Note 17: Allowance for expected credit losses continued
Corporate insolvency rates: £(9) million (2024: £(35) million)
The volume of UK corporate insolvencies continues to exhibit an elevated trend beyond December 2019 levels, revealing a marked
misalignment between observed UK corporate insolvencies and the Group’s equivalent credit performance. This dislocation gives rise to
uncertainty over the drivers of the observed trends in the metric and the appropriateness of the Group’s Commercial Banking model response
which uses observed UK corporate insolvencies data to anchor future loss estimates to. Given the Group’s stable credit performance, a
negative adjustment is applied by reverting judgementally to the long-term average of the insolvency rate. The scale of the negative adjustment
reduced in the period reflecting both the reduction in observed actual UK corporate insolvencies rates, narrowing the gap of the misalignment,
as well from changes due to the interaction with the implementation of loss rate model enhancements in the period.
Global tariff and geo-political disruption risks: £3 million (2024: £nil)
This new adjustment is to recognise the potential risks to specific drivers across various corporate sectors not reflected in broad
macroeconomic model drivers. These are potential nuanced risks to businesses inherent in the base case which could also worsen in the
downside scenarios. This assessment is judgemental and apportioned across all sectors given the uncertainty of how these risks would emerge.
Generation of multiple economic scenarios
The estimate of expected credit losses is required to be based on an unbiased expectation of future economic scenarios. The approach used to
generate the range of future economic scenarios depends on the methodology and judgements adopted. The Group’s approach is to start from
a defined base case scenario, used for planning purposes, and to generate alternative economic scenarios around this base case. The base case
scenario is a conditional forecast underpinned by a number of conditioning assumptions that reflect the Group’s best view of key future
developments. If circumstances appear likely to materially deviate from the conditioning assumptions, then the base case scenario is updated.
The base case scenario is central to a range of future economic scenarios generated by simulation of an economic model, for which the same
conditioning assumptions apply as in the base case scenario. These scenarios are ranked by using estimated relationships with industry-wide
historical loss data. With the base case already pre-defined, three other scenarios are identified as averages of constituent scenarios located
around the 15th, 75th and 95th percentiles of the distribution. The full distribution is therefore summarised by a practical number of scenarios
to run through ECL models representing an upside, the base case, and a downside scenario weighted at 30% each, together with a severe
downside scenario weighted at 10 %. The scenario weights represent the distribution of economic scenarios and not subjective views on
likelihood. The inclusion of a severe downside scenario with a smaller weighting ensures that the non-linearity of losses in the tail of the
distribution is adequately captured. Macroeconomic projections may employ reversionary techniques to adjust the paths of economic drivers
towards long-run equilibria after a reasonable forecast horizon. The Group does not use such techniques to force the MES scenarios to revert to
the base case planning view. Utilising such techniques would be expected to be immaterial for expected credit losses since loss sensitivity is
minimal after the initial five years of the projections.
A forum under the chairmanship of the Chief Economist meets at least quarterly to review and, if appropriate, recommend changes to the
method by which economic scenarios are generated, for approval by the Chief Financial Officer and Chief Risk Officer. Since 30 September
2025, the non-modelled adjustments previously applied to UK Bank Rate and CPI inflation in the severe downside scenario have been removed.
This is because the incremental ECL impact is no longer considered sufficiently material to justify their application. Accordingly, its removal has
had no material impact on ECL.
Base case and MES economic assumptions
The Group’s base case economic scenario has been updated to reflect global developments and changes in domestic economic policy. The
Group’s updated base case scenario has the following conditioning assumptions. First, developments in global conflicts, technology or financial
sector issues do not cause a significant degree of financial market volatility. Second, the US effective tariff rate is maintained at levels
prevailing at the balance sheet date pending a switch to a sector-based tariff framework. Third, the UK’s macroeconomic framework for
monetary and fiscal policy remains in place, alongside broader continuity on other areas of government policy.
Based on these assumptions and incorporating the economic data published for the third quarter of 2025, the Group’s base case scenario is for
a slow expansion in gross domestic product (GDP) and a further rise in the unemployment rate alongside small gains in residential and
commercial property prices. With underlying inflationary pressures expected to recede, modest further reductions in UK Bank Rate are
expected to continue in 2026. Risks around this base case economic view lie in both directions and are largely captured by the generation of
alternative economic scenarios.
The Group has taken into account the latest available information at the reporting date in defining its base case scenario and generating
alternative economic scenarios. The scenarios include forecasts for key variables as at the fourth quarter of 2025. Actual data for this period, or
restatements of past data, may have since emerged prior to publication and have not been included.
Scenarios by year
The key UK economic assumptions made by the Group are shown in the following tables across a number of measures explained below.
Annual assumptions
Gross domestic product (GDP) growth and Consumer Price Index (CPI) inflation are presented as an annual change, house price growth and
commercial real estate price growth are presented as the growth in the respective indices over each year. Unemployment rate and UK Bank
Rate are averages over the year.
Five year average
The five-year average reflects the average annual growth rate, or level, over the five-year period. It includes movements within the current
reporting year, such that the position as at 31 December 2025 covers the five years 2025 to 2029. The inclusion of the reporting year within the
five-year period reflects the need to predict variables which remain unpublished at the reporting date and recognises that credit models utilise
both level and annual changes. The use of calendar years maintains a comparability between the annual assumptions presented.
Five year start to peak and trough
The peak or trough for any metric may occur intra year and therefore not be identifiable from the annual assumptions, so they are also
disclosed. For GDP, house price growth and commercial real estate price growth, the peak, or trough, reflects the highest, or lowest cumulative
quarterly position reached relative to the start of the five-year period, which as at 31 December 2025 is 1 January 2025. Given these metrics
may exhibit increases followed by greater falls, the start to trough movements quoted may be smaller than the equivalent ‘peak to trough’
movement (and vice versa for start to peak). Unemployment, UK Bank Rate and CPI inflation reflect the highest, or lowest, quarterly level
reached in the five-year period.
