BPCE - Risk Report - Pillar III 2020

CREDIT RISKS

CREDIT RISK MANAGEMENT

these quantitative criteria are accompanied by a set of • qualitative criteria, including the existence of a payment more than 30 days past due, the classification of the contract as at-risk, the identification of forbearance exposure or the inclusion of the portfolio on a Watchlist; exposures rated by the large corporates, banks and specialized • financing software tool are also downgraded to Stage 2 depending on the sector rating and the level of country risk.

Exposures for which there is objective evidence of impairment loss due to an event representing a counterparty risk and occurring after initial recognition will be considered as impaired and classified as Stage 3. Identification criteria for impaired assets are similar to those under IAS 39 and are aligned with the default criterion. The accounting treatment of restructuring operations due to financial hardships is similar to their treatment under IAS 39.

Expected credit losses on Stage 1 or Stage 2 financial instruments are measured as the product of several inputs:

cash flows expected over the lifetime of the financial instrument, discounted at the valuation date – these flows • are determined according to the characteristics of the contract, its effective interest rate and the level of prepayment expected on the contract; loss given default (LGD); • probabilities of default (PD), for the coming year in the case of Stage 1 financial instruments and until the contract’s • maturity in the case of Stage 2 financial instruments.

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The Group draws on existing concepts and mechanisms to define these inputs, and in particular on internal models developed to calculate regulatory capital requirements and on projection models used in the stress test system. Certain adjustments are made to comply with the specifics of IFRS 9.

IFRS 9 inputs:

aim to provide an accurate estimate of expected credit losses for accounting provision purposes, whereas • prudential inputs are more cautious for regulatory framework purposes. Several of the safety buffers applied to prudential inputs are therefore restated; shall allow expected credit losses to be estimated until the contract’s maturity, whereas prudential inputs are • defined to estimate 12-month expected losses. 12-month inputs are thus projected over long periods; shall be forward-looking and take into account the expected economic environment over the projection period, • whereas prudential inputs correspond to through-the-cycle estimates (for PD) or downturn estimates (for LGD and the flows expected over the lifetime of the financial instrument). Prudential PD and LGD inputs are therefore also adjusted to reflect forecasts of future economic conditions.

Inputs are adjusted to economic conditions by defining three economic scenarios over a three-year period. The variables defined in each of these scenarios allow for the distortion of the PD and LGD inputs and the calculation of an expected credit loss for each economic scenario. Projections of inputs for periods longer than three years are based on the mean reversion principle. The models used to distort the PD and LGD inputs are based on those developed for the stress test system for consistency reasons. The economic scenarios are associated with probabilities of occurrence, making it possible to calculate the average probable loss, which is used as the IFRS 9 impairment amount. These scenarios are defined using the same organization and governance as those defined for the budget process, requiring an annual review based on proposals from the Economic Research department. For consistency purposes, the baseline

scenario serves as the budget scenario. Two variants – an optimistic view and a pessimistic view – are also developed around this scenario. The probability of occurrence of each scenario is reviewed on a quarterly basis by the Group’s Watchlist and Provisions Committee. The inputs thus defined are used to measure expected credit losses for all rated exposures, whether they were subject to the IRB or the standardized approach for the calculation of risk-weighted assets. For unrated exposures (insignificant for Groupe BPCE), prudent valuation rules are applied by default. The IFRS 9 input validation process is fully aligned with the Group’s existing model validation process. Inputs are reviewed by an independent unit responsible for internal model validation, the unit’s conclusions are then examined by the Group Models Committee, and subsequent recommendations followed up by the validation unit.

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RISK REPORT PILLAR III 2020 | GROUPE BPCE