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Note 7 - Risk Management
 12 Months Ended
Dec. 31, 2017
Risk Management Abstract  
Risk Management Explanatory

Risk management

General risk management and control model

The BBVA Group has an overall risk management and control model (hereinafter 'the model') tailored to its business model, its organization and the geographies in which it operates, This model allows BBVA Group to develop its activity in accordance with the risk strategy and risk controls and management policies defined by the governing bodies of the Bank and to adapt to a changing economic and regulatory environment, tackling risk management globally and adapted to the circumstances at all times. The model establishes a system of appropriate risk management regarding risk profile and strategy of the Group.

This model is applied comprehensively in the Group and consists of the basic elements listed below:

  • Governance and organization.
  • Risk Appetite Framework.
  • Decisions and processes.
  • Assessment, monitoring and reporting.
  • Infrastructure.

The Group promotes the development of a risk culture that ensures consistent application of the risk management and control model in the Group, and that guarantees that the risk function is understood and assimilated at all levels of the organization

Governance and organization

BBVA Group´s risk governance model is characterized by a special involvement of its corporate bodies, both in setting the risk strategy and in the ongoing monitoring and supervision of its implementation.

Thus, as developed below, the corporate bodies are the ones that approve this risk strategy and corporate policies for the different types of risk. The risk function is responsible at management level for their implementation and development, and reporting to the governing bodies.

The responsibility for the daily management of the risks lies on the businesses which abide in the development of their activity to meet the policies, rules, procedures, infrastructures and controls, which are defined by the function risk on the basis of the framework set by the governing bodies.

To perform this task properly, the risk function in the BBVA Group is configured as a single, global function with an independent role from commercial areas.

Corporate bodies

BBVA Board of Directors (hereinafter also referred to as "the Board") approves the risk strategy and oversees the internal management and control systems. Specifically, in relation to the risk strategy, the Board approves the Group's risk appetite statement, the core metrics and the main metrics by type of risk, as well as the general risk management and control model.

The Board of Directors is also responsible for approving and monitoring the strategic and business plan, the annual budget and management goals, as well as the investment and funding policy, in a consistent way and in line with the approved Risk Appetite Framework. For this reason, the processes for defining the Risk Appetite Framework proposals and the strategic and budgetary planning at Group level are coordinated by the executive areas for submission to the Board.

With the aim of ensuring the integration of the Risk Appetite Framework into management, on the basis established by the Board of Directors, the Executive Committee approves the remaining metrics by type of risk (in 2017 those in relation to concentration, profitability and reputational risk) and the Group's basic structure of limits by geographical area, risk type, asset type and portfolio level. This committee also approves specific corporate policies for each type of risk.

Lastly, the Board has set up a Board committee specialized in risks, the Risk Committee, that assists the Board and the Executive Committee in determining the Group's risk strategy and the risk limits and policies, respectively, analyzing and assessing beforehand the proposals submitted to those bodies. The Board of Directors has the exclusive authority to amend the Group’s risk strategy and its elements, including the Risk Appetite Framework metrics within its scope of decision, while the Executive Committee is responsible for amending the metrics by type of risk within its scope of decision and the Group's basic structure of limits (core limits), when applicable. In both cases, the amendments follow the same decision-making process described above, so the proposals for amendment are submitted by the executive area (Chief Risk Officer, “CRO”) and analyzed by the Risk Committee, for later submission to the Board of Directors or to the Executive Committee, as appropriate.

Moreover, the Risk Committee, the Executive Committee and the Board itself conduct proper monitoring of the risk strategy implementation and of the Group's risk profile. The risk function regularly reports on the development of the Group's Risk Appetite Framework metrics to the Board and to the Executive Committee, after the analysis by the Risk Committee, whose role in this monitoring and control work is particularly relevant.

Risk Function: CRO. Organizational structure and committees

The head of the risk function at executive level is the Group’s CRO, who carries out his functions independently and with the necessary authority, rank, experience, knowledge and resources. He is appointed by the Board as a member of its senior management and has direct access to its corporate bodies (Board, Executive Standing Committee and Risk Committee), to whom he reports regularly on the status of risks in the Group.

The CRO, for a better performance of its functions, is supported in the performance of its functions by a structure consisting of cross-sectional risk units in the corporate area and the specific risk units in the geographical and/or business areas of the Group. Each of the latter units is headed by a Chief Risk Officer for the geographical and/or business area who, within his/her area of responsibility, carries out risk management and control functions and is responsible for applying the corporate policies and rules approved at Group level in a consistent manner, adapting them if necessary to local requirements and reporting to the local corporate bodies.

The Chief Risk Officers of the geographical and/or business areas report both to the Group's CRO and to the head of their geographical and/or business area. This dual reporting system aims to ensure that the local risk management function is independent from the operating functions and enable its alignment with the Group's corporate risk policies and goals.

As explained above, the risk management function consists of risk units from the corporate area, which carry out cross-sectional functions, and risk units from the geographical and/or business areas.

1) The corporate area's risk units develop and submit to the Group CRO the proposal for the Group's Risk Appetite Framework, the corporate policies, rules and global procedures and infrastructures within the framework approved by the corporate bodies; they ensure their application and report either directly or through the CRO to the Bank's corporate bodies. Their functions include:

  • Management of the different types of risks at Group level in accordance with the strategy defined by the corporate bodies.
  • Risk planning aligned with the risk appetite framework principles defined by the Group.
  • Monitoring and control of the Group's risk profile in relation to the risk appetite framework approved by the Bank's corporate bodies, providing accurate and reliable information with the required frequency and in the necessary format.
  • Prospective analyses to enable an evaluation of compliance with the risk appetite framework in stress scenarios and the analysis of risk mitigation mechanisms.
  • Management of the technological and methodological developments required for implementing the Model in the Group.
  • Design of the Group's Internal Control model and definition of the methodology, corporate criteria and procedures for identifying and prioritizing the risk inherent in each unit's activities and processes.
  • Validation of the models used and the results obtained by them in order to verify their adaptation to the different uses to which they are applied.

2) The risk units in the business units develop and present to the Chief Risk Officer of the geographical and/or business area the risk appetite framework proposal applicable in each geographical and/or business area, independently and always within the Group's strategy/Risk Appetite Framework. They also ensure that the corporate policies and rules approved and applied consistently at a Group level, adapting them if necessary to local requirements; that they are provided with appropriate infrastructures for management and control of their risks, within the global risk infrastructure framework defined by the corporate areas; and that they report to their corporate bodies and/or to senior management, as appropriate.

The local risk units thus work with the corporate area risk units in order to adapt to the risk strategy at Group level and share all the information necessary for monitoring the development of their risks.

The risk function has a decision-making process to perform its functions, underpinned by a structure of committees, where the Global Risk Management Committee (GRMC) acts as the top-level committee within the risk function. It proposes, examines and, where applicable, approves, among others, the internal risk regulatory framework and the procedures and infrastructures needed to identify, assess, measure and manage the material risks faced by the Group in carrying out its business, and the determination of risk limits by portfolio. The members of this Committee are the Group's CRO and the heads of the risk units of the corporate area and of the most representative geographical and/or business areas.

The GRMC carries out its functions assisted by various support committees which include:

  • Global Credit Risk Management Committee: It is responsible for analyzing and decision-making related to wholesale credit risk admission.
  • Wholesale Credit Risk Management Committee: its purpose is the analysis and decision-making regarding the admission of wholesale credit risk of certain customer segments of the BBVA Group.
  • Work Out Committee: its purpose is to be informed about decisions taken under the delegation framework regarding risk proposals concerning clients on Watch List levels 1 and 2 and clients classified as NPL of certain customer segments of the BBVA Group, as well the sanction of proposals regarding entries, exits and changes of the Special Monitoring list.
  • Monitoring, Assessment & Reporting Committee: It guarantees and ensures the appropriate development of aspects related to risk identification, assessment, monitoring and reporting, with an integrated and cross-cutting vision.
  • Asset Allocation Committee: The executive authority responsible for analyzing and deciding on credit risk issues related to processes aimed at achieving a portfolios combination and composition that, under the restrictions imposed by the Risk Appetite framework, allows to maximize the risk adjusted profit subject to an appropriate risk-adjusted return on equity.
  • Technology & Analytics Committee: It ensures an appropriate decision-making process regarding the development, implementation and use of the tools and models required to achieve an appropriate management of those risks to which the BBVA Group is exposed.
  • Global Markets Risk Unit Global Committee: It is responsible for formalizing, supervising and communicating the monitoring of trading desk risk in all the Global Markets business units, as well as coordinating and approving GMRU key decisions activity, and developing and proposing to GRMC the corporate regulation of the unit.
  • Corporate Operational and Outsourcing Risk Admission Committee: It identifies and assesses the operational risks of new businesses, new products and services, and outsourcing initiatives.
  • Retail Risk Committee: It ensures the alignment of the practices and processes of the retail credit risk cycle with the approved risk tolerance and with the business growth and development objectives established in the corporate strategy of the Group.
  • Asset Management Global Risk Steering Committee: its purpose is to develop and coordinate the strategies, policies, procedures, and infrastructure necessary to identify, assess, measure and manage the material risks facing the bank in the operation of businesses linked to BBVA Asset Management.
  • Global Insurance Risk Committee: its purpose is to guarantee the alignment and the communication between all the Insurance Risk Units in the BBVA Group. It will do this by promoting the application of standardized principles, policies, tools and risk metrics in the different regions with the aim of maintaining proper integration of insurance risk management in the Group.
  • COPOR: its purpose is to analyze and make decision in relation to the operations of the various geographies in which Global Markets is present.

Each geographical and/or business area has its own risk management committee (or committees), with objectives and contents similar to those of the corporate area, which perform their duties consistently and in line with corporate risk policies and rules, whose decisions are reflected in the corresponding minutes.

Under this organizational scheme, the risk management function ensures the risk strategy, the regulatory framework, and standardized risk infrastructures and controls are integrated and applied across the entire Group. It also benefits from the knowledge and proximity to customers in each geographical and/or business area, and transmits the corporate risk culture to the Group's different levels. Moreover, this organization enables the risks function to conduct and report to the corporate bodies integrated monitoring and control of the entire Group's risks.

Internal Risk Control and Internal Validation

The Group has a specific Internal Risk Control unit. Its main function is to ensure there is an adequate internal regulatory framework, a process and measures defined for each type of risk identified in the Group (and for those other types of risk that may potentially affect the Group). It controls their application and operation, as well as ensuring the integration of the risk strategy into the Group's management. In this regard, the Internal Risk Control unit verifies the performance of their duties by the units that develop the risk models, manage the processes and execute the controls. Its scope of action is global, from the geographical point of view and the type of risks.

The Group's Head of Internal Risk Control is responsible for the function and reports on its activities and informs of its work plans to the CRO and to the Board's Risk Committee, assisting it in any matters where requested. For these purposes the Internal Risk Control department has a Technical Secretary's Office, which offers the Committee the technical support it needs to better perform its duties.

In addition, the Group has an Internal Validation unit, which reviews the performance of its duties by the units that develop the risk models and of those that use them in management. Its functions include review and independent validation at internal level of the models used for management and control of risks in the Group

Risk Appetite Framework

The Group's Risk Appetite Framework, approved by the corporate bodies, determines the risks (and their level) that the Group is willing to assume to achieve its business objectives considering an organic evolution of its business. These are expressed in terms of solvency, profitability, liquidity and funding, or other metrics, which are reviewed periodically as well as in case of material changes to the entity’s business or relevant corporate transactions. The definition of the risk appetite has the following goals:

  • To express the maximum levels of risk it is willing to assume, at both Group and geographical and/or business area level.
  • To establish a set of guidelines for action and a management framework for the medium and long term that prevent actions from being taken (at both Group and geographical and/or business area level) that could compromise the future viability of the Group.
  • To establish a framework for relations with the geographical and/or business areas that, while preserving their decision-making autonomy, ensures they act consistently, avoiding uneven behavior.
  • To establish a common language throughout the organization and develop a compliance-oriented risk culture.
  • Alignment with the new regulatory requirements, facilitating communication with regulators, investors and other stakeholders, thanks to an integrated and stable risk management framework.

Risk appetite framework is expressed through the following elements:

Risk Appetite Statement

It sets out the general principles of the Group's risk strategy and the target risk profile. The 2017 Group’s Risk appetite statement is:

BBVA Group’s risk policy is designed to achieve a moderate risk profile for the entity, through: prudent management and a responsible universal banking business model targeted to value creation, risk-adjusted return and recurrence of results; diversified by geography, asset class, portfolio and clients; and with presence in emerging and developed countries, maintaining a medium/low risk profile in every country, and focusing on a long term relationship with the client.

Core metrics

Based on the risk appetite statement, statements are established to set down the general risk management principles in terms of solvency, liquidity and funding, profitability and income recurrence.

  • Solvency: a sound capital position, maintaining resilient capital buffer from regulatory and internal requirements that supports the regular development of banking activity even under stress situations. As a result, BBVA proactively manages its capital position, which is tested under different stress scenarios from a regular basis.
  • Liquidity and funding: A sound balance-sheet structure to sustain the business model. Maintenance of an adequate volume of stable resources, a diversified wholesale funding structure, which limits the weight of short term funding and ensures the access to the different funding markets, optimizing the costs and preserving a cushion of liquid assets to overcome a liquidity survival period under stress scenarios.
  • Profitability and income recurrence: A sound margin-generation capacity supported by a recurrent business model based on the diversification of assets, a stable funding and a customer focus; combined with a moderate risk profile that limits the credit losses even under stress situations; all focused on allowing income stability and maximizing the risk-adjusted profitability.

The core metrics define, in quantitative terms, the principles and the target risk profile set out in the risk appetite statement and are in line with the strategy of the Group. Each metric has three thresholds (traffic-light approach) ranging from a standard business management to higher deterioration levels: Management reference, Maximum appetite and Maximum capacity. The 2017 Group’s Core metrics are:

By type of risk metrics

Based on the core metrics, statements are established for each type of risk reflecting the main principles governing the management of that risk and several metrics are calibrated, compliance with which enables compliance with the core metrics and the risk appetite statement of the Group. By type of risk metrics have a maximum appetite threshold.

Basic limits structure (core limits)

The purpose of the basic limits structure or core limits is to shape the Risk Appetite Framework at geographical area risk type, asset type and portfolio level, ensuring that the management of risks on an ongoing basis is within the thresholds set forth for "by type of risk".

In addition to this framework, there’s a level of management limits level that is defined and managed by the risk function developing the core limits, in order to ensure that the anticipatory management of risks by subcategories or by subportfolios complies with that core limits and, in general, with the Risk Appetite Framework.

The following graphic summarizes the structure of BBVA’s Risk Appetite Framework:

The corporate risk area works with the various geographical and/or business areas to define their risk appetite framework, which will be coordinated with and integrated into the Group's risk appetite to ensure that its profile fits as defined.

The Group Risk Appetite Framework expresses the levels and types of risk that the Bank is willing to assume to be able to implement its strategic plan with no relevant deviations, even in situations of stress. The Risk Appetite Framework is integrated into the management and the processes for defining the Risk Appetite Framework proposals and strategic and budgetary planning at Group level are coordinates.

As explained above, the core metrics of BBVA Risk Appetite Framework measure Groups performance in terms of solvency, liquidity and funding, profitability and income recurrence; most of the core metrics are accounting related or regulatory metrics which are published regularly to the market in the BBVA Group annual report and in the quarterly financial reports. During 2017, the Group risk profile evolved in line with the Risk Appetite metrics

Decisions and processes

The transfer of risk appetite framework to ordinary management is supported by three basic aspects:

  • A standardized set of regulations.
  • Risk planning.
  • Comprehensive management of risks over their life cycle.

Standardized regulatory framework

The corporate risk area is responsible for the definition and proposal of the corporate policies, specific rules, procedures and schemes of delegation based on which risk decisions should be taken within the Group.

This process aims for the following objectives:

  • Hierarchy and structure: well-structured information through a clear and simple hierarchy creating relations between documents that depend on each other.
  • Simplicity: an appropriate and sufficient number of documents.
  • Standardization: a standardized name and content of document.
  • Accessibility: ability to search for, and easy access to, documentation through the corporate risk management library.

The approval of corporate policies for all types of risks corresponds to the corporate bodies of the Bank, while the corporate risk area endorses the remaining regulations.

Risk units of geographical and / or business areas comply with this set of regulations and, where necessary, adapt it to local requirements for the purpose of having a decision process that is appropriate at local level and aligned with the Group policies. If such adaptation is necessary, the local risk area must inform the corporate area of GRM, who must ensure the consistency of the regulatory body at the Group level and, therefore,  if necessary, give prior approval to the modifications proposed by the local risk areas.

Risk planning

Risk planning ensures that the risk appetite framework is integrated into management through a cascade process for establishing limits and profitability adjusted to the risk profile, in which the function of the corporate area risk units and the geographical and/or business areas is to guarantee the alignment of this process with the Group's Risk Appetite Framework in terms of solvency, liquidity and funding, profitability and income recurrence.

There are tools in place that allow the Risk Appetite Framework defined at aggregate level to be assigned and monitored by business areas, legal entities, types of risk, concentrations and any other level considered necessary.

The risk planning process is aligned and taken into consideration within the rest of the Group's planning framework so as to ensure consistency.

Comprehensive management

All risks must be managed comprehensively during their life cycle, and be treated differently depending on the type.

The risk management cycle is composed of five elements:

  • Planning: with the aim of ensuring that the Group's activities are consistent with the target risk profile and guaranteeing solvency in the development of the strategy.
  • Assessment: a process focused on identifying all the risks inherent to the activities carried out by the Group.
  • Formalization: includes the risk origination, approval and formalization stages.
  • Monitoring and reporting: continuous and structured monitoring of risks and preparation of reports for internal and/or external (market, investors, etc.) consumption.
  • Active portfolio management: focused on identifying business opportunities in existing portfolios and new markets, businesses and products

Assessment, monitoring and reporting

Assessment, monitoring and reporting is a cross-cutting element that ensure the Model has a dynamic and proactive vision to enable compliance with the risk appetite framework approved by the corporate bodies, even in adverse scenarios. The materialization of this process has the following objectives:

  • Assess compliance with the risk appetite framework at the present time, through monitoring of the core metrics, metrics by type of risk and the basic structure of limits.
  • Assess compliance with the risk appetite framework in the future, through the projection of the risk appetite framework variables, in both a baseline scenario determined by the budget and a risk scenario determined by the stress tests.
  • Identify and assess the risk factors and scenarios that could compromise compliance with the risk appetite framework, through the development of a risk repository and an analysis of the impact of those risks.
  • Act to mitigate the impact in the Group of the identified risk factors and scenarios, ensuring this impact remains within the target risk profile.
  • Supervise the key variables that are not a direct part of the risk appetite framework, but that condition its compliance. These can be either external or internal.

This process is integrated in the activity of the risk units, both of the corporate area and in the business units, and it is carried out during the following phases:

  • Identification of the risk factors that can compromise the performance of the Group or of the geographical and/or business areas in relation to the defined risk thresholds.
  • Assessment of the impact of the materialization of the risk factors on the metrics that define the Risk Appetite Framework based on different scenarios, including stress scenarios.
  • Response to unwanted situations and proposals for readjustment to enable a dynamic management of the situation, even before it takes place.
  • Monitoring of the Group's risk profile and of the identified risk factors, through internal, competitor and market indicators, among others, to anticipate their future development.
  • Reporting: Complete and reliable information on the development of risks for the corporate bodies and senior management, with the frequency and completeness appropriate to the nature, significance and complexity of the reported risks. The principle of transparency governs al reporting of risk information

Infrastructure

The infrastructure is an element that must ensure that the Group has the human and technological resources needed for effective management and supervision of risks in order to carry out the functions set out in the Group's risk Model and the achievement of their objectives.

With respect to human resources, the Group risk function has an adequate workforce, in terms of number, skills, knowledge and experience.

With regards to technology, the Group risk function ensures the integrity of management information systems and the provision of the infrastructure needed for supporting risk management, including tools appropriate to the needs arising from the different types of risks for their admission, management, assessment and monitoring.

The principles that govern the Group risk technology are:

  • Standardization: the criteria are consistent across the Group, thus ensuring that risk handling is standardized at geographical and/or business area level.
  • Integration in management: the tools incorporate the corporate risk policies and are applied in the Group's day-to-day management.
  • Automation of the main processes making up the risk management cycle.
  • Appropriateness: provision of adequate information at the right time.

Through the “Risk Analytics” function, the Group has a corporate framework in place for developing the measurement techniques and models. It covers all the types of risks and the different purposes and uses a standard language for all the activities and geographical/business areas and decentralized execution to make the most of the Group's global reach. The aim is to continually evolve the existing risk models and generate others that cover the new areas of the businesses that develop them, so as to reinforce the anticipation and proactiveness that characterize the Group's risk function.

Also the risk units of geographical and / or business areas have sufficient means from the point of view of resources, structures and tools to develop a risk management in line with the corporate model

Risk culture

The Group promotes the development of a risk culture that ensure consistent application of the risk management and control model in the Group, and that guarantees that the risk function is understood and internalized at all levels of the organization.

The culture transfers the implications that are involved in the Group's activities and businesses to all the levels of the organization. The risk culture is organized through a number of levers, including the following:

  • Communication: promotes the dissemination of the Model, and in particular the principles that must govern risk management in the Group, in a consistent and integrated manner across the organization, through the most appropriate channels. GRM has a number of communication channels to facilitate the transmission of information and knowledge among the various teams in the function and the Group, adapting the frequency, formats and recipients based on the proposed goal, in order to strengthen the basic principles of the risk function. The risk culture and the management model thus emanate from the Group's corporate bodies and senior management and are transmitted throughout the organization.
  • Training: its main aim is to disseminate and establish the model of risk management across the organization, ensuring standards in the skills and knowledge of the different persons involved in the risk management processes.
  • Well defined and implemented training ensures continuous improvement of the skills and knowledge of the Group's professionals, and in particular of the GRM area, and is based on four aspects that aim to develop each of the needs of the GRM group by increasing its knowledge and skills in different fields such as: finance and risks, tools and technology, management and skills, and languages.
  • Motivation: the aim in this area is for the incentives of the risk function teams to support the strategy for managing those teams and the function's values and culture at all levels. Includes compensation and all those elements related to motivation – working environment, etc. which contribute to the achievement Model objectives

Risk factors

As mentioned earlier, BBVA has processes in place for identifying risks and analyzing scenarios that enable the Group to manage risks in a dynamic and proactive way.

The risk identification processes are forward looking to ensure the identification of emerging risks and take into account the concerns of both the business areas, which are close to the reality of the different geographical areas, and the corporate areas and senior management.

Risks are captured and measured consistently using the methodologies deemed appropriate in each case. Their measurement includes the design and application of scenario analyses and stress testing and considers the controls to which the risks are subjected.

As part of this process, a forward projection of the risk appetite framework variables in stress scenarios is conducted in order to identify possible deviations from the established thresholds. If any such deviations are detected, appropriate measures are taken to keep the variables within the target risk profile.

To this extent, there are a number of emerging risks that could affect the Group’s business trends. These risks are described in the following main blocks

1) Macroeconomic and geopolitical risks

Global growth has improved during 2017, and is more synchronized across developed and emerging markets, which makes the recovery more sustainable. Healthy global trade growth and calm financial markets, which rely on the support from central banks and the lack of inflation pressure, also contribute to the more upbeat outlook. The performance of the most advanced economies is solid, especially the Eurozone, where global demand adds to domestic factors and reduced political uncertainty. Growth momentum in The United States will be supported in the short term by the recently approved tax reform, although its long-term impact is unlikely to be large. As regards emerging economies, China's growth moderation continues, with a mix of policies oriented to diminish financial imbalances, while economic activity in Latin America recovers against a background of higher commodity prices and favorable global funding conditions.

The uncertainty around these positive economic perspectives has a downward bias but continues to be elevated. First, following a long period of exceptionally loose monetary policies, the main central banks are tapering their support, with uncertainty on their impact on markets and economies given the background of high leverage and signs of overvaluation in some financial assets. A second source of uncertainty is related with the political support to the multilateral global governance of trade. Third, both global geopolitics and domestic politics in some countries are relevant for the economic perspectives within the BBVA's footprint.

In this regard, the Group's geographical diversification remains a key element in achieving a high level of revenue recurrence, despite the background conditions and economic cycles of the economies in which it operates.

2) Regulatory and reputational risks

  • Financial institutions are exposed to a complex and ever-changing regulatory environment defined by governments and regulators. This can affect their ability to grow and the capacity of certain businesses to develop, and result in stricter liquidity and capital requirements with lower profitability ratios. The Group constantly monitors changes in the regulatory framework (such as IFRS9, Basel IV, etc.) that allow for anticipation and adaptation to them in a timely manner, adopt industry practices and more efficient and rigorous criteria in its implementation.
  • The financial sector is under ever closer scrutiny by regulators, governments and society itself. Negative news or inappropriate behavior can significantly damage the Group's reputation and affect its ability to develop a sustainable business. The attitudes and behaviors of the group and its members are governed by the principles of integrity, honesty, long-term vision and industry practices through, inter alia, internal control Model, the Code of Conduct, tax strategy and Responsible Business Strategy of the Group.

3) Business, operational and legal risks

  • New technologies and forms of customer relationships: Developments in the digital world and in information technologies pose significant challenges for financial institutions, entailing threats (new competitors, disintermediation…) but also opportunities (new framework of relations with customers, greater ability to adapt to their needs, new products and distribution channels...). Digital transformation is a priority for the Group as it aims to lead digital banking of the future as one of its objectives.
  • Technological risks and security breaches: The Group is exposed to new threats such as cyber-attacks, theft of internal and customer databases, fraud in payment systems, etc. that require major investments in security from both the technological and human point of view. The Group gives great importance to the active operational and technological risk management and control. One example was the early adoption of advanced models for management of these risks (AMA - Advanced Measurement Approach).
  • The financial sector is exposed to increasing litigation, so the financial institutions face a large number of proceedings which economic consequences are difficult to determine. The Group manages and monitors these proceedings to defend its interests, where necessary allocating the corresponding provisions to cover them, following the expert criteria of internal lawyers and external attorneys responsible for the legal handling of the procedures, in accordance with applicable legislation

Credit risk

Credit risk arises from the probability that one party to a financial instrument will fail to meet its contractual obligations for reasons of insolvency or inability to pay and cause a financial loss for the other party.

It is the most important risk for the Group and includes counterparty risk, issuer risk, settlement risk and country risk management.

The principles underpinning credit risk management in BBVA are as follows:

  • Availability of basic information for the study and proposal of risk, and supporting documentation for approval, which sets out the conditions required by the internal relevant body.
  • Sufficient generation of funds and asset solvency of the customer to assume principal and interest repayments of loans owed.
  • Establishment of adequate and sufficient guarantees that allow effective recovery of the operation, this being considered a secondary and exceptional method of recovery when the first has failed.

Credit risk management in the Group has an integrated structure for all its functions, allowing decisions to be taken objectively and independently throughout the life cycle of the risk.

  • At Group level: frameworks for action and standard rules of conduct are defined for handling risk, specifically, the circuits, procedures, structure and supervision.
  • At the business area level: they are responsible for adapting the Group's criteria to the local realities of each geographical area and for direct management of risk according to the decision-making circuit:

Retail risks: in general, the decisions are formalized according to the scoring tools, within the general framework for action of each business area with regard to risks. The changes in weighting and variables of these tools must be validated by the corporate GRM area.

Wholesale risks: in general, the decisions are formalized by each business area within its general framework for action with regard to risks, which incorporates the delegation rule and the Group's corporate policies

Credit risk exposure

In accordance with IFRS 7 “Financial Instruments: Disclosures”, the BBVA Group’s maximum credit risk exposure (see definition below) by headings in the balance sheets as of December 31, 2017, 2016 and 2015 is provided below. It does not consider the availability of collateral or other credit enhancements to guarantee compliance with payment obligations. The details are broken down by financial instruments and counterparties

Maximum Credit Risk Exposure (Millions of euros)
Notes201720162015
Financial assets held for trading 29,43031,99537,424
Debt securities10.122,57327,16632,825
Government20,71624,16529,454
Credit institutions8161,6521,765
Other sectors1,0411,3491,606
Equity instruments10.16,8014,6754,534
Loans and advances to customers5615465
Other financial assets designated at fair value through profit or loss 11 2,7092,0622,311
Loans and advances to customers648-62
Debt securities174142173
Government9384132
Credit institutions634729
Other sectors181111
Equity instruments1,8881,9202,075
Available-for-sale financial assets70,76179,553113,710
Debt securities12.166,27374,739108,448
Government53,37855,04781,579
Credit institutions3,9025,0118,069
Other sectors8,99314,68218,800
Equity instruments12.14,4884,8145,262
Loans and receivables 444,320482,011490,580
Loans and advances to central banks13.17,3008,89417,830
Loans and advances to credit institutions13.226,29731,41629,368
Loans and advances to customers13.3400,369430,474432,856
Government32,52534,87338,611
Agriculture3,8764,3124,315
Industry52,02657,07256,913
Real estate and construction29,67137,00238,964
Trade and finance47,95147,04543,576
Loans to individuals172,868192,281194,288
Other61,45257,88956,188
Debt securities13.410,35411,22610,526
Government4,4124,7093,275
Credit institutions3137125
Other sectors5,9116,4817,126
Held-to-maturity investments13,76517,710-
Government12,62016,049-
Credit institutions1,0561,515-
Other sectors89146-
Derivatives (trading and hedging) 10.4 - 1545,62854,12249,350
TOTAL FINANCIAL ASSETS RISK606,613667,454693,375
Loan commitments given33 94,268107,254123,620
Financial guarantees given33 16,54518,26719,176
Other Commitments given33 45,73842,59242,813
Total Maximum Credit Exposure763,165835,567878,984

The maximum credit exposure presented in the table above is determined by type of financial asset as explained below:

  • In the case of financial assets recognized in the consolidated balance sheets, exposure to credit risk is considered equal to its carrying amount (not including impairment losses), with the sole exception of derivatives and hedging derivatives.
  • The maximum credit risk exposure on financial guarantees granted is the maximum that the Group would be liable for if these guarantees were called in, and that is their carrying amount.
  • The calculation of risk exposure for derivatives is based on the sum of two factors: the derivatives fair value and their potential risk (or "add-on").

The first factor, fair value, reflects the difference between original commitments and fair values on the reporting date (mark-to-market). As indicated in Note 2.2.1, derivatives are accounted for as of each reporting date at fair value in accordance with IAS 39.

The second factor, potential risk (‘add-on’), is an estimate of the maximum increase to be expected on risk exposure over a derivative fair value (at a given statistical confidence level) as a result of future changes in the fair value over the remaining term of the derivatives.

The consideration of the potential risk ("add-on") relates the risk exposure to the exposure level at the time of a customer’s default. The exposure level will depend on the customer’s credit quality and the type of transaction with such customer. Given the fact that default is an uncertain event which might occur any time during the life of a contract, the BBVA Group has to consider not only the credit exposure of the derivatives on the reporting date, but also the potential changes in exposure during the life of the contract. This is especially important for derivatives, whose valuation changes substantially throughout their terms, depending on the fluctuation of market prices.

The breakdown by counterparty and product of loans and advances, net of impairment losses, classified in the different headings of the assets, as of December 31, 2017, 2016 and 2015 is shown below

December 2017 (Millions of euros)
Central banksGeneral governmentsCredit institutionsOther financial corporationsNon-financial corporationsHouseholdsTotal
On demand and short notice-222-2707,6632,40510,560
Credit card debt-6-31,86213,96415,835
Trade receivables1,624-49720,38519822,705
Finance leases-205-368,0403618,642
Reverse repurchase loans3051,29013,79310,912--26,300
Other term loans6,99326,9834,4635,763125,228155,418324,848
Advances that are not loans21,9648,0051,0441,45952212,995
Loans and advances7,30132,29426,26118,525164,637172,868421,886
of which: mortgage loans [Loans collateralized by immovable property]998-30837,353116,938155,597
of which: other collateralized loans7,16713,50112,90724,1009,09266,767
of which: credit for consumption40,70540,705
of which: lending for house purchase114,709114,709
of which: project finance loans16,41216,412

December 2016 (Millions of euros)
Central banksGeneral governmentsCredit institutionsOther financial corporationsNon-financial corporationsHouseholdsTotal
On demand and short notice-373-2468,1252,50711,251
Credit card debt-1-11,87514,71916,596
Trade receivables2,091-99820,24641823,753
Finance leases-261-578,6474779,442
Reverse repurchase loans8154415,5976,746--22,968
Other term loans8,81429,1407,6946,878136,105167,892356,524
Advances that are not loans-2,4108,0832,0821,19462014,389
Loans and advances8,89434,82031,37317,009176,192186,633454,921
of which: mortgage loans [Loans collateralized by immovable property]4,72211269044,406132,398182,328
of which: other collateralized loans3,70015,1918,16421,8636,06154,979
of which: credit for consumption44,50444,504
of which: lending for house purchase127,606127,606
of which: project finance loans19,26919,269

December 2015 (Millions of euros)
Central banksGeneral governmentsCredit institutionsOther financial corporationsNon-financial corporationsHouseholdsTotal
On demand and short notice-783-388,3562,05011,228
Credit card debt-1-21,89215,05716,952
Trade receivables3,055-80019,60541123,871
Finance leases-301-4207,5341,1039,357
Reverse repurchase loans14932611,6764,7179-16,877
Other term loans10,01731,9718,9905,968134,952168,729360,626
Advances that are not loans7,6642,1088,7132,26191986322,528
Loans and advances17,83038,54429,37914,206173,267188,213461,438
of which: mortgage loans [Loans collateralized by immovable property]4,48326465643,961135,102184,466
of which: other collateralized loans3,86812,4346,08522,9286,13151,446
of which: credit for consumption40,90640,906
of which: lending for house purchase126,591126,591
of which: project finance loans21,14121,141

Mitigation of credit risk, collateralized credit risk and other credit enhancements

In most cases, maximum credit risk exposure is reduced by collateral, credit enhancements and other actions which mitigate the Group’s exposure. The BBVA Group applies a credit risk hedging and mitigation policy deriving from a banking approach focused on relationship banking. The existence of guarantees could be a necessary but not sufficient instrument for accepting risks, as the assumption of risks by the Group requires prior evaluation of the debtor’s capacity for repayment, or that the debtor can generate sufficient resources to allow the amortization of the risk incurred under the agreed terms.

The policy of accepting risks is therefore organized into three different levels in the BBVA Group:

  • Analysis of the financial risk of the operation, based on the debtor’s capacity for repayment or generation of funds.
  • The constitution of guarantees that are adequate, or at any rate generally accepted, for the risk assumed, in any of the generally accepted forms: monetary, secured, personal or hedge guarantees; and finally.
  • Assessment of the repayment risk (asset liquidity) of the guarantees received.

The procedures for the management and valuation of collateral are set out in the Corporate Policies (retail and wholesale), which establish the basic principles for credit risk management, including the management of collaterals assigned in transactions with customers.

The methods used to value the collateral are in line with the best market practices and imply the use of appraisal of real-estate collateral, the market price in market securities, the trading price of shares in mutual funds, etc. All the collaterals assigned must be properly drawn up and entered in the corresponding register. They must also have the approval of the Group’s legal units.

The following is a description of the main types of collateral for each financial instrument class:

1) Financial instruments held for trading: The guarantees or credit enhancements obtained directly from the issuer or counterparty are implicit in the clauses of the instrument.

2) Derivatives and hedging derivatives: In derivatives, credit risk is minimized through contractual netting agreements, where positive- and negative-value derivatives with the same counterparty are offset for their net balance. There may likewise be other kinds of guarantees, depending on counterparty solvency and the nature of the transaction.

3) Other financial assets designated at fair value through profit or loss and Available-for-sale financial assets: The guarantees or credit enhancements obtained directly from the issuer or counterparty are inherent to the structure of the instrument.

4) Loans and receivables:

  • Loans and advances to credit institutions: These usually only have the counterparty’s personal guarantee.
  • Loans and advances to customers: Most of these loans and advances are backed by personal guarantees extended by the own customer. There may also be collateral to secure loans and advances to customers (such as mortgages, cash collaterals, pledged securities and other collateral), or to obtain other credit enhancements (bonds, hedging, etc.).
  • Debt securities: The guarantees or credit enhancements obtained directly from the issuer or counterparty are inherent to the structure of the instrument.

Collateralized loans granted by the Group as of December 31, 2017, 2016 and 2015 excluding balances deemed impaired, is broken down in Note 13.2.

5) Financial guarantees, other contingent risks and drawable by third parties: These have the counterparty’s personal guarantee

Credit quality of financial assets that are neither past due nor impaired

The BBVA Group has tools (“scoring” and “rating”) that enable it to rank the credit quality of its operations and customers based on an assessment and its correspondence with the probability of default (“PD”) scales. To analyze the performance of PD, the Group has a series of tracking tools and historical databases that collect the pertinent internally generated information, which can basically be grouped together into scoring and rating models.

Scoring

Scoring is a decision-making model that contributes to both the arrangement and management of retail loans: consumer loans, mortgages, credit cards for individuals, etc. Scoring is the tool used to decide to originate a loan, what amount should be originated and what strategies can help establish the price, because it is an algorithm that sorts transactions by their credit quality. This algorithm enables the BBVA Group to assign a score to each transaction requested by a customer, on the basis of a series of objective characteristics that have statistically been shown to discriminate between the quality and risk of this type of transactions. The advantage of scoring lies in its simplicity and homogeneity: all that is needed is a series of objective data for each customer, and this data is analyzed automatically using an algorithm.

There are three types of scoring, based on the information used and on its purpose:

  • Reactive scoring: measures the risk of a transaction requested by an individual using variables relating to the requested transaction and to the customer’s socio-economic data available at the time of the request. The new transaction is approved or rejected depending on the score.
  • Behavioral scoring: scores transactions for a given product in an outstanding risk portfolio of the entity, enabling the credit rating to be tracked and the customer’s needs to be anticipated. It uses transaction and customer variables available internally. Specifically, variables that refer to the behavior of both the product and the customer.
  • Proactive scoring: gives a score at customer level using variables related to the individual’s general behavior with the entity, and to his/her payment behavior in all the contracted products. The purpose is to track the customer’s credit quality and it is used to pre-approved new transactions.

Rating

Rating tools, as opposed to scoring tools, do not assess transactions but focus on the rating of customers instead: companies, corporations, SMEs, general governments, etc. A rating tool is an instrument that, based on a detailed financial study, helps determine a customer’s ability to meet his/her financial obligations. The final rating is usually a combination of various factors: on one hand, quantitative factors, and on the other hand, qualitative factors. It is a middle road between an individual analysis and a statistical analysis.

The main difference between ratings and scorings is that the latter are used to assess retail products, while ratings use a wholesale banking customer approach. Moreover, scorings only include objective variables, while ratings add qualitative information. And although both are based on statistical studies, adding a business view, rating tools give more weight to the business criterion compared to scoring tools.

For portfolios where the number of defaults is low (sovereign risk, corporates, financial entities, etc.) the internal information is supplemented by “benchmarking” of the external rating agencies (Moody’s, Standard & Poor’s and Fitch). To this end, each year the PDs compiled by the rating agencies at each level of risk rating are compared, and the measurements compiled by the various agencies are mapped against those of the BBVA master rating scale.

Once the probability of default of a transaction or customer has been calculated, a "business cycle adjustment" is carried out. This is a means of establishing a measure of risk that goes beyond the time of its calculation. The aim is to capture representative information of the behavior of portfolios over a complete economic cycle. This probability is linked to the Master Rating Scale prepared by the BBVA Group to enable uniform classification of the Group’s various asset risk portfolios.

The table below shows the abridged scale used to classify the BBVA Group’s outstanding risk as of December 31, 2017

External ratingInternal ratingProbability of default(basic points)
Standard&Poor's ListReduced List (22 groups)AverageMinimum from >=Maximum
AAAAAA1-2
AA+AA+223
AAAA334
AA-AA-445
A+A+556
AA869
A-A-10911
BBB+BBB+141117
BBBBBB201724
BBB-BBB-312439
BB+BB+513967
BBBB8867116
BB-BB-150116194
B+B+255194335
BB441335581
B-B-7855811,061
CCC+CCC+1,1911,0611,336
CCCCCC1,5001,3361,684
CCC-CCC-1,8901,6842,121
CC+CC+2,3812,1212,673
CCCC3,0002,6733,367
CC-CC-3,7803,3674,243

These different levels and their probability of default were calculated by using as a reference the rating scales and default rates provided by the external agencies Standard & Poor’s and Moody’s. These calculations establish the levels of probability of default for the BBVA Group’s Master Rating Scale. Although this scale is common to the entire Group, the calibrations (mapping scores to PD sections/Master Rating Scale levels) are carried out at tool level for each country in which the Group has tools available.

The table below outlines the distribution of exposure, including derivatives, by internal ratings, to corporates, financial entities and institutions (excluding sovereign risk), of BBVA, S.A., Bancomer, Garanti Bank, Compass and subsidiaries in Spain as of December 31, 2017, 2016 and 2015

December 2017December 2016December 2015
Credit Risk Distribution by Internal RatingAmount(Millions of Euros)%Amount(Millions of Euros)%Amount(Millions of Euros)%
AAA/AA+/AA/AA-38,12412.04%35,43011.84%27,9139.17%
A+/A/A-68,63821.68%58,70219.62%62,79820.64%
BBB+40,62612.83%43,96214.69%43,43214.27%
BBB28,1948.90%27,3889.15%28,6129.40%
BBB-51,84516.37%41,71313.94%40,82113.41%
BB+29,0889.19%32,69410.92%28,3559.32%
BB17,0095.37%19,6536.57%23,0087.56%
BB-15,6564.94%13,6644.57%12,5484.12%
B+11,1803.53%10,3663.46%8,5972.83%
B9,1012.87%4,8571.62%5,7311.88%
B-2,9620.94%3,6871.23%3,9981.31%
CCC/CC4,2231.33%7,1492.39%18,4886.08%
Total316,649100.00%299,264100.00%304,300100.00%

Past due but not impaired and impaired secured loans risks

The table below provides details by counterpart and by product of past due risks but not considered to be impaired, as of December 31, 2017, 2016 and 2015, listed by their first past-due date; as well as the breakdown of the debt securities and loans and advances individually and collectively estimated, and the specific allowances for individually estimated and for collectively estimated (see Note 2.2.1)

December 2017 (Millions of euros)
Past due but not impairedImpaired assetsCarrying amount of the impaired assetsSpecific allowances for financial assets, individually and collectively estimatedCollective allowances for incurred but not reported lossesAccumulated write-offs
≤ 30 days> 30 days ≤ 60 days> 60 days ≤ 90 days
Debt securities---6638(28)(21)-
Loans and advances3,43275950319,40110,726(8,675)(4,109)(29,938)
General governments75313171129(42)(69)(27)
Credit institutions---115(6)(30)(5)
Other financial corporations2--126(7)(19)(5)
Non-financial corporations84315317010,7915,192(5,599)(1,939)(18,988)
Households2,5126033198,4175,395(3,022)(2,052)(10,913)
TOTAL3,43275950319,46710,764(8,703)(4,130)(29,938)
Loans and advances by product, by collateral and by subordination
On demand (call) and short notice (current account)771211389151(238)
Credit card debt39766118629190(439)
Trade receivables11589515179(336)
Finance leases1386647431155(276)
Other term loans2,70560631717,41710,047(7,370)
Advances that are not loans1-1203(16)
of which: mortgage loans (Loans collateralized by immovable property)1,34536016411,3887,630(3,757)
of which: other collateralized loans59213743803493(310)
of which: credit for consumption1,2602482071,551457(1,093)
of which: lending for house purchase1,0343071075,7304,444(1,286)
of which: project finance loans13-251,165895(271)

(*) Corresponding to €2,763 million of specific allowances for financial assets, individually estimated and €5,940 million of specific allowances for financial assets collectively estimated

December 2016 (Millions of euros)
Past due but not impairedImpaired assetsCarrying amount of the impaired assetsSpecific allowances for financial assets, individually and collectively estimatedCollective allowances for incurred but not reported lossesAccumulated write-offs
≤ 30 days> 30 days ≤ 60 days> 60 days ≤ 90 days
Debt securities---272128(144)(46)(1)
Loans and advances3,38469673522,92512,133(10,793)(5,224)(29,346)
General governments66-2295256(39)(13)(13)
Credit institutions3-82103(7)(36)(5)
Other financial corporations4721348(25)(57)(6)
Non-financial corporations96820920413,7866,383(7,402)(2,789)(18,020)
Households2,3434794268,8015,483(3,319)(2,329)(11,303)
TOTAL3,38469673523,19712,261(10,937)(5,270)(29,347)
Loans and advances by product, by collateral and by subordination
On demand (call) and short notice (current account)791529562249(313)
Credit card debt37788124643114(529)
Trade receivables51151342487(337)
Finance leases18810759516252(264)
Reverse repurchase loans--821-(1)
Other term loans2,68546940720,76511,429(9,336)
Advances that are not loans5-21142(12)
of which: mortgage loans (Loans collateralized by immovable property)1,20226525416,5269,008(5,850)
of which: other collateralized loans593124471,129656(275)
of which: credit for consumption1,1862272691,622455(1,168)
of which: lending for house purchase8831941056,0944,546(1,548)
of which: project finance loans138--253105(147)

December 2015 (Millions of euros)
Past due but not impairedImpaired assetsCarrying amount of the impaired assetsSpecific allowances for financial assets, individually and collectively estimatedCollective allowances for incurred but not reported lossesAccumulated write-offs
≤ 30 days> 30 days ≤ 60 days> 60 days ≤ 90 days
Debt securities---8146(35)(113)-
Loans and advances3,44582540425,35812,527(12,831)(5,911)(26,143)
General governments1542782194157(37)(30)(19)
Credit institutions---259(17)(34)(5)
Other financial corporations71146729(38)(124)(5)
Non-financial corporations8381484816,2547,029(9,225)(3,096)(15,372)
Households2,4463993408,8175,303(3,514)(2,626)(10,743)
TOTAL3,44582540425,43912,573(12,866)(6,024)(26,143)
Loans and advances by product, by collateral and by subordination
On demand (call) and short notice (current account)134137634204(430)
Credit card debt38974126689161(528)
Trade receivables982622628179(449)
Finance leases1362921529222(307)
Reverse repurchase loans1--11(1)
Other term loans2,68568222722,76411,747(11,017)
Advances that are not loans2--11313(99)
of which: mortgage loans (Loans collateralized by immovable property)1,34226610616,5269,767(6,877)
of which: other collateralized loans589102271,129809(339)
of which: credit for consumption9571642201,543404(1,139)
of which: lending for house purchase6161741105,9184,303(1,615)
of which: project finance loans3-127666(211)

The breakdown of loans and advances of loans and receivables, impaired and accumulated impairment by sectors as of December 31, 2017, 2016 and 2015 is as follows

December 2017 (Millions of euros)
Non-performingAccumulated impairment or Accumulated changes in fair value due to credit riskNon-performing loans and advances as a % of the total
General governments171(111)0.5%
Credit institutions11(36)-
Other financial corporations12(26)0.1%
Non-financial corporations10,791(7,538)6.3%
Agriculture, forestry and fishing166(123)4.3%
Mining and quarrying177(123)3.7%
Manufacturing1,239(955)3.6%
Electricity, gas, steam and air conditioning supply213(289)1.8%
Water supply29(11)4.5%
Construction2,993(1,708)20.1%
Wholesale and retail trade1,706(1,230)5.9%
Transport and storage441(353)4.2%
Accommodation and food service activities362(222)4.3%
Information and communication984(256)17.0%
Real estate activities1,171(1,100)7.9%
Professional, scientific and technical activities252(183)3.8%
Administrative and support service activities188(130)6.3%
Public administration and defense, compulsory social security4(6)1.9%
Education31(25)3.4%
Human health services and social work activities75(68)1.7%
Arts, entertainment and recreation69(38)4.6%
Other services690(716)4.3%
Households8,417(5,073)4.7%
LOANS AND ADVANCES19,401(12,784)4.5%

December 2016 (Millions of euros)
Non-performingAccumulated impairment or Accumulated changes in fair value due to credit riskNon-performing loans and advances as a % of the total
General governments295(52)0.8%
Credit institutions10(42)-
Other financial corporations34(82)0.2%
Non-financial corporations13,786(10,192)7.4%
Agriculture, forestry and fishing221(188)5.1%
Mining and quarrying126(83)3.3%
Manufacturing1,569(1,201)4.5%
Electricity, gas, steam and air conditioning supply569(402)3.2%
Water supply29(10)3.5%
Construction5,358(3,162)26.3%
Wholesale and retail trade1,857(1,418)6.2%
Transport and storage442(501)4.5%
Accommodation and food service activities499(273)5.9%
Information and communication112(110)2.2%
Real estate activities1,441(1,074)8.7%
Professional, scientific and technical activities442(380)6.0%
Administrative and support service activities182(107)7.3%
Public administration and defense, compulsory social security18(25)3.0%
Education58(31)5.4%
Human health services and social work activities89(88)1.8%
Arts, entertainment and recreation84(51)5.1%
Other services691(1,088)4.2%
Households8,801(5,648)4.6%
LOANS AND ADVANCES22,925(16,016)5.0%

December 2015 (Millions of euros)
Non-performingAccumulated impairment or Accumulated changes in fair value due to credit riskNon-performing loans and advances as a % of the total
General governments194(67)0.5%
Credit institutions25(51)0.1%
Other financial corporations67(162)0.5%
Non-financial corporations16,254(12,321)8.8%
Agriculture, forestry and fishing231(180)5.4%
Mining and quarrying192(114)4.7%
Manufacturing1,947(1,729)5.8%
Electricity, gas, steam and air conditioning supply250(395)1.4%
Water supply44(23)5.2%
Construction6,585(4,469)30.1%
Wholesale and retail trade1,829(1,386)6.3%
Transport and storage616(607)6.4%
Accommodation and food service activities567(347)7.0%
Information and communication110(100)2.3%
Real estate activities1,547(1,194)9.1%
Professional, scientific and technical activities944(454)12.8%
Administrative and support service activities224(148)6.9%
Public administration and defense, compulsory social security18(25)2.8%
Education26(19)2.6%
Human health services and social work activities82(91)1.8%
Arts, entertainment and recreation100(63)6.6%
Other services942(977)6.1%
Households8,817(6,140)4.5%
LOANS AND ADVANCES25,358(18,742)5.5%

The changes during the years 2017, 2016 and 2015 of impaired financial assets and contingent risks are as follow

Changes in Impaired Financial Assets and Contingent Risks (Millions of euros)
2017(**)20162015
Balance at the beginning 23,87726,10323,234
Additions10,85611,13314,872
Decreases (*)(7,771)(7,633)(6,720)
Net additions3,0853,5008,152
Amounts written-off(5,758)(5,592)(4,989)
Exchange differences and other(615)(134)(295)
Balance at the end 20,59023,87726,103

(*) Reflects the total amount of impaired loans derecognized from the consolidated balance sheet throughout the period as a result of mortgage foreclosures and real estate assets received in lieu of payment as well as monetary recoveries (see Notes 20 and 21 to the consolidated financial statement for additional information)

(**) Includes impaired loans of Chile

The changes during the years 2017, 2016 and 2015 in financial assets derecognized from the accompanying consolidated balance sheet as their recovery is considered unlikely (hereinafter "write-offs"), is shown below

Changes in Impaired Financial Assets Written-Off from the Balance Sheet (Millions of Euros)
Notes201720162015
Balance at the beginning 29,34726,14323,583
Acquisition of subsidiaries in the year--1,362
Increase:5,9865,6996,172
Decrease:(4,442)(2,384)(4,830)
Re-financing or restructuring(9)(32)(28)
Cash recovery47(558)(541)(490)
Foreclosed assets(149)(210)(159)
Sales of written-off(2,284)(45)(54)
Debt forgiveness(1,121)(864)(3,119)
Time-barred debt and other causes (321)(692)(980)
Net exchange differences(752)(111)(144)
Balance at the end30,13929,34726,143

As indicated in Note 2.2.1, although they have been derecognized from the consolidated balance sheet, the BBVA Group continues to attempt to collect on these written-off financial assets, until the rights to receive them are fully extinguished, either because it is time-barred financial asset, the financial asset is condoned, or other reasons

Impairment losses

Below are the changes in the years ended December 31, 2017, 2016 and 2015, in the provisions recognized on the accompanying consolidated balance sheets to cover estimated impairment losses in loans and advances and debt securities, according to the different headings under which they are classified in the accompanying consolidated balance sheet:

December 2017 (Millions of euros)
Opening balanceIncreases due to amounts set aside for estimated loan losses during the periodDecreases due to amounts reversed for estimated loan losses during the periodDecreases due to amounts taken against allowancesTransfers between allowancesOther adjustmentsClosing balanceRecoveries recorded directly to the statement of profit or loss
Equity instruments
Specific allowances for financial assets, individually and collectively estimated(10,937)(7,484)2,8784,5031,810526(8,703)558
Debt securities(144)(26)6-12313(28)-
Credit institutions(15)(5)4-16---
Other financial corporations(26)(4)2--13(16)-
Non-financial corporations(103)(17)--107-(12)-
Loans and advances(10,793)(7,458)2,8724,5031,687513(8,675)558
General governments(39)(70)3714115(42)1
Credit institutions(7)(2)2--1(6)-
Other financial corporations(25)(287)33822738(7)-
Non-financial corporations(7,402)(3,627)1,9933,029(228)636(5,599)345
Households(3,319)(3,472)8371,4221,687(177)(3,022)212
Collective allowances for incurred but not reported losses on financial assets(5,270)(1,783)2,1591,537(1,328)557(4,130)-
Debt securities(46)(8)301-3(21)-
Loans and advances(5,224)(1,776)2,1281,536(1,328)554(4,109)-
Total(16,206)(9,267)5,0376,0384821,083(12,833)558

December 2016 (Millions of euros)
Opening balanceIncreases due to amounts set aside for estimated loan losses during the periodDecreases due to amounts reversed for estimated loan losses during the periodDecreases due to amounts taken against allowancesTransfers between allowancesOther adjustmentsClosing balanceRecoveries recorded directly to the statement of profit or loss
Equity instruments
Specific allowances for financial assets, individually and collectively estimated(12,866)(6,912)2,7085,673(123)583(10,937)540
Debt securities(35)(167)664(10)(2)(144)-
Credit institutions(20)--5--(15)-
Other financial corporations(15)(29)326(10)(1)(26)-
Non-financial corporations-(138)333-(1)(103)-
Loans and advances(12,831)(6,745)2,7025,610(113)585(10,793)540
General governments(37)(2)206(27)2(39)1
Credit institutions(17)(2)3-10(3)(7)-
Other financial corporations(38)(34)922106(25)-
Non-financial corporations(9,225)(3,705)2,1583,257(278)391(7,402)335
Households(3,514)(3,002)5112,325172189(3,319)205
Collective allowances for incurred but not reported losses on financial assets(6,024)(1,558)1,46388775(15)(5,270)1
Debt securities(113)(11)15164-(46)-
Loans and advances(5,911)(1,546)1,44987711(15)(5,224)-
Total(18,890)(8,470)4,1725,762652568(16,206)541

December 2015 (Millions of euros)
Opening balanceIncreases due to amounts set aside for estimated loan losses during the periodDecreases due to amounts reversed for estimated loan losses during the periodDecreases due to amounts taken against allowancesTransfers between allowancesOther adjustmentsClosing balanceRecoveries recorded directly to the statement of profit or loss
Equity instruments
Specific allowances for financial assets, individually and collectively estimated(10,519)(6,172)1,4355,162388(3,160)(12,866)490
Debt securities(33)(6)8--(3)(35)-
Credit institutions(17)(2)1-(1)-(20)-
Other financial corporations(16)(4)7-1(3)(15)-
Loans and advances(10,487)(6,166)1,4275,162388(3,156)(12,831)490
General governments(24)(16)173(12)(6)(37)-
Credit institutions(18)(11)5-9(2)(17)1
Other financial corporations(21)(276)2232313(38)-
Non-financial corporations(7,610)(3,229)1,1692,580(298)(1,837)(9,225)301
Households(2,814)(2,635)2342,555459(1,313)(3,514)187
Collective allowances for incurred but not reported losses on financial assets(3,829)(578)576110(486)(1,817)(6,024)-
Debt securities(42)(9)6-(67)(1)(113)-
Loans and advances(3,787)(569)570110(420)(1,816)(5,911)-
Total(14,348)(6,750)2,0115,272(98)(4,977)(18,890)490

Refinancing and restructuring operations

Group policies and principles with respect to refinancing and restructuring operations

Refinancing and restructuring operations (see definition in the Glossary) are carried out with customers who have requested such an operation in order to meet their current loan payments if they are expected, or may be expected, to experience financial difficulty in making the payments in the future.

The basic aim of a refinancing and restructuring operation is to provide the customer with a situation of financial viability over time by adapting repayment of the loan incurred with the Group to the customer’s new situation of fund generation. The use of refinancing and restructuring for other purposes, such as to delay loss recognition, is contrary to BBVA Group policies.

The BBVA Group’s refinancing and restructuring policies are based on the following general principles:

  • Refinancing and restructuring is authorized according to the capacity of customers to pay the new installments. This is done by first identifying the origin of the payment difficulties and then carrying out an analysis of the customers’ viability, including an updated analysis of their economic and financial situation and capacity to pay and generate funds. If the customer is a company, the analysis also covers the situation of the industry in which it operates.
  • With the aim of increasing the solvency of the operation, new guarantees and/or guarantors of demonstrable solvency are obtained where possible. An essential part of this process is an analysis of the effectiveness of both the new and original guarantees.
  • This analysis is carried out from the overall customer or group perspective.
  • Refinancing and restructuring operations do not in general increase the amount of the customer’s loan, except for the expenses inherent to the operation itself.
  • The capacity to refinance and restructure loan is not delegated to the branches, but decided on by the risk units.
  • The decisions made are reviewed from time to time with the aim of evaluating full compliance with refinancing and restructuring policies.

These general principles are adapted in each case according to the conditions and circumstances of each geographical area in which the Group operates, and to the different types of customers involved.

In the case of retail customers (private individuals), the main aim of the BBVA Group’s policy on refinancing and restructuring loan is to avoid default arising from a customer’s temporary liquidity problems by implementing structural solutions that do not increase the balance of customer’s loan. The solution required is adapted to each case and the loan repayment is made easier, in accordance with the following principles:

  • Analysis of the viability of operations based on the customer’s willingness and ability to pay, which may be reduced, but should nevertheless be present. The customer must therefore repay at least the interest on the operation in all cases. No arrangements may be concluded that involve a grace period for both principal and interest.
  • Refinancing and restructuring of operations is only allowed on those loans in which the BBVA Group originally entered into.
  • Customers subject to refinancing and restructuring operations are excluded from marketing campaigns of any kind.

In the case of non-retail customers (mainly companies, enterprises and corporates), refinancing/restructuring is authorized according to an economic and financial viability plan based on:

  • Forecasted future income, margins and cash flows to allow entities to implement cost adjustment measures (industrial restructuring) and a business development plan that can help reduce the level of leverage to sustainable levels (capacity to access the financial markets).
  • Where appropriate, the existence of a divestment plan for assets and/or operating segments that can generate cash to assist the deleveraging process.
  • The capacity of shareholders to contribute capital and/or guarantees that can support the viability of the plan.

In accordance with the Group’s policy, the conclusion of a loan refinancing and restructuring operation does not meet the loan is reclassified from "impaired" or "standard under special monitoring" to outstanding risk. The reclassification to the "standard under special monitoring" or normal risk categories must be based on the analysis mentioned earlier of the viability, upon completion of the probationary periods described below.

The Group maintains the policy of including risks related to refinanced and restructured loans as either:

  • "Impaired assets", as although the customer is up to date with payments, they are classified as impaired for reasons other than their default when there are significant doubts that the terms of their refinancing may not be met; or
  • "Normal-risk assets under special monitoring" until the conditions established for their consideration as normal risk are met).

The conditions established for assets classified as “standard under special monitoring” to be reclassified out of this category are as follows:

  • The customer must have paid past-due amounts (principal and interest) since the date of the renegotiation or restructuring of the loan or other objective criteria, demonstrating the borrower´s ability to pay, have been verified; and
  • At least two years must have elapsed since completion of the renegotiation or restructuring of the loan;
  • It is unlikely that the customer will have financial difficulties and, therefore, it is expected that the customer will be able to meet its loan payment obligations (principal and interest) in a timely manner.

The BBVA Group’s refinancing and restructuring policy provides for the possibility of two modifications in a 24 month period for loans that are not in compliance with the payment schedule.

The internal models used to determine allowances for loan losses consider the restructuring and renegotiation of a loan, as well as re-defaults on such a loan, by assigning a lower internal rating to restructured and renegotiated loans than the average internal rating assigned to non-restructured/renegotiated loans. This downgrade results in an increase in the probability of default (PD) assigned to restructured/renegotiated loans (with the resulting PD being higher than the average PD of the non- renegotiated loans in the same portfolios).

For quantitative information on refinancing and restructuring operations see Appendix VIII

Market risk

Market risk trading portfolios

Market risk originates as a result of movements in the market variables that impact the valuation of traded financial products and assets. The main risks generated can be classified as follows:

  • Interest-rate risk: This arises as a result of exposure to movements in the different interest-rate curves involved in trading. Although the typical products that generate sensitivity to the movements in interest rates are money-market products (deposits, interest-rate futures, call money swaps, etc.) and traditional interest-rate derivatives (swaps and interest-rate options such as caps, floors, swaptions, etc.), practically all the financial products are exposed to interest-rate movements due to the effect that such movements have on the valuation of the financial discount.
  • Equity risk: This arises as a result of movements in share prices. This risk is generated in spot positions in shares or any derivative products whose underlying asset is a share or an equity index. Dividend risk is a sub-risk of equity risk, arising as an input for any equity option. Its variation may affect the valuation of positions and it is therefore a factor that generates risk on the books.
  • Exchange-rate risk: This is caused by movements in the exchange rates of the different currencies in which a position is held. As in the case of equity risk, this risk is generated in spot currency positions, and in any derivative product whose underlying asset is an exchange rate. In addition, the quanto effect (operations where the underlying asset and the instrument itself are denominated in different currencies) means that in certain transactions in which the underlying asset is not a currency, an exchange-rate risk is generated that has to be measured and monitored.
  • Credit-spread risk: Credit spread is an indicator of an issuer's credit quality. Spread risk occurs due to variations in the levels of spread of both corporate and government issues, and affects positions in bonds and credit derivatives.
  • Volatility risk: This occurs as a result of changes in the levels of implied price volatility of the different market instruments on which derivatives are traded. This risk, unlike the others, is exclusively a component of trading in derivatives and is defined as a first-order convexity risk that is generated in all possible underlying assets in which there are products with options that require a volatility input for their valuation.

The metrics developed to control and monitor market risk in BBVA Group are aligned with market practices and are implemented consistently across all the local market risk units.

Measurement procedures are established in terms of the possible impact of negative market conditions on the trading portfolio of the Group's Global Markets units, both under ordinary circumstances and in situations of heightened risk factors.

The standard metric used to measure market risk is Value at Risk (“VaR”), which indicates the maximum loss that may occur in the portfolios at a given confidence level (99%) and time horizon (one day). This statistic value is widely used in the market and has the advantage of summing up in a single metric the risks inherent to trading activity, taking into account how they are related and providing a prediction of the loss that the trading book could sustain as a result of fluctuations in equity prices, interest rates, foreign exchange rates and credit spreads. The market risk analysis considers risks, such as credit spread, basis risk, volatility and correlation risk.

Most of the headings on the Group's balance sheet subject to market risk are positions whose main metric for measuring their market risk is VaR. This table shows the accounting lines of the consolidated balance sheet as of December 31, 2017, 2016 and 2015 in which there is a market risk in trading activity subject to this measurement:

Headings of the balance sheet under market risk (Millions of euros)
December 2017December 2016December 2015
Main market risk metrics - VaRMain market risk metrics - Others (*)Main market risk metrics - VaRMain market risk metrics - Others (*)Main market risk metrics - VaRMain market risk metrics - Others (*)
Assets subject to market risk
Financial assets held for trading59,00844164,6231,48064,3704,712
Available for sale financial assets5,66124,0837,11928,7718,23450,088
Of which: Equity instruments-2,404-3,559-4,067
Derivatives - Hedging accounting8291,3971,0411,4155281,888
Liabilities subject to market risk
Financial liabilities held for trading42,4682,52647,4912,22342,5506,277
Derivatives - Hedging accounting1,1576381,3056891,128806

(*) Includes mainly assets and liabilities managed by ALCO.

Although the prior table shows details the financial positions subject to market risk, it should be noted that the data are for information purposes only and do not reflect how the risk is managed in trading activity, where it is not classified into assets and liabilities.

With respect to the risk measurement models used in BBVA Group, the Bank of Spain has authorized the use of the internal model to determine bank capital requirements deriving from risk positions on the BBVA S.A. and BBVA Bancomer trading book, which jointly account for around 70% and 66% of the Group’s trading-book market risk as of December 31, 2017 and 2016. For the rest of the geographical areas (mainly South America, Garanti and BBVA Compass), bank capital for the risk positions in the trading book is calculated using the standard model.

The current management structure includes the monitoring of market-risk limits, consisting of a scheme of limits based on VaR, economic capital (based on VaR measurements) and VaR sub-limits, as well as stop-loss limits for each of the Group’s business units.

The model used estimates VaR in accordance with the "historical simulation" methodology, which involves estimating losses and gains that would have taken place in the current portfolio if the changes in market conditions that took place over a specific period of time in the past were repeated. Based on this information, it infers the maximum expected loss of the current portfolio within a given confidence level. This model has the advantage of reflecting precisely the historical distribution of the market variables and not assuming any specific distribution of probability. The historical period used in this model is two years. The historical simulation method is used in BBVA S.A., BBVA Bancomer, BBVA Chile, BBVA Colombia, Compass Bank and Garanti.

VaR figures are estimated following two methodologies:

  • VaR without smoothing, which awards equal weight to the daily information for the previous two years. This is currently the official methodology for measuring market risks for the purpose of monitoring compliance with risk limits.
  • VaR with smoothing, which gives a greater weight to more recent market information. This metric supplements the previous one.

In the case of South America (except BBVA Chile and BBVA Colombia), a parametric methodology is used to measure risk in terms of VaR.

At the same time, and following the guidelines established by the Spanish and European authorities, BBVA incorporates metrics in addition to VaR with the aim of meeting the Bank of Spain's regulatory requirements with respect to the calculation of bank capital for the trading book. Specifically, the new measures incorporated in the Group since December 2011 (stipulated by Basel 2.5) are:

  • VaR: In regulatory terms, the VaR charge incorporates the stressed VaR charge, and the sum of the two (VaR and stressed VaR) is calculated. This quantifies the losses associated with the movements of the two risk factors inherent to market operations (interest rates, FX, RV, credit, etc.). Both VaR and stressed VaR are rescaled by a regulatory multiplier set at three and by the square root of ten to calculate the capital charge.
  • Specific Risk: Incremental Risk Capital (“IRC”) Quantification of the risks of default and downgrading of the credit ratings of the bond and credit derivative positions in the portfolio. The specific capital risk by IRC is a charge exclusively used in the geographical areas with the internal model approved (BBVA S.A. and Bancomer). The capital charge is determined according to the associated losses (at 99.9% in a 1-year horizon under the hypothesis of constant risk) due to the rating migration and/or default state the issuer of an asset. In addition, the price risk is included in sovereign positions for the items specified.
  • Specific Risk: Securitization and correlation portfolios. Capital charge for securitizations and the correlation portfolio to include the potential losses associated at the level of rating a specific credit structure (rating). Both are calculated by the standard method. The scope of the correlation portfolios refers to the FTD-type market operation and/or tranches of market CDOs and only for positions with an active market and hedging capacity.

Validity tests are performed regularly on the risk measurement models used by the Group. They estimate the maximum loss that could have been incurred in the positions with a certain level of probability (backtesting), as well as measurements of the impact of extreme market events on risk positions (stress testing). As an additional control measure, backtesting is conducted at trading desk level in order to enable more specific monitoring of the validity of the measurement models.

Market risk in 2017

The Group’s market risk remains at low levels compared with the risk aggregates managed by BBVA, particularly in terms of credit risk. This is due to the nature of the business. During year ended December 31, 2017 the average VaR was €27 million, below the figure of 2016, with a high on January 11, 2017 of €34 million. The evolution in the BBVA Group’s market risk during 2017, measured as VaR without smoothing (see Glossary) with a 99% confidence level and a 1-day horizon (shown in millions of Euros) is as follows:

By type of market risk assumed by the Group's trading portfolio, the main risk factor for the Group continues to be that linked to interest rates, with a weight of 48% of the total at the end of year ended December 31, 2017 (this figure includes the spread risk). The relative weight has decreased compared with the close of 2016 (58%). Exchange-rate risk accounts 14%, increasing its proportion with respect to December 2016 (13%), while equity, volatility and correlation risk have increased, with a weight of 38% at the close of 2017 (vs. 29% at the close of 2016).

As of December 31, 2017, 2016 and 2015 the balance of VaR was €22 million, €26 million and €24 million, respectively. These figures can be broken down as follows

VaR by Risk Factor (Millions of euros)
Interest/Spread RiskCurrency RiskStock-market RiskVega/Correlation RiskDiversification Effect(*)Total
December 2017
VaR average in the period2510313(23)27
VaR max in the period2711212(19)34
VaR min in the period237414(26)22
End of period VaR237414(26)22
December 2016
VaR average in the period2810411(23)29
VaR max in the period3016411(23)38
VaR min in the period2110111(20)23
End of period VaR297212(24)26
December 2015
VaR average in the period24
VaR max in the period32539(18)30
VaR min in the period20639(17)21
End of period VaR219311(20)24

(*) The diversification effect is the difference between the sum of the average individual risk factors and the total VaR figure that includes the implied correlation between all the variables and scenarios used in the measurement.

Validation of the model

The internal market risk model is validated on a regular basis by backtesting in both BBVA S.A. and Bancomer. The aim of backtesting is to validate the quality and precision of the internal market risk model used by BBVA Group to estimate the maximum daily loss of a portfolio, at a 99% level of confidence and a 250-day time horizon, by comparing the Group's results and the risk measurements generated by the internal market risk model. These tests showed that the internal market risk model of both BBVA, S.A. and Bancomer is adequate and precise.

Two types of backtesting have been carried out during 2017, 2016 and 2015:

  • "Hypothetical" backtesting: the daily VaR is compared with the results obtained, not taking into account the intraday results or the changes in the portfolio positions. This validates the appropriateness of the market risk metrics for the end-of-day position.
  • "Real" backtesting: the daily VaR is compared with the total results, including intraday transactions, but discounting the possible minimum charges or fees involved. This type of backtesting includes the intraday risk in portfolios.

In addition, each of these two types of backtesting was carried out at the level of risk factor or business type, thus making a deeper comparison of the results with respect to risk measurements.

For the period between the end of the year ended December 31, 2016 and the end of the year ended December 31, 2016, it was carried out the backtesting of the internal VaR calculation model, comparing the daily results obtained with the estimated risk level estimated by the internal VaR calculation model. At the end of the semester the comparison showed the internal VaR calculation model was working correctly, within the "green" zone (0-4 exceptions), thus validating the internal VaR calculation model, as has occurred each year since the internal market risk model was approved for the Group.

Stress test analysis

A number of stress tests are carried out on BBVA Group's trading portfolios. First, global and local historical scenarios are used that replicate the behavior of an extreme past event, such as for example the collapse of Lehman Brothers or the "Tequilazo" crisis. These stress tests are complemented with simulated scenarios, where the aim is to generate scenarios that have a significant impact on the different portfolios, but without being anchored to any specific historical scenario. Finally, for some portfolios or positions, fixed stress tests are also carried out that have a significant impact on the market variables affecting these positions.

Historical scenarios

The historical benchmark stress scenario for the BBVA Group is Lehman Brothers, whose sudden collapse in September 2008 led to a significant impact on the behavior of financial markets at a global level. The following are the most relevant effects of this historical scenario:

  • Credit shock: reflected mainly in the increase of credit spreads and downgrades in credit ratings. 
  • Increased volatility in most of the financial markets (giving rise to a great deal of variation in the prices of different assets (currency, equity, debt).
  • Liquidity shock in the financial systems, reflected by a major movement in interbank curves, particularly in the shortest sections of the euro and dollar curves.

Simulated scenarios

Unlike the historical scenarios, which are fixed and therefore not suited to the composition of the risk portfolio at all times, the scenario used for the exercises of economic stress is based on Resampling methodology. This methodology is based on the use of dynamic scenarios are recalculated periodically depending on the main risks held in the trading portfolios. On a data window wide enough to collect different periods of stress (data are taken from 1-1-2008 until today), a simulation is performed by resampling of historic observations, generating a loss distribution and profits to analyze most extreme of births in the selected historical window. The advantage of this resampling methodology is that the period of stress is not predetermined, but depends on the portfolio maintained at each time, and making a large number of simulations (10,000 simulations) allows a richer information for the analysis of expected shortfall than what is available in the scenarios included in the calculation of VaR.

The main features of this approach are: a) the generated simulations respect the correlation structure of the data, b) flexibility in the inclusion of new risk factors and c) to allow the introduction of a lot of variability in the simulations (desirable to consider extreme events).

The impact of the stress test under multivariable simulation of the risk factors of the portfolio (Expected shortfall 95% to 20 days) as of December 31, 2017 is as follows

Millions of Euros
EuropeMexicoPeruVenezuelaArgentinaColombiaChileTurkey
Expected Shortfall(75)(29)(8)-(8)(8)(9)(1)

Structural risk

The Assets and Liabilities Committee (ALCO) is the main responsible body for the management of structural risks relating to liquidity/funding, interest rates, currency rates, equity and solvency. Every month, with the assistance of the CEO and representatives from the areas of Finance, Risks and Business Areas, this committee monitors the above risks and is presented with proposals for managing them for its approval. These management proposals are made proactively by the Finance area, taking into account the risk appetite framework and with the aim of guaranteeing recurrent earnings and financial stability and preserving the entity's solvency. All the balance-sheet management units have a local ALCO, assisted constantly by the members of the Corporate Center. There is also a corporate ALCO where the management strategies in the Group's subsidiaries are monitored and presented.

Structural interest-rate risk

The structural interest-rate risk (“SIRR”) is related to the potential impact that variations in market interest rates have on an entity's net interest income and equity. In order to properly measure SIRR, BBVA takes into account the main sources that generate this risk: repricing risk, yield curve risk, option risk and basis risk, which are analyzed from two complementary points of view: net interest income (short term) and economic value (long term).

ALCO monitors the interest-rate risk metrics and the Assets and Liabilities Management unit carries out the management proposals for the structural balance sheet. The management objective is to ensure the stability of net interest income and book value in the face of changes in market interest rates, while respecting the internal solvency and limits in the different balance-sheets and for BBVA Group as a whole; and complying with current and future regulatory requirements.

BBVA's structural interest-rate risk management control and monitoring is based on a set of metrics and tools that enable the entity's risk profile to be monitored correctly. A wide range of scenarios are measured on a regular basis, including sensitivities to parallel movements in the event of different shocks, changes in slope and curve, as well as delayed movements. Other probabilistic metrics based on statistical scenario-simulating methods are also assessed, such as earnings at risk (“EaR”) and economic capital (“EC”), which are defined as the maximum adverse deviations in net interest income and economic value, respectively, for a given confidence level and time horizon. Impact thresholds are established on these management metrics both in terms of deviations in net interest income and in terms of the impact on economic value. The process is carried out separately for each currency to which the Group is exposed, and the diversification effect between currencies and business units is considered after this.

In order to evaluate its effectiveness, the model is subjected to regular internal validation, which includes backtesting. In addition, the banking book’s interest-rate risk exposures are subjected to different stress tests in order to reveal balance sheet vulnerabilities under extreme scenarios. This testing includes an analysis of adverse macroeconomic scenarios designed specifically by BBVA Research, together with a wide range of potential scenarios that aim to identify interest-rate environments that are particularly damaging for the entity. This is done by generating extreme scenarios of a breakthrough in interest rate levels and historical correlations, giving rise to sudden changes in the slopes and even to inverted curves.

The model is necessarily underpinned by an elaborate set of hypotheses that aim to reproduce the behavior of the balance sheet as closely as possible to reality. Especially relevant among these assumptions are those related to the behavior of “accounts with no explicit maturity”, for which stability and remuneration assumptions are established, consistent with an adequate segmentation by type of product and customer, and prepayment estimates (implicit optionality). The hypotheses are reviewed and adapted, at least on an annual basis, to signs of changes in behavior, kept properly documented and reviewed on a regular basis in the internal validation processes.

The impacts on the metrics are assessed both from a point of view of economic value (gone concern) and from the perspective of net interest income, for which a dynamic model (going concern) consistent with the corporate assumptions of earnings forecasts is used.

The table below shows the profile of average sensitivities to net interest income and value of the main entities in BBVA Group in 2017 (certain information within this table is provisional. Its distribution should not be significantly affected)

Sensitivity to Interest-Rate Analysis - December 2017
Impact on Net Interest Income (*)Impact on Economic Value (**)
100 Basis-Point Increase100 Basis-Point Decrease100 Basis-Point Increase100 Basis-Point Decrease
Europe (***)+ (10% - 15%)- (5% - 10%)+ (0% - 5%)- (0% - 5%)
Mexico+ (0% - 5%)- (0% - 5%)- (0% - 5%)+ (0% - 5%)
USA+ (5% - 10%)- (5% - 10%)- (0% - 5%)- (0% - 5%)
Turkey- (0% - 5%)+ (0% - 5%)- (0% - 5%)+ (0% - 5%)
South America+ (0% - 5%)- (0% - 5%)- (0% - 5%)+ (0% - 5%)
BBVA Group+ (0% - 5%)- (0% - 5%)+ (0% - 5%)- (0% - 5%)

(*) Percentage of "1 year" net interest income forecast for each unit.

(**) Percentage of Core Capital for each unit.

(***) In Europe downward movement allowed until more negative level than current rates

In 2017 in Europe monetary policy has remained expansionary, maintaining rates at 0%. In USA the rising rate cycle initiated by the Federal Reserve in 2015 has been intensified. In Mexico and Turkey, the upward cycle has continued because of weak currencies and inflation prospects. In South America, monetary policy has been expansive, with rate declines in most of the economies where the Group operates, with the exception of Argentina, where rates increased during 2017.

The BBVA Group maintains, overall in its Balance Sheet Management Units ("BSMUs"), a positive sensitivity in its net interest income to an increase in interest rates. The higher relative net interest income sensitivities are observed in mature markets, particularly Europe, where however, the negative sensitivity in its net interest income to a decrease in interest rates is limited by the downward path scope in interest rates. The Group maintains a moderate risk profile, according to its target risk, through effective management of its balance sheet structural risk

Structural exchange-rate risk

In BBVA Group, structural exchange-rate risk arises from the consolidation of holdings in subsidiaries with functional currencies other than the euro. Its management is centralized in order to optimize the joint handling of permanent foreign currency exposures, taking into account the diversification.

The corporate Assets and Liabilities Management unit, through ALCO, designs and executes hedging strategies with the main purpose of controlling the potential negative effect of exchange-rate fluctuations on capital ratios and on the equivalent value in euros of the foreign-currency earnings of the Group's subsidiaries, considering transactions according to market expectations and their cost.

The risk monitoring metrics included in the framework of limits are integrated into management and supplemented with additional assessment indicators. At corporate level they are based on probabilistic metrics that measure the maximum deviation in the Group’s Capital, CET1 (“Common Equity Tier 1”) ratio, and net attributable profit. The probabilistic metrics make it possible to estimate the joint impact of exposure to different currencies taking into account the different variability in exchange rates and their correlations.

The suitability of these risk assessment metrics is reviewed on a regular basis through backtesting exercises. The final element of structural exchange-rate risk control is the analysis of scenarios and stress with the aim of identifying in advance possible threats to future compliance with the risk appetite levels set, so that any necessary preventive management actions can be taken. The scenarios are based both on historical situations simulated by the risk model and on the risk scenarios provided by BBVA Research.

2017 has been characterized by the depreciation against the euro of the main currencies of the geographies where the Group operates: US Dollar (-12%), Mexican peso (-8%) and Turkish lira (-18%).

The Group's structural exchange-rate risk exposure level has remained fairly stable since the end of 2016. The hedging policy intends to keep low levels of sensitivity to movements in the exchange rates of emerging currencies against the euro and focuses on Mexican peso and Turkish lira. The risk mitigation level in capital ratio due to the book value of BBVA Group's holdings in foreign emerging currencies stood at around 70% and, as of the end of 2017, CET1 ratio sensitivity to the appreciation of 1% in the euro exchange rate for each currency is: US Dollar +1,2 bps; Mexican peso -0,1 bps; Turkish Lira -0,1 bps; other currencies -0,3 bps. On the other hand, hedging of emerging-currency denominated earnings of 2017 has reached a 61%, concentrated in Mexican peso and Turkish lira.

Structural equity risk

BBVA Group's exposure to structural equity risk stems basically from investments in industrial and financial companies with medium- and long-term investment horizons. This exposure is mitigated through net short positions held in derivatives of their underlying assets, used to limit portfolio sensitivity to potential falls in prices.

Structural management of equity portfolios is the responsibility of the Group's units specializing in this area. Their activity is subject to the corporate risk management policies for equity positions in the equity portfolio. The aim is to ensure that they are handled consistently with BBVA's business model and appropriately to its risk tolerance level, thus enabling long-term business sustainability.

The Group's risk management systems also make it possible to anticipate possible negative impacts and take appropriate measures to prevent damage being caused to the entity. The risk control and limitation mechanisms are focused on the exposure, annual operating performance and economic capital estimated for each portfolio. Economic capital is estimated in accordance with a corporate model based on Monte Carlo simulations, taking into account the statistical performance of asset prices and the diversification existing among the different exposures.

Stress tests and analyses of sensitivity to different simulated scenarios are carried out periodically to analyze the risk profile in more depth. They are based on both past crisis situations and forecasts made by BBVA Research. This checks that the risks are limited and that the tolerance levels set by the Group are not at risk.

Backtesting is carried out on a regular basis on the risk measurement model used.

With regard to the equity markets, the world indexes have closed the year 2017 with significant increases helped by a positive macro environment. However, the European indexes, and especially the Spanish one, have lagged despite their positive performance. In the case of the IBEX (+7% in the year), the index have been partly penalized in the second half of the year by the political tensions in Catalonia.

Structural equity risk, measured in terms of economic capital, has decreased in the period mainly due to the sale of stakes. The aggregate sensitivity of the BBVA Group’s consolidated equity to a 1% fall in the price of shares of the companies making up the equity portfolio remained at around -€32 million as of December 31, 2017 and -€38 million as of December 31, 2016. This estimate takes into account the exposure in shares valued at market prices, or if not applicable, at fair value (excluding the positions in the Treasury Area portfolios) and the net delta-equivalent positions in derivatives on the same underlyings

Financial Instruments offset

Financial assets and liabilities may be netted, i.e. they are presented for a net amount on the consolidated balance sheet only when the Group's entities satisfy with the provisions of IAS 32-Paragraph 42, so they have both the legal right to net recognized amounts, and the intention of settling the net amount or of realizing the asset and simultaneously paying the liability.

In addition, the Group has presented as gross amounts assets and liabilities on the consolidated balance sheet for which there are master netting arrangements in place, but for which there is no intention of settling net. The most common types of events that trigger the netting of reciprocal obligations are bankruptcy of the entity, surpassing certain level of indebtedness threshold, failure to pay, restructuring and dissolution of the entity.

In the current market context, derivatives are contracted under different framework contracts being the most widespread developed by the International Swaps and Derivatives Association (“ISDA”) and, for the Spanish market, the Framework Agreement on Financial Transactions (“CMOF”). Almost all portfolio derivative transactions have been concluded under these framework contracts, including in them the netting clauses mentioned in the preceding paragraph as "Master Netting Agreement", greatly reducing the credit exposure on these instruments. Additionally, in contracts signed with professional counterparties, the collateral agreement annexes called Credit Support Annex (“CSA”) are included, thereby minimizing exposure to a potential default of the counterparty.

Moreover, in transactions involving assets purchased or sold under a purchase agreement there is a high volume transacted through clearing houses that articulate mechanisms to reduce counterparty risk, as well as through the signature of various master agreements for bilateral transactions, the most widely used being the Global Master Repurchase Agreement (GMRA), published by International Capital Market Association (“ICMA”), to which the clauses related to the collateral exchange are usually added within the text of the master agreement itself.

A summary of the effect of the compensation (via netting and collateral) for derivatives and securities operations is presented below as of December 31, 2017, 2016 and 2015

December 2017 (Millions of euros)
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets (D)
NotesGross Amounts Recognized (A)Gross Amounts Offset in the Condensed Consolidated Balance Sheets (B)Net Amount Presented in the Condensed Consolidated Balance Sheets (C=A-B)Financial InstrumentsCash Collateral Received/ PledgedNet Amount (E=C-D)
Trading and hedging derivatives10, 1549,33311,58437,74927,1067,4423,202
Reverse repurchase, securities borrowing and similar agreements26,4265626,36926,612141(384)
Total Assets75,75911,64164,11853,7177,5832,818
Trading and hedging derivatives10, 1550,69311,64439,04927,1068,3283,615
Repurchase, securities lending and similar agreements40,1345640,07840,15821(101)
Total liabilities90,82711,70179,12667,2648,3493,514

December 2016 (Millions of euros)
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets (D)
NotesGross Amounts Recognized (A)Gross Amounts Offset in the Condensed Consolidated Balance Sheets (B)Net Amount Presented in the Condensed Consolidated Balance Sheets (C=A-B)Financial InstrumentsCash Collateral Received/ PledgedNet Amount (E=C-D)
Trading and hedging derivatives10, 1559,37413,58745,78832,1466,5717,070
Reverse repurchase, securities borrowing and similar agreements25,8332,91222,92123,080174(333)
Total Assets85,20816,49968,70955,2266,7456,738
Trading and hedging derivatives10, 1559,54514,08045,46532,1467,2726,047
Repurchase, securities lending and similar agreements49,4742,91246,56247,915176(1,529)
Total liabilities109,01916,99192,02780,0617,4484,518

December 2015 (Millions of euros)
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets (D)
NotesGross Amounts Recognized (A)Gross Amounts Offset in the Condensed Consolidated Balance Sheets (B)Net Amount Presented in the Condensed Consolidated Balance Sheets (C=A-B)Financial InstrumentsCash Collateral Received/ PledgedNet Amount (E=C-D)
Trading and hedging derivatives10, 1552,2447,80544,43930,3505,4938,597
Reverse repurchase, securities borrowing and similar agreements21,5314,59616,93517,31324(402)
Total Assets73,77512,40161,37447,6635,5178,195
Trading and hedging derivatives10, 1553,2988,42344,87630,3509,8304,696
Repurchase, securities lending and similar agreements72,9984,59668,40268,783114(495)
Total liabilities126,29613,019113,27899,1339,9444,201

Liquidity risk

Liquidity risk management

Management of liquidity and structural finance within the BBVA Group is based on the principle of the financial autonomy of the entities that make it up. This approach helps prevent and limit liquidity risk by reducing the Group’s vulnerability in periods of high risk. This decentralized management avoids possible contagion due to a crisis that could affect only one or several BBVA Group entities, which must cover their liquidity needs independently in the markets where they operate. Liquidity Management Units (LMUs) have been set up for this reason in the geographical areas where the main foreign subsidiaries operate, and also for the parent BBVA S.A., within the Euro currency scope, which includes BBVA Portugal.

Assets and Liabilities Management unit manages BBVA Group's liquidity and funding. It plans and executes the funding of the long-term structural gap of each LMUs and proposes to ALCO the actions to adopt in this regard in accordance with the policies and limits established by the Standing Committee.

As first core element, the Bank's target in terms of liquidity and funding risk is characterized through the Liquidity Coverage Ratio (LCR) and the Loan-to-Stable-Customer-Deposits (LtSCD) ratio. LCR is a regulatory measurement aimed at ensuring entities’ resistance in a scenario of liquidity stress within a time horizon of 30 days. BBVA, within its risk appetite framework and its limits and alerts schemes, has established a level of requirement for compliance with the LCR ratio both for the Group as a whole and for each of the LMUs individually. The internal levels required are geared to comply sufficiently and efficiently in advance with the implementation of the regulatory requirement of 2018, at a level above 100%.

LCR ratio in Europe came into force on 1st October 2015. With an initial 60% minimum requirement, progressively increased (phased-in) up to 100% in 2018. Throughout the year 2017, LCR level at BBVA Group has been comfortably above 100%. As of December 2017, the ratio level is 128%.

Although this regulatory requirement is mandatory at a Group level and Eurozone banks, all subsidiaries are well above this minimum. In any case, it should be noted that liquidity excesses in subsidiaries are not deemed transferable when calculating the consolidated ratio. Taking into account the impact of these High Quality Liquid Assets excluded, LCR ratio would be 149%, which is +21% above

LCR main LMU
December 2017
Group 128%
Eurozone(*)151%
Bancomer148%
Compass(**)144%
Garanti134%

(*) Perimeter: Spain, Portugal and Rest of Eurasia

(**) Compass LCR calculated according to local regulation (Fed Modified LCR)

The LtSCD measures the relation between the net credit investment and stable funds. The aim is to preserve a stable funding structure in the medium term for each of the LMUs making up BBVA Group, taking into account that maintaining an adequate volume of stable customer funds is key to achieving a sound liquidity profile.

Customer funds captured and managed by business units are defined as stable customer funds. These funds usually show little sensitivity to market changes and are largely non-volatile in terms of aggregate amounts per operation, thanks to customer linkage to the unit. Stable funds in each LMU are calculated by analyzing the behavior of the balance sheets of the different customer segments identified as likely to provide stability to the funding structure, and by prioritizing an established relationship and applying bigger haircuts to the funding lines of less stable customers. The main base of stable funds is composed of deposits by individual customers and small businesses.

For the purpose of establishing the (maximum) target levels for LtSCD in each LMU and providing an optimal funding structure reference in terms of risk appetite, GRM-Structural Risks identifies and assesses the economic and financial variables that condition the funding structures in the various geographical areas. The behavior of the indicators reflects that the funding structure remained robust in 2017, 2016 and 2015, in the sense that all the LMUs maintain levels of self-funding with stable customer funds higher than the required levels

LtSCD by LMU
December 2017December 2016December 2015
Group (average)110%113%116%
Eurozone108%113%116%
Bancomer109%113%110%
Compass109%108%112%
Garanti122%124%128%
Other LMUs108%107%111%

The second core element in liquidity and funding risk management is to achieve proper diversification of the funding structure, avoiding excessive reliance on short-term funding and establishing a maximum level of short-term borrowing comprising both wholesale funding as well as funds from non-retail customers. Regarding long-term funding, the maturity profile does not show significant concentrations, which enables adaptation of the anticipated issuance schedule to the best financial conditions of the markets. Finally, concentration risk is monitored at the LMU level, with a view to ensuring the right diversification both per counterparty and per instrument type.

The third element promotes the short-term resilience of the liquidity risk profile, making sure that each LMU has sufficient collateral to address the risk of wholesale markets closing. Basic Capacity is the short-term liquidity risk management and control metric that is defined as the relationship between the available explicit assets and the maturities of wholesale liabilities and volatile funds, at different terms, with special relevance being given to 30-day maturities

Each entity maintains an individual liquidity buffer, both Banco Bilbao Vizcaya Argentaria SA and its subsidiaries, including BBVA Compass, BBVA Bancomer, Garanti Bank and the Latin American subsidiaries. The table below shows the liquidity available by instrument as of December 31, 2017 and 2016 for the most significant entities

December 2017 (Millions of euros)
BBVA Eurozone (1)BBVA Bancomer BBVA Compass Garanti BankOther
Cash and balances with central banks15,6348,6492,1506,6926,083
Assets for credit operations with central banks47,4295,73124,0395,6616,333
Central governments issues26,7843,8992,5985,6616,274
Of Which: Spanish government securities20,836----
Other issues20,6451,8317,023-58
Loans--14,417--
Other non-eligible liquid assets7,9865756211,607345
ACCUMULATED AVAILABLE BALANCE71,05014,95526,81013,95912,761
AVERAGE BALANCE67,82313,89627,62513,86213,211

(1) It includes Spain, Portugal and Rest of Eurasia

December 2016 (Millions of euros)
BBVA Eurozone (1)BBVA Bancomer BBVA Compass Garanti BankOther
Cash and balances with central banks16,0388,2211,4954,7586,504
Assets for credit operations with central banks50,7064,17526,8654,9354,060
Central governments issues30,7021,9641,0844,9353,985
Of Which: Spanish government securities23,353----
Other issues20,0052,2128,991-75
Loans--16,790--
Other non-eligible liquid assets6,8849386621,478883
ACCUMULATED AVAILABLE BALANCE73,62913,33529,02211,17111,447
AVERAGE BALANCE68,32213,10427,61012,87111,523

(1) It includes Banco Bilbao Vizcaya Argentaria, S.A. and Banco Bilbao Vizcaya Argentaria (Portugal), S.A

Figures originally reported in the year 2016 in accordance to the applicable regulation, without restatements

Stress analyses are also a basic element of the liquidity and funding risk monitoring system, as they help anticipate deviations from the liquidity targets and limits set out in the risk appetite as well as establish tolerance ranges at different management levels. They also play a key role in the design of the Liquidity Contingency Plan and in defining the specific measures for action for realigning the risk profile.

For each of the scenarios, a check is carried out whether BBVA has sufficient liquid assets to meet the liquidity commitments/outflows in the various periods analyzed. The analysis considers four scenarios, one core and three crisis-related: systemic crisis; unexpected internal crisis with a considerable rating downgrade and/or affecting the ability to issue in wholesale markets and the perception of business risk by the banking intermediaries and the BBVA's customers; and a mixed scenario, as a combination of the two aforementioned scenarios. Each scenario considers the following factors: liquidity existing on the market, customer behavior and sources of funding, impact of rating downgrades, market values of liquid assets and collateral, and the interaction between liquidity requirements and the performance of the BBVA's asset quality.

The results of these stress analyses carried out regularly reveal that BBVA has a sufficient buffer of liquid assets to deal with the estimated liquidity outflows in a scenario such as a combination of a systemic crisis and an unexpected internal crisis, during a period in general longer than 3 months for LMUs, including a major downgrade in the BBVA's rating (by up to three notches).

Beside the results of stress exercises and risk metrics, Early Warning Indicators play an important role in the corporate model and also in the Liquidity Contingency Plan. These are mainly financing structure indicators, related to asset encumbrance, counterparty concentration, outflows of customer deposits, unexpected use of credit lines, and market indicators, which help to anticipate potential risks and capture market expectations.

Below is a matrix of residual maturities by contractual periods based on supervisory prudential reporting as of December 31, 2017 and 2016:

December 2017. Contractual Maturities (Millions of euros)
Demand Up to 1 Month1 to 3 Months3 to 6 Months6 to 9 Months9 to 12 Months1 to 2 Years2 to 3 Years3 to 5 Years Over 5 YearsTotal
ASSETS
Cash, cash balances at central banks and other demand deposits8,17931,029--------39,208
Deposits in credit entities2524,3911811691201221161121571,8687,488
Deposits in other financial institutions19397587966284471,0296818061,9758,060
Reverse repo, securities borrowing and margin lending18,9792,6891,92154142681530727226-26,354
Loans and Advances26721,20326,32323,60615,38017,51643,97335,38350,809123,568358,028
Securities' portfolio settlement11,5794,1594,4232,38013,3915,78911,28912,07044,66699,747

December 2017. Contractual Maturities (Millions of euros)
Demand Up to 1 Month1 to 3 Months3 to 6 Months6 to 9 Months9 to 12 Months1 to 2 Years2 to 3 Years3 to 5 Years Over 5 YearsTotal
LIABILITIES
Wholesale funding-3,6484,2094,2381,2272,4565,7726,43218,39130,16276,535
Deposits in financial institutions6,8315,8631,0822,3353921,7149307651711,42921,512
Deposits in other financial institutions and international agencies10,7004,8273,2901,9595541,3289632863551,04525,307
Customer deposits233,06845,17118,61611,4288,71110,3687,6072,6121,8332,034341,448
Security pledge funding-35,5022,2841,4053969736423,0093381,69765,668
Derivatives, net-(18)(110)(116)(135)(117)(336)(91)(106)(419)(1,448)

December 2016. Contractual Maturities (Millions of euros)
Demand Up to 1 Month1 to 3 Months3 to 6 Months6 to 9 Months9 to 12 Months1 to 2 Years2 to 3 Years3 to 5 Years Over 5 YearsTotal
ASSETS
Cash, cash balances at central banks and other demand deposits23,19113,825--------37,016
Deposits in credit entities9914,0682541554872117871224,08710,002
Deposits in other financial institutions11,1929676757145321,3309189423367,608
Reverse repo, securities borrowing and margin lending-20,232544523-42850028612418922,826
Loans and Advances59120,27225,99022,31816,21215,61344,95635,09355,561133,589370,195
Securities' portfolio settlement-7083,5663,6882,3014,31219,32010,01016,66251,472112,039

December 2016. Contractual Maturities (Millions of euros)
Demand Up to 1 Month1 to 3 Months3 to 6 Months6 to 9 Months9 to 12 Months1 to 2 Years2 to 3 Years3 to 5 Years Over 5 YearsTotal
LIABILITIES
Wholesale funding4197,3802,9435,5473,4635,9677,8255,96314,01631,87585,397
Deposits in financial institutions6,7625,3651,1812,1048002,1767461,1568593,71424,862
Deposits in other financial institutions and international agencies15,3756,5428,6243,3822,5661,8971,3406868752,82544,114
Customer deposits206,14049,05325,52215,73611,86311,3438,6195,060781936335,052
Security pledge funding-38,1533,5611,4031,0049121,28164023,9591,71272,626
Derivatives, net-(2,123)(95)(190)(111)(326)(132)(82)(105)(47)(3,210)

The matrix shows the retail nature of the funding structure, with a loan portfolio being mostly funded by customer deposits. On the outflows side of the matrix, the “demand” maturity bucket mainly contains the retail customers sight accounts whose behavior shows a high level of stability. According to internal methodology they are estimated to mature on average around three years.

In the Euro Liquidity Management Unit (LMU), solid liquidity and funding situation, where activity has continued to generate liquidity through the decrease of Credit Gap and the good performance of the customer liabilities. In addition, during 2017 the Euro LMU made issues in the public market for €7,100 million, which has allowed it to obtain funding at favorable price conditions.

In Mexico, sound liquidity position, the dependence on wholesale financing remains low and closely associated with the securities portfolios. In 2017, BBVA Bancomer made local issuances at 3 and 5 years for 7000 million of Mexican pesos.

In the United States, the containment of the cost of liabilities has led to a slightly increase in the credit gap. At the end of December, 2017 BBVA Compass successfully issued 5 year senior debt for USD 750 million.

Comfortable liquidity situation in Turkey supported by the favorable market conditions, with slight Credit Gap increase due to lending growth under the government's Credit Guarantee Fund program. During 2017, Garanti realized USD 2,000 million foreign currency and 1,700 million of Turkish liras long term issuances. Additionally syndicate loans have been rolled over in the second and fourth quarter, with a new 2 years tenor.

The liquidity position of the rest of subsidiaries has continued to be sound, maintaining a solid liquidity position in all the jurisdictions in which the Group operates. Access to capital markets of these subsidiaries has also been maintained with recurring issuances in the local market.

In this context, BBVA has maintained its objective of strengthening the funding structure of the different Group entities based on growing their self-funding from stable customer funds, while guaranteeing a sufficient buffer of fully available liquid assets, diversifying the various sources of funding available, and optimizing the generation of collateral available for dealing with stress situations in the markets

Asset encumbrance

As of December 31, 2017 and 2016, the encumbered (those provided as collateral for certain liabilities) and unencumbered assets are broken down as follows:

December 2017 (Millions of euros)
Encumbered assetsNon-Encumbered assets
Book value of Encumbered assetsMarket value of Encumbered assetsBook value of non-encumbered assetsMarket value of non-encumbered assets
Equity instruments2,2972,2979,6169,616
Debt Securities28,70029,79884,39184,391
Loans and Advances and other assets79,604-485,451-

December 2016 (Millions of euros)
Encumbered assetsNon-Encumbered assets
Book value of Encumbered assetsMarket value of Encumbered assetsBook value of non-encumbered assetsMarket value of non-encumbered assets
Equity instruments2,2142,2149,0229,022
Debt Securities40,11439,97290,67990,679
Loans and Advances and other assets94,718495,109

The committed value of "Loans and Advances and other assets" corresponds mainly to loans linked to the issue of covered bonds, territorial bonds or long-term securitized bonds (see Note 22.3) as well as those used as a guarantee to access certain funding transactions with central banks. Debt securities and equity instruments respond to underlying that are delivered in repos with different types of counterparties, mainly clearing houses or credit institutions, and to a lesser extent central banks. Collateral provided to guarantee derivative operations is also included as committed assets.

As of December 31, 2017 and 2016, collateral pledge mainly due to repurchase agreements and securities lending, and those which could be committed in order to obtain funding are provided below:

December 2017. Collateral received (Millions of euros)
Fair value of encumbered collateral received or own debt securities issuedFair value of collateral received or own debt securities issued available for encumbranceNominal amount of collateral received or own debt securities issued not available for encumbrance
Collateral received23,8819,630201
Equity instruments1035-
Debt securities23,7159,619121
Loans and Advances and other assets63680
Own debt securities issued other than own covered bonds or ABSs3161-

December 2016. Collateral received (Millions of euros)
Fair value of encumbered collateral received or own debt securities issuedFair value of collateral received or own debt securities issued available for encumbranceNominal amount of collateral received or own debt securities issued not available for encumbrance
Collateral received19,92110,039173
Equity instruments5859-
Debt securities19,8638,23028
Loans and Advances and other assets-1,750144
Own debt securities issued other than own covered bonds or ABSs5--

The guarantees received in the form of reverse repos or security lending transactions are committed by their use in repos, as is the case with debt securities.

As of December 31, 2017 and 2016, financial liabilities issued related to encumbered assets in financial transactions as well as their book value were as follows:

December 2017. Sources of encumbrance (Millions of euros)
Matching liabilities, contingent liabilities or securities lentAssets, collateral received and owndebt securities issued other than covered bonds and ABSs encumbered
Book value of financial liabilities118,704133,312
Derivatives11,84311,103
Loans and Advances87,48498,478
Outstanding subordinated debt19,37723,732
Other sources3051,028

December 2016. Sources of encumbrance (Millions of euros)
Matching liabilities, contingent liabilities or securities lentAssets, collateral received and owndebt securities issued other than covered bonds and ABSs encumbered
Book value of financial liabilities134,387153,632
Derivatives9,3049,794
Loans and Advances96,137108,268
Outstanding subordinated debt28,94635,569
Other sources-2,594

Operational Risk

Operational risk is defined as one that could potentially cause losses due to human errors, inadequate or faulty internal processes, system failures or external events. This definition includes legal risk but excludes strategic and/or business risk and reputational risk.

Operational risk is inherent to all banking activities, products, systems and processes. Its origins are diverse (processes, internal and external fraud, technology, human resources, commercial practices, disasters, suppliers). Operational risk management is a part of the BBVA Group global risk management structure.

Operational risk management framework

Operational risk management in the Group is based on the value-adding drivers generated by the advanced measurement approach (AMA), as follows:

1) Active management of operational risk and its integration into day-to-day decision-making means:

  • Knowledge of the real losses associated with this type of risk.
  • Identification, prioritization and management of real and potential risks.
  • The existence of indicators that enable the Bank to analyze operational risk over time, define warning signals and verify the effectiveness of the controls associated with each risk.

2) The above helps create a proactive model for making decisions about control and business, and for prioritizing the efforts to mitigate relevant risks in order to reduce the Group's exposure to extreme events.

3) Improved control environment and strengthened corporate culture.

4) Generation of a positive reputational impact.

5) Model based on three lines of defense, aligned with international industry practices.

Operational Risk Management Principles

Operational risk management in BBVA Group should:

  • Be aligned with the risk appetite framework statement set out by the Board of BBVA.
  • Anticipate the potential operational risks to which the Group would be exposed as a result of new or modified products, activities, processes, systems or outsourcing decisions, and establish procedures to enable their evaluation and reasonable mitigation prior to their implementation.
  • Establish methodologies and procedures to enable a regular reassessment of the relevant operational risks to which the Group is exposed in order to adopt appropriate mitigation measures in each case, once the identified risk and the cost of mitigation (cost/benefit analysis) have been considered, while preserving the Group's solvency at all times.
  • Identify the causes of the operational losses sustained by the Group and establish measures to reduce them. Procedures must therefore be in place to enable the capture and analysis of the operational events that cause those losses.
  • Analyze the events that have caused operational risk losses in other institutions in the financial sector and promote, where appropriate, the implementation of the measures needed to prevent them from occurring in the Group.
  • Identify, analyze and quantify events with a low probability of occurrence and high impact in order to evaluate their mitigation. Due to their exceptional nature, it is possible that such events may not be included in the loss database or, if they are, they have impacts that are not representative.
  • Have an effective system of governance in place, where the functions and responsibilities of the areas and bodies involved in operational risk management are clearly defined.

These principles reflect BBVA Group's vision of operational risk, on the basis that the resulting events have an ultimate cause that should always be identified, and that the impact of the events is reduced significantly by controlling that cause.

Irrespective of the adoption of all the possible measures and controls for preventing or reducing both the frequency and severity of operational risk events, BBVA ensures at all times that sufficient capital is available to cover any expected or unexpected losses that may occur

Risk concentration

Policies for preventing excessive risk concentration

In order to prevent the build-up of excessive concentrations of credit risk at the individual, country and sector levels, BBVA Group maintains maximum permitted risk concentration indices updated at individual and portfolio sector levels tied to the various observable variables within the field of credit risk management.

Together with the limits for individual concentration, the Group uses the Herfindahl index to measure the concentration of the Group's portfolio and the banking group's subsidiaries. At the BBVA Group level, the index reached implies a "very low" degree of concentration.

The limit on the Group’s exposure or financial commitment to a specific customer therefore depends on the customer’s credit rating, the nature of the risks involved, and the Group’s presence in a given market, based on the following guidelines:

  • The aim is, as much as possible, to reconcile the customer's credit needs (commercial/financial, short-term/long-term, etc.) with the interests of the Group.
  • Any legal limits that may exist concerning risk concentration are taken into account (relationship between risks with a customer and the capital of the shareholder´s entity that assumes them), the markets, the macroeconomic situation, etc.

Risk concentrations by geography

The breakdown of the main figures in the most significant foreign currencies in the accompanying consolidated balance sheets is set forth in Appendix IX.

Sovereign risk concentration

Sovereign risk management

The risk associated with the transactions involving sovereign risk is identified, measured, controlled and tracked by a centralized unit integrated in the BBVA Group’s Risk Area. Its basic functions involve the preparation of reports in the countries where sovereign risk exists (called “financial programs”), tracking such risks, assigning ratings to these countries and, in general, supporting the Group in terms of reporting requirements for any transactions involving sovereign risk. The risk policies established in the financial programs are approved by the relevant risk committees.

The country risk unit tracks the evolution of the risks associated with the various countries to which the Group are exposed (including sovereign risk) on an ongoing basis in order to adapt its risk and mitigation policies to any macroeconomic and political changes that may occur. Moreover, it regularly updates its internal ratings and forecasts for these countries. The methodology is based on the assessment of quantitative and qualitative parameters which are in line with those used by certain multilateral organizations such as the International Monetary Fund (IMF) and the World Bank, rating agencies and export credit organizations.

For additional information on sovereign risk in Europe see Appendix IX.

Valuation and impairment methods

The valuation methods used to assess the instruments that are subject to sovereign risks are the same ones used for other instruments included in the relevant portfolios and are detailed in Note 8.

Specifically, the fair value of sovereign debt securities of European countries has been considered equivalent to their listed price in active markets (Level 1 as defined in Note 8).

Risk related to the developer and Real-Estate sector in Spain

One of the main Group activities of the Group in Spain is focused on developer and mortgage loans. The policies and strategies established by the Group to deal with risks related to the developer and real-estate sector are explained below:

Policies and strategies established by the Group to deal with risks related to the developer and real-estate sector

BBVA has teams specializing in the management of the Real-Estate Sector risk, given its economic importance and specific technical component. This specialization is not only in the Risk-Acceptance teams, but throughout the handling, commercial, problem risks and legal, etc. It also includes the research department of the BBVA Group (BBVA Research), which helps determine the medium/long-term vision needed to manage this portfolio. Specialization has been increased and the management teams in the areas of recovery and the Real Estate Unit itself have been reinforced.

The policies established to address the risks related to the developer and real-estate sector, aim to accomplish, among others, the following objectives: to avoid concentration in terms of customers, products and regions; to estimate the risk profile for the portfolio; and to anticipate possible worsening of the portfolio.

Specific policies for analysis and admission of new developer risk transactions

In the analysis of new operations, the assessment of the commercial operation in terms of the economic and financial viability of the project has been one of the constant points that have helped ensure the success and transformation of construction land operations for customers’ developments.

With regard the participation of the Risk Acceptance teams, they have a direct link and participate in the committees of areas such as Recoveries and the Real Estate Unit. This guarantees coordination and exchange of information in all the processes.

The following strategies have been implemented with customers in the developer sector: avoidance of large corporate transactions, which had already reduced their share in the years of greatest market growth; non active participation in the second-home market; commitment to public housing financing; and participation in land operations with a high level of urban development security, giving priority to land open to urban development.

Risk monitoring policies

The base information for analyzing the real estate portfolios is updated monthly. The tools used include the so-called “watch-list”, which is updated monthly with the progress of each client under watch, and the different strategic plans for management of special groups. There are plans that involve an intensification of the review of the portfolio for financing land, while, in the case of ongoing promotions, they are classified based on the rate of progress of the projects.

These actions have enabled BBVA to identify possible impairment situations, by always keeping an eye on BBVA’s position with each customer (whether or not as first creditor). In this regard, key aspects include management of the risk policy to be followed with each customer, contract review, deadline extension, improved collateral, rate review (repricing) and asset purchase.

Proper management of the relationship with each customer requires knowledge of various aspects such as the identification of the source of payment difficulties, an analysis of the company’s future viability, the updating of the information on the debtor and the guarantors (their current situation and business course, economic-financial information, debt analysis and generation of funds), and the updating of the appraisal of the assets offered as collateral.

BBVA has a classification of debtors in accordance with legislation in force in each country, usually categorizing each one’s level of difficulty for each risk.

Based on the information above, a decision is made whether to use the refinancing tool, whose objective is to adjust the structure of the maturity of the debt to the generation of funds and the customer’s payment capacity.

As for the policies relating to risk refinancing with the developer and real-estate sector, they are the same as the general policies used for all of the Group’s risks (see Note 7.3.6). In the developer and real estate sector, they are based on clear solvency and viability criteria for projects, with demanding terms for additional guarantees and legal compliance, given a refinancing tool that standardizes criteria and variables when considering any refinancing operation.

In the case of refinancing, the tools used for enhancing the Bank’s position are: the search for new intervening parties with proven solvency and initial payment to reduce the principal debt or outstanding interest; the improvement of the debt bond in order to facilitate the procedure in the event of default; the provision of new or additional collateral; and making refinancing viable with new conditions (period, rate and repayments), adapted to a credible and sufficiently verified business plan.

Policies applied in the management of real estate assets in Spain

The policy applied for managing these assets depends on the type of real-estate asset, as detailed below.

  • In the case of completed homes, the final aim is the sale of these homes to private individuals, thus reducing the risk and beginning a new business cycle. Here, the strategy has been to help subrogation (the default rate in this channel of business is notably lower than in any other channel of residential mortgages) and to support customers’ sales directly, using BBVA’s own channel (BBVA Services and its branches), creating incentives for sale and including sale orders for BBVA. In exceptional case we have even accepted partial haircuts, with the aim of making the sale easier.
  • In the case of ongoing home construction, the strategy has been to help and promote the completion of the construction in order to transfer the investment to completed homes. The whole developer Works in Progress portfolio has been reviewed and classified into different stages with the aim of using different tools to support the strategy. This includes the use of developer accounts-payable financing as a form of payment control, the use of project monitoring supported by the Real Estate Unit itself, and the management of direct suppliers for the works as a complement to the developer’s own management.
  • With respect to land, the fact that the risk of rustic land is not significant simplifies the management. Urban management and liquidity control to tackle urban planning costs are also subject to special monitoring.

For quantitative information about the risk related to the developer and Real-Estate sector in Spain see Appendix IX