2018 Registration document and annual fi nancial report - BNP PARIBAS 409

5RISKS AND CAPITAL ADEQUACY PILLAR 3

5

Market risk

MARKET RISK STRESS TESTING FRAMEWORK A range of stress tests are performed to simulate the impact of extreme market conditions on the value on the global trading books. Stress tests cover all market activities applying a range of stressed market conditions.

Scenarios

The fundamental approach of the current trading book stress testing framework combines bottom up and top down stress testing:

■ Macro Level Scenarios (top down) comprise the evaluation of a set of global level stress tests. These scenarios assess the impact of severe market moves on BNP Paribas trading positions related to large global or major regional market shock events. They can be based on historical events or forward-looking hypothetical scenarios. Scenarios include events such as an emerging markets crisis, credit crunch and a stock market crash, and some are based on past crises.

The offi cial macro stress tests scenarios currently comprise a range of eight different stress tests. The results of these scenarios are reviewed at each Capital Markets Risk Committee (CMRC). The scenarios are:

■ Scenario 1: unexpected rate hike, driving short-term rates higher with a fl attening of the interest rate curve,

■ Scenario 2: stock market crash, with a fl ight to quality assets leading to a drop and a steepening of the interest rate curve,

■ Scenario 3: generic emerging market crisis designed to test global risk of these markets,

■ Scenario 4: credit crunch, leading to a general risk aversion,

■ Scenario 5: euro crisis, low GDP expectations, potential threat of a country leaving the euro and a signifi cant weakening of the currency,

■ Scenario 6: energy crisis driven by severe geopolitical turmoil with serious consequences on energy markets,

■ Scenario 7: US crisis, mostly based on a structural US crisis spreading round the globe,

■ Scenario 8: risk-on scenario: rally in equity and emerging markets, low realised volatility and drop in implied volatility in all markets (effectively a return to risky assets);

■ Micro Level Scenarios (bottom up): instead of looking at the effect on the global portfolio, these types of scenarios aim to highlight risk exposures on specifi c trading desks, regions or risk concentrations. This bottom up approach enables the use of more complex stress scenarios and hence allows the detection of areas of potential losses which may not be easily achieved under the global macro scenarios (such as complex market dislocations or idiosyncratic risk). This bottom up process also facilitates the classifi cation of risk areas into those where there may be less liquidity or where the risk may be more structural in nature.

Process

It is the analysis of the above scenarios which enables the adverse scenario for the trading books to be constructed. The offi cial stress scenario is presented at each Capital Markets Risk Committee along with the adverse global stress scenarios and any bottom up stress test yielding signifi cant results.

The results of all stress tests are reviewed regularly by Executive Management and sent to the Board of directors.

The scenarios take market liquidity into account by simulating the drying up of certain assets or product liquidity as the stress event unfolds. To understand this process, it can be simplifi ed by considering an approach where the time horizon for the stress shock can vary between different instruments/assets (hence more advanced scenarios can take certain idiosyncratic factors into account). Moreover, it may sometimes be required to quantify the impact of a stress event occurring with re hedging assumptions factored into part of the exposure under stress.

Stress testing is governed by the Capital Markets Stress Testing Steering Committee (STSC). The committee meets monthly and sets the direction of all internal risk departmental stress scenario developments, infrastructure, analysis and reporting. The STSC governs all internal stress testing matters relating to both market and counterparty risk and decides upon the detailed defi nition of the CMRC Stress Tests.

Stress testing is the core element of the tail risk analysis, which is also captured through the stressed Value at Risk, the Incremental Risk Charge and the Comprehensive Risk Measure. Furthermore, the risk of a rare event used in the form of the average loss in addition to VaR (Expected Shortfall) in allocating capital in respect of market risk between business lines is an additional element allowing tail risk in the management and monitoring of market risk to be taken into account.