56.2. Credit risk

Credit risk is inherent in the core financial operations of the Group, the scope of which includes both lending and providing funding with the use of capital market products. Consequently, credit risk is identified as the risk with the highest potential to affect the present and future profits and equity of BNP Paribas. Proof of the key nature of credit risk is its 79% share in the total economic capital estimated by the Group for purposes of covering major risks involved in the Bank’s operations, in addition to its 89% share in the total value of regulatory capital.

Credit risk management is primarily aimed at implementation of the Group’s strategy through a harmonious increase in the loan portfolio, accompanied by maintenance of the credit risk appetite at an acceptable level.

Credit risk management principles adopted by the Group include:

• each credit transaction requires comprehensive credit risk assessment expressed in internal rating or scoring;
• in-depth and careful financial analysis serves as the basis for regarding the customer’s financial information and collateral-related data as reliable; prudential analyses performed by the Group always take into account a safety margin;
• as a rule, financing is provided based on the customer’s ability to generate cash flows that ensure payment of liabilities to the Group;
• credit risk assessment is additionally verified by credit risk assessment personnel, independent of the business;
• pricing terms of a credit transaction have to take account of the risk involved in such a transaction;
• credit risk is diversified with regard to geographical regions, industries, products and customers;
• credit decisions may only be taken by competent employees;
• the Group enters credit transactions only with known customers and long-term relationships are the basis for cooperation with customers;
• the customer and the transactions made with the customer are monitored transparently from the perspective of the customer, in a manner strengthening the relationship between the Bank and the customer.

Concentration risk is the Bank’s risk inherent to its statutory operations, which is appropriately defined and managed.

The Management Board assesses the concentration risk policy in terms of its application. In particular, it analyses the efficiency and adequacy of the principles applied in the context of the current and planned operations and risk management strategy. The adequacy of the concentration risk management is reviewed if any material changes are observed in the Group’s environment or if the risk management strategy is modified. The appropriate assessment of the concentration risk of the Group is highly dependent on correct identification of all key concentration risks. In justified cases, the Group identifies concentration risk when planning its new activities involving the development and launch of new products, services, expansion to new markets, considerable alterations of products and services or market changes.

Credit portfolio diversification is one of the key credit risk management tools. The Group avoids excessive credit concentration, as it increases the risk. Possible losses pose a considerable threat, and therefore the concentration level should be monitored, controlled and reported to the Group’s management. Key concentration risk mitigation tools include risk identification and measurement mechanisms and exposure limits in individual Bank portfolio segments and in subsidiaries. These tools enable internal differentiation of the loan portfolio and mitigation of negative effects of adverse changes in the economy.

A significant concentration area (aspect) is the one whose share in the Group’s balance sheet total is equal or higher than 10% or 5% of the net profit planned for a given year. In such cases, a given concentration area (aspect) is subject to analyses, reporting and management under the concentration risk management process.

High concentration of the Group’s credit exposures to each entity or group of entities with equity or organizational relationships is one of the potential sources of credit risk. For purposes of its reduction, the Regulation No. 575/2013 specifies the Group’s maximum exposure limit. Under Article 395 of the Regulation No. 575/2013: the institution does not assume any exposure to the client or related clients, the value of which, taking into account the effect of limiting credit risk in accordance with Articles 399-403, exceeds 25% of the value of its Tier 1 capital. If a client is an institution or if a group of related clients include at least one institution, the value does not exceed 25% of its Tier 1 capital or of the amount of EUR 150 million, depending on which one of these two amounts is higher, provided that the sum of the exposure to all related non-institutional customers, after taking into account the effect of credit risk mitigation under Articles 399-403, does not exceed 25% of the value of the institution’s Tier 1 capital.

The Group’s concentration limits are monitored in accordance with Article 387 of the Regulation No. 575/2013. The limits, defined in Article 395 of the Regulation No. 575/2013, had not been exceeded as at the end of 2021. As at the end of 2021, the Group’s exposure to customers/groups of customers with equity or organizational relationships had not exceeded the concentration limit. The Group’s largest exposure represented 20.14% of Tier 1 capital.

Concentration risk tolerance in the Group is determined by a system of internal limits, including both assumed development directions and speed of the Group’s business, an acceptable level of credit risk and liquidity, as well as external conditions, macroeconomic and sectoral perspective. Among others, internal limits for credit concentration risk are determined for:

• selected sectors / industries;
• exposures denominated in foreign currencies;
• customer segments (intra-bank customer segmentation);
• loans secured with a given type of collateral;
• geographical regions;
• average probability of default;
• exposures with a specified rating (the Group’s internal rating scale);
• exposures with a specified debt-to-income ratio;
• exposures with a specified loan-to-value ratio.

Activities that limit Group’s exposure to concentration risk may include systemic measures and one-off / specific decision and transactions. Systemic measures that limit concentration risk include:

• reduction of the scope of crediting of determined customer types through credit policy adjustment;
• reduction of limits charged with concentration risk;
• diversification of asset types on the level of the Group’s statement of financial position;
• change of business strategy to ensure prevention of excessive concentration;
• diversification of accepted collateral types.

Systemic measures that limit concentration risk include:

• reduction of further transactions with a given customer or a group of related customers;
• sale of selected assets/loan portfolios;
• securitization of assets;
• establishing of new collateral types (e.g. credit derivatives, guarantees, sub-participation, and insurance contracts) for existing or new credit exposures.

A concentration analysis by industry, conducted by the Group, focuses on all credit exposures of the Group to institutional customers. The Group defines industries based on Polish statistical classification of economic activities (NACE/PKD 2007). The Group’s exposure to industries analysed at the end of 2021 (presented based on the classification of industries in NACE/PKD), similarly as at the end of December 2020, is concentrated in the following industries: Agriculture, Forestry, Hunting and Fishing, manufacturing. As at the end of December 2021, the share of manufacturing increased by 3 p.p. to the level of 24% as compared to the end of 2020, while the share of agriculture, forestry and fishing decreased by 4 p.p. as compared to the end of 2020 to the level of 22% of industrial exposure.

The table below presents a comparison of the share of impaired loans in industries (gross balance sheet value) as at 31 December 2021 and 2020.

The Group manages the risk of collateral concentration. For this purpose, the Group introduced limits for the involvement of particular types of collateral, ensuring their appropriate diversification. As at the end of 2021, as well as at the end of 2020, the limits were not exceeded.

In the case of an individually assessed exposures as at 31 December 2021, the Group expects to recover, due to established collateral, the amount of PLN 325,251 thousand, which is 29% of the total exposure assessed individually with an impairment recognised as at 31 December 2020 (PLN 446,091 thousand and 30% as at 31 December 2020).

The table below presents the Group’s maximum exposure to credit risk for financial instruments both recognised and not recognised in the financial statements. The maximum exposure was presented in its gross value, before considering the impact of collateral and other credit quality improvement instruments.

The table below presents significant credit risk exposures to which the expected credit loss model was applied. The breakdown was based on the rating scale presented below:

For large enterprises and clients from the SME segment that prepare full financial reporting, the Group determines internal rating classes in accordance with the adopted credit policy. The rating classes are based on the risk model dedicated to this part of the loan portfolio and are the basis for estimating the amount of the provision in accordance with IFRS 9. The Group’s customers are assigned ratings from 1 (clients for whom the Group identifies the lowest credit risk) to 12 (clients for whom the Group identifies the highest credit risk). In order to assign ratings, the annual financial data provided by the client and the general quality assessment of its market situation are used.

The purpose of repayment overdue analysis is to indicate the level of potential credit loss (in respect of receivables without impairment). The higher delinquency in repayment, the more likely it is to identify an objective impairment trigger in the future. An increase in the delay in repayment above zero days increases the chance of identifying impairment trigger, but does not itself constitute grounds for giving this trigger. In the case of exposures overdue below 91 days, the impairment trigger may, however, be identified based on additional information about the economic and financial situation of the client.

The structure of the loan portfolio (measured at amortised cost and measured at fair value through profit or loss) divided into impaired exposures and not impaired exposures along with the level of arrears in repayment are presented in the tables below.

Impairment allowances reflect the expected credit loss calculated using the three-step approach required by IFRS 9, as described in Note 3.

The Group assesses the creditworthiness of each client on an individual basis. The value of collateral obtained, if it is deemed necessary by the Group due to the granting of a loan, is subject to valuation by the Group.

The Group accepts various forms of collateral for loans, while the main categories include:

• real estate mortgage;
•  insurance of real estate being the subject of a mortgage;
• life insurance of the borrower;
• registered pledge.

Impact of collaterals on the valuation of exposure with impairment identified (loans measured at amortised cost and at fair value through profit or loss)*:

In the period covered by the present financial statements, there were no significant changes in the quality of collateral as a result of deterioration or changes in the Group’s collateral policy.

Mortgage loans to individual customers account for ca. 31% of the loan portfolio of non-financial sector of the Group (gross carrying amount), with 17% being loans in foreign currencies the major part of which (99%) are denominated in CHF (the Swiss franc). The total gross carrying amount of mortgage loans in foreign currencies is PLN 4,569,608 thousand.

The Group performs revaluation of the residential property pledged as collateral for loans on an annual basis, on the following assumptions:

• where the debt is below PLN 12 million at the revaluation date – the property is revalued using a statistical method;
• where the debt is more than PLN 12 million at the revaluation date – the property is revalued on a case-by-case basis.

The revalued amount is the basis for calculation of the current LTV for a single exposure and the average LTV for the entire portfolio as the average weighted by the gross carrying amount of individual LTVs.

The total on-balance sheet exposure and the average LTVs for mortgage loans in foreign currencies considering impairment and delinquency in days is presented below.

The average current LTV for the entire foreign currency mortgage loan portfolio is at the level of 81%, while the average current LTV for mortgage loans in the Polish currency amounts to 69%.

Exposure structure and average current LTV by loan granting year (mortgage loans in foreign currencies) are presented in the table below:

The Group treats its exposures as forborne if the obligor is provided with a forbearance due to economic reasons (financial difficulties), including any forbearance granted for exposures with identified impairment triggers. In case the forbearance is granted for a customer with a material economic loss, the Bank classifies such a customer as default.

A facility is understood as the occurrence of at least one of the following events:

• a change to the repayment schedule, especially extending the loan maturity date;
• cancellation of overdue amounts (e.g. capitalization of an overdue amount, which can be repaid at a later date);
• redemption of principal, interest or fees;
• consolidation of loans into one new product, if the amounts of payments of the consolidated loan are lower than the sum of payments of these loans separately before the consolidation occurred;
• decrease of the base interest rate or margin;
• originating a new loan to repay the existing debt;
• conversion of an existing credit,
• amendment or waiver of significant provisions of the agreement (e.g. a condition of the agreement that was breached as a result of financial difficulties),
• additional collateral presented by the Borrower (if present together with another event meeting the definition of a facility) or sale of the collateral agreed with the Bank, with the proceeds from the repayment of the collateral being used to repay the Bank’s loan obligation.

Only in the period of customer’s financial difficulties or, in the period when, due to changes on the market, such difficulties may occur, i.e.:

• the exposure is subject to debt collection; or
• the exposure is not subject to debt collection but there is evidence (provided by the customer or obtained in the decision-making process) that the customer is facing financial difficulties or may be facing them in the near future.

A material economic loss is defined by the Bank as the drop of present value of expected cash flows, resulting from forbearance granted, equal or higher than 1%[1]. The drop of the present value is calculated in accordance with the below formula:

NPV₀ – NPV₁
__________

NPV₀

where:

NPV0 – the present value of expected cash flows (including interest and fees / commissions) prior to the introduction of changes in loan terms, discounted with the original effective interest rate ,

NPV1 – the present value of expected cash flows (including interest and fees / commissions), after the introduction of changes in the loan terms, discounted using the original effective interest rate. In the case of consolidation of many loans for the original interest rate for the purpose of assessing the significance of economic loss, the average EIR weighted with the gross balance sheet exposure at the moment of granting the facility is assumed.

The change in the present value of expected cash flows shall be calculated at the level of single exposure.

In justified cases resulting from complex restructuring measures for a given client (e.g. priority repayment of loans with a collateral of a low value), it is permissible to calculate NPV at the  level of a client.

The “forborne” status is no longer assigned if the following conditions have been satisfied:

• exposure reclassified to performing portfolio as a result of the analysis of financial situation (in case of corporate portfolio), which proved that the customer does not meet the criteria for being classified to the impaired portfolio;
• the exposure has not been considered impaired for 24 months in a row;
• none of the exposures to the customer are past due by more than 30 days;
• the obligor has been making regular and considerable payments for at least a half of the trial period.

^[1] change from 5% to 1% since 11.01.2021

In connection with the continuation of the COVID-19 pandemic, the Group continued a number of actions during the year 2021 regarding, including:

• review of the loan portfolio with focus on industries, particularly affected by and sensitive to the consequences of the COVID 19 pandemic;

The Group also actively participated in the works of the banking sector, regulators and organizers of government support addressed to entrepreneurs, has launched a number of solutions allowing customers to submit application to the Bank electronically and online as well as to use support programs related to the effects of a pandemic and has been conducting ongoing monitoring of the number of clients and credit exposures affected by the pandemic, including ongoing decisions on individual clients regarding the type and structure of client financing adequate to his current situation and government support programs.

The Group continued cooperation with BGK in relation to PLG-FGP liquidity guarantees offered to the Group’s clients, other liquidity guarantees and loan interest rate subsidy programs.

An electronic and simplified process of applying for postponement of principal and interest instalments on investment loans was introduced.

As a partner of the PFR program, the Bank provided its clients with technical possibilities to apply for funding from these programs using electronic banking.

In the period between 18 February and 31 March 2021, the Group was focusing on the use of available assistance programs for clients, including temporary postponement of instalments, examining clients’ applications in this respect on an ongoing basis.

After 31 March 2021, clients’ applications to postpone loan instalments could have been submitted and examined in a mode analogous to the situation before the COVID-19 pandemic.

The data in the tables below are based on balance sheet value and present the amounts recognized in the Group’s books as at 31 December 2021 and 31  December 2020.

As at 31 December 2021  the value of expired moratoriums amounted to PLN 5,696,483 thousand (PLN 6,949,777 thousand as at 31 December 2020).

As part of its response to the situation related to COVID-19 pandemic during the year, the Group has continued changes to the process of recognition of material increases in risk. The Group still monitors the behaviour of exposures subject to moratorium, both statutory and non-statutory. From the second quarter of 2021, the Bank did not offer non-statutory moratoria.

Exposures covered by statutory credit vacations are transferred to Stage 3. In case of exposures covered by non-statutory credit vacations, the Group applied stricter criteria and these are classified to Stage 2. For these exposures, more than 30 days overdue within 3 months after the end of moratorium is an indication of a significant increase of credit risk (Stage 2), which results in calculation of allowances within the exposure life horizon.

Within credit risk, the Bank additionally distinguishes country risk, which covers all risks related to conclusion of financial agreements with foreign parties, assuming that it is possible that economic, social or political events will have an adverse effect on creditworthiness of the Bank’s obligors in that country or where intervention of a foreign government could prevent the obligor (which could also be the government itself) from discharging his liabilities.

The Bank’s policy concerning country risk has been conservative. Country limits have been reviewed periodically and the limit level modified to precisely match the anticipated business needs and risk appetite of the Bank.

As at the end of 2021, 63% of the Bank’s exposure to countries other than Poland were transactions related to the Bank’s foreign lending activities, treasury transactions (including placement and derivative transactions) accounted for 14% while the remaining part, i.e. 23% was related to foreign trade transactions (letters of credit and guarantees). France accounted for 43%, Luxembourg for 22%, the Netherlands for 9%, Austria for 6%, and Belgium for 5% of the exposure. The remaining exposure was concentrated in Germany, Italy, the Great Britain and Switzerland.