Chief Executive's overview: a shared vision

Vision
The rationale underpinning the vision for Co-operative Financial Services (CFS) is straightforward. We have a customer base that values enormously the co-operative difference, and, historically, there was surprisingly little awareness amongst customers of CIS and The Co-operative Bank that we were sister organisations. There is also little customer overlap and this offers a significant opportunity with a combined base of more than seven million customers. In March 2004, CFS' new vision was communicated to its 14,000 staff: "To become the primary financial services provider for a broad range of co-operative customers accessed seamlessly through multiple channels." For this to happen we need to see in time:

• one set of customers offered one range of products;
• one high level of service offered through all channels;
• one employee community with one common culture; and
• one set of values based on our co-operative heritage.

Sustainable development
Our first Co-operative Financial Services' Sustainability Report provides a 'warts and all' account of how CFS is performing against its vision, and the degree to which value has been delivered to a range of Partners in a socially responsible and ecologically sustainable manner. You will find a more detailed description of CFS' approach to sustainable development here. We have taken the strongest elements of CIS' and the bank's previous work in the areas of ethics, diversity, community investment and ecological sustainability, and have brought them together into a bold, new coherent management framework. From the outset, I have been keen that a 'highest common denominator' approach should apply. Of course, conflicts can arise when managing the different wants and needs of a range of Partners. Therefore, alongside 'profitability', which is absolutely vital to CFS' continued existence, the pursuit of 'balance' is a key concept within CFS' approach to sustainable development. Are we getting the balance right over time? I believe that we are; but this 'warts and all' Report allows all Partners to review CFS' overall performance and decide for themselves.

Socially Responsible Investment
I am pleased that, once again, our sustainability auditors have confirmed that the bank's Ethical Policy has been fully implemented, and that in no instances has the bank provided financial services to organisations that conflict with our customer-mandated policy. Moreover, research continues to show that the bank's ethical positioning has contributed to its profitability. In 2003, 30% of bank profits can be attributed to customers who cite ethics as an important factor in their relationship with the bank. A key element of the bank's successful positioning is the fact that it is customer-led. With this in mind, in 2003 I initiated a project to substantially reconcile the historically different approaches of CIS and The Co-operative Bank to Socially Responsible Investment. Reconciliation will focus on establishing a customer mandate for CIS' Responsible Shareholding engagement programme, much as bank customers currently guide its Ethical Policy. It is planned that, following extensive customer consultation during 2004, a new CIS Socially Responsible Investment Policy will be launched in early 2005. In parallel, I am also keen that, where demand exists, CIS will extend its range of screened funds, such as Environ.

Challenges
2003 was not without challenges, and neither will 2004 be. You will find a description of the economic, regulatory and sustainability backcloth against which CFS operates here. It is not for the faint-hearted. On the banking side, household borrowing is at record levels, but I am pleased to say that our cautious lending policy has meant that our asset growth has been carefully targeted and, as a result, there was a reduction in the charge for bad debts in 2003. For the insurance industry, market conditions in 2003 were arguably the most testing on record. There was some recovery in the equity markets during the second half of the year; however, consumer confidence remains low, and the challenge to bridge the UK's 'savings gap' remains a significant one. CIS has always maintained a strong capital position. We support the industry's and the FSA's move to the realistic basis of calculating solvency capital. The proposed new solvency requirements are undoubtedly challenging, but we have been monitoring their effect on the balance sheet of our with-profits fund for some time. We are continuing to work towards these new requirements and are confident that CIS will remain appropriately capitalised. Customer research shows that CIS' Financial Advisers continue to be highly regarded by customers making provision for their life insurance, savings and retirement. However, I believe that over the next two to three years, building a single organisation with a more common business approach will be our biggest challenge. Insurance cultures and retail banking cultures tend to be quite different. Banks have evolved a culture based around the 'transactional relationships' they have with their customers. They usually deal with customers many, many times a year; customers might ring up three or four times a month, or they might regularly visit their local branch. However, for some insurance customers, the annual renewal of a policy may be the only point of contact all year. It is, of course, also vital that our pursuit of a more common business approach does not in any way inhibit our drive to become more diverse in terms of the customers we serve and the staff we employ. Both CIS and the bank have made significant improvements in recent years with regards to diversity issues, but there is much more work to be done, and I will be looking for further improvements in these areas over 2004 and 2005.

Financial performance
I am delighted that leading-edge customer service and a distinctive ethical positioning enabled The Co-operative Bank to announce record profits for 2003 - for the tenth year in succession. The bank reported pre-tax profits of £130.1 million for 2003, up 6.2 per cent (£7.6 million) on the previous year. In difficult market conditions, CIS also reported an improvement in its financial performance in 2003. Profit before tax (excluding short-term investment fluctuations) rose to £61.7 million, compared with £27.5 million in 2002. The result, including short-term investment fluctuations, was a pre-tax profit of £134.6 million, compared with the pre-tax loss of £257.5 million in 2002, which reflected the fall in value of equity markets. However, both CIS and the bank currently operate with relatively high cost bases in comparison with many competitors. These will need to be addressed and some hard choices will, inevitably, need to be faced in 2004 and beyond.

Looking forward
With the formation of CFS we stand on the brink of a promising new era. During 2004, we will endeavour to harness the strengths, traditions and values of both CIS and The Co-operative Bank and pursue our vision to offer customers a broader range of products and an even more convenient service.

Mervyn Pedelty, Chief Executive