2018 Registration document and annual fi nancial report - BNP PARIBAS 167

4CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2018

4

Notes to the fi nancial statements

For exposures classifi ed in stage 3, expected credit losses are measured as the value, discounted at the effective interest rate, of all cash shortfalls over the life of the fi nancial instrument. Cash shortfalls represent the difference between the cash-fl ows that are due in accordance with the contract, and the cash-fl ows that are expected to be received.

The methodology developed is based on existing concepts and methods (in particular the Basel framework) on exposures for which capital requirement for credit risk is measured according to the IRBA methodology. This method is also applied to portfolios for which capital requirement for credit risk is measured according to the standardised approach. Besides, the Basel framework has been supplemented with the specifi c provisions of IFRS 9, in particular the use of forward-looking information.

Maturity

All contractual terms of the fi nancial instrument (including prepayment, extension and similar options) over the life of the instrument are taken into account. In the rare cases where the expected life of the fi nancial instrument cannot be estimated reliably, the residual contractual term must be used. The standard specifi es that the maximum period to consider when measuring expected credit losses is the maximum contractual period. However, for revolving credit cards and overdrafts, in accordance with the exception provided by IFRS 9 for these products, the maturity considered for expected credit losses measurement is the period over which the entity is exposed to credit risk, which may extend beyond the contractual maturity (notice period). For revolving credits and overdrafts to non-retail counterparties, the contractual maturity can be taken, for example if the next review date is the contractual maturity as they are individually managed.

Probabilities of Default (PD)

The Probability of Default is an estimate of the likelihood of default over a given time horizon.

The measurement of expected credit losses requires the estimation of both 1- year probabilities of default and lifetime probabilities of default:

■ 1- year PDs are derived from long- term average regulatory through the cycle PDs to refl ect the current situation ( point in time or PIT );

■ lifetime PDs are determined from the rating migration matrices refl ecting the expected rating evolution of the exposure until maturity, and the associated probabilities of default.

Loss Given Default (LGD)

The Loss Given Default is the difference between the contractual cash- flows and the expected cash-flows, discounted using the effective interest rate (or an approximation thereof) at the default date. The LGD is expressed as a percentage of the EAD.

The estimate of expected cash flows takes into account cash flows resulting from the sale of collateral held or other credit enhancements if they are part of the contractual terms and are not accounted for separately by the entity (for example, a mortgage associated with a residential loan), net of the costs of obtaining and selling the collateral.

The LGD used for IFRS 9 purpose is derived from the Basel LGD parameter. It is retreated from downturn and conservatism margins (in particular regulatory margins), except margins for model uncertainties.

Exposure At Default (EAD)

The Exposure At Default (EAD) of an instrument is the anticipated outstanding amount owed by the obligor at the time of default. It is determined by the expected payment profile taking into account, depending on the product type: the contractual repayment schedule, expected early repayments and expected future drawings for revolving facilities.

Forward looking

The amount of expected credit losses is measured on the basis of probability-weighted scenarios, in view of past events, current conditions and reasonable and supportable economic forecasts.

The principles applied to take into account forward looking information when measuring expected credit losses are detailed in note 3.h Cost of risk.

Write-offs A write-off consists in reducing the gross carrying amount of a fi nancial asset when there are no longer reasonable expectations of recovering that fi nancial asset in its entirety or a portion thereof, or when it has been fully or partially forgiven. The write-off is recorded when all other means available to the Bank for recovering the receivables or guarantees have failed, and also generally depends on the context specifi c to each jurisdiction.

If the amount of loss on write-off is greater than the accumulated loss allowance, the difference is an additional impairment loss posted in cost of risk . For any receipt occurring when the fi nancial asset (or part of it) is no longer recognised on the balance-sheet, the amount received is recorded as an impairment gain in Cost of risk .

Recoveries through the repossession of the collateral When a loan is secured by a fi nancial or a non-fi nancial asset serving as a guarantee and the counterparty is in default, the Group may decide to exercise the guarantee and, according to the jurisdiction, it may then become owner of the asset. In such a situation, the loan is written-off in counterparty of the asset received as collateral.

Once ownership of the asset is carried out, it is accounted for at fair value and classifi ed according to the intent of use.

Restructuring of financial assets for financial difficulties A restructuring due to the borrower s fi nancial diffi culties is defi ned as a change in the terms and conditions of the initial transaction that the Group is considering only for economic or legal reasons related to the borrower s fi nancial diffi culties.

For restructurings not resulting in derecognition of the fi nancial asset, the restructured asset is subject to an adjustment of its gross carrying amount, to reduce it to the discounted amount, at the original effective interest rate of the asset, of the new expected future fl ows. The change in the gross carrying amount of the asset is recorded in the income statement in Cost of risk .