19. Fair values of financial assets and liabilities

The valuations of financial instruments have been classified into three levels according to the quality and reliability of information used to determine those fair values. Note 49 to the Group’s 2018 financial statements describes the definitions of the three levels in the fair value hierarchy.

Valuation control framework

Key elements of the valuation control framework, which covers processes for all levels in the fair value hierarchy including level 3 portfolios, include model validation (incorporating pre-trade and post-trade testing), product implementation review and independent price verification. Formal committees meet quarterly to discuss and approve valuations in more judgemental areas.

Transfers into and out of level 3 portfolios

Transfers out of level 3 portfolios arise when inputs that could have a significant impact on the instrument’s valuation become market observable; conversely, transfers into the portfolios arise when sources of data cease to be observable.

Valuation methodology

For level 2 and level 3 portfolios, there is no significant change to the valuation methodology (techniques and inputs) disclosed in the Group’s 2018 Annual Report and Accounts applied to these portfolios.

The table below summarises the carrying values of financial assets and liabilities presented on the Group’s balance sheet. The fair values presented in the table are at a specific date and may be significantly different from the amounts which will actually be paid or received on the maturity or settlement date.


	30 June 2019		31 December 2018
	Carrying	Fair	Carrying	Fair
	value	value	value	value
	£m	£m	£m	£m
Financial assets
Financial assets at fair value through profit or loss	155,108	155,108	158,529	158,529
Derivative financial instruments	26,148	26,148	23,595	23,595

Loans and advances to banks	8,374	8,363	6,283	6,286
Loans and advances to customers	495,138	496,768	484,858	484,660
Debt securities	5,434	5,427	5,238	5,244
Financial assets at amortised cost	508,946	510,558	496,379	496,190
Financial assets at fair value through other comprehensive income	27,078	27,078	24,815	24,815
Financial liabilities
Deposits from banks	34,777	34,761	30,320	30,322
Customer deposits	421,692	422,277	418,066	418,450
Financial liabilities at fair value through profit or loss	24,754	24,754	30,547	30,547
Derivative financial instruments	23,026	23,026	21,373	21,373
Debt securities in issue	97,815	100,102	91,168	93,233
Liabilities arising from non-participating investment contracts	14,706	14,706	13,853	13,853
Subordinated liabilities	17,809	20,200	17,656	19,564

The carrying amount of the following financial instruments is a reasonable approximation of fair value: cash and balances at central banks, items in the course of collection from banks, items in course of transmission to banks and notes in circulation.

The Group manages valuation adjustments for its derivative exposures on a net basis; the Group determines their fair values on the basis of their net exposures. In all other cases, fair values of financial assets and liabilities measured at fair value are determined on the basis of their gross exposures.

The following tables provide an analysis of the financial assets and liabilities of the Group that are carried at fair value in the Group’s consolidated balance sheet, grouped into levels 1 to 3 based on the degree to which the fair value is observable.

Financial assets


	Level 1	Level 2	Level 3	Total
	£m	£m	£m	£m
At 30 June 2019
Financial assets at fair value through profit or loss:
Loans and advances to customers	—	14,907	11,042	25,949
Loans and advances to banks	—	3,082	—	3,082
Debt securities	17,931	21,459	1,778	41,168
Equity shares	82,833	13	2,043	84,889
Treasury and other bills	20	—	—	20
Total financial assets at fair value through profit or loss	100,784	39,461	14,863	155,108
Financial assets at fair value through other comprehensive income:
Debt securities	15,252	11,083	171	26,506
Equity shares	—	—	25	25
Treasury and other bills	547	—	—	547
Total financial assets at fair value through other comprehensive income	15,799	11,083	196	27,078
Derivative financial instruments	83	24,881	1,184	26,148
Total financial assets carried at fair value	116,666	75,425	16,243	208,334

At 31 December 2018
Financial assets at fair value through profit or loss:
Loans and advances to customers	—	27,285	10,565	37,850
Loans and advances to banks	—	3,026	—	3,026
Debt securities	18,010	20,544	1,594	40,148
Equity shares	75,701	26	1,758	77,485
Treasury and other bills	20	—	—	20
Total financial assets at fair value through profit or loss	93,731	50,881	13,917	158,529
Financial assets at fair value through other comprehensive income:
Debt securities	18,879	5,366	246	24,491
Treasury and other bills	303	—	—	303
Equity shares	—	—	21	21
Total financial assets at fair value through other comprehensive income	19,182	5,366	267	24,815
Derivative financial instruments	93	22,575	927	23,595
Total financial assets carried at fair value	113,006	78,822	15,111	206,939

Financial liabilities



	Level 1	Level 2	Level 3	Total
	£m	£m	£m	£m

At 30 June 2019
Financial liabilities at fair value through profit or loss:
Liabilities held at fair value through profit or loss	—	7,930	52	7,982
Trading liabilities	2,672	14,100	—	16,772
Total financial liabilities at fair value through profit or loss	2,672	22,030	52	24,754
Derivative financial instruments	274	21,479	1,273	23,026
Total financial liabilities carried at fair value	2,946	43,509	1,325	47,780

At 31 December 2018
Financial liabilities at fair value through profit or loss:
Liabilities held at fair value through profit or loss	—	7,085	11	7,096
Trading liabilities	1,464	21,987	—	23,451
Total financial liabilities at fair value through profit or loss	1,464	29,072	11	30,547
Derivative financial instruments	132	20,525	716	21,373
Total financial liabilities carried at fair value	1,596	49,597	727	51,920

Movements in level 3 portfolio

The tables below analyse movements in the level 3 financial assets portfolio.



		Financial
	Financial	assets at		Total
	assets at	fair value		financial
	fair value	through other		assets
	through profit	comprehensive	Derivative	carried at
	or loss	income	assets	fair value
	£m	£m	£m	£m


At 1 January 2019	13,917	267	927	15,111
Exchange and other adjustments	3	1	—	4
Gains recognised in the income statement within other income	489	—	251	740
Gains (losses) recognised in other comprehensive income within the revaluation reserve in respect of financial assets carried at fair value through other comprehensive income	—	8	—	8
Purchases/ increases to customer loans	1,511	—	2	1,513
Sales/ repayments	(1,522)	(80)	(16)	(1,618)
Transfers into the level 3 portfolio	563	—	22	585
Transfers out of the level 3 portfolio	(98)	—	(2)	(100)
At 30 June 2019	14,863	196	1,184	16,243
Gains (losses) recognised in the income statement within other income relating to those assets held at 30 June 2019	189	—	285	474


		Financial
	Financial	assets held		Total
	assets at	at fair value		financial
	fair value	through other		assets
	through profit	comprehensive	Derivative	carried at
	or loss	income	assets	fair value
	£m	£m	£m	£m

At 1 January 2018	14,152	302	1,056	15,510
Exchange and other adjustments	3	(1)	—	2
Gains recognised in the income statement within other income	111	—	2	113
Gains recognised in other comprehensive income within the revaluation reserve in respect of financial assets held at fair value through other comprehensive income	—	1	—	1
Purchases/ increases to customer loans	206	—	—	206
Sales/ repayments	(491)	(91)	(90)	(672)
Transfers into the level 3 portfolio	532	334	—	866
Transfers out of the level 3 portfolio	(320)	(193)	—	(513)
At 30 June 2018	14,193	352	968	15,513
Gains (losses) recognised in the income statement within other income relating to those assets held at 30 June 2018	160	—	2	162

The tables below analyse movements in the level 3 financial liabilities portfolio.


	Financial		Total
	liabilities at		financial
	fair value		liabilities
	through	Derivative	carried at
	profit or loss	liabilities	fair value
	£m	£m	£m

At 1 January 2019	11	716	727
Exchange and other adjustments	—	—	—
Losses recognised in the income statement within other income	—	204	204
Additions	—	1	1
Redemptions	(1)	(12)	(13)
Transfers into the level 3 portfolio	53	364	417
Transfers out of the level 3 portfolio	(11)	—	(11)
At 30 June 2019	52	1,273	1,325
Losses recognised in the income statement within other income relating to those liabilities held at 30 June 2019	—	249	249


	Financial		Total
	liabilities at		financial
	fair value		liabilities
	through	Derivative	carried at
	profit or loss	liabilities	fair value
	£m	£m	£m

At 1 January 2018	—	804	804
Exchange and other adjustments	—	—	—
Gains recognised in the income statement within other income	—	(30)	(30)
Additions	—	—	—
Redemptions	—	(2)	(2)
Transfers into the level 3 portfolio	10	—	10
Transfers out of the level 3 portfolio	—	—	—
At 30 June 2018	10	772	782
Gains recognised in the income statement within other income relating to those liabilities held at 30 June 2018	—	(30)	(30)

The tables below set out the effects of reasonably possible alternative assumptions for categories of level 3 financial assets and financial liabilities which have an aggregated carrying value greater than £500 million.


				At 30 June 2019
					Effect of reasonably
					possible alternative
		Significant			assumptions1
	Valuation	unobservable		Carrying	Favourable	Unfavourable
	technique(s)	inputs	Range2	value	changes	changes
				£m	£m	£m
Financial assets at fair value through profit or loss
Loans and advances to customers	Discounted cash flows	Gross interest rates, inferred spreads (bps)	76 bps / 208 bps	11,042	347	(406)

Equity and venture capital investments	Market approach	Earnings multiple	0.9 / 14.6	1,786	102	(96)
Equity and venture capital investments	Underlying asset/net asset value (incl. property prices)³	n/a		524	51	(74)
Unlisted equities and debt securities, property partnerships in the life funds	Underlying asset/net asset value (incl. property prices)³	n/a		1,153	16	(40)
Other				358	47	(47)
				14,863	—	—
Financial assets at fair value through other comprehensive income				196	—	—
Derivative financial assets
Interest rate derivatives	Option pricing model	Interest rate volatility	7% / 121%	1,184	8	(4)
				1,184	—	—
Financial assets carried at fair value				16,243	—	—

Financial liabilities at fair value through profit or loss				52

Derivative financial liabilities
Interest rate derivatives	Option pricing model	Interest rate volatility	7% / 121%	1,273	—	—
Financial liabilities carried at fair value				1,325	—	—

Where the exposure to an unobservable input is managed on a net basis, only the net impact is shown in the table.

The range represents the highest and lowest inputs used in the level 3 valuations.

Underlying asset/net asset values represent fair value.


				At 31 December 2018
					Effect of reasonably
					possible alternative
		Significant			assumptions1
	Valuation	unobservable		Carrying	Favourable	Unfavourable
	technique(s)	inputs	Range2	value	changes	changes
				£m	£m	£m
Financial assets at fair value through profit or loss:
Loans and advances to customers	Discounted cash flows	Gross interest rates, inferred spreads (bps)	97bps / 208bps	10,565	380	(371)
Equity and venture capital investments	Market approach	Earnings multiple	0.9 /14.6	1,657	54	(55)
	Underlying assets/net asset value (incl. property prices)³			523	48	(57)
Unlisted equities and debt securities, property partnerships in the life funds	Underlying asset/net asset value (incl. property prices, broker quotes or discounted cash flows)3	n/a	n/a	898	2	(45)
Other				274	92	(21)
				13,917	—	—
Financial assets at fair value through other comprehensive income				267	—	—
Derivative financial assets:
Interest rate derivatives	Option pricing model	Interest rate volatility	19% / 80%	927	7	(5)
				927	—	—
Financial assets carried at fair value				15,111	—	—
Financial liabilities at fair value through profit or loss				11
Derivative financial liabilities:
Interest rate derivatives	Option pricing model	Interest rate volatility	19% / 80%	716	—	—
				716	—	—
Financial liabilities carried at fair value				727	—	—

Where the exposure to an unobservable input is managed on a net basis, only the net impact is shown in the table.

The range represents the highest and lowest inputs used in the level 3 valuations.

Underlying asset/net asset values represent fair value.

Unobservable inputs

Significant unobservable inputs affecting the valuation of debt securities, unlisted equity investments and derivatives are unchanged from those described in the Group’s 2018 financial statements.

Reasonably possible alternative assumptions

Valuation techniques applied to many of the Group’s level 3 instruments often involve the use of two or more inputs whose relationship is interdependent. The calculation of the effect of reasonably possible alternative assumptions included in the table above reflects such relationships and are unchanged from those described in note 49 to the Group’s 2018 financial statements.