2020 Universal registration document and annual financial report - BNP PARIBAS286

5 risks and CaPital adequaCy Pillar 3

5

Annual risk survey

■ proactive and forward-looking discussions on emerging risks and their impacts on the Bank s risk profile in the Risk Anticipation Committee;

■ an analysis and a monitoring of changes to the regulatory framework and their consequences on the Bank s capital and liquidity management as well as on its activities.

TOP RISKS A top risk is defined as having:

■ the potential to have a material impact, across a business area or geographical area, on the financial results, reputation or sustainability of the Group;

■ the potential to occur in the near future.

The top risks to which the Group is exposed are described below.

Macroeconomic environment

Macroeconomic and market conditions affect the Bank s results. The nature of the Bank s business makes it particularly sensitive to macroeconomic and market conditions in Europe.

After an increase of 3% in 2019, the world economy shrank by more than 3.5% in 2020, severely hit by the consequences of the health crisis. Mature economies have been particularly impacted, with a GDP decline estimated at nearly 7.2% in the eurozone and close to 3.4% in the United States (according to IMF publication of January 2021 World Economic Outlook).

The consequences of the health crisis have led the major central banks (the US Federal Reserve and the European Central Bank) to amplify quantitative easing measures against the backdrop of very low inflation. Without any significant change in oil prices, inflation remained very low (slightly above 0.5% in the eurozone and 1% in the United States). The short- and medium-term consequences of the pandemic are expected to lead to central bank policy rates and bond yields remaining at extremely low or even negative levels in many mature economies in the coming years, with flat yield curves. The major central banks have thus made it clear in recent months that they plan to maintain extremely favourable conditions until 2023. For their part, governments have put in place exceptional support mechanisms such as job maintenance programmes, stimulus packages, or State-guaranteed loans. All these monetary and fiscal measures have helped to mitigate the consequences of the health crisis, in particular the shutdowns or the slowdown in business activity in some sectors during lockdowns.

Emerging countries were not spared by the health crisis in 2020, with a recession estimated by the IMF at 3.3% in 2020, despite China s relatively good performance (+1.9%). The latter, that had embarked on a process of rebalancing its growth towards domestic demand, chose recovery through public spending and infrastructure investment, thus weakening its public finances but avoiding a decline in business activity. Countries in other emerging zones have fallen into recession, sometimes very severe (as in India or in Mexico). In many cases, their central banks quickly eased

monetary policy to offset the effects of lockdowns on domestic business activity and reduced sources of external financing.

In addition, the positive developments in vaccines since the end of 2020 could lead to a marked recovery in the second half of 2021. The IMF expects a 5.5% increase in global GDP, although the risk of a fluctuating pace of business activity may remain as long as vaccines are not widely distributed.

In this context, the following risk categories can be identified:

Medium-term consequences of the current health crisis The crisis may have lasting effects. Some particularly exposed sectors of the economy may take longer to recover than the rest of the economy (e.g. tourism, air transport and some retail trade), even though they have benefited from the support measures previously mentioned. Public finances have been impacted by the crisis and the exceptional budgetary policy measures that have helped to preserve economic production capacity and the social fabric. The strong rebound in business activity in the third quarter of 2020, whilst largely mechanical, also evidences the effectiveness of these measures. However, the private debt market could also be impacted by debt levels and unemployment, and bankruptcies could increase depending on the pace at which countries withdraw the exceptional support measures for employees. In addition, the health crisis could lead to structural changes in certain sectors (transport, infrastructure, etc.) as well as in the production chains that could adapt to this new context. These developments could weigh on growth over the medium term, contribute to maintaining very low interest rates over a long period of time and, in some cases, produce further episodes of slow growth.

Risks of financial instability due to the conduct of monetary policies Commercial bank revenues are strongly impacted by the flat yield curve, negative central bank deposit rates and the difficulty of passing on negative rates to customers. Life insurers and pension funds are also deeply impacted, as the low-yield environment increases liabilities and holds down on long-term investment returns (impacting in particular life insurers with guaranteed returns and defined-benefit pension schemes). Monetary policy s room to manoeuvre seems increasingly limited, and central banks are more likely to be affected by budgetary issues. Such developments, which would have been considered temporary and exceptional a few years ago, now seem to be a new normal.

Some major financial players (insurance companies, pension funds, asset managers, etc.) have an increasingly systemic dimension and, in the event of market turbulence, could be brought to unwind large positions in a context of relatively weak market liquidity. Indeed, in a number of asset markets, risk premiums are low compared with their historical average following a decade of accommodative monetary policies (lending to non-Investment Grade companies and countries, certain equity and bond market segments, etc.).