5 NotesCONSOLIDATED FINANCIAL STATEMENTSto the financial s tatements p repared in accordance with I nternational Financial Reporting S tandards as adopted by the European Union< Contents >Note 4.RISK E XPOSURE AND H EDGING S TRATEGIESOrganisation of r isk m anagementRisk management is key in the business of banking. At BNP Paribas,operating methods and procedures throughout the organisation aregeared towards effectively addressing this matter. The entire process issupervised by the Group Risk Management Department (GRM), whichis responsible for measuring and controlling risks at Group level. GRM isindependent from the divisions, business lines and territories and reportsdirectly to Group Executive Management.While front-line responsibility for managing risks lies with the divisionsand business lines that propose the underlying transactions, GRM isresponsible for providing assurance that the risks taken by the Bankcomply and are compatible with its risk policies and its profitability andrating objectives. GRM performs continuous, generally ex-ante controlsthat are fundamentally different from the periodic, ex-post examinationsof the Internal Auditors. The department reports regularly to the InternalControl and Risk Management Committee of the Board on its mainfindings, as well as on the methods used by GRM to measure these risksand consolidate them on a Group-wide basis.GRM’s role is to hedge all financial risks resulting from the Group’sbusiness operations. It intervenes at all levels in the process of risk takingand risk monitoring. Its remit includes formulating recommendationsconcerning risk policies, analysing the loan portfolio on a forward-lookingbasis, approving corporate loans and trading limits, guaranteeing thequality and effectiveness of monitoring procedures, defining and/orvalidating risk measurement methods, and producing comprehensiveand reliable risk reporting data for Group management. GRM is alsoresponsible for ensuring that all the risk implications of new businessesor products have been adequately evaluated. These evaluations are4.a.1Group’s gross exposure to credit riskperformed jointly by the sponsoring business line and all the functionsconcerned (legal affairs, compliance, financial security, tax affairs,information systems, general and management accounting). The qualityof the validation process is overseen by GRM which reviews identifiedrisks and the resources deployed to mitigate them, as well as definingthe minimum criteria to be met to ensure that growth is based on soundbusiness practices.The GRM function is organised based on a differentiated approach byrisk-type: Credit and Counterparty Risk, Market and Liquidity Risk; andOperational Risk, supported by specialist units responsible for analysing,summarising and reporting risk data.4.a CREDIT RISKCredit risk is the risk of incurring an economic loss on loans and receivables(existing or potential due to commitments given) as a result of a changein the credit quality of the Bank’s debtors, which can ultimately resultin default. Credit quality is measured primarily based on probability ofdefault and loss given default. Credit risk is measured at portfolio level,taking into account correlations between the values of the loans andreceivables making up the portfolio concerned.Credit risk arises in relation to lending activities as well as market,investing and/or payment transactions that potentially expose the Bankto the risk of default by the counterparty.Counterparty risk is the risk that the other party in a credit transactionwill default. The amount of this risk may vary over time in line withmarket parameters that impact the value of the transaction.The following table shows all of the BNP Paribas Group’s financial assets, including government bonds and Treasury bills, exposed to credit risk. Creditrisk exposure, determined without taking account of unrecognised netting or collateral, equates to the carrying amount of financial assets in thebalance sheet net of impairment.1234567In millions of euros 31 December <strong>2007</strong> 31 December 2006Financial assets at fair value through profi t or loss (excluding variable-income securities)(Note 5.a) 787,022 607,541Derivatives used for hedging purposes 2,154 2,803Available-for-sale fi nancial assets (excluding variable-income securities) (Note 5.c) 90,725 78,033Loans and receivables due from credit institutions 71,116 75,170Loans and receivables due from customers 445,103 393,133Held-to-maturity fi nancial assets 14,808 15,149Balance sheet commitment exposure, net of impairment provisions 1,410,928 1,171,829Financing commitments given (Note 6.a) 231,227 235,736Guarantee commitments given (Note 6.b) 91,099 80,945Provisions for off balance sheet commitments (Note 2.f) (202) (238)Off-balance sheet commitment exposure, net of provisions 322,124 316,443TOTAL NET EXPOSURE 1,733,052 1,488,272891011136<strong>2007</strong> Registration document - BNP PARIBAS
CONSOLIDATED FINANCIAL STATEMENTS5Notes to the financial s tatements p repared in accordance with I nternational Financial Reporting S tandards as adopted by the European Union< Contents >This exposure does not take into account the effect of master nettingagreements in force during each period or collateral on over-the-counterforward financial instruments. Based on calculations prepared usingthe method provided for in banking regulations, the impact of theseitems would reduce the Group’s credit risk exposure by EUR 166 billionat 31 December <strong>2007</strong> (approximately EUR 123 billion at 31 December2006). In addition, this exposure does not take into account collateraland other security obtained by the Bank in connection with its lendingactivities, nor purchases of credit protection.4.a.2Management of c redit r isk – l endinga ctivitiesGeneral credit policy and credit control andprovisioning proceduresThe Bank’s lending activities are governed by the Global Credit Policyapproved by the Risk Policy Committee, chaired by the Chief ExecutiveOfficer. The purpose of the Committee is to determine the Group’s riskmanagement strategy. The policy is underpinned by core principlesrelated to compliance with the Group’s ethical standards, clear definitionof responsibilities, the existence and implementation of procedures andthorough analysis of risks. It is rolled down in the form of specific policiestailored to each type of business or counterparty.Decision-making proceduresA system of discretionary lending limits has been established, underwhich all lending decisions must be approved by a formally designatedmember of GRM. Approvals are systematically evidenced in writing,either by means of a signed approval form or in the minutes of formalmeetings of a Credit Committee. Discretionary lending limits correspondto aggregate commitments by business group and vary according tointernal credit ratings and the specific nature of the business concerned.Certain types of lending commitments, such as loans to banks, sovereignloans and loans to customers operating in certain industries, are requiredto be passed up to a higher level for approval. In addition, an industryexpert or designated specialist may also be required to sign off on theloan application. In Retail Banking, simplified procedures are applied,based on statistical decision-making aids.Loan applications must comply with the Bank’s Global Credit Policyand with any specific policies, and must in all cases comply withthe applicable laws and regulations. In particular, before making anycommitments BNP Paribas carries out an in-depth review of any knowndevelopment plans of the borrower, and ensures that it has thoroughknowledge of all the structural aspects of the borrower’s operations andthat adequate monitoring will be possible.The Group Credit Committee, chaired by one of the Chief OperatingOfficers or the head of GRM, has ultimate decision-making authorityfor all credit and counterparty risks.Monitoring proceduresA comprehensive risk monitoring and reporting system has beenestablished, covering all Group entities. The system is organised aroundControl and Reporting units which are responsible for ensuring thatlending commitments comply with the loan approval decision, thatcredit risk reporting data are reliable and that risks accepted by theBank are effectively monitored. Daily exception reports are produced andvarious forecasting tools are used to provide early warnings of potentialescalations of credit risks. Monitoring is carried out at different levels,generally reflecting the organisation of discretionary lending limits.Depending on the level, the monitoring teams report to GRM or to theGroup Debtor Committee. This Committee meets at monthly intervalsto examine all sensitive or problem loans in excess of a certain amount.Its responsibilities include deciding on any adjustments to impairmentprovisions, based on the recommendations of the business line and GRM.A tailored system is applied in the Retail Banking business.Impairment proceduresGRM reviews all corporate, bank and sovereign loans in default atmonthly intervals to determine the amount of any impairment loss tobe recognised, either by reducing the carrying amount or by recordinga provision for impairment, depending on the applicable accountingstandards. The amount of the impairment loss is based on the presentvalue of probable net recoveries, including from the realisation ofcollateral.In addition, a portfolio-based impairment provision is established foreach core business. A committee comprising the Core Business Director,the Group Chief Financial Officer and the head of GRM meets quarterlyto determine the amount of the impairment. This is based on simulationsof losses to maturity on portfolios of loans whose credit quality isconsidered as impaired, but where the customers in question have notbeen identified as in default (i.e. loans not covered by specific impairmentprovisions). The simulations carried out by GRM use the parameters ofthe internal rating system described below.Internal rating systemThe Bank has a comprehensive internal rating system that has beenupgraded in order to comply with the requirements of banking supervisorsfor determining risk-weighted assets used to compute capital adequacyratios. A periodic assessment and control process is being deployed toensure that the system is appropriate and is being correctly implemented.The system was formally validated by the French banking supervisor(Commission Bancaire) in December <strong>2007</strong>. For corporate loans, thesystem is based on a default probability rating and an overall recoveryrate which depends on the structure of the transaction. There aretwelve counterparty ratings. Ten cover clients that are not in defaultwith credit assessments ranging from “excellent” to “very concerning”,and two relate to clients classified as in default, as per the definition bythe banking supervisor. Ratings are determined at least once a year, inconnection with the loan approval process, drawing on the combinedexpertise of business line staff and GRM credit risk managers, who havethe final say. High quality tools have been developed to support therating process, including analysis aids and credit scoring systems. Thedecision to use these tools and the choice of technique depends on thenature of the risk. Various quantitative and other methods are used tocheck rating consistency and the rating system’s robustness. Loans toprivate customers and very small businesses are rated using statisticalanalyses of groups of risks with the same characteristics. GRM has overallresponsibility for the quality of the entire system. This responsibility isfulfilled by either defining the system directly, validating it or verifyingits performance.Portfolio policyIn addition to carefully selecting and evaluating individual risks, BNPParibas follows a portfolio-based policy designed to diversify risks amongborrowers, industries and countries. The results of this policy are regularlyreviewed by the Risk Policy Committee, which may modify or fine-tuneit as required, based on GRM’s analyses and recommendations. As partof this policy, BNP Paribas uses credit risk transfer instruments (suchas securitisation programmes or credit derivatives) to hedge individualrisks, reduce portfolio concentration or cap potential losses from crisisscenarios. The Bank also purchases credit risks as part of its portfoliodiversification and capital utilisation strategy, based on strict risk/yieldratio guidelines.<strong>2007</strong> Registration document - BNP PARIBAS 1371234567891011