Consolidation of Arval exposures adds €20bn to BNP Paribas’ RWAs

Bank shifts exposures from soon-to-be retired equity IRB treatment to standardised approach

BNP Paribas integrated exposures stemming from auto leasing subsidiary Arval into its credit and operational risk frameworks ahead of Basel III implementation next year, generating €20.2 billion ($21.5 billion) in new risk-weighted assets (RWAs) in the third quarter.

In 2021, the European Banking Authority revised rules around simplified weighting of assets in banking groups’ non-bank subsidiaries, a restriction set to expand further under Basel III regulations due to be implemented in the European Union on January 1, 2025.

Until June 30, BNP Paribas reflected Arval’s assets and liabilities on its balance sheet, but only risk-weighted its equity stake in the unit, rather than the underlying credit exposures.

On July 1, the bank began capitalising Arval exposures similarly to other assets in its portfolio. This change added €15.7 billion to the bank’s standardised credit RWAs, driving almost half of its 17.9% increase to €222.4 billion during Q3.

Additionally, it pushed operational RWAs under the basic indicator approach (BIA) up €4.4 billion, or 124%, to €7.9 billion.

 

The integration was offset partially by a €9.1 billion drop in RWAs under the simple risk-weight approach to equity exposures, suggesting this had been the method used to capitalise the equity in Arval.

BNP Paribas also reported a €5.9 billion reduction in RWAs under the internal ratings-based (IRB) approach due to acquisitions and disposals, though it is unclear how much of this pertains to Arval’s reclassification and what accounted for the remaining €3.2 billion decline in equity-exposure RWAs.

 

As of end-September, the standardised approach underpinned 38.1% of total credit RWAs, while equity simple risk-weighting and the advanced IRB (A-IRB) approach represented 6.4% and 55.4%, respectively. These shares marked a 4.4 percentage point increase in standardised approach use since end-June, along with drops of 1.9pp and 2.6pp for the other two approaches.

Operational RWAs also saw the BIA’s coverage double, from 6.1% to 12.5%.

BNP Paribas quantified the impact of Arval’s consolidation at 30 basis points off its Common Equity Tier 1 capital ratio.

What is it?

Basel Committee on Banking Supervision rules allow credit risk RWAs to be calculated using the standardised and internal ratings-based approaches.

Under the standardised approach, credit exposures are assessed using industry-wide risk weightings. The F-IRB approach allows banks to estimate the probability of default for their exposures, while relying on a regulator-set framework for other risk components, such as loss given default, to determine RWAs. The A-IRB approach allows banks to use their own estimates of key risk parameters: the probability of default, loss given default and exposure at default.

Within the IRB framework, non-credit assets outside the trading book, such as equity participations, can be risk-weighted through a simple approach, applying fixed weights based on asset type; a market-based approach informed by trading-book practices; or a more complex method incorporating a bank’s internal estimates of probability of default and loss given default.

Under Basel II rules, banks can calculate operational risk capital requirements using the basic indicator approach, the standardised approach and the advanced measurement approach (AMA), each of which entails different data inputs and methodologies.

The first two use bank data inputs and regulator-set formulas to generate the required capital, while the AMA allows banks to use their own models to produce the outputs, using internal loss data, external data, scenario analysis and business environment and internal control factors.

The Basel III framework, published in December 2017 and set for implementation in the EU on January 1, 2025, replaces these three methods with a revised standardised measurement approach.

Why it matters

The 30bp reduction in BNP Paribas’ capital headroom from the Arval consolidation is relatively minor and won’t require a rethink of the subsidiary’s business strategy. In fact, chief financial officer Lars Machenil promised that the integration of Arval’s operations will ultimately improve profitability.

However, the move places a larger share of the banks’ exposures under standardised approaches, which rely on fixed regulatory metrics the bank cannot adjust through internal models.

The bank had little choice in this shift. Along with the EBA’s revised standards for equity risk-weighting eligibility, Basel III will eliminate the existing equity treatment altogether, bringing all equity exposures under the standardised approach for credit risk.

In principle, nothing prevents BNP Paribas from reassigning some of Arval’s exposures back under its internal credit-risk models, subject to regulatory approval. But Basel III reforms impose stricter constraints on IRB model calculations, on top of introducing an output floor, which may make it more cost-effective for the bank to keep the Arval book under the standardised approach’s purview.

BNP Paribas did not respond to a request for comment in time for publication.

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