Société Générale / Risk report 2021 - Pillar 3 2020

6 CREDIT RISK RISK MEASUREMENT AND INTERNAL RATINGS PILLAR 3 - 2021 | SOCIETE GENERALE GROUP | 82 RISKMEASUREMENT AND INTERNAL RATINGS 6.5 Since 2007, Societe Generale has been authorised by its supervisory authorities to apply, for the majority of its exposures, the internal method (IRB method, Internal Ratings-Based) to calculate the capital required for credit risk. The rating model monitoring system is operational, in accordance with regulatory requirements, and detailed in this section “Risk measurement and internal ratings”. In accordance with the texts published by the EBA as part of the “IRB Repair” programme and following the review missions carried out by the ECB (TRIM – Targeted Review of Internal Models), the Group plans to develop its internal model system for credit risk, so as to comply strictly with these new requirements. A programme (“Haussmann”) has been launched in this direction within the Group, and deals with aspects such as: the simplification of the architecture of the models, and the p improvement of its auditability: either by ex nihilo development of new models based on the New Definition of Default (NDoD), and natively integrating the expectations of the EBA and ECB, or by bringing certain existing models up to standard; simplifying the architecture of models, and improving its p auditability; improving the quality of data and its traceability throughout the p chain; the review of the roles and responsibilities of the teams, particularly p with regard to the construction and monitoring (“backtest”) of the system; the review of certain IT application bricks, and their rationalisation; p the establishment of a more complete normative base and a more p closely monitored relationship with the supervisor; the roll-out plan towards the IRB approach and the maintenance p of the standardised approach (Permanent Partial Use – PPU), in consultation with the supervisors. The exposures subject to the standardised approach mainly concern the portfolios of retail customers and SMEs (Small and Medium Enterprises) of the International Retail Banking division. For exposures processed under the standard method excluding retail banking, the Group mainly uses external ratings from Standard & Poor’s, Moody’s and Fitch rating agencies and the Banque de France . In the event that several ratings are available for a third party, the second best rating is retained. General framework of the internal approach To calculate its capital requirements under the IRB approach, Societe Generale estimates the Risk-Weighted Assets (RWA) and the Expected Loss (EL) that may be incurred in light of the nature of the transaction, the quality of the counterparty ( via internal rating) and all measures taken to mitigate risk. Should an external rating be available, the corresponding exposure is assigned a risk weight according to the mapping tables provided in CRR (Articles 120-121-122) or more precisely to the tables published by the French supervisor ACPR (link: https://acpr.banque-france.fr/sites/ default/files/media/2020/08/07/21._notice_2020_-_version_clean_du_ 31.07.2020.pdf ). TABLE 26: CREDIT RATING AGENCIES USED IN STANDARDISED APPROACH MOODY'S FITCH S&P Sovereigns P P P Institutions P P P Corporates P P P The calculation of RWA is based on the Basel parameters which are estimated using its internal risk measurement system: the Exposure at Default (EAD) value is defined as the Group’s p exposure in the event that the counterparty should default. The EAD includes exposures recorded on the balance sheet (loans, receivables, accrued income, market transactions, etc.), and a proportion of off-balance sheet exposures calculated using internal or regulatory Credit Conversion Factors (CCF); the Probability of Default (PD): the probability that a counterparty of p the Bank will default within one year; the Loss Given Default (LGD): the ratio between the loss incurred on p an exposure in the event a counterparty defaults and the amount of the exposure at the time of the default. The estimations of these parameters are based on a quantitative evaluation system which is sometimes supplemented by expert or business judgment. In addition, a set of procedures sets out the rules relating to ratings (scope, frequency of review, grade approval procedure, etc.) as well as those for supervision, backtesting and the validation of models. These procedures allow, among other things, to facilitate critical human judgment, an essential complement to the models for these portfolios. The Group also takes into account: the impact of guarantees and credit derivatives, by substituting the p PD, the LGD and the risk-weighting calculation of the guarantor for that of the obligor (the exposure is considered to be a direct exposure to the guarantor) in the event that the guarantor’s risk weighting is more favourable than that of the obligor; collateral used as guarantees (physical or financial). This impact is p taken into account via the LGD level.