Bank of Scotland plc

Report and Accounts

2009

Member of Lloyds Banking Group

 Bank of Scotland plc

Contents

Directors’ report................................................. 2

Directors .......................................................... 6

Principal risks and uncertainties .......................... 7

Independent auditors’ report ............................. 10

Consolidated income statement ......................... 12

Consolidated statement of comprehensive income 13

Consolidated balance sheet............................... 14

Consolidated statement of changes in equity ....... 16

Consolidated cash flow statement ...................... 17

Bank statement of comprehensive income .......... 18

Bank balance sheet ......................................... 19

Bank statement of changes in equity.................. 21

Bank cash flow statement ................................ 22

Notes to the consolidated financial statements .... 23

Registered office:
The Mound, Edinburgh EH1 1YZ
Registered in Scotland No. 327000
 Bank of Scotland plc

Directors’ report

Results
The consolidated income statement on page 12 shows a loss attributable to equity shareholders for the year ended
31 December 2009 of £12,240 million.
Principal activities
Bank of Scotland plc (the Bank) and its subsidiaries (the Group) provide a wide range of banking and financial services through
branches and offices in the UK and overseas.
The Group’s revenue is earned through interest and fees on a broad range of financial services products including current and
savings accounts, personal loans, credit cards and mortgages within the retail market; loans and capital market products to
commercial, corporate and asset finance customers; and private banking.
Acquisition of the Group by Lloyds Banking Group plc
On 16 January 2009, Lloyds Banking Group plc acquired 100 per cent of the ordinary share capital of HBOS plc, the Bank’s
parent company.
Business review
The loss before tax increased by £4,649 million or 44 per cent to £15,284 million. The trading surplus increased by
75 per cent or £2,386 million to £5,584 million but is more than offset by the increase in the impairment charge, reflecting the
weak credit environment and current economic conditions.
Net interest income decreased by £2,345 million or 27 per cent to £6,195 million as both interest income and interest expense
fell as assets have contracted, in response to the historically low interest rate environment that has prevailed throughout the
year.
Other income, including subvention income, increased by £4,338 million from £632 million to £4,970 million; the increase
arising primarily from the receipt by Bank of Scotland plc of a subvention payment of £3,000 million from Lloyds TSB Bank plc.
This payment was made by Lloyds TSB Bank plc to support the financial and reputational position of Bank of Scotland plc and
to facilitate the ongoing integration of the group’s banking operations. Net trading income improved by £2,382 million from a
loss of £2,938 million to a loss of £556 million, reflecting the inclusion of substantial write-downs associated with the
dislocation in financial markets in 2008. The Group’s insurance activities have ceased following the sale of St. Andrews in the
last quarter of 2008. Net fee and commission income decreased by £483 million or 31 per cent to £1,096 million reflecting
lower volumes of new business.
Operating expenses decreased 6 per cent or £356 million to £5,581 million, principally as a result of lower depreciation.
This was offset by increased goodwill impairment which increased by £243 million to £385 million. The 2009 charge was
principally in respect of Lex Vehicle Leasing Services.
Impairment losses increased by £8,005 million or 66 per cent. This largely represents falls in the values of commercial real
estate and the impact of the economic deterioration during the year, including the effects of rising unemployment and reduced
corporate cash flows. Significant provisions were required against the Group’s Irish and Australian commercial real estate
portfolios.
The Group suffered an additional loss of £100 million in 2009 in respect of the disposal of the Australian businesses, BankWest
and St. Andrews, in addition to the £845 million loss recorded in 2008.
Loans and advances to customers fell by £48,675 million, or 10 per cent, to £439,538 million reflecting activity undertaken in
accordance with the strategy to reduce assets associated with non-relationship lending. Customer deposits decreased by
£11,428 million, or 4 per cent, to £265,971 million resulting in a decrease in the customer loans to deposits ratio from
176 per cent at 31 December 2008 to 165 per cent at 31 December 2009.
Loans and advances to banks increased from £12,445 million to £91,259 million and deposits from banks increased from
£97,066 million to £174,338 million reflecting transactions with other parts of the Lloyds Banking Group following the
acquisition of HBOS plc by Lloyds Banking Group plc on 16 January 2009.
Debt securities in issue decreased by £69,291 million or 37 per cent as some of the maturing debt securities were replaced by
deposits by banks as the Group repositioned its funding through transactions with other Lloyds Banking Group subsidiaries.

2
 Bank of Scotland plc

Directors’ report

Shareholders’ equity has increased by £10,486 million to £22,147 million as capital injections and gains on available-for-sale
assets during the year were significantly greater than the Group’s loss for the year.

Capital
The following table shows a summary of the Group’s capital position at the end of 2009 and 2008.
2009 2008
£m £m

Tier 1 capital 25,565 17,328

Tier 2 capital 14,112 15,238
39,677 32,566
Supervisory deductions (1,062) (919)
Total capital 38,615 31,647

Risk weighted assets 322,866 326,703

Core tier 1 ratio 7.5% 4.7%

Tier 1 capital ratio 7.9% 5.3%
Total capital ratio 12.0% 9.7%

Financial risk management objectives and policies

Information regarding the financial risk management objectives and policies of the Bank and its subsidiary undertakings, in
relation to the use of financial instruments, is given in note 46 of the financial statements.
Group structure
On 16 January 2009, the Bank’s ultimate parent company, Lloyds TSB Group plc, changed its name to Lloyds Banking Group
plc, following the acquisition of HBOS plc, the Bank’s immediate parent company.
Directors
The names of the directors of the Company are shown on page 6.
Mr R J Cousins, Mr P J Cummings, Mr M H Ellis, Sir Ron Garrick, Mr A J Hobson, Mr A H Hornby, Ms K E D Jones,
Mr J E Mack, Mr C Matthew, Ms C L McConville, Ms K A Nealon and Lord Stevenson left the board on 16 January 2009.
Dr W C G Berndt, Sir Victor Blank, Mr Ewan Brown, Mr J E Daniels, Mr J P du Plessis, Mr P N Green, Sir Julian Horn-Smith,
Mr A G Kane, Lord Leitch, Sir David Manning, Ms C J McCall, Mr M A Scicluna, Mr G T Tate, Mr T J W Tookey and
Mrs H A Weir joined the board on 16 January 2009.
Mr J P du Plessis, Mr Ewan Brown, Sir Victor Blank, Mr P N Green, Sir David Manning and Ms C J McCall left the board on
17 April 2009, 5 June 2009, 15 September 2009, 23 October 2009, 2 November 2009 and 31 December 2009,
respectively. Ms J Dawson, Mr P A Gore-Randall and Mr D J Watkins left the board on 8 April 2009.
Mr T T Ryan, Mr Anthony Watson and Sir Winfried Bischoff joined the board on 1 March 2009, 2 April 2009 and
15 September 2009, respectively and Mr G R Moreno and Mr D L Roberts have been appointed directors from 1 March 2010.
Directors’ interests
The directors are also directors of Lloyds Banking Group plc and their interests in the share and loan capital of Lloyds Banking
Group plc and its subsidiaries are shown in the report and accounts of that company.
Directors’ indemnities
The directors, including seven former directors who left during the year, have entered into individual contracts of indemnity with
Lloyds Banking Group plc which constituted ‘qualifying third party indemnity provisions’ and ‘qualifying pension scheme
indemnity provisions’ for the purposes of the Companies Act 2006. These contracts were in force during the whole of the
financial year or from the date of appointment in respect of the directors who joined the board in 2009. The contracts for existing
directors remain in force and are available for inspection at the registered office of Lloyds Banking Group plc.

3
 Bank of Scotland plc

Directors’ report

Statement of directors’ responsibilities

The directors are responsible for preparing the annual report and the financial statements in accordance with applicable law and
regulations.
Company law requires the directors to prepare financial statements for each financial year. Under that law the directors have
prepared the consolidated and parent company financial statements in accordance with International Financial Reporting
Standards as adopted by the European Union. The financial statements are required by law to give a true and fair view of the
state of affairs of the parent company and the Group and of the profit or loss of the Group for that period. The directors consider
that, in preparing the financial statements on pages 12 to 97, the Bank and the Group have used appropriate accounting
policies, consistently applied and supported by reasonable and prudent judgements and estimates, and that all accounting
standards which they consider applicable have been followed.
The directors have responsibility for ensuring that the Bank and the Group keep adequate accounting records which disclose
with reasonable accuracy at any time the financial position of the Bank and the Group and which enable them to ensure that the
financial statements comply with the Companies Act 2006 and, as regards the consolidated financial statements, Article 4 of
the IAS Regulation. They have a general responsibility for taking such steps as are reasonably open to them to safeguard the
assets of the Bank and the Group and to prevent and detect fraud and other irregularities.
A copy of the financial statements is placed on our website www.lloydsbankinggroup.com. The directors are responsible for the
maintenance and integrity of statutory and audited information in relation to the Bank on that website. Information published on
the internet is accessible in many countries with different legal requirements. Legislation in the United Kingdom governing the
preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
Each of the current directors, whose names are shown on page 6 of this annual report, confirms that, to the best of his or her
knowledge:
. the financial statements, prepared in accordance with International Financial Reporting Standards as adopted by the
European Union, give a true and fair view of the assets, liabilities and financial position of the Bank and Group and the profit
or loss of the Group; and
. the management report contained in the business review includes a fair review of the development and performance of the
business and the position of the Bank and Group, together with a description of the principal risks and uncertainties they face.
Going concern
The going concern of the Bank and the Group is dependent on successfully funding their respective balance sheets and
maintaining adequate levels of capital. In order to satisfy themselves that the Bank and the Group have adequate resources to
continue to operate for the foreseeable future the directors have considered a number of key dependencies as discussed in
note 1 and additionally have considered projections for the Group’s capital and funding position. Having considered these, the
directors consider that it is appropriate to continue to adopt the going concern basis in preparing the accounts.
Employees
The Group is committed to providing employment practices and policies which recognise the diversity of our workforce and
ensure equality for employees regardless of sex, race, disability, age, sexual orientation or religious belief.
In the UK, the Group belongs to the major employer groups campaigning for equality for the above groups of staff, including
Employers’ Forum on Disability, Employers’ Forum on Age, Stonewall and the Race for Opportunity. Our involvement with these
organisations enables us to identify and implement best practice for our staff.
Employees are kept closely involved in major changes affecting them through measures such as team meetings, briefings,
internal communications and opinion surveys. There are well established procedures, including regular meetings with
recognised unions, to ensure that the views of employees are taken into account in reaching decisions.
Schemes offering share options or the acquisition of shares are available for most staff, to encourage their financial involvement
in Lloyds Banking Group plc.

4
 Bank of Scotland plc

Directors’ report

Policy and practice on payment of creditors

The Bank has signed up to the ‘Prompt Payment Code’ published by the Department for Business Innovation and Skills (‘BIS’),
regarding the making of payments to suppliers. A copy of the code and information about it may be obtained from the BIS
Publications Orderline 0845 015 0010, quoting ref URN 04/606. Alternatively, visit www.payontime.co.uk for details.
The Bank policy is to agree terms of payment with suppliers and these normally provide for settlement within 30 days after the
date of the invoice, except where other arrangements have been negotiated. It is the policy of the Bank to abide by the agreed
terms of payment, provided the supplier performs according to the terms of the contract.
The number of days required to be shown in this report, to comply with the provisions of the Companies Act 2006, is 20. This
bears the same proportion to the number of days in the year as the aggregate of the amounts owed to trade creditors at
31 December 2009 bears to the aggregate of the amounts invoiced by suppliers during the year.
Auditors and audit information
Each person who is a director at the date of approval of this report confirms that, so far as the director is aware, there is no
relevant audit information of which the Bank’s auditors are unaware and each director has taken all the steps that he or she
ought to have taken as a director to make himself or herself aware of any relevant audit information and to establish that the
Bank’s auditors are aware of that information. This confirmation is given and should be interpreted in accordance with the
provisions of the Companies Act 2006.

On behalf of the board

Harry F Baines
Company Secretary
25 February 2010
Company Number 327000

5
 Bank of Scotland plc

Directors

Sir Winfried Bischoff Chairman

J E Daniels Chief Executive

T J W Tookey Finance Director

Dr W C G Berndt

Sir Julian Horn-Smith

A G Kane

Lord Leitch

G R Moreno
(from 1 March 2010)

D L Roberts
(from 1 March 2010)

T T Ryan, Jr

M A Scicluna

G T Tate

A Watson CBE

H A Weir CBE

6
 Bank of Scotland plc

Principal risks and uncertainties

At present the most significant risks faced by the Group are:

Credit
Definition: The risk of reductions in earnings and/or value, through financial 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).
Features: Arising from the Group’s lending activities in its retail, wholesale and wealth and international operations. Over the
last two years the deteriorating economic outlook, both in the UK and overseas, brought about by the banking crisis has
impacted the financial services industry resulting in further high profile losses and writedowns. The Group is impacted by the
economic downturn and a further worsening of the business environment could adversely impact earnings.
This poses a major risk to the Group and its lending to:
. Retail customers, where reducing affordability and/or asset values arising from a combination of house price falls, continuing
high, or increasing levels of unemployment, consumer over-indebtedness, and rising interest rates impact both secured and
unsecured retail exposures.
. Wholesale customers, where companies are facing increasingly difficult business conditions, resulting in corporate default
levels rising and leading to increases in corporate impairment. The Group has high levels of exposure in both the UK and
internationally, including Ireland, USA, Australia and Spain. There are particular concentrations to: financial institutions,
commercial real estate, and joint ventures, with high leverage and exposures through capital structure.
The Group follows a through the economic cycle, relationship based, business model with risk management processes,
appetites and experienced staff in place.

Legal and regulatory

Definition: The risk of regulatory action leading to fine and/or public censure and/or successful legal action being taken against
the Group as a result of failure to meet one or more legal and/or regulatory requirements either in the UK or overseas.
Features: The industry is currently subject to a wide range of international and UK consultations on proposals to change the
regulatory requirements. For example the Basel Committee on Banking Supervision has issued proposals with respect to capital
and liquidity requirements for banks (‘Strengthening the resilience of the banking sector’ and ‘International framework for
liquidity risk measurement, standards and monitoring’) and draft proposals have also been issued for new capital requirements
for insurers (Solvency II). In the UK we have seen the Turner review and more recently, proposals have been issued for
governance, recovery and resolution (‘Living Wills’) arrangements and also, potentially conduct of business requirements, which
could have significant implications for past business as well as future product offerings for customers. There is a high level of
uncertainty both as to the financial outcome in terms of specific requirements and the speed of implementation in the UK and
internationally.
The Group is currently assessing the impacts of these regulatory proposals, and will participate in the consultation and
calibration processes to be undertaken by the various regulatory bodies during 2010. The Group currently meets and exceeds its
regulatory capital requirements and expects to continue to do so. However, the FSA could impose more stringent capital and
liquidity requirements, and/or introduce new ratios and/or change the manner in which it applies existing requirements to
recapitalised banks, including those within the Group. Any one or combination of these events could result in the Group being
forced to raise further capital or to divest assets.
The Group has made good preparations for the FSA’s new liquidity regime (ILAS) and is ready to meet the reporting implications
later in the year.
The Group’s policy is to maintain high levels of compliance with regulatory requirements and it will organise its business to
maintain this level of compliance as the requirements become clearer, being mindful of maintaining an appropriate balance
between risk and reward.

7
 Bank of Scotland plc

Principal risks and uncertainties

Liquidity and funding

Definition: Liquidity risk is defined as the risk that the Group has insufficient financial resources to meet its commitments as they
fall due, or can only secure them at excessive cost. Funding risk is defined as the risk that the Group does not have sufficiently
stable and diverse sources of funding or the funding structure is inefficient.
Features: Arising in the banking business of the Group and reflecting the risk that the Group is unable to attract and retain either
retail, wholesale or corporate deposits or issue debt securities. Like all major banks, the Group is dependent on confidence in
the short and longer term wholesale funding markets; should the Group, due to exceptional circumstances, be unable to
continue to source sustainable funding and provide liquidity when necessary, it could impact its ability to fund its financial
obligations.
The key dependencies for successfully funding the Group’s balance sheet include the continued functioning of the money and
capital markets at their current levels; successful right sizing of the Group’s balance sheet; the continuation of HM Treasury
facilities in accordance with the terms agreed; limited further deterioration in the UK’s and the Group’s credit rating and no
significant or sudden withdrawal of deposits resulting in increased reliance on money markets or UK Government support
schemes. A return to the extreme market conditions of 2008 would place a strain on the Group’s ability to meet its financial
commitments.
Liquidity risk is managed within a board approved framework using a range of metrics to monitor the Group’s profile against its
stated appetite and potential market conditions.

Customer treatment
Definition: The risk of regulatory censure and/or a reduction in earnings/value, through financial or reputational loss, from
inappropriate or poor customer treatment.
Features: Customer treatment and how the Group manages its customer relationships affects all aspects of the Group’s
operations and is closely aligned with achievement of the Group’s strategic aim – to create deep long lasting relationships with
its customers. There is currently a high level of scrutiny regarding the treatment of customers by financial institutions from the
press, politicians and regulatory bodies.
The Office of Fair Trading’s (OFT) investigation and legal test case in respect of unarranged overdraft charges on personal current
accounts concluded in 2009. The OFT is however continuing to discuss its concerns in relation to the personal current account
market with the banks, consumer groups and other organisations under the auspices of its Market Study into personal current
accounts. In October 2009, the OFT published voluntary initiatives agreed with the industry and consumer groups to improve
transparency of the costs and benefits of personal current accounts and improvements to the switching process. The OFT aims
to report on progress in respect of further changes it believes are required to make the market work in the best interest of bank
customers by the end of March 2010.
The Group regularly reviews its product range to ensure that it meets regulatory requirements and is competitive in the market
place. Treating Customers Fairly remains the key principle underpinning the FSA’s consumer protection objective. An additional
challenge for the Group is ensuring the fair treatment of customers during integration of the two heritage businesses. As a result
the customer relationship management risks posed by integration are carefully considered through the integration governance
process in place. If the Group is unable to demonstrate the fair treatment of its customers there is the risk of increased
complaints from customers, the potential for regulatory action (which could include reviews of past business and/or the payment
of fines and compensation) and adverse media coverage (leading to reputational damage in the marketplace). The Group has
policies, procedures and governance arrangements in place to facilitate the fair treatment of customers.

People
Definition: The risk of reduction in earnings and/or value, through financial or reputational loss, from failure to retain, train,
reward, recruit and incentivise appropriately skilled staff, inappropriate staff behaviour or industrial action.
Features: The delivery of the Group’s objectives is underpinned by the ability to attract, retain and develop the best talent in the
industry. The challenges to the people agenda have never been greater with increased regulatory and public interest in
remuneration practices, the effects of the Government shareholding and the impacts of integration. The Group welcomes the
regulation of remuneration provided there is an international consensus and will comply with the FSA Code. The Group has

8
 Bank of Scotland plc

Principal risks and uncertainties

managed the initial stages of integration, working to establish control by defining and implementing the new organisational
structures and continues to manage the relationship with colleagues during this period of change. The Group has policies,
procedures and governance arrangements in place to ensure the effective management of people risk as the Group integrates
and grows its business. Proposals to harmonise employee terms and conditions have been published and the Group is
consulting with the various representative unions. The Group actively manages its relationships with unions, but is aware of the
danger of industrial action, business disruption and reputational impact arising from union behaviour and communications.
People risk is closely monitored as a key risk indicator, as well as being subject to oversight by the board.

Integration
Definition: The risk that the Group fails to realise the business growth opportunities, revenue benefits, cost synergies,
operational efficiencies and other benefits anticipated from, or incurs unanticipated costs and losses associated with, the
acquisition of HBOS plc by Lloyds TSB Group plc.
Features: The integration of the two legacy organisations presents one of the largest integration challenges that has been seen in
the UK financial services industry. There is a risk that the Group may fail to realise the business growth opportunities, revenue
benefits, cost synergies, operational efficiencies and other benefits anticipated from the acquisition of HBOS plc by
Lloyds Banking Group plc, or may incur unanticipated costs and losses associated as a result. As a consequence, the Group’s
results may suffer as a result of operational, financial management and other integration risks. The risk of failure to deliver
synergy benefits or to meet publicly stated targets could potentially result in a loss of shareholder or market confidence with
negative perceptions of the Group’s integration strategy. As the Group goes through the integration process there is a danger of
losing key staff potentially impacting upon integration plans.
An integration executive board has been created to oversee the integration process. The Group is now one year into the
integration programme and has a fully developed and functioning governance framework to manage these risks, with clear
understanding of the dependencies and phased deliverables through to 2012. The programme is ahead of plan.

9
 Bank of Scotland plc

Independent auditors’ report to the members of Bank of Scotland plc

We have audited the Consolidated and Bank financial statements (the ‘financial statements’) of Bank of Scotland plc for the year
ended 31 December 2009 which comprise the Consolidated Income Statement, the Consolidated and Bank Statements of
Comprehensive Income, the Consolidated and Bank Balance Sheets, the Consolidated and Bank Statements of Changes in
Equity, the Consolidated and Bank Cash Flow Statements, and the related notes. The financial reporting framework that has
been applied in their preparation is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the
European Union and, as regards the parent company financial statements, as applied in accordance with the provisions of the
Companies Act 2006.

Respective responsibilities of directors and auditors

As explained more fully in the Statement of Directors’ Responsibilities set out on page 4, the directors are responsible for the
preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit the
financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those
standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors.
This report, including the opinions, has been prepared for and only for the Bank’s members as a body in accordance with
Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or
assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may
come save where expressly agreed by our prior consent in writing.

Scope of the audit of the financial statements

An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable
assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an
assessment of: whether the accounting policies are appropriate to the Group’s and Bank’s circumstances and have been
consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the directors;
and the overall presentation of the financial statements.

Opinion on financial statements

In our opinion:
. the financial statements give a true and fair view of the state of the Group’s and of the Bank’s affairs as at 31 December
2009 and of the Group’s loss and Group’s and Bank’s cash flows for the year then ended;
. the Consolidated financial statements have been properly prepared in accordance with IFRSs as adopted by the European
Union;
. the Bank financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union
and as applied in accordance with the provisions of the Companies Act 2006; and
. the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as
regards the Consolidated financial statements, Article 4 of the lAS Regulation.

Opinion on other matter prescribed by the Companies Act 2006

In our opinion the information given in the Directors’ Report for the financial year for which the financial statements are prepared
is consistent with the financial statements.

10
 Bank of Scotland plc

Independent auditors’ report to the members of Bank of Scotland plc

Matters on which we are required to report by exception

We have nothing to report in respect of the following matters where the Companies Act 2006 requires us to report to you if, in
our opinion:
. adequate accounting records have not been kept by the Bank, or returns adequate for our audit have not been received
from branches not visited by us; or
. the Bank financial statements are not in agreement with the accounting records and returns; or
. certain disclosures of directors’ remuneration specified by law are not made; or
. we have not received all the information and explanations we require for our audit.

Ian Rankin (Senior Statutory Auditor)

for and on behalf of PricewaterhouseCoopers LLP
Chartered Accountants and Statutory Auditors
Edinburgh
25 February 2010

11
 Bank of Scotland plc

Consolidated income statement

for the year ended 31 December 2009

2009 2008
(restated)1
Note £ million £ million

Interest and similar income 19,060 36,093

Interest and similar expense (12,865) (27,553)
Net interest income 5 6,195 8,540
Fee and commission income 1,304 1,961
Fee and commission expense (208) (382)
Net fee and commission income 6 1,096 1,579
Net trading income 7 (556) (2,938)
Insurance premium income – 215
Subvention income 8 3,000 –
Other operating income 8 1,430 1,776
Other income 4,970 632
Total income 11,165 9,172
Insurance claims – (37)
Total income, net of insurance claims 11,165 9,135
Operating expenses 9 (5,581) (5,937)
Trading surplus 5,584 3,198
Impairment 10 (20,055) (12,050)
Share of results of joint ventures and associates 11 (713) (938)
Loss on sale of businesses 12 (100) (845)
Loss before tax (15,284) (10,635)
Taxation 13 3,057 2,448
Loss for the year (12,227) (8,187)
Profit attributable to minority interests 13 51
Loss attributable to equity shareholders (12,240) (8,238)
Loss for the year (12,227) (8,187)

1
See note 48.
The accompanying notes are an integral part of the consolidated financial statements.

12
 Bank of Scotland plc

Consolidated statement of comprehensive income

for the year ended 31 December 2009

2009 20081
£ million £ million

Loss for the year (12,227) (8,187)

Other comprehensive income:
Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax:
Change in fair value 1,877 (5,897)
Transferred to income statement in respect of disposals 2 (17)
Transferred to income statement in respect of impairment 446 915
2,325 (4,999)
Movement in cash flow hedging reserve, net of tax:
Effective portion of changes in fair value taken to other comprehensive income (442) (2,801)
Net gains transferred to the income statement 645 1,844
203 (957)

Currency translation differences, net of tax 9 95

Other comprehensive income for the year, net of tax 2,537 (5,861)
Total comprehensive income for the year (9,690) (14,048)

Total comprehensive income attributable to minority interests 13 51

Total comprehensive income attributable to equity shareholders (9,703) (14,099)
Total comprehensive income for the year (9,690) (14,048)

1
See note 48.

13
 Bank of Scotland plc

Consolidated balance sheet

as at 31 December 2009

1 January
2009 2008 2008
(restated)1 (restated)1
Note £ million £ million £ million

Assets
Cash and balances at central banks 2,905 2,502 2,944
Items in the course of collection from banks 534 445 945
Trading and other financial assets at fair value through profit or loss 14 27,867 23,430 55,789
Derivative financial instruments 15 30,222 50,517 13,794
Loans and receivables:
Loans and advances to banks 16 91,259 12,445 4,095
Loans and advances to customers 17 439,538 488,213 485,201
Debt securities 20 31,211 38,878 527
562,008 539,536 489,823
Available-for-sale financial assets 22 21,565 28,035 49,980
Investment properties 23 30 43 34
Investments in joint ventures and associates 11 423 1,193 1,739
Goodwill 25 376 667 1,041
Other intangible assets 26 91 108 110
Tangible fixed assets 27 4,903 5,527 6,300
Current tax recoverable 745 865 –
Deferred tax assets 34 5,153 3,182 –
Other assets 28 4,522 3,126 6,067
Total assets 661,344 659,176 628,566

1
See note 48.
The accompanying notes are an integral part of the consolidated financial statements.

The directors approved the consolidated financial statements on 25 February 2010.

Sir Winfried Bischoff J Eric Daniels Tim J W Tookey

Chairman Chief Executive Finance Director

14
 Bank of Scotland plc

Consolidated balance sheet

as at 31 December 2009

1 January
2009 2008 2008
(restated)1 (restated)1
Note £ million £ million £ million

Equity and liabilities

Liabilities
Deposits from banks 29 174,338 97,066 41,513
Customer deposits 30 265,971 277,399 297,621
Items in course of transmission to banks 495 521 542
Trading and other financial liabilities at fair value through profit or loss 31 27,372 18,851 22,552
Derivative financial instruments 15 27,452 40,827 12,160
Notes in circulation 981 957 1,034
Debt securities in issue 32 119,157 188,448 206,520
Liabilities arising from insurance contracts and participating investment
contracts – – 24
Liabilities arising from non-participating investment contracts – – 98
Other liabilities 33 6,291 4,235 4,912
Current tax liabilities 3 23 728
Deferred tax liabilities 34 – – 965
Other provisions 35 247 145 172
Subordinated liabilities 36 16,684 18,779 17,881
Total liabilities 638,991 647,251 606,722
Equity
Share capital 37 5,847 1,324 499
Share premium account 38 26,684 11,018 6,343
Other reserves 39 (2,094) (4,694) 1,167
Retained profits 40 (8,290) 4,013 13,479
Shareholders’ equity 22,147 11,661 21,488
Minority interests 206 264 356
Total equity 22,353 11,925 21,844
Total equity and liabilities 661,344 659,176 628,566

1
See note 48.
The accompanying notes are an integral part of the consolidated financial statements.

15
 Bank of Scotland plc

Consolidated statement of changes in equity

for the year ended 31 December 2009

Attributable to equity shareholders

Share capital Other Retained Minority
and premium reserves profits Total interests Total
£ million £ million £ million £ million £ million £ million

Balance at 1 January 2008 6,842 1,167 13,479 21,488 356 21,844

Total comprehensive income – (5,861) (8,238) (14,099) 51 (14,048)
Dividends – – (1,228) (1,228) (43) (1,271)
Issue of ordinary and preference shares 5,500 – – 5,500 – 5,500
Repayment of capital to minority shareholders – – – – (100) (100)
Balance at 31 December 2008 12,342 (4,694) 4,013 11,661 264 11,925
Total comprehensive income – 2,537 (12,240) (9,703) 13 (9,690)
Dividends – – – – (12) (12)
Issue of ordinary and preference shares 20,189 – – 20,189 – 20,189
Capital redemption reserve – 63 (63) – – –
Extinguishment of minority interests – – – – (59) (59)
Balance at 31 December 2009 32,531 (2,094) (8,290) 22,147 206 22,353

16
 Bank of Scotland plc

Consolidated cash flow statement

for the year ended 31 December 2009

2009 2008
(restated)1
Note £ million £ million

Loss before tax (15,284) (10,635)

Adjustments for:
Change in operating assets 43a 45,204 (73,045)
Change in operating liabilities 43b 911 33,318
Non-cash and other items 43c 24,760 16,143
Tax received (paid) 374 (1,061)
Net cash (used in) provided by operating activities 55,965 (35,280)
Cash flows from investing activities
Purchase of available-for-sale financial assets 10,935 55,637
Proceeds from sale and maturity of available-for-sale financial assets (15,760) (18,238)
Purchase of fixed assets (188) (565)
Proceeds from sale of fixed assets 54 587
Acquisition of businesses, net of cash acquired 43f (279) (454)
Disposal of businesses, net of cash disposed 43g 137 1,224
Net cash (used in) provided by investing activities (5,101) 38,191
Cash flows from financing activities
Dividends paid to equity shareholders – (1,228)
Dividends paid to minority interests 43e (12) (43)
Interest paid on subordinated liabilities (816) (1,323)
Proceeds from issue of subordinated liabilities 43e – 3,000
Proceeds from issue of ordinary shares 43e 20,189 5,500
Repayment of subordinated liabilities 43e (1,781) (3,405)
Minority interest acquired 43e – 242
Repayment of capital to minority shareholders 43e (59) (353)
Net cash provided by financing activities 17,521 2,390
Effects of exchange rate changes on cash and cash equivalents 39 (245)
2
Change in cash and cash equivalents 68,424 5,056
Cash and cash equivalents at beginning of year 7,967 2,911
Cash and cash equivalents at end of year 43d 76,391 7,967

The accompanying notes are an integral part of the consolidated financial statements.
1
Following the reclassification of the Group balance sheet to align the presentation with the presentation practices adopted by
Lloyds Banking Group plc (as detailed in note 48) the cash flow statement has been represented on a basis consistent with the
reclassified balance sheet.
2
Mandatory reserve deposits of £373 million at 1 January 2008 have been reclassified from loans and advances to banks to
cash and balances at central banks. In addition, total cash and cash equivalents at 1 January 2008 have been restated to
include certain cash deposits held with the Central Bank of Ireland of £853 million and cash held at central bank as collateral
against notes in circulation of £881 million which are available to finance the Group’s day to day operations. The cash flow
statement has been adjusted accordingly.

17
 Bank of Scotland plc

Bank statement of comprehensive income

for the year ended 31 December 2009

2009 2008
(restated)1
£ million £ million

Loss for the year (14,168) (7,062)

Other comprehensive income:
Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax:
Change in fair value 1,331 (2,992)
Transferred to income statement in respect of disposals 42 31
Transferred to income statement in respect of impairment – 466
1,373 (2,495)
Movement in cash flow hedging reserve, net of tax:
Effective portion of changes in fair value taken to other comprehensive income (454) (2,789)
Net losses transferred to the income statement 652 1,863
198 (926)

Currency translation differences, net of tax 33 –

Other comprehensive income for the year, net of tax 1,604 (3,421)
Total comprehensive income for the year (12,564) (10,483)

1
See note 48.

18
 Bank of Scotland plc

Bank balance sheet

for the year ended 31 December 2009

1 January
2009 2008 2008
(restated)1 (restated)1
Assets Note £ million £ million £ million

Cash and balances at central banks 2,168 1,820 1,667

Items in the course of collection from banks 538 449 890
Trading and other financial assets at fair value through
profit or loss 14 27,628 22,920 52,574
Derivative financial instruments 15 26,680 43,260 12,067
Loans and receivables:
Loans and advances to banks 16 108,133 34,144 25,458
Loans and advances to customers 17 439,967 578,528 478,840
Debt securities 20 23,684 19,259 7
571,784 631,931 504,305
Available-for-sale financial assets 22 19,316 24,339 26,608
Investment in subsidiary undertakings 24 2,451 4,383 3,298
Investments in joint ventures and associates 11 104 103 103
Goodwill 25 376 376 426
Other intangible assets 26 85 98 88
Tangible fixed assets 27 1,344 1,359 1,406
Current tax recoverable 975 1,180 –
Deferred tax assets 34 4,410 2,563 165
Other assets 28 5,792 2,876 5,331

Total assets 663,651 737,657 608,928

1
See note 48.
The accompanying notes are an integral part of the financial statements.

Approved by the Board on 25 February 2010 and signed on its behalf by:

Sir Winfried Bischoff J Eric Daniels Tim J W Tookey

Chairman Chief Executive Finance Director

19
 Bank of Scotland plc

Bank balance sheet

for the year ended 31 December 2009

1 January
2009 2008 2008
(restated)1 (restated)1
Equity and liabilities Note £ million £ million £ million

Liabilities
Deposits from banks 29 168,246 97,091 47,321
Customer deposits 30 300,124 373,173 332,322
Items in course of transmission to banks 495 522 543
Trading and other financial liabilities at fair value through
profit or loss 31 27,372 18,851 22,145
Derivative financial instruments 15 27,171 39,613 10,073
Notes in circulation 981 957 881
Debt securities in issue 32 98,075 172,464 158,257
Other liabilities 33 4,925 4,422 2,968
Current tax liabilities – – 544
Other provisions 35 235 132 481
Subordinated liabilities 36 16,052 18,082 14,855
Total liabilities 643,676 725,307 590,390
Equity
Share capital 37 5,847 1,324 499
Share premium account 38 26,684 11,018 6,343
Other reserves 39 (449) (2,116) 1,318
Retained profits 40 (12,107) 2,124 10,378
Shareholders’ equity 19,975 12,350 18,538
Total equity and liabilities 663,651 737,657 608,928

1
See note 48.
The accompanying notes are an integral part of the financial statements.

20
 Bank of Scotland plc

Bank statement of changes in equity

for the year ended 31 December 2009

Share capital Other Retained

and premium reserves profits Total
£ million £ million £ million £ million

Balance at 31 December 2007 as previously stated 6,842 1,296 10,041 18,179

Prior year adjustment (note 48) – 9 350 359
Balance at 1 January 2008 as restated 6,842 1,305 10,391 18,538
Total comprehensive income – (3,421) (7,062) (10,483)
Dividends – – (1,205) (1,205)
Issue of ordinary and preference shares 5,500 – – 5,500
Balance at 31 December 2008 12,342 (2,116) 2,124 12,350
Total comprehensive income – 1,604 (14,168) (12,564)
Issue of ordinary shares 20,189 – – 20,189
Capital redemption – 63 (63) –
Balance at 31 December 2009 32,531 (449) (12,107) 19,975

21
 Bank of Scotland plc

Bank cash flow statement

for the year ended 31 December 2009

2009 2008
(restated)1
Note £ million £ million

Loss before tax (17,080) (9,051)

Adjustments for:
Fair value and exchange adjustments 1,671 923
Change in operating assets 43a 118,144 (180,300)
Change in operating liabilities 43b (69,621) 190,960
Non-cash and other items 43c 21,899 11,795
Tax received (paid) 642 (759)
Net cash provided by operating activities 55,655 13,568
Cash flows from investing activities
Acquisition of business, net of cash acquired 43f (2,517) (1,217)
Purchase of fixed assets (142) (230)
Proceeds from sale of fixed assets 39 130
Net cash used in investing activities (2,620) (1,317)
Cash flows from financing activities
Dividends paid to equity shareholders – (1,205)
Proceeds from issue of subordinated liabilities 43e – 3,000
Repayment of debt securities/subordinated liabilities in issue 43e (1,781) (870)
Proceeds from issue of other ordinary shares 43e 20,189 5,500
Interest paid on subordinated liabilities (757) (1,045)
Net cash provided by financing activities 17,651 5,380
Change in cash and cash equivalents 70,686 17,631
Cash and cash equivalents at beginning of year 19,353 1,722
Cash and cash equivalents at end of year 43d 90,039 19,353

The accompanying notes are an integral part of the financial statements.

1
Following the reclassification of the Bank balance sheet to align the presentation with the presentation practices adopted by
Lloyds Banking Group plc (as detailed in note 48) the cash flow statement has been represented on a basis consistent with the
reclassified balance sheet.

22
 Bank of Scotland plc

Notes to the consolidated financial statements

1 Basis of preparation

The global upheaval in the financial markets that occurred during 2008 has abated during the latter part of 2009. The steps taken in 2008 by HM Treasury through
the introduction of the UK Government’s Credit Guarantee Scheme for senior funding and the Bank of England through various facilities have together continued to
provide assurance of liquidity support to the banking markets. Notwithstanding the improvement in market liquidity during 2009, Lloyds Banking Group plc
continues to be reliant upon these facilities in order to maintain its wholesale funding position. The Bank is dependent upon its ultimate parent, Lloyds Banking Group
plc and its fellow subsidiary undertaking, Lloyds TSB Bank plc, to provide capital and funding.

During the year, Lloyds Banking Group plc has taken steps to strengthen the Bank’s capital position in order to provide a buffer against further shocks arising from the
economic environment.

Based upon projections prepared by management, which take into account the funding needs of the Lloyds Banking Group as a whole and which assume that the
Government sponsored facilities will continue to be available, the directors are satisfied that the Bank has adequate resources to continue in business for the
foreseeable future. Accordingly, the financial statements of the Bank have been prepared on a going concern basis.

2 Accounting policies

The financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU) and, as
regards to the Bank financial statements, as applied in accordance with the provisions of the Companies Act 2006. IFRS comprises accounting standards prefixed
IFRS issued by the International Accounting Standards Board (IASB) and those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by
the International Financial Reporting Interpretations Committee and its predecessor body. The EU endorsed version of IAS 39 Financial Instruments: Recognition and
Measurement relaxes some of the hedge accounting requirements; the Group has not taken advantage of this relaxation, and therefore there is no difference in
application to the Group between IFRS as adopted by the EU and IFRS as issued by the IASB.

The financial information has been prepared under the historical cost convention, as modified by the revaluation of investment properties, available-for-sale financial
assets, trading securities and certain other financial assets and liabilities at fair value through profit or loss and all derivative contracts.

The following relevant IFRS pronouncements have been adopted in these financial statements:

(i) IAS 1 (revised), ‘Presentation of financial statements’. The revised standard prohibits the presentation of items of income and expense (that is ‘non-owner
changes in equity’) in the statement of changes in equity, requiring ‘non-owner changes in equity’ to be presented separately from owner changes in equity. All
non-owner changes in equity are required to be shown in a performance statement. Entities can choose whether to present one performance statement (the
statement of comprehensive income) or two statements (the income statement and statement of comprehensive income). The Group has elected to present
two statements: an income statement and a statement of comprehensive income. The financial statements have been prepared under the revised disclosure
requirements; the application of this revised standard, which affects presentation only, has not had any impact for amounts recognised in these financial
statements. A balance sheet as at 1 January 2008 is presented to deal with the reclassifications as detailed in note 48.

(ii) Amendments to IFRS 7 ‘Financial Instruments: Disclosures – Improving Disclosures about Financial Instruments’. The amendment requires enhanced
disclosures about fair value measurement and liquidity risk. In particular, the amendment requires disclosure of a three level fair value measurement
hierarchy for financial instruments carried on the Group’s balance sheet at fair value. As the amendments only result in additional disclosures, the
amendments have not had any impact for amounts recognised in these financial statements.

(iii) IFRS 8 ‘Operating Segments’. The new standard replaces IAS 14 ‘Segment Reporting’ and requires reporting of financial and descriptive information about
operating segments which are based on how financial information is reported and evaluated internally. The chief operating decision maker has been identified
as the Group Executive Committee (GEC). The Group is managed on the entity basis and not by segment, and the GEC does not assess performance and
allocate resources across any segments; accordingly no segmental information is provided. A brief overview of its sources of income is provided in the
Business review.

The ultimate parent undertaking, Lloyds Banking Group plc, produces consolidated accounts which set out the basis of the segments through which it manages
performance and allocates resources across the consolidated Group.

The application of the following IFRS pronouncements which all became effective in 2009 has had no material impact on these financial statements:
. Amendments to IFRIC 9 Reassessment of Embedded Derivatives and IAS 39 Financial Instruments: Recognition and Measurement. This amendment clarifies that
a reassessment of embedded derivatives is required whenever a financial asset has been reclassified out of the fair value through profit or loss category.
. IFRIC 13 Customer Loyalty Programmes. This interpretation addresses accounting by entities who grant customer loyalty award credits to customers as part of sales
transactions and which can be redeemed in the future for free or discounted goods or services. The majority of customer loyalty award schemes are operated by
third parties.
. IFRIC 16 Hedges of a Net Investment in a Foreign Operation. This interpretation provides guidance on accounting for hedges of net investments in foreign
operations in an entity’s consolidated financial statements.
. IAS 23 Borrowing Costs. This revised standard requires interest and other costs incurred in connection with the borrowing of funds to be recognised as an expense
excepting that those which are directly attributable to the acquisition, construction or production of assets that take a substantial period of time to get ready for their
intended use or sale must be capitalised as part of the cost of those assets.
. Amendments to IAS 32 Financial Instruments: Presentation and IAS 1 Presentation of Financial Statements – Puttable Financial Instruments and Obligations
Arising on Liquidation. The amendments require some puttable financial instruments (being those which give the holder the right to put the instrument back to the
issuer for cash or another financial asset) and some financial instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net
assets of the entity only on liquidation to be classified as equity.
. Improvements to IFRSs (issued May 2008). Sets out minor amendments to IFRS standards as part of annual improvements process. Most amendments clarified
existing practice.

23
 Bank of Scotland plc

Notes to the consolidated financial statements

2 Accounting policies (continued)

. Amendment to IAS 27 Consolidated and Separate Financial Statements – Cost of an Investment in a Subsidiary, Jointly Controlled Entity or Associate. This
amendment removes the definition of the cost method and requires the presentation of dividends as income in the separate financial statements of the investor.

The application of these new interpretations has not had any impact for amounts recognised in these financial statements.

Details of those IFRS pronouncements which will be relevant to the Group but which were not effective at 31 December 2009 and which have not been applied in
preparing these financial statements are given in note 50.

The accounting policies are set out below.

a Consolidation
The assets, liabilities and results of Group undertakings (including special purpose entities) are included in the financial statements on the basis of accounts made up
to the reporting date. Group undertakings include subsidiaries, joint ventures and associates.

(1) Subsidiaries
Subsidiaries include entities over which the 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 Group controls another entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Group; they are de-consolidated
from the date that control ceases. Details of the principal subsidiaries are given in note 24.

Intercompany transactions, balances and unrealised gains and losses on transactions between Group companies are eliminated.

The Group applies a policy of treating transactions with minority interests as transactions with parties external to the Group. Disposals to minority interests result in
gains and losses for the Group that are recorded in the income statement. Purchases from minority interests result in goodwill, being the difference between any
consideration paid and the relevant share acquired of the carrying value of net assets of the subsidiary.

(2) Joint ventures and associates

Joint ventures are entities over which the Group has joint control under a contractual arrangement with other parties. Associates are entities over which the Group has
significant influence, but not control or joint control, over the financial and operating policies. Significant influence is the power to participate in the financial and
operating policy decisions of the entity and is normally achieved through holding between 20 per cent and 50 per cent of the voting share capital of the entity.

The Group utilises the venture capital exemption for investments where significant influence or joint control is present and the business unit operates as a venture
capital business. These investments are designated at initial recognition at fair value through profit or loss. Otherwise, the Group’s investments in joint ventures and
associates are accounted for by the equity method of accounting and are initially recorded at cost and adjusted each year to reflect the Group’s share of the post-
acquisition results of the joint venture or associate based on audited accounts which are coterminous with the Group or made up to a date which is not more than
three months before the Group’s reporting date. The share of any losses is restricted to a level that reflects an obligation to fund such losses.

b Goodwill
Goodwill arises on business combinations, including the acquisition of subsidiaries, and on the acquisition of interests in joint ventures and associates, and represents
the excess of the cost of an acquisition over the fair value of the Group’s share of the identifiable assets, liabilities and contingent liabilities acquired. Where the fair
value of the Group’s share of the identifiable assets, liabilities and contingent liabilities of the acquired entity is greater than the cost of acquisition, the excess is
recognised immediately in the income statement.

Goodwill is recognised as an asset at cost and is tested at least annually for impairment. If an impairment is identified the carrying value of the goodwill is written
down immediately through the income statement and is not subsequently reversed. Goodwill arising on acquisitions of joint ventures and associates is included in the
Group’s investment in joint ventures and associates. At the date of disposal of a subsidiary, the carrying value of attributable goodwill is included in the calculation of
the profit or loss on disposal except where it has been written off directly to reserves in the past.

c Other intangible assets

Other intangible assets comprise software enhancement and brands. Intangible assets which have been determined to have a finite useful life are amortised on a
straight line basis over their estimated useful life as follows:

Capitalised software enhancements up to 5 years

Brands (which have been assessed as having finite lives) 10-15 years

Intangible assets with finite useful lives are reviewed at each reporting date to assess whether there is any indication that they are impaired. If any such indication
exists the recoverable amount of the asset is determined and in the event that the asset’s carrying amount is greater than its recoverable amount, it is written down
immediately. Certain brands have been determined to have an indefinite useful life and are not amortised. Such intangible assets are reassessed annually to reconfirm
that an indefinite useful life remains appropriate. In the event that an indefinite life is inappropriate a finite life is determined and an impairment review is performed
on the asset.

d Revenue recognition
Interest income and expense are recognised in the income statement for all interest-bearing financial instruments, except for those classified at fair value through profit
or loss, using the effective interest method. The effective interest method is a method of calculating the amortised cost of a financial asset or liability and of allocating
the interest income or interest expense over the expected life of the financial instrument. The effective interest rate is the rate that exactly discounts the estimated
future cash payments or receipts over the expected life of the financial instrument or, when appropriate, a shorter period, to the net carrying amount of the financial
asset or financial liability.

24
 Bank of Scotland plc

Notes to the consolidated financial statements

2 Accounting policies (continued)

The effective interest rate is calculated on initial recognition of the financial asset or liability by estimating the future cash flows after considering all the contractual
terms of the instrument but not future credit losses. The calculation includes all amounts expected to be paid or received by the Group including expected early
redemption fees and related penalties and premiums and discounts that are an integral part of the overall return. Direct incremental transaction costs related to the
acquisition, issue or disposal of a financial instrument are also taken into account in the calculation. Once a financial asset or a group of similar financial assets has
been written down as a result of an impairment loss, interest income is recognised using the rate of interest used to discount the future cash flows for the purpose of
measuring the impairment loss (see h).

Fees and commissions which are not an integral part of the effective interest rate are generally recognised when the service has been provided. Loan commitment fees
for loans that are likely to be drawn down are deferred (together with related direct costs) and recognised as an adjustment to the effective interest rate on the loan
once drawn. Where it is unlikely that loan commitments will be drawn, loan commitment fees are recognised over the life of the facility. Loan syndication fees are
recognised as revenue when the syndication has been completed and the Group retains no part of the loan package for itself or retains a part at the same effective
interest rate for all interest-bearing financial instruments, including loans and advances, as for the other participants.

Dividend income is recognised when the right to receive payment is established.

e Financial assets and liabilities

On initial recognition, financial assets are classified into fair value through profit or loss, available-for-sale financial assets or loans and receivables. Financial liabilities
are measured at amortised cost, except for trading liabilities and other financial liabilities designated at fair value through profit or loss on initial recognition which are
held at fair value. Purchases and sales of securities and other financial assets and liabilities are recognised on trade date, being the date that the Group is committed
to purchase or sell an asset.

(1) Financial instruments at fair value through profit or loss

Financial instruments are classified at fair value through profit or loss where they are trading securities or where they are designated at fair value through profit or loss
by management. Derivatives are carried at fair value (see accounting policy f).

Trading securities are debt securities and equity shares acquired principally for the purpose of selling in the short term or which are part of a portfolio which is
managed for short-term gains. Such securities are classified as trading securities and recognised in the balance sheet at their fair value. Gains and losses arising from
changes in their fair value together with interest coupons and dividend income are recognised in the income statement within net trading income in the period in
which they occur.

Other financial assets and liabilities at fair value through profit or loss are designated as such by management upon initial recognition. Such assets and liabilities are
carried in the balance sheet at their fair value and gains and losses arising from changes in fair value together with interest coupons and dividend income are
recognised in the income statement within net trading income in the period in which they occur. Financial assets and liabilities are designated as at fair value through
profit or loss on acquisition in the following circumstances:

– it eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets and liabilities or recognising gains or losses on
different bases.

– the assets and liabilities are part of a group which is managed, and its performance evaluated, on a fair value basis in accordance with a documented risk
management or investment strategy, with management information also prepared on this basis. As noted in accounting policy 2(a)(2), certain of the
Group’s investments are managed as venture capital investments and evaluated on the basis of their fair value and these assets are designated at fair value through
profit or loss.

– where the assets and liabilities contain one or more embedded derivatives that significantly modify the cash flows arising under the contract and would otherwise
need to be separately accounted for.

The fair values of assets and liabilities traded in active markets are based on current bid and offer prices respectively. If the market is not active the Group establishes a
fair value by using valuation techniques. These include the use of recent arm’s length transactions, reference to other instruments that are substantially the same,
discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants. Refer to note 3 (Critical accounting
estimates and judgements: Valuation of financial instruments) and note 46 (Financial risk management: Fair values of financial assets and liabilities) for details of
valuation techniques and significant inputs to valuation models.

The Group is permitted to reclassify, at fair value at the date of transfer, non-derivative financial assets (other than those designated at fair value through profit or loss
by the entity upon initial recognition) out of the trading category if they are no longer held for the purpose of being sold or repurchased in the near term, as follows:

– if the financial assets would have met the definition of loans and receivables (but for the fact that they had to be classified as held for trading at initial recognition),
they may be reclassified into loans and receivables where the Group has the intention and ability to hold the assets for the foreseeable future or until maturity;

– if the financial assets would not have met the definition of loans and receivables, they may be reclassified out of the held for trading category into available-for-sale
financial assets in ‘rare circumstances’.

(2) Available-for-sale financial assets

Debt securities and equity shares that are not classified as trading securities, at fair value through profit or loss or as loans and receivables are classified as available-
for-sale financial assets and are recognised in the balance sheet at their fair value, inclusive of transaction costs. Available-for-sale financial assets are those intended
to be held for an indeterminate period of time and may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. Gains
and losses arising from changes in the fair value of investments classified as available-for-sale are recognised directly in other comprehensive income, until the
financial asset is either sold, becomes impaired or matures, at which time the cumulative gain or loss previously recognised in other comprehensive income is
recognised in the income statement. Interest calculated using the effective interest method and foreign exchange gains and losses on debt securities denominated in
foreign currencies are recognised in the income statement.

25
 Bank of Scotland plc

Notes to the consolidated financial statements

2 Accounting policies (continued)

The Group is permitted to transfer, at fair value at the date of transfer, a financial asset from the available-for-sale category to the loans and receivables category where
that asset would have met the definition of loans and receivables at the time of reclassification (if the financial asset had not been designated as available-for-sale)
and where there is both the intention and ability to hold that financial asset for the foreseeable future. For assets transferred, gains or losses recognised in equity in
respect of these assets as at the date of transfer are amortised to profit or loss over the remaining life of the asset using the effective interest method.

(3) Loans and receivables

Loans and receivables include loans and advances to banks and customers and eligible assets including those transferred into this category out of the fair value
through profit or loss or available-for-sale financial assets categories. Loans and receivables are initially recognised when cash is advanced to the borrowers at fair
value inclusive of transaction costs or, for eligible assets transferred into this category, their fair value at the date of transfer. Financial assets classified as loans and
receivables are accounted for at amortised cost using the effective interest method (see d) less provision for impairment (see h).

The Group has entered into securitisations and similar transactions to finance certain loans and advances to customers. These loans and advances to customers
continue to be recognised by the Group, together with a corresponding liability for the funding.

(4) Borrowings
Borrowings (which include deposits from banks, customer accounts, debt securities in issue and subordinated liabilities) are recognised initially at fair value, being
their issue proceeds net of transaction costs incurred. These instruments are subsequently stated at amortised cost using the effective interest method.

Preference shares and other instruments which carry a mandatory coupon or are redeemable on a specific date are classified as financial liabilities. The coupon on
these instruments is recognised in the income statement as interest expense.

An exchange of financial liabilities on substantially different terms is accounted for as an extinguishment of the original financial liability and the recognition of a new
financial liability. The difference between the carrying amount of a financial liability extinguished and the new financial liability is recognised in profit or loss together
with any related costs or fees incurred.

When a financial liability is exchanged for an equity instrument, the new equity instrument is recognised at fair value and any difference between the original carrying
value of the liability and the fair value of the new equity is recognised in the profit or loss together with any related costs or fees incurred.

(5) Sale and repurchase agreements

Securities sold subject to repurchase agreements (‘repos’) continue to be recognised on the balance sheet where substantially all of the risks and rewards are retained.
Funds received under these arrangements are included in deposits from banks, customer accounts, or trading liabilities. Conversely, securities purchased under
agreements to resell (‘reverse repos’), where the Group does not acquire substantially all of the risks and rewards of ownership, are recorded as loans and receivables
or trading securities. The difference between sale and repurchase price is treated as interest and accrued over the life of the agreements using the effective interest
method.

Securities lent to counterparties are retained in the financial statements. Securities borrowed are not recognised in the financial statements, unless these are sold to
third parties, in which case the obligation to return them is recorded at fair value as a trading liability.

(6) Derecognition of financial assets and liabilities

Financial assets are derecognised when the contractual right to receive cash flows from those assets has expired or when the Group has transferred its contractual
right to receive the cash flows from the assets and either:

– substantially all of the risks and rewards of ownership have been transferred; or

– the Group has neither retained nor transferred substantially all the risks and rewards, but has not retained control.

Financial liabilities are derecognised when they are extinguished (i.e. when the obligation is discharged), cancelled or expires.

f Derivative financial instruments and hedge accounting

All derivatives are recognised at their fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and using
valuation techniques, including discounted cash flow and option pricing models, as appropriate. Derivatives are carried in the balance sheet as assets when their fair
value is positive and as liabilities when their fair value is negative. Refer to note 3 (Critical accounting estimates and judgements: Valuation of financial instruments)
and note 46 (Financial risk management: Fair values of financial assets and liabilities) for details of valuation techniques and significant inputs to valuation models.

Changes in the fair value of any derivative instrument that is not part of a hedging relationship are recognised immediately in the income statement.

Derivatives embedded in financial instruments are treated as separate derivatives when their economic characteristics and risks are not closely related to those of the
host contract and the host contract is not carried at fair value through profit or loss. These embedded derivatives are measured at fair value with changes in fair value
recognised in the income statement.

The method of recognising the movements in the fair value of the derivatives depends on whether they are designated as hedging instruments and, if so, the nature of
the item being hedged. Hedge accounting allows one financial instrument, generally a derivative such as a swap, to be designated as a hedge of another financial
instrument such as a loan or deposit or a portfolio of the same. At the inception of the hedge relationship, formal documentation is drawn up specifying the hedging
strategy, the hedged item and the hedging instrument and the methodology that will be used to measure the effectiveness of the hedge relationship in offsetting
changes in the fair value or cash flow of the hedged risk. The effectiveness of the hedging relationship is tested both at inception and throughout its life and if at any
point it is concluded that it is no longer highly effective in achieving its documented objective, hedge accounting is discontinued.

The Group designates certain derivatives as either: (1) hedges of the fair value of the particular risks inherent in recognised assets or liabilities (fair value hedges);
(2) hedges of highly probable future cash flows attributable to recognised assets or liabilities (cash flow hedges); or (3) hedges of net investments in foreign operations
(net investment hedges). These are accounted for as follows:

26
 Bank of Scotland plc

Notes to the consolidated financial statements

2 Accounting policies (continued)

(1) Fair value hedges

Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with the changes in the fair
value of the hedged asset or liability that are attributable to the hedged risk; this also applies if the hedged asset is classified as an available-for-sale financial asset. If
the hedge no longer meets the criteria for hedge accounting, changes in the fair value of the hedged item attributable to the hedged risk are no longer recognised in the
income statement. The cumulative adjustment that has been made to the carrying amount of the hedged item is amortised to the income statement using the effective
interest method over the period to maturity.

(2) Cash flow hedges

The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in other comprehensive income in the
cash flow hedge reserve. The gain or loss relating to the ineffective portion is recognised immediately in the income statement. Amounts accumulated in equity are
reclassified to the income statement in the periods in which the hedged item affects profit or loss. When a hedging instrument expires or is sold, or when a hedge no
longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity and is recognised in the income statement
when the forecast transaction is ultimately recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss
that was reported in equity is immediately transferred to the income statement.

(3) Net investment hedges

Hedges of net investments in foreign operations are accounted for similarly to cash flow hedges. Any gain or loss on the hedging instrument relating to the effective
portion of the hedge is recognised in other comprehensive income; the gain or loss relating to the ineffective portion is recognised immediately in the income
statement. Gains and losses accumulated in equity are included in the income statement when the foreign operation is disposed of. The hedging instrument in net
investment hedges may include non-derivative liabilities as well as derivative financial instruments.

g Offset
Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right of set-off and there is an intention
to settle on a net basis, or realise the asset and settle the liability simultaneously. In certain situations, even though master netting agreements exist, the lack of
management intention to settle on a net basis results in the financial assets and liabilities being reported gross on the balance sheet.

h Impairment of financial assets

(1) Assets accounted for at amortised cost
At each balance sheet date the Group assesses whether, as a result of one or more events occurring after initial recognition and prior to the balance sheet date, there is
objective evidence that a financial asset or group of financial assets has become impaired.

The criteria that the Group uses to determine that there is objective evidence of an impairment loss include:

– Delinquency in contractual payments 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 arrangement proceedings.

For impaired debt instruments which are classified as loans and receivables, impairment losses are recognised in subsequent periods when it is determined that there
has been a further negative impact on expected future cash flows. A reduction in fair value caused by general widening of credit spreads would not, of itself, result in
additional impairment.

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 two months and twelve months.

If there is objective evidence that an impairment loss has been incurred, an allowance is established which is calculated as the difference between the balance sheet
carrying value of the asset and the present value of estimated future cash flows discounted at that asset’s original effective interest rate. If an asset has a variable
interest rate, the discount rate used for measuring the impairment loss is the current effective interest rate.

For the Group’s portfolios of smaller balance homogenous loans, such as the residential mortgage, personal lending and credit card portfolios, allowances are
calculated for groups of assets taking into account historical cash flow experience. For the Group’s other lending portfolios, allowances are established on a case-by-
case basis. The calculation of the present value of the estimated future cash flows of a collateralised asset or group of assets reflects the cash flows that may result
from foreclosure less the costs of obtaining and selling the collateral, whether or not foreclosure is probable.

If there is no objective evidence of individual impairment the asset is included in a group of financial assets with similar credit risk characteristics and collectively
assessed for impairment. Segmentation takes into account such factors as the type of asset, industry, geographical location, collateral type, past-due status and other
relevant factors. These characteristics are relevant to the estimation of future cash flows for groups of such assets as they are indicative of the borrower’s ability to pay
all amounts due according to the contractual terms of the assets being evaluated. Future cash flows are estimated on the basis of the contractual cash flows of the
assets in the Group and historical loss experience for assets with similar credit risk characteristics. Historical loss experience is adjusted on the basis of current
observable data to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of
conditions in the historical period that do not exist currently. The methodology and assumptions used for estimating future cash flows are reviewed regularly by the
Group to reduce any differences between loss estimates and actual loss experience.

If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was
recognised, such as an improvement in the borrower’s credit rating, the allowance is adjusted and the amount of the reversal is recognised in the income statement.

27
 Bank of Scotland plc

Notes to the consolidated financial statements

2 Accounting policies (continued)

A loan or advance is normally written off, either partially or in full, against the related allowance when the proceeds from realising any available security have been
received or there is no realistic prospect of recovery (as a result of the customer’s insolvency, ceasing to trade or other reason) and the amount of the loss has been
determined. Subsequent recoveries of amounts previously written off decrease the amount of impairment losses recorded in the income statement.

Equity securities acquired in exchange for loans in order to achieve an orderly realisation are accounted for as a disposal of the loan and an acquisition of equity
securities. Where control is obtained over an entity as a result of the transaction, the entity is consolidated; where the Group has significant influence over an entity as
a result of the transaction, the investment is accounted by the equity method of accounting (see accounting policy a). Any subsequent impairment of the assets or
business acquired is treated as an impairment of the relevant asset or business and not as an impairment of the original instrument.

(2) Available-for-sale financial assets

The Group assesses at each balance sheet date whether there is objective evidence that an available-for-sale financial asset is impaired. In addition to the criteria for
financial assets accounted for at amortised cost set out above, this assessment involves reviewing the current financial circumstances (including creditworthiness) and
future prospects of the issuer assessing the future cash flows expected to be realised and, in the case of equity shares, considering whether there has been a
significant or prolonged decline in the fair value of the asset below its cost. If an impairment loss has been incurred, the cumulative loss measured as the difference
between the acquisition cost (net of any principal repayment and amortisation) and the current fair value, less any impairment loss on that asset previously
recognised, is reclassified from equity to the income statement. For impaired debt instruments, impairment losses are recognised in subsequent periods when it is
determined that there has been a further negative impact on expected future cash flows; a reduction in fair value caused by general widening of credit spreads would
not, of itself, result in additional impairment. If, in a subsequent period, the fair value of a debt instrument classified as available-for-sale increases and the increase
can be objectively related to an event occurring after the impairment loss was recognised, an amount not greater than the original impairment loss is credited to the
income statement; any excess is taken to other comprehensive income. Impairment losses recognised in the income statement on equity instruments are not reversed
through the income statement.

i Investment property
Investment property comprises freehold and long leasehold land and buildings that are held either to earn rental income or for capital appreciation or both. The
Group’s investment property primarily relates to property held for long-term rental yields and capital appreciation within the long-term assurance funds. Investment
property is carried in the balance sheet at fair value, being the open market value as determined in accordance with the guidance published by the Royal Institution of
Chartered Surveyors. If this information is not available, the Group uses alternative valuation methods such as discounted cash flow projections or recent prices on
less active markets. These valuations are reviewed at least annually by an independent valuation expert. Investment property being redeveloped for continuing use as
investment property, or for which the market has become less active, continues to be measured at fair value. Changes in fair value are recognised in the income
statement as net trading income for investment property within the long-term assurance funds and as other operating income for other investment property.

j Tangible fixed assets

Tangible fixed assets are included at cost less accumulated depreciation. The value of land (included in premises) is not depreciated. Depreciation on other assets is
calculated using the straight-line method to allocate the difference between the cost and the residual value over their estimated useful lives, as follows:

Premises (excluding land):

– Freehold/long and short leasehold premises: shorter of 50 years or the remaining period of the lease

– Leasehold improvements: shorter of 10 years or, if lease renewal is not likely, the remaining period of the lease

Equipment:

– Fixtures and furnishings: 10 to 20 years

– Other equipment and motor vehicles: 2 to 8 years

The assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.

Assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. In the event that an
asset’s carrying amount is determined to be greater than its recoverable amount it is written down immediately. The recoverable amount is the higher of the asset’s fair
value less costs to sell and its value in use.

k Leases
(1) As lessee
The leases entered into by the Group are primarily operating leases. Operating lease rentals payable are charged to the income statement on a straight-line basis over
the period of the lease.

When an operating lease is terminated before the end of the lease period, any payment made to the lessor by way of penalty is recognised as an expense in the period
of termination.

(2) As lessor
Assets leased to customers are classified as finance leases if the lease agreements transfer substantially all the risks and rewards of ownership to the lessee but not
necessarily legal title. All other leases are classified as operating leases. When assets are subject to finance leases, the present value of the lease payments, together
with any unguaranteed residual value, is recognised as a receivable, net of provisions, within loans and advances to banks and customers. The difference between
the gross receivable and the present value of the receivable is recognised as unearned finance lease income. Finance lease income is recognised in interest income
over the term of the lease using the net investment method (before tax) so as to give a constant rate of return on the net investment in the leases. Unguaranteed
residual values are reviewed regularly to identify any impairment.

28
 Bank of Scotland plc

Notes to the consolidated financial statements

2 Accounting policies (continued)

Operating lease assets are included within tangible fixed assets at cost and depreciated over their estimated useful lives, which equates to the lives of the leases, after
taking into account anticipated residual values. Operating lease rental income is recognised on a straight line basis over the life of the lease.

The Group evaluates non-lease arrangements such as outsourcing and similar contracts to determine if they contain a lease which is then accounted for separately.

l Taxation
Current income tax which is payable on taxable profits is recognised as an expense in the period in which the profits arise.

Deferred tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in
the consolidated financial statements. However, deferred tax is not accounted for if it arises from initial recognition of an asset or liability in a transaction other than a
business combination that at the time of the transaction affects neither accounting nor taxable profit or loss. Deferred tax is determined using tax rates that have been
enacted or substantially enacted by the balance sheet date which are expected to apply when the related deferred tax asset is realised or the deferred tax liability is
settled.

Deferred tax assets are recognised where it is probable that future taxable profit will be available against which the temporary differences can be utilised. Deferred tax
is provided on temporary differences arising from investments in subsidiaries and associates, except where the timing of the reversal of the temporary difference is
controlled by the Group and it is probable that the difference will not reverse in the foreseeable future. Income tax payable on profits is recognised as an expense in the
period in which those profits arise. The tax effects of losses available for carry forward are recognised as an asset when it is probable that future taxable profits will be
available against which these losses can be utilised. Deferred tax related to gains and losses on the fair value re-measurement of available-for-sale investments and
cash flow hedges, where these gains and losses are recognised in other comprehensive income, the deferred tax is also recognised in other comprehensive income.
Such deferred tax is subsequently transferred to the income statement together with the deferred gain or loss.

Deferred and current tax assets and liabilities are offset when they arise in the same tax reporting group and where there is both a legal right of offset and the intention
to settle on a net basis or to realise the asset and settle the liability simultaneously.

m Foreign currency translation

Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity
operates (the ‘functional currency’). The consolidated financial statements are presented in sterling, which is the Bank’s functional and presentation currency.

Foreign currency transactions are translated into the appropriate functional currency using the exchange rates prevailing at the dates of the transactions. Foreign
exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and liabilities
denominated in foreign currencies are recognised in the income statement, except when recognised in other comprehensive income as qualifying cash flow or net
investment hedges. Non-monetary assets that are measured at fair value are translated using the exchange rate at the date that the fair value was determined.
Translation differences on equities and similar non-monetary items held at fair value through profit or loss are recognised in profit or loss as part of the fair value gain
or loss. Translation differences on available-for-sale non-monetary financial assets, such as equity shares, are included in the fair value reserve in other
comprehensive income unless the asset is a hedged item in a fair value hedge.

The results and financial position of all group entities that have a functional currency different from the presentation currency are translated into the presentation
currency as follows:

The assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on the acquisition of a foreign entity, are translated into sterling at
foreign exchange rates ruling at the balance sheet date.

The income and expenses of foreign operations are translated into sterling at average exchange rates unless these do not approximate to the foreign exchange rates
ruling at the dates of the transactions in which case income and expenses are translated at the dates of the transactions.

Foreign exchange differences arising on the translations of a foreign operation are recognised in other comprehensive income and accumulated in a separate
component of equity together with exchange differences arising from the translation of borrowings and other currency instruments (see f(3)). On disposal of a foreign
operation, the cumulative amount of exchange differences relating to that foreign operation are reclassified from equity and included in determining the profit or loss
arising on disposal.

n Provisions
Provisions are recognised in respect of present obligations arising from past events where it is probable that outflows of resources will be required to settle the
obligations and they can be reliably estimated.

The Group recognises provisions in respect of vacant leasehold property where the unavoidable costs of the present obligations exceed anticipated rental income.

Contingent liabilities are possible obligations whose existence depends on the outcome of uncertain future events or those present obligations where the outflows of
resources are uncertain or cannot be measured reliably. Contingent liabilities are not recognised in the financial statements but are disclosed unless they are remote.

o Dividends
Dividends paid on the Group’s ordinary shares are recognised as a reduction in equity in the period in which they are paid.

p Cash and cash equivalents

For the purposes of the cash flow statement, cash and cash equivalents comprise cash and non-mandatory balances with central banks and amounts due from banks
with a maturity of less than three months.

29
 Bank of Scotland plc

Notes to the consolidated financial statements

2 Accounting policies (continued)

q Balance sheet presentation

To provide a more relevant presentation of the Group’s financial instruments, an additional line has been added to the consolidated balance sheet to separately show
debt securities classified as loans and receivables. In addition, certain amounts have been reclassified to present these statements on a basis consistent with the
presentation practices adopted by Lloyds Banking Group (see note 48).

Comparatives have been reclassified to conform to the revised presentation.

r Investment in subsidiaries
Investments in subsidiaries are carried at historical cost, less any provisions for impairment.

3 Critical accounting judgements and estimates

The preparation of the Group’s financial statements requires management to make judgements, estimates and assumptions in applying the accounting policies that
affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent uncertainty in making estimates, actual results reported in future periods
may be based upon amounts which differ from those estimates. Estimates, judgements and assumptions are continually evaluated and are based on historical
experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.

The significant judgements made by management in applying the Group’s accounting policies and the key sources of estimation uncertainty in these financial
statements and which together are deemed critical to the Group’s results and financial position are discussed below.

Allowance for impairment losses on loans and receivables

The Group’s accounting policy for losses arising on financial assets classified as loans and receivables is described in accounting policy 2(h). The allowance for
impairment losses on loans and receivables is management’s best estimate of losses incurred in the portfolio at the balance sheet date. Impairment allowances are
established to recognise incurred impairment losses in the Group’s loan portfolios carried at amortised cost. In determining whether an impairment has occurred at
the balance sheet date the Group considers whether there is any observable data indicating that there has been a measurable decrease in the estimated future cash
flows or their timings. Where this is the case, the impairment loss is the difference between the carrying value of the loan and the present value of the estimated future
cash flows discounted at the loan’s original effective interest rate.

At 31 December 2009 gross loans and receivables totalled £585,195 million (2008: £551,152 million) against which impairment allowances of £23,187 million
(2008: £11,616 million) had been made (see note 21). Impairment allowances are made up of two components, those determined individually and those
determined collectively. At 31 December 2009 the individual component was £20,355 million (2008: £6,736 million) and the collective component was
£2,832 million (2008: £4,880 million)

Individual component
All impaired loans which exceed a certain threshold are individually assessed for impairment having regard to expected future cash flows including those that could
arise from the realisation of security. The determination of these allowances often requires the exercise of considerable judgement by management involving matters
such as local economic conditions and the resulting trading performance of the customer and the value of the security held, for which there may not be a readily
accessible market. In particular, significant judgement is required by management in the current economic environment in assessing borrower’s cash flows and debt
servicing capability together with the realisable value of commercial real estate collateral. The actual amount of the 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
time progresses and the circumstances of the customer become clearer.

Collective component
Impairment allowances for portfolios of smaller balance homogenous loans, such as residential mortgages, personal loans and credit card balances that are below the
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. Collective impairment allowances are calculated on a portfolio basis using models which take into account factors such as historical experience of accounts
progression through the various stages of delinquency, historical loss rates, the credit quality of the portfolio, and the value of any collateral held, which is estimated,
where appropriate, using indices such as house price indices.

The calculation of the collective impairment allowance is therefore subject to estimation uncertainty. The variables used in the collective impairment models are kept
under regular review to ensure that as far as possible they reflect current economic circumstances. However, significant management judgement is applied in
assessing whether current economic conditions and borrowers’ behaviour are fully reflected in the historical loss data and other inputs to the impairment models.

The collective impairment allowance is sensitive to changes in economic and credit conditions, including the interdependency of house prices, unemployment rates,
interest rates, borrowers’ behaviour, and consumer bankruptcy trends. It is, however, inherently difficult to estimate how changes in one or more of these factors
might impact the collective impairment allowance.

Given the relative size of the Group’s mortgage portfolio, a key variable is UK house prices which determine the collateral value supporting loans in such portfolios.
The value of this collateral is estimated by applying changes in house price indices to the original assessed value of the property. If average house prices within the
Group’s mortgage portfolio were 10 per cent lower than those estimated at 31 December 2009, the house price index related impact on the impairment charge would
be an increase of approximately £280 million.

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 Group performs an objective review of the current
financial circumstances and future prospects of the issuer and, in the case of equity shares, 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 Group is whether the decline in fair value

30
 Bank of Scotland plc

Notes to the consolidated financial statements

3 Critical accounting judgements and estimates (continued)

is 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 future cash flows expected to
be realised from the asset, taking into account, where appropriate, the quality of underlying security and credit protection available. The increase in the fair value of
available-for-sale financial assets during the year was £2,550 million (2008: decrease of £8,173 million). Impairment losses in respect of available-for-sale financial
assets transferred from reserves to the income statement totalled £620 million (2008: £1,270 million).

Valuation of financial instruments

Financial instruments classified by management as trading and other financial assets and liabilities at fair value through profit or loss, derivative financial instruments
and available-for-sale financial assets are carried at fair value which is determined as being the amount for which the instrument could be exchanged in a current
transaction between willing parties, other than in a forced or liquidation sale. Management judgement is required in determining the appropriate classification of
financial instruments.

In 2009, the Group adopted ‘Amendments to IFRS 7 ’Financial Instruments: Disclosures – Improving Disclosures about Financial Instruments’ which among other
matters, established a three level valuation hierarchy for disclosure of fair value measurements of financial instruments carried on the Group’s balance sheet at fair
value.

Management judgement is required in determining the categorisation of the Group’s financial instruments that are carried at fair value. Financial instruments
categorised as level 1 are valued using quoted market prices and therefore there is less judgement applied in determining fair value. However, the fair value of
financial instruments categorised as level 2 and level 3 is determined using valuation techniques which include discounted cash flow analysis and pricing models
and, where appropriate, comparison to similar instruments. These require management judgment and therefore contain significant estimation uncertainty.

In particular, significant judgement is required by management in determining appropriate assumptions to be used for level 3 financial instruments. In valuing level 3
asset-backed securities and derivatives, such assumptions include prepayment rates, probability of default, loss given default and yield curves. In respect of the
group’s unlisted equity investments, fair value is determined through the use of third party valuations which may be adjusted to take into account other relevant
information that management judge to be relevant.

The valuation techniques used are set out in note 45. This provides details of the inputs into valuation models that have the potential to significantly impact the value
determined, sets out the assumptions, used for those inputs and provides the effects of applying reasonably possible alternative assumptions.

Taxation
At 31 December 2009 the Group carried net deferred tax assets on its balance sheet of £5,153 million (2008: £3,182 million) (note 34).

This statutory presentation takes into account the ability of the Group to net deferred tax assets and liabilities only where there is a legally enforceable right of offset.
Note 34 also presents the Group’s deferred tax assets and liabilities by tax category. The largest category of deferred tax asset which contains significant estimation
uncertainty and which requires management judgement in assessing its recoverability relates to tax losses carried forward. At 31 December 2009, the Group
recognised a deferred tax asset of £3,624 million (2008: £1,514 million) in respect of tax losses carried forward. The significant increase reflects the tax losses
generated by certain Group companies, primarily Bank of Scotland plc, in the last two years.

Applicable accounting standards permit the recognition of deferred tax assets only to the extent that it is probable that future taxable profits will be available to utilise
the tax losses carried forward. The assessment of future taxable profits involves significant estimation uncertainty, principally relating to an assessment of
management’s projections of future taxable income based on business plans and ongoing tax planning strategies. These projections include assumptions about the
future strategy of the Group, the economic and regulatory environment in which the Group operates, future tax legislation, customer behaviour, and the ability of the
Group to deliver expected integration benefits, amongst other variables. At 31 December 2009, management has concluded that future taxable profits generated by
the Group companies with tax losses carried forward are expected to be sufficient to utilise the tax losses carried forward in full.

At 31 December 2009 the Group carried an asset for current tax recoverable of £745 million (2008: £865 million) and current tax liabilities of £3 million
(2008: £23 million). In determining the carrying value of these balances, management have taken account of tax issues that are subject to ongoing discussion with
HM Revenue & Customs and other tax authorities. Inherent in this is management’s assessment of legal and professional advice, case law and other relevant
guidance. The determination of the outcome of such matters requires significant management judgement in assessing the various risks and applying appropriate
probability weightings in determining the carrying value of current and deferred tax balances.

Goodwill
At 31 December 2009 the Group carried goodwill on its balance sheet totalling £376 million (2008: £667 million), substantially all of which relates to acquisitions
made a number of years ago.

The Group reviews the goodwill for impairment at least annually or when events or changes in economic circumstances indicate that impairment may have taken
place. The impairment review is performed by projecting future cash flows, excluding finance and tax, based upon budgets and plans and making appropriate
assumptions about rates of growth and discounting these using a rate that takes into account prevailing market interest rates and the risks inherent in the business. If
the present value of the projected cash flows is less than the carrying value of the underlying net assets and related goodwill an impairment charge is required in the
income statement. This calculation requires the exercise of significant judgement by management; if the estimates made prove to be incorrect or performance does
not meet expectations which affect the amount and timing of future cash flows, goodwill may become impaired in future periods. Further details are given in note 25.

Effective interest rate

The Group accounts for its revenue on loans and receivables on an effective interest rate basis. This approach takes into account interest received or paid and fees and
commission paid or received that are integral to the yield as well as incremental transaction costs and all other premiums and discounts. Following the acquisition of
HBOS plc by Lloyds Banking Group plc on 16 January 2009, the Group reviewed the effective interest rate methodology applied to the Group’s mortgage portfolio. As
a result of this methodology review, the Group has revised the period over which the fees, commissions and costs are spread into the yield. This change in accounting
estimate has resulted in an additional charge to the income statement of £945 million in the year to 31 December 2009.

31
 Bank of Scotland plc

Notes to the consolidated financial statements

4 Segmental analysis

Geographical areas
The Group’s external customers are predominantly based in the UK and revenues are determined by the location of the customer. Information on assets and liabilities
is included based on the location of the branch or entity holding those assets and liabilities.
2009 2008
UK Non-UK Total UK Non-UK Total
£m £m £m £m £m £m

Total income 10,111 1,054 11,165 9,954 (782) 9,172

Total assets 588,559 72,785 661,344 569,163 90,013 659,176

There are no individual non-UK countries contributing more than 5 per cent of total income or total assets.

5 Net interest income

Weighted average
effective interest rate

2009 2008 2009 2008

% % £m £m

Interest and similar income:

Loans and advances to banks 0.78 5.16 399 450
Loans and advances to customers 3.59 6.79 17,142 32,490
Debt securities designated as loans and receivables 1.84 3.14 663 619
Lease and hire purchase receivables 4.86 6.76 254 299
Interest receivable on loans and receivables 3.24 6.62 18,458 33,858
Available-for-sale financial assets 2.06 4.63 572 2,108
Other – – 30 127
Total interest and similar income 3.19 6.48 19,060 36,093
Interest and similar expense:
Deposits from banks 0.77 4.16 (1,121) (2,880)
Customer deposits 2.60 4.25 (6,133) (11,967)
Debt securities in issue 2.31 4.91 (3,329) (10,141)
Subordinated liabilities 3.82 5.43 (724) (392)
Liabilities under sale and repurchase agreements 2.22 4.89 (1,261) (1,496)
Interest payable on liabilities held at amortised cost 2.09 4.52 (12,568) (26,876)
Other – – (297) (677)
Total interest and similar expense 2.14 4.63 (12,865) (27,553)
Net interest income 6,195 8,540

Included within interest and similar income is £969 million (2008: £351 million) in respect of impaired financial assets. Net interest income also includes a charge
of £890 million (2008: £2,559 million) transferred from the cash flow hedging reserve.

6 Net fee and commission income

2009 2008
£m £m

Fee and commission income:

Current accounts 329 361
Insurance broking 239 254
Credit and debit card fees 212 253
Other 524 1,093
1,304 1,961
Fee and commission expense (208) (382)
Net fee and commission income 1,096 1,579

As discussed in note accounting policy 2(d), fees and commissions which are an integral part of the effective interest rate form part of net interest income shown in
note 5. Fees and commissions relating to instruments that are held at fair value through profit or loss are included within net trading income shown in note 7.

32
 Bank of Scotland plc

Notes to the consolidated financial statements

7 Net trading income

2009 2008
£m £m

Foreign exchange translation gains (losses) 65 (9)

Gains on foreign exchange trading transactions 111 101
Total foreign exchange 176 92
Investment property losses (note 23) (13) (10)
Securities and other losses (719) (3,020)
Net trading income (556) (2,938)

Securities and other losses comprise net gains arising on assets and liabilities held for trading or designated at fair value through profit or loss as follows:
2009 2008
£m £m

Net income (expense) arising on assets designated at fair value through profit or loss:
Debt securities, loans and advances to banks and customers – –
Equity shares 7 51
Total net income arising on assets designated at fair value through profit or loss 7 51
Net expense arising on liabilities designated at fair value through profit or loss – –
Total net gains arising on assets and liabilities designated at fair value through profit or loss 7 51
Net losses on financial instruments held for trading (726) (3,071)
Securities and other losses (719) (3,020)

8 Other operating income

2009 2008
£m £m

Operating lease rental income 1,100 1,287

Other rents receivable 20 26
(Losses) gains on disposal of available-for-sale financial assets (note 39) (3) 24
Gains on capital transactions 125 –
Rental income from investment properties – 2
Other income 188 437
1,430 1,776

During the year, the Bank received a payment of £3,000 million from its fellow subsidiary, Lloyds TSB Bank plc, to support its financial and reputational position and
to facilitate the on-going integration of the group’s banking operations.

33
 Bank of Scotland plc

Notes to the consolidated financial statements

9 Operating expenses
2009 2008
£m £m

Staff costs:
Salaries 1,829 2,016
Social security costs 168 183
Pensions and other post-retirement benefit schemes 260 264
Restructuring costs 222 71
Other staff costs 168 176
2,647 2,710
Premises and equipment:
Rent and rates 213 271
Hire of equipment 9 11
Repairs and maintenance 48 38
Other 142 158
412 478
Other expenses:
Communications and data processing 103 127
Advertising and promotion 128 199
Professional fees 171 141
Other 642 598
1,044 1,065
Depreciation and amortisation:
Depreciation of tangible fixed assets (note 27) 233 330
Amortisation of other intangible assets (note 26) 25 34
Operating lease assets (note 27) 835 1,178
1,093 1,542
Goodwill impairment (note 25) 385 142
Total operating expenses 5,581 5,937

The average number of persons on a headcount basis employed by the Group during the year was as follows:
2009 2008

UK 57,463 56,599
Overseas 3,037 6,220
60,500 62,819

Fees payable to the Bank’s auditors

During the year the auditors earned the following fees:

2009 2008
£m £m

Fees payable for the audit of the Bank’s current year annual report 2.6 1.7
Fees payable for other services:
Audit of the Bank’s subsidiaries pursuant to legislation 5.2 3.3
Other services supplied pursuant to legislation 0.4 0.5
Services relating to taxation 0.5 0.5
Services relating to corporate finance transactions – 0.1
All other services 0.2 0.6
Total fees payable to the Bank’s auditors by the Group 8.9 6.7

During the year, the auditors also earned fees payable by entities outside the consolidated Group in respect of the following:
2009 2008
£m £m

Reviews of the financial position of corporate and other borrowers 12.0 3.8

The amounts detailed above are in respect of the Bank’s current auditors for 2009 and its predecessor auditors for 2008.

34
 Bank of Scotland plc

Notes to the consolidated financial statements

10 Impairment
2009 2008
£m £m

Impairment losses on loans and receivables (note 21):

Loans and advances to customers 18,231 9,857
Debt securities classified as loans and receivables 1,199 923
19,430 10,780
Impairment of available-for-sale financial assets (note 39) 620 1,270
Other credit risk provisions (note 35) 5 –
Total impairment charged to the income statement 20,055 12,050

11 Investments in joint ventures and associates

The Group’s share of results of and investments in joint ventures and associates comprise:
Joint ventures Associates Total
2009 2008 2009 2008 2009 2008
£m £m £m £m £m £m

Income 145 (320) 5 (233) 150 (553)

Expenses (445) (89) (97) (18) (542) (107)
Impairment (272) (267) (77) (53) (349) (320)
Loss before tax (572) (676) (169) (304) (741) (980)
Tax 26 25 2 17 28 42
Share of post-tax results (546) (651) (167) (287) (713) (938)

Current assets 2,658 2,149 605 1,131 3,263 3,280

Non-current assets 4,553 4,885 1,611 1,557 6,164 6,442
Current liabilities (2,030) (1,429) (493) (615) (2,523) (2,044)
Non-current liabilities (4,868) (4,635) (1,613) (1,850) (6,481) (6,485)
Share of net assets 313 970 110 223 423 1,193
At 1 January 970 1,367 223 372 1,193 1,739
Additional investments 123 253 12 120 135 373
Acquisitions 3 59 60 40 63 99
Disposals (198) (43) (39) (14) (237) (57)
Share of post-tax results (546) (651) (167) (287) (713) (938)
Dividends paid (21) (10) – (8) (21) (18)
Exchange and other adjustments (18) (5) 21 – 3 (5)
At 31 December 313 970 110 223 423 1,193

The Group’s unrecognised share of losses of associates for the year is £64 million (2008: £126 million) and of joint ventures is £424 million (2008: £164 million).
For entities making losses, subsequent profits earned are not recognised until previously unrecognised losses are extinguished. The Group’s unrecognised share of
losses net of unrecognised profits on a cumulative basis of associates is £155 million (2008: £131 million) and of joint ventures is £623 million (2008:
£211 million).

The Group’s most significant joint venture is Sainsbury’s Bank plc, a banking business with operations principally in the UK. Bank of Scotland plc has a 50 per cent
stake in the ordinary share capital of Sainsbury Bank plc, which makes up its statutory accounts to 31 December each year. All other interests in joint ventures are
held by subsidiaries. Where entities have statutory accounts drawn up to a date other than 31 December management accounts are used when accounting for them
by the Group.

12 Loss on sale of businesses

2009 2008
£m £m

Loss on the sale of Bank of Western Australia Limited and St. Andrews Australia Pty Limited (100) (845)

On 8 October 2008, the Group agreed the sale of part of its Australian operations, principally Bank of Western Australia Limited and St. Andrews Australia Pty
Limited, to Commonwealth Bank of Australia Limited. The sale completed on 19 December 2008 and resulted in an estimated pre-tax loss on disposal of
£845 million (including goodwill written-off of £240 million). The agreement provided for adjustments to the consideration received in certain circumstances and as
a result a further loss of £100 million has been recognised in the current year.

35
 Bank of Scotland plc

Notes to the consolidated financial statements

13 Taxation

(a) Analysis of tax credit for the year 2009 2008

£m £m

UK corporation tax:
Current tax on loss for the year 354 525
Adjustments in respect of prior years (121) 181
233 706
Double taxation relief – 21
233 727
Foreign tax:
Current tax on loss for the year (49) (195)
Adjustments in respect of prior years 33 (14)
(16) (209)
Current tax credit 217 518
Deferred tax (note 34):
Origination and reversal of temporary differences 2,707 1,931
Adjustments in respect of prior years 133 (1)
2,840 1,930

Tax credit 3,057 2,448

The tax credit for the year is based on a UK corporation tax rate of 28.0 per cent (2008: 28.5 per cent).

(b) Factors affecting the tax credit for the year

A reconciliation of the credit that would result from applying the standard UK corporation tax rate to loss before tax to the tax credit for the year is given below:
2009 2008
£m £m

Loss before tax (15,284) (10,635)

Tax credit thereon at UK corporation tax rate of 28.0 per cent (2008: 28.5 per cent) 4,279 3,031
Factors affecting credit:
Goodwill impairment (110) (26)
Disallowed and non-taxable items (41) (64)
Overseas tax rate differences (428) (83)
Gains exempted or covered by capital losses (16) 102
Adjustments in respect of previous years 45 166
Impairment of financial instruments 43 (52)
Reduction in deferred tax from changes in tax rates – (10)
Effect of profit or loss in joint ventures and associates (196) (268)
Tax losses where no deferred tax provided (484) (310)
Other items (35) (38)
Tax credit on loss on ordinary activities 3,057 2,448

36
 Bank of Scotland plc

Notes to the consolidated financial statements

13 Taxation (continued)

(c) The tax effects relating to each component of comprehensive income are as follows: Tax
Before tax (expense) After tax
amount benefit amount
Year ended 31 December 2009 £m £m £m

Movements in available-for-sale financial assets:

Change in fair value 2,550 (673) 1,877
Transferred to income statement in respect of disposals 3 (1) 2
Transferred to income statement in respect of impairment 620 (174) 446
3,173 (848) 2,325
Movements in cash flow hedges:
Effective portion of changes in fair value taken to other comprehensive income (613) 171 (442)
Net gains transferred to the income statement 895 (250) 645
282 (79) 203
Currency translation differences and other movements 14 (5) 9
Other comprehensive income for the year 3,469 (932) 2,537
Tax
Before tax (expense) After tax
amount benefit amount
Year ended 31 December 2008 £m £m £m

Movements in available-for-sale financial assets:

Change in fair value (8,173) 2,276 (5,897)
Transferred to income statement in respect of disposals (24) 7 (17)
Transferred to income statement in respect of impairment 1,270 (355) 915
(6,927) 1,928 (4,999)
Movements in cash flow hedges:
Effective portion of changes in fair value taken to other comprehensive income (3,889) 1,088 (2,801)
Net gains transferred to the income statement 2,561 (717) 1,844
(1,328) 371 (957)
Currency translation differences and other movements 92 3 95
Other comprehensive income for the year (8,163) 2,302 (5,861)

14 Trading and other financial assets at fair value through profit or loss
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Trading assets 27,611 22,571 27,611 22,571

Other financial assets at fair value through profit or loss 256 859 17 349
27,867 23,430 27,628 22,920

These assets are comprised as follows: 2009 2008 2009 2008

Other Other Other Other
financial financial financial financial
assets at assets at assets at assets at
fair value fair value fair value fair value
Trading through Trading through Trading through Trading through
assets profit or loss assets profit or loss assets profit or loss assets profit or loss
£m £m £m £m £m £m £m £m

Loans and advances to banks 5,577 – 3,344 – 5,577 – 3,344 –

Loans and advances to customers 13,307 – 5,689 – 13,307 – 5,689 –

Debt securities:
Government securities 2,864 – 5,792 – 2,864 – 5,792 –
Bank and building society certificates of deposit 2,034 – 3,068 – 2,034 – 3,068 –
Mortgage-backed securities – – 15 – – – 15 –
Other asset-backed securities 891 – 2,509 346 891 – 2,509 346
Corporate and other debt securities 2,938 4 2,154 217 2,938 4 2,154 –
8,727 4 13,538 563 8,727 4 13,538 346
Equity shares:
Listed – 13 – 3 – 13 – 3
Unlisted – 239 – 293 – – – –
– 252 – 296 – 13 – 3
27,611 256 22,571 859 27,611 17 22,571 349

37
 Bank of Scotland plc

Notes to the consolidated financial statements

14 Trading and other financial assets at fair value through profit or loss (continued)

At 31 December 2009 £3,939 million (2008: £4,247 million) of trading and other financial assets at fair value through profit or loss of the Group and
£3,791 million (2008: £4,247 million) of the Bank had a contractual residual maturity of greater than one year.

The carrying value of financial assets held for trading of the Group that are subject to repurchase agreements was £3,799 million at 31 December 2009
(2008: £4,369 million).

Included in trading assets of the Group were amounts advanced to counterparties under reverse repurchase agreements which are treated as collateralised loans and
amounted to £18,867 million at 31 December 2009 (2008: £9,027 million). The related securities held as collateral are not recognised on balance sheet as the
risks and rewards of ownership remain with the counterparty.

15 Derivative financial instruments

The Group holds derivatives as part of the following strategies:

– Customer driven, where derivatives are held as part of the provision of risk management products to Group customers;

– To manage and hedge the Group’s interest rate and foreign exchange risk arising from normal banking business. The hedge accounting strategy adopted by
the Group is to utilise a combination of fair value, cash flow and net investment hedge approaches as described in note 46; and

Derivatives are classified as trading except those designated as effective hedging instruments which meet the criteria under IAS 39. Derivatives are held at fair value
on the Group’s balance sheet. A description of the methodology used to determine the fair value of derivative financial instruments and the effect of using reasonably
possible alternative assumptions for those derivatives valued using unobservable inputs is set out in note 45.

The principal derivatives used by the Group are as follows:

– Interest rate related contracts include interest rate swaps, forward rate agreements and options. An interest rate swap is an agreement between two parties to
exchange fixed and floating interest payments, based upon interest rates defined in the contract, without the exchange of the underlying principal amounts.
Forward rate agreements are contracts for the payment of the difference between a specified rate of interest and a reference rate, applied to a notional principal
amount at a specific date in the future. An interest rate option gives the buyer, on payment of a premium, the right, but not the obligation, to fix the rate of
interest on a future loan or deposit, for a specified period and commencing on a specified future date.

– Exchange rate related contracts include forward foreign exchange contracts, currency swaps and options. A forward foreign exchange contract is an agreement
to buy or sell a specified amount of foreign currency on a specified future date at an agreed rate. Currency swaps generally involve the exchange of interest
payment obligations denominated in different currencies; the exchange of principal can be notional or actual. A currency option gives the buyer, on payment
of a premium, the right, but not the obligation, to sell specified amounts of currency at agreed rates of exchange on or before a specified future date.

– Credit derivatives, principally credit default swaps, are used by the Group as part of its trading activity and to manage its own exposure to credit risk. A credit
default swap is a swap in which one counterparty receives a premium at pre-set intervals in consideration for guaranteeing to make a specific payment should
a negative credit event take place.

– Equity derivatives are also used by the Group as part of its equity based retail product activity to eliminate the Group’s exposure to fluctuations in various
international stock exchange indices. Index-linked equity options are purchased which give the Group the right, but not the obligation, to buy or sell a
specified amount of equities, or basket of equities, in the form of published indices on or before a specified future date.

38
 Bank of Scotland plc

Notes to the consolidated financial statements

15 Derivative financial instruments (continued)

2009 2008
Contract/ Contract/
notional Fair value Fair value notional Fair value Fair value
The Group amount assets liabilities amount assets liabilities
£m £m £m £m £m £m

Trading
Exchange rate contracts:
Spot, forwards and futures 22,074 281 279 77,769 2,101 3,562
Currency swaps 92,342 4,301 565 55,535 3,144 1,208
114,416 4,582 844 133,304 5,245 4,770
Interest rate contracts:
Interest rate swaps 698,522 14,557 14,907 823,710 18,781 20,725
Forward rate agreements 796,099 401 381 656,700 1,474 1,461
Options purchased 20,018 689 – 22,993 884 –
Options written 25,134 – 791 26,092 – 758
Futures 11,963 – – 42,140 47 120
1,551,736 15,647 16,079 1,571,635 21,186 23,064
Credit derivatives 4,980 153 11 7,150 748 33
Equity and other contracts 11,052 895 860 2,068 1,256 958
Total derivative assets/liabilities held for trading 1,682,184 21,277 17,794 1,714,157 28,435 28,825
Hedging
Derivatives designated as fair value hedges:
Interest rate swaps 53,979 3,053 557 67,649 4,738 805
Cross currency swaps 26,162 632 1,675 60,282 8,863 2,713
80,141 3,685 2,232 127,931 13,601 3,518
Derivatives designated as cash flow hedges:
Interest rate swaps 229,390 5,247 7,276 323,971 7,218 8,337
Forward rate agreements – – – 3,474 1,037 21
Cross currency swaps 8,938 8 144 10,484 180 123
Options 2,754 4 5 36,876 46 –
Futures 5,137 1 1 16 – 3
246,219 5,260 7,426 374,821 8,481 8,484
Total derivative assets/liabilities held for hedging 326,360 8,945 9,658 502,752 22,082 12,002
Total recognised derivative assets/liabilities 2,008,544 30,222 27,452 2,216,909 50,517 40,827

At 31 December 2009 £25,822 million of total recognised derivative assets of the Group and £23,792 million of total recognised derivative liabilities of the Group
(2008: £41,185 million of assets and £31,508 million of liabilities) had a contractual residual maturity of greater than one year.

39
 Bank of Scotland plc

Notes to the consolidated financial statements

15 Derivative financial instruments (continued)

The Bank 2009 2008

Contract/ Contract/
notional Fair value Fair value notional Fair value Fair value
amount assets liabilities amount assets liabilities
£m £m £m £m £m £m

Trading
Exchange rate contracts:
Spot, forwards and futures 25,388 285 359 79,211 2,205 3,677
Currency swaps 78,328 1,108 554 55,535 3,131 1,207
103,716 1,393 913 134,746 5,336 4,884
Interest rate contracts:
Interest rate swaps 697,740 14,503 14,859 831,891 18,737 19,755
Forward rate agreements 792,962 401 381 656,717 1,481 1,465
Options purchased 19,999 688 – 23,768 882 –
Options written 25,117 – 789 26,021 – 1,006
Futures – – – 44,800 47 120
1,535,818 15,592 16,029 1,583,197 21,147 22,346
Credit derivatives 4,980 153 11 7,150 705 33
Equity and other contracts 11,052 585 585 4,920 618 614
Total derivative assets/liabilities held for trading 1,655,566 17,723 17,538 1,730,013 27,806 27,877
Hedging
Derivatives designated as fair value hedges:
Interest rate swaps (including swap options) 49,554 3,063 544 68,474 4,941 556
Cross currency swaps 26,162 627 1,675 60,282 2,588 2,713
75,716 3,690 2,219 128,756 7,529 3,269
Derivatives designated as cash flow hedges:
Interest rate swaps 229,812 5,250 7,276 323,971 6,681 8,337
Forward rate agreements – – – 3,474 1,037 3
Cross currency swaps 8,938 8 130 10,484 180 123
Options 2,754 8 5 36,876 27 –
Futures 5,137 1 3 16 – 4
246,641 5,267 7,414 374,821 7,925 8,467
Total derivative assets/liabilities held for hedging 322,357 8,957 9,633 503,577 15,454 11,736
Total recognised derivative assets/liabilities 1,977,923 26,680 27,171 2,233,590 43,260 39,613

At 31 December 2009 £22,630 million of total recognised derivative assets of the Bank and £23,467 million of total recognised derivative liabilities of the Bank
(2008: £37,584 million of assets and £30,664 million of liabilities) had a contractual residual maturity of greater than one year.

16 Loans and advances to banks

At 31 December 2009, the Group had loans and advances to banks of £91,259 million (2008: £12,445 million) and the Bank had £108,133 million
(2008: £34,144 million). No allowance for impaired loans was carried against these exposures at 31 December 2009 or 31 December 2008.

At 31 December 2009, £2,285 million (2008: £1,276 million) of loans and advances to banks of the Group and £2,247 million (2008: £1,133 million) of the
Bank had a contractual residual maturity of greater than one year.

Included in loans and advances to banks of the Group were amounts advanced to counterparties under reverse repurchase agreements which are treated as
collateralised loans and amounted to £34,423 million at 31 December 2009 (2008: £632 million). The related securities held as collateral are not recognised on
balance sheet as the risks and rewards of ownership remain with the counterparty.

Included in loans and advances to banks of the Group were collateral balances in the form of cash provided in respect of repurchase and reverse repurchase
agreements amounting to £19 million (2008: £14 million).

40
 Bank of Scotland plc

Notes to the consolidated financial statements

17 Loans and advances to customers

The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Agriculture, forestry and fishing 772 854 521 803

Energy and water supply 1,129 890 779 786
Manufacturing 6,836 7,436 5,236 6,403
Construction 11,169 11,456 7,730 10,012
Transport, distribution and hotels 21,496 22,664 15,841 23,769
Postal and telecommunications 1,449 958 1,328 735
Property companies 65,144 63,807 49,503 54,018
Financial, business and other services 72,076 92,988 128,857 235,940
Personal:
Mortgages 252,745 263,644 230,325 232,891
Other 19,518 23,854 16,121 22,714
Lease financing 4,990 5,655 – –
Hire purchase 3,486 4,700 2,467 932
460,810 498,906 458,708 589,003
Allowance for impairment losses (note 21) (21,272) (10,693) (18,741) (10,475)
439,538 488,213 439,967 578,528

At 31 December 2009 £325,855 million (2008: £328,999 million) of loans and advances to customers of the Group and £281,579 million
(2008: £271,550 million) of the Bank had a contractual residual maturity of greater than one year.

The carrying value of loans and advances to customers of the Group that are subject to repurchase agreements was £8,749 million at 31 December 2009
(2008: £56,858 million) all of which the secured party is permitted by contract or custom to sell or repledge.

Included in loans and advances to customers of the Group were amounts advanced to counterparties under reverse repurchase agreements which are treated as
collateralised loans and amounted to £nil at 31 December 2009 (2008: £1,350 million). The related securities held as collateral are not recognised on balance
sheet as the risks and rewards of ownership remain with the counterparty.

Included in loans and advances to customers of the Group are collateral balances in the form of cash provided in respect of repurchase and reverse repurchase
agreements amounting to £203 million (2008: £429 million).

Loans and advances to customers include finance lease receivables, which may be analysed as follows:
The Group
2009 2008
£m £m

Gross investment in finance leases, receivable:

Not later than 1 year 726 576
Later than 1 year and not later than 5 years 2,106 2,568
Later than 5 years 2,988 3,518
5,820 6,662
Unearned future finance income on finance leases (830) (1,007)
Net investment in finance leases 4,990 5,655

The Group
2009 2008
£m £m

The net investment in finance leases represents amounts recoverable as follows:

Not later than 1 year 644 487
Later than 1 year and not later than 5 years 1,511 2,180
Later than 5 years 2,835 2,988
4,990 5,655

Equipment leased to customers under finance leases primarily relates to structured financing transactions to fund the purchase of aircraft, ships and other large
individual value items. During 2009 and 2008 no contingent rentals in respect of finance leases were recognised in the income statement. The allowance for
uncollectable finance lease receivables included in the allowance for impairment losses is £193 million for the Group (2008: £103 million).

41
 Bank of Scotland plc

Notes to the consolidated financial statements

18 Securitisations and covered bonds

The Group’s principal securitisation and covered bonds programmes, together with the balances of the advances subject to notes in issue at 31 December, are listed
below. The notes in issue are reported in note 32.
2009 20081
Gross assets Notes Gross assets Notes
securitised in issue securitised in issue
Securitisation Type of asset £m £m £m £m

Permanent UK residential mortgages 38,915 31,878 38,602 38,490

Balliol UK residential mortgages 12,771 12,819 12,701 12,549
Pendeford UK residential mortgages 12,240 9,174 12,894 9,870
Trinity UK residential mortgage 11,033 11,466 12,975 12,638
Mound UK residential mortgages 8,779 7,153 10,147 8,238
Picard US residential mortgage-backed securities 7,897 7,897 – –
Brae UK residential mortgages 7,838 9,588 9,213 9,955
Deva UK residential mortgages 6,691 6,906 6,747 6,703
Wolfhound Irish residential mortgages 6,522 6,585 4,083 4,107
Penarth Credit card receivables 5,155 2,699 4,189 2,633
Candide Dutch residential mortgages 4,812 4,834 5,569 5,704
Dakota UK residential mortgages 3,832 3,826 3,988 3,885
Handbridge Personal Loans 3,730 2,613 – –
Tioba UK residential mortgages 2,094 2,249 2,647 2,568
Prominent Commercial loans 928 976 1,053 1,149
Bella Motor vehicle loans 443 470 – –
Other UK residential mortgages 64 169 68 179
133,744 121,302 124,876 118,668
Less held by the Group (87,359) (75,960)
Total securitisation (note 32) 33,943 42,708
Covered Bonds Type of asset
Covered Bonds UK residential mortgages 61,537 49,644 51,756 49,408
Covered Bonds UK social housing loans 3,407 2,976 3,475 2,919
64,944 52,620 55,231 52,327
Less held by the Group (23,060) (18,305)

Total covered bonds (note 32) 29,560 34,022

Total securitisations and covered bonds 63,503 76,730

1
Following the acquisition of the Group by Lloyds Banking Group plc, the presentation of gross securitised assets and notes in issue has been aligned to a basis
consistent with the presentation practices adopted by Lloyds Banking Group plc and comparatives have been represented accordingly.

Securitisation
Loans and advances to customers and debt securities classified as loans and receivables include advances securitised under the Group’s securitisation programmes,
the majority of which have been sold by subsidiary companies to bankruptcy remote special purpose entities (SPEs). As the SPEs are funded by the issue of debt on
terms whereby some of the risks and rewards of the portfolio are retained by the subsidiary, the SPEs are consolidated fully and all of these advances are retained on
the Group’s balance sheet, with the related notes in issue included within debt securities in issue.

Covered bonds
Certain loans and advances to customers have been assigned to bankruptcy remote limited liability partnerships to provide security to issues of covered bonds by the
Group. The Group retains all of the risks and rewards associated with these loans and the partnerships are consolidated fully with the loans retained on the Group’s
balance sheet, with the related covered bonds included within debt securities in issue.

Cash deposits of £24,271 million (2008: £12,423 million) held by the Group are restricted in use to repayment of the debt securities issued by the SPEs, covered
bonds issued by Bank of Scotland plc and other legal obligations.
In total the Group has securitised £124,088 million (2008: £97,363 million) of mortgage and other assets under certain securitisation and covered bond
programmes and purchased all of the loan notes in issue relating to those issuances for £110,419 million (2008: £94,265 million). These transactions do not lead
to any derecognition of the assets as the Group has retained all of the risks and rewards associated with the loan notes.

42
 Bank of Scotland plc

Notes to the consolidated financial statements

19 Special purpose entities

In addition to the SPEs disclosed in note 18, which are used for securitisation and covered bond programmes, the Group sponsors two asset-backed conduits,
Grampian and Landale which invest in asset-backed securities and other assets. The total consolidated exposures in these conduits are set out in the table below:
Grampian Landale Total
At 31 December 2009 £m £m £m

Debt securities classified as loans and receivables (note 20) 9,924 698 10,622
Total assets 9,924 698 10,622

Grampian Landale Total

At 31 December 2008 £m £m £m

Debt securities classified as:

Loans and receivables (note 20) 17,703 – 17,703
Available-for-sale financial assets (note 22) – 681 681
Total assets 17,703 681 18,384

20 Debt securities classified as loans and receivables

Debt securities accounted for as loans and receivables comprise:

The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Asset-backed securities:
Mortgage-backed securities 15,555 18,273 11,968 9,375
Other asset-backed securities 16,706 20,783 12,853 10,068
Corporate and other debt securities 865 745 390 231
33,126 39,801 25,211 19,674
Allowance for impairment losses (note 21) (1,915) (923) (1,527) (415)
31,211 38,878 23,684 19,259

At 31 December 2009, £31,063 million (2008: £26,826 million) of debt securities designated as loans and receivables of the Group and £22,195 million
(2008: £16,557 million) of the Bank had a contractual residual maturity of greater than one year.

The carrying value of debt securities classified as loans and receivables of the Group that are subject to repurchase agreements was £12,238 million at 31 December
2009 (2008: £18,509 million) all of which the secured party is permitted by contract or custom to sell or repledge.

21 Allowance for impairment losses on loans and receivables

The Group
Loans and
advances to Debt
customers securities Total
£m £m £m

Balance at 1 January 2008 3,373 – 3,373

Exchange and other adjustments 135 – 135
Advances written off (2,515) – (2,515)
Recoveries of advances written off in previous years 107 – 107
Disposals of subsidiary undertakings (115) – (115)
Unwinding of discount (149) – (149)
Charge to the income statement (note 10) 9,857 923 10,780
At 31 December 2008 10,693 923 11,616
Exchange and other adjustments 162 (172) (10)
Advances written off (7,459) (35) (7,494)
Recoveries of advances written off in previous years 36 – 36
Unwinding of discount (391) – (391)
Charge to the income statement (note 10) 18,231 1,199 19,430
At 31 December 2009 21,272 1,915 23,187

43
 Bank of Scotland plc

Notes to the consolidated financial statements

21 Allowance for impairment losses on loans and receivables (continued)

The Bank
Loans and
advances to Debt
customers securities Total
£m £m £m

Balance at 1 January 2008 2,997 – 2,997

Exchange and other adjustments 18 – 18
Advances written off (2,120) – (2,120)
Recoveries of advances written off in previous years 99 – 99
Unwinding of discount (140) – (140)
Charge to the income statement 9,621 415 10,036
At 31 December 2008 10,475 415 10,890
Exchange and other adjustments (27) (3) (30)
Advances written off (6,812) (18) (6,830)
Recoveries of advances written off in previous years 35 – 35
Unwinding of discount (394) – (394)
Charge to the income statement 15,464 1,133 16,597
At 31 December 2009 18,741 1,527 20,268

22 Available-for-sale financial assets

The Group 2009 2008

£m £m

Debt securities:
Government securities 326 380
Bank and building society certificates of deposit 285 2,958
Asset-backed securities:
Mortgage-backed securities 17 17
Other asset-backed securities 79 843
Corporate and other debt securities 18,924 21,580
19,631 25,778
Equity shares:
Listed 85 110
Unlisted 1,849 2,147
1,934 2,257
21,565 28,035
Included within other asset backed securities are £nil (2008: £681 million) held within the Group’s conduit entities.
Included within corporate and other debt securities are £18,781million (2008: £21,495 million) managed within the Group’s wholesale activities, which includes
£13,851 million (2008: £15,985 million) of floating rate notes issued by financial institutions, £1,045 million (2008: £1,405 million) of fixed rate bonds,
£3,871 million (2008: £4,062 million) of covered bonds and £14 million (2008: £43 million) of other debt securities.

The Bank 2009 2008

£m £m

Debt securities:
Government securities 325 379
Bank and building society certificates of deposit 285 2,958
Asset-backed securities:
Other asset-backed securities 60 148
Corporate and other debt securities 17,569 19,791
18,239 23,276
Equity shares:
Listed 26 5
Unlisted 1,051 1,058
1,077 1,063
19,316 24,339

Included within corporate and other debt securities of the Bank are £17,425 million (2008: £19,712 million) managed within the wholesale activities, which
includes £12,509 million (2008: £14,245 million) of floating rate notes issued by financial institutions, £1,045 million (2008: £1,405 million) of fixed rate bonds
and £3,871 million (2008: £4,062 million) of covered bonds.
At 31 December 2009 £18,810 million (2008: £17,847 million) of available-for-sale financial assets of the Group and £17,021 million (2008: £20,925 million)
of the Bank had a contractual residual maturity of greater than one year.
The carrying value of available-for-sale financial assets of the Group that are subject to repurchase agreements was £10,628 million at 31 December 2009 (2008:
£18,753 million) all of which the secured party is permitted by contract or custom to sell or repledge.

44
 Bank of Scotland plc

Notes to the consolidated financial statements

22 Available-for-sale financial assets (continued)

All assets have been individually assessed for impairment. The criteria used to determine whether an impairment loss has been incurred are disclosed in accounting
policy 2(h). Included in available-for-sale financial assets at 31 December 2009 are debt securities individually determined to be impaired whose gross amount
before impairment allowances was £329 million and in respect of which no collateral was held.
Comparatives have not been disclosed in relation to these amounts due to the fact that data was not collected on this basis in the prior year and it is impracticable to
recreate this information.

23 Investment properties
2009 2008
£m £m

At 1 January 43 34
Exchange and other adjustments – 1
Additions:
Acquisitions of new properties – 8
Additional expenditure on existing properties – 10
Total additions – 18
Changes in fair value (note 7) (13) (10)
At 31 December 30 43

The investment properties are valued at least annually at open-market value, by independent, professionally qualified valuers, who have recent experience in the
location and categories of the investment properties being valued.
No capital expenditure has been contracted for, but not recognised in the financial statements, at the balance sheet date (2008: £nil).

24 Investment in subsidiary undertakings

2009 2008
£m £m

At 1 January 4,383 3,273

Additions – 1,217
Additional capital injections and transfers 2,517 –
Impairment (4,449) (107)
At 31 December 2,451 4,383

A reassessment of the carrying value of the Bank’s investments in Bank of Scotland (Ireland) and HBOS Australia resulted in the recognition of an impairment charge
of £4,449 million which represents the write down of the Bank’s investments to their recoverable amount.

Recoverable amount is based on the fair value less cost to sell and was determined by using a discounted cash flow valuation technique. This calculation uses
projections of future cash flows based on management’s plans covering a five year period. These cash flows are based on past experience and have been adjusted to
take into account expected future market conditions. Cash flows beyond the five year period have been extrapolated using a steady 2.5 per cent rate of increase. The
expected cash flows have been discounted at a rate of 17.75 per cent which has been determined to be in line with available market information.

The impairment charge of £4,449 million (2008: £107 million) in the Bank’s investment in Bank of Scotland (Ireland) and HBOS Australia was triggered by the
continued deterioration of the financial performance of these companies, principally due to increased impairment losses in their lending portfolios.

The principal group undertakings, all of which have prepared accounts to 31 December and whose results are included in the consolidated accounts of
Bank of Scotland plc, are:
Country of Percentage of equity
registration/ share capital and
incorporation voting rights held Nature of business

Bank of Scotland (Ireland) Limited Ireland 100% Banking

Uberior Investments plc UK 100% Investment holding

The principal area of operation for each of the above group undertakings is its country of registration/incorporation.

In November 2009, as part of the restructuring plan that was a requirement for European Community (EC) approval of state aid received by the Group,
Lloyds Banking Group agreed to suspend the payment of coupons and dividends on certain of the Group preference shares and preferred securities for the two year
period from 31 January 2010 to 31 January 2012. The Group has agreed to temporarily suspend and/or waive dividend payments on certain preference shares
which have been issued intra-group. Consequently, in accordance with the terms of some of these instruments, subsidiaries may be prevented from making dividend
payments on ordinary shares during this period. In addition, certain subsidiary companies currently have insufficient distributable reserves to make dividend
payments.

Subject to the foregoing, there were no further significant restrictions on any of the Bank’s subsidiaries in paying dividends or repaying loans and advances. All
regulated banking and insurance subsidiaries are required to maintain capital at levels agreed with the regulators; this may impact those subsidiaries’ ability to make
distributions.

45
 Bank of Scotland plc

Notes to the consolidated financial statements

25 Goodwill
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

At 1 January 667 1,041 376 426

Exchange and other adjustments (5) 24 – –
Acquired through business combinations 99 – – –
Disposals – (256) – –
Impairment charged to the income statement (385) (142) – (50)
At 31 December 376 667 376 376

Cost* 944 850 426 426

Accumulated impairment losses (568) (183) (50) (50)
At 31 December 376 667 376 376

*For acquisitions made prior to 1 January 2004, the date of transition to IFRS, cost is included net of amounts amortised up to 31 December 2003.

The goodwill held in the Group’s and the Bank’s balance sheet is tested at least annually for impairment. For the purposes of impairment testing the goodwill is
allocated to the appropriate cash generating unit, which is principally the retail banking activities. This compares the recoverable amount, being the higher of a
cash-generating units’ fair value less costs to sell and its value in use, with the carrying value. When this indicates that the carrying value is not recoverable it is written
down through the income statement as goodwill impairment.

The recoverable amount of goodwill carried at 31 December 2009 has been based upon value in use. This calculation uses cash flow projections based upon the
Group’s business plans where the main assumptions relate to the current economic outlook and opinions in respect of economic growth, unemployment, property
markets, interest rates and credit quality. Cash flows for the period subsequent to the term of the business plan are extrapolated using a growth rate of 2.5 per cent
reflecting management’s view of the expected future long term trend in growth rate of the respective economies concerned, predominantly being in the UK, and the
long term performances of the businesses concerned. The discount rate used in discounting the projected cash flows is 12.5 per cent (pre-tax) reflecting, inter alia,
the perceived risks within those businesses. Management believes that any reasonably possible change in the key assumptions would not cause the recoverable
amount to fall below the balance sheet carrying value.

The goodwill impairment charge of £385 million (2008: £142 million) includes the write-down, triggered primarily by deteriorating economic conditions, of the
goodwill arising on the acquisition of Lex Vehicle Leasing Services (£265 million).

26 Other intangible assets

The Group The Bank
Capitalised Capitalised
software software
enhance- enhance-
Brands ments Total ments
£m £m £m £m

Cost:
At 1 January 2008 19 241 260 229
Exchange and other adjustments (2) – (2) –
Additions 2 38 40 38
Disposals (9) – (9) –
At 31 December 2008 10 279 289 267
Additions – 11 11 10
Disposals – (2) (2) –
At 31 December 2009 10 288 298 277
Accumulated amortisation:
At 1 January 2008 5 145 150 141
Charge for the year 3 31 34 28
Disposals (3) – (3) –
At 31 December 2008 5 176 181 169
Exchange and other adjustments 1 – 1 –
Charge for the year (note 9) 1 24 25 23
At 31 December 2009 7 200 207 192
Balance sheet amount at 31 December 2009 3 88 91 85
Balance sheet amount at 31 December 2008 5 103 108 98

Capitalised software enhancements principally comprise identifiable and directly associated internal staff and other costs.

46
 Bank of Scotland plc

Notes to the consolidated financial statements

27 Tangible fixed assets

The Group The Bank
Operating Total Operating Total
lease tangible lease tangible
Premises Equipment assets fixed assets Premises Equipment assets fixed assets
£m £m £m £m £m £m £m £m

Cost:
At 1 January 2008 1,541 2,459 6,483 10,483 1,395 2,045 30 3,470
Exchange and other adjustments 17 70 96 183 2 3 2 7
Adjustments on disposal of businesses (53) (108) – (161) – – – –
Additions 63 444 1,488 1,995 48 314 – 362
Disposals (116) (319) (1,733) (2,168) (83) (148) (30) (261)
At 31 December 2008 1,452 2,546 6,334 10,332 1,362 2,214 2 3,578
Exchange and other adjustments – (3) (78) (81) – 1 (2) (1)
Additions 59 118 1,478 1,655 43 87 102 232
Disposals (55) (55) (2,511) (2,621) (50) (42) – (92)
At 31 December 2009 1,456 2,606 5,223 9,285 1,355 2,260 102 3,717
Accumulated depreciation and impairment:
At 1 January 2008 625 1,718 1,840 4,183 600 1,463 1 2,064
Exchange and other adjustments 7 30 34 71 (1) (2) – (3)
Adjustments on disposal of businesses (16) (85) – (101) – – – –
Charge for the year 61 269 1,178 1,508 55 206 (6) 255
Disposals (18) (153) (685) (856) (13) (89) 5 (97)
At 31 December 2008 659 1,779 2,367 4,805 641 1,578 – 2,219
Exchange and other adjustments 4 (1) 5 8 3 (2) – 1
Charge for the year (note 9) 54 179 835 1,068 50 146 – 196
Disposals (17) (28) (1,454) (1,499) (21) (22) – (43)
At 31 December 2009 700 1,929 1,753 4,382 673 1,700 – 2,373
Balance sheet amount at 31 December 2009 756 677 3,470 4,903 682 560 102 1,344
Balance sheet amount at 31 December 2008 793 767 3,967 5,527 721 636 2 1,359

At 31 December the future minimum rentals receivable by the Group under non-cancellable operating leases were as follows: 2009 2008
£m £m

Receivable within 1 year 428 849

1 to 5 years 1,376 2,245
Over 5 years 51 52
1,855 3,146

Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2009 and 2008 no contingent rentals in
respect of operating leases were recognised in the income statement.

In addition, total future minimum sub-lease income of £3 million for the Group and £nil for the Bank at 31 December 2009 (2008: £13 million for the Group and
£nil for the Bank) is expected to be received under non-cancellable sub-leases of the Group’s premises.

47
 Bank of Scotland plc

Notes to the consolidated financial statements

28 Other assets
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Settlement balances 1,354 942 1,354 893

Other assets and prepayments 3,168 2,184 4,438 1,983
4,522 3,126 5,792 2,876

29 Deposits from banks

The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Deposits from banks 174,338 97,066 168,246 97,091

At 31 December 2009 £6,374 million (2008: £2,205 million) of deposits from banks of the Group and £3,592 million (2008: £1,658 million) of the Bank had a
contractual residual maturity of greater than one year.

Included in deposits from banks of the Group were amounts received from counterparties under repurchase agreements which are treated as secured borrowings and
amounted to £66,441 million at 31 December 2009 (2008: £83,783 million).

Included in deposits from banks of the Group are collateral balances in the form of cash received in respect of repurchase and reverse repurchase agreements
amounting to £19 million (2008: £42 million).

30 Customer deposits
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Non-interest bearing current accounts 2,471 1,878 2,471 1,878

Interest bearing current accounts 80,097 85,217 118,644 125,394
Savings and investment accounts 137,902 142,218 109,439 165,084
Other customer deposits 45,501 48,086 69,570 80,817
Customer deposits 265,971 277,399 300,124 373,173

At 31 December 2009 £19,011 million (2008: £11,743 million) of customer deposits of the Group and £81,598 million (2008: £91,740 million) of the Bank had
a contractual residual maturity of greater than one year.

Included in customer deposits of the Group were amounts received from counterparties under repurchase agreements which are treated as secured borrowings and
amounted to £35,330 million at 31 December 2009 (2008: £18,229 million).

Included in customer deposits of the Group were collateral balances in the form of cash received in respect of repurchase and reverse repurchase agreements
amounting to £22 million (2008: £nil).

31 Trading and other financial liabilities at fair value through profit or loss
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Liabilities held at fair value through profit or loss – – – –

Trading liabilities 27,372 18,851 27,372 18,851
Trading and other financial liabilities at fair value through profit or loss 27,372 18,851 27,372 18,851

At 31 December 2009, for both the Group and the Bank, £131 million (2008: £nil) of trading liabilities had a contractual residual maturity of greater than one year.
Included in trading liabilities of the Group were amounts received from counterparties under repurchase agreements which are treated as secured borrowings and
amounted to £26,852 million at 31 December 2009 (2008: £18,842 million).

48
 Bank of Scotland plc

Notes to the consolidated financial statements

32 Debt securities in issue

The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Medium-term notes 36,455 48,630 36,455 47,897

Covered bonds (note 18) 29,560 34,022 29,560 34,022
Certificates of deposit 6,413 50,956 6,724 50,956
Securitisation notes (note 18) 33,943 42,708 22,037 30,503
Commercial paper 12,786 12,132 3,299 9,086
Total debt securities in issue 119,157 188,448 98,075 172,464

Included within commercial paper above is £9,330 million (2008: £2,979 million) issued by the Grampian conduit and £138 million (2008: £nil) issued by the
Landale conduit.

At 31 December 2009 £76,484 million (2008: £97,341 million) of debt securities in issue of the Group and £46,660 million (2008: £65,142 million) of the Bank
had a contractual residual maturity of greater than one year.

33 Other liabilities
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Settlement balances 1,610 337 1,610 952

Other creditors and accruals 4,681 3,898 3,315 3,470
6,291 4,235 4,925 4,422

34 Deferred tax

The statutory position reflects the deferred tax assets and liabilities as disclosed in the consolidated balance sheet and takes account of the inability to offset assets and
liabilities where there is no legally enforceable right of offset. The tax disclosure of deferred tax assets and liabilities ties to the amounts outlined in the table below
which splits the deferred tax assets and liabilities by type.
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Statutory position
Deferred tax asset 5,153 3,182 4,410 2,563
Deferred tax liability – – – –
Net deferred tax asset 5,153 3,182 4,410 2,563
Tax disclosure
Deferred tax asset 5,325 3,969 4,533 2,722
Deferred tax liability (172) (787) (123) (159)
Net deferred tax asset 5,153 3,182 4,410 2,563

49
 Bank of Scotland plc

Notes to the consolidated financial statements

34 Deferred tax (continued)

The movement in the net deferred tax balance is as follows:

The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Asset (liability) at 1 January as previously stated (965) 152

Prior year adjustment – 13
Asset (liability) at 1 January as restated 3,182 (965) 2,563 165
Exchange and other adjustments 60 (33) 1 13
Adjustment on acquisition 3 – – –
Disposals – (41) – –
Income statement credit (note 13) 2,840 1,930 2,462 1,038
Amount (charged) credited to equity:
Available-for-sale financial assets (note 39) (848) 1,917 (534) 982
Cash flow hedges (note 39) (79) 371 (82) 367
Employee benefits (5) 3 – (2)
(932) 2,291 (616) 1,347
Asset at 31 December 5,153 3,182 4,410 2,563

The deferred tax credit in the income statement comprises the following temporary differences:
The Group
2009 2008
£m £m

Accelerated capital allowances 547 516

Pensions and other post-retirement benefits 21 (5)
Effective interest rate – 12
Tax losses carried forward 2,207 1,513
Provisions (121) 348
Unrealised gains 1 (977)
Other temporary differences 185 523
2,840 1,930

Deferred tax assets and liabilities are comprised as follows:

The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Deferred tax assets:

Employee benefits 40 19 27 6
Capital allowances – – 174 53
Other provisions 386 478 122 142
Derivatives 326 405 324 406
Available-for-sale asset revaluation 612 924 – –
Tax losses carried forward 3,624 1,514 3,612 1,935
Other temporary differences 337 629 274 180
5,325 3,969 4,533 2,722
Deferred tax liabilities:
Accelerated capital allowances (45) (620) – –
Available-for-sale asset revaluation – – (10) (11)
Effective interest rate (86) (86) (76) (89)
Other temporary differences (41) (81) (37) (59)
(172) (787) (123) (159)

50
 Bank of Scotland plc

Notes to the consolidated financial statements

34 Deferred tax (continued)

Deferred tax assets are recognised for tax losses carried forward to the extent that the realisation of the related tax benefit through future taxable profits is probable.
Group companies have recognised a deferred tax asset of £3,624 million and £3,612 million for the Bank (2008: £1,514 million for the Group and £1,935 million
for the Bank) in relation to tax losses carried forward. After reviews of medium term profit forecasts, the Group considers that there will be sufficient profits in the future
against which these losses will be offset.

Deferred tax assets of £349 million for the Group and £nil for the Bank (2008: £nil for the Group and the Bank) have not been recognised in respect of trading losses
carried forward mainly in overseas companies as there are limited predicted future trading profits to offset them. Trading losses can be carried forward indefinitely.

Deferred tax assets of £349 million for the Group and £nil for the Bank (2008: £92 million for the Group and the Bank) have not been recognised in respect of capital
losses carried forward as there are no predicted future capital profits. Capital losses can be carried forward indefinitely.

In addition, deferred tax assets have not been recognised in respect of unrelieved foreign tax carried forward as at 31 December 2009 of £40 million for the Group
and the Bank (2008: £42 million for the Group and £40 million for the Bank), as there are no predicted future taxable profits against which the unrelieved foreign tax
credits can be utilised. These tax credits can be carried forward indefinitely.

35 Other provisions
Provisions for Vacant
contingent Customer leasehold
liabilities and remediation property
commitments provisions and other Total
The Group £m £m £m £m

At 1 January 2009 – 96 49 145

Provisions applied – (5) (3) (8)
Charge for the year (note 10) 5 105 – 110
At 31 December 2009 5 196 46 247

Provisions for
contingent Customer Vacant leasehold
liabilities and remediation property and
commitments provisions other Total
The Bank £m £m £m £m

At 1 January 2009 – 96 36 132

Provisions applied – (5) – (5)
Charge for the year 5 103 – 108
At 31 December 2009 5 194 36 235

Provisions for contingent liabilities and commitments

Provisions are held in cases where the Group is irrevocably committed to advance additional funds, but where there is doubt as to the customer’s ability to meet its
repayment obligations.

Customer remediation provisions

The Group establishes provisions for the estimated cost of making redress payments to customers in respect of past product sales where the original sales processes
have been found to be deficient or where fees and premiums have been overcharged.

Vacant leasehold property and other

Vacant leasehold property provisions are made by reference to a prudent estimate of expected sub-let income, compared to the head rent, and the possibility of
disposing of the Group’s interest in the lease, taking into account conditions in the property market. These provisions are reassessed on a biennial basis and will
normally run off over the period of under-recovery of the leases concerned, currently averaging five years; where a property is disposed of earlier than anticipated, any
remaining balance in the provision relating to that property is released.

51
 Bank of Scotland plc

Notes to the consolidated financial statements

36 Subordinated liabilities
Group Bank
2009 2008 2009 2008
£m £m £m £m

Preference shares 800 1,227 800 1,227

Preferred securities 403 403 – –
Undated subordinated liabilities 5,565 5,948 5,967 6,350
Dated subordinated liabilities 9,916 11,201 9,285 10,505
16,684 18,779 16,052 18,082

Group Bank
2009 2008 2009 2008
Preference shares £m £m £m £m

61/8% Non-cumulative Redeemable preference shares (£800 million) 800 815 800 815
91/4% Non-cumulative Irredeemable £1 preference shares (£300 million) – 309 – 309
93/4% Non-cumulative Irredeemable £1 preference shares (£100 million) – 103 – 103
800 1,227 800 1,227

Group Bank
2009 2008 2009 2008
Preferred securities £m £m £m £m

8.117% Non-cumulative Perpetual Preferred Securities Series 1 of £1.000 each (Class B)

(£250 million) 252 252 – –
7.754% Non-cumulative Perpetual Preferred Securities Series 2 of £1.000 each (Class B)
(£150 million) 151 151 – –
403 403 – –

Group Bank
2009 2008 2009 2008
Undated subordinated liabilities £m £m £m £m

£200 million Perpetual Notes 62 203 62 203

£300 million Perpetual Regulatory Tier 1 Securities 300 300 300 300
c500 million Instruments 445 481 445 481
US$250 million Floating Rate Primary Capital Notes 146 171 146 171
£150 million Instruments 77 205 77 205
JPY 17 billion Instruments 136 150 136 150
£100 million Instruments 60 104 60 104
£300 million Instruments 300 300 300 300
£250 million Perpetual Preferred Notes – – 252 251
£150 million Perpetual Preferred Notes – – 150 151
£150 million Floating Rate Subordinated Notes 150 150 150 150
£500 million Floating Rate Subordinated Notes 500 500 500 500
£100 million 12% Perpetual Subordinated Bonds* 104 104 104 104
£100 million 8.75% Perpetual Subordinated Bonds* 103 103 103 103
£75 million 13.625% Perpetual Subordinated Bonds* 78 76 78 76
£50 million 9.375% Perpetual Subordinated Bonds* 54 51 54 51
£500 million Floating Rate Subordinated Notes* 500 500 500 500
£300 million Floating Rate Subordinated Notes* 300 300 300 300
£250 million Floating Rate Subordinated Notes* 250 250 250 250
£2,000 Floating Rate Subordinated Notes 2,000 2,000 2,000 2,000
5,565 5,948 5,967 6,350
*Transferred in under the HBOS Group Reorganisation Act 2006
On 30 September 2008, £2 billion floating rate subordinated notes were issued by the Bank, at par, to its parent undertaking HBOS plc. The notes bear interest at
the three month LIBOR rate plus 133 basis points.
No exercise of any redemption option or purchase by the relevant entity of any of the undated subordinated liabilities may be made without the consent of the
Financial Services Authority. On a winding up of the Bank or subsidiary, the claims of the holders of undated loan capital shall be subordinated in right of payment to
the claims of all depositors and creditors of the Bank or subsidiary other than creditors whose claims are expressed to rank pari passu with or junior to the claims of
the holders of the undated loan capital. The undated loan capital is junior in point of subordination to the dated loan capital referred to above.

52
 Bank of Scotland plc

Notes to the consolidated financial statements

36 Subordinated liabilities (continued)

Group Bank
2009 2008 2009 2008
Dated subordinated liabilities £m £m £m £m

c500 million 5.50% Instruments 2009 – 489 – 489

c650 million 4.75% Subordinated Bonds 2009* – 644 – 644
US$500 million Notes 2010 326 368 326 368
US$150 million Notes 2011 101 116 101 116
c12.8 million 6.25% Instruments 2012 10 12 – –
c325 million 6.125% Notes 2013 306 326 306 326
£250 million 6.375% Instruments 2019 287 304 287 304
c750 million 5.5% Notes 2012 725 764 725 764
US$1,000 million 4.25% Subordinated Guaranteed Notes 2013 621 684 – –
£330 million Floating Rate Subordinated Notes 2014 330 330 330 330
£300 million Floating Rate Subordinated Notes 2014 300 300 300 300
£700 million Floating Rate Subordinated Notes 2014 700 700 700 700
£300 million Floating Rate Subordinated Notes 2014 300 300 300 300
£250 million 11% Subordinated Bonds 2014* 276 276 276 276
£150 million 10.5% Subordinated Bonds 2018* 164 164 164 164
£500 million 9.375% Subordinated Bonds 2021* 580 534 580 534
£520 million Floating Rate Subordinated Notes 2014 520 520 520 520
£300 million Floating Rate Subordinated Notes 2014* 300 300 300 300
£300 million Floating Rate Subordinated Notes 2014* 300 300 300 300
£270 million Floating Rate Subordinated Notes 2014* 270 270 270 270
£500 million Floating Rate Subordinated Notes 2014 500 500 500 500
£2,000 Floating Rate Subordinated Notes 2014 2,000 2,000 2,000 2,000
£1,000 million Floating Rate Subordinated Notes 2014 1,000 1,000 1,000 1,000
9,916 11,201 9,285 10,505

*Transferred in under the HBOS Group Reorganisation Act 2006

On 30 June 2008, £1 billion floating rate subordinated notes were issued by the Bank, at par, to its parent undertaking HBOS plc. The notes bear interest at the
three month LIBOR plus 67 basis points.
At 31 December 2009 £9,590 million (2008: £10,068 million) of subordinated liabilities of the Group and £8,959 million (2008: £9,372 million) of the Bank has
a contractual residual maturity of greater than one year.
No repayment, for whatever reason, of dated subordinated liabilities prior to their stated maturity and no purchase by the relevant entity of its subordinated debt may
be made without the consent of the Financial Services Authority. On a winding up of the Bank or subsidiary, the claims of the holders of dated loan capital shall be
subordinated in right of payment to the claims of all depositors and creditors of the Bank or subsidiary other than creditors whose claims are expressed to rank
pari passu with, or junior to, the claims of the holders of the dated loan capital.

37 Share capital

(1) Authorised share capital

On 16 January 2009 the Bank approved an increase in the authorised ordinary share capital of £4,000 million, by creating 16,000 million new authorised ordinary
shares of £0.25 each. The balance of authorised ordinary share capital at 31 December 2009 was £6,021 million, comprising 24,085 million authorised ordinary
shares of £0.25 each.
On 4 August 2009 the redemption of all the Bank’s equity preference shares was approved. These shares had been classified as subordinated debt rather than as
issued share capital due to their terms.
(2) Issued share capital
2009 2008 2009 2008
Number of shares Number of shares £m £m

Ordinary shares of 25p each

At 1 January 5,296,712,311 1,996,712,311 1,324 499
Ordinary share issue June 2008 – 300,000,000 – 75
Ordinary share issue September 2008 – 500,000,000 – 125
Ordinary share issue December 2008 – 2,500,000,000 – 625
Ordinary share issue February 2009 13,918,333,333 – 3,480 –
Ordinary share issue March 2009 1,500,000,000 – 375 –
Ordinary share issue June 2009 2,500,000,000 – 625 –
Ordinary share issue October 2009 169,000,000 – 42 –
Ordinary share issue December 2009 3,500,000 – 1 –
At 31 December 23,387,545,644 5,296,712,311 5,847 1,324

Details of movements in preference shares that are treated for accounting purposes as debt are given in note 36.

53
 Bank of Scotland plc

Notes to the consolidated financial statements

37 Share capital (continued)

Share issuances during 2009

Ordinary shares
On 26 February 2009 £8,351 million was raised through a capital injection by HBOS plc, comprising £3,480 million of ordinary shares and £4,871 million of share
premium.

On 31 March 2009 £3,000 million was raised through a capital injection by HBOS plc, comprising £375 million of ordinary shares and £2,625 million of share
premium.

On 26 June 2009 £5,000 million was raised through a capital injection by HBOS plc, comprising £625 million of ordinary shares and £4,375 million of share
premium.

On 14 October 2009 £338 million was raised through the issue of ordinary shares, comprising £42 million of ordinary shares and £296 million of share premium.
This transaction arose following the redemption of preference shares noted in note 36.

On 18 December 2009 £3,500 million was raised through a capital injection by HBOS plc, comprising £1 million of ordinary shares and £3,499 million of share
premium.

38 Share premium account

Group and Bank
2009 2008
£m £m

At 1 January 11,018 6,343

Issue of ordinary shares 15,666 4,675
At 31 December 26,684 11,018

39 Other reserves
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Other reserves comprise:

Merger and other reserves 1,600 1,600 1,600 1,600
Capital redemption reserve 63 – 63 –
Revaluation reserve in respect of available-for-sale financial assets (2,972) (5,335) (1,356) (2,729)
Cash flow hedging reserve (839) (1,042) (832) (1,030)
Foreign currency translation reserve 54 83 76 43
(2,094) (4,694) (449) (2,116)

Movements in other reserves were as follows:

The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Merger and other reserves

At 1 January 1,600 1,600 1,600 1,600
At 31 December 1,600 1,600 1,600 1,600

The Group The Bank

2009 2008 2009 2008
£m £m £m £m

Capital redemption reserve

At 1 January – – – –
Redemption of preference shares 63 – 63 –
At 31 December 63 – 63 –

54
 Bank of Scotland plc

Notes to the consolidated financial statements

39 Other reserves (continued)

2009 2008 2009 2008

£m £m £m £m

Revaluation reserve in respect of available-for-sale financial assets

At 1 January (5,335) (313) (2,729) (234)
Exchange and other adjustments 38 (23) – –
Change in fair value of available-for-sale financial assets 2,550 (8,173) 1,848 (4,181)
Deferred tax (673) 2,265 (517) 1,179
Current tax – 11 – 10
1,877 (5,897) 1,331 (2,992)
Income statement transfers:
Disposals (note 8) 3 (24) 59 43
Deferred tax (1) 7 (17) (12)
2 (17) 42 31
Impairment (note 10) 620 1,270 – 651
Deferred tax (174) (355) – (185)
446 915 - 466
At 31 December (2,972) (5,335) (1,356) (2,729)

2009 2008 2009 2008

£m £m £m £m

Cash flow hedging reserve

At 31 December 2007 as previously stated (85) (113)
Prior year adjustment – 9
At 1 January as restated (1,042) (85) (1,030) (104)
Change in fair value of hedging derivatives (613) (3,889) (627) (3,881)
Deferred tax 171 1,088 173 1,092
(442) (2,801) (454) (2,789)
Income statement transfer 895 2,561 907 2,588
Deferred tax (250) (717) (255) (725)
645 1,844 652 1,863
At 31 December (839) (1,042) (832) (1,030)

2009 2008 2009 2008

£m £m £m £m

Foreign currency translation reserve

At 1 January 83 (35) 43 43
Currency translation differences arising in the year (29) 118 33 –
At 31 December 54 83 76 43

40 Retained profits
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

At 31 December 2007 as previously stated 13,479 10,041

Prior year adjustment – 350
At 1 January as restated 4,013 13,479 2,124 10,391
Loss for the year* (12,240) (8,238) (14,168) (7,062)
Capital redemption (63) – (63) –
Dividends – (1,228) – (1,205)
At 31 December (8,290) 4,013 (12,107) 2,124

*No income statement has been shown for the Bank, as permitted by Section 408 of the Companies Act 2006.

55
 Bank of Scotland plc

Notes to the consolidated financial statements

41 Dividends
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Ordinary share dividends

Final dividend for previous year paid during the current year – 1,205 – 1,205
Interim dividend – – – –
Total ordinary share dividends – 1,205 – 1,205
Preference share dividends
Equity dividends paid – 23 – –
– 1,228 – 1,205

The directors do not propose to pay a final dividend (2008: £nil).

42 Related party transactions

Key management personnel

Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of an entity. At
31 December 2008, key management personnel comprised the members of the board of the Bank, the Company Secretary and the HBOS Executive Committee. At
31 December 2009, the Group’s key management personnel are the members of the board of Bank of Scotland plc and the members of the Lloyds Banking Group
executive committee.

The table below details, on an aggregated basis, key management personnel compensation which has been allocated to the Bank on an estimated basis. In 2008, no
director received emoluments for qualifying services to the Bank:
2009
£m

Compensation
Salaries and other short-term benefits 6

The aggregate of the emoluments of the directors for qualifying services to the Bank, on an estimated basis, in 2009 was £3,960,000. The total for the highest paid
director G T Tate was £722,000.

As a result of the acquisition of HBOS plc by Lloyds Banking Group plc on 16 January 2009, the Board of the Bank changed in its entirety. Accordingly, the
disclosures for 2009 begin with the balances of key management personnel on 16 January 2009. The disclosures for 2008, which are based on the previous
members of key management personnel, are presented separately.

The information below is in relation to key management personnel for 2009:

2009
million

Share options
At 16 January 2009 and 31 December 2009 2

2009
million

Share incentive plans

At 16 January 2009 7
Granted (including entitlements of appointed directors) 17
Exercised/lapsed (including entitlements of former directors) (5)
At 31 December 2009 19

The tables below detail, on an aggregated basis, balances outstanding at the year end and related income and expense, together with information relating to other
transactions between the Group and its key management personnel:
2009
£m

Loans
At 16 January 2009 3
Advanced (including loans of appointed directors) –
Repayments (including loans of former directors) (1)
At 31 December 2009 2

The loans are on both a secured and unsecured basis and are expected to be settled in cash. The loans attracted interest rates of between 1.28 per cent and 24.9 per
cent in 2009.

56
 Bank of Scotland plc

Notes to the consolidated financial statements

42 Related party transactions (continued)

No provisions have been recognised in respect of loans given to key management personnel.
2009
£m

Deposits
At 16 January 2009 6
Placed (including deposits of appointed directors) 12
Withdrawn (including deposits of former directors) (14)
At 31 December 2009 4

Deposits placed by key management personnel attracted interest rates of up to 6.5 per cent.

At 31 December 2009, the Group did not provide any guarantees in respect of key management personnel.

At 31 December 2009, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons included
amounts outstanding in respect of loans and credit card transactions of £2 million with seven directors and four connected persons.

The information below is in relation to key management personnel for 2008:

2008
£m

Loans
At 1 January 2008 2
Advanced –
Repayments –
At 31 December 2008 2

2008
£m

Deposits
At 1 January 2008 12
Net movements (5)
At 31 December 2008 7

Share schemes
Potential pre-tax gains on share options exercised
During 2008, two key management personnel exercised 2,045 options under share option schemes.

Shares vested under long-term incentive schemes

During 2008, one key management personnel had a share grant of 43,350 shares released under long term incentive schemes, in accordance with his contractual
entitlement under the rules of the schemes. This relates to the 2003-2006 long term incentive plan granted in January 2003. HBOS’s Total Shareholder Return over
the five year performance period exceeded the weighted average of the comparator group by 1.57 per cent, consequently 183 per cent of the original share grant was
released under the terms of the long term incentive scheme on 27 February 2008.

Shares vested under short-term incentive schemes

During 2008, seven key management personnel had share grants of 428,938 shares in total released under short term incentive schemes, in accordance with
contractual entitlements under the rules of the schemes. The release of these 428,938 shares relates to the shares placed in trust using short term incentive plan
awards in 2004 together with the additional shares awarded following the three year holding period. In respect of one key management personnel, a share grant of
49,191 was released under short term incentive plans, and a special award originally granted in 2002 of 212,739 shares was also released. Both of these releases
occurred before April 2008. None of these releases related to performance in 2008.

The value of additional shares is shown net of income tax and National Insurance liability although the value of the additional shares was grossed up to take account
of the associated income tax and National Insurance payable by the participant.

Value of shares vested under free shares plan

During 2008, 2,674 free shares relating to six key management personnel vested. In 2008, seven key management personnel were awarded shares under the free
shares plan.

Change of control
All of the HBOS share plans contained a provision relating to change of control. The acquisition of HBOS by Lloyds Banking Group resulted in awards and options
vesting and becoming exercisable, in accordance with contractual entitlements under plan rules. Certain awards were exchanged for awards over
Lloyds Banking Group ordinary shares, but otherwise subject to the same terms as the original award. Certain options will also be exchanged to the extent they
have not been exercised within the six month exercise period following the change of control.

57
 Bank of Scotland plc

Notes to the consolidated financial statements

42 Related party transactions (continued)

Where the vesting of awards and options were subject to the satisfaction of performance conditions, in accordance with the plan rules and the terms of such
conditions, the Remuneration Committee of the Bank determined the extent to which such awards and options vested by taking into account the level of performance.
In relation to the directors, the Remuneration Committee exercised this discretion by reducing vesting to exclude any payments in relation to the 2008 financial year.

The total payments made to directors of the Bank on change of control were £914,000 and 16,310 share options.

Subsidiaries
Details of the principal subsidiaries are given in note 24. In accordance with IAS 27, transactions and balances with subsidiaries have been eliminated on
consolidation.

Transactions with Lloyds Banking Group

On 16 January 2009 Lloyds Banking Group plc acquired HBOS plc and its subsidiaries, including Bank of Scotland plc and as a result Lloyds Banking Group and its
subsidiaries became related parties.

The Group transacts with other Lloyds Banking Group companies during the ordinary course of business. Details of transactions and outstanding balances as at and
for the year ended 31 December 2009 are set out below:
2009
£m

Transactions
Interest income 277
Interest expense (823)
Other income 2,530

As at
31 December
2009
£m

Balances
Loans and advances to banks 85,456
Loans and advances to customers 261
Debt securities classified as loans and receivables 554
Trading and other financial assets designated at fair value through profit or loss 876
Derivative assets 664
Available-for-sale financial assets 132
Other assets 197

Deposits from banks (144,876)

Trading and other financial liabilities designated at fair value through profit or loss (5,463)
Debt securities in issue (1,578)
Derivative liabilities (853)
Subordinated liabilities (14)

HM Treasury
On 15 January 2009, HM Treasury subscribed for £8.5 billion of new ordinary shares and £3.0 billion of new preference shares in HBOS plc which, at that time was
the Bank’s ultimate parent company. Consequently, from 15 January 2009, HM Treasury became a related party of the Bank. On 16 January 2009, the
HBOS Group was acquired by Lloyds Banking Group plc, which became the Bank’s ultimate parent company. As at 16 January 2009, HM Treasury had a
43.4 per cent interest in Lloyds Banking Group plc, and therefore HM Treasury remained a related party of the Bank.

There were no material transactions between the Group and HM Treasury during the period between 15 January 2009 and 31 December 2009 that were not made
in the ordinary course of business or that are unusual in their nature or conditions.

Other related party disclosures

In the year ended 31 December 2009, the Group provided both administration and processing services to Sainsbury’s Bank plc. The amount payable to the Group
during the year was £34 million (2008: £26 million), of which £10 million was outstanding at the year end (2008: £10 million). At 31 December 2009,
Sainsbury’s Bank plc also had balances with the Group and the Bank that were included in loans and advances to banks of £1,218 million (2008: £906 million).
Balances with the Group and Bank that were included in deposits by banks were £1,405 million (2008: £1,274 million) and £1,405 million
(2008: £1,274 million) respectively.

The Group has a number of associates held by its venture capital business that it accounts for at fair value through profit or loss. At 31 December 2009, these
companies had total assets of approximately £11,816 million (2008: £12,113 million ), total liabilities of approximately £12,106 million (2008: £11,068 million)
and for the year ended 31 December 2009 had turnover of approximately £8,766 million (2008: £7,411 million) and made a net loss of approximately
£557 million (2008: net loss of £36 million). In addition, the Group has provided £5,245 million (2008: £5,986 million) of financing to these companies on which
it received £140 million (2008: £207 million) of interest income in the year.

Banking transactions are entered into by the Bank with its subsidiaries in the normal course of business and are at normal commercial terms. These include loans,
deposits and foreign currency transactions.

58
 Bank of Scotland plc

Notes to the consolidated financial statements

42 Related party transactions (continued)

At 31 December 2009 the Group had loans and advances to customers of £12,216 million (2008: £14,180 million), the Bank had loans and advances to
customers of £12,197 million (2008: £14,153 million), and the Group and Bank had outstanding balances within customer accounts of £174 million
(2008: £213 million) relating to jointly controlled entities and associated undertakings.
At 31 December 2009, the Group’s pension funds had call deposits with Bank of Scotland plc amounting to £46 million (2008: £34 million).
Included within the balances of the Group and Bank are the following amounts relating to fellow subsidiary undertakings: Group: loans and advances to customers
£35,460 million (2008: £36,341 million), customer accounts £33,395 million (2008: £37,354 million); Bank: loans and advances to customers £34,829 million
(2008: £37,106 million), customer accounts £33,385 million (2008: £38,513 million).
Included within balances of the Bank are the following amounts relating to its own subsidiaries: loans and advances to banks £17,193 million
(2008: £22,826 million), loans and advances to customers £57,730 million (2008: £141,859 million), deposits by banks £3,402 million
(2008: £7,676 million), customer accounts £45,346 million (2008: £76,407 million).
The ultimate parent of the Group during 2008 was HBOS plc. The Group entered into banking transactions with it and its subsidiaries in the normal course of
business. Interest income and interest expense for the year ended 31 December 2009 was £1,948 million and £627 million respectively (2008: £2,101 million and
£2,873 million respectively). HBOS plc is the principal employer of the Group and staff and other costs of £2,187 million (2008: £2,251 million) were recharged to
the Group in the year ended 31 December 2009.

43 Cash flow statement

a Change in operating assets

Group Bank
2009 2008 2009 2008
£m £m £m £m

Change in loans and advances to banks (10,772) (8,350) (3,624) (8,686)

Change in loans and advances to customers 16,824 (12,748) 111,554 (116,665)
Change in debt securities held as loans and receivables 7,667 (10,331) (4,425) (77,272)
Change in derivative financial instruments, trading and other financial assets at fair value through profit or loss 15,858 13,511 11,872 19,800
Change in other operating assets 15,627 (55,127) 2,767 2,523
Change in operating assets 45,204 (73,045) 118,144 (180,300)

b Change in operating liabilities

Group Bank
2009 2008 2009 2008
£m £m £m £m

Change in deposits from banks 77,272 55,553 71,155 49,770

Change in customer deposits (11,428) (10,486) (73,049) 142,118
Change in debt securities in issue (69,291) (18,072) (74,389) (5,732)
Change in derivative financial instruments, trading and other liabilities at fair value through profit or loss (4,854) 3,743 (3,921) 5,477
Change in investment contract liabilities – (98) – –
Change in other operating liabilities 9,212 2,678 10,583 (673)
Change in operating liabilities 911 33,318 (69,621) 190,960

c Non-cash and other items

Group Bank
2009 2008 2009 2008
£m £m £m £m

Depreciation and amortisation 1,093 1,542 219 313

Revaluation of investment properties 13 9 – –
Allowance for loan losses 19,430 10,780 16,597 10,036
Write-off of allowance for loan losses (7,458) (2,408) (6,795) (2,021)
Impairment of available-for-sale securities 620 1,270 99 659
Impairment of goodwill 385 142 – 50
Impairment losses on investments in subsidiaries – – 4,449 107
Change in insurance contract liabilities – (24) – –
Other provision movements 102 173 103 197
Other non-cash items 9,733 2,491 6,546 1,409
Total non-cash items 23,918 13,975 21,218 10,750
Interest expense on subordinated liabilities 742 1,323 681 1,045
Loss on disposal of businesses 100 845 – –
Total other items 842 2,168 681 1,045
Non-cash and other items 24,760 16,143 21,899 11,795

59
 Bank of Scotland plc

Notes to the consolidated financial statements

43 Cash flow statement (continued)

d Analysis of cash and cash equivalent as shown in the balance sheet

Group Bank
2009 2008 2009 2008
£m £m £m £m

Cash and balances with central banks 2,905 2,502 2,168 1,820
Less: mandatory reserve deposits1 (336) (315) (323) (296)
2,569 2,187 1,845 1,524
Loans and advances to banks 91,259 12,445 108,133 34,144
Less: amounts with a maturity of three months or more (17,437) (6,665) (19,939) (16,315)
73,822 5,780 88,194 17,829
Total cash and cash equivalents 76,391 7,967 90,039 19,353

1
Mandatory reserve deposits are held with local central banks in accordance with statutory requirements; these deposits are not available to finance the Group’s day-to-
day operations.

e Analysis of changes in financing during the year

Group Bank
2009 2008 2009 2008
£m £m £m £m

Share capital (including share premium account and merger reserve):

At 1 January 13,942 8,442 13,942 8,442
Issue of share capital:
Private placement 20,189 5,500 20,189 5,500
At 31 December 34,131 13,942 34,131 13,942

Group Bank
2009 2008 2009 2008
£m £m £m £m

Minority interests:
At 1 January 264 356 – –
Exchange and other adjustments – 11 – –
Minority interest acquired – 242 – –
Repayment of capital to minority shareholders (59) (353) – –
Minority share of profit after tax 13 51 – –
Dividends to minority shareholders (12) (43) – –
At 31 December 206 264 – –

Group Bank
2009 2008 2009 2008
£m £m £m £m

Subordinated liabilities:
At 1 January 18,779 18,082 18,082 14,855
Exchange and other adjustments (314) 1,102 (249) 1,097
Issue of subordinated liabilities – 3,000 – 3,000
Repayments of subordinated liabilities (1,781) (3,405) (1,781) (870)
At 31 December 16,684 18,779 16,052 18,082

f Acquisition of group undertakings, joint ventures and associates

Group Bank
2009 2008 2009 2008
£m £m £m £m

Capital subscriptions in joint ventures and associates (279) (454) – –

Additional capital injections and investment in subsidiaries – – (2,517) (1,217)
At 31 December (279) (454) (2,517) (1,217)

60
 Bank of Scotland plc

Notes to the consolidated financial statements

43 Cash flow statement (continued)

g Disposal and closure of group undertakings, joint ventures and associates

Group Bank
2009 2008 2009 2008
£m £m £m £m

Cash and balances at central banks – 577 – –

Trading and other financial assets at fair value through profit or loss – 490 – –
Liabilities arising from insurance contracts and participating investment contracts – (27) – –
Liabilities arising from non-participating investment contracts – (77) – –
Other net assets and liabilities – 1,626 – –
– 2,589 – –
Loss on sale of businesses (100) (845) – –
Cash and cash equivalents disposed of – (577) – –
Net cash inflow from disposals (100) 1,167 – –
Capital redemptions in joint ventures and associates 237 57 – –
At 31 December 137 1,224 – –

44 Contingent liabilities and commitments

Legal proceedings

Payment protection insurance

In January 2009, the UK Competition Commission (the ‘Competition Commission’) completed its formal investigation into the supply of Payment Protection
Insurance (PPI) services (except store card PPI) to non-business customers in the UK and published its final report setting out its remedies. The Competition
Commission decided to adopt various remedies including a prohibition on the active sale of PPI by a distributor to a customer within seven days of the distributor’s
sale of credit to that customer.

On 30 March 2009, Barclays Bank plc lodged an appeal in the UK Competition Appeal Tribunal (the ‘Competition Appeal Tribunal’) against the Competition
Commission’s findings. Lloyds Banking Group, was granted permission by the Competition Appeal Tribunal to intervene in the appeal. The Competition Appeal
Tribunal handed down its judgment on 16 October 2009 finding in favour of Barclays in respect of its challenge to the Competition Commission’s prohibition of
distributors selling PPI at the credit point of sale but it did not uphold Barclays’ challenge to the Competition Commission’s findings on market definition. The matter
has now been referred back to the Competition Commission. This may or may not result in the Competition Commission ultimately reaching a different conclusion.

On 1 July 2008 the Financial Ombudsman Service referred concerns regarding the handling of PPI complaints to the FSA as an issue of wider implication. The Lloyds
Banking Group has been working with other industry members and trade associations in preparing an industry response to address regulatory concerns regarding the
handling of PPI complaints. On 29 September 2009, the FSA issued a consultation paper on PPI complaints handling. The FSA has escalated its regulatory activity in
relation to past PPI sales generally and has proposed new guidance on the fair assessment of a complaint and the calculation of redress and a new rule requiring firms
to reassess historically rejected complaints.

The statement on 29 September 2009 also announced that several firms had agreed to carry out reviews of past sales of single premium loan protection insurance.
The Lloyds Banking Group has subsequently agreed in principle that it will undertake a review in relation to sales of single premium loan protection insurance made
through its branch network since 1 July 2007. The precise details of the review are still being discussed with the FSA. The ultimate impact on the Group of any review
and/or reassessment can only be known at the conclusion of these discussions and on publication of the FSA’s final rules.

Interchange fees
The European Commission has adopted a formal decision finding that an infringement of European Commission competition laws has arisen from arrangements
whereby MasterCard issuers charged a uniform fallback interchange fee in respect of cross-border transactions in relation to the use of a MasterCard or Maestro
branded payment card. The European Commission has required that the fee be reduced to zero for relevant cross-border transactions within the European Economic
Area. This decision has been appealed to the General Court of the European Union (the ‘General Court’). Bank of Scotland plc (along with certain other MasterCard
issuers) have successfully applied to intervene in the appeal in support of MasterCard’s position that the arrangements for the charging of a uniform fallback
interchange fee are compatible with European Commission competition laws. Meanwhile, the European Commission and the UK’s OFT are pursuing investigations
with a view to deciding whether arrangements adopted by other payment card schemes for the levying of uniform fallback interchange fees in respect of domestic and/
or cross-border payment transactions also infringe European Commission and/or UK competition laws. As part of this initiative the OFT will also intervene in the
General Court appeal supporting the European Commission’s position. The ultimate impact of the investigations on the Group can only be known at the conclusion of
these investigations and any relevant appeal proceedings.

Unarranged overdraft charges

The Supreme Court published its judgement in respect of the fairness of unarranged overdraft charges on personal current accounts on 25 November 2009, finding in
favour of the litigant banks. On 22 December 2009, the OFT announced that it will not continue its investigation into the fairness of these charges. The Group is
working with the regulators to ensure that outstanding customer complaints are concluded as quickly as possible and anticipate that most cases in the county courts
will be discontinued. The Group expects that some customers will argue that despite the test case ruling they are entitled to a refund of unarranged overdraft charges
on the basis of other legal arguments or challenges. The Group would robustly defend any such complaints or claims and does not expect the outcome of any such
complaints or claims to have a material adverse effect on its financial position.

61
 Bank of Scotland plc

Notes to the consolidated financial statements

44 Contingent liabilities and commitments (continued)

Other legal proceedings

In addition, during the ordinary course of business the Group is subject to threatened or actual legal proceedings both in the UK and overseas. All such material cases
are periodically reassessed, with the assistance of external professional advisers where appropriate, to determine the likelihood of the Lloyds Banking Group incurring
a liability. In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management’s best
estimate of the amount required to settle the obligation at the relevant balance sheet date. In some cases it will not be possible to form a view, either because the facts
are unclear or because further time is needed to properly assess the merits of the case and no provisions are held against such cases. However the Lloyds Banking
Group does not currently expect the final outcome of any such case to have a material adverse effect on its financial position.

Contingent liabilities and commitments arising from the banking business

Acceptances and endorsements arise where the Group agrees to guarantee payment on a negotiable instrument drawn up by a customer.

Other items serving as direct credit substitutes include standby letters of credit, or other irrevocable obligations, where the Group has an irrevocable obligation to pay a
third party beneficiary if the customer fails to repay an outstanding commitment; they also include acceptances drawn under letters of credit or similar facilities where
the acceptor does not have specific title to an identifiable underlying shipment of goods.

Performance bonds and other transaction-related contingencies (which include bid or tender bonds, advance payment guarantees, VAT Customs & Excise bonds and
standby letters of credit relating to a particular contract or non-financial transaction) are undertakings where the requirement to make payment under the guarantee
depends on the outcome of a future event.

The Group’s maximum exposure to loss is represented by the contractual nominal amount detailed in the table below. Consideration has not been taken of any
possible recoveries from customers for payments made in respect of such guarantees under recourse provisions or from collateral held.
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Contingent liabilities
Acceptances and endorsements 5 – 3 –
Other:
Other items serving as direct credit substitutes 99 73 99 73
Performance bonds and other transaction-related contingencies 1,251 1,279 2,332 979
1,350 1,352 2,431 1,052
1,355 1,352 2,434 1,052

The contingent liabilities of the Group, as detailed above, arise in the normal course of its banking business and it is not practicable to quantify their future
financial effect.
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Commitments
Documentary credits and other short-term trade-related transactions 69 137 34 76
Undrawn formal standby facilities, credit lines and other commitments to lend:
Less than 1 year original maturity:
Mortgage offers made 6,188 11,847 6,085 10,980
Other commitments 30,130 38,364 50,955 36,136
36,318 50,211 57,040 47,116
1 year or over original maturity 17,665 26,341 16,510 24,203
54,052 76,689 73,584 71,395

Of the amounts shown above in respect of undrawn formal standby facilities, credit lines and other commitments to lend, £30,124 million (2008: £49,551 million)
for the Group and £63,207 million (2008: £46,081 million) for the Bank were irrevocable.

Operating lease commitments

Where a Group company is the lessee the future minimum lease payments under non-cancellable premises operating leases are as follows:
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Not later than 1 year 174 161 138 124

Later than 1 year and not later than 5 years 608 593 492 453
Later than 5 years 1,095 1,120 701 751
1,877 1,874 1,331 1,328

62
 Bank of Scotland plc

Notes to the consolidated financial statements

44 Contingent liabilities and commitments (continued)

Operating lease payments represent rental payable by the Group for certain of its properties. Some of these operating lease arrangements have renewal options and
rent escalation clauses, although the effect of these is not material. No arrangements have been entered into for contingent rental payments.

Capital commitments
Excluding commitments of the Group in respect of investment property (note 23), capital expenditure contracted but not provided for at 31 December 2009
amounted to £127 million for the Group and nil for the Bank (2008: £144 million for the Group and nil for the Bank). Of the capital commitments of the Group,
£107 million (2008: £126 million) relates to assets to be leased to customers under operating leases. The Group’s management is confident that future net revenues
and funding will be sufficient to cover these commitments.

45 Financial instruments
(1) Measurement basis of financial assets and liabilities
The accounting policies in accounting policy 2(f) describe how different classes of financial instruments are measured, and how income and expenses, including fair
value gains and losses, are recognised. The following table analyses the carrying amounts of the financial assets and liabilities by category and by balance sheet
heading.
At fair value
The Group through profit or loss
Derivatives
designated Designated Held at
as hedging Held for upon initial Available- Loans and amortised
instruments trading recognition for-sale receivables cost Total
£m £m £m £m £m £m £m

As at 31 December 2009
Financial assets
Cash and balances at central banks – – – – – 2,905 2,905
Items in the course of collection from banks – – – – – 534 534
Trading and other financial assets at fair value through profit or loss – 27,611 256 – – – 27,867
Derivative financial instruments 8,945 21,277 – – – – 30,222
Loans and receivables:
Loans and advances to banks – – – – 91,259 – 91,259
Loans and advances to customers – – – – 439,538 – 439,538
Debt securities – – – – 31,211 – 31,211
– – – – 562,008 – 562,008
Available-for-sale financial assets – – – 21,565 – – 21,565
Total financial assets 8,945 48,888 256 21,565 562,008 3,439 645,101
Financial liabilities
Deposits from banks – – – – – 174,338 174,338
Customer deposits – – – – – 265,971 265,971
Items in course of transmission to banks – – – – – 495 495
Trading and other financial liabilities at fair value through
profit or loss – 27,372 – – – – 27,372
Derivative financial instruments 9,658 17,794 – – – – 27,452
Notes in circulation – – – – – 981 981
Debt securities in issue – – – – – 119,157 119,157
Subordinated liabilities – – – – – 16,684 16,684
Total financial liabilities 9,658 45,166 – – – 577,626 632,450

63
 Bank of Scotland plc

Notes to the consolidated financial statements

45 Financial instruments (continued)

At fair value
The Group through profit or loss
Derivatives
designated Designated Held at
as hedging Held for upon initial Available- Loans and amortised
instruments trading recognition for-sale receivables cost Total
£m £m £m £m £m £m £m

As at 31 December 2008
Financial assets
Cash and balances at central banks – – – – – 2,502 2,502
Items in the course of collection from banks – – – – – 445 445
Trading and other financial assets at fair value through profit or loss – 22,571 859 – – – 23,430
Derivative financial instruments 22,082 28,435 – – – – 50,517
Loans and receivables:
Loans and advances to banks – – – – 12,445 – 12,445
Loans and advances to customers – – – – 488,213 – 488,213
Debt securities – – – – 38,878 – 38,878
– – – – 539,536 – 539,536
Available-for-sale financial assets – – – 28,035 – – 28,035
Total financial assets 22,082 51,006 859 28,035 539,536 2,947 644,465
Financial liabilities
Deposits from banks – – – – – 97,066 97,066
Customer deposits – – – – – 277,399 277,399
Items in course of transmission to banks – – – – – 521 521
Trading and other financial liabilities at fair value through profit or
loss – 18,851 – – – – 18,851
Derivative financial instruments 12,002 28,825 – – – – 40,827
Notes in circulation – – – – – 957 957
Debt securities in issue – – – – – 188,448 188,448
Subordinated liabilities – – – – – 18,779 18,779
Total financial liabilities 12,002 47,676 – – – 583,170 642,848

64
 Bank of Scotland plc

Notes to the consolidated financial statements

45 Financial instruments (continued)

At fair value through

The Bank profit or loss
Derivatives
designated Designated Held at
as hedging Held for upon initial Available- Loans and amortised
instruments trading recognition for-sale receivables cost Total
£m £m £m £m £m £m £m

As at 31 December 2009
Financial assets
Cash and balances at central banks – – – – – 2,168 2,168
Items in the course of collection from banks – – – – – 538 538
Trading and other financial assets at fair value through profit or loss – 27,611 17 – – – 27,628
Derivative financial instruments 8,957 17,723 – – – – 26,680
Loans and advances to banks – – – – 108,133 – 108,133
Loans and advances to customers – – – – 439,967 – 439,967
Debt securities – – – – 23,684 – 23,684
– – – – 571,784 – 571,784
Available-for-sale financial assets – – – 19,316 – – 19,316
Total financial assets 8,957 45,334 17 19,316 571,784 2,706 648,114
Financial liabilities
Deposits from banks – – – – – 168,246 168,246
Customer deposits – – – – – 300,124 300,124
Items in course of transmission to banks – – – – – 495 495
Trading and other financial liabilities at fair value
through profit or loss – 27,372 – – – – 27,372
Derivative financial instruments 9,633 17,538 – – – – 27,171
Notes in circulation – – – – – 981 981
Debt securities in issue – – – – – 98,075 98,075
Subordinated liabilities – – – – – 16,052 16,052
Total financial liabilities 9,633 44,910 – – – 583,973 638,516

At fair value through

The Bank profit or loss
Derivatives
designated Designated Held at
as hedging Held for upon initial Available- Loans and amortised
instruments trading recognition for-sale receivables cost Total
£m £m £m £m £m £m £m

As at 31 December 2008
Financial assets
Cash and balances at central banks – – – – – 1,820 1,820
Items in the course of collection from banks – – – – – 449 449
Trading and other financial assets at fair value through profit or loss – 22,571 349 – – – 22,920
Derivative financial instruments 15,454 27,806 – – – – 43,260
Loans and advances to banks – – – – 34,144 – 34,144
Loans and advances to customers – – – – 578,528 – 578,528
Debt securities – – – – 19,259 – 19,259
– – – – 631,931 – 631,931
Available-for-sale financial assets – – – 24,339 – – 24,339
Total financial assets 15,454 50,377 349 24,339 631,931 2,269 724,719
Financial liabilities
Deposits from banks – – – – – 97,091 97,091
Customer deposits – – – – – 373,173 373,173
Items in course of transmission to banks – – – – – 522 522
Trading and other financial liabilities at fair value through
profit or loss – 18,851 – – – – 18,851
Derivative financial instruments 11,736 27,877 – – – – 39,613
Notes in circulation – – – – – 957 957
Debt securities in issue – – – – – 172,464 172,464
Subordinated liabilities – – – – – 18,082 18,082
Total financial liabilities 11,736 46,728 – – – 662,289 720,753

65
 Bank of Scotland plc

Notes to the consolidated financial statements

45 Financial instruments (continued)

(2) Reclassification of financial assets

In accordance with the amendment to IAS 39 that became applicable during 2008, the Group reviewed the categorisation of its financial assets classified as held for
trading and available-for-sale. On the basis that there was no longer an active market for some of those assets, which are therefore more appropriately managed as
loans, the Group reclassified the following financial assets:
In January 2009, the Group reclassified £1,825 million of debt securities classified as held for trading to debt securities classified as loans and receivables.
In addition, the Group reclassified £649 million of securities classified as available-for-sale to debt securities classified as loans and receivables.
With effect from 1 July 2008, the Group transferred £12,210 million of assets previously classified as held for trading into available-for-sale.
With effect from 1 November 2008, the Group transferred £35,446 million of assets previously classified as available-for-sale into loans and receivables.
At the time of these transfers, the Group had the intention and ability to hold them for the foreseeable future or until maturity. As at the date of reclassification, the
weighted average effective interest rate of the assets transferred was 0.7 per cent to 9.5 per cent with the estimated recoverable cash flows of £56,743 million.

Carrying amount and fair values of reclassified assets

The table below sets out the carrying value and fair value of reclassified financial assets.
31 December 2009 31 December 2008
Carrying Fair Carrying Fair
Value Value Value Value
£m £m £m £m

From held for trading to loans and receivables 1,428 1,120 – –

From held for trading to available-for-sale 10,478 10,176 13,542 13,542
From available-for-sale to loans and receivables 29,153 27,820 37,173 36,191
41,059 39,116 50,715 49,733

Additional fair value gains (losses) that would have been recognised had the reclassifications not occurred
The table below shows the additional gains (losses) that would have been recognised since the date of reclassification in the Group’s income statement or through the
Group’s available-for-sale revaluation reserve if the reclassifications had not occurred.
2009 2008
Reclassified Reclassified Reclassified
in 2009 in 2008 Total in 2008 Total
£m £m £m £m £m

From held for trading to loans and receivables 13 – 13 – –

From held for trading to available-for-sale – 904 904 981 981
From available-for-sale to loans and receivables1 70 1,147 1,217 708 708
83 2,051 2,134 1,689 1,689

1
amounts recognised through available-for-sale revaluation reserve (post tax).

Actual amounts recognised in respect of reclassified assets

After reclassification the reclassified financial assets contributed the following amounts to the Group income statement:
2009 2008
Reclassified Reclassified Reclassified
in 2009 in 2008 Total in 2008 Total
£m £m £m £m £m

From held for trading to loans and receivables:

Net interest income 45 – 45 – –
Impairment losses (110) – (110) – –
Gains on disposal 17 – 17 – –
Total (48) – (48) – –
From held for trading to available-for-sale:
Net interest income – 281 281 442 442
Impairment losses – (305) (305) (215) (215)
Gains on disposal – 70 70 – –
Total – 46 46 227 227
From available-for-sale to loans and receivables:
Net interest income 25 377 402 82 82
Impairment losses – (371) (371) (558) (558)
Gains (losses) on disposal – (152) (152) 16 16
Total 25 (146) (121) (460) (460)

66
 Bank of Scotland plc

Notes to the consolidated financial statements

45 Financial instruments (continued)

(3) Fair values of financial assets and liabilities

The following table 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.
The Group The Bank
Carrying Carrying Carrying Carrying
value value Fair value Fair value value value Fair value Fair value
2009 2008 2009 2008 2009 2008 2009 2008
£m £m £m £m £m £m £m £m

Financial assets
Trading and other financial assets at fair value through
profit or loss 27,867 23,430 27,867 23,430 27,628 22,920 27,628 22,920
Derivative financial instruments 30,222 50,517 30,222 50,517 26,680 43,260 26,680 43,260
Loans and receivables:
Loans and advances to banks 91,259 12,445 91,322 12,478 108,133 34,144 108,193 34,179
Loans and advances to customers 439,538 488,213 418,005 477,260 439,967 578,528 419,440 568,089
Debt securities 31,211 38,878 37,736 38,056 23,684 19,259 29,045 18,852
Available-for-sale financial assets 21,565 28,035 21,565 28,035 19,316 24,339 19,316 24,339
Financial liabilities
Deposits from banks 174,338 97,066 174,413 97,100 168,246 97,091 168,319 97,126
Customer deposits 265,971 277,399 266,005 278,150 300,124 373,173 299,659 373,763
Trading and other financial liabilities at fair value
through profit or loss 27,372 18,851 27,372 18,851 27,372 18,851 27,372 18,851
Derivative financial instruments 27,452 40,827 27,452 40,827 27,171 39,613 27,171 39,613
Debt securities in issue 119,157 188,448 116,133 182,470 98,075 172,464 95,318 167,573
Subordinated liabilities 16,684 18,779 15,548 20,839 16,052 18,082 14,915 17,514

(4) Valuation methodology

Financial instruments include financial assets, financial liabilities and derivatives. The fair value of a financial instrument is the amount at which the instrument could
be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.

Wherever possible, fair values have been estimated using market prices for instruments held by the Group. Where market prices are not available, or are unreliable
because of poor liquidity, fair values have been determined using valuation techniques which, to the extent possible, use market observable inputs. Valuation
techniques used include discounted cash flow analysis and pricing models and, where appropriate, comparison to instruments with characteristics either identical or
similar to those of the instruments held by the Group. These estimation techniques are necessarily subjective in nature and involve several assumptions.

Because a variety of estimation techniques are employed and significant estimates made, comparisons of fair values between financial institutions may not be
meaningful. Readers of these financial statements are thus advised to use caution when using this data to evaluate the Group’s financial position.

Fair value information is not provided for items that do not meet the definition of a financial instrument. These items include intangible assets, premises, equipment
and shareholders’ equity. These items are material and accordingly the Group believes that the fair value information presented does not represent the underlying
value of the Group.

The table below provides 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.

Valuation hierarchy
Level 1 Level 2 Level 3 Total
At 31 December 2009 £m £m £m £m

Trading and other financial assets at fair value through profit or loss (i) 2,881 23,861 1,125 27,867
Available-for-sale financial assets (ii) 1,819 17,881 1,865 21,565
Derivative financial instruments (iii) 20 30,128 74 30,222
Financial assets 4,720 71,870 3,064 79,654
Trading and other financial liabilities at fair value through profit or loss (iv) 511 26,861 – 27,372
Derivative financial instruments (iii) 22 27,234 196 27,452
Financial liabilities 533 54,095 196 54,824

67
 Bank of Scotland plc

Notes to the consolidated financial statements

45 Financial instruments (continued)

Level 1 Level 2 Level 3 Total

At 31 December 2008 £m £m £m £m

Trading and other financial assets at fair value through profit or loss 5,799 14,476 3,155 23,430
Available-for-sale financial assets 786 24,959 2,290 28,035
Derivative financial instruments 121 49,827 569 50,517
Financial assets 6,706 89,262 6,014 101,982
Trading and other financial liabilities at fair value through profit or loss – 18,851 – 18,851
Derivative financial instruments 55 39,670 1,102 40,827
Financial liabilities 55 58,521 1,102 59,678

There were no significant transfers between Level 1 and Level 2 portfolios during the year.

Level 1 portfolios
Level 1 fair value measurements are those derived from unadjusted quoted prices in active markets for identical assets or liabilities. Products classified as level 1
predominantly comprise government securities.

Level 2 portfolios
Level 2 valuations are those where quoted market prices are not available, for example where the instrument is traded in a market that is not considered to be active
or valuation techniques are used to determine fair value and where these techniques use inputs that are based significantly on observable market data, the instrument
is considered to be level 2. Examples of such financial instruments include most over-the-counter derivatives, financial institution issued securities, certificates of
deposit and certain asset-backed securities.

Level 3 portfolios
Level 3 portfolios are those where at least one input which could have a significant effect on the instrument’s valuation is not based on observable market data. Such
instruments would include the Group’s venture capital and unlisted equity investments which are valued using various valuation techniques that require significant
management judgement in determining appropriate assumptions, including earnings multiples and estimated future cash flows. Certain of the Group’s asset-backed
securities, principally where there is no trading activity in such securities, are also classified as level 3.

Level 3 portfolio
At 31 December 2009 Valuation basis/technique Main assumptions Carrying Effect of
value reasonably
possible
alternative
assumptions
£m £m

Trading and other financial assets at fair

value through profit or loss:
Asset-backed securities Industry standard model/consensus pricing Prepayment rates, probability of default, 891 74
from market data provider loss given default and yield curves
Equity investments Various valuation techniques Earnings, net asset value, underlying asset 234
values, property prices, forecast cash flows

1,125
Available-for-sale financial assets
Equity investments Various valuation techniques Earnings, net asset value, underlying asset 1,865
values, property prices, forecast cash flows

Derivative financial assets Industry standard model/consensus pricing Prepayment rates, probability of default, 74 31
from market data provider loss given default and yield curves

Financial assets 3,064

Derivative financial liabilities Industry standard model/consensus pricing Prepayment rates, probability of default, 196 8
from market data provider loss given default and yield curves

Financial liabilities 196

Reasonably possible alternative valuations have been calculated for asset-backed securities by using alternative pricing sources and calculating an absolute difference
and for derivative financial instruments by flexing the spread between the underlying asset and the credit derivative, or adjusting market yields, by a reasonable
amount.

68
 Bank of Scotland plc

Notes to the consolidated financial statements

45 Financial instruments (continued)

The valuation techniques used for unlisted equities vary depending on the nature of the investment. Further details of these are given below. As these factors differ for
each investment depending on the nature of the valuation technique used and the inputs there is no single common factor that could be adjusted to provide a
reasonable alternative valuation for these investments portfolios.

The main products where level 3 valuations have been used are described below:

Asset-backed securities
Where there is no trading activity in asset-backed securities, valuation models, consensus pricing information from third party pricing services and broker or lead
manager quotes are used to determine an appropriate valuation. Asset-backed securities are then classified as either level 2 or level 3 depending on whether there is
more than one consistent independent source of data. If there is a single, uncorroborated market source for a significant valuation input or where there are materially
inconsistent levels then the valuation is reported as level 3. Asset classes classified as level 3 mainly comprise certain residential mortgage backed securities,
collateralised loan obligations and collateralised debt obligations.

Equity investments
Unlisted equities and funds accounted for as available-for-sale assets are valued using different techniques as a result of the variety of investments across the
portfolio. A valuation technique is selected for each investment in accordance with the Group’s valuation policy. Depending on the business sector and the
circumstances of the investment, unlisted equity valuations are based on earnings multiples, net asset values or discounted cash flows.

– The earnings multiple methodology involves applying the relevant earnings multiple to the maintainable earnings of the business being valued. A number of
earnings multiples are used in valuing the portfolio including price earnings, earnings before interest and tax and earnings before interest, tax, depreciation and
amortisation. The particular multiple selected being appropriate for the type of business being valued and is derived by reference to the current market-based
multiple. Consideration is given to the risk attributes, growth prospects and financial gearing of comparable businesses when selecting an appropriate multiple.
Recent transactions involving the sale of similar businesses may sometimes be used as a frame of reference in deriving an appropriate multiple.

– Valuations using net asset values are often used for property-based businesses and use the latest valuations included in management or statutory accounts adjusted
for subsequent movements in property valuations and other factors including recoverability.

– Discounted cash flow valuations use estimated future cash flows, usually based on management forecasts, with the application of appropriate exit yields or terminal
multiples and discounted using rates appropriate to the specific investment, business sector or recent economic rates of return.

For fund investments the most recent capital account value calculated by the fund manager is used as the basis for the valuation and adjusted, if necessary, to align
valuation techniques with the Group’s valuation policy.

Derivatives
Where the Group’s derivative assets and liabilities are not traded on an exchange, they are valued using valuation techniques, including discounted cash flow and
options pricing models, as appropriate. The types of derivatives classified as level 2 and the valuation techniques used include:

– Interest rate swaps which are valued using discounted cash flow models; the most significant inputs into those models are interest rate yield curves which are
developed from publicly quoted rates.

– Foreign exchange derivatives that do not contain options which are priced using rates available from publicly quoted sources.

– Credit derivatives, except for the items classified as level 3 which are valued using publicly available yield and credit default swap curves; the Group uses standard
models with observable inputs.

– Less complex interest rate and foreign exchange option products which are valued using volatility surfaces developed from publicly available interest rate cap,
interest rate swaption and other option volatilities; option volatility skew information is derived from a market standard consensus pricing service. For more complex
option products, the Group calibrates its models using observable at-the-money data; where necessary, the Group adjusts for out-of-the-money positions using a
market standard consensus pricing service.

Where credit protection, usually in the form of credit default swaps, has been purchased or written on asset-backed securities, the securities are referred to as negative
basis asset-backed security and the resulting derivative assets or liabilities have been classified as either level 2 or level 3 according to the classification of the
underlying security.

Credit valuation adjustment

A credit valuation adjustment (CVA) is applied to the Group’s over-the-counter derivative instruments to adjust the counterparty credit risk free derivative valuations
provided by standard interbank lending interest rate curves. The Group uses a simulation model to develop expected future exposures and calculate a bilateral CVA.
Credit and debit valuation adjustments are calculated by counterparty and the net adjustment booked. At 31 December 2009 the total reserve booked was
£585 million (31 December 2008: £607 million). This adjustment has been made to the valuation of over-the-counter derivative instruments classified as level 2.

69
 Bank of Scotland plc

Notes to the consolidated financial statements

45 Financial instruments (continued)

Movement in level 3 portfolio

The table below analyses asset movements in the Level 3 portfolio:
Trading and
other
financial
assets at fair
value Total
through Available Derivative financial
profit or loss for sale assets assets
£m £m £m £m

At 31 December 2008 3,155 2,290 569 6,014

Losses recognised in the income statement (244) (600) (555) (1,399)
Gains recognised in other comprehensive income – 141 – 141
Purchases 8 403 60 471
Sales (51) (259) – (310)
Transfers into the level 3 portfolio – 11 – 11
Transfers out of the level 3 portfolio (1,743) (121) – (1,864)
At 31 December 2009 1,125 1,865 74 3,064

The table below analyses liability movements in the level 3 portfolio. Total
Derivative financial
liabilities liabilities
£m £m

At 31 December 2008 1,102 1,102

Gains recognised in the income statement (123) (123)
Transfers out of the level 3 portfolio (783) (783)
At 31 December 2009 196 196

Included with the gains (losses) recognised in the income statement are losses of £977 million related to financial instruments that are held at the relevant year end.

Fair value of financial instruments carried at amortised cost

Loans and receivables

The Group provides loans and advances to commercial, corporate and personal customers at both fixed and variable rates. The carrying value of the variable rate
loans and those relating to lease financing is assumed to be their fair value. For fixed rate lending, several different techniques are used to estimate fair value, as
considered appropriate. For commercial and personal customers, fair value is principally estimated by discounting anticipated cash flows (including interest at
contractual rates) at market rates for similar loans offered by the Group and other financial institutions. The fair value for corporate loans is estimated by discounting
anticipated cash flows at a rate which reflects the effects of interest rate changes, adjusted for changes in credit risk. Certain loans secured on residential properties
are made at a fixed rate for a limited period, typically two to five years, after which the loans revert to the relevant variable rate. The fair value of such loans is
estimated by reference to the market rates for similar loans of maturity equal to the remaining fixed interest rate period. The fair values of asset-backed securities and
secondary loans, which were previously within assets held for trading and were reclassified to loans and receivables (see page 66), are determined predominantly
from lead manager quotes and, where these are not available, by alternative techniques including reference to credit spreads on similar assets with the same obligor,
market-standard consensus pricing services, broker quotes and other research data.

Deposits from banks and customers

The fair value of deposits repayable on demand is considered to be equal to their carrying value. The fair value for all other deposits is estimated using discounted
cash flows applying either market rates, where applicable, or current rates for deposits of similar remaining maturities.

Debt securities in issue and subordinated liabilities

The fair value of short-term debt securities in issue is approximately equal to their carrying value. Fair value for other debt securities and for subordinated liabilities is
estimated using quoted market prices.

70
 Bank of Scotland plc

Notes to the consolidated financial statements

46 Financial risk management

Financial instruments are fundamental to the Group’s activities and, as a consequence, the risks associated with financial instruments represent a significant
component of the risks faced by the Group.

The Group has adopted the heritage Lloyds TSB approach to risk management.

The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and currency risk; and
liquidity risk. Qualitative and quantitative information about the Group’s management of these risks is given below.

(i) Qualitative information

(1) Credit risk

Definition
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 set by the Lloyds Banking Group board and is described and reported through a suite of metrics derived from a combination of accounting and
credit portfolio performance measures which in turn use the various credit risk rating systems as inputs. These metrics are supported by a comprehensive suite of
policies, sector caps, product and country limits to manage concentration risk and exposures within the Group’s approved risk appetite.

Exposures
The principal sources of credit risk within the Group arise from loans and advances to retail customers, financial institutions and corporate clients. The credit risk
exposures of the Group are set out within this note below.

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, private equity investments, derivatives and foreign exchange activities. Note 15 to the financial statements shows the
total notional principal amount of interest rate, exchange rate, credit derivative and equity and other contracts outstanding at 31 December 2009. The notional
principal amount 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. Such amounts are reflected in the credit risk table on page 75.

Measurement
In measuring the credit risk of loans and advances to customers and to banks at a counterparty level, the Group reflects three components: (i) the ’probability of
default’ 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 loss ratio on the defaulted obligations (the ’loss given default’).

The Group assesses the probability of default of individual counterparties using internal rating models tailored to the various categories of counterparty. In its principal
retail portfolios, and a growing number of wholesale lending portfolios, exposure at default and loss given default models are also in use. 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. All material rating
models are authorised by executive management.

Each probability of default 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. Each rating system is required to map to a master scale, which 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, a retail master scale and a wholesale master scale.

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 models that are used for internal operational management and banking regulation purposes.

Mitigation
The Group uses a range of approaches to mitigate credit risk.

Internal control
– Credit principles and policy: Lloyds Banking Group Risk sets out the Group’s credit principles and policy according to which credit risk is managed, which in turn
is the basis for business unit credit policy. Principles and policy are reviewed regularly and any changes are subject to a review and approval process. Business
unit policy includes lending guidelines, which define the responsibilities of lending officers and provide a disciplined and focused benchmark for credit decisions.

– 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 set and limit breaches are subject to escalation procedures.

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Notes to the consolidated financial statements

46 Financial risk management (continued)

– 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 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 credit risk appetite criteria for counterparty
underwriting are the same as that for assets intended to be held over the period to maturity.

– Credit scoring: In its principal retail portfolios, the Group uses statistically-based decisioning techniques (primarily credit scoring). Business unit risk departments
review scorecard effectiveness and approve changes, with material changes being subject to Lloyds Banking Group risk approval.

– Controls over rating systems: The Group has established an 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. The internal rating systems are
developed and implemented by independent risk functions in the business units 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, supported and challenged by specialist functions in their respective
business unit.

– Cross-border and cross-currency exposures: Country limits are authorised by the Lloyds Banking Group Country Limits Panel taking into account economic and
political factors.

– Concentration risk: Credit risk management includes portfolio controls on certain industries, sectors and product lines to reflect risk appetite. Credit policy is
aligned to the Group’s risk appetite and restricts exposure to certain high risk and more vulnerable sectors and segments. Note 17 provides an analysis of loans
and advances to customers by industry (for wholesale customers) and product (for retail customers). 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 Group’s large exposures are reported in accordance with regulatory reporting requirements.

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

– 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.

– 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.

– Risk assurance and oversight: 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.

Collateral

The principal collateral types for loans and advances are:

– mortgages over residential and commercial real estate;

– 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 Group maintains 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. Collateral or other security is also not usually obtained for credit
risk exposures on derivative instruments, except where the Group requires margin deposits from counterparties.

It is the 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 minimize the credit loss, the Group may seek additional collateral from the counterparty as soon as impairment indicators are identified for the relevant
individual loans and advances.

The 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 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 amounts with the counterparty are terminated and settled on a net
basis. The Group’s overall exposure to credit risk on derivative instruments subject to master netting agreements can change substantially within a short period since it
is affected by each transaction subject to the agreement.

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Notes to the consolidated financial statements

46 Financial risk management (continued)

Other credit risk transfers

The 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
– Portfolio monitoring and reporting: In conjunction with Lloyds Banking Group Risk, business units 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. Lloyds Banking 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 Lloyds Banking Group Business Risk Committee.

– The performance of all rating models is comprehensively monitored on a regular basis, to seek 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.

(2) Market risk

Definition
The risk of reductions in earnings, value and/or reserves, through financial or reputational loss, arising from unexpected changes in financial prices, including interest
rates, inflation rates, exchange rates, credit spreads and prices for bonds, commodities, equities, property and other instruments. It arises in all areas of the 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
Lloyds Banking Group wishes to manage this. This statement of the Lloyds Banking Group’s overall appetite for market risk is reviewed and approved annually by the
Lloyds Banking Group board.

Exposures
The 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. The volatility of market values can be affected by both the transparency of prices and the amount of liquidity in the market for the relevant asset.

Most of the 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 Group’s retail portfolios and in the Group’s capital and funding activities arises from the different repricing characteristics of the 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 Group’s investment in its overseas operations.

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.

Banking - trading assets and other treasury positions

Since the acquisition of HBOS plc, it has been the policy of Lloyds Banking Group to monitor and report its trading and other treasury positions on a consolidated basis
to facilitate management and control and capture diversification benefits it is therefore not appropriate to report this data separately for the Group.

Banking - non-trading
Market risk in non-trading books consists almost entirely of exposure to changes in interest rates. This is the potential impact on earnings and value that could occur
when, if rates fall, liabilities cannot be re-priced as quickly or by as much as assets; or when, if rates rise, assets cannot be re-priced as quickly or by as much as
liabilities.

Risk exposure is monitored monthly at the Lloyds Banking Group level, primarily, market value sensitivity. This methodology considers all re-pricing mismatches in
the current balance sheet and calculates the change in market value that would result from a set of defined interest rate shocks. Where re-pricing maturity is based on
assumptions about customer behaviour these assumptions are also reviewed monthly.

A limit structure exists to ensure that risks stemming from residual and temporary positions or from changes in assumptions about customer behaviour remain within
the Lloyds Banking Group’s risk appetite.

Since the acquisition of HBOS plc, it has been the policy of Lloyds Banking Group to monitor and report its banking-non-trading exposure on a consolidated basis to
facilitate management and control. It is therefore not appropriate to report this data separately for the Group.

73
 Bank of Scotland plc

Notes to the consolidated financial statements

46 Financial risk management (continued)

Mitigation
Various mitigation activities are undertaken across the Group to manage portfolios and seek to ensure they remain within approved limits.

Banking - non-trading activities

Interest rate risk arising from the different repricing characteristics of the Group’s non-trading assets and liabilities, and from the mismatch between interest rate
insensitive liabilities and interest rate sensitive assets, is managed centrally. Matching assets and liabilities are offset against each other and internal interest rate
swaps are also used.

The Group incurs 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.

Monitoring
The Lloyds Banking Group 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 executive management 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 Lloyds Banking 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 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 Group’s retail portfolios and in the Group’s capital and funding activities is managed within limits defined in the detailed Lloyds Banking Group
policy for interest rate risk in the banking book, which is reviewed and approved annually.

(3) Liquidity risk

Definition
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.

Risk appetite
Liquidity risk appetite for the banking businesses is set by the Lloyds Banking Group board and reviewed on an annual basis. It is reported through various metrics
that enable the Lloyds Banking Group to manage liquidity and funding constraints. Executive management, assisted by the Lloyds Banking Group Asset and Liability
Committee regularly reviews performance against risk appetite.

Exposure
Liquidity exposure represents the amount of potential outflows in any future period less committed inflows. 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, liquidity gaps, early warning
indicators and stress test survival period triggers. Strict criteria and limits are in place to ensure highly liquid marketable securities are available as part of the portfolio
of liquid assets.

Mitigation
The Group mitigates the risk of a liquidity mismatch in excess of its risk appetite by managing the liquidity profile of the balance sheet through both short-term liquidity
management and long-term funding strategy. Short-term liquidity management is considered from two perspectives; business as usual and liquidity under stressed
conditions, 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 having an original maturity of more than one year.

The Group’s funding and liquidity position is underpinned by its 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 raise 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 a qualitative analysis of the market’s
capacity for the Group’s credit. The Group has developed strong relationships with certain wholesale market segments, and also has access to central banks and
corporate customers, to supplement its retail deposit base.

Monitoring
Liquidity is actively monitored at business unit and Group level at an appropriate frequency. Routine reporting is in place to executive management and through the
Lloyds Banking Group’s committee structure, in particular the Lloyds Banking Group Asset and Liability Committee which meets monthly. In a stress situation the
level of monitoring and reporting is increased commensurate with the nature of the stress event. Liquidity policies and procedures are subject to independent
oversight.

Daily monitoring and control processes are in place to address both statutory and prudential liquidity requirements. In addition, the framework has two other
important components:

74
 Bank of Scotland plc

Notes to the consolidated financial statements

46 Financial risk management (continued)

– Firstly, Lloyds Banking Group stress tests its potential cash flow mismatch position under various scenarios on an ongoing basis. The cash flow mismatch position
considers on-balance sheet cash flows, commitments received and granted, and material derivative cash flows. Specifically, commitments granted include the
pipeline of new business awaiting completion as well as other standby or revolving credit facilities. Behavioural adjustments are developed, evaluating how the
cash flow position might change under each stress scenario to derive a stressed cash flow position. Scenarios cover both Lloyds Banking Group name specific and
systemic difficulties. The scenarios and the assumptions are reviewed at least annually to gain assurance they continue to be relevant to the nature of the
business.

– Secondly, the Group has a contingency funding plan embedded within the Lloyds Banking Group Liquidity Policy which has been designed to identify emerging
liquidity concerns at an early stage, so that mitigating actions can be taken to avoid a more serious crisis developing.

(ii) Quantitative information

The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk;
and liquidity risk. Information about the Group’s exposure to each of the above risks, the Group’s objectives, policies and processes for measuring and managing risk
and the Group’s management of capital can be found below. The following additional disclosures, which provide quantitative information about the risks within
financial instruments held or issued by the Group, should be read in conjunction with that earlier information.

(1) Credit risk

The Group’s credit risk exposure arises predominantly in the United Kingdom, the European Union, Australia and the United States.
The maximum credit risk exposure of the Group in the event of other parties failing to perform their obligations is detailed below. No account is taken of any collateral
held and the maximum exposure to loss is considered to be the balance sheet carrying amount or, for non-derivative off-balance sheet transactions and financial
guarantees, their contractual nominal amounts.
The Group The Bank
2009 2008 2009 2008
£m £m £m £m
Loans and receivables:
Loans and advances to banks 91,259 12,445 108,133 34,144
Loans and advances to customers 460,810 498,906 458,708 589,003
Debt securities 33,126 39,801 25,211 19,674
Deposit amounts available for offset1 (9,257) (15,198) (9,257) (15,198)
Impairment losses (23,187) (11,616) (20,268) (10,890)
552,751 524,338 562,527 616,733
Available-for-sale financial assets (excluding equity shares) 19,631 25,778 18,239 23,276
Trading and other financial assets at fair value through profit or loss (excluding equity shares) 27,615 23,134 27,615 22,917
Derivative assets, before netting 30,222 50,517 26,680 43,260
Amounts available for offset under master netting arrangements1 (19,910) (37,022) (19,910) (37,022)
10,312 13,495 6,770 6,238
Financial guarantees 8,025 10,314 26,974 17,068
Irrevocable loan commitments and other credit-related contingencies2 31,479 50,903 65,641 47,133
Maximum credit risk exposure 649,813 647,962 707,766 733,365
Maximum credit risk exposure before offset items 678,980 700,182 736,933 785,585

1
Deposit amounts available for offset and amounts available for offset under master netting arrangements do not meet the criteria under IAS 32 to enable loans and
advances and derivative assets respectively to be presented net of these balances in the financial statements.
2
See note 44 – Contingent liabilities and commitments for further information.

Loans and advances to banks – the Group may require collateral before entering into a credit commitment with another bank, depending on the type of the financial
product and the counterparty involved, and netting agreements are obtained whenever possible and to the extent that such agreements are legally enforceable.

Available-for-sale debt securities, treasury and other bills, and trading and other financial assets at fair value through profit or loss – the credit quality of the
Group’s available-for-sale debt securities, treasury and other bills, and the majority of the Group’s trading and other financial assets at fair value through profit or loss
held is set out below. An analysis of trading and other financial assets at fair value through profit or loss is included in note 14 and a similar analysis for
available-for-sale financial assets is included in note 22.

Derivative assets – the Group reduces exposure to credit risk by using master netting agreements and by obtaining cash collateral. An analysis of derivative assets is
given in note 15. Of the net derivative assets of the Group shown above of £10,312 million (2008: £13,495 million), cash collateral of £568 million
(2008: £298 million) was held and a further £3,879 million was due from OECD banks (2008: £3,807 million).

75
 Bank of Scotland plc

Notes to the consolidated financial statements

46 Financial risk management (continued)

Financial guarantees – these represent undertakings that the Group will meet a customer’s obligation to third parties if the customer fails to do so. Commitments to
extend credit represent unused portions of authorisations to extend credit in the form of loans, guarantees or letters of credit. The Group is theoretically exposed to loss
in an amount equal to the total guarantees or unused commitments, however, the likely amount of loss is expected to be significantly less; most commitments to
extend credit are contingent upon customers maintaining specific credit standards.

Reverse repurchase and repurchase transactions – for reverse repurchase transactions which are accounted for as collateralised loans, it is the Group’s policy to
seek collateral which is at least equal to the amount loaned. At 31 December 2009, the fair value of collateral accepted under reverse repurchase transactions that
the Group is permitted by contract or custom to sell or repledge was £53,072 million (2008: £15,880 million). Of this, £50,138 million (2008: £9,366 million)
was sold or repledged as at 31 December 2009. The fair value of collateral pledged in respect of repurchase transactions, accounted for as secured borrowings,
where the secured party is permitted by contract or custom to repledge was £138,728 million (2008: £155,838 million).

Stock lending - in addition to the financial assets on the Group’s balance sheet which are subject to repurchase agreements, there are financial assets on the Group’s
balance sheet pledged as collateral as part of securities lending transactions which amounted to £87,191 million at 31 December 2009 (2008: £89,109 million).

Stock borrowing – Securities held as collateral for stock borrowed or under reverse repurchase agreements amounted to £137,635 million at 31 December 2009
(2008: £76,017 million); of which £128,236 million at 31 December 2009 (2008: £64,377 million) had been resold or repledged.

Loans and advances – The Group

Loans and advances to customers
Loans and
advances
designated
Loans and at fair value
advances to Retail – Retail – through
banks mortgages other Wholesale Total profit or loss
£m £m £m £m £m £m

31 December 2009
Neither past due nor impaired 91,259 236,050 17,672 144,763 398,485 18,884
Past due but not impaired – 9,793 805 4,708 15,306 –
Impaired – no provision required – 1,515 26 5,015 6,556 –
– provision held – 4,405 1,438 34,620 40,463 –
Gross 91,259 251,763 19,941 189,106 460,810 18,884
Allowance for impairment losses (note 21) – (1,412) (749) (19,111) (21,272) –
Net 91,259 250,351 19,192 169,995 439,538 18,884
31 December 2008
Neither past due nor impaired 12,445 243,011 21,448 191,398 455,857 9,033
Past due but not impaired – 11,974 660 6,745 19,379 –
Impaired – no provision required – 1,057 1 3,327 4,385 –
– provision held – 2,928 2,556 13,801 19,285 –
Gross 12,445 258,970 24,665 215,271 498,906 9,033
Allowance for impairment losses (note 21) – (1,280) (1,907) (7,506) (10,693) –
Net 12,445 257,690 22,758 207,765 488,213 9,033

The analysis of lending between retail and wholesale has been prepared based upon the type of exposure and not the business segment in which the exposure is
recorded. Included within retail are exposures to personal customers and small businesses, whilst included within wholesale are exposures to corporate customers
and other large institutions.

The criteria that the Group uses to determine that there is objective evidence of an impairment loss are disclosed in accounting policy 2(h). All impaired loans which
exceed certain thresholds are individually assessed for impairment by reviewing expected future cash flows including those that could arise from the realisation of
security. Included in loans and receivables are advances individually determined to be impaired with a gross amount before impairment allowances of
£39,788 million (2008: £17,302 million) which have associated collateral with a fair value of £9,558 million (2008: £4,322 million).

76
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Notes to the consolidated financial statements

46 Financial risk management (continued)

Loans and advances which are neither past due nor impaired – The Group
Loans and advances to customers
Loans and
advances
designated
Loans and at fair value
advances to Retail – Retail – through
banks mortgages other Wholesale Total profit or loss
£m £m £m £m £m £m

31 December 2009
Good quality 91,259 227,558 11,237 56,148 18,884
Satisfactory quality – 6,296 4,212 32,262 –
Lower quality – 746 632 38,712 –
Below standard, but not impaired – 1,450 1,591 17,641 –
Total 91,259 236,050 17,672 144,763 398,485 18,884
31 December 2008
Good quality 12,445 238,891 14,660 69,822 9,033
Satisfactory quality – 3,193 4,796 66,956 –
Lower quality – 371 552 41,295 –
Below standard, but not impaired – 556 1,440 13,325 –
Total 12,445 243,011 21,448 191,398 455,857 9,033

The definitions of good quality, satisfactory quality, lower quality and below standard, but not impaired applying to retail and wholesale are not the same, reflecting
the different characteristics of these exposures and the way they are managed internally, and consequently totals are not provided. Wholesale lending has been
classified using internal probability of default rating models mapped so that they are comparable to external credit ratings. Good quality lending comprises the lower
assessed default probabilities, with other classifications reflecting progressively higher default risk. Classifications of retail lending incorporate expected recovery levels
for mortgages, as well as probabilities of default assessed using internal rating models. Good quality lending includes the lower assessed default probabilities and all
loans with low expected losses in the event of default, with other categories reflecting progressively higher risks and lower expected recoveries.

Loans and advances which are past due but not impaired – The Group
Loans and advances to customers
Loans and
advances
designated
Loans and at fair value
advances to Retail – Retail – through
banks mortgages other Wholesale Total profit or loss
£m £m £m £m £m £m

31 December 2009
0-30 days – 4,693 503 2,123 7,319 –
30-60 days – 2,087 150 787 3,024 –
60-90 days – 1,337 47 740 2,124 –
90-180 days – 1,676 47 538 2,261 –
Over 180 days – – 58 520 578 –
Total – 9,793 805 4,708 15,306 –
Fair value of collateral held – 8,578 n/a n/a n/a
31 December 2008
0-30 days – 343 460 3,917 4,720 –
30-60 days – 5,632 148 1,257 7,037 –
60-90 days – 2,571 28 447 3,046 –
90-180 days – 3,428 10 918 4,356 –
Over 180 days – – 14 206 220 –
Total – 11,974 660 6,745 19,379 –
Fair value of collateral held – 10,096 n/a n/a n/a

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 Bank of Scotland plc

Notes to the consolidated financial statements

46 Financial risk management (continued)

A financial asset is ‘past due’ if a counterparty has failed to make a payment when contractually due.

Collateral held against retail mortgage lending is principally comprised of residential properties; their fair value has been estimated based upon the last actual
valuation, adjusted to take into account subsequent movements in house prices, after making allowance for indexation error and dilapidations. The resulting valuation
has been limited to the principal amount of the outstanding advance in order to provide a clearer representation of the Group’s credit exposure.

Lending decisions are based on an obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. Collateral
values for non-mortgage lending are assessed more rigorously at the time of loan origination or when taking enforcement action and may fluctuate, as in the case of
floating charges, according to the level of assets held by the customer. Whilst collateral is reviewed on a regular basis in accordance with business unit credit policy,
this varies according to the type of lending and collateral involved. It is therefore not practicable to estimate and aggregate current fair values of collateral for
non-mortgage lending.

Loans and advances – The Bank

Loans and
advances
Loans and advances to customers designated
Loans and at fair value
advances Retail – Retail – through
to banks mortgages other Wholesale Total profit or loss
£m £m £m £m £m £m

31 December 2009
Neither past due nor impaired 108,133 216,001 13,044 181,929 410,974 18,884
Past due but not impaired – 8,322 489 3,131 11,942 –
Impaired – no provision required – 787 2 2,340 3,129 –
– provision held – 3,672 1,259 25,217 30,148 –
Gross 108,133 228,782 14,794 212,617 456,193 18,884
Allowance for impairment losses – (1,145) (590) (14,491) (16,226) –
Net 108,133 227,637 14,204 198,126 439,967 18,884

Loans and
advances
Loans and advances to customers designated
Loans and at fair value
advances Retail – Retail – through
to banks mortgages other Wholesale Total profit or loss
£m £m £m £m £m £m

31 December 2008
Neither past due nor impaired 34,144 220,720 13,849 318,955 553,524 9,033
Past due but not impaired – 10,177 516 4,547 15,240 –
Impaired – no provision required – 672 1 1,961 2,634 –
– provision held – 2,526 2,542 12,755 17,823 –
Gross 34,144 234,095 16,908 338,218 589,221 9,033
Allowance for impairment losses – (1,280) (1,907) (7,506) (10,693) –
Net 34,144 232,815 15,001 330,712 578,528 9,033

No impairment allowances have been raised in respect of amounts due from fellow Lloyds Banking Group undertakings.

78
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Notes to the consolidated financial statements

46 Financial risk management (continued)

Loans and advances which are neither past due nor impaired – The Bank
Loans and
advances
Loans and advances to customers designated
Loans and at fair value
advances Retail – Retail – through
to banks mortgages other Wholesale Total profit or loss
£m £m £m £m £m £m

31 December 2009
Good quality 108,133 211,471 8,557 111,494 18,884
Satisfactory quality – 3,302 2,545 22,879 –
Lower quality – 444 569 34,516 –
Below standard, but not impaired – 784 1,373 13,040 –
Total 108,133 216,001 13,044 181,929 410,974 18,884
31 December 2008
Good quality 34,144 218,908 8,896 223,049 9,033
Satisfactory quality – 1,625 3,288 50,326 –
Lower quality – 89 534 35,971 –
Below standard, but not impaired – 98 1,131 9,609 –
Total 34,144 220,720 13,849 318,955 553,524 9,033

Loans and advances which are past due but not impaired – The Bank
Loans and
advances
Loans and advances to customers designated
Loans and at fair value
advances Retail – Retail – through
to banks mortgages other Wholesale Total profit or loss
£m £m £m £m £m £m

31 December 2009
0-30 days – 4,139 286 1,592 6,017 –
30-60 days – 1,652 87 372 2,111 –
60-90 days – 1,065 17 405 1,487 –
90-180 days – 1,466 42 311 1,819 –
Over 180 days – – 57 451 508 –
Total – 8,322 489 3,131 11,942 –
Fair value of collateral held – 7,234 n/a n/a n/a –
31 December 2008
0-30 days – 172 359 3,349 3,880 –
30-60 days – 4,908 122 739 5,769 –
60-90 days – 2,120 11 42 2,173 –
90-180 days – 2,977 10 417 3,404 –
Over 180 days – – 14 – 14 –
Total – 10,177 516 4,547 15,240 –
Fair value of collateral held – 8,338 n/a n/a n/a –

79
 Bank of Scotland plc

Notes to the consolidated financial statements

46 Financial risk management (continued)

Renegotiated loans and advances

Loans and advances that were renegotiated during the year and that would otherwise have been past due or impaired at 31 December 2009 totalled £3,702 million
(2008: £478 million) for the Group and £2,072 million (2008: £424 million) for the Bank.
The Group The Bank
2009 2008 2009 2008
Repossessed collateral £m £m £m £m

Residential property 1,143 617 981 537

Other 17 – – –
Total 1,160 617 981 537

The Group does not take physical possession of properties or other assets held as collateral and uses external agents to realise the value as soon as practicable,
generally at auction, to settle indebtedness. Any surplus funds are returned to the borrower or are otherwise dealt with in accordance with appropriate insolvency
regulations.
The Group The Bank
2009 2008 2009 2008
Loan-to-value ratio of mortgage lending £m £m £m £m

Analysis by loan-to-value ratio of residential mortgage lending which is neither

past due nor impaired:
Less than 70 per cent 88,795 92,098 82,981 88,276
70 per cent to 80 per cent 37,214 33,052 34,422 28,694
80 per cent to 90 per cent 37,177 38,877 34,443 35,315
Greater than 90 per cent 72,864 78,984 64,155 68,435
Total 236,050 243,011 216,001 220,720

Debt securities – analysis by credit rating:

The Group Rated BB
AAA AA A BBB or lower Not rated Total
£m £m £m £m £m £m £m

As at 31 December 2009
Debt securities held at fair value through profit or loss
Trading assets
Government securities 2,059 805 – – – – 2,864
Corporate and other debt securities 1,331 1,613 2,608 283 28 – 5,863
Total held as trading assets 3,390 2,418 2,608 283 28 – 8,727
Other assets held at fair value through profit or loss
Corporate and other debt securities – – – – – 4 4
Total held at fair value through profit or loss* 3,390 2,418 2,608 283 28 4 8,731
Available-for-sale financial assets
Debt securities:
Government securities 12 314 – – – – 326
Bank and building society certificates of deposit 22 142 99 22 – – 285
Asset-backed securities:
Mortgage-backed securities 17 – – – – – 17
Other asset-backed securities 69 10 – – – – 79
86 10 – – – – 96
Corporate and other debt securities 2,011 6,653 8,667 1,350 228 15 18,924
Total debt securities held as available-for-sale financial assets 2,131 7,119 8,766 1,372 228 15 19,631
Debt securities classified as loans and receivables
Asset-backed securities:
Mortgage-backed securities 9,192 2,917 1,524 890 1,032 – 15,555
Other asset-backed securities 11,768 2,308 1,383 412 835 – 16,706
20,960 5,225 2,907 1,302 1,867 – 32,261
Corporate and other debt securities – – – – – 865 865
Total debt securities classified as loans and receivables 20,960 5,225 2,907 1,302 1,867 865 33,126

*This total excludes equity shares of £252 million and loans and advances of £18,884 million.

80
 Bank of Scotland plc

Notes to the consolidated financial statements

46 Financial risk management (continued)

Debt securities – analysis by credit rating:

The Group Rated BB
AAA AA A BBB or lower Not rated Total
£m £m £m £m £m £m £m

As at 31 December 2008
Debt securities held at fair value through profit or loss
Trading assets
Government securities 5,556 236 – – – – 5,792
Corporate and other debt securities 2,543 2,626 2,307 106 164 – 7,746
Total held as trading assets 8,099 2,862 2,307 106 164 – 13,538
Other assets held at fair value through profit or loss
Asset-backed securities 346 – – – – – 346
Corporate and other debt securities – 62 – – – 155 217
Total held at fair value through profit or loss* 8,445 2,924 2,307 106 164 155 14,101
Available-for-sale financial assets
Debt securities:
Government securities 23 343 – 14 – – 380
Bank and building society certificates of deposit 1,032 977 904 45 – – 2,958
Asset-backed securities:
Mortgage-backed securities 5 12 – – – – 17
Other asset-backed securities 240 591 – – – 12 843
245 603 – – – 12 860
Corporate and other debt securities 3,739 9,302 7,926 298 204 111 21,580
Total debt securities held as available-for-sale financial assets 5,039 11,225 8,830 357 204 123 25,778
Debt securities classified as loans and receivables
Asset-backed securities:
Mortgage-backed securities 13,090 1,930 824 1,054 1,375 – 18,273
Other asset-backed securities 15,649 1,735 1,422 785 1,192 – 20,783
28,739 3,665 2,246 1,839 2,567 – 39,056
Corporate and other debt securities – – – – – 745 745
Total debt securities classified as loans and receivables 28,739 3,665 2,246 1,839 2,567 745 39,801

*This total excludes equity shares of £296 million and loans and advances of £9,033 million

There are no material amounts for debt securities, treasury and other bills which are past due but not impaired.

81
 Bank of Scotland plc

Notes to the consolidated financial statements

46 Financial risk management (continued)

Debt securities – analysis by credit rating:

The Bank Rated BB
AAA AA A BBB or lower Not rated Total
£m £m £m £m £m £m £m

As at 31 December 2009
Debt securities held at fair value through profit or loss
Trading assets
Government securities 2,059 805 – – – – 2,864
Corporate and other debt securities 1,331 1,613 2,608 283 28 – 5,863
Total held as trading assets 3,390 2,418 2,608 283 28 – 8,727
Other assets held at fair value through profit or loss
Corporate and other debt securities – – – – – 4 4
Total held at fair value through profit or loss 3,390 2,418 2,608 283 28 4 8,731
Available-for-sale financial assets
Debt securities:
Government securities
Other public sector securities 12 313 – – – – 325
Bank and building society certificates of deposit 22 142 99 22 – – 285
Asset-backed securities 50 10 – – – – 60
Corporate and other debt securities 2,011 6,382 7,633 1,313 228 2 17,569
Total debt securities held as available-for-sale assets 2,095 6,847 7,732 1,335 228 2 18,239

As at 31 December 2008
Debt securities held at fair value through profit or loss
Trading assets
Government securities 5,556 236 – – – – 5,792
Corporate and other debt securities 2,543 2,626 2,307 106 164 – 7,746
Total held as trading assets 8,099 2,862 2,307 106 164 – 13,538
Other assets held at fair value through profit or loss
Asset-backed securities 346 – – – – – 346
Total held at fair value through profit or loss 8,445 2,862 2,307 106 164 – 13,884
Available-for-sale financial assets
Debt securities:
Government securities 23 342 – 14 – – 379
Bank and building society certificates of deposit 1,032 977 904 45 – – 2,958
Asset-backed securities 101 47 – – – – 148
Corporate and other debt securities 3,739 8,305 7,216 272 204 55 19,791
Total debt securities 4,895 9,671 8,120 331 204 55 23,276
Treasury bills and other bills – – – – – – –
Total held as available-for-sale assets 4,895 9,671 8,120 331 204 55 23,276

(2) Market Risk

Interest rate risk

In the Group’s retail banking business interest rate risk arises from the different repricing characteristics of the assets and liabilities. Liabilities are either insensitive to
interest rate movements, for example interest free or very low interest customer deposits, or are sensitive to interest rate changes but bear rates which may be varied at
the Group’s discretion and that for competitive reasons generally reflect changes in the Bank of England’s base rate. There are a relatively small volume of deposits
whose rate is contractually fixed for their term to maturity.

Many banking assets are sensitive to interest rate movements; there is a large volume of managed rate assets such as variable rate mortgages which may be
considered as a natural offset to the interest rate risk arising from the managed rate liabilities. However a significant proportion of the Group’s lending assets, for
example personal loans and mortgages, bear interest rates which are contractually fixed for periods of up to five years or longer.

The Group establishes two types of hedge accounting relationships for interest rate risk: fair value hedges and cash flow hedges. The Group is exposed to fair value
interest rate risk on its fixed rate customer loans, its fixed rate customer deposits and the majority of its subordinated debt, and to cash flow interest rate risk on its
variable rate loans and deposits together with its floating rate subordinated debt. The majority of the Group’s hedge accounting relationships are fair value hedges
where interest rate swaps are used to hedge the interest rate risk inherent in the fixed rate mortgage portfolio.

At 31 December 2009 the aggregate notional principal of interest rate swaps designated as fair value hedges was £53,979 million (2008: £67,649 million) with a
net fair value asset of £2,496 million (2008: £3,933 million) (see derivative note 15). The losses on the hedging instruments were £1,125 million (2008: gains of
£2,413 million). The gains on the hedged items attributable to the hedged risk were £1,103 million (2008: losses of £2,246 million).

82
 Bank of Scotland plc

Notes to the consolidated financial statements

46 Financial risk management (continued)

In addition the Group has a small number of cash flow hedges which are primarily used to hedge the variability in the cost of funding within the wholesale business.
These cash flows are expected to occur over the next six years and the hedge accounting adjustments will be reported in the income statement as the cash flows arise.
The notional principal of the interest rate swaps designated as cash flow hedges at 31 December 2009 was £229,390 million (2008: £323,971 million) with a net
fair value liability of £2,029 million (2008: £1,119 million) (see note 15). In 2009, ineffectiveness recognised in the income statement that arises from cash flow
hedges was £5 million (2008: £2 million). There were no transactions for which cash flow hedge accounting had to be ceased in 2009 or 2008 as a result of the
highly probable cash flows no longer being expected to occur.

Currency risk
Foreign exchange exposures comprise those originating in treasury trading activities and structural foreign exchange exposures, which arise from investment in the
Group’s overseas operations.

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. These risks reside in the authorised trading centres who are
allocated exposure limits. The limits are monitored daily by the local centres and reported to the central market risk function.

Risk arises from the Group’s investments in its overseas operations. The Group’s structural foreign currency exposure is represented by the net asset value of the foreign
currency equity and subordinated debt investments in its subsidiaries and branches. Gains or losses on structural foreign currency exposures are taken to reserves.

The Group hedges part of the currency translation risk of the net investment in certain foreign operations using cross currency borrowings.

The Group’s main overseas operations are in the Americas, Australia and Europe. Details of the Group’s structural foreign currency exposures, after net investment
hedges, are as follows:
The Group The Bank
2009 2008 2009 2008
£m £m £m £m

Functional currency of Group operations:

Euro:
Gross exposure 1,906 2,201 – –
Net exposure (1,906) (2,201) – –
– – – –
US dollar:
Gross exposure (62) 191 (14) 39
Net exposure 62 (181) 14 (29)
– 10 – 10
Australian Dollar:
– Gross exposure 1,869 2,015 – –
– Net investment hedge (1,832) (2,015) – –
37 – – –
Other non-sterling (2) (23) – –
35 (13) – 10

83
 Bank of Scotland plc

Notes to the consolidated financial statements

46 Financial risk management (continued)

(3) Liquidity risk

The table below analyses financial instrument liabilities of the Group, on an undiscounted future cash flow basis according to contractual maturity, into relevant
maturity groupings based on the remaining period at the balance sheet date; balances with no fixed maturity are included in the over 5 years category.
The Group Up to 1-3 3-12 1-5 Over 5
1 month months months years years Total
£m £m £m £m £m £m

As at 31 December 2009
Deposits from banks 82,967 71,519 16,167 2,281 2,493 175,427
Customer deposits 159,232 29,194 23,271 20,267 35,997 267,961
Trading and other financial liabilities at fair value through profit or loss 15,471 5,120 6,684 134 – 27,409
Debt securities in issue 14,169 11,938 18,722 69,671 20,270 134,770
Subordinated liabilities 28 60 658 3,396 15,306 19,448
Total non-derivative financial liabilities 271,867 117,831 65,502 95,749 74,066 625,015
Derivative financial liabilities:
Gross settled derivatives – outflow 14,582 6,021 8,282 37,602 37,720 104,207
Gross settled derivatives – inflow (14,399) (6,134) (8,364) (37,097) (36,202) (102,196)
Gross settled derivatives – netflow 183 (113) (82) 505 1,518 2,011
Gross settled derivatives liabilities 16,135 1,017 3,349 3,254 93 23,848
Total derivative financial liabilities 16,318 904 3,267 3,759 1,611 25,859
As at 31 December 2008
Deposits from banks 49,711 41,710 3,880 1,428 492 97,221
Customer deposits 176,183 16,669 42,758 25,795 30,133 291,538
Trading and other financial liabilities at fair value through profit or loss 10,994 4,640 3,518 – – 19,152
Debt securities in issue 21,684 25,443 40,453 83,513 26,732 197,825
Subordinated liabilities 28 861 1,150 5,936 20,636 28,611
Total non-derivative financial liabilities 258,600 89,323 91,759 116,672 77,993 634,347
Derivative financial liabilities:
Gross settled derivatives – outflow 35,701 31,615 19,016 42,827 35,077 164,236
Gross settled derivatives – inflow (36,761) (32,588) (19,028) (42,323) (33,121) (163,821)
Gross settled derivatives – netflow (1,060) (973) (12) 504 1,956 415
Net settled derivative liabilities 1,041 1,085 8,557 15,198 7,576 33,457
Total derivative financial liabilities (19) 112 8,545 15,702 9,532 33,872

Trading derivatives and trading liabilities are included in the up to 1 month column at their fair value. Liquidity risk on these items is not managed on the basis of
contractual maturity as they are frequently settled on demand at fair value and therefore this is considered a better presentation of the Group’s liquidity risk.
Derivatives used in a hedging relationship are included according to their contractual maturity.

Cash flows for undated subordinated liabilities whose terms give the Group the option to redeem at a future date are included within the table on the basis that the
Group will exercise its option to redeem.

The principal amount for undated subordinated liabilities with no redemption option is included within the over 5 years column; interest of approximately £11 million
(2008: £15 million) of the Group and the Bank per annum which is payable in respect of those instruments for as long as they remain in issue is not included beyond
five years.

84
 Bank of Scotland plc

Notes to the consolidated financial statements

46 Financial risk management (continued)

Up to 1-3 3-12 1-5 Over 5

1 month months months years years Total
The Bank £m £m £m £m £m £m

As at 31 December 2009
Deposits from banks 81,295 72,141 11,601 2,081 5,254 172,372
Customer deposits 140,095 24,417 20,438 53,462 74,138 312,550
Trading and other financial liabilities at fair value through profit or loss 15,471 5,120 6,684 134 – 27,409
Debt securities in issue 5,659 10,611 20,750 42,282 23,830 103,132
Subordinated liabilities 28 60 915 2,699 15,194 18,896
Total non-derivative financial liabilities 242,548 112,349 60,388 100,658 118,416 634,359

Derivative financial liabilities:

Gross settled derivatives – outflow 14,567 7,440 8,354 37,592 37,393 105,346
Gross settled derivatives – inflow (14,399) (7,472) (8,434) (37,095) (36,172) (103,572)
Gross settled derivatives – netflow 168 (32) (80) 497 1,221 1,774
Net settled derivative liabilities 16,083 1,003 3,291 3,029 308 23,714
Total derivative financial liabilities 16,251 971 3,211 3,526 1,529 25,488

As at 31 December 2008
Deposits from banks 51,118 40,900 5,620 8,779 579 106,996
Customer deposits 182,915 14,092 40,341 110,496 40,647 388,491
Trading and other financial liabilities at fair value through profit or loss 10,994 4,640 3,518 – – 19,152
Debt securities in issue 18,543 30,011 46,030 58,627 30,634 183,845
Subordinated liabilities 28 861 1,121 5,138 20,636 27,784
Total non-derivative financial liabilities 263,598 90,504 96,630 183,040 92,496 726,268

Derivative financial liabilities:

Gross settled derivatives – outflow 37,667 33,718 18,561 39,760 34,320 164,026
Gross settled derivatives – inflow (38,784) (34,704) (18,578) (39,254) (32,721) (164,041)
Gross settled derivatives – netflow (1,117) (986) (17) 506 1,599 (15)
Net settled derivative liabilities 877 1,087 8,571 15,183 7,161 32,879
Total derivative financial liabilities (240) 101 8,554 15,689 8,760 32,864

85
 Bank of Scotland plc

Notes to the consolidated financial statements

46 Financial risk management (continued)

The following tables set out the amounts and residual maturities of the Group’s off balance sheet contingent liabilities and commitments.
Within 1-3 3-5 Over 5
1 year years years years Total
The Group £m £m £m £m £m

31 December 2009
Acceptances and endorsements 5 – – – 5
Other contingent liabilities 489 54 753 54 1,350
Total contingent liabilities 494 54 753 54 1,355
Lending commitments 36,318 3,283 10,787 3,595 53,983
Other commitments 55 – 14 – 69
Total commitments 36,373 3,283 10,801 3,595 54,052
Total contingents and commitments 36,867 3,337 11,554 3,649 55,407

Within 1-3 3-5 Over 5

1 year years years years Total
£m £m £m £m £m

31 December 2008
Acceptances and endorsements – – – – –
Other contingent liabilities 495 74 644 139 1,352
Total contingent liabilities 495 74 644 139 1,352
Lending commitments 50,211 1,492 15,272 9,577 76,552
Other commitments 83 – 54 – 137
Total commitments 50,294 1,492 15,326 9,577 76,689
Total contingents and commitments 50,789 1,566 15,970 9,716 78,041

Within 1-3 3-5 Over 5

1 year years years years Total
The Bank £m £m £m £m £m

31 December 2009
Acceptances and endorsements 3 – – – 3
Other contingent liabilities 392 11 748 1,280 2,431
Total contingent liabilities 395 11 748 1,280 2,434
Lending commitments 57,040 2,647 10,609 3,254 73,550
Other commitments 20 – 14 – 34
Total commitments 57,060 2,647 10,623 3,254 73,584
Total contingents and commitments 57,455 2,658 11,371 4,534 76,018

31 December 2008
Acceptances and endorsements – – – – –
Other contingent liabilities 295 – 638 119 1,052
Total contingent liabilities 295 – 638 119 1,052
Lending commitments 47,116 3,142 14,380 6,681 71,319
Other commitments 43 19 14 – 76
Total commitments 47,159 3,161 14,394 6,681 71,395
Total contingents and commitments 47,454 3,161 15,032 6,800 72,447

86
 Bank of Scotland plc

Notes to the consolidated financial statements

47 Capital

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 Lloyds Banking 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.

The Group’s regulatory capital is divided into tiers defined by the European Community Banking Consolidation Directive as implemented in the UK by the Financial
Services Authority’s (FSA) General Prudential Sourcebook. Tier 1 capital comprises mainly shareholders’ equity, tier 1 capital instruments and minority interests, after
deducting goodwill, other intangible assets and 50 per cent of the net excess of expected losses over accounting provisions and certain securitisation positions. During
the year the FSA has defined Core Tier 1 capital. Accounting equity is adjusted in accordance with FSA requirements, particularly in respect of pensions and
available-for-sale assets. Tier 2 capital mainly comprises qualifying subordinated debt after deducting 50 per cent of the excess of expected losses over accounting
provisions, and certain securitisation positions. The amount of qualifying tier 2 capital cannot exceed that of tier 1 capital. Total capital is reduced by deducting
investments in subsidiaries, joint ventures and associates that are not consolidated for regulatory purposes.
The Group’s capital resources are summarised as follows:
2009 2008
£m £m

Tier 1 capital 25,565 17,328

Tier 2 capital 14,112 15,238
39,677 32,566
Supervisory deductions (1,062) (919)
Total capital 38,615 31,647

A number of limits are imposed by the FSA on the proportion of the regulatory capital base that can be made up of subordinated debt and preferred securities.

The FSA sets Individual Capital Guidance (ICG) for each UK bank calibrated by reference to its Capital Resources Requirement, broadly equivalent to 8 per cent of
risk-weighted assets and thus representing the capital required under Pillar 1 of the Basel II framework. Also a key input into the FSA’s ICG setting process, (which
addresses the requirements of Pillar 2 of the Basel II framework), is each bank’s Internal Capital Adequacy Assessment Process. The FSA’s approach is to monitor the
available capital resources in relation to the ICG requirement. The Group has been given ICG by the FSA and the board has also 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.

During the year, the individual entities within the Group and the Group complied with all of the externally imposed capital requirements to which they are subject.

87
 Bank of Scotland plc

Notes to the consolidated financial statements

48 Prior year reclassifications

The following table sets out the balance sheet as at 31 December 2008 of the Group as presented in the 2008 financial statements for the Group with
reclassifications made to present these statements on a basis consistent with the presentation practices adopted by Lloyds Banking Group plc.

Consolidated balance sheet as at 31 December 2008

As previously Balance sheet
presented reclassifications As restated
£m £m £m

Assets
Cash and balances at central banks 2,502 – 2,502
Items in course of collection from banks 445 – 445
Trading and other financial assets designated at fair value (i) 22,571 859 23,430
Derivative financial instruments 50,517 – 50,517
Loans and receivables:
Loans and advances to customers (v) 473,015 15,198 488,213
Loans and advances to banks 12,445 – 12,445
Debt securities (i) – 38,878 38,878
485,460 54,076 539,536
Investment securities (i) 67,772 (67,772) –
Available-for-sale financial assets (i) – 28,035 28,035
Interests in joint ventures and associates 1,193 – 1,193
Goodwill (iv) – 667 667
Goodwill and other intangible assets (iv) 1,148 (1,148) –
Other intangible assets (iv) – 108 108
Property and equipment/tangible fixed assets (ii), (iv) 1,187 4,340 5,527
Investment property 43 – 43
Operating lease assets (ii) 3,967 (3,967) –
Deferred costs (iii) 2 (2) –
Current tax assets 865 – 865
Deferred tax assets 3,182 – 3,182
Other assets (iii) 2,430 696 3,126
Prepayments and accrued income (iii) 694 (694) –
Total assets 643,978 15,198 659,176
Liabilities
Deposits from banks 97,066 – 97,066
Customer deposits (v) 262,201 15,198 277,399
Items in course of transmission to banks (vi) – 521 521
Trading and other financial liabilities at fair value 18,851 – 18,851
Derivative financial instruments 40,827 – 40,827
Debt securities in issue 188,448 – 188,448
Notes in circulation 957 – 957
Other liabilities (vi) 2,250 1,985 4,235
Current tax liabilities 23 – 23
Accruals and deferred income (vi) 2,306 (2,306) –
Other provisions (vi) 345 (200) 145
Subordinated liabilities/other borrowed funds 18,779 – 18,779
Total liabilities 632,053 15,198 647,251
Net assets 11,925 – 11,925

88
 Bank of Scotland plc

Notes to the consolidated financial statements

48 Prior year reclassifications (continued)

The significant balance sheet reclassifications (none of which require the remeasurement of an asset or liability) are in relation to:

(i) the reclassification of investment securities (£67,772 million) to trading and other financial assets at fair value through the profit and loss (£859 million);
available-for-sale financial assets (£28,035 million) and debt securities classified as loans and receivables (£38,878 million);

(ii) the reclassification of operating lease assets (£3,967 million) to tangible fixed assets;

(iii) the reclassification of deferred costs (£2 million) and prepayments and accrued income (£694 million) to other assets;

(iv) the reclassification of goodwill and intangible assets into their separate components, goodwill (£667 million) and other intangibles (£108 million), and the
reclassification of software items deemed integral to the equipment balance from within intangibles to tangible fixed assets (£373 million);

(v) the representation of certain customer deposit amounts (£15,198 million) available for offset onto a gross basis; and

(vi) the reclassification of accruals and deferred income (£2,306 million) to other liabilities, the reclassification of other liabilities (£521 million) to items in the
course of transmission to banks. The reclassification of other provisions (£200 million) to other liabilities.

The following table sets out the balance sheet as at 31 December 2008 as presented in the 2008 financial statements of the Bank with a prior year adjustment and
reclassifications made to present these statements on a basis consistent with the presentation practices adopted by Lloyds Banking Group plc:

Bank balance sheet as at 31 December 2008

Adjustments
As previously Prior year Balance sheet
presented adjustment reclassifications As restated
£m £m £m £m

Assets
Cash and balances at central banks 1,820 – – 1,820
Items in course of collection from banks 449 – – 449
Trading and other assets designated at fair value through profit or loss (i) 22,571 – 349 22,920
Derivative financial instruments 46,374 (3,114) – 43,260
Loans and receivables:
Loans and advances to banks 34,144 – – 34,144
Loans and advances to customers (v) 570,255 (6,925) 15,198 578,528
Debt securities (i) – (63,905) 83,164 19,259
604,399 (70,830) 98,362 631,931
Investment securities (i) 107,852 – (107,852) –
Available-for-sale financial assets (i) – – 24,339 24,339
Investment in subsidiary undertakings 4,383 – – 4,383
Interests in joint ventures and associates 103 – – 103
Goodwill and other intangible assets (iv) 770 – (770) –
Goodwill (iv) – – 376 376
Other intangible assets (iv) – – 98 98
Property and equipment/tangible fixed assets (ii) 1,061 – 298 1,359
Operating lease assets (ii) 2 – (2) –
Current tax assets 1,180 – – 1,180
Deferred tax assets 2,123 440 – 2,563
Retirement benefit asset – – – –
Other assets (iii) 2,661 (350) 565 2,876
Prepayments and accrued income (iii) 565 – (565) –
Total assets 796,313 (73,854) 15,198 737,657

89
 Bank of Scotland plc

Notes to the consolidated financial statements

48 Prior year reclassifications (continued)

Bank balance sheet as at 31 December 2008

Adjustments
As previously Prior year Balance sheet
presented adjustment reclassifications As restated
£m £m £m £m

Liabilities
Deposits from banks 97,091 – – 97,091
Customer deposits (v) 458,967 (100,992) 15,198 373,173
Items in course of transmission to banks (vi) – – 522 522
Notes in circulation 957 – – 957
Trading and other financial liabilities at fair value through profit or loss 18,851 – – 18,851
Derivative financial instruments 39,648 (35) – 39,613
Debt securities in issue 143,456 29,008 – 172,464
Other liabilities (vi) 2,359 548 1,515 4,422
Accruals and deferred income (vi) 1,837 – (1,837) –
Other provisions (vi) 332 – (200) 132
Subordinated liabilities/other borrowed funds 18,082 – – 18,082
Total liabilities 781,580 (71,471) 15,198 725,307
Net assets 14,733 (2,383) – 12,350

Prior year adjustment

For further details of the prior year adjustment, refer to the end of this note.

Balance sheet reclassifications

The significant balance sheet reclassifications (none of which require the remeasurement of an asset or liability) are in relation to:

(i) the reclassification of investment securities (£107,852 million) to trading and other financial assets designated at fair value (£349 million); available-for-sale
financial assets (£24,339 million), and debt securities classified as loans and receivables (£83,164 million);

(ii) the reclassification of operating lease assets (£2 million) to tangible fixed assets;

(iii) the reclassification of prepayments and accrued income (£565 million) to other assets;

(iv) the reclassification of goodwill and intangible assets into their separate components, goodwill (£376 million) and other intangibles (£98 million), and the
reclassification of software items deemed integral to the equipment balance from within intangibles to tangible fixed assets (£296 million);

(v) the representation of certain customer deposit amounts (£15,198 million) available for offset onto a gross basis;

(vi) the reclassification of accruals and deferred income (£1,837 million) to other liabilities, the reclassification of other liabilities (£522 million) to items in the
course of transmission to banks. The reclassification of other provisions (£200 million) to other liabilities.

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Notes to the consolidated financial statements

48 Prior year reclassifications (continued)

The following table sets out the balance sheet as at 1 January 2008 as presented in the 2008 financial statements of the Group with reclassifications made to present
these statements on a basis consistent with the presentation practices adopted by Lloyds Banking Group plc:

Consolidated balance sheet as at 1 January 2008

As previously Balance sheet

presented reclassifications As restated
£m £m £m

Assets
Cash and balances at central banks 2,944 – 2,944
Items in course of collection from banks 945 – 945
Trading and other assets designated at fair value through profit or loss (i) 54,681 1,108 55,789
Derivative financial instruments 13,794 – 13,794
Loans and receivables:
Loans and advances to banks 4,095 – 4,095
Loans and advances to customers (v) 460,267 24,934 485,201
Debt securities (i) – 527 527
464,362 25,461 489,823
Investment securities (i) 51,615 (51,615) –
Available-for-sale financial assets (i) – 49,980 49,980
Investment property 34 – 34
Interests in joint ventures and associates 1,739 – 1,739
Goodwill and other intangible assets (iv) 1,517 (1,517) –
Goodwill (iv) – 1,041 1,041
Other intangible assets (iv) – 110 110
Property and equipment/tangible fixed assets (ii), (iv) 1,291 5,009 6,300
Operating lease assets (ii) 4,643 (4,643) –
Deferred costs (iii) 4 (4) –
Other asset (iii) 4,633 1,434 6,067
Prepayments and accrued income (iii) 1,430 (1,430) –
Total assets 603,632 24,934 628,566

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Notes to the consolidated financial statements

48 Prior year reclassifications (continued)

Consolidated balance sheet as at 1 January 2008

As previously Balance sheet
presented reclassifications As restated
£m £m £m

Liabilities
Deposits from banks 41,513 – 41,513
Customer deposits (v) 272,687 24,934 297,621
Items in course of transmission to banks (vi) – 542 542
Notes in circulation 881 153 1,034
Trading and other financial liabilities at fair value through profit or loss 22,705 (153) 22,552
Derivative financial instruments 12,160 – 12,160
Debt securities in issue 206,520 – 206,520
Insurance contract liabilities (vii) 24 (24) –
Investment contract liabilities (vii) 98 (98) –
Liabilities arising from insurance contracts and participating investment contracts (vii) – 24 24
Liabilities arising from non-participating investment contracts (vii) – 98 98
Other liabilities (vi) 2,560 2,352 4,912
Retirement benefit obligations – – –
Current tax liabilities 728 – 728
Deferred tax liabilities 965 – 965
Accruals and deferred income (vi) 2,894 (2,894) –
Other provisions 172 – 172
Subordinated liabilities/other borrowed funds 17,881 – 17,881
Total liabilities 581,788 24,934 606,722
Net assets 21,844 – 21,844

The significant balance sheet reclassifications (none of which require the remeasurement of an asset or liability) are in relation to:

(i) the reclassification of investment securities (£51,615 million) to trading and other financial assets at fair value through the profit or loss (£1,108 million);
available-for-sale financial assets (£49,980 million), and debt securities classified as loans and receivables (£527 million);

(ii) the reclassification of operating lease assets (£4,643 million) to tangible fixed assets;

(iii) the reclassification of prepayments and accrued income (£1,430 million) and deferred costs (£4 million) to other assets;

(iv) the reclassification of goodwill and intangible assets into their separate components goodwill (£1,041 million), other intangibles (£110 million), and the
reclassification of software items deemed integral to the equipment balance within intangibles to tangible fixed assets (£366 million);

(v) the representation of certain customer deposit amounts (£24,934 million) available for offset onto a gross basis; and

(vi) the reclassification of accruals and deferred income (£2,894 million) to other liabilities, the reclassification of other liabilities (£542 million) to items in the
course of transmission to banks.

(vii) the reclassification of insurance contract liabilities (£24 million) to liabilities arising from insurance contracts and participating investment contracts, and the
reclassification of investment contract liabilities (£98 million) to liabilities arising from non-participating investment contracts.

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 Bank of Scotland plc

Notes to the consolidated financial statements

48 Prior year reclassifications (continued)

The following table sets out the balance sheet as at 1 January 2008 as presented in the 2008 financial statements of the Bank with a prior year adjustment and
reclassifications made to present these statements on a basis consistent with the presentation practices adopted by Lloyds Banking Group plc.

Bank balance sheet as at 1 January 2008

Adjustments
As previously Prior year Balance sheet
presented adjustment reclassifications As restated
£m £m £m £m

Assets
Cash and balances at central banks 1,667 – – 1,667
Items in course of collection from banks 890 – – 890
Trading and other assets designated at fair value through profit or loss (i) 52,169 – 405 52,574
Derivative financial instruments 12,134 (67) – 12,067
Loans and receivables:
Loans and advances to banks 25,458 – – 25,458
Loans and advances to customers (v) 453,590 316 24,934 478,840
Debt securities (i) – – 7 7
479,048 316 24,941 504,305
Investment securities (i) 27,020 – (27,020) –
Available-for-sale financial assets (i) – – 26,608 26,608
Investment in subsidiary undertakings 3,273 25 – 3,298
Interests in joint ventures and associates 103 – – 103
Goodwill and other intangible assets (iv) 783 – (783) –
Goodwill (iv) – – 426 426
Other intangible assets (iv) – – 88 88
Property and equipment/tangible fixed assets (ii), (iv) 1,108 – 298 1,406
Operating lease assets (ii) 29 – (29) –
Deferred tax assets 152 13 – 165
Other assets (iii) 4,364 (325) 1,292 5,331
Prepayments and accrued income (iii) 1,292 – (1,292) –
Total assets 584,032 (38) 24,934 608,928

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Notes to the consolidated financial statements

48 Prior year reclassifications (continued)

Bank balance sheet as at 1 January 2008

Adjustments
As previously Prior year Balance sheet
presented adjustment reclassifications As restated
£m £m £m £m

Liabilities
Deposits from banks 47,321 – – 47,321
Customer deposits (v) 316,849 (9,461) 24,934 332,322
Items in course of transmission to banks (vi) – – 543 543
Notes in circulation 881 – – 881
Trading and other financial liabilities at fair value through profit or loss 22,145 – – 22,145
Derivative financial instruments 10,546 (473) – 10,073
Debt securities in issue 149,188 9,069 – 158,257
Other liabilities (vi) 1,735 – 1,233 2,968
Current tax liabilities 544 – – 544
Accruals and deferred income (vi) 1,654 – (1,654) –
Other provisions (vi) 135 468 (122) 481
Subordinated liabilities/other borrowed funds 14,855 – – 14,855
Total liabilities 565,853 (397) 24,934 590,390
Net assets 18,179 359 – 18,538

Prior year adjustment

For further details of the prior year adjustment at 1 January 2008, refer to the end of this note.

Balance sheet reclassifications

The significant balance sheet reclassifications (none of which require the remeasurement of an asset or liability) are in relation to:

(i) the reclassification of investment securities (£27,020 million) to trading and other assets at fair value through the profit or loss (£405 million);
available-for-sale financial assets (£26,608 million) and debt securities classified as loans and receivables (£7 million);

(ii) the reclassification of operating lease assets (£29 million) to tangible fixed assets;

(iii) the reclassification of prepayments and accrued income (£1,292 million) to other assets;

(iv) the reclassification of goodwill and intangible assets into their separate components goodwill (£426 million) and other intangibles (£88 million), and the
reclassification of software items deemed integral to the equipment balance within intangibles to tangible fixed assets (£269 million);

(v) the representation of certain customer deposit accounts (£24,934 million) available for offset onto a gross basis; and

(vi) the reclassification of accruals and deferred income (£1,654 million) to other liabilities the reclassification of other liabilities (£543 million) to items in the
course of transmission to banks and the reclassification of other provisions (£122 million) to other liabilities.

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Notes to the consolidated financial statements

48 Prior year reclassifications (continued)

The following table sets out the income statement for the year ended 31 December 2008 of the Group as presented in the 2008 financial statements for the Group
with reclassifications made to present these statements on a basis consistent with the presentation practices adopted by Lloyds Banking Group plc.

Income statement for the year to 31 December 2008

As previously Reclassifi-
The Group presented cations As restated
£m £m £m

Interest and similar income (i) 39,332 (3,239) 36,093

Interest and similar expense (i) (31,039) 3,486 (27,553)
Fee and commission income (i) 2,208 (247) 1,961
Fee and commission expense (382) – (382)
Net earned premiums on insurance contracts 215 (215) –
Net trading income (2,963) 25 (2,938)
Net investment income related to insurance and investment business 34 (34) –
Insurance premium income – 215 215
Other operating income 1,665 111 1,776
Change in investment contract liabilities 17 (17) –
Net claims incurred on insurance contracts (76) 76 –
Net change in insurance contract liabilities 22 (22) –
Insurance claims – (37) (37)
Operating expenses (ii) – (5,937) (5,937)
Administrative expenses (ii) (4,253) 4,253 –
Depreciation and amortisation:
Intangible assets other than goodwill (ii) (153) 153 –
Property and equipment (ii) (211) 211 –
Operating lease assets (ii) (1,178) 1,178 –
(1,542) 1,542 –
Goodwill impairment (ii) (142) 142 –
Impairment losses on loans and advances (iii) (9,857) 9,857 –
Impairment on investment securities (iii) (2,193) 2,193 –
Impairment (iii) – (12,050) (12,050)
Share of profits of jointly controlled entities (iv) (651) 651 –
Share of losses of associated undertakings (iv) (287) 287 –
Share of results of joint ventures and associates (iv) – (938) (938)
Non-operating income/loss on sale of businesses (743) (102) (845)
Loss before taxation (10,635) – (10,635)
Tax 2,448 – 2,448
Loss for the year (8,187) – (8,187)

Certain income statement captions and presentations have been aligned to a basis consistent with the practices adopted by the Lloyds Banking Group. The significant
income statement reclassifications are in relation to:
(i) the representation of certain derivative income amounts (£3,486 million) that are available for offset onto a net basis from within interest and similar income
to interest and similar expense and the reclassification of certain loan fees from fee and commission income to interest and similar income (£247 million) as
they form part of the effective yield;
(ii) the reclassification of administrative expenses (£4,253 million), depreciation and amortisation (£1,542 million) and goodwill impairment (£142 million) to
operating expenses;
(iii) the reclassification of impairment losses on loans and advances (£9,857 million) and investment securities (£2,193 million) to impairment losses; and

(vi) the reclassification of share of profits of jointly controlled entities (£651 million) and share of losses of associated undertakings (£287 million) to shares of
results of joint ventures and associates.

Prior year adjustment

On 16 January 2009, the Bank as the principal banking subsidiary of the HBOS Group was acquired by Lloyds Banking Group. Following the acquisition the Bank
adopted the accounting practices of the Lloyds Banking Group.

The essential features of the change in practices, relating to the accounting for Securitisation and Covered Bond activities which are only applicable to the Bank and
have no impact at a consolidated level set below:

(a) Where the Bank transfers mortgage assets to a Special Purpose Vehicles (SPV) and the parties enter into a basis swap where the SPV pays the Bank the
interest received on the mortgages and receives LIBOR based payments in return. In prior periods the Bank separately recognised these swaps in the accounts
of the Bank and the SPVs. The Bank now incorporates these swaps into the deemed loan rather than separately recognising them and accordingly; in order to
align with Lloyds Banking Group practices, the swaps that were previously separately recognised are derecognised for all periods presented. Deferred tax
balances on the fair values of these swaps are also reversed. The impact of this is to reduce derivative financial assets and retained earnings by
£2,383 million at 31 December 2008 and decrease derivative financial liabilities and increase retained earnings by £359 million at 1 January 2008.

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Notes to the consolidated financial statements

48 Prior year reclassifications (continued)

(b) The Bank previously recorded an asset and an associated liability for certain notes issued from SPVs where those notes were bought back by the Bank rather
than sold to third parties. These notes are held for the purposes of accessing central bank liquidity schemes, or used in other collateral pledging transactions.
Following a review of the Bank’s accounting treatment for such notes, the Bank will not record an asset for the notes it retains. As a consequence, the Bank
will show on its balance sheet a financing liability for the amount of the securitisation notes held by third parties, but will not show a liability in relation to
notes which it holds itself on the basis that the transaction is purely internal and there is no observable external market data for similar retained transactions.

49 Ultimate parent undertaking

From 16 January 2009, Bank of Scotland plc’s ultimate parent undertaking and controlling party is Lloyds Banking Group plc (formerly Lloyds TSB Group plc) which
is incorporated in Scotland. Lloyds Banking Group plc will produce consolidated accounts for the year ended 31 December 2009. Copies of the annual report and
accounts of Lloyds TSB Group plc for the year ended 31 December 2008 may be obtained from Lloyds Banking Group’s head office at 25 Gresham Street, London
EC2V 7HN or downloaded via www.lloydsbankinggroup.com

Prior to 16 January 2009, HBOS plc was the ultimate parent undertaking of Bank of Scotland plc. Copies of the annual report and accounts of HBOS plc for
the year ended 31 December 2008 may be obtained from HBOS plc’s registered office at The Mound, Edinburgh, EH1 1YZ or downloaded via
www.lloydsbankinggroup.com.

50 Future accounting developments

The following pronouncements will be relevant to the Group but were not effective at 31 December 2009 and have not been applied in preparing these financial
statements. The full impact of these accounting changes is being assessed by the Group. With the exception of IFRS 9 ‘Financial Instruments: Classification and
Measurement’, the initial view is that none of these pronouncements are expected to cause any material adjustments to reported numbers in the financial statements.

IFRS 9 is the initial stage of a project to replace IAS 39 ‘Financial Instruments: Recognition and Measurement’ and will fundamentally change the way in which the
Group accounts for financial instruments. Future stages are expected to result in amendments to IFRS 9 to deal with classification and measurement of financial
liabilities, amortised cost and impairment and hedge accounting. Until all stages of the replacement project are complete, it is not possible to determine the overall
impact on the financial statements from the replacement of IAS 39.
Pronouncement Nature of change Effective date

IFRS 3 Business Combinations The revised standard continues to apply the acquisition method to Annual periods beginning on or after
business combinations, however, all payments to purchase a business 1 July 2009.
are to be recorded at fair value at the acquisition date, some contingent
payments are subsequently remeasured at fair value through income,
goodwill may be calculated based on the parent’s share of net assets or
it may include goodwill related to the minority interest, and all
transaction costs are expensed.

IAS 27 Consolidated and Separate Financial Requires the effects of all transactions with non-controlling interests to Annual periods beginning on or after
Statements be recorded in equity if there is no change in control; any remaining 1 July 2009.
interest in an investee is re-measured to fair value in determining the
gain or loss recognised in profit or loss where control over the investee
is lost.

IFRIC 17 Distributions of Non-cash Assets to Owners Provides accounting guidance for non-reciprocal distributions of non- Annual periods beginning on or after
cash assets to owners (and those in which owners may elect to receive 1 July 2009.
a cash alternative).

Amendment to IAS 39 Financial Instruments: Clarifies how the principles underlying hedge accounting should be Annual periods beginning on or after
Recognition and Measurement – Eligible Hedged applied in particular situations. 1 July 2009.
Items

Improvements to IFRSs1 Sets out minor amendments to IFRS standards as part of annual Dealt with on a standard by standard
(issued April 2009) improvements process. basis but not earlier than annual periods
beginning on or after 1 January 2010.

Amendments to IFRS 2 Group Cash-settled Clarifies that an entity that receives goods or services in a share-based Annual periods beginning on or after
Share-based Payment Transactions1 payment arrangement must account for those goods or services no 1 January 2010.
matter which entity in the group settles the transaction, whether or not
settled in shares or cash.

Amendment to IAS 32 Financial Instruments: Requires rights issues denominated in a currency other than the Annual periods beginning on or after
Presentation – Classification of Rights Issues functional currency of the issuer to be classified as equity regardless of 1 February 2010.
the currency in which the exercise price is denominated.

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Notes to the consolidated financial statements

50 Future accounting developments (continued)

IFRIC 19 Extinguishing Financial Liabilities with Clarifies that when an entity renegotiates the terms of its debt with the Annual periods beginning on or after
Equity Instruments1 result that the liability is extinguished by the debtor issuing its own 1 July 2010.
equity instruments to the creditor, a gain or loss is recognised in profit
or loss representing the difference between the carrying value of the
financial liability and the fair value of the equity instruments issued;
the fair value of the financial liability is used to measure the gain or loss
where the fair value of the equity instruments cannot be reliably
measured.

IAS 24 Related Party Disclosures1 Simplifies the definition of a related party and provides a partial Annual periods beginning on or after
exemption from the disclosure requirements for government related 1 January 2011.
entities

Amendment to IFRIC 14 Prepayments of a Minimum Applies when an entity is subject to minimum funding requirements Annual periods beginning on or after
Funding Requirement1 and makes an early payment of contributions to cover those 1 January 2011.
requirements and permits such an entity to treat the benefit of such an
early payment as an asset

IFRS 9 Financial Instruments: Classification and Replaces those parts of IAS 39 Financial Instruments: Recognition and Annual periods beginning on or after
Measurement1 Measurement relating to the classification and measurement of 1 January 2013.
financial assets. Requires financial assets to be classified into two
measurement categories, fair value and amortised cost, on the basis of
the objectives of entity’s business model for managing it financial
assets and the contractual cash flow characteristics of the instrument.
The available-for-sale financial asset and held-to-maturity categories in
existing IAS 39 will be eliminated.

1
At the date of this report, these pronouncements are awaiting EU endorsement.

51 Post balance sheet events

Corporate structure
On 23 December 2009 Lloyds Banking Group plc announced its intention to adjust the Group’s corporate structure and transfer its current holding in the Group to
Lloyds TSB Bank plc. Following this move Lloyds TSB Bank plc became the immediate parent of the Group. Lloyds Banking Group plc will continue to directly own
Lloyds TSB Bank plc.

This transfer follows a review by management of the structure of the Lloyds Banking Group and a programme to develop and implement a legal entity structure that is
efficient from a financial, regulatory and capital perspective. The transfer has been approved by the Financial Services Authority, and became effective on 1 January
2010.

52 Approval of financial statements

These financial statements were approved by the directors of Bank of Scotland plc on 25 February 2010.

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