Distinctions between Pillar 3 and IFRS Quantitative Disclosures There are two different types of table included in this document, those compiled based on accounting standards (sourced from the Group s Annual Report 31 December 2009 and the Group s Form 20-F December 31, 2009) and those compiled using Basel Il methodologies. Unless specified otherwise, both sets of data reflect the position as at 31 December 2009, which is the Group s new financial year end. The specific methodology used is indicated in each individual table. It should be noted that there are fundamental differences in the basis of calculation between financial statement information based on IFRS accounting standards and Basel II Pillar 1 information based on regulatory capital adequacy concepts and rules. This is most evident for credit risk disclosures where credit exposure under Basel II (referred to as exposure at default ) is defined as the expected amount of exposure at default and is estimated under specified Basel II parameters and includes potential future drawings of committed credit lines whereas in the financial statements the Group s loans are recorded at fair value plus transaction costs when cash is advanced to the borrower. They are subsequently accounted for at amortised cost using the effective interest method and take no account of potential future drawings. While some of the Pillar 3 quantitative disclosures based on Basel II methodologies overlap with quantitative disclosures in the Group s Annual Report 31 December 2009 and the Group s Form 20-F December 31, 2009 in terms of disclosure topic covered, any comparison should bear these fundamental differences in mind. The disclosures contained in this document have been reviewed internally, and this review is consistent with reviews undertaken for unaudited information published in the Group s Annual Report 31 December Comparative Analysis The primary factors behind movements between 31 March 2009 and 31 December 2009 are outlined below. Capital Resources Total tier 1 capital decreased by 2,998 million, reflecting the loss of 1,469 million in the nine month period ended 31 December 2009 (which includes the benefit of the gain generated from the debt repurchased of 1,037 million) and the reduction of 1,670 million associated with the tier 1 debt repurchase. Tier 2 capital increased by 6% or 239 million to 4,310 million. The movement was driven by an increase in IBNR provisions of 465 million offset by a decrease in dated loan capital of 111 million. 9

10 Volumes The reduction in the Institutions exposure class from March 2009 to December 2009 is mainly due to a reduction in liquid assets held by the Group. This decrease is due to a reduction in the overall level of wholesale funding together with an extension of the maturity profile of this lower level of wholesale funding. This has led to a reduction in the Group s requirement for liquid assets. The reduction in the Central Governments or Central Banks exposure class from March 2009 to December 2009 is due to a reduction in gross collateralised borrowing through the normal monetary operations of the Monetary Authorities as the Group reduced the overall level of wholesale funding. Drawings from Monetary Authorities at 31 December 2009 were 8 billion net, down from 17 billion net at 31 March In January 2009 the Group announced its withdrawal from the intermediary sourced mortgage market in the UK and commenced the process of winding down a series of non-core international lending portfolios in Capital Markets which the Group expects will reduce the size of its balance sheet over time. These deleveraging activities have impacted on volumes since 31 March Volumes were also impacted by movements in exchange rates, and additional loan drawdowns of committed facilities. Asset Quality Asset quality continues to deteriorate on a reducing loan book primarily due to the deterioration in the global and Irish economic environments, resulting in continuing low levels of economic activity across the Group s main markets, impacting upon credit quality. This deterioration is reflected in the sections below on Asset Quality and Securitisation. Default, Impairment and Provisioning The volume of loans in default in accordance with the CRD definition of default (greater than 90 days past due) has increased (this is particularly visible in the Standardised approach Past Due exposure class). The volume of impaired loans and provisions has also increased. This reflects the severe deterioration in general economic conditions, weaker consumer sentiment and a sharp slowdown in the property and construction sector. 10

11 2. Capital The Group s approach to assessing the adequacy of its internal capital to support current and future activities is set out on page 105 of the Group s Annual Report 31 December 2009 under Capital Management. The Group uses Foundation Internal Ratings Based approach (IRB), IRB Retail and Standardised approaches for the calculation of its credit risk capital requirements. It is anticipated that a number of portfolios currently on the Standardised approach will move in due course to the Internal Ratings Based approach. The capital requirements for market risk are calculated using the Standardised approach applicable to market risk. The capital requirements for operational risk are calculated using the Standardised approach applicable to operational risk. There is a requirement to disclose any impediment to the prompt transfer of funds within the Group. In order to maintain capital and/or liquidity ratios at or above the levels set down by their regulators, the licensed subsidiaries would be unable to remit capital to the parent when to do so would result in such ratios being breached. Apart from this requirement there is no restriction on the prompt transfer of own funds or the repayment of liabilities between the subsidiary companies and the parent. At 31 December 2009, the Group s actual own funds were not less than the required minimum in all subsidiaries not included in consolidation. 11

12 Capital Requirements Table 2.1 shows the minimum amount of capital the Group would be required to set aside to meet the minimum rate of 8% of RWA set by the CRD. Table 2.1 Capital Requirements 31 December March 2009 Credit Risk & Counterparty Risk of which 7,070 7,565 IRB 3,113 3,105 of which Central Government & Central Banks - - Institutions Corporates 1,953 1,935 Retail: Exposures secured by real estate collateral Qualifying revolving retail exposures Other retail exposures Securitisation position Standardised 3,957 4,460 of which Central Government & Central Banks - - Regional Government or Local Authorities - - Administrative bodies & non-commercial undertakings 2 2 Multilateral Development banks - - International Organisations - - Institutions - - Corporates 3,140 3,915 Retail Secured by real estate property - - Past Due items Items belonging to regulatory high risk categories 3 3 Covered Bonds - - Short term claims on institutions and corporates Collective Investment Undertakings - - Others items 3 3 Securitisation Positions - - Market Risk of which FX Operational Risk Other Assets Total Capital Requirements 7,867 8,429 12

13 Breakdown of the Group s Regulatory Capital Requirement The Group has received further approvals (May 2010) from the Financial Regulator for its IRB models and now has regulatory approval to use the IRB approach to calculate its capital requirement for the majority of its credit exposures by EAD (81%) and by RWA (66%). The Group has further portfolios that will transition to the IRB approach (subject to regulatory approval). Table 2.2 shows the Group s minimum capital requirements (based on 8% of risk weighted assets), risk weighted assets (RWA) and exposure at default by risk type. Table 2.2 Breakdown of the Group s Regulatory Capital Requirement Risk Type Capital Requirement 31 December March 2009 Risk Weighted Assets Exposure at Default Capital Requirement Risk Weighted Assets Exposure at Default Standardised Approach 3,957 49,458 59,633 4,460 55,739 72,490 Retail & Foundation IRB Approach 3,113 38, ,936 3,105 38, ,940 Market Risk 171 2, ,509 - Operational Risk 513 6, ,473 - Other Assets 113 1, ,830 - Total 7,867 98, ,569 8, , ,430 13

14 Capital Resources Table 2.3 sets out the Group s capital position as at 31 December This table shows the amount and type of regulatory capital the Group held at that date to meet its capital requirements. Summary information on the terms and conditions of the main features of the Group s capital resources and components thereof can be found in the Group s Annual Report 31 December 2009 on page 107 Capital Adequacy Data, in Note 39 Subordinate liabilities on page 218 and in Note 45 Capital Stock on page 229. See also Capital Securities Issued by the Group below.tale Capital Resources Table 2.3 Capital Resources 31 December March 2009 Share capital and reserves 6,437 6,913 Regulatory retirement benefit obligation adjustments 1,632 1,478 Available-for-sale revaluation reserve and cash flow hedging 1,118 reserve 2,124 Goodwill and other intangibles (488) (511) Preference Stock (59) (58) New Preference Stock and Warrants (3,462) (3,462) Other Adjustments Equity Tier 1 Capital 5,258 6,506 Preference Stock New Preference Stock 3,462 3,462 Core Tier 1 Capital 8,779 10,026 Innovative Hybrid Debt 752 1,197 Non-Innovative Hybrid Debt 574 1,798 Supervisory deductions (454) (372) of which: Regulatory Deduction (40) (31) First Loss Deduction (71) (69) Expected Loss Deduction (343) (272) Total Tier 1 Capital 9,651 12,649 Tier 2 Capital Undated loan capital Dated loan capital 3,716 3,827 IBNR Provisions Revaluation Reserves Supervisory deductions (454) (372) of which: Regulatory Deduction (40) (31) First Loss Deduction (71) (69) Expected Loss Deduction (343) (272) Other adjustment 11 - Total Tier 2 Capital 4,310 4,071 Total Tier 1 and Tier 2 Capital 13,961 16,720 Supervisory deductions - - Life and Pensions businesses (797) (749) Total Capital 13,164 15,971 For background information on movements in Table 2.3 see the Comparative Analysis section above. 14

15 Capital Securities Issued by the Group The main features of the Group s issued capital securities (hybrid capital instruments and subordinated liabilities) are described below. For regulatory purposes, these securities are divided into two categories, tier 1 and tier 2, depending on the degree of subordination, permanency and loss absorbency exhibited. The balances disclosed in the tables below are the accounting balance sheet carrying amounts and are not the amounts that the instruments contribute to regulatory capital. The regulatory treatment of these instruments and the accounting treatment differ, for example, in the treatment of issuance costs or regulatory amortisation. Therefore, the balances disclosed below will not reconcile to the amounts disclosed in Table 2.3. Tier 1 Certain of the Group s capital securities qualify as tier 1 capital. Preference stock, including the Government s investments in the Group, qualifies as core tier 1 capital and other innovative and non innovative securities issued by the Group qualify as non core tier 1 capital. In June 2009 the Group repurchased certain amounts of non core tier 1 securities as part of its ongoing capital management activities. This explains the decreases in certain issuances in Tables 2.5 and 2.6 below. Preference Stock The 2009 Government Preference Stock was issued by the Group to the National Pension Reserve Fund Commission (NPRFC) on 31 March This stock is perpetual and entitles the NPRFC to receive a noncumulative cash dividend payable at the discretion of the Group. If the dividend is not paid by the Group in cash it is settled via the issuance of ordinary stock to the NPRFC. The stock ranks ahead of ordinary stock as regards dividends and ranks pari passu as regards dividends with other core tier 1 securities. The stock may be repurchased, in whole or in part, at its nominal value within the first five years from the date of issue and thereafter at a premium of 25% to nominal value. Table 2.4 Preference Stock 31 December March Government Preference Stock (and Warrants per December 2009) 3,462 3,462 Other Preference Stock Total 3,521 3,520 Further information in relation to the above can be found in Note 45 Capital Stock and Note 55 Summary of relations with the Irish Government of the Group s Annual Report 31 December 2009 and Item 10 Charter and Bye-Laws of the Group s Form 20-F December 31, Innovative non core Tier 1 securities Innovative non core tier 1 capital securities are subordinate securities, with some additional equity like features that allows them to be included as tier 1 capital. Innovative non core tier 1 securities have no obligation to pay a coupon (and typically contain a moderate incentive to redeem). Such securities do not generally carry voting rights and rank above ordinary shares for coupon payments and in the event of a winding-up. The securities may be called and redeemed by the issuer, subject to the prior approval of the Financial Regulator. If not redeemed, coupons payable may step-up and become floating rate or, fixed rate thereafter based on the relevant reference security plus a margin. The following table lists the qualifying innovative non core tier 1 securities in issue as at 31 December 2009 along with 31 March 2009 comparatives: 15

16 Table 2.5 Innovative non core Tier 1 securities 600 million 7.4% Guaranteed Step-up Callable Perpetual Preferred Securities US$800 million Fixed Rate / Variable rate Guaranteed Non-voting Noncumulative Perpetual Preferred Securities 31 December March Total 771 1,311 Non Innovative non core Tier 1 securities Non innovative non core tier 1 capital securities are subordinated securities, with some equity like features that can be included as tier 1 capital. Non innovative non core tier 1 securities have no obligation to pay a coupon. Such securities do not generally carry voting rights and rank higher than ordinary shares for coupon payments and in the event of a winding-up. The securities may be called and redeemed by the issuer, subject to the prior approval of the Financial Regulator. The following table lists the qualifying non innovative non core tier 1 securities in issue as at 31 December 2009 along with 31 March 2009 comparatives: Table 2.6 Non Innovative non core Tier 1 securities 31 December March 2009 Stg 350 million 6.25% Guaranteed Callable Perpetual Preferred Securities million Fixed Rate / Variable rate Guaranteed Non-voting Noncumulative Perpetual Preferred Securities US$400 million Fixed Rate / Variable rate Guaranteed Non-voting Noncumulative Perpetual Preferred Securities Stg 500 million Fixed Rate/ Variable Rate Guaranteed Non-voting Noncumulative Perpetual Preferred Securities Total 573 1,905 Tier 2 Tier 2 securities are subordinate instruments but do not have the same loss absorbing and permanency features as tier 1 securities. Tier 2 securities are further classified into upper tier 2 and lower tier 2. Upper Tier 2 capital Upper tier 2 securities are subordinated loan capital that do not have a stated maturity date but may be called and redeemed by the issuer, subject to the prior approval of the Financial Regulator. The following table lists the qualifying upper tier 2 securities in issue as at 31 December 2009 along with 31 March 2009 comparatives: Table 2.7 Upper Tier 2 instruments 31 December March 2009 Stg 75 million 13 3/8% Perpetual Subordinated Bonds Stg 32.6 million 8 1/8% Non cumulative Preference Shares US $150 million Capital note (Classified as other equity reserves in the Group s Annual Report 31 December 2009) Total

17 Lower Tier 2 securities Lower tier 2 securities comprise dated subordinated loan capital repayable at par on maturity and which have an original maturity of at least five years. Some subordinated loan capital may be called and redeemed by the issuer, subject to the prior approval of the Financial Regulator. If not redeemed, interest coupons payable may step-up or become floating rate related to interbank offer rates. For regulatory purposes, it is a requirement that lower tier 2 securities be amortised on a straight-line basis in their final five years of maturity thus reducing the amount of capital that is recognised for regulatory purposes. The following table lists the qualifying lower tier 2 securities in issue as at 31 December 2009 along with 31 March 2009 comparatives: Table 2.8 Lower Tier 2 instruments 31 December March million 6.45% Subordinate Bonds CAD$400 million Fixed/Floating Rate Subordinate Notes million Subordinate Floating Rate Notes million Floating Rate Subordinate Notes Stg 400 million Fixed/Floating Rate Subordinate Notes US $600 million Subordinate Floating Rate Notes due Stg 75 million 10 ¾% Subordinate Bonds million Fixed/Floating Rate Subordinate Notes Stg 450 million dated callable step-up Fixed/Floating Rate Subordinate Notes September Total 4,532 4,557 Further information on events that have occurred since 31 December 2009 which have had an impact on the Group s issued capital securities can be found in the post balance sheet events note in the Group s Form 20-F December 31, The 750m 6.45% Subordinate Bonds mature in 2010 and are fully amortised from a regulatory capital perspective. 17

18 3. Risk Management The Group follows an integrated approach to risk management to ensure that all material classes of risk are taken into account and that its risk management and capital management strategies are aligned with its overall business strategy. The key risks to which the Group is exposed are credit risk, liquidity risk, market risk, operational risk, pension risk, business risk, life insurance risk, model risk, reputation risk and regulatory risk. Detail regarding how these risks are identified, managed, measured and mitigated is provided in the Risk Management section on page 60 of the Group s Annual Report 31 December The Group s risk objectives are set out in the Risk Strategy and Appetite section on page 68 of the Group s Annual Report 31 December Risk Management Structure and Organisation Responsibilities for risk management extend throughout the organisation. Details of the risk governance structure, including risk committees, is set out on pages of the Group s Annual Report 31 December Court of Directors Court Risk Committee* Group Audit Committee* Group Risk Policy Committee Group Credit Committee Approval of all large credit transactions Risk Measurement Committee Governance of credit risk measurement & risk model validation Asset & Liability Committee (ALCO) Oversight of interest rate, market & liquidity risk, capital & funding Group Liquidity Committee Invoked during periods of market disruption** Group Regulatory Compliance & Operational Risk Committee Governance of Regulatory & Op Risk Group Equity Underwriting Committee Approval of equity underwriting transactions Portfolio Review Committee Assessment of composition of the loan portfolio, concentrations, risk adjusted return Private Equity Governance Committee Approval of equity investments Group Tax Committee Oversight of tax policy and approval of tax proposals Basel II Steering Governance and oversight of Basel II programme Business Units * Membership comprises only non-executive directors ** The committee has been invoked and is overseeing the management of funding and liquidity The Group completed a review of its risk governance framework in May 2009 taking account of the impact of the global financial crisis on the Group and on the financial services sector. The outcome of the review has resulted in several recommendations that have been or are currently being implemented. These include: Establishment of a new non-executive board level committee the Court Risk Committee (CRC) with specific responsibility for advising the Court on all risk issues, The terms of reference and membership of key risk committees have been refined and updated for emerging best practice recommendations, The content of risk reporting has been enhanced and the frequency of reporting to senior management and the Court has increased, An internal reorganisation has been implemented, which includes a split of the role of the Chief Risk officer into two functions Chief Credit & Market Risk Officer (CCMRO) and Chief Governance Risk Officer (CGRO) both of whom report directly to the Group Chief Executive Officer. The restructure was designed 18

19 to enhance the status of risk at executive level and give greater line of sight on accountability and responsibility for risk. The responsibilities of the CCMRO include the management of credit and market risk and overall integrated risk reporting to the Group Executive team, the CRC and the Court. The CGRO has responsibility for the management of the Group Regulatory, Compliance and Operational Risk function, Group Internal Audit, Group Legal Services, and the Group Secretariat. 19

20 4. Credit Risk Credit risk is defined as the risk of loss resulting from a counterparty being unable to meet its contractual obligations to the Group in respect of loans or other financial transactions. The core values and principles governing credit risk are contained in the Group s Credit Policy. Further detail regarding this policy and strategies and processes by which credit risk is managed are included in the Credit Risk Management section from page 71 of the Group s Annual Report 31 December The Group seeks to ensure that adequate up to date credit management information is available to support the credit management of individual account relationships and the overall loan portfolio. Detail on the schedule and content of credit risk reporting is provided under the heading Credit Reporting/Monitoring on page 74 of the Group s Annual Report 31 December Disclosures relating to the active monitoring of credit risk are also included in this section. The processes by which credit risk is assessed and measured are set out in the Credit Risk Assessment and Measurement section on page 77 of the Group s Annual Report 31 December Credit Risk Mitigation for Risk Management Purposes Hedging and mitigation of credit risk for risk management purposes is covered in the Group s credit risk policies. The Group mitigates credit risk through the adoption of both proactive preventative measures (e.g. controls and limits) and the development and implementation of strategies to assess and reduce the impact of particular risks, should these materialise (e.g. hedging, securitisation and collateralisation). Further detail on credit risk mitigation for risk management purposes is contained on page 78 of the Group s Annual Report 31 December Credit Risk Mitigation for Regulatory Capital Calculation For Retail IRB assets the effect of credit risk mitigation, principally the collateral taken to secure loans, is taken into account in the development of the Group s Loss Given Default (LGD) models, which in turn are used in the calculation of the Group s capital requirements. For non-retail Foundation IRB assets (corporate and commercial lending) Supervisory LGDs are used for capital calculation purposes as is required under the CRD. These Supervisory LGDs are either applied directly to obligors, or the Supervisory LGD is reduced through the recognition of the risk-mitigating impact of tangible collateral held as security. Under the IRB approach, depending on the type of credit risk mitigation applied, Probability of Default (PD) or LGD may be impacted. The Group does not apply credit risk mitigation to the calculation of EAD, therefore the amounts shown in the tables below, which are based on EAD, do not change following the application of credit risk mitigation. Under the Standardised approach, credit risk mitigation impacts on the risk weight which is then subsequently applied to the exposure amount to derive the capital requirement. Therefore, the amounts shown in the Standardised tables below do not alter following the application of credit risk mitigation. Further information on credit risk mitigation is provided in the Credit Risk Mitigation section below. 20

21 Maximum Exposure to Credit Risk Tables 4.1 and 4.2 are based on EAD and show the Group s point-in-time and average maximum exposure to credit risk. The average exposures for 31 December 2009 are calculated based on the period from 1 April 2009 to 31 December The average exposures for 31 March 2009 are calculated based on the period from 1 April 2008 to 31 March Table 4.1 Maximum Exposure to Credit Risk IRB Exposure Class 31 December March 2009 Average Exposures over the nine months to Total 31 Dec 2009 Exposure Total Exposure Average Exposures over the year Institutions 23,051 24,375 27,356 29,802 Corporates 28,017 27,546 27,040 24,406 Retail 61,358 61,733 59,970 64,276 Securitisation Positions 1,510 1,512 1,574 1,986 Total 113, , , ,470 Table 4.2 Maximum Exposure to Credit Risk : Standardised Approach Standardised Credit Risk Exposure Class 31 December March 2009 Average Exposures over the nine months to Total 31 Dec 2009 Exposure Total Exposure Average Exposures over the year Central governments or central banks 10,588 11,623 16,246 6,350 Administrative bodies and non-commercial undertakings Corporates 39,902 44,734 49,367 53,075 Retail 2,948 3,784 3,985 4,834 Past due items 5,665 4,590 2,224 1,501 Items belonging to regulatory high risk categories Short term claims on institutions and corporates ,142 Other items Total 59,633 65,370 72,490 66,983 21

22 Geographic Analysis of Exposures The Group s primary markets are Ireland and the UK. Tables 4.3 and 4.4 below are based on EAD, and the geographic locations shown are based on the location of the business unit where the exposure is booked. Table 4.3 Geographic Analysis of Exposure : IRB Approach IRB Credit Risk Exposure Class Ireland 31 December March 2009 UK & Other Total Ireland UK & Other Total Institutions 23, ,051 27, ,356 Corporates 17,617 10,400 28,017 17,554 9,486 27,040 Retail 31,080 30,278 61,358 30,788 29,182 59,970 Securitisation Positions 1, ,510 1, ,574 Total 73,122 40, ,936 77,168 38, ,940 h Table 4.4 Geographic Analysis of Exposure : Standardised Approach 31 December March 2009 UK & UK & Standardised Credit Risk Exposure Class Ireland Other Total Ireland Other Total Central governments or central banks 10,588-10,588 16,246-16,246 Administrative bodies and non-commercial undertakings Corporates 31,978 7,924 39,902 40,230 9,137 49,367 Retail 1,230 1,718 2,948 2,288 1,697 3,985 Past due items 4,282 1,383 5,665 1, ,224 Items belonging to regulatory high risk categories Short term claims on institutions and corporates Other items Total 48,580 11,053 59,633 61,200 11,290 72,490 22

23 Industry Analysis of Exposures Tables 4.5 and 4.6 are based on EAD. The industry classification below is based on the purpose of the loan. Similar industry headings to those in the industry analysis contained in the Group s Annual Report 31 December 2009 have been used, however, the values and distribution within the tables will differ. Values will differ due to the calculation of the exposure amount as these tables are based on EAD. The distribution will differ as information on an accounting basis is used in the Group s Annual Report 31 December 2009 and exposures are thus classified using a different methodology. Table 4.5 Industry Analysis of Exposures : IRB Approach 31 December 2009 Business Central Personal Agriculture Services Govt. & Property Distribution Energy Financial turing Transport Other Mortgages Total & Other & Local Construction Manufac- Personal Residential IRB Exposure Class Institutions , ,051 Corporates 216 4, ,087 1, , ,017 Retail ,678 54,535 61,358 Securitisation Positions ,510 Total 634 5, ,312 1, , ,360 54, ,936 IRB Exposure Class 31 March 2009 Institutions , ,356 Corporates 232 4, ,880 1, , ,040 Retail ,006 52,728 59,970 Securitisation Positions ,574 Total 683 5, ,054 1, , ,185 52, ,940 23