2019 Universal registration document and annual financial report - BNP PARIBAS184

4 Consolidated finanCial statements for the year ended 31 deCemBer 2019

4

Notes to the financial statements

The link between the macroeconomic scenarios and the ECL measurement is mainly achieved through a modelling of the probabilities of default and deformation of migration matrices based on internal rating (or risk parameter). The probabilities of default determined according to these scenarios are used to measure expected credit losses under each scenario.

The weighting of the expected credit losses under each scenario is performed as follows:

■ 50% for the baseline scenario;

■ the weighting of the two alternative scenarios is computed using a relationship with the position in the credit cycle. In this approach, the adverse scenario receives a higher weight when the economy is in strong expansion than in lower growth period in anticipation of a potential downturn of the economy.

In addition, when appropriate, the ECL measurement can take into account scenarios of sale of the assets.

Macroeconomic scenarios The three macroeconomic scenarios are defined with a 3-year horizon. They correspond to:

■ a baseline scenario which describes the most likely path of the economy over the projection horizon. This scenario is updated on a quarterly basis. It is designed by Group Economic Research in collaboration with various experts within the Group. Projections are provided for key markets of the Group, through main macroeconomic variables (GDP and its components, unemployment rate, consumer prices, interest rates, foreign exchange rates, oil prices, real estate prices, etc.) which are drivers for risk parameter models used downstream in the credit stress testing process;

■ an adverse scenario which describes the impact of the materialisation of some of the risks weighing on the baseline scenario, resulting in a much less favourable economic path than in the baseline scenario. The starting point is a shock on GDP. This shock on GDP is applied with variable magnitudes, but simultaneously among economies when the crisis considered is a global contemporaneous crisis. These assumptions are broadly consistent with those proposed by the regulators. Other variables (unemployment, inflation, interest rate) are deducted on the basis of econometric relationships and expert judgment;

■ a favourable scenario which reflects the impact of the materialisation of some of the upside risks for the economy, resulting in a much more favourable economic path. To achieve an unbiased estimation of provisions, the favourable scenario is designed in such a way that the probability of the shock on GDP growth (on average over the cycle) is equal to the probability of the corresponding shock in the adverse scenario. The magnitude of favourable GDP shocks generally

corresponds to 80%-95% of the magnitude of adverse GDP shocks. Other variables (unemployment, inflation, interest rate) are deducted in the same way as in the adverse scenario.

The adverse scenario assumes that a number of risks for the economy materialise, leading to a much poorer economic trajectory than in the reference scenario. The assumptions used for the adverse scenario at 31 December 2019 are as follows:

■ negative impact on international trade from the trade dispute between the United States and China and its consequences for financial markets;

■ Brexit-related risks: uncertainty surrounding the terms of the future relationship between the United Kingdom and the European Union remains high. The United Kingdom could suffer disruption in some sectors with higher uncertainty impacting investment and consumption, weaker commercial momentum, financial tensions and negative impacts on Real estate markets. The euro zone would also be affected by negative Brexit impacts;

■ possible tensions in the euro zone related to public finances: high public debt ratios in some countries at a time when activity could slow;

■ significant correction to some stock and real estate markets: with a slowing growth cycle, a correction could affect some markets;

■ geopolitical risks: tensions in the Middle East could affect the global economy with price shocks impacting raw materials and business confidence;

■ difficulties in emerging markets: some emerging markets have internal economic imbalances, owing to the strength of the US dollar, political changes at a national level and deteriorating international relations. In some cases, activity could be more affected than currently estimated;

■ slowdown in China: a more pronounced slowdown in activity than anticipated or a further deterioration in public finance ratios and levels of external sales, could have an impact on financial markets at a global level, affecting global trade and the price of raw materials.

The effect of the adverse scenario on GDP growth in OECD countries is reflected in the gap vis-à-vis the central scenario after three years of between -6% and -12% according to the country and, in particular, -7% on average in terms of euro zone growth and -6% in terms of United States growth.

At 31 December 2019, the weighting of the adverse scenario is 26% for the Group (24% for the favourable scenario), reflecting a position above the average of the credit cycle, with a very favourable level in its domestic markets offset by a global economic slowdown, particularly in emerging countries.

➤ COST OF CREDIT RISK FOR THE PERIOD

In millions of euros Year to

31 Dec. 2019 Year to

31 Dec. 2018

Net allowances to impairment (2,649) (2,490)

Recoveries on loans and receivables previously written off 429 483

Losses on irrecoverable loans (983) (757)

TOTAL COST OF RISK FOR THE PERIOD (3,203) (2,764)