Lloyds TSB Bank plc

Pillar 3 Disclosures

31 December 2008

FORWARD LOOKING STATEMENTS

This announcement contains forward looking statements with respect to the business, strategy and plans of the Lloyds TSB Bank Group, its current goals and expectations relating to its future financial condition and performance. By their nature, forward looking statements involve risk and uncertainty because they relate to events and depend on circumstances that will occur in the future. The Lloyds TSB Bank Group’s actual future results may differ materially from the results expressed or implied in these forward looking statements as a result of a variety of factors, including UK domestic and global economic and business conditions, risks concerning borrower credit quality, market related risks such as interest rate risk and exchange rate risk in its banking business and equity risk in its insurance businesses, changing demographic trends, unexpected changes to regulation, the policies and actions of governmental and regulatory authorities in the UK and jurisdictions outside the UK, including other European countries and the US, exposure to legal proceedings or complaints, changes in customer preferences, competition and other factors. Please refer to the latest Lloyds Banking Group plc Annual Report on Form 20-F filed with the US Securities and Exchange Commission for a discussion of such factors. The forward looking statements contained in this announcement are made as at the date of this announcement, and the Lloyds TSB Bank Group undertakes no obligation to update any of its forward looking statements.

BASIS OF PRESENTATION

Lloyds TSB Bank plc (‘Lloyds TSB Bank’ or the ‘Bank’) is a European Economic Area (‘EEA’) parent institution, as defined by the Financial Services Authority (‘FSA’), and is therefore required to disclose the information set out in Chapter 11 of the Prudential sourcebook for banks, building societies, and investment firms (‘BIPRU 11’)*. Lloyds TSB Bank is wholly owned by, and as at 31 December 2008 was the only direct subsidiary of, Lloyds Banking Group plc (formerly Lloyds TSB Group plc); the risks of Lloyds Banking Group plc and its subsidiaries at 31 December 2008 (together the ‘Lloyds Banking Group’ or the ‘Group’) were, therefore, substantially the same as Lloyds TSB Bank plc and its subsidiaries (together the ‘Lloyds TSB Bank Group’ or the ‘Bank Group’). As a result, the Bank has not duplicated all of the committees of the Lloyds Banking Group plc board. This document sets out the governance structure of the Lloyds Banking Group. * These disclosure requirements, which are also known as Pillar 3, are intended to complement the minimum capital requirements

(‘Pillar 1’) and the supervisory review process (‘Pillar 2’) and aim to encourage market discipline by the provision of key data on risk

exposures and risk management.

CONTENTS

Page

Overview 1

Scope of application of directive requirements 2

Risk management objectives and policies 3

Our approach to risk 3

Risk as a strategic differentiator 4

Risk governance structures 5

Risk management framework 7

Business risk 10

Financial soundness risk 11

Credit risk 15

Market risk 22

Insurance risk 25

Operational risk 27

Accounting definitions and methodologies 30

Impairment and past due exposures 31

Equity investments in the non-trading book 33

Counterparty credit risk 34

Securitisation activities 35

Capital adequacy and capital requirements 37

Credit risk 39

Market risk 51

Operational risk 53

Approach to assessing the adequacy of internal capital to support current and future activities 55

Contacts 56

Page 1 of 56

Overview The disclosures in this report have been prepared for the UK consolidation group, the parent company of which is Lloyds TSB Bank plc. The information contained in this disclosure has not been reviewed by the Lloyds TSB Bank Group’s external auditors. This report is available from the Lloyds Banking Group plc Investor Relations website. (www.lloydsbankinggroup.com)

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Scope of application of directive requirements Consolidation basis For accounting purposes, all subsidiary undertakings are consolidated into the income statement and balance sheet of the Bank Group. For prudential regulatory reporting purposes, capital requirements are consolidated for all subsidiaries that are credit institutions or investment firms regulated under BIPRU1, which are financial institutions or which carry out ancillary activities. For those subsidiaries subject to other regulation, principally insurance companies regulated under INSPRU2, capital requirements are not consolidated; instead, these are classified as material holdings and the Bank Group’s investment in those undertakings (determined as the higher of the accounting carrying value of such entities and those entities’ own regulatory capital requirements) is deducted from capital resources. There are no entities that are proportionally consolidated for either accounting or regulatory purposes and all entities are either consolidated or deducted for regulatory purposes. Restrictions and impediments on transfer of funds or regulatory capital within the Group The Bank Group’s interests are predominately in the UK. A number of the structured lending transactions entered into involve overseas entities but such structures in the main include clauses allowing them to be collapsed at short notice and are established in jurisdictions from where the Bank Group does not anticipate any impediments to the repatriation of funds. The Bank Group’s overseas banking activities are principally carried out through its branches. Each branch holds sufficient capital to meet local regulatory requirements but, beyond this, there are no significant amounts invested in branches in any country where other legal impediments would affect the transfer of funds. Of Lloyds TSB Bank’s subsidiaries in the UK, a number are individually regulated entities and as such must maintain sufficient capital resources at all times. There are no other restrictions on the transferability of capital between Lloyds TSB Bank and its UK subsidiaries other than in the case of Scottish Widows plc. Scottish Widows plc was created following the demutualisation of Scottish Widows Fund and Life Assurance Society in 2000; the terms of the demutualisation are governed by a Court-approved Scheme of Transfer, which established protected capital support for the with-profits policyholders at the date of demutualisation. Capital surpluses and deficiencies of subsidiaries not included in the capital of the Bank Group

Each of the separate regulated entities excluded from the prudential regulatory consolidation and for which Lloyds TSB Bank’s investment is deducted from its capital resources had individual regulatory capital in excess of its own prudential regulatory requirements as at 31 December 2008.

1 BIPRU: The Financial Services Authority’s Prudential Sourcebook for Banks, Building Societies and Investment firms 2 INSPRU: The Financial Services Authority’s Prudential Sourcebook for Insurers

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Risk management objective and policies Our approach to risk The Lloyds TSB approach to risk is founded on strong corporate governance practices whereby the board takes the lead in establishing the tone at the ‘top’ and approving professional standards and corporate values for itself, senior management and other colleagues. The board ensures that senior management implements strategic policies and procedures designed to promote professional behaviour and integrity. The board also ensures that senior management implements risk policies and risk appetites that prohibit and, where appropriate, limit activities, relationships, and situations, that might diminish the quality of corporate governance. All colleagues from the group chief executive down are assessed against a balanced scorecard that explicitly addresses their risk performance. This board-level engagement, coupled with the direct involvement of senior management in group-wide risk issues at group executive committee level, ensures that issues are escalated on a timely basis and appropriate remediation plans are put in place. The interaction of the executive and non-executive governance structures relies upon a culture of transparency and openness that is encouraged by senior management. Key decisions are always taken by more than one person. Within Lloyds TSB there is a strong culture of command and control from the centre with short lines of communication between divisions and functions. The group business risk committee and the group asset and liability committee are chaired by the group chief executive and include all members of the group executive committee. The aggregate groupwide risk profile and portfolio appetite are discussed at their respective monthly meetings. This is a key component of the Lloyds TSB approach to risk management and provides oversight on behalf of the board to line management in specific business areas and activities. It is supported by the chief risk officer being a full member of the group executive committee and reporting to the group chief executive with direct access to the chairman and the risk oversight committee. The risk governance section sets out the role of the second line of defence and in particular that of the risk oversight committee and its interaction with the chief risk officer, the group risk directors and the divisional risk officers. This structure which has been in place for a number of years, has evolved with the risk oversight committee reviewing regular reports on the Group’s risk exposures as well as taking a keen interest in the adequacy and capability of resources within the risk functions. Lloyds TSB has a conservative business model and risk culture. The focus has been and remains on building and maintaining long-term relationships with customers. This involves taking a ‘through the cycle’ view whereby the sustainability of a relationship through good and bad economic times is taken into account. The approach is supported by a ‘through the cycle’ approach to risk with strong central control and monitoring. There is a matrix approach to risk management which includes group risk directors being responsible for individual risk types in aggregate across the Group and divisional risk officers being responsible for the aggregate risk profile within their respective divisions. The group risk directors and divisional risk officers all have a direct reporting line to the chief risk officer. This matrix approach enables the group executive committee members to fulfil their accountabilities for risk management and enables the chief risk officer to inform the risk oversight committee of the aggregate risk profile of the Group. The paragraphs that follow set out the risk management policies, practices and structures that applied during the past year to Lloyds TSB Group plc. These policies, practices and structures were adopted by Lloyds Banking Group from the date of completion of the HBOS plc transaction.

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Risk as a strategic differentiator The Group seeks to optimise performance by allowing divisions and business units to operate within capital and risk parameters and the Group’s policy framework. They must do so in a way which is consistent with realising the Group’s strategy and meets agreed business performance targets. The Group’s approach to risk management seeks to ensure the business remains accountable for risk whilst also ensuring there is effective independent oversight. The Group has continued to focus on enhancing its capabilities in providing both qualitative and quantitative data to the board on risks associated with strategic objectives and facilitating more informed and effective decision making. The Group‘s ability to take risks which are well understood, consistent with its strategy and plans and appropriately remunerated, is a key driver of shareholder return. The maintenance of a strong control framework remains a priority and is the foundation for the delivery of effective risk management. Risk analysis and reporting capabilities support the identification of opportunities as well as risks and it provides an aggregate view of the overall risk portfolio. Risk mitigation strategies clearly aligned with responsibilities and timescales are monitored at group and divisional level. Risk continues to be a key component of routine management information reporting and is embedded within staff objectives via balanced scorecards. Reflecting the importance the Group places on risk management, risk is included as one of the five principal criteria within the Group’s balanced scorecard on which individual staff performance is judged. Business executives have specified risk management objectives, and incentive schemes take account of performance against these.

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Risk governance structures The Group maintains a risk governance structure that is intended to strengthen risk evaluation and management, whilst also positioning the Group to manage the changing regulatory environment in an efficient and effective manner. The structure has been tried and tested by Lloyds TSB and has remained the same for Lloyds Banking Group.

Board and committees

The board, assisted by its committees, the risk oversight committee, the group executive committee, and the group audit committee, approves the Group’s overall risk management framework. The board also reviews the Group’s aggregate risk exposures and concentrations of risk to seek to ensure that these are consistent with the board’s appetite for risk.

The group executive committee, assisted by the group business risk committee and the group asset and liability committee, supports the group chief executive in ensuring the effectiveness of the Group’s risk management framework and the clear articulation of the Group’s risk policies, whilst also reviewing the Group’s aggregate risk exposures and concentrations of risk. The group executive committee members are also members of the group business risk committee and the group asset and liability committee which are chaired by the group chief executive. The group business risk committee is supported by the following: The Group compliance and operational risk committee is responsible for proactively identifying current and emerging significant compliance and operational risks or accumulation of risks and control deficiencies across the Group and reviewing associated oversight plans to ensure pre-emptive risk management action. The committee also seeks to ensure that adequate divisional engagement occurs to develop, implement and maintain the Group’s compliance and operational risk management framework. The Group credit risk committee (‘GCRC’) is responsible for the development and effectiveness of the Group’s credit risk management framework; clear description of the Group’s credit risk appetite; setting of high

1st line of defence

Business Management

3rd line of defence Group Audit

Nominations Committee

Remuneration Committee

Risk Oversight Committee

Group Audit Committee

Group Executive Committee

Group Asset & Liability Committee

Group Business Risk Committee

Director of Group Audit

Chief Risk Officer

Risk Forum

Divisional Risk Officer

Group Chief Executive

Group Executive Director

Insurance

Group Executive Director Retail

Group Operations Director

Group Finance Director

Divisional Risk Officer

Divisional Risk Officer

Divisional Risk Officer

BU Risk BU Risk BU Risk BU Risk BU Risk

Group Insurance Risk Committee

Group Model Governance Committee

Senior Asset & Liability

Committee

Group Compliance and Operational Risk Committee

Group Credit Risk Committee

Divisional Risk Officer

BU Risk

Group Human Resources Director

Group Risk

Governance Committees

Business functions Oversight

Lloyds Banking Group Board

2nd line of defence

Group and Divisional Oversight Functions

Reporting line Functional reporting line from BU risk officer or function to divisional risk officers Functional reporting line to support the committees

Wealth & International

Director

Divisional Risk Officer

Group Integration

Director

Group Executive Director

Wholesale

Divisional Risk Officer

BU Risk

Page 6 of 56

level Group credit policy; and compliance with regulatory credit requirements. On behalf of the GBRC, the GCRC monitors and reviews the Group’s aggregate credit risk exposures and concentrations of risk. The Group model governance and approvals committee is responsible for setting the control framework and standards for models across the Group, including establishing appropriate levels of delegated authority; the approval of models that are considered to be material to the Group (including credit risk rating systems); and the principles underlying the Group’s economic capital framework. The Group insurance risk committee is responsible for the development and effectiveness of the Group’s insurance risk management framework (embracing policies, methodologies, systems, processes, regulations, procedures and people), clear articulation and recommendation of the Group’s insurance risk appetite and monitoring and reviewing the Group’s insurance risk. The Group asset and liability committee is supported by the senior asset and liability committee which is responsible for the review and escalation of issues of group level significance to GALCO relating to the strategic management of the Group’s assets and liabilities and the profit and loss implications of balance sheet management actions. It is also responsible for the risk management framework for market risk, liquidity risk, capital risk and earnings volatility.

Supporting the chief risk director, the risk forum consists of the divisional risk officers and the group risk directors. The risk forum regularly reviews a summary of risks across the risk management spectrum to determine areas of focus for remedial action across the Group.

Group executive directors have primary responsibility for measuring, monitoring and controlling risks within their areas of accountability and are required to establish control frameworks for their businesses that are consistent with the Group’s high level policies and within the parameters set by the board, group executive committee and group risk. Compliance with policies and parameters is overseen by the risk oversight committee, the group business risk committee, the group asset and liability committee, group risk and the divisional risk officers. Risk management oversight

The chief risk director, a member of the group executive committee and reporting directly to the group chief executive, oversees and promotes the development and implementation of a consistent group wide risk management framework. The chief risk director, supported by the group risk department and divisional risk officers, provides objective challenge to the Group’s senior management. The chief risk officer also reports independently to the risk oversight committee that comprises non-executive directors and is chaired by the Group Chairman.

Group risk directors are allocated responsibility for specific risk types and are responsible for ensuring the adequacy of risk resources as well as the oversight of the risk profile across the Group.

Divisional risk officers provide oversight of risk management activity for all risks within each of the Group’s divisions. Reporting directly to the group executive directors responsible for the divisions and the chief risk director, their day-to-day contact with business management, business operations and risk initiatives seeks to provide an effective risk oversight mechanism.

The director of group audit provides the required independent assurance to the audit committee and the board that risks within the Group are recognised, monitored and managed within acceptable parameters. Group audit is fully independent of group risk, seeking to ensure objective challenge to the effectiveness of the risk governance framework.

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Business risk management

Line management are directly accountable for the management of risks arising from the Group’s business. A key objective is to ensure that business decisions strike an appropriate balance between risk and reward, consistent with the Group’s risk appetite. The senior executive team and board receive regular briefings and guidance from the chief risk director to ensure awareness of the overarching risk management framework and a clear understanding of their accountabilities for risk and internal control.

All business units, divisions and group functions complete a control self-assessment annually, reviewing the effectiveness of their internal controls and putting in place enhancements where appropriate. Managing directors and group executive directors certify the accuracy of their assessment.

Business risk management forms part of a tiered risk management model, as shown on page 5 with the divisional risk officers and group risk providing oversight and challenge, as described above, and the chief risk director and group committees establishing the group wide perspective.

This approach seeks to provide the Group with an effective mechanism for developing and embedding risk policies and risk management strategies which are aligned with the risks faced by its businesses. It also designed to facilitate effective communication on these matters across the Group.

Risk management framework

The Group’s risk management principles and risk management framework cover the full spectrum of risks that a group, that encompasses both banking and insurance businesses, would encounter.

The Group uses an enterprise-wide risk management framework for the identification, assessment, measurement and management of risk, designed to meet its customers’ needs. It seeks to maximise value for shareholders over time by aligning risk management with the corporate strategy, assessing the impact of emerging risks from legislation, new technologies or the market, and developing risk tolerances and mitigating strategies. The framework seeks to strengthen the Group’s ability to identify and assess risks; aggregate group wide risks and define the corporate risk appetite; develop solutions for reducing or transferring risk, where appropriate; and exploit risks to gain competitive advantage, thereby seeking to increase shareholder value. The principal elements of the risk management framework are shown below:

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The risk management framework above comprises 10 interdependent activities which map to the components of the internal control-integrated framework issued by the Committee of Sponsoring Organisations of the Treadway Commission (COSO).

The framework is dynamic and allows for proportionate adjustment of policies and controls where business strategy and risk appetite is amended in response to changes in market conditions.

Lloyds Banking Group business strategy is used to determine the Group’s high level risk principles and risk appetite measures and metrics for the primary risk drivers. A key focus has been to develop earnings volatility measures to complement existing capital measures for risk appetite. The risk appetite is proposed by the group chief executive and reviewed by various governance bodies including the group executive committee and the risk oversight committee. Responsibility for the approval of risk appetite rests with the board. The approved high level appetite and limits are delegated to individual group executive directors by the group chief executive.

The more detailed description of the risk principles and distribution of the risk appetite measures amongst the divisions and businesses are determined by the group chief executive, in consultation with the group business risk committee and the group asset and liability committee.

The risk principles are executed through the policy framework and accountabilities. These principles are supported by the policy levels below: • Principles – high level principles for the six primary risk drivers • High level group policy – policy for the main risk types aligned to the risk drivers • Detailed group policy – detailed policy that applies across the Group • Divisional policy – local policy that specifically applies to a division • Business unit policy – local policy that specifically applies to a business unit;

Divisional and business unit policy is only produced by exception and is not necessary unless there is a specific area for which a particular division or business unit requires a greater level of detail than is appropriate for group level policy. The governance arrangements for development of, and compliance with, group, divisional and business unit policy and the associated accountabilities are clearly outlined. All staff are expected to be aware of the policies and procedures which apply to them and their work and to observe the relevant policies and procedures. Line management in each business area has primary responsibility for ensuring that group policies and the relevant local policies and procedures are known and observed by all staff within that area.

Lloyds Banking Group – Strategic Vision

Group high level principles and policies

Aggregate appetite by primary driver

Group, divisions and business units

Detailed policy and authorities – including metrics and qualitative measures

Business Credit Insurance Market Financial

Soundness Operational

Risk

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Group and divisional risk functions have responsibility for overseeing effective implementation of policy. Group Audit provides independent assurance to the board about the effectiveness of the Group’s control framework and adherence to policy. Policies are reviewed annually to ensure they remain fit for purpose.

Proportionate Control Activity strategy is in place to design mitigating controls, to transfer risk where appropriate and ensure executives are content with the residual level of risk accepted.

Risk and Control Assessments are undertaken to assess the effectiveness of current mitigations and whether risks taken are consistent with the Group’s risk appetite (this includes the annual control self-assessment exercise).

The impact of risks and issues (including financial, reputational and regulatory capital) are determined through effective Risk Measurement including modelling and stress testing.

The outcomes of Independent Reviews (including internal and external audit and regulatory reviews) are integrated into risk management activities and action plans.

Risk reporting is standardised through the use of standard definitions when reporting, to enable risk aggregation. Divisions monitor their risk levels against their risk appetite seeking to ensure effective mitigating action is being taken where appropriate. Divisional risk reports are reviewed by divisional executive committees to ensure that respective senior management are satisfied with the overall risk profile, risk accountabilities and progress on any necessary mitigating actions. Reporting, including that of performance against relevant limits or policies, is in place to provide a level of detail, appropriate to the exposures concerned and regular information is provided to group risk for review and aggregate reporting. Any significant issues identified in the monitoring process are appropriately reported, and an escalation process is in place to report significant losses to appropriate levels of management. Group risk reports on risk exposures and material issues quarterly to the group asset and liability committee, group business risk committee, group executive committee, risk oversight committee and the board.

At group level a consolidated risk report is produced which is reviewed and debated by the group business risk committee, group executive committee, risk oversight committee and the board to ensure senior management and the board are satisfied with the overall risk profile, risk accountabilities and mitigating actions. The consolidate risk report provides a regular assessment of the aggregated residual risk for the primary risk drivers, comparing the assessment with the previous quarter and providing a forecast for the next 12 months.

Page 10 of 56

Risk drivers

The Group’s risk language is designed to capture the Group’s principal risks referred to as the ‘primary risk drivers’. A description of each risk, including definition, appetite, control and exposures is included in the detail to this report. These are further broken down into 28 more granular risk types to enable more detailed review and facilitate appropriate reporting and monitoring, as set out below.

Through the Group’s risk management processes these risks are assessed on an ongoing basis to ensure optimisation of risk and reward and that, where required, appropriate mitigation is in place. Both quantitative and qualitative factors are considered in assessing the Group’s current and potential future risks.

Business risk Business risk is defined as the risk to economic profit in the Group’s budget and over the medium term plan arising from a sub optimal business strategy, or the sub optimal implementation of the plan as agreed by the board of directors. In assessing business risk consideration is given to internal and external factors. Risk appetite Business risk appetite is encapsulated in the Group’s budget and medium-term plan, which are sanctioned by the board on an annual basis. Divisions and business units subsequently align their plans to the Group’s overall business risk appetite. Exposures The Group’s portfolio of businesses exposes it to a number of internal and external factors: • internal factors: resource capability and availability, customer treatment, service level agreements,

products and funding and the risk appetite of other risk categories; and • external factors: economic, technological, political, social and ethical, environmental, legal and regulatory,

market expectations, reputation and competitive behaviour. Measurement For the planning round and regularly during the year, the Group conducts both scenario analysis and stress tests to assess risks to future earning streams. The Group assesses a wide array of scenarios including economic recessions, regulatory action scenarios and scenarios specific to the operations of each part of the business.

BusinessFinancial soundness Credit

Interest Rate

Foreign

Exchange

Equity

Credit Spread

Mortality

Longevity

Morbidity

Persistency

Business Insurance Operational

Retail

Wholesale

Capital

Liquidity and

funding

Regulatory

reporting &

disclosure

Tax

Primary Risk

Drivers

Detailed Risk

Types

Legal &

regulatory

Customer

treatment

Business

Process

Security

Financial Crime

People

Change

Governance

Strategy Setting

Execution of

strategy

Market

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Mitigation As part of the annual business planning process, the Group develops a set of management actions to prevent or mitigate the impact on earnings in the event that business risks materialise. Additionally, business risk monitoring, through regular reports and oversight, results in corrective actions to plans and reductions in exposures where necessary. Revenue and capital investment decisions require additional formal assessment and approval. Formal risk assessment is conducted as part of the financial approval process. Significant mergers and acquisitions by business units require specific approval by the board. In addition to the standard due diligence conducted during a merger or acquisition, group risk conducts, where appropriate, an independent risk assessment of the target company and its proposed integration into the Group. Monitoring and reporting The Group’s strategy is reviewed and approved by the board. Regular reports are provided to the group executive committee and the board on the progress of the Group’s key strategies and plans. Group risk conducts oversight to seek to ensure that business plans remain consistent with the Group’s strategy. The board reviews business risk appetite on an annual basis. Financial soundness risk Financial soundness risk have three distinct detailed risk types that are described separately for liquidity and funding risk; capital risk; and regulatory reporting, disclosure and tax risk. Liquidity and funding Liquidity risk is defined as the risk that the Group does not have sufficient financial resources to meet its commitments when they fall due, or can secure them only at excessive cost. Funding risk is further defined as the risk that the Group does not have sufficiently stable and diverse sources of funding or the funding structure is inefficient.

Risk appetite Liquidity and funding risk appetite is set by the board and reviewed on an annual basis. It is reported through various metrics that enable the Group to manage liquidity and funding constraints. The chief executive, assisted by the group asset and liability committee, regularly reviews performance against risk appetite. The board reviews liquidity and funding risk on an annual basis.

Exposure Liquidity exposure represents the amount of potential outflows in any future period less committed inflows in that period such that the Group is unable to meet its financial obligations as they fall due, or can only secure them at excessive cost. Liquidity is considered from both an internal and regulatory perspective.

Measurement A series of measures are used across the Group to monitor both short and long term liquidity including; ratios, cash outflow triggers, and stress test survival period triggers. Mitigation The Group mitigates the risk of a liquidity mismatch which is outside of its appetite by managing the liquidity profile of the balance sheet through both short-term liquidity management and long-term strategic funding. Short-term liquidity management is considered from two perspectives; business as usual and crisis liquidity, both of which relate to funding in the less than one year time horizon. Longer term funding is used to manage the Group’s strategic liquidity profile which is determined by the Group’s balance sheet structure. Longer term is defined as an original maturity of more than one year.

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The Group’s funding and liquidity management is fundamentally based on a significant retail deposit base, accompanied by appropriate funding from the wholesale markets. A substantial proportion of the retail deposit base is made up of customers’ current and savings accounts which, although repayable on demand, have traditionally in aggregate provided a stable source of funding. Additionally, the Group accesses the short-term wholesale markets to provide inter-bank deposits and to issue certificates of deposit and commercial paper to meet short-term obligations. The Group’s short-term money market funding is based on an analysis of the market’s capacity for the Group’s credit, based on quantitative data. The Group has developed strong relationships with certain wholesale market segments, for example central banks and corporate customers, to supplement its retail deposit base. The ability to deploy assets quickly, either through the repo market or through outright sale, is also an important source of liquidity for the Group’s banking businesses. The Group holds sizeable balances of marketable debt securities which can be sold to provide, or used to secure, additional short term funding should the need arise. Monitoring and reporting Liquidity is actively monitored at business unit and group level at an appropriate frequency. Routine reporting is in place to senior management and through the Group’s committee structure, in particular GALCO. In a stress situation the level of monitoring and reporting is increased commensurate with the nature of the event. Liquidity policies and procedures are subject to independent oversight. Capital Capital risk is defined as the risk that the Group has insufficient capital to provide a sufficient resource to absorb predetermined levels of losses or that the capital structure is inefficient. Risk appetite Capital risk appetite is set by the board and reported through various metrics that enable the Group to manage capital constraints and shareholder expectations. The chief executive, assisted by the group asset and liability committee, regularly reviews performance against risk appetite. The board reviews capital risk on an annual basis. Exposure Capital exposure arises should the Group have insufficient regulatory capital resources to support its strategic objectives and plans, and meet external stakeholder requirements and expectations. The Group’s capital management policy is focused on optimising value for shareholders. Measurement The FSA’s approach to such measurement under Basel II is now based primarily on monitoring the relationship of the Capital Resources Requirement (‘CRR’), broadly equivalent to 8% of risk weighted assets and thus representing the capital required under Pillar 1 of Basel II, to available capital resources. However, the Bank Group expects the reporting and analysis of ratios to continue, both internally and externally. The Financial Services Authority (‘FSA’) also sets Individual Capital Guidance (‘ICG’) for each UK bank, calibrated by reference to its CRR. A key input to the FSA’s ICG setting process (which addresses the requirements of Pillar 2 of Basel II) is each bank’s Internal Capital Adequacy Assessment Process (‘ICAAP’). The Bank Group has been given ICG by the FSA; the board has agreed a formal buffer to be maintained in addition to this requirement. Any breaches of the formal buffer must be notified to the FSA, together with proposed remedial action. The FSA has made it clear that each ICG remains a confidential matter between each bank and the FSA.

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The Bank Group’s regulatory capital is divided into tiers defined by the European Community Banking Consolidation Directive as implemented in the UK by the FSA’s General Prudential Sourcebook. Tier 1 comprises mainly shareholders’ equity, tier 1 capital instruments and minority interests, after deducting goodwill, other intangible assets and 50% of the net excess of expected loss over accounting provisions. Accounting equity is adjusted in accordance with FSA requirements, in respect of pensions and available-for sale assets. For the purposes of Pillar 3, Tier 2 capital comprises qualifying subordinated debt after deducting 50% of the excess of expected loss over accounting provisions, with restrictions on the debt which may be included. The amount of qualifying tier 2 capital cannot exceed that of tier 1 capital. Total capital is reduced by deducting investments in subsidiaries and associates that are not consolidated for regulatory purposes. In the case of the Bank Group, this means that the net assets of its life assurance and general insurance businesses are deducted from its regulatory capital. There are limits imposed by the FSA as to the proportion of the regulatory capital base that can be made up of subordinated debt and preferred securities. The unpredictable nature of movements in the value of the investments supporting the long-term assurance funds could cause the amount of qualifying tier 2 capital to be restricted because of falling tier 1 resources. The Bank Group seeks to ensure that even in the event of such restrictions the total capital ratio will remain adequate. The Group has developed procedures meant to ensure that compliance with both current and potential future requirements are understood and that policies are aligned to its risk appetite. In addition to the regulatory framework, the Bank Group also operates an internal capital framework – set out in more detail in the section entitled “Approach to assessing the adequacy of internal capital to support current and future activities”. Mitigation The Group is able to raise funds by issuing subordinated liabilities or equity. The cost and availability of subordinated liability finance are influenced by credit ratings. A reduction in these ratings could increase the cost and could reduce market access. Monitoring and reporting Capital is actively managed at an appropriate level of frequency and regulatory ratios are a key factor in the Group’s budgeting and planning processes with updates of expected ratios reviewed regularly during the year by the group asset and liability committee. Capital raised takes account of expected growth and currency of risk assets. Capital policies and procedures are subject to independent oversight. Regulatory reporting, disclosure and tax The risk of reputational damage, loss of investor confidence and/or financial loss arising from, the adoption of inappropriate accounting policies, ineffective controls over financial, prudential regulatory and tax reporting and the failure to disclose information on a timely basis about the legal constitution of the Group. Risk appetite The risk appetite is set by the board and reviewed on an annual basis. It includes the avoidance of the need for restatement of published financial and prudential regulatory reporting, disclosure and tax.

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Exposure Regulatory reporting, disclosure and tax exposure represents the sufficiency of our policies and procedures to maintain adequate books and records to support statutory, regulatory and tax reporting, to present and detect financial reporting fraud and to manage the Group’s tax exposure. Mitigation The Group maintains a system of internal controls, which are designed to be consistently applied, and to provide a reasonable assurance that transactions are recorded and undertaken in accordance with delegated authorities that permit the preparation and disclosure of financial statements, prudential regulatory reporting and tax returns in accordance with IFRS, statutory and regulatory requirements. Monitoring and reporting The Group undertakes a programme of work designed to support an annual assessment of the effectiveness of internal controls over financial reporting, in accordance with the requirements of s.404 of the US Sarbanes-Oxley Act of 2002; to identify and maintain tax liabilities and to assess emerging regulation and legislation.

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Credit Risk Credit risk is defined as the risk of reductions in earnings and/or value, through financial or reputational loss, as a result of the failure of the party with whom the Group has contracted to meet its obligations (both on and off balance sheet). Risk appetite Credit risk appetite is expressed both in terms of credit risk economic equity and in terms of the impact of credit risk on earnings volatility. Credit risk appetite is set by the Board and is described and reported through a suite of metrics derived from a combination of accounting and credit portfolio model parameters which in turn use the various credit risk rating systems as inputs. These metrics are supplemented by a variety of policies, sector caps and limits to manage concentration risk at an acceptable level. Exposures The principal sources of credit risk within the Group arise from loans and advances to retail customers, financial institutions and corporate clients. In terms of loans and advances, credit risk arises both from amounts lent and commitments to extend credit to a customer as required. These commitments can take the form of loans and overdrafts, or credit instruments such as guarantees and standby, documentary and commercial letters of credit. With respect to commitments to extend credit, the Group is potentially exposed to loss in an amount equal to the total unused commitments. However, the likely amount of loss is less than the total unused commitments, as most retail commitments to extend credit can be cancelled and the credit-worthiness of customers is monitored frequently. In addition, most wholesale commitments to extend credit are contingent upon customers maintaining specific credit standards which are regularly monitored. Credit risk can also arise from debt securities, derivatives and foreign exchange activities. The notional principal amount of such exposures does not, however, represent the Group’s credit risk exposure, which is limited to the current cost of replacing contracts with a positive value to the Group. Credit risk exposures in the insurance businesses arise primarily from holding investments and from exposure to reinsurers. Measurement In measuring the credit risk of loans and advances to customers and to banks at a counterparty level, the Bank Group reflects three components: (i) the ‘probability of default’ (PD) by the client or counterparty on its contractual obligations; (ii) current exposures to the counterparty and their likely future development, from which the Group derives the ‘exposure at default’; and (iii) the likely recovery ratio on the defaulted obligations (the ‘loss given default’). In calculating the Bank Group’s capital requirements, the probability of default of individual counterparties is assessed using internal rating models tailored to the various categories of counterparty. For its retail lending, exposure at default and loss given default models are also in use. All material rating models are authorised by executive management,. They have been developed internally and use statistical analysis, combined, where appropriate, with external data and subject matter expert judgement. Each rating model is subject to a rigorous validation process, undertaken by independent risk teams, which includes benchmarking to externally available data, where possible.

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Each probability of default rating model segments counterparties into a number of rating grades, each representing a defined range of default probabilities. Exposures migrate between classifications if the assessment of the obligor probability of default changes. Given the differing number of internal rating systems within the Bank Group, each rating system is required to map to a master scale. A master scale supports the consolidation of credit risk information across portfolios through the adoption of a common rating scale. Given the differing risk profiles and credit rating considerations, the underlying risk reporting has been split into two distinct master scales. Wholesale master scale For its sovereign, institution (banks) and corporate (including corporate small & medium sized enterprises, and corporate purchased receivables) exposures, the Bank Group uses a scale with eight categories.

1 2 3 4 5 6 7 Default

PD

(Basis pts)

<=1 1.1 – 2.5 2.6 – 10 11 – 51 52 – 300 301 – 2000 2001 - 9999 10,000

Mid-Point 0.5 1.8 6.3 31 176 1150 6000 10,000

Rating categories 1 to 4 correspond largely to investment grade level of the external rating agencies, whereas categories 5 and 6 are sub-investment grade. Rating category 7 applies to customers with an increased risk, and these customers are closely monitored. The final classification is for defaulted obligors. Specialised Lending, which also uses the wholesale master scale, refers to asset or project specific lending. Underlying credit risks are primarily associated with economic and financial viability of a facility, which is structured specifically to finance an asset or project. Specialised Lending typically possesses the following characteristics, either in legal or economic substance: • the exposure is to an entity, often a special purpose entity, which was created specifically to finance

and/or operate physical assets; • the obligor has little or no other material assets or activities, and therefore little or no independent

capacity to repay the exposure, apart from the income that it receives from the asset/s being financed; • the terms of the obligation give the lender a substantial degree of control over the asset/s and the income

that it generates in the event of a covenant breach and/or trigger event; and • as a result of the preceding factors, the primary source of repayment, and therefore risks, will be

dependent on the income generated by the asset/s, rather than the independent capacity of the broader commercial entity responsible for establishing the special purpose vehicle and the specialised lending project.

The Bank Group applies specific models and processes for rating such exposures.

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Retail master scale For its retail exposures including residential mortgages, revolving exposures (overdrafts and credit cards) and other exposures (including retail small & medium sized enterprises and retail purchased receivables) the Bank Group uses a 14 point scale. .

0 1 2 3 4 5 6 7 8 9 10 11 12 Default

PD

(Bps)

0 -

10

11 -

40

41 –

80

81 -

120

121 -

250

251 -

450

451 -

750

751 -

1,000

1,001

-

1,400

1,401

-

2,000

2,001

-

3,000

3,001

-

4,500

4,501

-

9,999

10,000

Mid-

Point

5 26 61 101 186 351 601 876 1,201 1,701 2,501 3,751 7,250 10,000

Rating categories 0 and 1 correspond largely to investment grade level of the external rating agencies, whereas categories 2 to 9 are sub-investment grade although with an acceptable credit risk. Rating categories 10 to 12 apply to customers with an increased risk, and these customers are closely monitored. The final classification is for defaulted obligors. The rating systems described above assess probability of default, exposure at default and loss given default, in order to derive an expected loss. In contrast, impairment allowances are recognised for financial reporting purposes only for losses that have been incurred at the balance sheet date based on objective evidence of impairment. Due to the different methodologies applied, the amount of incurred credit losses provided for in the financial statements differs from the amount determined from the expected loss model that is used for internal operational management and banking regulation purposes. The Group’s debt securities holdings, which are the subject of external agency ratings, are marked to market and independently checked by the middle office function within the products and markets business. Similarly, debt security investments within Scottish Widows are independently marked to market. Mitigation The Bank Group uses a range of approaches to mitigate credit risk.

Internal control i) Credit principles and policy: Group risk sets out the group credit principles and policy according to

which credit risk is managed, which in turn is the basis for divisional and business unit credit policy. Principles and policy are reviewed regularly and any changes are subject to a review and approval process. Divisional and business unit policy includes lending guidelines, which define the responsibilities of lending officers and provide a disciplined and focused benchmark for credit decisions. Credit policy also specifies maximum holding period limits for the credit trading portfolios.

ii) Counterparty limits: Limits are set against all types of exposure in a counterparty name, in accordance with an agreed methodology for each exposure type. This includes credit risk exposure on individual derivative transactions, which incorporates potential future exposures from market movements. Aggregate facility levels by counterparty are considered and limit breaches are subject to escalation procedures.

iii) Individual credit assessment and sanction: Credit risk in wholesale portfolios is subject to individual credit assessments, which consider the strengths and weaknesses of individual transactions and the balance of risk and reward. Exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning

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authorities. Approval requirements for each decision are based on the transaction amount, the customer’s aggregate facilities, credit risk ratings and the nature and term of the risk. The Group’s risk appetite criteria for counterparty underwriting are the same as that for assets intended to be held over the period to maturity.

iv) Credit scoring: In its principal retail portfolios, the Bank Group uses statistically-based decisioning techniques (primarily credit scoring). Divisional risk departments review scorecard effectiveness and approve changes, with material changes to scorecards that form part of a probability of default rating system being subject to group risk approval.

v) Cross-border and cross-currency exposures: Country limits are authorised by a Country Limit Panel and managed by a dedicated unit taking into account economic and political factors.

vi) Concentration risk: Credit risk management includes portfolio controls on certain industries, sectors and product lines that reflect risk appetite. Credit policy is aligned to the Group’s risk appetite and restricts exposure to certain high risk and more vulnerable sectors. Exposures are monitored to prevent excessive concentration of risk. These concentration risk controls are not necessarily in the form of a maximum limit on lending but may instead require new business in concentrated sectors to fulfil additional hurdle requirements. The Bank Group’s large exposures are reported in accordance with regulatory reporting requirements.

vii) Stress testing and scenario analysis: The credit portfolio is also subjected to stress-testing and scenario analysis, to simulate events and calculate their associated impact. Events are modelled at a group wide level, at divisional and business unit level and by rating model and portfolio, for example, for a specific industry sector.

viii) Specialist expertise: Credit quality is maintained by specialist units providing, for example: intensive management and control; security perfection, maintenance and retention; expertise in documentation for lending and associated products; sector-specific expertise; and legal services applicable to the particular market place and product range offered by the business.

ix) Daily settlement limits: Settlement risk arises in any situation where a payment in cash, securities or equities is made in the expectation of a corresponding receipt in cash, securities or equities. Daily settlement limits are established for each counterparty to cover the aggregate of all settlement risk arising from the Group’s market transactions on any single day.

x) Risk assurance and oversight: Divisional and group level oversight teams monitor credit performance trends, review and challenge exceptions to planned outcomes and test the adequacy of credit risk infrastructure and governance processes throughout the Group. This includes tracking portfolio performance against an agreed set of key risk indicators. Risk assurance teams are engaged where appropriate to conduct further credit reviews if a need for closer scrutiny is identified.

Controls over rating systems The Group has established a robust and independent process built on a set of common minimum standards designed to challenge the discriminatory power of the systems, accuracy of calibration and ability to rate consistently over time and across obligors. Through this process, the validity of all rating systems is ensured, both before the rating systems are embedded into business as usual and periodically thereafter, in compliance with regulatory requirements.

Accountability The internal rating systems are developed and implemented by independent risk functions either in the business units or divisions with the business unit managing directors having ownership of the systems. They also take responsibility for ensuring the validation of the respective internal rating systems, aided by specialist functions in their respective division. Divisional risk officers, supported by dedicated functions, are responsible for:

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• ensuring independent validation of the systems in accordance with group standards and hence compliance with regulatory requirements; and

• generally overseeing the risk management activities of the business units.

Independence The Group has established a governance framework for those functions responsible for the development, implementation, performance and supervision of credit rating systems. This framework reinforces the Group’s governance arrangements and ensures appropriate segregation of duties. The requirements for independent credit risk control are fulfilled by a combination of activities split between business unit/divisional risk functions and specialist divisional oversight teams, all of whom are independent from staff originating and/or approving credit exposures.

Key responsibilities of these divisional and business unit functions include: • design or selection, implementation, maintenance, performance monitoring and validation of the

rating systems. These are business unit risk function activities; • oversight and challenge of the business unit risk function’s activities together with establishing

standards for validation, performance monitoring and benchmarking, is undertaken at divisional level; • constructing management information, and relevant policy and procedures (business unit activity

with oversight by division); • production and analysis of reports using the output of the rating systems. This is undertaken at both

business unit and divisional levels.

The independent credit risk control teams within the divisions are independent from the activities of the business unit model development teams.

Internal audit provides independent assurance on a risk assessed basis over: • the independence of areas performing validation and oversight roles; • the quality and effectiveness of performance monitoring controls; and, • management assurance practices. Model validation Validation is performed by divisional and business units with oversight provided by divisional independent credit risk control unit (‘ICRCs’) as an integral part of the rating system approval process prior to implementation into business as usual. Every rating system is also subject to validation, at least annually or at the request of the business unit or divisional management to ensure that the predictive nature of the system is in line with experience. If it is not, the rating system is recalibrated. Model performance monitoring

The performance of all rating models is comprehensively monitored on a regular basis, to ensure that models continue to provide optimum risk differentiation capability, the generated ratings remain as accurate and robust as possible and the models assign appropriate risk estimates to grades/pools. All models are monitored against a series of agreed key performance indicators. In the event that monthly monitoring identifies material exceptions or deviations from expected outcomes, these will be escalated to senior management or the approving body. Rating system approval The board has delegated authority to the group model governance and approvals committee to authorise material credit rating systems. Authority to approve non-material credit rating systems is

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vested in the group credit and business risk director, acting jointly with the relevant divisional risk officer, subject to noting of the approval by the group model governance and approvals committee.

Whether a credit rating system model is categorised as material or non-material is based on its level of risk weighted assets. Where quantitative data indicate the rating system will be defined as non-material, the approving body may overlay qualitative judgement to re-define the model as material, where necessary.

Collateral The principal collateral types for loans and advances are: • Mortgages over residential properties; • Charges over business assets such as premises, inventory and accounts receivable; • Charges over financial instruments such as debt securities and equities; and • Guarantees received from third parties.

The Bank Group has implemented guidelines on the acceptability of specific classes of collateral. Collateral held as security for financial assets other than loans and advances is determined by the nature of the instrument. Debt securities, treasury and other eligible bills are generally unsecured, with the exception of asset-backed securities and similar instruments, which are secured by portfolios of financial assets. Collateral is generally not held against loans and advances to financial institutions, except where securities are held as part of reverse repurchase or securities borrowing transactions or where a collateral agreement has been entered into under a master netting agreement. Third party guarantees are taken from banks, government entities, export credit agencies, and corporate entities and are included, where appropriate, in PD estimates. Personal guarantees are considered in the normal credit process where there is a charge over specific assets. While personal guarantees may be required, no value is given to unsupported personal guarantees in any credit models. All credit derivative activity is conducted through specialist units. The principal counterparties are banks, investment firms and other market participants, with the majority subject to collateralisation under a credit support annex It is the Bank Group’s policy that collateral should always be realistically valued by an appropriately qualified source, independent of the customer, at the time of borrowing. Collateral is reviewed on a regular basis in accordance with business unit credit policy, which will vary according to the type of lending and collateral involved. In order to minimise the credit loss, the Bank Group may seek additional collateral from the counterparty as soon as impairment indicators are noticed for the relevant individual loans and advances. The Bank Group considers risk concentrations by collateral providers and collateral type, as appropriate, with a view to ensuring that any potential undue concentrations of risk are identified and suitably managed by changes to strategy, policy and/or business plans. Master netting agreements Where it is efficient and likely to be effective (generally with counterparties with which it undertakes a significant volume of transactions), the Bank Group enters into master netting agreements. Although master netting agreements do not generally result in an offset of balance sheet assets and liabilities, as transactions are usually settled on a gross basis, they do reduce the credit risk to the extent that, if an event of default occurs, all referenced amounts with the counterparty are terminated and settled on a net basis. The Bank Group’s overall exposure to credit risk on derivative instruments subject to master

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netting agreements can change substantially within a short period since it is affected by each transaction subject to the agreement.

Derivatives Credit risk exposure on individual derivative transactions is managed as part of overall lending limits with customers, together with potential exposures from market movements. Collateral or other security is not usually obtained for credit risk exposures on these instruments, except where the Bank Group requires margin deposits from counterparties. Other credit risk transfers The Bank Group also undertakes asset sales, securitisations and credit derivative-based transactions as a means of mitigating or reducing credit risk, taking into account the nature of assets and the prevailing market conditions.

Monitoring and reporting Portfolio monitoring and reporting: In conjunction with group risk, businesses and divisions identify and define portfolios of credit and related risk exposures and the key benchmarks, behaviours and characteristics by which those portfolios are managed in terms of credit risk exposure. This entails the production and analysis of regular portfolio monitoring reports for review by senior management. Group risk in turn produces an aggregated review of credit risk throughout the Group, including reports on significant credit exposures, which are presented to the group business risk committee. Business unit risk and finance teams use rating systems output to verify, validate and challenge financial forecasts, where appropriate. Risk assurance and oversight: Divisional and group level oversight teams monitor credit performance trends, review and challenge exceptions to planned outcomes and test the adequacy of credit risk infrastructure and governance processes throughout the Group. This includes tracking portfolio performance against an agreed set of key risk indicators. Risk assurance teams are engaged where appropriate to conduct further credit reviews if a need for closer scrutiny is identified.

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Market risk Market risk is defined as the risk of reductions in earnings and/or value, through financial or reputational loss, arising from unexpected changes in financial prices, including interest rates, exchange rates, credit spreads and prices for bonds, commodities, equities, property and other instruments. It arises in all areas of the Bank Group’s activities and is managed by a variety of different techniques. Risk appetite Market risk appetite is defined with regard to the quantum and composition of market risk that exists currently in the Group and the direction in which the Group wishes to manage this. This statement of the Group’s overall appetite for market risk is reviewed and approved annually by the board. With the support of the group asset and liability committee, the group chief executive allocates this risk appetite across the Group. Individual members of the group executive committee ensure that market risk appetite is further delegated to an appropriate level within their areas of responsibility. Exposures The Bank Group’s banking activities expose it to the risk of adverse movements in interest rates, credit spreads, exchange rates and equity prices, with little or no exposure to commodity risk. Most of the Bank Group’s trading activity is undertaken to meet the requirements of wholesale and retail customers for foreign exchange and interest rate products. However, some interest rate, exchange rate and credit spread positions are taken using derivatives and other on-balance sheet instruments with the objective of earning a profit from favourable movements in market rates. Market risk in the Bank Group’s retail portfolios and in the Bank Group’s capital and funding activities arises from the different repricing characteristics of the Bank Group’s non-trading assets and liabilities. Interest rate risk arises predominantly from the mismatch between interest rate insensitive liabilities and interest rate sensitive assets. Foreign currency risk also arises from the Bank Group’s investment in its overseas operations. The Bank Group’s insurance activities also expose it to market risk, encompassing interest rate, exchange rate, property, credit spreads and equity risk: • The management of the With Profit Fund within Scottish Widows plc involves mismatching of assets and

liabilities with the aim of generating a higher rate of return on assets to meet policyholders’ expectations. • Unit-linked liabilities are matched with the same assets that are used to define the liability but future fee

income is dependent upon the performance of those assets. • For other insurance liabilities the aim is to invest in assets such that the cash flows on investments will

match those on the projected future liabilities. It is not possible to eliminate risk completely as the timing of insured events is uncertain and bonds are not available at all of the required maturities. As a result the cash flows cannot be precisely matched and so sensitivity tests are used to test the extent of the mismatch.

• Surplus assets are held primarily in three portfolios: the surplus in the non-profit fund within the long term fund of Scottish Widows plc, assets in shareholder funds of life assurance companies and an investment portfolio within the general insurance business.

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The Group’s defined benefit staff pension schemes are exposed to significant risks from the constituent parts of their assets and from the present value of their liabilities, primarily equity and real interest rate risk. Measurement The primary market risk measure used within the Group is the Value at Risk (‘VaR’) methodology, which incorporates the volatility of relevant market prices and the correlation of their movements. This is used for determining the Group’s overall market risk appetite and for the high level allocation of risk appetite across the Group. Although an important measure of risk, VaR has limitations as a result of its use of historical data, assumed distribution, holding periods and frequency of calculation. In addition, the use of confidence levels does not convey any information about potential loss when the confidence level is exceeded. Where VaR models are less well suited to the nature of positions, the Group recognises these limitations and supplements its use with a variety of other techniques. These reflect the nature of the business activity, and include interest rate repricing gaps, open exchange positions and sensitivity analysis. Stress testing and scenario analysis are also used in certain portfolios and at group level, to simulate extreme conditions to supplement these core measures. During the year the Group introduced group wide stress testing to measure exposure to credit spread widening across all businesses in response to the market dislocation that has impacted the observable inputs to asset pricing. Banking – Non-trading The estimated impact of an immediate 25 basis point increase in interest rates on economic value for the years ended 31 December 2008 and 2007 is shown below. Economic value is defined as the present value of the non-trading portfolios concerned. Impacts have only been shown in one direction but can be assumed to be reasonably symmetrical. No currency breakdown has been provided as most of the exposure is in pounds sterling. These calculations are made monthly using assumptions regarding the maturity of interest rate insensitive assets and liabilities. The portfolio is updated monthly to reflect any changes in the relationship between customer behaviour and the level of interest rates. This is a risk based disclosure and the amounts below would be amortised in the income statement over the duration of the portfolio. The change in the 25 basis point increase compared to the previous year is due to the impact on retail balances of significant cuts in base rate during the last few months of 2008. In view of the unprecedented low interest rate environment in 2009, the assumptions underlying this particular risk measure are under review and likely to change. 31 December 31 December 2008 2007 £m £mReduction in value (158) 8 Mitigation Various mitigation activities are undertaken across the Bank Group to manage portfolios and ensure they remain within approved limits.

Banking – non-trading activities Interest rate risk arising from the different repricing characteristics of the Bank Group’s non-trading assets and liabilities, and from the mismatch between interest rate insensitive liabilities and interest rate sensitive

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assets, is managed centrally. Matching assets and liabilities are offset against each other and internal interest rate swaps are also used.

The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled.

Insurance activities Investment holdings are diversified across markets and, within markets, across sectors. Holdings are diversified to minimise specific risk and the relative size of large individual exposures is monitored closely. For assets held outside unit-linked funds, investments are only permitted in countries and markets which are sufficiently regulated and liquid.

Monitoring and reporting The senior asset and liability committee regularly reviews high level market risk exposure including, but not limited to, the data described above. It also makes recommendations to the group chief executive concerning overall market risk appetite and market risk policy. Exposures at lower levels of delegation are monitored at various intervals according to their volatility, from daily in the case of trading portfolios to monthly or quarterly in the case of less volatile portfolios. Levels of exposures compared to approved limits are monitored locally by independent risk functions and at a high level by group risk. Where appropriate, escalation procedures are in place.

Banking activities Trading is restricted to a number of specialist centres, the most important centre being the Treasury and Trading business in London. These centres also manage market risk in the wholesale non-trading portfolios, both in the UK and internationally. The level of exposure is strictly controlled and monitored within approved limits. Active management of the wholesale portfolios is necessary to meet customer requirements and changing market circumstances. Market risk in the Bank Group’s retail portfolios and in the Bank Group’s capital and funding activities is managed within limits defined in the detailed group policy for interest rate risk in the banking book, which is reviewed and approved annually.

Insurance activities Market risk exposures from the insurance businesses are controlled via approved investment policies and limits set with reference to the Group’s overall risk appetite and regularly reviewed by the senior asset and liability committee: • The With Profit Fund is managed in accordance with the relevant Principles and Practices of

Financial Management and legal requirements. • The investment strategy for other insurance liabilities is determined by the term and nature of the

underlying liabilities and asset/liability matching positions are actively monitored. Actuarial tools are used to project and match the cash flows.

• Investment strategy for surplus assets held in excess of liabilities takes account of the legal, regulatory and internal business requirements for capital to be held to support the business now and in the future.

The Group also agrees strategies for the overall mix of pension assets with the pension scheme trustees.

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Insurance risk The risk of reductions in earnings and/or value, through financial or reputational loss, due to fluctuations in the timing, frequency and severity of insured/underwritten events and to fluctuations in the timing and amount of claim settlements. This includes fluctuations in profits due to customer behaviour. Risk appetite Insurance risk appetite is defined with regard to the quantum and composition of insurance risk that exists currently in the Group and the direction in which the Group wishes to manage this. Exposures The major sources of insurance risk within the Group are the insurance businesses and the Group’s defined benefit staff pension schemes. The nature of insurance business involves the accepting of insurance risks which relate primarily to mortality, longevity, morbidity, persistency, expenses, property damage and unemployment. The prime insurance risk carried by the Group’s staff pension schemes is related to mortality. Measurement Insurance risks are measured using a variety of techniques including stress and scenario testing; and, where appropriate, stochastic modelling. Current and potential future insurance risk exposures are assessed and aggregated using risk measures based on 1-in-20 year stresses and other supporting measures where appropriate. Mitigation A key element of the control framework is the consideration of insurance risk by a suitable combination of high level committees/boards. For the life assurance businesses the key control body is the board of Scottish Widows Group Limited with the more significant risks also being subject to approval by the group executive committee and/or the Lloyds Banking Group board. For the general insurance businesses the key control body is the Lloyds TSB General Insurance Limited board with the more significant risks again being subject to group executive committee and/or Lloyds Banking Group board approval. All group staff pension schemes issues are covered by the group asset and liability committee and the group business risk committee. The overall insurance risk is mitigated through pooling and through diversification across large numbers of uncorrelated individuals, geographical areas, and different types of risk exposure. Insurance risk is primarily controlled via the following processes: • Underwriting (the process to ensure that new insurance proposals are properly assessed) • Pricing-to-risk (new insurance proposals would usually be priced in accordance with the underwriting

assessment) • Claims management • Product design • Product wording • Product management • The use of reinsurance or other risk mitigation techniques. In addition, limits are used as a control mechanism for insurance risk at policy level.

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At all times close attention is paid to the adequacy of reserves, solvency management and regulatory requirements. General insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements which are broadly spread over different reinsurers. Detailed modelling, including that of the potential losses under various catastrophe scenarios, supports the choice of reinsurance arrangements. Appropriate reinsurance arrangements also apply within the life and pensions businesses with significant mortality risk and morbidity risk being transferred to our chosen reinsurers. Options and guarantees are incorporated in new insurance products only after careful consideration of the risk management issues that they present. In respect of insurance risks in the staff pension schemes, the Group ensures that effective communication mechanisms are in place for consultation with the trustees and that risk management is in line with the Group’s risk appetite. Monitoring and reporting Ongoing monitoring is in place to track the progression of insurance risks. This normally involves monitoring relevant experiences against expectations (for example claims experience, option take up rates, persistency experience, expenses, non-disclosure at the point of sale), as well as evaluating the effectiveness of controls put in place to manage insurance risk.

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Operational risk Operational risk is defined as the risk of reductions in earnings and/or value, through financial or reputational loss, from inadequate or failed internal processes and systems, or from people related or external events. There are a number of categories of operational risk:

Legal and regulatory risk The risk of reductions in earnings and/or value, through financial or reputational loss, from failure to comply with or amendments to the applicable laws, regulations or codes.

Customer treatment risk The risk of reductions in earnings and/or value, through financial or reputational loss, from inappropriate or poor customer treatment. Business process risk The risk of reductions in earnings and/or value, through financial or reputational loss, resulting from inadequate or failed internal processes and systems, people-related events, damage to resources (excluding human resources), and deficiencies in the performance of external suppliers/service providers. Financial crime risk The risk of reductions in earnings and/or value, through financial or reputational loss, associated with financial crime and failure to comply with related legal and regulatory obligations, these losses may include censure, fines or the cost of litigation. People risk The risk of reductions in earnings and/or value, through financial or reputational loss, from inappropriate staff behaviour, industrial action or health and safety issues. Loss can also be incurred through failure to recruit, retain, train, reward and incentivise appropriately skilled staff to achieve business objectives and through failure to take appropriate action as a result of staff underperformance. Change risk The risk of reductions in earnings and/or value, through financial or reputational loss, from change initiatives failing to deliver to requirements, budget or timescale or failing to implement change effectively or realise the desired benefits. Governance risk The risk of reductions in earnings and/or value, through financial or reputational loss, from poor corporate governance at group, divisional and business unit level. Corporate governance in this context embraces the structures, systems and processes that provide direction, control and accountability for the enterprise. Security risk The risk of reductions in earnings and/or value, through financial or reputational loss, resulting from theft or damage to the Bank Group’s assets, the loss, corruption, misuse or theft of the Bank Group’s information assets or threats or actual harm to the Bank Group’s people.

Risk appetite Operational risk appetite is set by the board and defined as the quantum and composition of operational risk identified in the Bank Group and the direction in which the Bank Group wishes to manage it. The board reviews the operational risk appetite on an annual basis.

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The Bank Group has developed an impact on earnings approach to operational risk appetite. This involves analysing how much the Bank Group could lose due to operational risk losses at various levels of certainty. For legal and regulatory risk the Bank Group has minimal risk appetite and seeks to operate to high ethical standards. The Bank Group encourages and maintains an appropriately balanced legal and regulatory compliance culture and seeks to promote policies and procedures to enable Bank Group businesses and their staff to operate in accordance with the laws, regulations and voluntary codes which impact on the Bank Group and its activities. Exposures The main sources of operational risk within the Bank Group relate to uncertainties created by the changing business environment, in particular the legal and regulatory environment in which financial firms operate both in the UK and overseas. As a result the most significant operational risk exposures are legal and regulatory. Legal and regulatory exposure is driven by the significant volume of current legislation and regulation with which the Bank Group has to comply, along with new legislation and regulation which needs to be reviewed, assessed and embedded into day to day operational and business practices across the Bank Group as a whole. This exposure is exacerbated in the current financial crisis, as regulators are likely to introduce more interventionist measures to stabilise the industry. For example, in the UK, the Turner review has proposed fundamental changes to capital and liquidity requirement. Legislative changes can also curtail business activities, which may result in reduction in earnings e.g. the proposed ban on the sale of single premium payment protection insurance. Further uncertainties arise where regulations are principles based without significantly prescriptive minimum standards. This gives rise to both the risk of retrospective action from a regulator and the risk of interpretative differences between (i) the Bank Group or (ii) For example, the jurisdiction of the UK Financial Ombudsmen Service is to consider what is “fair and reasonable“ in its opinion by individual regulators. For legal and regulatory risks there are significant reputational risks associated with potential censure which drive the Bank Group’s stance on appetites referred to above. There are also financial ramifications on non-compliance with regulations, which are relevant to the Bank Group’s risk appetite, as the cost of financial penalties or providing reparation to customers can be significant. There are clear accountabilities and processes in place for reviewing new and changing requirements. Each business has a nominated individual with ‘compliance oversight’ responsibility under FSA rules. The role of such individuals is to advise and assist management to ensure that each business has a control structure which creates awareness of the rules and regulations, to which the Bank Group is subject, and to monitor and report on adherence to these rules and regulations. In addition to legal and regulatory risk, the risk of political intervention in the Bank Group’s operations has increased as a result of Lloyds Banking Group’s intended entry into the UK Government Asset Protection Scheme (“Scheme”), which could result in HM Treasury holding up to 65% of ordinary shares in Lloyds Banking Group (its current holding is 43.4%). This could be increased to as much as 77% if the preference shares to be allocated to HM Treasury were converted to ordinary shares under the agreed terms of Lloyds Banking Group’s entry into the Scheme. The size of HM Treasury’s shareholding in Lloyds Banking Group would allow it to exert significant influence over the financial management or operational matters of Lloyds Banking Group, including the financial management or operation of the Bank Group. HM Treasury has informed Lloyds Banking Group that it does not intend to exercise influence over these aspects of Lloyds Banking Group’s business. It is possible however that it might change its views on this, and may disagree with the commercial decisions of Lloyds Banking Group, including over such matters as the implementation of synergies and commercial and consumer lending policies.

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European State Aid clearance is also required for participation in the Scheme and approval may be given with conditions which are adverse to the earnings and/or value of Lloyds Banking Group. Any such conditions may also be adverse to the earnings and/or value of the Bank Group. Measurement There is ongoing development of operational risk appetites and metrics to ensure both current and potential future operational risk exposures are understood in terms of both risk and reward potential. The Bank Group has a comprehensive and consistent operational risk management framework for the timely identification, measurement, monitoring and control of operational risk. Integral to this operational risk management framework is a hybrid approach to calculating capital to support unexpected losses. The capital model calculations are driven by internal and external data that creates a historic view and business unit scenarios that capture a forward looking view. The capital model outputs are used to determine the internal economic capital, regulatory capital and appetite monitoring for the Bank Group. Mitigation The Bank Group’s operational risk management framework consists of five key components: • Identification of the key operational risks facing a business area. • Evaluation of the effectiveness of the control framework covering each of the key risks to which the

business area is exposed. • Evaluation of the non-financial exposures (e.g. reputational impact) for each of the risks to which the

business area is exposed. • For each of the material risks identified, an estimate of the exposure to financial losses that could result

within the coming financial year, together with an estimate of losses in a stressed environment • For each of the material risks identified an estimate of exposure to high impact, low frequency events

through a scenario. The Bank Group purchases insurance to mitigate certain operational risk events. Monitoring and reporting Business unit risk exposure is aggregated at divisional level and reported to group risk where a group-wide report is prepared. The report is discussed at the monthly group compliance and operational risk committee, with an extended report being reviewed once a quarter. This committee can escalate matters to the chief risk director, or higher committees if appropriate. The insurance programme is monitored and reviewed regularly, with recommendations being made to the Bank Group’s senior management annually prior to each renewal. Insurers are monitored on an ongoing basis, to ensure counterparty risk is minimised. A process is in place to manage any insurer rating changes or insolvencies. The Bank Group has adopted a formal approach to operational risk event escalation. This involves the identification of an event, an assessment of the materiality of the event in accordance with a risk event impact matrix and appropriate escalation.

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Accounting definitions and methodologies The Bank Group’s definition of past due and its methodologies for assessing loan impairment and the impairment of available-for-sale financial assets are set out below: Past due A financial asset is past due when a counterparty has failed to make a payment when contractually due. Loan impairment At each balance sheet date the Bank Group assesses whether, as a result of one or more events occurring after initial recognition, there is objective evidence that a financial asset or group of financial assets has become impaired. The criteria that the Bank Group uses to determine that there is objective evidence of an impairment loss may include: • delinquency in contractual payment of principal and/or interest; • indications that the borrower or group of borrowers is experiencing significant financial difficulty; • restructuring of debt to reduce the burden on the borrower; • breach of loan covenants or conditions; and • initiation of bankruptcy or individual voluntary arrangements. The estimated period between a loss occurring and its identification is determined by local management for each identified portfolio. In general, the periods used vary between three months and twelve months. There are two components of the Bank Group’s loan impairment allowances:

Individually assessed impairment allowances All impaired loans which exceed a certain threshold, principally within the Bank Group’s corporate banking business, are individually assessed for impairment having regard to expected future cash flows including those that could arise from realisable security. The determination of these allowances often requires the exercise of considerable judgement by management involving matters such as local economic conditions and resulting trading performance of the customer and the value of the security held, for which there may not be a readily accessible market. The actual amount of future cash flows and their timing may differ significantly from the assumptions made for the purposes of determining the impairment allowances and consequently these allowances can be subject to variation as times progress and the circumstances of the customer become clearer.

Collectively assessed impairment allowances Impairment allowances for portfolios of smaller balance homogenous loans, such as residential mortgages, personal loans and credit card balances, that are below individual assessment thresholds and for loan losses that have been incurred but not separately identified at the balance sheet date are determined on a collective basis. Collectively assessed impairment allowances are calculated on a portfolio basis taking into account factors such as the length of time that a customer’s account has been out of order, historical loss rates, the credit quality of the portfolios and any value of security held. The variables used in the calculation are kept under regular review to ensure that as far as possible they reflect current economic circumstances; however changes in interest rates, unemployment levels and bankruptcy trends, particularly in the UK, could result in actual losses differing from reported impairment allowances.

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Impairment of available-for-sale financial assets In determining whether an impairment loss has been incurred in respect of an available for sale financial asset, the Bank Group performs an objective review of the current financial circumstances and future prospects of the issuer and considers whether there has been a significant or prolonged decline in the fair value of that asset below its cost. This consideration requires management judgement. Among factors considered by the Bank Group is whether the decline in fair value is as a result of a change in the quality of the asset or a downward movement in the market as a whole. An assessment is performed of the expected future cash flows expected to be realised from the asset, taking into account, where appropriate, the quality of underlying security and credit protection available. Table 1: Impaired and past due lending exposures by industry

Impaired

lending

Past due but not

impaired TotalLoans and advances to customers £m £m £mAgriculture, forestry and fishing 47 77 124Energy and water supply 86 3 89Manufacturing 142 91 233Construction 35 64 99Transport, distribution and hotels 132 197 329Postal and telecommunications 6 3 9Property companies 177 297 474Financial, business and other services 1,038 273 1,311Mortgages – Personal 1,361 3,134 4,495Other personal lending 5,145 542 5,687Lease financing - - -Hire purchase 373 154 527 8,542 4,835 13,377Loans and advances to banks 158 17 175Total 8,700 4,852 13,552

Table 2: Impaired and past due loans by geography

Impaired

lending

Past due but not

impaired TotalLoans and advances to customers and banks £m £m £mUnited Kingdom 8,329 4,739 13,068Europe 223 51 274United States 144 - 144Asia 2 60 62Other 2 2 4Total 8,700 4,852 13,552The above analyses of impaired lending include all amounts that are required to be recorded as such under International Financial Reporting Standards; this includes balances which are technically impaired but which are covered by security of sufficient value that management considers that no allowances are required in respect of the lending for accounting purposes (these balances largely relate to UK domestic mortgages). £mImpaired lending against which provisions are held 6,818Other impaired lending in respect of which management are confident that no allowances are required

1,882

8,700

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Table 3: Allowance for impairment losses on loans and advances Movements in the allowance for impairment losses on loans and advances over the period have been as follows:

Loans and

advances to customers

Loans and advances to banks

Total loans and advances

£m £m £mAt 1 January 2008 2,408 - 2,408 Exchange and other adjustments 43 - 43 Advances written off (1,610) - (1,610) Recoveries of advances written off in previous years 112 - 112 Unwinding of discount (102) - (102) Charge to the income statement 2,718 158 2,876 At 31 December 2008 3,569 158 3,727 The analyses by industry type of the charge to the income statement and the closing balance at 31 December 2008 are as follows:

Charge to the income

statement £m

Allowance at 31 December

2008£m

Loans and advances to customers: - Mortgages 171 186- Other personal lending 1,455 2,047- Agricultural, forestry and fishing 2 5- Energy and water supply 35 33- Manufacturing 122 119- Construction 61 60- Transport, distribution and hotels 66 75- Postal services and telecommunications - -- Financial, business and other services 625 706- Property companies 73 70- Lease financing 1 15- Hire purchase 107 253 2,718 3,569Loans and advances to banks 158 158Total 2,876 3,727 In addition to the above, a total charge of £130 million was made to the income statement in respect of the impairment of available-for-sale investments; £100 million in respect of debt securities and £30 million in respect of equity shares.

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Carrying and fair value of non-trading book equity investments The carrying value, which is equal to the fair value, of equity investments can be analysed as follows: Table 4: Equity investments Venture

capital £m

Other £m

Total £m

Exchange traded 3 3 6 Unlisted 304 42 346 Total 307 45 352

There is no material difference between the fair value and the quoted market value of exchange traded equities. The venture capital investments are classified as held at fair value through profit or loss for accounting purposes and as a result net unrealised losses of £21 million on these equity shares and the related debt security investments are included in Tier 1 capital; other investments are designated as available-for-sale and unrealised gains of £8 million are included in Tier 2 capital.

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Counterparty credit risk Methodology used to assign internal capital and credit limits for counterparty credit exposures Counterparty credit risk is the risk that the Bank Group may incur loss as a result of a counterparty defaulting on a financial contract or portfolio of contracts that have a positive value to the Bank Group. Internal credit limits are generally set using ‘add-ons’ dependant on the underlying asset (e.g. interest rate, currency) and maturity of the contract. Policies for securing collateral and establishing credit reserves Collateral for traded products is documented under standard agreements (e.g. International Swaps and Derivatives Association Master Agreement with Credit Support Annex or Global Master Repurchase Agreement). Policy is set governing types of acceptable collateral and haircuts, which is in line with industry norms. On a weekly basis, for treasury and liquidity management purposes, the Group calculates its additional requirements to post collateral under a Credit Support Annex by Treasury counterparty and, in aggregate, upon a downgrade in its external credit rating Policies with respect to wrong-way risk exposures Collateral Policy and Repo Policy restrict acceptable collateral to specified high-quality government securities and cash. Policy requires specific reference to the business unit credit function where wrong-way risk may feature in repo transactions.

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Securitisation activities Objectives in relation to securitisation activity The Bank Group undertakes securitisation activities for three principal reasons: to manage risk concentrations in its own book; to support relationships with customers; and to manage its liquidity and capital positions. Roles played in the securitisation process The Bank Group acts as originator, sponsor and investor in securitisation transactions. Extent of involvement in securitisation roles The Bank Group has originated transactions from its own balance sheet in the following asset classes; Retail mortgages; Corporate SME loans; Corporate Loans. The Bank Group is the sponsor of Cancara, an Asset Backed Commercial Paper (‘ABCP’) Conduit which sources both loan assets and other commercial paper assets in order to repackage them and issue Commercial Paper backed by these assets. The Bank Group invests in high quality (principally A-1+ or P-1 rated) ABCP and other securitisation paper in order to manage its liquidity position. Approaches to calculating risk-weighted amounts for securitisation activities The Bank Group has approval to utilise the IRB approach for the calculation of risk-weighted amounts for its securitisation activities, as well as approval to utilise the Internal Assessment Approach for calculating risk-weighted amounts for liquidity facilities provided to securitisation conduits. Accounting policies for securitisation activities The assets, liabilities and results of Bank Group undertakings (including special purpose entities) are included in the financial statements on the basis of accounts made up to the reporting date. The Bank’s undertakings include all entities over which the Bank Group has the power to govern the financial and operating policies which generally accompanies a shareholding of more than one half of the voting rights. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Bank Group controls another entity. The Bank’s Group undertakings are fully consolidated from the date on which control is transferred to the Bank Group; they are de-consolidated from the date that control ceases. Details of External Credit Assessment Institutions used for securitisations The Group utilises ratings services from Moody’s Investor Services, Standard & Poors, and Fitch for rating securitisation transactions.

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Table 5: Outstanding exposures securitised by exposure type A number of synthetic securitisations have been entered into in respect of corporate, retail and commercial assets which are subject to the securitisation framework. The analysis of securitised exposures as at 31 December 2008 over these asset classes is as follows:

Exposure type

Total outstanding

exposures £m

Credit events*

£m Losses

£m Corporate 6,437 12.8 0.1Retail and commercial 3,961 47.0 0.9Total 10,398 59.8 1.0

* Credit events are specific to each transaction, however these events typically include the raising of an impairment charge and exposures

becoming past due beyond an agreed level (typically 90 days).

Table 6: Analysis of securitisation exposures by risk weight bands – IRB Foundation Positions for which the securitisation treatment is adopted fall into four categories: retained positions in synthetic securitisations of the Group’s SME and Corporate lending exposures; provision of liquidity lines to the Group’s sponsored Asset Backed Commercial Paper programme; provision of liquidity lines to third party securitisation vehicles; and investments in third party securitisation notes (asset backed securities). Risk Weight Bands £m7% (AAA rating) 31,2218% (AA rating) 6,67510% (A+ rating) 80412% (A rating) 1,93520% (A - rating) 1,41235% (BBB+ rating) 6760% (BBB rating) 441100% (BBB- rating) 191250% (BB+ rating) 40425% (BB rating) 126650% (BB- rating) 1Below BB- or unrated: 1250% or Deduction 364Total 43,277

Summary of 2008 securitisation activity by underlying asset type During the year ended 31 December 2008 the Group has entered into a new synthetic securitisation of some £8,724 million of commercial lending utilising credit default swaps; in addition there has been a net increase in the liquidity lines made available to Cancara of £1,724 million, a net decrease in other liquidity lines of £3,990 million and a net increase in holdings of third party securitisation notes of £4,650 million.

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Capital adequacy Since 1 January 2008 the Bank Group has been operating under the Basel II framework which compares the Bank Group’s regulatory capital with the capital requirements arising from credit, market and operational risk. CAPITAL RESOURCES AND CAPITAL REQUIREMENTS – LLOYDS TSB BANK GROUP Table 7: Regulatory capital as at 31 December 2008 Tier 1 £mCore tier 1 Permanent share capital 1,542 Share premium account 2,960 Retained profits and other reserves 4,944 Available-for-sale revaluation reserve and cash flow hedging reserve 2,997 Regulatory post-retirement benefit adjustments 435 Goodwill (2,256)Other items (97)Expected loss amounts in excess of provisions held (920)Securitisation positions (179)Core tier 1 capital 9,426 Perpetual non-cumulative preference shares Preference share capital 1,974 Innovative tier 1 † Innovative tier 1 capital instruments 3,169 Less: restriction in amount eligible (995) 2,174 Total tier 1 capital 13,574 Tier 2 Upper tier 2 Innovative capital restricted from tier 1 995 Perpetual subordinated loan capital 5,192 Available-for-sale revaluation reserve in respect of equities 8 Collective provisions in respect of standardised portfolios 21 Lower tier 2 Dated subordinated loan capital 5,320 Total tier 2 capital before deductions 11,536 Deductions from tier 2 capital Expected loss amounts in excess of provisions held (920)Securitisation positions (179) (1,099)Total tier 2 capital 10,437 Total tier 1 plus tier 2 capital 24,011

Page 38 of 56

CAPITAL RESOURCES AND CAPITAL REQUIREMENTS – LLOYDS TSB BANK GROUP (continued) Table 7: Regulatory capital (continued) £m Total tier 1 plus tier 2 capital 24,011 Deductions from total of tier 1 plus tier 2 capital Material holdings (4,685)Qualifying holdings (73)Total deductions (4,758) Total capital 19,253

Tier 1 capital, excluding innovative instruments 11,400 Tier 2 capital before deductions including innovative instruments 12,319 Table 8: Capital requirements and surplus at 31 December 2008 Capital requirements £mCredit risk capital requirement 11,971Market and counterparty risk capital requirement 681Operational risk capital requirement 987Total capital requirements 13,639 Surplus of capital over capital requirements 5,614 † A firm is permitted to include innovative tier 1 capital in its tier 1 capital resources for the purposes of GENPRU 1.2 (adequacy of financial resources) but is required to exclude these amounts from tier 1 for the purposes of meeting the main BIPRU firm Pillar 1 rules. Additionally where innovative tier 1 capital is included in tier 1 capital resources, it is restricted to 15% of those resources; any excess above this threshold can be included in tier 2.

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Credit risk During 2007 the Bank Group was successful in obtaining the FSA’s approval of its credit risk waiver application to use an Internal Ratings Based (IRB) approach for the majority of its credit portfolios (Retail IRB for retail portfolios and Foundation IRB for non-retail portfolios) with effect from 1 January 2008. Asset classes not falling within the scope of the Bank Group’s IRB permission are treated under the standardised approach. Exposures under the standardised approach The FSA has confirmed that the Bank Group may adopt the standardised approach for the following exposure classes: • Exposures to the central government of the United Kingdom and to its regional governments, local

authorities and administrative bodies. • Equity exposures; and • Intra Group exposures. The Bank Group has also gained the FSA’s approval to use the standardised approach for a number of non-significant business units. For the purpose of calculating non-retail credit risk requirements under the standardised approach, the Bank Group uses the following external credit assessment institutions (‘ECAI’s): Moody’s Investor Services, Standard & Poors and Fitch. The external rating of each ECAI is mapped to the prescribed credit quality assessment scale that in turn produces standard risk weightings. Exposures under the internal ratings based approach The scope of the Bank Group’s IRB permission is set out below: Division Business Unit Portfolio Approach adopted

Cheltenham & Gloucester Residential Mortgages

Consumer Banking

Other Retail (Loans) and Qualifying Revolving Retail Exposures (Overdrafts and Credit Cards)

Retail IRB

Other Retail (Loans) and Qualifying Revolving Retail Exposures (Overdrafts) and Residential Mortgages

Retail IRB

UK Retail Banking

LTSB Scotland

Sovereigns (excluding the UK), Institutions, Corporates Foundation IRB

Insurance and Investments Scottish Widows Bank Residential Mortgages Retail IRB

Residential Mortgages Other Retail (Loans)

Retail IRB Asset Finance

Sovereigns (excluding the UK), Institutions, Corporates Foundation IRB

Commercial Finance Corporates Foundation IRB

Sovereigns (excluding the UK), Institutions, Corporate, IPRE specialised lending

Foundation IRB

Wholesale and International Banking

Corporate Markets

Project Finance

Object Finance Slotting approach (Foundation IRB approach)

Page 40 of 56

Division Business Unit Portfolio Approach adopted

Securitisations Securitisations

Other Retail (Loans & Overdraft) and Residential Mortgages Retail IRB

Commercial Banking Corporates Foundation IRB

Wholesale and International Banking (cont.)

International Banking – (Belgium, Netherlands and Spain only)

Sovereigns (excluding the UK), Institutions, Corporates Foundation IRB

Table 9: Credit risk capital requirements and risk weighted assets by portfolio

Standardised Foundation IRB Retail IRB Capital

requirementRisk

weightedCapital

requirementRisk

weighted Capital

requirementRisk

weighted assets assets assets £m £m £m £m £m £mCentral governments and central banks 9 113 17 213 Administrative bodies and non-commercial undertakings 3 38 Institutions 40 500 332 4,149 Corporates 362 4,525 5,725 71,562 Retail Exposures to retail SMEs 173 2,163 Exposures secured by real estate 2,180 27,250 Qualifying revolving retail exposures 759 9,487 Other retail exposures 1,162 14,524 Total retail 141 1,763 4,274 53,424Secured by real estate property 109 1,363 Past due items 4 50 Items belonging to regulatory high risk categories 281 3,513 Securitisation positions - - 413 5,162 Non-credit obligation assets 181 2,263 80 1,000 Totals 1,130 14,128 6,567 82,086 4,274 53,424

Capital requirement

Risk weighted

assets £m £mTotal under all approaches 11,971 149,638

Page 41 of 56

Table 10: Credit exposure by credit exposure type

Credit risk exposure* at

end of period – Internal Ratings Based

approach

Credit risk exposure* at end of period

– Standardised

approach

Total credit risk

exposure* at end of

period

Average credit risk exposure*

over period £m £m £m £mInternal ratings based Central governments and central banks 4,751 4,751 2,455Institutions 41,190 41,190 36,383Corporates 112,016 112,016 109,668Retail 173,990 173,990 168,455Securitisations 43,277 43,277 37,510Non-credit obligation assets 1,259 1,259 1,428 376,483 376,483 355,899Standardised Central governments and central banks 37,433 37,433 7,009Administrative bodies and non-commercial undertakings 143 143 56Institutions 1,480 1,480 1,652Corporates 5,333 5,333 5,674Retail 2,565 2,565 4,156Secured by real estate property 3,105 3,105 2,714Past due items 36 36 39Items belonging to regulatory high risk categories 1,008 1,008 843Other items 5,123 5,123 3,574 56,226 56,226 25,717 Total 432,709 381,616 * For the purposes of the disclosures in this table, exposure is defined as exposure-at-default before credit risk mitigation.

Page 42 of 56

Table 11: Credit exposure by counterparty type

Agr

icul

ture

, fo

rest

ry a

nd

fishi

ng

Ene

rgy

and

wat

er

supp

ly

Man

ufac

turin

g

Con

stru

ctio

n

Tran

spor

t, di

strib

utio

n an

d ho

tels

Pos

tal a

nd

com

mun

icat

ions

Pro

perty

co

mpa

nies

Fina

ncia

l, bu

sine

ss a

nd

othe

r ser

vice

s

Per

sona

l: M

ortg

ages

Per

sona

l: O

ther

s

Leas

e fin

anci

ng

Hire

pur

chas

e

Total credit risk exposure*

Internal ratings based Central governments and central banks - 1 - - - - - 4,750 - - - - 4,751 Institutions - - - - - - - 39,447 - - 1,743 - 41,190 Corporates 565 2,638 19,970 4,234 12,236 1,363 23,248 43,145 - - 3,723 894 112,016 Retail 1,012 2 395 717 1,586 40 1,913 1,725 120,096 42,496 - 4,008 173,990 Securitisations 290 1 - 165 977 21 1,296 40,526 - 1 - - 43,277 1,867 2,642 20,365 5,116 14,799 1,424 26,457 129,593 120,096 42,497 5,466 4,902 375,224 Non-credit obligation assets 1,259 376,483 Standardised Central governments and central banks 116 - 7,581 - - 7 - 29,668 - 50 11 37,433 Administrative bodies and non-commercial undertakings - 142 - - - - - 1 - - - 143 Institutions 147 - - - - - 246 257 - 830 - - 1,480 Corporates 1,115 - 609 240 675 11 410 1,596 7 670 - - 5,333 Retail 1,294 - 21 40 11 - 22 54 12 984 - 127 2,565 Secured by real estate property - - - 195 9 - 22 214 2,148 517 - - 3,105 Past due items 1 - - - 2 - - 25 1 1 - 6 36 Items belonging to regulatory high risk categories - - 361 62 80 - 46 459 - - - - 1,008 2,673 142 8,572 537 777 18 746 32,274 2,168 3,052 11 133 51,103 Other items 5,123 Total 56,226

* For the purposes of the disclosures in this table, exposure is defined as exposure-at-default before credit risk mitigation.

Page 43 of 56

Table 12: Credit exposure* by geography

United

Kingdom Rest of Europe

UnitedStates Asia Other Total

£m £m £m £m £m £mInternal ratings based Central governments and central banks 6 2,167 815 1,358 405 4,751Institutions 15,518 19,632 3,881 668 1,491 41,190Corporates 75,887 13,811 16,246 374 5,698 112,016Retail 173,077 303 132 142 336 173,990Securitisations 18,057 17,709 6,854 - 657 43,277Non-credit obligation assets 1,163 8 - 28 60 1,259 283,708 53,630 27,928 2,570 8,647 376,483Standardised Central governments and central banks 37,050 36 - 259 88 37,433Administrative bodies and non-commercial undertakings - - - 139 4 143Institutions 398 113 48 878 43 1,480Corporates 1,942 1,307 243 1,168 673 5,333Retail 1,842 334 5 202 182 2,565Secured by real estate property 607 810 165 1,450 73 3,105Past due items 9 18 - 1 8 36Items belonging to regulatory high risk categories 1,006 - 2 - - 1,008Other items 4,825 133 2 76 87 5,123 47,679 2,751 465 4,173 1,158 56,226 Total 331,387 56,381 28,393 6,743 9,805 432,709

* For the purposes of the disclosures in this table, exposure is defined as exposure-at-default before credit risk mitigation.

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Table 13: Credit exposure* by residual maturity

On demand

or less than 1 month

1 month to 1 year 1 year to

5 yearsOver 5 years

No fixed maturity Total

£m £m £m £m £m £mInternal ratings based Central governments and central banks 2,503 718 832 698 - 4,751Institutions 17,645 11,616 8,810 3,119 - 41,190Corporates 17,017 15,931 51,628 27,438 2 112,016Retail 34,890 7,340 29,567 102,191 2 173,990Securitisations 3,991 17,178 5,707 16,401 - 43,277Non-credit obligation assets 773 - 301 70 115 1,259 76,819 52,783 96,845 149,917 119 376,483Standardised Central governments and central banks 32,259 4,551 336 277 10 37,433Administrative bodies and non-commercial undertakings 138 4 1 - - 143Institutions 854 545 21 60 - 1,480Corporates 2,169 1,551 831 778 4 5,333Retail 604 444 385 1,122 10 2,565Secured by real estate property 18 83 246 2,676 82 3,105Past due items 15 2 5 14 - 36Items belonging to regulatory high risk categories 206 - 4 798 - 1,008Other items 267 1 75 20 4,760 5,123 36,530 7,181 1,904 5,745 4,866 56,226 Total 113,349 59,964 98,749 155,662 4,985 432,709

* For the purposes of the disclosures in this table, exposure is defined as exposure-at-default before credit risk mitigation.

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Credit risk IRB specialised lending The internal ratings based approach provides for a different treatment of specialised lending, which is defined as lending where: (1) the exposure is to an entity which was created specifically to finance and/or operate physical assets; (2) the contractual arrangements give the lender a substantial degree of control over the assets and the

income that they generate; and (3) the primary source of repayment of the obligation is the income generated by the assets being financed,

rather than the independent capacity of a broader commercial enterprise. Specialised lending therefore largely comprises leasing exposures. For such exposures, BIPRU prescribes analysis over five risk-weighting categories using a method known as “slotting” which takes into account financial strength, political and legal environment, transaction and/or asset characteristics, strength of the sponsor and developer, including any public private partnership income stream, and the security package. The Group’s specialised lending exposures, analysed over these supervisory risk-weight bandings, were as follows:

Total

exposureTable 14: Analysis of specialised lending exposures by supervisory risk-weight banding

£m

Strong 2,100Good 1,527Satisfactory 1,259Weak 15Default 77Total 4,978

Page 46 of 56

Table 15: Credit exposures for items dealt with under the Internal Ratings based approach Amount of exposure*

Portfolio

Foundation IRB £m

Retail IRB £m

Total

£mCentral government or central banks 4,751 4,751Institutions 41,190 41,190Corporates 112,016 112,016Retail: Exposures to retail SMEs 2,554 2,554 Retail exposures secured by real estate collateral 125,753 125,753 Qualifying revolving retail exposures 26,923 26,923 Other retail exposures 18,760 18,760Securitisation positions 43,277 43,277Non-credit obligation assets 1,259 1,259Total 202,493 173,990 376,483

* For the purposes of the disclosures in this table, exposure is defined as exposure-at-default before credit risk mitigation.

Page 47 of 56

Table 16: Total exposure* by probability of default banding for items dealt with under the Foundation Internal Ratings Based approach: Wholesale lending Probability of default

Central governments

and central banks

£mInstitutions

£mCorporates

£m Total

£mUp to 0.01% † 4,702 - 6,633 11,335From 0.01% to 0.025% † 22 8,048 528 8,598From 0.025% to 0.10% 21 30,974 23,830 54,825From 0.10% to 0.51% - 1,764 35,495 37,259From 0.51% to 3.00% 1 238 38,381 38,620From 3.00% to 20.00% 3 28 5,156 5,187From 20.00% to 99.99% 2 1 631 634In default - 137 1,362 1,499 4,751 41,190 112,016 157,957* For the purposes of the disclosures in this table, exposure is defined as exposure-at-default before credit risk mitigation. † For internal management purposes some exposures are determined to have a probability of default of less that 0.03%; however a floor of 0.03% applies for regulatory reporting purposes. Table 17: Exposure-weighted average risk weight* by probability of default banding for items dealt with under the Foundation Internal Ratings Based approach: Wholesale lending Probability of default

Central governments

and central banks

%Institutions

%Corporates

% Total

%Up to 0.01% † 4.2 - 13.7 9.7From 0.01% to 0.025% † 9.1 13.7 12.9 13.7From 0.025% to 0.10% 19.0 7.2 23.6 14.3From 0.10% to 0.51% - 29.7 52.5 51.5From 0.51% to 3.00% 100.0 103.8 98.9 98.9From 3.00% to 20.00% 200.0 150.0 139.7 139.8From 20.00% to 99.99% 150.0 100.0 183.0 182.8In default - - 0.7 0.7 4.5 10.1 63.9 48.1* For the purposes of the disclosures in this table, exposure is defined as exposure-at-default before credit risk mitigation. † For internal management purposes some exposures are determined to have a probability of default of less that 0.03%; however a floor of 0.03% applies for regulatory reporting purposes.

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Table 18: Retail lending dealt with under the Retail Internal Ratings Based approach: Retail SME’s

Probability of default

Total exposure*

£m

Exposure* weighted

average loss given default

%

Exposure* weighted

average risk weight

%

Undrawn commitments

£m

Exposure* †

weighted average

exposure £

Up to 0.40% - - - - -

From 0.41% to 0.80% - - - - -

From 0.81% to 1.20% 803 62.9 73.4 583 12,800

From 1.21% to 2.50% 173 61.8 68.8 77 14,100

From 2.51% to 4.50% 338 60.7 78.4 127 14,200

From 4.51% to 7.50% 255 60.4 87.5 76 14,700

From 7.51% to 10.00% 208 60.6 95.2 49 14,500

From 10.01% to 14.00% 77 58.4 94.8 15 32,800

From 14.01% to 20.00% 210 61.4 111.0 40 5,400

From 20.01% to 30.00% 156 60.3 135.9 20 11,900

From 30.01% to 45.00% 55 60.0 165.5 4 12,000

From 45.01% to 99.99% 52 61.5 101.9 2 11,900

100% (in default) 227 10.1 47.6 2 10,300

Total 2,554 56.9 84.7 995 11,800 * For the purposes of the disclosures in this table, exposure is defined as exposure-at-default before credit risk mitigation. † Exposure weighted average exposure is defined as the average individual exposure value in each probability of default banding. Table 19: Lending dealt with under the Retail Internal Ratings Based approach: Mortgages

Probability of default

Total exposure*

£m

Exposure* weighted

average loss given default

%

Exposure* weighted

average risk weight

%

Undrawn commitments

£m

Exposure* † weighted average

exposure £

Up to 0.10% 65,967 16.9 6.9 2,531 110,300

From 0.11% to 0.40% 38,906 25.4 22.9 438 129,800

From 0.41% to 0.80% 6,572 23.0 40.5 445 110,400

From 0.81% to 1.20% 1,263 35.2 47.0 58 138,900

From 1.21% to 2.50% 4,657 23.7 66.7 79 113,900

From 2.51% to 4.50% 1,719 22.6 73.8 54 60,800

From 4.51% to 7.50% 2,179 21.2 104.1 35 75,800

From 7.51% to 10.00% 115 9.9 43.6 5 147,400

From 10.01% to 14.00% 524 11.5 56.5 29 66,800

From 14.01% to 20.00% 886 20.3 124.4 12 98,400

From 20.01% to 30.00% 130 26.6 160.7 - 20,800

From 30.01% to 45.00% 609 22.9 133.6 2 71,800

From 45.01% to 99.99% 637 22.3 83.9 1 106,500

100% (in default) 1,589 11.1 60.8 3 72,300

Total 125,753 20.9 21.7 3,692 111,800 * For the purposes of the disclosures in this table, exposure is defined as exposure-at-default before credit risk mitigation. † Exposure weighted average exposure is defined as the average individual exposure value in each probability of default banding.

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Table 20: Lending dealt with under the Retail Internal Ratings Based approach: Qualifying revolving retail exposures

Probability of default

Total exposure*

£m

Exposure* weighted

average loss given default

%

Exposure* weighted

average risk weight

%

Undrawn commitments

£m

Exposure* † weighted average

exposure £

Up to 0.10% 2,343 72.7 2.3 1,070 800

From 0.11% to 0.40% 5,726 51.0 6.5 8,141 1,100

From 0.41% to 0.80% 5,514 46.3 12.9 8,356 1,900

From 0.81% to 1.20% 984 41.7 16.7 1,660 3,500

From 1.21% to 2.50% 3,511 45.2 30.9 2,997 2,000

From 2.51% to 4.50% 1,900 46.4 51.5 940 1,700

From 4.51% to 7.50% 1,021 41.5 66.8 404 4,500

From 7.51% to 10.00% 1,060 45.1 75.4 288 1,200

From 10.01% to 14.00% 912 44.7 96.4 382 4,100

From 14.01% to 20.00% 407 49.5 119.9 99 1,000

From 20.01% to 30.00% 366 42.6 127.3 90 1,200

From 30.01% to 45.00% 1,181 40.1 132.0 167 3,400

From 45.01% to 99.99% 244 46.7 114.8 22 2,200

100% (in default) 1,754 57.7 55.6 44 1,200

Total 26,923 49.5 35.3 24,660 1,500 * For the purposes of the disclosures in this table, exposure is defined as exposure-at-default before credit risk mitigation. † Exposure weighted average exposure is defined as the average individual exposure value in each probability of default banding. Table 21: Lending dealt with under the Retail Internal Ratings Based approach: Other retail exposures

Probability of default

Total exposure*

£m

Exposure* weighted

average loss given default

%

Exposure* weighted

average risk weight

%

Undrawn commitments

£m

Exposure* † weighted average

exposure £

From 0.11% to 0.40% 584 50.1 31.3 - 2,500

From 0.41% to 0.80% 2,033 46.2 41.9 33 4,000

From 1.21% to 2.5% 4,768 52.3 66.8 34 7,000

From 2.51% to 4.5% 2,436 61.3 87.3 29 6,000

From 4.51% to 7.5% 3,382 58.5 92.0 22 7,400

From 7.51% to 10.0% 726 61.3 102.9 11 7,500

From 10.01% to 14.0% 1,236 61.9 116.1 3 5,900

From 14.01% to 20.0% 192 63.3 136.5 2 6,400

From 20.01% to 30.00% 583 64.0 154.0 2 4,800

From 30.01% to 45.00% 550 62.2 169.1 1 5,500

From 45.01% to 99.99% 269 56.5 101.1 - 6,400

100% (in default) 2,001 56.4 26.1 - 3,000

Total 18,760 56.1 77.4 137 5,300 * For the purposes of the disclosures in this table, exposure is defined as exposure-at-default before credit risk mitigation. † Exposure weighted average exposure is defined as the average individual exposure value in each probability of default banding.

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Table 22: Comparison of actual to expected losses in respect of portfolios assessed under the Internal Ratings Basis Actual losses in the year ended 31 December 2008, on the basis of the charge to the income statement for impairment, were £2,973 million compared to expected losses, as calculated for regulatory purposes, at 31 December 2007 of £4,125 million. Table 23: Credit risk mitigation for standardised portfolios No regulatory benefit is taken from collateral held in respect of standardised portfolios as at 31 December 2008. Table 24: Credit risk mitigation for Foundation Internal Ratings Based portfolios

Portfolio

Total exposure*

covered by eligible

financial collateral

(post haircuts)

£m

Total exposure*

covered by other eligible

collateral £m

Total exposure*

covered by guarantees

£m

Total exposure*

covered by credit

derivatives £m

Total £m

Central government or central banks - - 1,057 - 1,057Institutions 16,657 - 3,762 - 20,419Corporates 9,379 2,353 678 - 12,410Other retail exposures - 172 - - 172Total 26,036 2,525 5,497 - 34,058 * For the purposes of the disclosures in this table, exposure is defined as exposure-at-default before credit risk mitigation.

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Market risk The Bank has a waiver which enables it to calculate Market Risk capital for the trading book using a VaR model. The VaR model is the internal model used by the Bank Group for internal risk measurement of the trading book. The waiver covers foreign exchange, general interest rate and specific interest rate asset classes. The capital charge is based on the 10 day 99% VaR calculated by the model. The Bank Group uses a historical simulation methodology to calculate VaR for the trading book. This methodology consists of calculating historical daily price movements in a full range of market risk factors. The historical daily price movements are applied to positions to create a distribution of hypothetical daily profit and loss scenarios. The hypothetical daily changes in portfolio value are ranked, and the 95th and 99th percentile worst losses are identified. The model incorporates all relevant and significant market risk factors so that the market risk from a full range of trading strategies can be captured accurately. The Bank Group compares daily profit and loss with VaR calculated at a 1 day 99% confidence level on a daily basis. The purpose of this analysis is to provide an indication of how well the VaR model's output, a VaR forecast, has described the corresponding trading outcome. Analysis is performed at the Aggregate trading book level, and individual trading desk level. The Bank Group also compares hypothetical profit or loss with the VaR calculated at a 1 day 99% confidence level on a daily basis. Hypothetical profit or loss is the profit or loss that would have resulted assuming that the portfolio remains unchanged from one day to the next. The Bank Group's trading book stress testing program consists of sensitivity tests, historical scenario tests and hypothetical scenario tests. Sensitivity tests consist of stressing individual market risk factors, such as interest rates and foreign exchange rates, and calculating the resultant loss. Historical scenario tests consist of identifying major stress events that have occurred historically, and calculating the resultant loss from these scenarios reoccurring. Hypothetical scenario tests consist of forecasting major economic events, predicting the resultant impact on financial markets and calculating the losses that would occur from these moves in financial markets. In general, the Bank Group’s trading book stress tests are applied across all asset classes, and all trading book portfolios simultaneously in order that diversification and correlation effects are fully captured. The consolidated financial statements of the Bank are prepared in accordance with International Financial Reporting Standards. Trading securities, other financial assets and liabilities at fair value through profit or loss, derivatives and available-for-sale financial assets are stated at fair value. The fair value of these financial instruments is the amount for which an asset could be exchanged or a liability settled between willing parties in arm’s length transactions. The fair values of financial instruments are determined by reference to observable market prices where these are available and the market is active. Where market prices are not available or are unreliable because of poor liquidity, fair values are determined using valuation techniques including cash flow models which, to the extent possible, use observable market parameters. The process of calculating the fair value using valuation techniques may necessitate the estimation of certain pricing parameters, assumptions or model characteristics The Bank Group maintains systems and controls sufficient to provide reliable valuation estimates, including documented policies, clearly defined roles and responsibilities and departments accountable for verification that are independent of the front office and report ultimately to a main board director. Where models are used, the assumptions, methodologies, mathematics and software implementation are assessed and challenged by suitably qualified parties independent of the development process. The Bank Group considers the need for reserves including unearned credit spreads, close-out costs, investing and funding costs. Any material adjustments required by GENPRU 1.3 that are not required by

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International Financial Reporting Standards are reconciled to the financial statements and reported to the FSA in prudential returns.

Standardised approach Internal Models Table 25: Trading and market risk capital requirements Capital

requirementRisk

weighted assets

Capital requirement

Risk weighted

assets£m £m £m £m

Trading book Commodity position risk - 5 - - Foreign exchange position risk 5 64 - - Interest rate position risk 6 73 117 1,459 Market risk capital component 11 142 117 1,459 Counterparty risk capital component - - 553 6,912 Total trading book 11 142 670 8,371 * includes foreign exchange position risk in respect of the non-trading book which is not significant; no commodity position risk arises in

the non-trading book.

Table 26: Trading derivatives – counterparty credit risk exposure £m Gross positive fair value of contracts: Interest rate contracts 12,771 Foreign exchange contracts 8,804 Equity contracts 205 Credit derivatives 4,257 26,037 Netting (10,598) Collateral (2,970) Netted current credit exposure * 12,469

* the credit exposure on derivative transactions after considering the benefits from both legally enforceable netting agreements and

collateral arrangements.

Table 27: Trading derivative counterparty credit risk exposure values £mMark to market 13,501 Standardised - Internal model - 13,501 Table 28: Credit derivatives Notional value of credit derivative hedges: Used to synthetically securitise tranches of commercial banking loans 1,682 Used for trading 30,813 32,495

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Operational risk The Advanced Measurement Approach (‘AMA’) waiver granted by the FSA enables the outputs from the AMA capital model to be used to determine the Bank Group’s regulatory capital for Operational Risk (‘OR’) with effect from 1 January 2008. There is no partial use within the Bank Group. The Bank Group’s operational risk capital model is an extension of the operational risk framework. The aim of the model is to derive the best estimate of capital required to support potential future operational risk losses. To achieve this, the model quantifies expected and unexpected operational loss exposure using actuarial techniques. The model uses a combination of two approaches; these are the Loss Data Approach (‘LDA’) and the Scenario Based Approach (‘SBA’). Each approach develops a set of loss distributions from which gross risk measures, such as mean and value at risk, can be derived for individual businesses and operational risk categories. These loss distributions are aggregated using Monte Carlo simulation, taking into account a weighting between the two approaches and two diversification effects (one between the business units and one between operational risk types). Again, gross risk measures can be taken from the aggregate distribution. Discounts are applied to the capital requirement derived from the operational risk capital model in respect of insurance coverage and expected losses in accordance with AMA Waiver approach agreed with the FSA. Methodology used in the advanced measurement approach There are four primary data collection activities for the model: • Internal loss data; • External loss data; • Scenarios; and • Internal Control Factors. Internal Loss Data The Bank Group started collecting loss data on 1 January 2004. Loss event data points are used to measure and manage operational risk, to produce internal reports for senior management and to meet external reporting requirements. Loss events and their impacts must be reported. Reporting is completed through the loss event database.

External Loss Data The Bank Group joined the Operational Risk Data Exchange Association (‘ORX’) on 20 December 2006 to improve the accuracy and relevancy of external loss data used in the model. In addition, the Bank Group subscribes to the Algo First Database.

Scenarios Scenarios are an important tool to analyse the Bank Group’s exposure to large remote risks. The Bank Group has chosen to consider scenarios within the business at the first Line of Defence, as local management are closest to the business plans; risks, the relevant controls, their effectiveness and how risks might best be managed. Group wide scenarios are also used where appropriate to reflect the shared nature of some risk exposures and impacts.

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Internal Control Factors Internal Control Factors include Control Assessments and key indicators that influence the Scenario analysis. Although Key Indicators are not direct inputs to the model, they are also used in the business as a management tool to support risk reporting. Table 29: Operational risk capital requirement Capital Risk weighted requirement assets Operational risk £m £m Advanced measurement approach 987 12,339

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Approach to assessing the adequacy of internal capital to support current and future activities The Group uses a variety of risk models to determine its internal capital requirement and quantifies the capital required to cover five broad risk types: credit, market (structural as well as trading), operational, insurance and business. Risks where the Group does not consider capital to be an appropriate mitigant, for example longer term strategic risk, are controlled using a combination of policies, procedures and limits. The internal capital requirement takes account of diversification within risk categories and between risk categories. The Group’s overriding philosophy is that the internal capital requirement should be stable ‘through-the-cycle’ and model inputs are adjusted accordingly. The Group uses internal capital models (economic capital requirement) to support value-based management and help ensure that decisions are in line with the Group objective to maximise shareholder value. The models are used to determine the internal capital requirements of businesses/activities and to assess the economic profit of businesses, business segments or transactions. This information in turn is used to support strategic planning decisions and supplement information used to assess corporate actions, performance measurement and reward schemes, product pricing and business modelling (e.g. analysing risk appetite). The Group periodically monitors internal capital requirements against capital resources to assess adequacy. The Group also projects and assesses adequacy over the plan period.

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CONTACTS

For further information please contact:-

Michael Oliver Director of Investor Relations

Lloyds Banking Group plc 020 7356 2167

Email: michael.oliver@ltsb-finance.co.uk

Registered office: Lloyds TSB Bank plc

25 Gresham Street, London, EC2V 7HN. Registered in England no. 2065