The Board is responsible for approving the bank group's strategy, its principal markets and the level of acceptable risks. The significant risks arise in four broad categories: credit risk, market risk, liquidity risk and operational risk. The Board has established Board Committees and Executive Management Committees to administer a risk management process which identifies the key risks facing the business and reviews reports submitted to those Committees on how those risks are being managed. Specific authority has been delegated to Board Committees and the Chief Executive who may, in turn, delegate elements of his discretions to appropriate Executive Directors and their senior line managers.

The bank's Executive Risk Review Committee, comprising all Executive Directors, the Chief Executive and Chief Operating Officer has continued to meet in 2002. The Terms of Reference include the maintenance of the Risk Management Policy, the identification and evaluation of risks and the provision of assurance to Board and Audit and Risk Committees. Regular risk and control assessments are provided by line management to the Risk Committee in respect of the bank's significant risks.

Credit Risk
arises from the possibility of customers and counterparties failing to meet their obligations to the bank and represents the most significant category of risk.

The Advances Policy Statement is approved by the Board annually and determines the criteria for the management of personal, corporate and wholesale market exposures. It specifies credit management standards, including country, sector and counterparty limits, along with delegated authorities. Larger corporate facilities are sanctioned by the Board's Advances Committee who also review, each month, facilities granted within the Chief Executive's discretion. He exercises his discretion within the forum of the Credit Committee which comprises another Executive Director and senior credit managers.

The Group's personal lending policy is to establish credit criteria which determine the optimum balance between volume growth (generating higher income) and higher bad debts, so as to maximise overall profitability. Personal lending is tightly controlled through advanced credit and behavioural scoring techniques administered by a specialist department. The Board receives regular reports on the performance of the portfolio.

The Group's corporate sector policy is to maintain a broad sectoral spread of exposures which reflect the Group's areas of expertise. Credit exposures to corporate and business banking customers are assessed individually. The quality of the overall portfolio is monitored, using a credit grading system calibrated to the probability of incurring losses. All aspects of credit management are controlled centrally. The Board receives regular reports on new facilities and changes in facilities, sector exposures, bad debt provisions and the realisation of problem loans.

Credit policy for wholesale market counterparties involves establishing limits for each of these counterparties based on their financial strength and credit rating. Counterparty limits are largely uncommitted. All counterparties are reviewed at least annually by the Treasury Credit Department and the counterparty list is also reviewed by the Board's Advances Committee.

Market Risk
arises from the effect of changes in market prices of financial instruments, on income derived from the structure of the balance sheet, execution of customer and inter-bank business and proprietary trading. The majority of the risk arises from changes in interest rates as the bank does not trade in equities or commodities and has limited foreign currency activity.

Interest Rate Risk Policy Statements, approved by the Audit and Risk Committee on behalf of the Board, specify the scope of the bank's wholesale market activity, market risk limits and delegated authorities. The policy is executed by the bank's Asset and Liability Committee (ALCO) which is chaired by the Chief Executive and meets monthly. Its prime task is to assess the interest rate risk inherent in the maturity and re-pricing characteristics of the Group's assets and liabilities. It sets limits within which Treasury and the bank's Asset and Liability Management department manage the effect of interest rate changes on the bank's overall net interest income. The principal analytical techniques involve assessing the impact of different interest rate scenarios and changes in balances over various time periods.

Treasury executes funding and hedging transactions with the wholesale markets on behalf of the bank and its customers. It also generates incremental income from proprietary trading within strict risk limits. There are two prime measures of risk supplemented by additional controls such as maturity and stop loss limits. Risk units express the various re-pricing and maturity mismatches as a common unit of measurement. Value at Risk (VaR) measures the daily maximum potential gain or loss due to recent market volatility to a statistical confidence level of 95% and uses 250 days of historical data and a one day holding period. During 2002, the daily VaR in the trading portfolios was less than £1.3 million. The VaR methodology has inherent limitations in that market volatility in the past may not be a reliable predictor of the future, and may not reflect the time required to hedge or dispose of the position, hence VaR is not used by the bank as the sole measure of risk.

The Board receives quarterly reports on the management of Balance Sheet risk and, each month, ALCO reviews the Balance Sheet risk position and the utilisation of wholesale market risk limits.

Liquidity Risk
arises from the timing of cashflows arising from the Group's assets, liabilities and off-balance sheet instruments. Treasury manages the Group's liquidity within guidelines laid down by ALCO and in accordance with standards established for all banks by banking regulators. Short-term liquidity standards ensure the Group can always meet its obligations without recourse to the wholesale markets for at least the next five working days.

The Group's liquidity management policies are reviewed and approved annually by the Audit and Risk Committee and reviewed monthly by ALCO.

Operational Risk
arises from the potential for key system failures, breaches in internal controls or from external events resulting in financial loss or reputational damage. Key operational risks include outsourced contracts, payment systems and information systems.

Operational risk is controlled and mitigated through comprehensive, ongoing risk management practices which include formal internal control procedures, training, segregation of duties, delegated authorities and contingency planning. Internal Audit Department conduct a programme of operational reviews and report regularly to Executive Directors and to the Audit and Risk Committee.

The Executive Directors are responsible for controlling the operating risks within their direct areas of accountability and for compliance with Group policies, which are extensively documented in Procedures Manuals.

Financial Instruments
The use of Financial Instruments is essential to the Group's business activities and financial instruments constitute a significant proportion of the Group's assets and liabilities. Risk management procedures are described earlier in this report, and analysis of the financial instruments is provided in the Notes to the Financial Statements. The main financial instruments used by the Group, and the purposes for which they are held, is outlined below:

Customer Loans and Deposits - The provision of banking facilities to customers is the prime activity of the Group and customer loans and deposits are major constituents of the balance sheet. The Group has detailed policies and procedures to manage risks. Much of the lending to corporate and business banking customers is secured.

Debt Securities, Wholesale Market Loans and Deposits - Wholesale market loans and deposits are used to fund customer balances and manage interest rate risk. The Group issues medium-term notes within an established Euro Medium Term Note programme and also issues Certificates of Deposit as part of its normal Treasury activities. Overall, customer deposits exceed loan balances and these excess funds, along with the Group's capital, are substantially invested in marketable, investment grade, debt securities and short-term wholesale market placements. Debt securities also underpin the Group's liquidity requirements and generate incremental net interest and trading income.

Capital Funds - Subordinated Note Issues and Preference Shares The Group has a policy of maintaining prudent capital ratios and utilises a broad spread of capital funds. In addition to ordinary share capital and retained earnings, the Group has issued £60 million Preference shares and, when appropriate, also issues perpetual and fixed term Subordinated Notes.

Foreign Exchange - The Group undertakes foreign exchange dealing to facilitate customer requirements and to generate incremental income from short-term trading in the major currencies. Structured risk and trading related risk are managed formally within position limits approved by the Board.

Derivatives - A derivative is an off-balance sheet financial instrument that derives its value from an underlying rate or price such as interest rates, exchange rates and other market prices. Derivatives are an efficient means of managing market risk and limiting counterparty exposure. The bank uses them mainly for hedging purposes and to meet the needs of customers.

The most frequently used derivative contracts are interest rate swaps, exchange traded futures and options, caps and floors, forward rate agreements, currency swaps and forward currency transactions. Terms and conditions are determined by using standard industry documentation. Derivatives are subject to the same market and credit risk control procedures as are applied to other wholesale market instruments and are aggregated with other exposures to monitor total counterparty exposure which is managed within approved limits for each counterparty.