The Halifax Board gives significant priority to risk management. The Audit Committee is supported by four Risk Control Committees, covering Retail Financial Services, Treasury & Wholesale Banking, Clerical Medical Investment Group and Birmingham Midshires. With effect from 1st January 2001 a fifth committee came into operation for Intelligent Finance. These committees meet regularly and review risk management reports prepared by business management together with independent reports from the Risk functions namely Financial Risk, Operational Risk and Regulatory Risk together with Group Audit.

Board policy statements are in place for liquidity, credit and market risks as well as trading. These policy statements establish the Board's appetite for risk, set out the parameters within which businesses can operate and delegate authority, where appropriate, to the relevant management committee.

The Group Asset and Liability Committee (Group ALCO) consists of Executive Directors and senior Executives and meets every two weeks or as required by business needs. Group ALCO has overall responsibility for managing the net interest margin including the approval of retail business plans, structural balance sheet positions and Treasury & Wholesale Banking investment and trading activity. In addition it considers the Group's liquidity policy and capital utilisation.

The Group Credit Committee, with a similar membership to Group ALCO, also meets every two weeks and reviews policies and credit exposures throughout the Group. A sub-committee of the Group Credit Committee meets as required to consider individual large transactions within the authority delegated by the Board.

Operationally, the Group's risk management function is structured as a single entity under the direct control of the Group Finance Director. The heads of each risk function meet formally each month as a Group Risk Management Committee to review progress on key initiatives, share information from their respective teams and debate the risk framework of the Group. This Committee has Board authority to investigate any risk-related concerns within any part of the Group.

The regulatory background for liquidity management is set out in the FSA's Banking Supervisory policy. In accordance with this policy, Halifax maintains a minimum level of sterling stock liquidity as agreed with the FSA.

The Group's liquidity is managed by Treasury & Wholesale Banking and monitored by Group ALCO. Treasury & Wholesale Banking ensures that it holds sufficient assets, which are immediately realisable into cash without significant exposure to market risks or costs, to cover both maturing wholesale funds and a realistic estimate of retail funds that could potentially be withdrawn. This is achieved through cash flow monitoring and control, and by maintaining a suitable mix of short and longer term funding as well as a mix of liquid assets. While a significant proportion of retail savings and current account balances is on instant access terms, in practice the majority of such funds represent a stable and consistent funding base for the Group.

Credit risk is the risk that counterparties will not be able to meet their obligations as they fall due. The Group Credit function within Group Risk Management produces high level credit policies, monitors the various asset portfolios and undertakes an independent review of all major counterparties and sector risks. Day-to-day management of credit risk is undertaken by specialist credit teams working within each business unit and in compliance with approved Group policies. Performance of each portfolio is reported to the Group Credit Committee monthly.

In all retail businesses lending policies and processes are determined centrally to ensure consistency in the management and monitoring of credit risk exposure. Full use is made of software technology in credit scoring new applications and current account overdraft extensions. In addition behavioural scoring is used for credit cards and current accounts. Collections activity for credit card and current accounts, and for personal loans, is centralised for the various products and sophisticated systems are used to prioritise action. Mortgage collection is conducted through a number of collection payment departments.

In Treasury & Wholesale Banking policies are established and reviewed by the Group Credit Committee, including limits for exposure to individual countries, sectors and corporate and financial institutions. The approval of some specific counterparty exposures has been delegated to individuals with personal lending authorities. These individuals are independent from any front office activity. The level of delegation is dependent both on the expertise of the individual and on the risk of the transaction as demonstrated by its internal credit grading, size and fit with approved normal policy. Higher risk exposures require sanction by individuals within the independent risk function or by a sanctioning sub-committee of the Group Credit Committee. Expansion into new areas of business is strictly controlled and monitored by Group Credit Committee. A substantial proportion of Treasury assets is with borrowers rated AA or higher.

The controls applied to lending processes consider environmental risk and the potential impact this may have on the value of the underlying security.

Market risk is defined as the potential loss in value or earnings from changes in value of financial instruments. Typically this would arise from movements in interest rates, foreign exchange rates, equity prices or other indices. The primary market risk faced by the Group is interest rate risk: interest rate risk exists where assets and liabilities have interest rates set under different bases or which reset at different times. The Group also manages currency risk, for which exposures are currently modest. Equity exposure is also managed within modest limits.

Retail businesses are responsible for market risks associated with their products, including launch risk, prepayment risk, basis risk and risks arising through the need to maintain operational efficiency. Retail businesses endeavour to match market risk exposures, taking into account expected future flows. This type of risk arises mainly in Retail Operations as a consequence of offering fixed and capped rate mortgages and fixed rate savings. The majority of market risk arising from products with market related prices is removed from Retail Operations and transfer priced into Treasury & Wholesale Banking where it is managed as part of the overall position.

Market risk in Treasury & Wholesale Banking's activity arises mainly in three separate portfolios:

In carrying out this activity, Treasury & Wholesale Banking uses a range of financial instruments, including derivatives. Loans and deposits to banks, debt securities and bills are held for liquidity, investment and trading purposes. Core liquidity is held in bills, short term certificates of deposit and Gilts. Investments are made in sterling and currency money market instruments and debt securities, including asset backed securities. Derivatives are contracts whose values are derived from those of the underlying assets, liabilities, interest and exchange rates or indices. They are used for both non-trading and trading purposes.

A prime aim of Group ALCO is to reduce the volatility of Group profits resulting from changes in market rates. This is achieved by reviewing the composite risk profile of all operations on a consistent basis and assessing the impact of market rate sensitivities on both a market value and earnings basis. Critical to this analysis is an understanding of the assumptions underpinning customer behavioural characteristics in different economic scenarios.

Daily monitoring takes place within each of the businesses. Group Risk Management monitor any residual market risk within the business units and the position of the Group as a whole. Particular attention is paid to the control of market risk within Treasury & Wholesale Banking, where the risk profile and business dynamics are more volatile than within the retail businesses.

Within Treasury & Wholesale Banking, the level of exposure to changes in market conditions for both banking and trading activity is monitored by Group Risk Management against a clearly defined risk framework overseen by Group ALCO and approved by the Board.

A series of complementary, quantitative controls is applied to Treasury & Wholesale Banking as a whole and to each business component within Treasury & Wholesale Banking, with clear segregation maintained between banking and trading activities. Sensitivity analysis of the net interest margin is the key risk tool used to measure banking activities.

For trading, a key risk tool used by the Group is Value at Risk (VaR) which is calculated daily. This technique estimates potential losses that could occur as a result of movements in market prices and rates within a given confidence level. Group Risk Management currently use a confidence level of 95% and an assumed holding period of 1 day which is believed appropriate given the nature of products in which the Group trades and underlying liquidity in those instruments.

To test the validity of model assumptions, VaR is assessed against daily profit and loss. The table below indicates the Group VaR for 2000:

Whilst VaR is a principal tool in the management of market risk within Treasury & Wholesale Banking, it is subject to a number of limitations. The use of a 95% confidence level indicates that a loss exceeding this VaR number will occur on only one occasion in twenty. However it does not give any indication of the level of loss which might be experienced beyond this level of confidence. Furthermore, the use of historic data as a proxy for the future will not cover all possible events especially where extreme circumstances exist.

The Group addresses these limitations by a series of explicit sensitivity measures. These assess Treasury & Wholesale Banking's exposure to incremental movements in underlying market price drivers e.g. interest rates and option volatility.

In addition, portfolio values for both banking and trading are considered in the context of remote, albeit plausible economic events. The results of such market 'stress tests' are presented to Group ALCO and to the Board.

Operational risk is the risk of direct or indirect loss resulting from inadequate or failed internal processes, people, systems and management or from external events. External events include legal and regulatory risks, disasters and infrastructure failures, business risks and outsourcing and supplier risks.

The management of such risk is an intrinsic part of every business manager's role. Halifax's approach is to ensure business managers identify, assess, prioritise and effectively manage all substantive risks and that a co-ordinated, cost-effective approach is taken. This involves a combination of internal control systems, sound processes, firm contractual relationships with critical suppliers, appropriate insurance cover and contingency arrangements.

Each line of business is required to compile an Operational Risk Profile which sets out the internal assessment of risk and controls against consistent categories as a form of self certification. These profiles have been presented to the Board and are subject to half-yearly updates and independent review by the relevant risk teams. These are validated by Group Audit in the course of their work.

In addition a number of specialist support functions provide centralised expertise in operational risk areas such as information security, fraud, security and business continuity planning.

Regulatory risk is the risk that the Group, or any part of it, fails to meet the requirements or expectations of regulatory authorities or supervisors responsible for enforcing legislation, codes, or regulations governing the way that the Group's business activities are conducted within the UK or elsewhere. Regulatory risk can also arise where the Group fails to anticipate and manage regulatory change adequately.

The management of these risks is overseen by a Regulatory Risk function which has put in place structured internal arrangements for ensuring that all parts of the Group with an interest in a specific regulatory area contribute through relevant committees towards the coherent and consistent management of the regulatory issues in question; and consider and comment on proposed changes to the regulatory environment.

While responsibility for managing regulatory risks rests with the appropriate boards and management, independent validation of the effectiveness, and comprehensiveness of the Group's compliance with codes, regulations, and legislation takes place through a combination of the Regulatory Risk function itself, and Group Audit. The Regulatory Risk and Group Audit functions work together under the ambit of a Memorandum of Understanding to ensure that there are proper arrangements in place for the sharing of information; and the co-ordination of work programmes so as to ensure comprehensive coverage of, and reporting on, regulatory risk issues.

For the participating countries, the transition period finishes at the end of 2001 with the withdrawal of legacy currencies. Halifax business units operating in the first wave countries are in the process of implementing their plans to complete the final changeover to the euro.

Halifax's programme of preparation for possible UK entry into EMU is based on responsibilities at individual business unit level. Each business unit has identified what euro services would be provided during a changeover, together with lead times and critical paths for the preparations.

HM Treasury published a second Outline National Changeover Plan in March 2000. This provided an indicative timetable of 40 months from a Government decision to the withdrawal of sterling. Provided there is a sufficient period of time from the decision to enter to the actual point of entry then based on the work undertaken so far, Halifax is confident that the preparations can be completed.

No further significant work is planned until there is more certainty on possible UK entry.