2018 Registration document and annual fi nancial report - BNP PARIBAS290

5 RISKS AND CAPITAL ADEQUACY PILLAR 3

5

Annual risk survey

The Bank maintains trading and investment positions in the debt, currency, commodity and equity markets, and in unlisted securities, real estate and other asset classes, including through derivative contracts. These positions could be adversely affected by extreme volatility in these markets, i.e., the degree to which prices fl uctuate over a particular period in a particular market, regardless of market levels. Moreover, volatility trends that prove substantially different from the Bank s expectations may lead to losses relating to a broad range of other products that the Bank uses, including swaps, forward and future contracts, options and structured products.

To the extent that the Bank owns assets, or has net long positions, in any of those markets, a market downturn could result in losses from a decline in the value of its positions. Conversely, to the extent that the Bank has sold assets that it does not own, or has net short positions in any of those markets, a market upturn could, in spite of the existing limitation of risks and control systems, expose it to potentially substantial losses as it attempts to cover its net short positions by acquiring assets in a rising market. The Bank may from time to time hold a long position in one asset and a short position in another, in order to hedge transactions with clients and/or from which it expects to gain based on changes in the relative value of the two assets. If, however, the relative value of the two assets changes in a direction or manner that the Bank did not anticipate or against which it is not hedged, the Bank might realize a loss on those paired positions. Such losses, if signifi cant, could adversely affect the Bank s results and fi nancial condition.

The Group uses a value at risk (VaR) model to quantify its exposure to potential losses from market risks, and also performs stress tests with a view to quantifying its potential exposure in extreme scenarios. However, these techniques rely on statistical methodologies based on historical observations, which may turn out to be unreliable predictors of future market conditions. Accordingly, the Group s exposure to market risk in extreme scenarios could be greater than the exposures predicted by its quantifi cation techniques.

The Bank may generate lower revenues from commission and fee-based businesses during market downturns.

Financial and economic conditions affect the number and size of transactions for which the Bank provides securities underwriting, financial advisory and other Investment Banking services. These revenues, which include fees from these services, are directly related to the number and size of the transactions in which it participates and can thus be signifi cantly affected by economic or fi nancial changes that are unfavorable to its Investment Banking business and clients. In addition, because the fees that the Bank charges for managing its clients portfolios are in many cases based on the value or performance of those portfolios, a market downturn that reduces the value of its clients portfolios or increases the amount of withdrawals would reduce the revenues the Bank receives from its asset management, equity derivatives and Private Banking businesses. Independently of market changes, below-market performance by the Bank s mutual funds may result in increased withdrawals and reduced infl ows, which would reduce the revenues the Bank receives from its asset management business.

The Bank experienced some or all of these effects during the various signifi cant market downturns of recent years and could experience them again in future market downturns, which may occur periodically and unexpectedly.

Protracted market declines can reduce liquidity in the markets, making it harder to sell assets and possibly leading to material losses.

In some of the Bank s businesses, particularly Global Markets and Asset/ Liability Management, protracted market movements, particularly asset price declines, can reduce the level of activity in the market or reduce market liquidity. These developments can lead to material losses if the Bank cannot close out deteriorating positions in a timely way. This is particularly true for assets that are intrinsically illiquid. Assets that are not traded on stock exchanges or other public trading markets, such as certain derivative contracts between fi nancial institutions, may have values that the Bank calculates using models rather than publicly- quoted prices. Monitoring the deterioration of prices of assets like these is diffi cult and could lead to signifi cant losses that the Bank did not anticipate.

The Bank must ensure that its assets and liabilities properly match in order to avoid exposure to losses.

The Bank is exposed to the risk that the maturity, interest rate or currencies of its assets might not match those of its liabilities. The timing of payments on many of the Bank s assets is uncertain, and if the Bank receives lower revenues than expected at a given time, it might require additional funding from the market in order to meet its obligations on its liabilities. While the Bank imposes strict limits on the gaps between its assets and its liabilities as part of its risk management procedures, it cannot be certain that these limits will be fully effective to eliminate potential losses arising from asset and liability mismatches.

REGULATORY RISKS Laws and regulations adopted in recent years, particularly in response to the global fi nancial crisis, as well as new legislative proposals, may materially impact the Bank and the fi nancial and economic environment in which it operates.

Laws and regulations have been enacted in the past few years or could be adopted, in particular in France, Europe and the United States, with a view to introducing a number of changes, some permanent, in the fi nancial environment. The impact of the measures has changed substantially the environment in which the Bank and other fi nancial institutions operate. The measures that have been or may be proposed and adopted include:

■ more stringent capital and liquidity requirements (particularly for global systemically important banks such as the Bank), as well as changes to the risk-weighting methodologies and the methods of using internal models that could lead to increased capital requirements;

■ restrictions on certain types of activities considered as speculative undertaken by commercial banks that are prohibited or need to be ring-fenced in subsidiaries (particularly proprietary trading) and are subject to prudential requirements and autonomous fi nancing;