Arbuthnot Regulatory News (ARBB)

17 March 2011

For immediate release

ARBUTHNOT BANKING GROUP ("Arbuthnot" or "the Group")

Audited Final Results for the year to 31 December, 2010

YEAR OF CONTINUED PROGRESS

Arbuthnot Banking Group has made good progress in 2010. All of the Group's core businesses traded profitably and made a positive contribution to the full year results.

Arbuthnot Banking Group PLC is the holding company for Arbuthnot Latham & Co., Limited, Secure Trust Bank PLC and Arbuthnot Securities Limited,

FINANCIAL HIGHLIGHTS

·; Group pre-tax profit £5.1m (2009: £5.1m)

·; Group earnings per share (EPS) increased by 7% to 25.0p (2009: 23.4p)

·; Dividend per share (DPS) up 1p to 23p (2009: 22p)

·; Capital, liquidity and balance sheet remain strong

OPERATIONAL HIGHLIGHTS

Private Banking - Arbuthnot Latham

·; Customer deposits grew £57.5m to £349.5m (2009: £292m) and loans grew 19% to £211m (2009: £178m) whilst improving interest margin and asset quality

·; Loan to deposit ratio at 60%, maintaining strong liquidity

·; Pre-tax profit increased to £1m (2009: £0.2m) as the core Private Banking business began to see the results of the market opportunities that have arisen during the financial crisis

Retail Banking - Secure Trust Bank

·; Profit before tax reduced to £8.5m (2009: £10.2m), but underlying profits up 19% after one off items

·; Good progress in developing three main lending activities, motor finance loan book grew to £31.3m (2009: £4.7m), point-of sale asset finance (mainly musical & cycle) grew to £21.4m (2009: £6.4m) and personal loans grew to £25.8m (2009: £14.8m)

·; Current account with prepaid card re-launched with cash reward scheme, account numbers growing to 9,576 (2009: 2,740)

Investment Banking - Arbuthnot Securities

·; Returned to profitability with pre-tax profit of £1m (2009: loss of £0.1m)

·; Trading book performed strongly, recording a profit of £4.4m (2009: £3.7m)

·; Completed 16 corporate transactions including main market IPO of Shaft Sinkers Holdings PLC

Commenting on the results, Henry Angest, chairman and chief executive of Arbuthnot, said: "Arbuthnot Banking Group performed well in 2010 across all its divisions. This is the result of our prudent approach which has served us well throughout the financial crisis. We now have a strong platform on which to make further progress this year and, while maintaining the important caveats of the fragile status of the geopolitical and economic environment, we are optimistic about the outlook for 2011"

ENQUIRIES:

Arbuthnot Banking Group

Herny Angest, Chairman and Chief Executive 020 7012 2400

Andrew Salmon, Chief Operating Officer

James Cobb, Group Finance Director

Hawkpoint Partners Ltd (Nominated Advisor)

Lawrence Guthrie 020 7665 4500

Sunil Duggal

Numis Securities Ltd (Broker)Chris Wilkinson 020 7260 1000

Mark Lander

Pelham Bell Pottinger (Financial PR)

Ben Woodford 020 7861 3917

Zoë Pocock

The 2010 Annual Report, Notice of Meeting and accompanying letter from the Chairman will be posted and available on the Arbuthnot Banking Group website http://www.arbuthnotgroup.com/Presentations.aspx by 8 April 2011. Copies may be obtained from the Company Secretary, Arbuthnot Banking Group PLC, Arbuthnot House, 20 Ropemaker Street, London, EC2Y 9AR.

Chairman's statement

Arbuthnot Banking Group recorded a profit before tax of £5.1m for the year ended 31 December 2010 (2009: £5.1m). All of the Group's core businesses traded profitably and made a positive contribution to the full year result. Although Group profit is satisfactory it does not fully reflect the progress that has been made this year in the two banking subsidiaries, which have seen substantial growth in deposits and lending and gained momentum in developing their fee-related businesses.

In keeping with our progressive dividend policy, the final dividend will be increased by 0.5p to 12p per share, making a dividend for the full year of 23p (2009: 22p).

Arbuthnot is one of the few banking groups that came through the biggest financial crisis in living memory unscathed and in good shape. We did not need state support or new equity. It is no accident that we are in this strong position. Our culture and philosophy is to develop sustainable businesses for the long term. The key elements of our strategy involve diversification of businesses and of risk, and maintaining a strong and liquid balance sheet. In other words we sacrifice short-term profits to ensure long-term value and security. In 2010, for example, I estimate that to maintain liquidity we carried surplus deposits (placed in the money market at negligible interest rates rather than lent out to customers) which cost us in excess of £2 million in our Private Bank.

Arbuthnot is in its 178th year and our longevity is due to our culture and philosophy. This, I believe, makes us well qualified to pass comment on the current state of the banking industry. The crisis which began three years ago is not over yet. Many banks still depend on central banks for liquidity. Others may still not have written down their toxic assets or may engage again in risking their solvency by investing in high-yielding sovereign or other debt instruments of doubtful quality.

The most remarkable aspect of this crisis is the way that the blame - often expressed in the most hysterical and vindictive terms - was initiated and placed by the last Government squarely and almost exclusively onto the bankers. They exploited populist noise around some bankers' remuneration to whip up an anti-banker hysteria and in so doing minimise their own responsibility and that of others for the disaster.

This demonisation of bankers has provided politicians with a convenient scapegoat. But, while it is true that some senior bankers behaved with appalling greed and took huge risks to enrich themselves, the vast majority of bankers were simply not in a position to influence the course of events in any meaningful way. They were not well placed to make judgements about the overall level of risk being taken by the national or global economy - that was principally the job of the politicians and the regulators.

The outcry about bonuses epitomises the persecution of bankers. Speaking as perhaps the only senior banker who has never taken a bonus, it seems to me that these constant attacks threaten the whole future of the City of London, and we have to make up our minds. Do we want London to be a global centre of financial excellence, contributing over 11% of total revenue to the UK exchequer, or are we happy for London to be merely a regional player? If the former, we must accept that compensation will be set by global standards. It is interesting to note that the initiative of trying to surround remuneration with petty rules and unnecessary red tape is driven mainly by sclerotic European institutions; successful and growing economies like the USA, India and China seem much more hesitant in following suit. It is easy to forget how mobile financial institutions are and how much they value a welcoming environment.

Private Banking - Arbuthnot Latham & Co., Limited

Arbuthnot Latham's pre-tax profits were £1.0m (2009: £0.2m). Market conditions for lending in the high net worth segment remain strong and as a result Arbuthnot Latham grew its lending to £211m at the year end (2009: £178m) whilst improving its interest margin and asset quality. This was a strong performance, despite the continuing impact of the cost of the Bank's prudent liquidity policy and the start-up losses recorded by Gilliat Financial Solutions, the structured products business launched in 2009.

The loan to deposit ratio ended the year at 60%, a level the Board believed was appropriate to ensure liquidity for the last year's economic environment. With rates for surplus funds in the money market still at historic lows, Arbuthnot Latham's profits continue to be adversely affected.

Gilliat, having shown improvement in the third quarter, experienced further income shortfalls in the final quarter. Gilliat negatively affected the result for Arbuthnot Latham by £0.6m in 2010 (2009: £0.5m).

Central to Arbuthnot Latham's strategy is the development of its fee-based earnings, and in this regard it is pleasing to report that both asset management and wealth planning performed well in 2010.

Significant progress was also made in improving the take-up by banking clients of non-banking services.

Retail Banking - Secure Trust Bank PLC

Pre-tax profits for Secure Trust Bank were £8.5m (2009: £10.2m). Overall the business made good progress as the previous year's result included a one off gain of £1.1m and this year's result was adversely affected by the cost of carrying surplus deposits (£1.7m), and by the costs associated with restructuring the management team (£0.7m).

During the year the business further developed its three main lending activities. The motor finance loan book grew to £31.3m at the year end (2009: £4.7m). Point-of-sale asset finance, based mainly on musical instrument and bicycle retailers, grew its loan book to £21.4m (2009: £6.4m). Personal loans, mainly to OneBill or broker-introduced customers, grew to £25.8m (2009: £14.8m). All three of these areas remain very attractive markets for further expansion in 2011 and beyond.

The portfolios of books acquired in 2009 continue to be collected out in line with expectations, and with no evidence of deterioration in bad debt experience.

The current account with prepaid card was relaunched late in 2010 with a customer reward scheme arranged in conjunction with a portfolio of well known retailers to offset the monthly charge. Current account numbers have grown to 9,576 (2009: 2,740).

Investment Banking - Arbuthnot Securities Limited

Arbuthnot Securities recorded a profit of £1.0m (2009: loss of £0.1m). Having experienced a very difficult third quarter, trading in the final quarter saw a marked improvement, with corporate finance finishing the year strongly.

In former years, revenues in this business have depended heavily on contributions from the investment funds and natural resources teams. In 2010, these sectors made minimal contributions, and the result was attributable to a doubling in revenues by the remaining parts of the business.

Twelve transactions, including the £30.6m IPO of Shaft Sinkers Holdings PLC, were completed in the second half of the year, compared with four in the first half. For the year as a whole, primary revenue was £9.1m (2009: £9.2m).

Commission income continued to be challenging, with a continuing fall in market volumes and an increasing use by clients of Direct Market Access. Nevertheless, net secondary revenue (commission and trading) increased to £7.2m (2009: £6.9m).

Board Changes and Personnel

We were pleased to announce the appointment to the Board of Paul Lynam on 13 September. Paul joined as Chief Executive of Secure Trust Bank, replacing Gary Jennison, who resigned from the Board on 10 May. Sir Michael Peat resigned from the Board on 11 March 2010 for personal reasons. We are most grateful to him for the contribution he made during his time on the Board and we hope he will rejoin us one day.

These results reflect once again the continuing dedication and commitment of our employees who have done well in the current environment. On behalf of the Board I extend our thanks to all staff for their contribution in 2010. I extend particular thanks to my PA, Pat Tottenham, for her exceptional loyalty and dedication as she completed 50 years of service at Arbuthnot on 16 December 2010.

Dividend

The Board is proposing a final dividend of 12p, an increase of 0.5p on last year, making a total dividend for the year of 23p (2009: 22p). If approved, the dividend will be paid on 13 May 2011 to shareholders on the register as at 15 April 2011.

Outlook

Our retail and private banking businesses are liquid and well-capitalised, and are operating in banking markets which continue to be favourable to us. Both businesses are making good progress in developing their client networks and their fee-based services. Our investment banking business is clearly improving the quality of its franchise. Whilst maintaining the important caveats of the fragile status of the geopolitical and economic environment, we are optimistic about the outlook for 2011.

Arbuthnot Latham's pre-tax profits were £1m (2009: £0.2m). The bank has two component business lines with a common management team: Arbuthnot Latham, the private bank, which seeks to provide private banking services and wealth management solutions to its clients; and Gilliat Financial Solutions, a business which designs, packages and distributes structured products to the financial intermediary market.

The private banking business performed well, contributing pre-tax profits of £1.7m in 2010 with market conditions for lending in the high net worth segment remaining favourable. Arbuthnot Latham grew its lending by £33m to £211m, a 19% growth on 2009. Both interest margin and the quality of collateral held as security improved during the year. In line with the long-held policy of the Bank, all lending operations were financed by client deposits rather than through the inter-bank market. Deposits increased 20% year-on-year to £349m. The loan to deposit ratio ended the year at 60%, a level the business believe is appropriate to ensure liquidity for the current economic environment. The bad debt experience continued to be favourable, at less than 0.5% of the book.

Arbuthnot Latham's prudent approach to lending and liquidity management entails costs to the business which are incurred in order to ensure the security and stability of the Bank. Surplus funds are mainly invested in the money market where rates remain at historic lows, and significantly below rates paid to depositors.

During 2010 considerable management attention has focused on expanding the asset management and wealth planning offering, and on extending the take-up of these services by private banking clients. As a result discretionary assets under management grew by 26%. Total customer assets including deposits reached approximately £1 billion.

Gilliat Financial Solutions reduced Arbuthnot Latham's profits by £0.6m (2009: £0.5m). This business was a start-up in 2009. The early stage losses were exacerbated by a number of issues arising elsewhere in the structured products industry which undermined public confidence in these products. In response, a major cost reduction exercise was undertaken. In the third quarter of 2010, sales improved substantially and it delivered a break-even result, but further sales shortfalls occurred in the fourth quarter.

The pre-tax profits of Secure Trust Bank were £8.5m (2009: £10.2m). Overall the business made good progress as the result for 2009 benefitted from the write back of a £1.1m provision carried over from the sale of the insurance business and in 2010 the profits were affected by two adverse factors. When allowance is made for all three items, it becomes evident that the underlying business performed well in 2010.

The first adverse factor which affected profits arose from the carrying of surplus deposits. Having successfully completed the acquisition of two loan portfolios in 2009, Secure Trust Bank was in advanced negotiations to make further such acquisitions and raised sufficient funds to finance them. In the event, it proved unable to complete the acquisitions and, despite reducing headline deposit interest rates, carried a significantly higher level of deposits than it was able to deploy in the business for much of 2010. It is estimated that the cost of those surplus deposits was approximately £1.7m.

The second adverse factor was the cost of restructuring the management team, involving the departure of both the Chief Executive and his deputy. We were very pleased to announce the appointment of Paul Lynam as Chief Executive on 13 September 2010. Overall, the costs associated with restructuring the management team amounted to £0.7m.

During the year the Bank's lending operations achieved very strong, controlled, organic growth. Motor finance, a business which we entered cautiously during 2009, grew to a book of £31.3m at 31 December 2010 (2009: £4.7m). This business, which focuses on the near prime market segment, substantially expanded its network of brokers and dealers to the point where it now has national coverage and a fully independent sales force.

Secure Trust Bank entered the market for point-of-sale asset finance in a small way in 2009 when it took over Arbuthnot Latham's musical instrument finance business. It has doubled the size of the point-of-sale asset finance book in 2010, after adding two new business streams. It entered the cycle finance business when it took over from a clearing bank an arrangement put in place by the Association of Cycle Traders to provide finance to customers of their members. Also, it began to provide point-of-sale finance, in conjunction with RentSmart, to business customers of PC World and Currys. It is now in the process of extending this relationship to their retail customers. Overall, point-of-sale finance balances amounted to £21.4m at the year end (2009: £6.4m).

The portfolios of books acquired in 2009 continue to be collected out in line with expectations, with the balance outstanding declining to £10.8m at 31 December 2010 (2009: £25.5m). There has been no evidence of deterioration in the bad debt experience for these books.

Late in 2010 the current account with a prepaid Mastercard product was relaunched. It now comes with the added benefit of a reward scheme which pays a monthly cash sum, of up to 4%, based on a customer's spend on their Mastercard at qualifying retailers. In addition, the account has full online capabilities. As a result, account openings have exceeded 1,000 per month, and the total stock of live accounts at the end of the year was 9,576 (2009: 2,740).

As anticipated, OneBill customer numbers continue to decline over time, however, the growth of profit streams developed over the last two years means that this product is becoming progressively less significant to the profitability of the business.

Arbuthnot Securities returned to profit for the first time since 2007. Profits for the year to December 2010 were £1.0m (2009: loss of £0.1m).

In previous years, revenues in our securities business have benefited significantly from contributions from the investment funds and natural resources sector teams, both of which left during 2010. In their absence, the remaining parts of the business showed a dramatic improvement in performance. On an ongoing basis, corporate finance revenues increased by 117%, and secondary revenue (trading and commission) by 83%.

Twelve corporate transactions, including the £30.6m raise associated with the IPO of Shaft Sinkers Holdings PLC, were completed in the second half of the year, compared with four in the first half. For the year as a whole, primary revenue was £9.1m (2009: £9.2m). Those fundraisings completed in the year also generated good returns for investors with all stocks trading at a premium. Taken as a whole, we are delighted that the combined absolute return for all our fundraises completed during 2010 was a gain of 128% at the year end.

The number of corporate clients at the year end was 75 compared with 93 at the prior year end. This reduction is largely attributable to the departure of the investment funds and natural resources teams. Encouragingly, however, a number of good client wins have been reported since the year end. The quality of our AIM client base also improved during the year. The average market capitalisation of the AIM client base increased to £32m by the year end (2009: £17m).

Commission income has remained challenging, with the continuing low market volumes and increasing use of Direct Market Access (DMA) by clients. Excluding the two departed teams, underlying commissions rose by 8%.

For the second successive year the trading book performed very strongly, recording a profit of £4.4m (£3.7m). The book is still managed at the low level to which it was reduced by management actions in 2008.

Since the year end Arbuthnot Securities has completed a £25m fund raising for MAM Funds plc, and a number of other significant corporate finance transactions are being worked on (although, as ever, their outcome remains uncertain). Secondary market conditions remain difficult. The business has recruited in the investment funds and natural resources sectors and continues to hire actively where there is an opportunity to upgrade staff or expand the research product. Costs in the business remain carefully controlled, with headcount ending the year unchanged at 72 (2009: 72).

Financial Review

Arbuthnot Banking Group adopts a conservative approach to risk taking and seeks to maximise long term revenues and returns. Given its relative size, it is able to remain entrepreneurial and capable of taking advantage of market opportunities when they arise.

It provides a range of financial services to customers and clients in its three chosen niche markets of Private Banking (Arbuthnot Latham), Investment Banking (Arbuthnot Securities) and Retail Banking (Secure Trust Bank). The Group's revenues are derived from a combination of net interest income from its lending, deposit-taking and money market activities, fees for services provided to customers and clients, commissions earned on the sale of financial instruments and products and equity market-making profits.

Highlights

The Group has experienced two very different types of market conditions across its trading divisions. The lending markets are currently notable for the lack of capacity available to borrowers, which has arisen while the larger banks repair their damaged balance sheets. At the same time, the ability of borrowers to service their commitments seems to be holding up, resulting in the level of bad debts remaining low.

During this time our Private and Retail Banking businesses have taken the opportunity to develop their lending into niche areas and deepen customer relationships. We believe this will allow us to remain competitive when lending capacity returns to the market.

The corporate markets have remained volatile and while the level of IPOs and fundraising has increased during 2010, this activity has been confined to a few sectors. The level and the terms of trade in the secondary market have deteriorated, leading to lower commission throughout the industry. Given these factors it is therefore a creditable performance by our Investment Banking business to return to profitability during 2010. In fact all three businesses have reported a profit and generated good improvement in the quality of their underlying earnings.

Overall the Group made a profit before tax of £5.1m the same as reported in the prior year. However, once the impact of the provisions related to the sale of insurance business released in the prior year (£1.1m), the cost of carrying surplus deposits and management restructuring in the Retail Bank (£1.7m) and (£0.7m) respectively are adjusted for, the underlying profitability improved by 85%.

Operating income increased during the year by 6% offset by expense growth of only 3% giving an organic operating leverage improvement of net 3%.

Balance Sheet Strength

The total assets of the Group increased by 25% due to the continued growth in our lending businesses and also as a result of the surplus deposits, which are held as liquid assets.

The Group's total assets now exceed half a billion pounds for the first time in its history closing at £565.1m (2009: £452.5m) and customer assets now exceed £300m.

Customer deposits grew by 30% during the year to close at £503.3m. The Group continues with its conservative funding policy, remaining entirely funded by retail deposits and closed with a loan to deposit ratio of 59.7% (2009: 59.5%).

Segmental Analysis

The segmental analysis in Note 36 to the Consolidated Financial Statements of the Annual Report highlights the disclosures required under IFRS 8 'Operating Segments'. The operating segments are Private Banking (Arbuthnot Latham), International Private Banking (Arbuthnot AG), Investment Banking (Arbuthnot Securities) and Retail Banking (Secure Trust Bank). Group costs and intercompany elimination journals are shown separately to reconcile back to the Group consolidated result. The analysis presented below, and in the business reviews, is prior to any consolidation adjustments to remove the impact of intergroup operating activities and also intergroup recharges and is a fair reflection of the way the Directors manage the Group.

Private Banking - Arbuthnot Latham

The profit before tax increased to £1m (2009: £0.2m) as the core Private Banking business began to see the results of the market opportunities that have arisen during the financial crisis. It has been able selectively to lend to a better quality of proposition, while improving yields.

Also the fully rounded customer proposition has continued to be developed, with growth not only in customer deposits, but the successful introduction of these customers to more advisory services and discretionary management as a consequence fees and commission income shows a 21% increase to £5m.

Profitability continues to be reduced as a result of the low returns earned on the surplus deposits that are invested in the interbank market.

Impairment losses declined during the year. As a result, the core banking business closed the year with total profits before tax of £1.7m (2009: £0.7m).

Offsetting this was the continued investment in Gilliat Financial Solutions which cost the Private Banking division a further £0.6m net (the Group also absorbed Gilliat costs of £0.3m during the year).

Total assets increased by 13% to £417.9m (2009: £370.1m) as the customer lending portfolio increased by 19%. The loan to value on this portfolio remains at an extremely robust level of 47%.

The liability side of the balance sheet continued to see strong net inflows of new deposits growing by 20% to close at £349.5m (2009: £292m) this performance is even better when it is noted that £30m of deposits have been converted to assets under management as the relationships with customers have been deepened.

The Private Bank remains well capitalised maintaining a total capital ratio of 13.1% (2009: 11.2%) and a core tier 1 ratio of 11.1% (2009: 8.8%).

International Private Banking - Arbuthnot AG

Cost associated with the ongoing establishment of the Swiss Bank fell to £0.1m (2009: £0.5m) as the costs have mainly been covered by a third party who, subject to regulatory approval, intends to invest in the Swiss bank.

Retail Banking - Secure Trust Bank

Profit before tax reduced to £8.5m (2009: £10.2m) however, this does not reflect the improvement in the underlying quantity and quality of the earnings of the business.

If the following items are discounted from the comparisons, a) Release of provisions in the prior year (£1.1m), b) The cost of the surplus liquidity carried in the business (£1.7m) and c) The cost of restructuring the management team (£0.7m) then the underlying business grew by 19%.

This growth is mainly a result of the increased levels of activity in the lending business, which now has three main product areas, asset finance, personal lending and acquired portfolios. It is intended to create diversified and balanced growth in our lending books which will serve the business well, when the market becomes more competitive.

It is important for the business to maintain its sources of fee income and the current account with a pre-paid card is beginning to offset some of the continued decline in revenues from the One Bill account. The current account closed the year with 9,576 open accounts (2009: 2,740) and OneBill closed the year with 31,720 open accounts (2009: 36,104).

During this year the asset finance business increased its portfolio size by 374% to close at a total of £52.6m. This growth was largely due to the Motor vehicle portfolio which closed the year at £31.3m. However, this growth was augmented by the launch of our cycle and personal computer lending portfolios which grew to £9m and £5.1m in respectively.

The personal lending portfolio grew by 74% to close at £25.8m as the business was able to source new business from online brokers and offer new financing to customers from the acquired portfolios. The acquired portfolios reduced to £10.7m as the customers continued to repay their loans according to our expectations.

Customer deposit balances increased by 65% to £153.8m.

Investment Banking - Arbuthnot Securities

The business returned to profitability recording a profit before tax of £1m (2009: £0.1m loss).

As noted in the business review the Investment Banking division has in the past relied heavily on the contributions of two sector teams. These teams departed during 2010 and in their absence the remaining parts of the business were able to generate the same levels of operating income, but with a reduced cost base.

Primary revenues remained unchanged at £9m with the business completing sixteen corporate transactions, twelve of which were finalised in the second half. The secondary revenues also remained at approximately the same levels as in the prior year, but with the slightly different mix between trading and commission revenues.

The non controlling interest remained unchanged at 40.4% and therefore the Group's resultant share is 59.6%.

Group & Other Costs

The Group costs increased by 14% to £5.4m (2009: £4.7m). This was due to higher salary costs and the reduction in the fair value of securities held. The Group also made a further contribution of £0.3m (2009: £0.5m) to the investment in Gilliat Financial Solutions.

Capital

The Group's capital management policy is focused on optimising shareholder value over the long term. There is a clear focus on delivering organic growth and ensuring capital resources are sufficient to support planned levels of growth. The Board regularly reviews the capital position.

In accordance with the EU's Capital Requirements Directive (CRD) and the required parameters set out in the FSA Handbook (BIPRU 2.2), the Individual Capital Adequacy Assessment Process (ICAAP) is embedded in the risk management framework of the Group and is subject to ongoing updates and revisions when necessary. However, at a minimum, the ICAAP is updated annually as part of the business planning process. The ICAAP is a process that brings together the management framework (i.e. the policies, procedures, strategies, and systems that the Group has implemented to identify, manage and mitigate its risks) and the financial disciplines of business planning and capital management.

The Group's regulated entities are also the principal trading subsidiaries as detailed in Note 35.

Not all material risks can be mitigated by capital, but where capital is appropriate the Board has adopted a "Pillar I plus" approach to determine the level of capital the Group needs to hold. This method takes the Pillar I capital formula calculations (standardised approach for credit, market and operational risk) as a starting point, and then considers whether each of the calculations deliver a sufficient capital sum adequately to cover management's anticipated risks. Where the Board considered that the Pillar I calculations did not reflect the risk, an additional capital add-on in Pillar II is applied.

The Group's regulatory capital is divided into two tiers:

• Tier 1 comprises mainly shareholders' funds and non-controlling interest, after deducting goodwill and other intangible assets.

• Lower Tier 2 comprises qualifying subordinated loan capital and revaluation reserves. Lower Tier 2 capital cannot exceed 50% of tier 1 capital.

The ICAAP includes a summary of the capital required to mitigate the identified risks in its regulated entities and the amount of capital that the Group has available. The latest version of the Group ICAAP was approved by the Board on 11 February 2011. All regulated entities have complied with all of the externally imposed capital requirements to which they are subject.

* - Risk Weighted Assets (RWAs)

Risks and Uncertainties

The Group regards the monitoring and controlling of risks and uncertainties as a fundamental part of the management process. Consequently, senior management are involved in the development of risk management policies and in monitoring their application. A detailed description of risk management and their associated policies is set out in note 4 to the financial statements.

The principal risks inherent in the Group's business are credit, market, liquidity, operational and regulatory.

Credit risk, is the risk that a counterparty will be unable to pay amounts in full, when due. This risk exists mainly in Arbuthnot Latham & Co., Limited and Secure Trust Bank, who currently have loan books of £210.8 m and £89.2 m respectively.

The lending portfolio in Arbuthnot Latham is extended to our Private Banking clients, the majority of which is secured against cash, property or other assets.

The portfolios within Secure Trust are extended to retail customers, and are largely unsecured.

Credit risk is managed through the Credit Committees of each of the two banks with significant exposures also being approved by the Group Risk Committee.

Market risk arises in relation to movement in the interest rates, currencies and equity markets.

Through Arbuthnot Securities, the Group is involved in market-making and underwriting UK equities. The market making book is subject to Group approved limits, both in aggregate and in relation to individual stocks. Outstanding positions are monitored against these limits both intraday and overnight. All significant underwriting transactions are individually approved by the Group Risk Committee.

The Group's treasury function operates mainly to provide a service to clients and does not take significant unmatched positions in any market for its own account. Hence, the Group's exposure to adverse movements in interest rates and currencies is limited to interest earnings on it free cash and interest rate re-pricing mismatches.

Liquidity risk is the risk that the Group cannot meet is liabilities as they fall due. The Group takes a conservative approach to managing its liquidity profile. It has placed no reliance on the wholesale lending markets and is entirely funded by retail customer deposits. The loan to deposit ratios are maintained at prudent levels. Following introduction of the new liquidity regime, which came into force on 1 October 2010, the Group now maintains liquidity asset buffers which comprise high quality, unencumbered assets such as Government Securities, which can be called upon to meet the Group's liabilities.

Operational risk is the risk that the Group may be exposed to financial losses from conducting its business. The largest exposure to this risk exists in Arbuthnot Latham as mis-selling risk via its wealth management advisory service and its structured product distribution business.

The Group maintains clear compliance guidelines and provides ongoing training to all staff. Periodic spot checks and internal audits are performed to ensure these guidelines are being maintained. The Group also has insurance policies in place to cover any claims that may arise.

The Group is also exposed to operational risks from its Information Technology and Operations platforms. There are additional internal controls in these processes that are designed to protect the group from these risks. The Group's overall approach to managing internal control and financial reporting is described in the Corporate Governance section of the Annual Report.

Regulatory risk is the risk that the Group will have insufficient capital resources to support the business or does not comply with regulatory requirements. The Group adopts a conservative approach to managing the capital of the Group. The principal regulated entities maintain capital ratios in excess of the minimum level set by the regulator. Capital requirements are forecast as part of the annual budgeting process and these are regularly monitored. Annually the Group Board assesses the robustness of the capital requirements as part of the Individual Capital Adequacy Assessment Process (ICAAP) where stringent stress tests are performed to ensure that capital resources are adequate over a future three year horizon.

Dividend

The Board proposes a final dividend of 12 pence per share to be paid on 13 May 2011, giving a total dividend for the year of 23 pence (2009: 22 pence) per share.

Going Concern

After making appropriate enquiries which assessed strategy, profitability, funding, risk management (see Note 4) and capital resources (see Note 5), the directors are satisfied that the Company and the Group have adequate resources to continue in operation for the foreseeable future. The financial statements are, therefore, prepared on the going concern basis.

Principal accounting policies

The principal accounting policies applied in the preparation of these consolidated financial statements are set out below. These policies have been consistently applied to all the years presented, unless otherwise stated.

1.1. Reporting entity

Arbuthnot Banking Group PLC is a company domiciled in United Kingdom. The registered address of the Arbuthnot Banking Group PLC is One Arleston Way, Solihull B90 4LH. The consolidated financial statements of the Arbuthnot Banking Group PLC as at and for the year ended 31 December 2010 comprise the Arbuthnot Banking Group PLC and its subsidiaries (together referred to as the "Group" and individually as "subsidiaries"). The Company is primarily involved in banking and financial services.

1.2. Basis of presentation

The Group's consolidated financial statements and the Company's financial statements have been prepared in accordance with International Financial Reporting Standards (IFRSs as adopted and endorsed by the EU) and the Companies Act 2006 applicable to companies reporting under IFRS. They have been prepared under the historical cost convention, as modified by the revaluation of land and buildings, available-for-sale financial assets, and financial assets and financial liabilities at fair value through profit or loss.

The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the Group's accounting policies. The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements are disclosed in Note 2.

The Group's business activities and financial position, the factors likely to affect its future development and performance, and its objectives and policies in managing the financial risks to which it is exposed and its capital are discussed in the Financial Review. The Directors have assessed, in the light of current and anticipated economic conditions, the Group's ability to continue as a going concern. The Directors confirm they are satisfied that the Company and the Group have adequate resources to continue in business for the foreseeable future. For this reason, they continue to adopt the 'going concern' basis for preparing accounts.

(a) Standards, interpretations and amendments effective in 2010 - relevant to the Group

• IFRS 2 (Revised), 'Share-based payments'. The revised standard clarifies the scope and accounting for group cash-settled share-based payments in the separate financial statements of the entity receiving the goods or services when that entity has no obligation to settle the share-based payment transaction.

• IFRS 3 (Revised), 'Business combinations'. The revised standard continues to apply the acquisition method to business combinations, however, all payments to purchase a business are to be recorded at fair value at the acquisition date, with contingent payments classified as debt subsequently re-measured through the income statement. There is a choice on an acquisition-by-acquisition basis to measure the non-controlling interest in the acquiree either at fair value or at the non-controlling interest's proportionate share of the acquiree's net assets. All acquisition-related costs should be expensed.

• IAS 24 (Revised), 'Related party disclosures' (effective from 1 January 2011 - early adopted). The revised standard includes an exemption from the disclosure requirements for related party transactions between "state controlled" entities and includes a revised definition for related parties.

• IAS 27 (Revised), 'Consolidated and separate financial statements'. The revised standard requires the effects of all transactions with non-controlling interests to be recorded in equity if there is no change in control. Any remaining 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.

• Improvements to IFRSs. Sets out minor amendments to IFRS standards as part of annual improvements process.

The above changes did not have any material impact on the financial statements.

(b) Standards, interpretations and amendments to existing standards that are not yet effective and have not been early adopted by the Group

The following standards, interpretations and amendments to existing standards have been published and are mandatory for the Group's accounting periods beginning on or after 1 January 2011 or later periods, but the Group has not early adopted them:

• IFRS 7 (Revised), 'Disclosures - Transfers of Financial Assets' (effective from 1 July 2011). The revised standard require additional disclosures for transfers of financial assets and where there are a disproportionate amount of transactions undertaken around the period end. The revised standard will not have any material impact on the Group's financial accounts.*

• IFRS 9, 'Financial instruments' (effective from 1 January 2013). This standard deals with the classification and measurement of financial assets and will replace IAS 39. The requirements of this standard represent a significant change from the existing requirements in IAS 39. The standard contains two primary measurement categories for financial assets: amortised cost and fair value. The standard eliminates the existing IAS 39 categories of 'held to maturity', 'available for sale' and ' loans and receivables'. The potential effect of this standard is currently being evaluated but it is expected to have a pervasive impact on the Group's financial statements, due to the nature of the Group's operations.*

* - The revised IFRS 7 and IFRS 9 have not yet been endorsed by the EU.

1.3. Consolidation

(a) Subsidiaries

Subsidiaries are all entities (including special purpose entities) over which the Group has the power to govern the financial and operating policies, generally accompanying 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.

The purchase method of accounting is used to account for the acquisition of subsidiaries by the Group. The cost of an acquisition is measured as the fair value of the assets given, equity instruments issued and liabilities incurred or assumed at the date of exchange, plus costs directly attributable to the acquisition. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any non-controlling interest. The excess of the cost of acquisition over the fair value of the Group's shares of the identifiable net assets acquired is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognised directly in the income statement.

Inter-company transactions, balances and unrealised gains on transactions between group companies are eliminated. Unrealised losses are also eliminated. Accounting policies of subsidiaries have been changed where necessary to ensure consistency with the policies adopted by the Group.

(b) Special purpose entities

Special purpose entities (SPEs) are entities that are created to accomplish a narrow and well-defined objective such as the securitisation of particular assets, or the execution of a specific borrowing or lending transaction. SPEs are consolidated when the substance of the relationship between the Group and the entity and the evaluation of the Group's exposure to the risks and rewards of the SPE indicates control. The following circumstances may indicate control by the Group and would therefore require consolidation of the SPE:

• in substance, the activities of the SPE are being conducted on behalf of the entity according to its specific business needs so that the entity obtains benefits from the SPE's operation;

• in substance, the entity has the decision-making powers to obtain the majority of the benefits of the activities of the SPE or, by setting up an 'autopilot' mechanism, the entity has delegated these decision-making powers;

• in substance, the entity has rights to obtain the majority of the benefits of the SPE and therefore may be exposed to risks incident to the activities of the SPE; or

• in substance, the entity retains the majority of the residual or ownership risks related to the SPE or its assets in order to obtain benefits from its activities.

The assessment of whether the Group has control over an SPE is carried out at inception and the initial assessment is only reconsidered at a later date if there were any changes to the structure or terms of the SPE, or there were additional transactions between the Group and the SPE.

(c) Transactions and non-controlling interests

Changes in ownership interest in a subsidiary that do not result in the loss of control are accounted for as equity transactions and no gain or loss is recognised.

1.4. Segment reporting

Operating segments are reported in a manner consistent with the internal reporting provided to the Group Board. The Group Board, which is responsible for allocating resources and assessing performance of the operating segments, has been identified as the chief operating decision maker. All transactions between segments are conducted on an arm's length basis. Income and expenses directly associated with each segment are included in determining segment performance. There are four main operating segments:

• Retail Banking

• International Private Banking

• UK Private Banking

• Investment Banking

1.5. Foreign currency translation

(a) Functional and presentational currency

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 pounds sterling, which is the Company's functional and the Group's presentational currency.

(b) Transactions and balances

Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions or valuation where items are remeasured. 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.

(c) Group companies

The results and financial position of all the Group entities (none of which has the currency of a hyperinflationary economy) that have a functional currency different from the presentational currency are translated into the presentation currency as follows:

• assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that

balance sheet;

• income and expenses for each income statement are translated at average exchange rates (unless this average is

not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in

which case income and expenses are translated at the rate on the dates of the transactions); and

• all resulting exchange differences are recognised as a separate component of equity.

On consolidation, exchange differences arising from the translation of the net investment in foreign operations, and of borrowings and other currency instruments designated as hedges of such investments, are taken to shareholders' equity. When a foreign operation is partially disposed of or sold, exchange differences that were recorded in equity are recognised in the income statement as part of the gain or loss on sale.

Goodwill and fair value adjustments arising on the acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and translated at the closing rate.

1.6. Interest income and expense

Interest income and expense are recognised in the statement of comprehensive income for all instruments measured at amortised cost using the effective interest method.

The effective interest method is a method of calculating the amortised cost of a financial asset or a financial liability and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through 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. When calculating the effective interest rate, the Group takes into account all contractual terms of the financial instrument but does not consider future credit losses. The calculation includes all fees paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums or discounts.

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.

1.7. Fee and commission income

Fees and commissions which are not considered integral to the effective interest rate are generally recognised on an accrual basis when the service has been provided. Loan commitment fees are deferred and recognised as an adjustment to the effective interest rate on the loan.

Commission and fees arising from negotiating, or participating in the negotiation of, a transaction for a third party - such as the issue or the acquisition of shares or other securities or the purchase or sale of businesses - are recognised on completion of the underlying transaction. Asset and other management, advisory and service fees are recognised based on the applicable service contracts, usually on a time apportioned basis. The same principle is applied for financial planning and insurance services that are continuously provided over an extended period of time. Commissions arising from the sale of structured products are recognised at the point of sale as there are no further services provided or due.

1.8. Gains less losses arising from dealing in securities

This includes the net gains arising from both buying and selling securities and from positions held in securities, including related interest income and dividends, recognised on trade-date - the date on which the Group commits to purchase or sell the asset.

1.9. Financial assets and financial liabilities

The Group classifies its financial assets and financial liabilities in the following categories: financial assets and financial liabilities at fair value through profit or loss; loans and receivables; held-to-maturity investments; available-for-sale financial assets and other financial liabilities. Management determines the classification of its investments at initial recognition. A financial asset or financial liability is measured initially at fair value. At inception transaction costs that are directly attributable to its acquisition or issue, for an item not at fair value through profit or loss, is added to the fair value of the financial asset and deducted from the fair value of the financial liability.

(a) Financial assets and financial liabilities at fair value through profit or loss

This category comprises financial assets and financial liabilities held for trading and listed securities. All listed securities are held for trading. Financial assets and liabilities at fair value through profit or loss are initially recognised on trade-date - the date on which the Group becomes a party to the contractual provisions of the instrument. Subsequent measurement of financial assets and financial liabilities held in this category are carried at fair value through profit or loss.

(b) Loans and receivables

Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They arise when the Group provides money, goods or services directly to a debtor with no intention of trading the receivable. Loans are recognised when cash is advanced to the borrowers. Loans and receivables are carried at amortised cost using the effective interest method.

(c) Held-to-maturity

Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group's management has the positive intention and ability to hold to maturity. Held-to-maturity investments are carried at amortised cost using the effective interest method.

(d) Available-for-sale

Available-for-sale investments are those intended to be held for an indefinite period of time, which may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. Included in available-for-sale are equity investments in special purpose vehicles set up to acquire and enhance the value of commercial properties and equity investments in unquoted vehicles. These investments are of a medium term nature. There is no open market for these assets and there are no available-for-sale debt securities. Unquoted equity securities whose fair value cannot reliably be measured are carried at cost. All other available-for-sale investments are carried at fair value. Fair value changes on the equity securities are recognised in other comprehensive income (fair value reserve) until the investment is sold or impaired. Once sold or impaired the cumulative gains or losses previously recognised in other comprehensive income is reclassified to profit or loss.

(e) Other financial liabilities

Other financial liabilities are non-derivative financial liabilities with fixed or determinable payments. Other financial liabilities are recognised when cash is received from the depositors. Other financial liabilities are carried at amortised cost using the effective interest method. The fair value of other liabilities repayable on demand is assumed to be the amount payable on demand at the balance sheet date.

Derecognition

Financial assets are derecognised when the rights to receive cash flows from the financial assets have expired or where the Group has transferred substantially all risks and rewards of ownership. Any interest in transferred financial assets that qualify for derecognition that is created or retained by the Group is recognised as a separate asset or liability in the statement of financial position. In transactions in which the Group neither retains nor transfers substantially all the risks and rewards of ownership of a financial asset and it retains control over the asset, the Group continues to recognise the asset to the extent of its continuing involvement, determined by the extent to which it is exposed to changes in the value of the transferred asset. There have not been any instances where assets have only been partially derecognised.

The Group derecognises a financial liability when its contractual obligations are discharged or cancelled or expire.

Amortised cost measurement

The amortised cost of a financial asset or financial liability is the amount at which the financial asset or financial liability is measured at initial recognition, minus principal payments, plus or minus the cumulative amortisation using the effective interest method of any difference between the initial amount recognised and the maturity amount, minus any reduction for impairment.

Fair value measurement

Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction on the measurement date. The fair value 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 appropriate valuation techniques. These include the use of recent arm's length transactions, reference to other instruments that are substantially the same for which market observable prices exist, net present value and discounted cash flow analysis.

1.10. Derivative financial instruments

All derivatives are recognised at their fair value. Fair values are obtained from quoted market prices in active markets, including recent arm's length transactions. Derivatives are shown in the statement of financial position as assets when their fair value is positive and as liabilities when their fair value is negative. Changes in the fair value of derivatives are recognised immediately in the statement of comprehensive income.

1.11. Offsetting financial instruments

Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously.

1.12. Impairment of financial assets

(a) Assets carried at amortised cost

On an ongoing basis the Group assesses whether there is objective evidence that a financial asset or group of financial assets is impaired. A financial asset or a group of financial assets is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a 'loss event') and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated.

The criteria that the Group uses to determine that there is objective evidence of an impairment loss include, but are not limited to, the following:

• Delinquency in contractual payments of principal or interest;

• Cash flow difficulties experienced by the borrower;

• Initiation of bankruptcy proceedings;

• Deterioration in the value of collateral;

• Deterioration of the borrower's competitive position;

If there is objective evidence that an impairment loss on loans and receivables or held-to-maturity investments carried at amortised cost has been incurred, the amount of the loss is measured as the difference between the asset's carrying amount and the present value of estimated future cash flows discounted at the financial asset's original effective interest rate. The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognised in the income statement. If a loan or held-to maturity investment has a variable interest rate, the discount rate for measuring any impairment loss is the current effective interest rate determined under the contract. When a loan is uncollectible, it is written off against the related provision for loan impairment. Such loans are written off after all the necessary procedures have been completed and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off decrease the amount of the provision for loan impairment in the income statement.

(b) Assets classified as available for sale

The Group assesses at each balance sheet date whether there is objective evidence that a financial asset or a group of financial assets is impaired. In the case of equity investments classified as available-for-sale, a significant or prolonged decline in the fair value of the security below its cost is considered as an indicator that the securities are impaired. If any such evidence exists for available-for-sale financial assets, the cumulative loss - measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that financial asset previously recognised in profit or loss - is removed from equity and recognised in the income statement. Impairment losses recognised in the income statement on equity instruments are not reversed through the income statement.

(c) Renegotiated loans

Loans that are either subject to collective impairment assessment or individually significant and whose terms have been renegotiated are no longer considered to be past due but are treated as new loans.

1.13. Intangible assets

(a) Goodwill

Goodwill represents the excess of the cost of an acquisition over the fair value of the Group's share of the net identifiable assets of the acquired subsidiary at the date of acquisition. Goodwill on acquisitions of subsidiaries is included in 'intangible assets'. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold.

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 and carry goodwill at cost less accumulated impairment losses. Assets are grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows of other assets or groups of assets (the "cash-generating unit" or "CGU"). For impairment testing purposes goodwill cannot be allocated to a CGU that is greater than a reported operating segment. CGUs to which goodwill has been allocated are aggregated so that the level at which impairment is tested reflects the lowest level at which goodwill is monitored for internal reporting purposes. Goodwill acquired in a business combination is allocated to groups of CGUs that are expected to benefit from the synergies of the combination.

The recoverable amount of an asset or CGU is the greater of its value in use and its fair value less costs to sell. There are currently two CGU's with goodwill attached to it; the core Arbuthnot Latham CGU and the Music Finance CGU.

Management considers the value in use for the core Arbuthnot Latham CGU to be the discounted cash flows over 5 years with a terminal value (2009: 5 years with a terminal value). The 5 year plan with a terminal value is considered to be appropriate as the goodwill relates to an ongoing well established business and not underlying assets with finite lives. The terminal value is calculated by applying a discounted perpetual growth model to the profit expected in 2013 as per the approved 3 year plan. A growth rate of 8% (2009: 7%) was used for income and 9% (2009: 4%) for expenditure from 2011 to 2013 (these rates were the best estimate of future forecasted performance), while a 4% (2009: 4%) percent growth rate for income and expenditure (a more conservative approach was taken for latter years as these were not budgeted for in detail as per the three year plan approved by the Board of Directors) was used for cash flows after the approved three year plan.

Management considers the value in use for the Music Finance CGU to be the discounted cash flows over 5 years (2009: 5 years). Income and expenditure were kept flat (2009: 0%) over the 5 year period.

Cash flows were discounted at a pre-tax rate of 12% (2009: 12%) to their net present value. The discount rate of 12% is considered to be appropriate after evaluating current market assessments of the time value of money and the risks specific to the assets or CGUs. Currently the value in use and fair value less costs to sell far exceeds the carrying value and as such no sensitivity analysis was done.

Impairment losses are recognised in profit and loss if the carrying amounts exceed the recoverable amounts.

(b) Computer software

Acquired computer software licences are capitalised on the basis of the costs incurred to acquire and bring to use the specific software. These costs are amortised on the basis of the expected useful lives (three to five years).

Costs associated with developing or maintaining computer software programs are recognised as an expense as incurred.

1.14. Property, plant and equipment

Land and buildings comprise mainly branches and offices and are stated at the latest valuation with subsequent additions at cost less depreciation. Plant and equipment is stated at historical cost less depreciation. Historical cost includes expenditure that is directly attributable to the acquisition of the items.

Land is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate their cost to their residual values over their estimated useful lives, applying the following annual rates, which are subject to regular review:

Gains and losses on disposals are determined by comparing proceeds with carrying amount. These are included in the income statement. Depreciation on revalued freehold buildings is calculated using the straight-line method over the remaining useful life. Revaluation of assets and any subsequent disposals are addressed through the revaluation reserve and any changes are transferred to retained earnings.

1.15. Leases

(a) As a lessor

Assets leased to customers under agreements which transfer substantially all the risks and rewards of ownership, with or without ultimate legal title, are classified as finance leases. When assets are held subject to finance leases, the present value of the lease payments is recognised as a receivable. The difference between the gross receivable and the present value of the receivable is recognised as unearned finance income. Lease income is recognised over the term of the lease using the net investment method, which reflects a constant periodic rate of return.

Assets leased to customers under agreements which do not transfer substantially all the risks and rewards of ownership are classified as operating leases. When assets are held subject to operating leases, the underlying assets are held at cost less accumulated depreciation, The assets are depreciated down to their estimated residual values on a straight line basis over the lease term. Lease rental income is recognised on a straight line basis over the lease term.

(b) As a lessee

Rentals made under operating leases are recognised in the income statement on a straight line basis over the term of the lease.

1.16. Cash and cash equivalents

For the purposes of the cash flow statement, cash and cash equivalents comprises cash on hand and demand deposits, and cash equivalents comprise highly liquid investments that are convertible into cash with an insignificant risk of changes in value with a maturity of three months or less at the date of acquisition, including certain loans and advances to banks and building societies and short-term highly liquid debt securities.

1.17. Employee benefits

(a) Post-retirement obligations

The Group contributes to a defined contribution scheme and to individual defined contribution schemes for the benefit of certain employees. The schemes are funded through payments to insurance companies or trustee-administered funds at the contribution rates agreed with individual employees.

The Group has no further payment obligations once the contributions have been paid. The contributions are recognised as an employee benefit expense when they are due. Prepaid contributions are recognised as an asset to the extent that a cash refund or a reduction in the future payments is available.

There are no post-retirement benefits other than pensions.

(b) Share-based compensation

As set out in note 34, in 2008 and 2009 the Group awarded share options to three directors under an equity settled share-based compensation plan. No options were awarded in 2010. The fair value of the services received in exchange for the grant of the options is recognised as an expense. The total amount to be expensed over the vesting period is determined by reference to the fair value of the options granted. At each balance sheet date, the Group revises its estimates of the number of options that are expected to vest and recognises the impact of the revision to original estimates, if any, in the income statement, with a corresponding adjustment to equity.

The proceeds received net of any directly attributable transaction costs are credited to share capital (nominal value) and share premium when the options are exercised.

1.18. Taxation

Current income tax which is payable on taxable profits is recognised as an expense in the period in which the profits arise. Income tax recoverable on tax allowable losses is recognised as an asset only to the extent that it is regarded as recoverable by offset against current or future taxable profits.

Deferred tax is provided in full 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 the initial recognition of goodwill, the 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, and differences relating to investments in subsidiaries to the extent that they probably will not reverse in the foreseeable future. Deferred tax is determined using tax rates (and laws) that have been enacted or substantively enacted by the statement of financial position date and 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 profits will be available against which the temporary differences can be utilised.

1.19. Issued debt and equity securities

Issued financial instruments or their components are classified as liabilities where the contractual arrangement results in the Group having a present obligation to either deliver cash or another financial asset to the holder, to exchange financial instruments on terms that are potentially unfavourable. Issued financial instruments, or their components, are classified as equity where they meet the definition of equity and confer on the holder a residual interest in the assets of the Company. The components of issued financial instruments that contain both liability and equity elements are accounted for separately with the equity component being assigned the residual amount after deducting from the instrument as a whole the amount separately determined as the fair value of the liability component.

Financial liabilities, other than trading liabilities at fair value, are carried at amortised cost using the effective interest method as set out in policy 1.5. Equity instruments, including share capital, are initially recognised at net proceeds, after deducting transaction costs and any related income tax. Dividend and other payments to equity holders are deducted from equity, net of any related tax.

1.20. Share capital

(a) Share issue costs

Incremental costs directly attributable to the issue of new shares or options or to the acquisition of a business are shown in equity as a deduction, net of tax, from the proceeds.

(b) Dividends on ordinary shares

Dividends on ordinary shares are recognised in equity in the period in which they are approved.

(c) Share buybacks

Where any group company purchases the company's equity share capital (treasury shares), the consideration paid, including any directly attributable incremental costs (net of income taxes) is deducted from equity attributable to the company's equity holders until the shares are cancelled or reissued.

1.21. Fiduciary activities

The Group commonly acts as trustees and in other fiduciary capacities that result in the holding or placing of assets on behalf of individuals, trusts, retirement benefit plans and other institutions. These assets and income arising thereon are excluded from these financial statements, as they are not assets of the Group.

1.22. Financial guarantee contracts

Financial guarantees 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. Liabilities under financial guarantee contracts are initially recorded at their fair value, and the initial fair value is amortised over the life of the financial guarantee. Subsequently, the financial guarantee liabilities are measured at the higher of the initial fair value, less cumulative amortisation, and the best estimate of the expenditure to settle obligations.

Notes to the consolidated financial statements

2. Critical accounting estimates and judgements in applying accounting policies

The Group makes estimates and assumptions that affect the reported amounts of assets and liabilities within the next financial year. Estimates and judgements 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.

2.1. Estimation uncertainty

Credit losses

The Group reviews its loan portfolios and held-to-maturity investments to assess impairment at least on a half-yearly basis. The basis for evaluating impairment losses is described in accounting policy 1.12. Where financial assets are individually evaluated for impairment, management uses their best estimates in calculating the net present value of future cash flows. Management has to make judgements on the financial position of the counterparty and the net realisable value of collateral, in determining the expected future cash flows.

In determining whether an impairment loss should be recorded in the income statement, the Group makes judgements as to whether there is any observable data indicating that there is a measurable decrease in the estimated future cash flows from a portfolio of loans or held-to-maturity investments with similar credit characteristics, before the decrease can be identified with an individual loan in that portfolio. This evidence may include observable data indicating that there has been an adverse change in the payment status of borrowers in a group, or national or local economic conditions that correlate with defaults on assets in the Group. Management uses estimates based on historical loss experience for assets with credit risk characteristics and objective evidence of impairment similar to those in the portfolio when scheduling its future cash flows. The methodology and assumptions used for estimating both the amount and timing of future cash flows are reviewed regularly to reduce any differences between loss estimates and actual loss experience.

Goodwill impairment

The accounting policy for goodwill is described in note 1.13 (a). The Company reviews the goodwill for impairment at least annually or when events or changes in economic circumstances indicate that impairment may have taken place. Significant management judgements are made in estimations, to evaluate whether an impairment of goodwill is necessary. Impairment testing is done at CGU level and the following two items, with judgements surrounding them, have a significant impact on the estimations used in determining the necessity of an impairment charge:

• Future cash flows - Cash flow forecasts reflect managements view of future business forecasts at the time of the assessment. A detailed three year budget is done every year and management also uses judgement in applying a growth rate. The accuracy of future cash flows is subject to a high degree of uncertainty in volatile market conditions. During such conditions, management would do impairment testing more frequently than annually to ensure that the assumptions applied are still valid in the current market conditions.

• Discount rate - Management also apply judgement in determining the discount rate used to discount future expected cash flows. The discount rate is derived from the cost of capital for each CGU.

At the time of the impairment testing, if the future expected cash flows decline and/or the cost of capital has increased, then the recoverable amount will reduce.

Taxation

The group is subject to direct and indirect taxation in a number of jurisdictions. There may be some transactions and calculations for which the ultimate tax determination has an element of uncertainty during the ordinary course of business. The Group recognises liabilities based on estimates of the quantum of taxes that may be due. Where the final tax determination is different from the amounts that were initially recorded, such differences will impact the income tax an deferred tax expense in the year in which the determination is made.

2.2. Judgements

Impairment of equity securities

A significant or prolonged decline in the fair value of an equity security is objective evidence of impairment. The Group regards a decline of more than 20 percent in fair value as "significant" and a decline in the quoted market price that persists for nine months or longer as "prolonged".

Valuation of financial instruments

Fair values of financial assets and financial liabilities that are traded in active markets are based on quoted market prices. If the market is not active the Group establishes a fair value by using appropriate valuation techniques. These include the use of recent arm's length transactions, reference to other instruments that are substantially the same for which market observable prices exist, net present value and discounted cash flow analysis. The objective of valuation techniques is to determine the fair value of the financial instrument at the reporting date as the price that would have been agreed between active market participants in an arm's length transaction.

The Group measures fair value using the following fair value hierarchy that reflects the significance of the inputs used in making measurements:

• Level 1: Quoted prices in active markets for identical assets or liabilities

• Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (i.e.

as prices) or indirectly (i.e. derived from prices).

• Level 3: inputs for the asset or liability that are not based on observable market data (unobservable inputs).

The consideration of factors such as the magnitude and frequency of trading activity, the availability of prices and the size of bid/offer spreads, assist in the judgement as to whether a market is active. If in the opinion of management, a significant proportion of the instrument's carrying amount is driven by unobservable inputs, the instrument in its entirety is classified as valued using significant unobservable inputs. 'Unobservable' in this context means that there is little or no current market data available from which to determine the level at which an arm's length transaction would be likely to occur. It generally does not mean that there is no market data available at all upon which to base a determination of fair value (consensus pricing data may, for example, be used).

The tables below analyses financial instruments measured at fair value by the level in the fair value hierarchy into which the measurement is categorised: