This excerpt taken from the LYG 20-F filed May 7, 2009.
FINANCIAL SOUNDNESS RELATED RISKS
The Groups businesses are subject to inherent risks concerning liquidity, particularly if the availability of traditional sources of funding such as retail deposits or the access to wholesale money markets continues to be limited or becomes more limited, which could materially adversely affect the Groups ability to meet its financial obligations as they fall due.
The Groups businesses are subject to risks concerning liquidity, which are inherent in banking operations, and could affect the Groups ability to meet financial obligations as they fall due or to fulfil commitments be lend. These risks can be exacerbated by many enterprise-specific factors, including an over reliance on a particular source of funding (including, for example, securitisations, covered bonds and short-term and overnight money markets), and changes in credit ratings, or market-wide phenomena such as market dislocation and major disasters. There is also a risk that corporate and institutional counterparties may look to reduce aggregate credit exposures to the Lloyds Banking Group which could increase the Groups cost of funding and limit its access to liquidity. In addition, the funding structure employed by the Group may prove to be inefficient giving rise to a level of funding cost that is not sustainable in the long run. The funding needs of the Group will increase to the extent that customers, including conduit vehicles of the Group, draw down under existing credit arrangements with the Group and such increases in funding needs may be material. In order to continue to meet its funding obligations and to maintain or grow its businesses generally, the Group relies on customer savings and transmission balances, as well as ongoing access to the wholesale funding markets, central bank liquidity facilities (for example Bank of England, European Central Bank and Federal Reserve Bank of New York) and the UK Government funding scheme. The ability of the Group to access wholesale and retail funding sources on satisfactory economic terms is subject to a variety of factors, including a number of factors outside of its control, such as liquidity constraints, general market conditions, the encouraged or mandated repatriation of deposits by foreign wholesale or central bank depositors and loss of confidence in the UK banking system.
Medium-term growth in the Groups lending activities will depend, in part, on the availability of retail funding on appropriate terms, for which there is increasing competition. This reliance has increased in the recent past given the difficulties in accessing wholesale funding. Increases in the cost of such funding will impact on the Groups margins and affect profit, and a lack of availability of such retail deposit funding could impact on the Groups future growth.
The ongoing availability of retail deposit funding is dependent on a variety of factors outside the Groups control, such as general economic conditions, the confidence of retail depositors in the economy in general and in Lloyds Banking Group in particular, the financial services industry specifically and the availability and extent of deposit guarantees. These or other factors could lead to a reduction in the Groups ability to access retail deposit funding on appropriate terms in the future. If the current difficulties in the wholesale funding markets are not resolved or central bank lending to financial institutions is withdrawn it is likely that wholesale funding will prove even more difficult to obtain.
Any loss in consumer confidence in the banking businesses of the Lloyds Banking Group could significantly increase the amount of retail deposit withdrawals in a short space of time. Should the Group experience an unusually high level of withdrawals, this may have an adverse effect on the Groups business, financial position and results of operations and could, in extreme circumstances, prevent the Group from meeting its regulatory minimum liquidity requirements. In such extreme circumstances the Group may not be in a position to continue to operate without additional funding support, which it may be unable to access.
See Risk Factors Business and Economic Risks The Groups businesses are conducted in highly competitive environments and the Groups financial performance depends upon managements ability to respond effectively to competitive pressures for a discussion of the competitive nature of the banking industry and competitive pressures that could have a negative impact on the availability of customer deposits and retail funding. In the current environment of unprecedented market volatility, banks access to traditional sources of liquidity has been and is likely to continue to be significantly restricted which may affect the Groups access to such sources of liquidity.
Whilst various governments, including the UK Government, have taken substantial measures to ease the crisis in liquidity, for example, the UK Government funding scheme, there can be no assurance that these measures will succeed in materially improving the liquidity position of major UK banks, including Lloyds Banking Group. In addition, the availability and the terms on which any such measures have been, or will continue to be made available to Lloyds Banking Group are uncertain. The Group does not have influence over the policy making behind such measures. Further, there can be no assurance that these conditions will not lead to an increase in the overall cost of funding of Lloyds Banking Group. The Group expects that it will substantially rely for the foreseeable future on the continued availability of Bank of England liquidity facilities as well as the UK Governments funding scheme. If the Bank of England liquidity facility, the UK Government funding scheme or other sources of short-term funding are not available after that period, the Group could face serious liquidity constraints, which would have a material adverse impact on its solvency.
At the time of the acquisition, the HBOS Group had a funding profile that involved the need to refinance a higher volume of maturing wholesale funding than that of the heritage Lloyds TSB Group. As this continues to be the case, the funding profile of Lloyds Banking Group involves substantially higher refinancing risk than the funding profile of the heritage Lloyds TSB Group on a stand-alone basis. The Lloyds Banking Group will also continue to be dependent on its credit ratings in order to be able to attract wholesale investors into its debt issuance programmes; should the ratings fall, the cost of refinance will increase and it may not be possible to refinance borrowings as they mature.
The Group has been and could continue to be negatively affected by the soundness and/or the perceived soundness of other financial institutions, which could result in significant systemic liquidity problems, losses or defaults by other financial institutions and counterparties, and which could materially adversely affect the Groups results of operations, financial condition and prospects.
Against the backdrop of the lack of liquidity and high cost of funds relative to official rates in the interbank lending market, which is unprecedented in recent history, the Group is subject to the risk of deterioration of the commercial soundness and/or perceived soundness of other financial services institutions within and outside the United Kingdom. Financial services institutions that deal with each other are interrelated as a result of trading, investment, clearing, counterparty and other relationships. This risk is sometimes referred to as systemic risk and may adversely affect financial intermediaries, such as clearing agencies, clearing houses, banks, securities firms and exchanges with whom the Group interacts on a daily basis, all of which could have an adverse effect on the Groups ability to raise new funding.
The Group routinely executes a high volume of transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds and other institutional clients, resulting in a significant credit concentration. The Group is exposed to counterparty risk as a result of recent financial institution failures and nationalisations and will continue to be exposed to the risk of loss if counterparty financial institutions fail or are otherwise unable to meet their obligations. A default by, or even concerns about the ability of, one or more financial services institutions could lead to further significant systemic liquidity problems, or losses or defaults by other financial institutions, which could have a material adverse effect on the Groups results of operations, financial condition and prospects.