HSBC 2010 Annual Report Download - page 35

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Overview Operating & Financial Review Governance Financial Statements Shareholder Information
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 estimations 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$978bn (2009: US$922bn), US$15bn or 2%
(2009: US$15bn; 2%) were individually assessed
for impairment, and US$963bn or 98% (2009:
US$907bn; 98%) were collectively assessed for
impairment.
The most significant judgemental area is the
calculation of collective impairment allowances. The
geographical area with most exposure to collectively
assessed loans and advances is North America,
which comprised US$198bn or 21% (2009:
US$219bn; 24%) of the total. Collective impairment
allowances in North America were US$9bn,
representing 64% (2009: US$13bn; 68%) 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, though
sometimes 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.
However, the exercise of judgement requires the
use of assumptions which are highly subjective and
very sensitive to the risk factors, in particular to
changes in economic and credit conditions across
a large number of geographical areas. Many of the
factors have a high degree of interdependency
and there is no single factor to which our loan
impairment allowances as a whole are sensitive. They
are particularly sensitive to general economic and
credit conditions in North America, however. For
example, a 10% increase in impairment allowances
on collectively assessed loans and advances in North
America would increase loan impairment allowances
by US$0.9bn at 31 December 2010 (2009: US$1.3bn).
It is possible that the outcomes within the next