2018 Registration document and annual fi nancial report - BNP PARIBAS164

4 CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2018

4

Notes to the fi nancial statements

Interest consists of consideration for the time value of money, for the credit risk, and for the remuneration of other risks (e.g. liquidity risk), costs (e.g. administration fees), and a profi t margin consistent with that of a basic lending arrangement. The existence of negative interest does not call into question the cash fl ow criterion.

The time value of money is the component of interest usually referred to as the rate component which provides consideration for only the passage of time. The relationship between the interest rate and the passage of time shall not be modifi ed by specifi c characteristics that would likely call into question the respect of the cash fl ow criterion.

Thus, when the variable interest rate of the fi nancial asset is periodically reset on a frequency that does not match the duration for which the interest rate is established, the time value of money may be considered as modifi ed and, depending on the signifi cance of that modifi cation, the cash fl ow criterion may not be met. Some fi nancial assets held by the Group present a mismatch between the interest rate reset frequency and the maturity of the index, or interest rates indexed on an average of benchmark rate. The Group has developed a consistent methodology for analysing this alteration of the time value of money.

Regulated rates meet the cash flow criterion when they provide a consideration that is broadly consistent with the passage of time and does not expose to risks or volatility in the contractual cash fl ows that would be inconsistent with those of a basic lending arrangement (example: loans granted in the context of Livret A savings accounts).

Some contractual clauses may change the timing or the amount of cash fl ows. Early redemption options do not call into question the cash fl ow criterion if the prepayment amount substantially represents the principal amount outstanding and the interest thereon, which may include a reasonable compensation for the early termination of the contract. For example, as regards loans to retail customers, the compensation limited to 6 months of interest or 3% of the capital outstanding is considered as reasonable. Actuarial penalties, corresponding to the discount value of the difference between the residual contractual cash-fl ows of the loan, and their reinvestment in a loan to a similar counterparty or in the interbank market for a similar residual maturity are also considered as reasonable, even when the compensation can be positive or negative (i.e. so called symmetric compensations). An option that permits the issuer or the holder of a fi nancial instrument to change the interest rate from fl oating to fi xed rate does not breach the cash fl ow criterion if the fi xed rate is determined at origination, or if it represents the time value of money for the residual maturity of the instrument at the date of exercise of the option.

In the particular case of fi nancial assets contractually linked to payments received on a portfolio of underlying assets and which include a priority order for payment of cash fl ows between investors ( tranches ), thereby creating concentrations of credit risk, a specifi c analysis is carried out. The contractual characteristics of the tranche and those of the underlying fi nancial instruments portfolios must meet the cash fl ow criterion and the credit risk exposure of the tranche must be equal or lower than the exposure to credit risk of the underlying pool of fi nancial instruments.

Certain loans may be non-recourse , either contractually, or in substance when they are granted to a special purpose entity. That is in particular the case of numerous project fi nancing or asset fi nancing loans. The cash-fl ow criterion is met as long as these loans do not represent a direct exposure on the assets acting as collateral. In practice, the sole fact that the fi nancial asset explicitly gives rise to cash-fl ows that are consistent with payments of principal and interest is not suffi cient to conclude that the instrument meets the cash-fl ows criterion. In that case, the particular underlying assets to which there is limited recourse shall be analysed using the look-through approach. If those assets do not themselves meet the cash-fl ows criterion, an assessment of the existing credit enhancement has to be performed. The following aspects are considered: structuring and sizing of the transaction, own funds level of the structure, expected source of repayment, volatility of the underlying assets. This analysis is applied to non-recourse loans granted by the Group.

The fi nancial assets at amortised cost category includes, in particular, loans granted by the Group, as well as, reverse repurchase agreements and securities held by the Group ALM Treasury in order to collect contractual fl ows and meeting the cash-fl ows criterion.

Recognition On initial recognition, fi nancial assets are recognised at their fair value, including transaction costs directly attributable to the transaction as well as commissions related to the origination of the loans.

They are subsequently measured at amortised cost, including accrued interest and net of repayments of principal and interest during the past period. These fi nancial assets are also subject, from initial recognition, to the measurement of a loss allowance for expected credit losses (note 1.e.5).

Interest is calculated using the effective interest method determined at inception of the contract.

1.e.2 Financial assets at fair value through shareholders equity

Debt instruments Debt instruments are classifi ed at fair value through shareholders equity if the following two criteria are met:

■ business model criterion: Financial assets are held in a business model whose objective is achieved by both holding the fi nancial assets in order to collect contractual cash fl ows and selling the fi nancial assets ( collect and sale ). The latter is not incidental but is an integral part of the business model;

■ cash fl ow criterion: The principles are identical to those applicable to fi nancial assets at amortised cost.

The securities held by the Group ALM Treasury in order to collect contractual fl ows or to be sold and meeting the cash fl ow criterion are in particular classifi ed in this category.