326 2019 Universal registration document and annual financial report - BNP PARIBAS

5 risks and CaPital adequaCy Pillar 3

5

Credit risk

Furthermore, since 2018 the General Credit Policy has included specific checks to be conducted for loans granted to clients presenting high leverage ratios, in accordance with European Central Bank guidelines.

Overall portfolio management and monitoring

The selection and careful evaluation of individual exposures are supported by a reporting system based on more aggregated portfolio levels in terms of division/business line, country, industry, business/product.

The overall portfolio management policy, including concentration of risk by single name, industry and country, is based on this reporting system and Group Risk Committees review all reports and analyses produced:

■ risk concentration by country is managed through country risk limits that are set at the appropriate level of delegated authority for each country. The Group, which is naturally present in most economically active areas endeavours to avoid excessive concentrations of risk in countries with weak economic or unstable political structures or which economic position has been undermined. Country envelope limits are reviewed at least once a year, and quarterly reports are drawn up on their utilisation;

■ the Group closely monitors individual concentrations, in particular on business groups or sovereign debts. The largest exposures to groups of corporate clients, financial institutions and sovereign debt are reported in the quarterly risk report to the CCIRC. BNP Paribas has also implemented concentration policies on exposures to corporate clients and financial institutions. These policies are described in the Credit risk diversification section (section 5.4);

■ regular reviews are carried out of portfolios in certain industries, either because of the magnitude of the Group s exposure to the sector or because of sector-specific risks, such as the cyclical nature of the industry or rapid technological developments. In conducting these reviews, the Group draws on the expertise of the relevant business lines and independent industry specialists working in RISK (Industry and Sector Studies). These reviews provide Executive Management, and if appropriate the CCIRC, with an overview of the Group s exposure to the sector under consideration, and assist it to decide on strategic guidelines. As an illustration, in 2019, an internal portfolio review was undertaken on the Metal & Mining and the Oil & Gas sectors (see the paragraph on Industry Diversification in this section). In addition, the Group also monitors certain sectors on a regular basis such as, for example, commercial or residential real estate.

Stress tests assess portfolio vulnerabilities by measuring the impact of various adverse scenarios. They are conducted on a quarterly basis on the entire portfolio and on an ad hoc basis on sub-portfolios to identify any concentrations. They help to ensure that the Bank s credit risk exposure is in line with its risk appetite.

Lastly, BNP Paribas may use credit risk transfer instruments, such as securitisation programmes, credit derivatives or credit insurance, to mitigate individual risks, reduce portfolio concentration or cap potential losses arising from adverse scenarios.

IMPAIRMENT VALUATION PROCEDURES [Audited] The Group applied the impairment procedures described below for all loans subject to impairment (see note 1.e.5):

■ impairment valuation procedure for performing loans:

A loss allowance for loans in stage 1 or stage 2 is constituted by each operating division based on an estimation of expected credit losses. This is determined on a quarterly basis during a Committee meeting attended by the Chief Financial Officer and Chief Risk Officer of each operating division. Estimations of expected credit losses result from the default risk in the coming twelve months for financial instruments whose credit risk has not significantly increased since initial recognition (stage 1) or upon maturity for unimpaired loans whose credit risk has significantly increased since initial recognition (stage 2). A tool used by most of the Group s business lines enables simulations to be performed based on the parameters of the rating system described below;

■ impairment valuation procedure for defaulted exposures:

RISK reviews corporate, bank and sovereign loans in default at monthly intervals to determine the amount of any decrease in value to be recognised, either by reducing the carrying amount or by recording a provision for impairment, in accordance with applicable accounting standards (see chapter 4 note 1.e.5 Impairment of financial assets at amortised cost and debt instruments at fair value through shareholders equity). The Group uses various methodologies (expert opinions, statistical calculations) for defaulted exposures to retail customers. These impairments are referred to as stage 3. The amount of this impairment loss is based on the present value of probable recovered net cash flows, including from the possible realisation of the collateral held.

RATING SYSTEM [Audited] Each counterparty is rated internally by the Group using uniform principles, regardless of the approach used to calculate regulatory capital requirements.

The Bank has a comprehensive internal rating system compliant with regulatory requirements regarding capital adequacy. A periodic assessment and control process has been deployed within the Bank to ensure that the system is appropriate and correctly implemented. The system was formally validated by the supervisor in December 2007 and is inspected on a regular basis.

For loans to institutions, corporates, sovereigns and specialised lendings, the system is based on three parameters: the counterparty s probability of default (PD) expressed via a rating, the global recovery rate (GRR) or its complement, loss given default (LGD), which depends on the structure of the transaction, and the credit conversion factor (CCF) which estimates the off-balance sheet exposure at risk.

There are twelve counterparty ratings. Ten cover performing clients with credit assessments ranging from excellent to very concerning , and two relate to clients classified as in default, as per the definition by the banking supervisor.