2012 Registration document and annual financial report - BNP Paribas

RISKS AND CAPITAL ADEQUACYRisk management5CREDIT RISKCredit risk is the potential that a bank borrower or counterparty will failto meet its obligations in accordance with agreed terms. The probabilityof default and the expected recovery on the loan or receivable in theevent of default are key components of the credit quality assessment.COUNTERPARTY RISKCounterparty risk is the translation of the credit risk embedded in themarket, investment and/or payment transactions. Those transactionsinclude bilateral contracts (i.e. Over-The-Counter – OTC) which potentiallyexpose the Bank to the risk of default of the counterparty faced. Theamount of this risk (referred as “exposure” in the rest of the document)may vary over time in line with market parameters which impact thevalue of the relevant market transactions.SECURITISATIONSecuritisation means a transaction or scheme, whereby the credit riskassociated with an exposure or pool of exposures is tranched, having thefollowing characteristics:■ there is a significant transfer of risk;■ payments made in the transaction or scheme are dependent upon theperformance of the exposure or pool of exposures;■ the subordination of tranches determines the distribution of lossesduring the ongoing risk transfer of the transaction or scheme.As a consequence, any commitment (including derivatives and liquiditylines) granted to a securitisation operation must be treated as asecuritisation exposure.MARKET RISKMarket risk is the risk of incurring a loss of value due to adverse trendsin market prices or parameters, whether directly observable or not.Observable market parameters include, but are not limited to, exchangerates, interest rates, prices of securities and commodities (whether listedor obtained by reference to a similar asset), prices of derivatives, pricesof other goods, and other parameters that can be directly inferred fromthem, such as credit spreads, volatilities and implied correlations orother similar parameters.Non-observable factors are those based on working assumptions suchas parameters contained in models or based on statistical or economicanalyses, non confirmed by market information.Liquidity is an important component of market risk. In times of limitedor no liquidity, instruments or goods may not be tradable or may not betradable at their estimated value. This may arise, for example, due to lowtransaction volumes, legal restrictions or a strong imbalance betweendemand and supply for certain assets.The market risk related to banking activities encompasses the risk of losson equity holdings on the one hand, and the interest rate and foreignexchange risks stemming from banking intermediation activities on theother hand. Only the equity and foreign exchange risks give rise to aweighted assets calculation under Pillar 1. The interest rate risk fallsunder Pillar 2.OPERATIONAL RISKOperational risk is the risk of incurring a loss due to inadequate orfailed internal processes, or due to external events, whether deliberate,accidental or natural occurrences. Management of operational risk isbased on an analysis of the “cause – event – effect” chain.Internal processes giving rise to operational risk may involve employeesand/or IT systems. External events include, but are not limited to floods,fire, earthquakes and terrorist attacks. Credit or market events such asdefault or fluctuations in value do not fall within the scope of operationalrisk.Operational risk encompasses human resources risks, legal risks, taxrisks, information system risks, misprocessing risks, risks related topublished financial information and the financial implications resultingfrom reputation and compliance risks.COMPLIANCE AND REPUTATION RISKAccording to French regulation, compliance risk is the risk of legal,administrative or disciplinary sanctions, together with the significantfinancial loss that a bank may suffer as a result of its failure to complywith all the laws, regulations, codes of conduct and standards ofgood practice applicable to banking and financial activities (includinginstructions given by an executive body, particularly in application ofguidelines issued by a supervisory body).By definition, this risk is a sub-category of operational risk. However,as certain implications of compliance risk involve more than a purelyfinancial loss and may actually damage the institution’s reputation, theBank treats compliance risk separately.Reputation risk is the risk of damaging the trust placed in a corporationby its customers, counterparties, suppliers, employees, shareholders,supervisors and any other stakeholder whose trust is an essentialcondition for the corporation to carry out its day-to-day operations.Reputation risk is primarily contingent on all the other risks borne bythe Bank.52012 Registration document and annual financial report - BNP PARIBAS 241