Notes to the Consolidated Financial Statements

1. Introduction, basis for the presentation of the Consolidated Financial Statements, internal control over financial information and other information

1.1 Introduction

Banco Bilbao Vizcaya Argentaria, S.A. (hereinafter “the Bank” or “BBVA") is a private-law entity subject to the laws and regulations governing banking entities operating in Spain. It carries out its activity through branches and agencies across the country and abroad.

The Bylaws and other public information are available for inspection at the Bank’s registered address (Plaza San Nicolás, 4 Bilbao) as noted on its web site (www.bbva.com).

In addition to the activities it carries out directly, the Bank heads a group of subsidiaries, joint ventures and associates which perform a wide range of activities and which together with the Bank constitute the Banco Bilbao Vizcaya Argentaria Group (hereinafter, “the Group” or “the BBVA Group”). In addition to its own separate Financial Statements, the Bank is required to prepare Consolidated Financial Statements comprising all consolidated subsidiaries of the Group.

As of December 31, 2018, the BBVA Group had 297 consolidated entities and 66 entities accounted for using the equity method (see Notes 3 and 16 and Appendix I to V).

The Consolidated Financial Statements of the BBVA Group for the year ended December 31, 2017 were approved by the shareholders at the Annual General Meetings (“AGM”) on March 16, 2018.

BBVA Group's Consolidated Financial Statements and the Financial Statements for the Bank and the majority of the remaining entities within the Group have been prepared as of December 31, 2018, and are pending approval by their respective AGMs. Notwithstanding, the Board of Directors of the Bank understands that said financial statements will be approved without changes.

1.2 Basis for the presentation of the Consolidated Financial Statements

The BBVA Group's Consolidated Financial Statements are presented in accordance with the International Financial Reporting Standards endorsed by the European Union (hereinafter, “EU-IFRS”) applicable as of December 31, 2018, considering the Bank of Spain Circular Circular 4/2017, and with any other legislation governing financial reporting applicable to the Group in Spain (see Note 1.3).

The BBVA Group's accompanying Consolidated Financial Statements for the year ended December 31, 2018 were prepared by the Group's Directors (through the Board of Directors meeting held on February 11, 2019) by applying the principles of consolidation, accounting policies and valuation criteria described in Note 2, so that they present fairly the Group's total consolidated equity and financial position as of December 31, 2018, together with the consolidated results of its operations and cash flows generated during the year ended December 31, 2018.

These Consolidated Financial Statements were prepared on the basis of the accounting records kept by the Bank and each of the other entities in the Group. Moreover, they include the adjustments and reclassifications required to harmonize the accounting policies and valuation criteria used by the Group (see Note 2.2).

All effective accounting standards and valuation criteria with a significant effect in the Consolidated Financial Statements were applied in their preparation.

The amounts reflected in the accompanying Consolidated Financial Statements are presented in millions of euros, unless it is more appropriate to use smaller units. Some items that appear without a balance in these Consolidated Financial Statements are due to how the units are expressed. Also, in presenting amounts in millions of euros, the accounting balances have been rounded up or down. It is therefore possible that the totals appearing in some tables are not the exact arithmetical sum of their component figures.

The percentage changes in amounts have been calculated using figures expressed in thousands of euros.

1.3 Comparative information

The information included in the accompanying consolidated financial statements relating to the years ended December 31, 2017 and December 31, 2016, in accordance to the applicable regulation, is presented for the purpose of comparison with the information for December, 31 2018.

Changes in accounting policies
Application of IFRS 9

As of January 1, 2018, IFRS 9 “Financial instruments” replaced IAS 39 “Financial Instruments: Recognition and Measurement” and includes changes in the requirements for the classification and measurement of financial assets and financial liabilities, the impairment of financial assets and hedge accounting (see Note 2.2.1). As permitted by the standard, IFRS 9 has not been applied retrospectively for previous years. The impact of the first application of IFRS 9 is presented in Note 2.4.

As a consequence of the application of IFRS 9, the comparative information for the financial years 2017 and 2016 included in these Consolidated Financial Statements has been subject to some non-significant modifications in order to improve the comparability with the figures of the financial year 2018.

Hyperinflationary economies

The Group experience applying IAS 29 "Financial information in hyperinflationary economies" in its subsidiaries in Venezuela allows us to confirm the complexity of applying the accounting mechanism of inflation together with the historical movements of the exchange rates in a way that results are economically understandable, especially when there is not a consistent evolution between inflation and exchange rate in each period.

In this context, with the aim of improving the faithful representation of the financial statements, during 2018 the Group made an accounting policy change which involves recording in a single account of "Shareholders’ funds – retained earnings", both the revaluation of non-monetary items due to the effect of hyperinflation and the differences generated when translating the restated financial statements of the subsidiaries in hyperinflationary economies into euros. Translation differences, prior to the accounting policy change were recorded in the item “Accumulated other comprehensive income – items that may be reclassified to profit or loss – foreign currency translation” (see Notes 2.2.16 and 2.2.20). The accounting policy change, in accordance with IAS 8, offers and provides more reliable and relevant information of operations in hyperinflationary economies.

In order to make the information comparable, we have restated the information of the previous years, in such a way that €1,853, €1,836 and €1,826 million have been reclassified from "Accumulated other comprehensive income – items that may be reclassified to profit or loss – foreign currency translation" to "Shareholders’ funds – retained earnings" as of December 31, 2017, December 31, 2016 and January 1, 2016, respectively, relating to the Group companies registered in Venezuela (an economy that was also considered hyperinflationary in 2017 and 2016). Additionally, €828, €817 and €816 million of euros have been reclassified from “Non-controlling interest –Accumulated other comprehensive income” to “Non-controlling interest – other” as of December 31, 2017, December 31, 2016 and January 1, 2016, respectively.

The reclassification corresponding to January 1, 2018, 2017 and 2016 is recorded as "Effects of changes in accounting policies" in the Consolidated Statement of Changes in Equity corresponding to the years ended December 31, 2018, 2017 and 2016. In the consolidated balance sheet as of December 31, 2018, 2017 and 2016, the heading " Shareholders’ funds – retained earnings” includes both the translation differences and the effects of restatement for inflation for the years 2018, 2017 and 2016.

Operating segments

During 2018, there were no significant changes to the existing structure of the BBVA Group's operating segments in comparison to 2017 (see Note 6). Certain prior year balances have been reclassified to conform to current year presentation.

1.4 Seasonal nature of income and expenses

The nature of the most significant activities carried out by the BBVA Group's entities is mainly related to typical activities carried out by financial institutions, which are not significantly affected by seasonal factors within the same year.

1.5 Responsibility for the information and for the estimates made

The information contained in the BBVA Group's Consolidated Financial Statements is the responsibility of the Group's Directors.

Estimates were required to be made at times when preparing these Consolidated Financial Statements in order to calculate the recorded or disclosed amount of some assets, liabilities, income, expenses and commitments. These estimates relate mainly to the following:

  • Impairment on certain financial assets (see Notes 7, 13, 14 and 16).
  • The assumptions used to quantify certain provisions (see Note 24) and for the actuarial calculation of post-employment benefit liabilities and commitments (see Note 25).
  • The useful life and impairment losses of tangible and intangible assets (see Notes 17, 18, 20 and 21).
  • The valuation of goodwill and price allocation of business combinations (see Note 18).
  • The fair value of certain unlisted financial assets and liabilities (see Notes 7, 8, 10, 11, 12 and 13).
  • The recoverability of deferred tax assets (See Note 19).

Although these estimates were made on the basis of the best information available as of December 31, 2018, future events may make it necessary to modify them (either up or down) over the coming years. This would be done prospectively in accordance with applicable standards, recognizing the effects of changes in the estimates in the corresponding consolidated income statement.

During 2018 there were no significant changes to the assumptions and estimations made as of December 31, 2017, except as indicated in these Consolidated Financial Statements.

1.6 BBVA Group's Internal Control over Financial Reporting

BBVA Group's Financial Statements is prepared under an Internal Control over Financial Reporting Model (hereinafter “ICFR"). It provides reasonable assurance with respect to the reliability and the integrity of the consolidated financial statements. It is also aimed to ensure that the transactions are processed in accordance with the applicable laws and regulations.

The ICFR is in accordance with the control framework established in 2013 by the “Committee of Sponsoring Organizations of the Treadway Commission” (hereinafter, "COSO"). The COSO 2013 framework sets five components that constitute the basis of the effectiveness and efficiency of the internal control systems:

  • The establishment of an appropriate control framework.
  • The assessment of the risks that could arise during the preparation of the financial information.
  • The design of the necessary controls to mitigate the identified risks.
  • The establishment of an appropriate system of information to detect and report system weaknesses.
  • The monitoring activities over the controls to ensure they perform correctly and are effective over time.

The ICFR is a dynamic model that evolves continuously over time to reflect the reality of the BBVA Group's businesses and processes, as well as the risks and controls designed to mitigate them. It is subject to a continuous evaluation by the internal control units located in the different entities of BBVA Group.

These internal control units are integrated within the BBVA internal control model which is based in two pillars:

  • A control system organized into three lines of defense:
  • The first line is located within the business and support units, which are responsible for identifying risks associated with their processes and to execute the controls established to mitigate them.
  • The second line comprises the specialized control units (Compliance, Internal Financial Control, Internal Risk Control, Engineering Risk, Fraud & Security, and Operations Control among others). This second line defines the models and controls under their areas of responsibility and monitors the design, correct implementation and effectiveness of the controls
  • The third line is the Internal Audit unit, which conducts an independent review of the model, verifying the compliance and effectiveness of the model.
  • A set of committees called Corporate Assurance that helps to escalate the internal control issues to the management at a Group level and also in each of the countries where the Group operates.

The internal control units comply with a common and standard methodology established at Group level, as set out in the following diagram:

BBVA's INTERNAL CONTROL OVER FINANCIAL REPORTING


The ICFR Model is subject to annual evaluations by the Group's Internal Audit Unit. It is also supervised by the Audit and Compliance Committee of the Bank’s Board of Directors.

The BBVA Group also complies with the requirements of the Sarbanes-Oxley Act (hereafter “SOX”) for Consolidated Financial Statements as a listed company with the U.S. Securities and Exchange Commission (“SEC”). The main senior executives of the Group are involved in the design, compliance and implementation of the internal control model to make it effective and to ensure the quality and accuracy of the financial information.

The description of the ICFR included in the Corporate Governance Annual Report within the Management Report attached to the consolidated financial statements for the year ended December 31, 2018.

2. Principles of consolidation, accounting policies and measurement bases applied and recent IFRS pronouncements

The Glossary includes the definition of some of the financial and economic terms used in Note 2 and subsequent Notes.

2.1 Principles of consolidation

In terms of its consolidation, in accordance with the criteria established by IFRS, the BBVA Group is made up of four types of entities: subsidiaries, joint ventures, associates and structured entities, defined as follows:

  • Subsidiaries
  • Subsidiaries are entities controlled by the Group. The financial statements of the subsidiaries are fully consolidated with those of the Bank. The share of non-controlling interests from subsidiaries in the Group's consolidated total equity is presented under the heading “Minority interests (Non-controlling interests)” in the consolidated balance sheet. Their share in the profit or loss for the period or year is presented under the heading “Attributable to minority interest (non-controlling interests)” in the accompanying consolidated income statement (see Note 31).
  • Note 3 includes information related to the main subsidiaries in the Group as of December 31, 2018. Appendix I includes other significant information on these entities.
  • Joint ventures
  • Joint ventures are those entities over which there is a joint arrangement to joint control with third parties other than the Group (for definitions of joint arrangement, joint control and joint venture, refer to Glossary).
  • The investments in joint ventures are accounted for using the equity method (see Note 16). Appendix II shows the main figures for joint ventures accounted for using the equity method.
  • Associates
  • Associates are entities in which the Group is able to exercise significant influence (for definition of significant influence, see Glossary). Significant influence is deemed to exist when the Group owns 20% or more of the voting rights of an investee directly or indirectly, unless it can be clearly demonstrated that this is not the case.
  • However, certain entities in which the Group owns 20% or more of the voting rights are not included as Group associates, since the Group does not have the ability to exercise significant influence over these entities. Investments in these entities, which do not represent material amounts for the Group, are classified as “Financial assets at fair value through other comprehensive income”.
  • In contrast, some investments in entities in which the Group holds less than 20% of the voting rights are accounted for as Group associates, as the Group is considered to have the ability to exercise significant influence over these entities. As of December 31, 2018, these entities are not significant in the Group.
  • Appendix II shows the most significant information related to the associates (see Note 16), which are accounted for using the equity method.
  • Structured Entities
  • A structured entity is an entity that has been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity, such as when the voting rights relate to administrative matters only and the relevant activities are directed by means of contractual arrangements (see Glossary).
  • In those cases where the Group sets up entities or has a holding in such entities, in order to allow its customers access to certain investments, to transfer risks or for other purposes, in accordance with internal criteria and procedures and with applicable regulations, the Group determines whether control over the entity in question actually exists and therefore whether it should be subject to consolidation.
  • Such methods and procedures determine whether there is control by the Group, considering how the decisions are made about the relevant activities, assesses whether the Group has all power over the relevant elements, exposure, or rights, to variable returns from involvement with the investee and the ability to use power over the investee to affect the amount of the investor’s returns.
  • Structured entities subject to consolidation
  • To determine if a structured entity is controlled by the Group, and therefore should be consolidated into the Group, the existing contractual rights (different from the voting rights) are analyzed. For this reason, an analysis of the structure and purpose of each investee is performed and, among others, the following factors will be considered:
  • - Evidence of the current ability to manage the relevant activities of the investee according to the specific business needs (including any decisions that may arise only in particular circumstances).
  • - Potential existence of a special relationship with the investee.
  • - Implicit or explicit Group commitments to support the investee.
  • - The ability to use the Group´s power over the investee to affect the amount of the Group's returns.
  • There are cases where the Group has a high exposure to variable returns and retains decision-making power over the investee, either directly or through an agent.
  • The main structured entities of the Group are the asset securitization funds, to which the BBVA Group transfers loans and receivables portfolios, and other vehicles, which allow the Group's customers to gain access to certain investments or to allow for the transfer of risks or for other purposes (see Appendices I and V). The BBVA Group maintains the decision-making power over the relevant activities of these vehicles and financial support through securitized market standard contracts. The most common ones are: investment positions in equity note tranches, funding through subordinated debt, credit enhancements through derivative instruments or liquidity lines, management rights of defaulted securitized assets, “clean-up” call derivatives, and asset repurchase clauses by the grantor.
  • For these reasons, the loans and receivable portfolios related to the vast majority of the securitizations carried out by the Bank or Group subsidiaries are not derecognized in the books of said entity and the issuances of the related debt securities are registered as liabilities within the Group's consolidated balance sheet.
  • Non-consolidated structured entities
  • The Group owns other vehicles also for the purpose of allowing customers access to certain investments, to transfer risks, and for other purposes, but without the Group having control of the vehicles, which are not consolidated in accordance with “IFRS 10 - Consolidated Financial Statements”. The balance of assets and liabilities of these vehicles is not material in relation to the Group's Consolidated Financial Statements.
  • As of December 31, 2018, there was no material financial support from the Bank or its subsidiaries to unconsolidated structured entities.
  • The Group does not consolidate any of the mutual funds it manages since the necessary control conditions are not met (see definition of control in the Glossary). Particularly, the BBVA Group does not act as arranger but as agent since it operates the mutual funds on behalf and for the benefit of investors or parties (arranger or arrangers) and, for this reason it does not control the mutual funds when exercising its authority for decision making.
  • The mutual funds managed by the Group are not considered structured entities (generally, retail funds without corporate identity over which investors have participations which gives them ownership of said managed equity). These funds are not dependent on a capital structure that could prevent them from carry out activities without additional financial support, being in any case insufficient as far as the activities themselves are concerned. Additionally, the risk of the investment is absorbed by the fund participants, and the Group is only exposed when it becomes a participant, and as such, there is no other risk for the Group.

In all cases, the operating results of equity method investees acquired by the BBVA Group in a particular period only include the period from the date of acquisition to the financial statements date. Similarly, the results of entities disposed of during any only include year the period from the start of the year to the date of disposal.

The consolidated financial statements of subsidiaries, associates and joint ventures used in the preparation of the Consolidated Financial Statements of the Group have the same presentation date as the Consolidated Financial Statements. If financial statements at those same dates are not available, the most recent will be used, as long as these are not older than three months, and adjusted to take into account the most significant transactions. As of December 31, 2018, except for the case of the consolidated financial statements of two subsidiaries and six associates and joint-ventures deemed non-significant for which financial statements as of November 30, 2018 were used, the December 31, 2018 financial statements for of all Group entities were utilized.

BBVA banking subsidiaries, associates and joint ventures worldwide, are subject to supervision and regulation from a variety of regulatory bodies in relation to, among other aspects, the satisfaction of minimum capital requirements. The obligation to satisfy such capital requirements may affect the ability of such entities to transfer funds in the form of cash dividends, loans or advances. In addition, under the laws of the various jurisdictions where such entities are incorporated, dividends may only be paid out through funds legally available for such purpose. Even when the minimum capital requirements are met and funds are legally available, the relevant regulators or other public administrations could discourage or delay the transfer of funds to the Group in the form of cash, dividends, loans or advances for prudential reasons.

Separate financial statements

The separate financial statements of the parent company of the Group (Banco Bilbao Vizcaya Argentaria, S.A.) are prepared under Spanish regulations (Circular 4/2017 of the Bank of Spain) and following other regulatory requirements of financial information applicable to the Bank. The Bank uses the cost method to account in its separate financial statements for its investments in subsidiaries, associates and joint venture entities, which are consistent with the requirements of Bank of Spain Circular 4/2017 and IAS 27.

As of January 1, 2018, Circular 4/2017 issued by the Bank of Spain on public and reserved financial information standards, and financial statement models entered into force for credit institutions. The purpose of this circular is to adapt the Spanish credit institutions accounting system to changes in the European accounting system resulting from the adoption of two new International Financial Reporting Standards (IFRS), specifically "IFRS 15 - Revenue from contracts with customers "and" IFRS 9 - Financial instruments ".

Appendix IX shows BBVA’s financial statements as of and for the years ended December 31, 2018 and 2017.

2.2 Accounting policies and valuation criteria applied

The accounting standards and policies and the valuation criteria applied in preparing these Consolidated Financial Statements may differ from those used by some of the entities within the BBVA Group. For this reason, necessary adjustments and reclassifications have been made in the consolidation process to standardize these principles and criteria and comply with the EU-IFRS.

The accounting standards and policies and valuation criteria used in preparing the accompanying Consolidated Financial Statements are as follows:

2.2.1 Financial instruments

As mentioned before in Note 1.3, IFRS 9 became effective as of January 1, 2018 and replaced IAS 39 regarding the classification and measurement of financial assets and liabilities, the impairment of financial assets and hedge accounting.

The disclosures related to the financial years 2017 and 2016 which are presented for the purpose of comparability, are based on the accounting policies and valuation criteria applicable under IAS 39.

Classification and measurement of financial assets under IFRS 9
Classification of financial assets

IFRS 9 contains three main categories for financial assets classification: measured at amortized cost, measured at fair value with changes in through other comprehensive income, and measured at fair value through profit or loss.

The classification of financial assets measured at amortized cost or fair value must be carried out on the basis of two tests: the entity's business model and the assessment of the contractual cash flow, commonly known as the "solely payments of principle and interest" criterion (hereinafter, the SPPI).

A debt instrument will be classified in the amortized cost portfolio if the two following conditions are fulfilled:

  • The financial asset is managed within a business model whose purpose is to maintain the financial assets to receive contractual cash flows; and
  • In accordance with the contractual characteristics of the instrument its cash flows only represent the return of the principal and interest, basically understood as consideration for the time value of money and the debtor's credit risk.

A debt instrument will be classified in the portfolio of financial assets at fair value with changes through other comprehensive income if the two following conditions are fulfilled:

  • The financial asset is managed with a business model whose purpose combines collection of the contractual cash flows and sale of the assets, and
  • The contractual characteristics of the instrument generate, at specific dates, cash flows which only represent the return of the principal and interest.

A debt instrument will be classified at fair value with changes in profit and loss provided that the entity's business model for their management or the contractual characteristics of its cash flows do not require classification into one of the portfolios described above.

In general, equity instruments will be measured at fair value through profit or loss. However the Group may make an irrevocable election at initial recognition to present subsequent changes in the fair value through other comprehensive income.

Financial assets will only be reclassified when BBVA Group decides to change the business model. In this case, all of the financial assets assigned to this business model will be reclassified. The change of the objective of the business model should occur before the date of the reclassification.

Valuation of financial assets

All financial instruments are initially recognized at fair value plus, in the case of a financial asset not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the instrument.

Excluding all trading derivatives not considered as accounting or economic hedges, all the changes in the fair value of the financial instruments arising from the accrual of interest and similar items are recognized under the headings “Interest and other income” or “Interest expense”, as appropriate, in the accompanying consolidated income statement in the period in which the change occurred (see Note 37). The changes in fair value after the initial recognition, for reasons other than those mentioned in the preceding paragraph, are treated as described below, according to the categories of financial assets.

“Financial assets held for trading”, “Non-trading financial assets mandatorily at fair value through profit and loss” and “Financial assets designated at fair value through profit or loss”

Financial assets are recorded under the heading “Financial assets held for trading” if the objective of the business model is to generate gains by buying and selling these financial instruments or generate short-term results. The financial assets recorded in the heading “Non-trading financial assets mandatorily at fair value through profit and loss” are assigned to a business model which objective is to obtain the contractual cash flows and / or to sell those instruments but its contractual cash flows do not comply with the requirements of the SPPI test. In “Financial assets designated at fair value through profit or loss” the Group classifies financial assets only if it eliminates or significantly reduces a measurement or recognition inconsistency (an ‘accounting mismatch’) that would otherwise arise from measuring financial assets or financial liabilities, or recognizing gains or losses on them, on different bases.

The assets recognized under these headings of the consolidated balance sheets are measured upon acquisition at fair value and changes in the fair value (gains or losses) are recognized as their net value under the heading “Gains (losses) on financial assets and liabilities, net” in the accompanying consolidated income statements (see Note 41). Interests from derivatives designated as economic hedges on interest rate are recognized in “Interest and other income” or “Interest expense” (see Note 37), depending on the result of the hedging instrument. However, changes in fair value resulting from variations in foreign exchange rates are recognized under the heading “Gains (losses) on financial assets and liabilities, net” in the accompanying consolidated income statements (Note 41).

”Financial assets at fair value through other comprehensive income”
  • Debt instruments

Assets recognized under this heading in the consolidated balance sheets are measured at their fair value. Subsequent changes in fair value (gains or losses) are recognized temporarily net of tax effect, under the heading “Accumulated other comprehensive income- Items that may be reclassified to profit or loss - Fair value changes of debt instruments measured at fair value through other comprehensive income” in the consolidated balance sheets (see Note 30).

The amounts recognized under the headings “Accumulated other comprehensive income- Items that may be reclassified to profit or loss - Fair value changes of financial assets measured at fair value through other comprehensive income” and “Accumulated other comprehensive income- Items that may be reclassified to profit or loss - Exchange differences” continue to form part of the Group's consolidated equity until the corresponding asset is derecognized from the consolidated balance sheet or until an impairment loss is recognized on the corresponding financial instrument. If these assets are sold, these amounts are derecognized and included under the headings “Gains (losses) on financial assets and liabilities, net” or “Exchange differences, net", as appropriate, in the consolidated income statement for the year in which they are derecognized (see Note 41).

The net impairment losses in “Financial assets at fair value through other comprehensive income” over the year are recognized under the heading “Impairment losses on financial assets, net – Financial assets at fair value through other comprehensive income” (see Note 47) in the consolidated income statements for that period.

Changes in foreign exchange rates which affect monetary items are recognized under the heading “Exchange differences, net" in the accompanying consolidated income statements (see Note 41).

  • Equity instruments

The BBVA Group, at the time of the initial recognition, may elect to present changes in the fair value in other comprehensive income of an investment in an equity instrument that is not held for trading. The election is irrevocable and can be made on an instrument-by-instrument basis. Subsequent changes in fair value (gains or losses) are recognized, under the heading “Accumulated other comprehensive income (loss) – Items that will not be reclassified to profit or loss – Fair value changes of equity instruments measured at fair value through other comprehensive income”.

“Financial assets at amortized cost”

A financial asset is classified as subsequently measured at amortized cost if it is held within a business model whose objective is to hold financial assets in order to collect and it meets the SPPI Criterion.

The assets under this category are subsequently measured at amortized cost, using the effective interest rate method.

Net impairment losses of assets recorded under these headings arising in each period are recognized under the heading “Impairment or reversal of impairment on financial assets not measured at fair value through profit or loss – financial assets measured at cost” (see Note 47) in the consolidated income statement for that period.

Classification and measurement of financial liabilities under IFRS 9
Classification of financial liabilities

Under IFRS 9, financial liabilities are classified in the following categories:

  • Financial liabilities at amortized cost;
  • Financial liabilities that are held for trading including derivatives are financial instruments which are recorded in this category when the Group's objective is to generate gains by buying and selling these financial instruments;
  • Financial liabilities that are designated at fair value through profit or loss on initial recognition under the Fair Value Option. The Group has the option to designate irrevocably on initial recognition a financial liability as at fair value through profit or loss provided that doing so results in the elimination or significant reduction of measurement or recognition inconsistency, or if a group of financial liabilities, or a group of financial assets and financial liabilities, has to be managed, and its performance evaluated, on a fair value basis in accordance with a documented risk management or investment strategy.
Valuation of financial liabilities

All financial instruments are initially recognized at fair value plus, in the case of a financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial liability. Unless there is evidence to the contrary, the best evidence of the fair value of a financial instrument at initial recognition shall be the transaction price.

Excluding all trading derivatives not considered as accounting or economic hedges, all the changes in the fair value of the financial instruments arising from the accrual of interest and similar items are recognized under the headings “Interest and other income” or “Interest expense”, as appropriate, in the accompanying consolidated income statement in the period in which the change occurred (see Note 37).

The changes in fair value after the initial recognition, for reasons other than those mentioned in the preceding paragraph, are treated as described below, according to the categories of financial liabilities.

“Financial liabilities held for trading” and “Financial liabilities designated at fair value through profit or loss“

The subsequent changes in the fair value (gains or losses) of the liabilities recognized under these headings of the consolidated balance sheets are recognized as their net value under the heading “Gains (losses) on financial assets and liabilities, net” in the accompanying consolidated income statements (see Note 41), except for the financial liabilities designated at fair value through profit and loss under the fair value option for which the amount of change in the fair value that is attributable to changes in the own credit risk which is presented in under the heading “Accumulated other comprehensive income (loss) – Items that will not be reclassified to profit or loss – Fair value changes of financial liabilities at fair value through profit or loss attributable to changes in their credit risk”. Interests from derivatives designated as economic hedges on interest rate are recognized in “Interest and other income” or “Interest expense” (Note 37), depending on the result of the hedging instrument. However, changes in fair value resulting from variations in foreign exchange rates are recognized under the heading “Gains (losses) on financial assets and liabilities, net” in the accompanying consolidated income statements (Note 41).

“Financial liabilities at amortized cost”

The liabilities under this category are subsequently measured at amortized cost, using the effective interest rate method.

Measurement of financial assets and liabilities under IAS 39 applicable in the financial years 2017 and 2016
Measurement of financial instruments and recognition of changes in subsequent fair value

All financial instruments are initially accounted for at fair value plus, in the case of a financial asset or financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability. Unless there is evidence to the contrary, the best evidence of the fair value of a financial instrument at initial recognition shall be the transaction price.

Excluding all trading derivatives not considered as accounting or economic hedges, all the changes in the fair value of the financial instruments arising from the accrual of interest and similar items are recognized under the headings “Interest and other income” or “Interest expense”, as appropriate, in the accompanying consolidated income statement the year in which the change occurred (see Note 37). The dividends received from other entities, other than associated entities and joint venture entities, are recognized under the heading “Dividend income” in the accompanying consolidated income statement in the year in which the right to receive them arises (see Note 38).

The changes in fair value after the initial recognition, for reasons other than those mentioned in the preceding paragraph, are treated as described below, according to the categories of financial assets and liabilities.

“Financial assets and liabilities held for trading” and “Financial assets and liabilities designated at fair value through profit or loss”

The assets and liabilities recognized under these headings of the consolidated balance sheets are measured upon acquisition at fair value and changes in the fair value (gains or losses) are recognized as their net value under the heading “Gains (losses) on financial assets and liabilities, net” in the accompanying consolidated income statements (see Note 41). Interests from derivatives designated as economic or accounting hedges on interest rate are recognized under the heading “Interest and other income” or “Interest expense” (Note 37), depending on the result of the hedging instrument. Changes in fair value resulting from variations in foreign exchange rates are recognized under the heading “Gains (losses) on financial assets and liabilities, net” in the accompanying consolidated income statements (Note 41).

“Financial assets at fair value through other comprehensive income”

Assets recognized under this heading in the consolidated balance sheets are measured at their fair value. Subsequent changes in fair value (gains or losses) are recognized temporarily net of tax effect, under the heading “Accumulated other comprehensive income - Items that may be reclassified to profit or loss - Financial assets at fair value through other comprehensive income” in the consolidated balance sheets (see Note 30).

The amounts recognized under the headings “Accumulated other comprehensive income - Items that may be reclassified to profit or loss - Financial assets at fair value through other comprehensive income” and “Accumulated other comprehensive income - Items that may be reclassified to profit or loss - Exchange differences” continue to form part of the Group's consolidated equity until the corresponding asset is derecognized from the consolidated balance sheet or until an impairment loss is recognized on the corresponding financial instrument. If these assets are sold, these amounts are derecognized and included under the headings “Gains (losses) on financial assets and liabilities, net” or “Exchange differences, net", as appropriate, in the consolidated income statement for the year in which they are derecognized (see Note 41).

The net impairment losses in “Financial assets at fair value through other comprehensive income” over the year are recognized under the heading “Impairment losses on financial assets, net – Other financial instruments not at fair value through profit or loss” (see Note 47) in the consolidated income statements for that year.

Changes in the value of non-monetary items resulting from changes in foreign exchange rates are recognized temporarily under the heading “Accumulated other comprehensive income - Items that may be reclassified to profit or loss - Exchange differences” in the accompanying consolidated balance sheets. Changes in foreign exchange rates which affect monetary items are recognized under the heading “Exchange differences, net" in the accompanying consolidated income statements (see Note 41).

“Financial assets and liabilities at amortized cost”

Assets and liabilities recognized under these headings in the accompanying consolidated balance sheets are subsequently measured at “amortized cost” using the “effective interest rate” method. This is because the consolidated entities generally intend to hold such financial instruments to maturity.

Net impairment losses of assets recognized under these headings arising in each year are recognized under the heading “Impairment or reversal of impairment on financial assets not measured at fair value through profit or loss – financial assets measured at cost” (see Note 47) in the consolidated income statement for that year.

“Derivatives-Hedge Accounting” and “Fair value changes of the hedged items in portfolio hedges of interest-rate risk” applicable in the financial years 2018, 2017 and 2016

Assets and liabilities recognized under these headings in the accompanying consolidated balance sheets are measured at fair value.

Changes occurring subsequent to the designation of the hedging relationship in the measurement of financial instruments designated as hedged items as well as financial instruments designated as hedge accounting instruments are recognized as follows:

  • In fair value hedges, the changes in the fair value of the derivative and the hedged item attributable to the hedged risk are recognized under the heading “Gains or losses from hedge accounting, net” in the consolidated income statement, with a corresponding offset under the headings where hedging items ("Hedging derivatives") and the hedged items are recognized, as applicable. Almost all of the hedges used by the Group are for interest-rate risks. Therefore, the valuation changes are recognized under the headings “Interest and other income” or “Interest expense”, as appropriate, in the accompanying consolidated income statement (see Note 37).
  • In fair value hedges of interest rate risk of a portfolio of financial instruments (portfolio-hedges), the gains or losses that arise in the measurement of the hedging instrument are recognized in the consolidated income statement, and the gains or losses that arise from the change in the fair value of the hedged item (attributable to the hedged risk) are also recognized in the consolidated income statement (in both cases under the heading “Gains or losses from hedge accounting, net”, using, as a balancing item, the headings "Fair value changes of the hedged items in portfolio hedges of interest rate risk" in the consolidated balance sheets, as applicable).
  • In cash flow hedges, the gain or loss on the hedging instruments relating to the effective portion are recognized temporarily under the heading ”Accumulated other comprehensive income - Items that may be reclassified to profit or loss - Hedging derivatives. Cash flow hedges” in the consolidated balance sheets, with a balancing entry under the heading “Hedging derivatives” of the Assets or Liabilities of the consolidated balance sheets as applicable. These differences are recognized in the accompanying consolidated income statement under the headings “Interest and other income” or “Interest expense” at the time when the gain or loss in the hedged instrument affects profit or loss, when the forecast transaction is executed or at the maturity date of the hedged item (see Note 37).
  • Differences in the measurement of the hedging items corresponding to the ineffective portions of cash flow hedges are recognized directly in the heading “Gains or losses from hedge accounting, net” in the consolidated income statement (see Note 41).
  • In the hedges of net investments in foreign operations, the differences attributable to the effective portions of hedging items are recognized temporarily under the heading "Accumulated other comprehensive income - Items that may be reclassified to profit or loss – Hedging of net investments in foreign transactions" in the consolidated balance sheets with a balancing entry under the heading “Hedging derivatives” of the Assets or Liabilities of the consolidated balance sheets as applicable. These differences in valuation are recognized under the heading “Exchange differences, net" in the consolidated income statement when the investment in a foreign operation is disposed of or derecognized (see Note 41).
Other financial instruments under IAS 39 applicable in the financial years 2017 and 2016

The following exceptions are applicable with respect to the above general criteria:

  • Equity instruments whose fair value cannot be determined in a sufficiently objective manner and financial derivatives that have those instruments as their underlying asset and are settled by delivery of those instruments are recorded in the consolidated balance sheet at acquisition cost; this may be adjusted, where appropriate, for any impairment loss (see Note 8).
  • Accumulated other comprehensive income arising from financial instruments classified at the consolidated balance sheet date as “Non-current assets and disposal groups classified as held for sale” are recognized with the corresponding entry under the heading “Accumulated other comprehensive income- Items that may be reclassified to profit or loss – Non-current assets and disposal groups classified as held for sale” in the accompanying consolidated balance sheets (see note 30).
Impairment losses on financial assets
Definition of impaired financial assets under IFRS 9

IFRS 9 replaced the "incurred loss" model in IAS 39 with one of "expected credit loss". The IFRS 9 impairment model is applied to financial assets valued at amortized cost and to financial assets valued at fair value with changes in accumulated other comprehensive income, except for investments in equity instruments and contracts for financial guarantees and loan commitments unilaterally revocable by BBVA. Likewise, all the financial instruments valued at fair value with change through profit and loss are excluded from the impairment model.

The new standard classifies financial instruments into three categories, which depend on the evolution of their credit risk from the moment of initial recognition. The first category includes the transactions when they are initially recognized (Stage 1); the second comprises the financial assets for which a significant increase in credit risk has been identified since its initial recognition (Stage 2) and the third one, the impaired financial assets (Stage 3).

The calculation of the provisions for credit risk in each of these three categories must be done differently. In this way, expected loss up to 12 months for the financial assets classified in the first of the aforementioned categories must be recorded, while expected losses estimated for the remaining life of the financial assets classified in the other two categories must be recorded. Thus, IFRS 9 differentiates between the following concepts of expected loss:

  • Expected loss at 12 months: expected credit loss that arises from possible default events within 12 months following the presentation date of the financial statements; and
  • Expected loss during the life of the transaction: this is the expected credit loss that arises from all possible default events over the remaining life of the financial instrument.

All this requires considerable judgment, both in the modeling for the estimation of the expected losses and in the forecasts, on how the economic factors affect such losses, which must be carried out on a weighted probability basis.

The BBVA Group has applied the following definitions in accordance with IFRS 9:

  • Default
  • BBVA has applied a definition of default for financial instruments that is consistent with that used in internal credit risk management, as well as the indicators under applicable regulation at the date of implementation of IFRS 9. Both qualitative and quantitative indicators have been considered.
  • The Group has considered there is a default when one of the following situations occurs:
  • Payment past-due for more than 90 days; or
  • There are reasonable doubts regarding the full reimbursement of the instrument.
  • An asset is credit-impaired according to IFRS 9 if one or more events have occurred and they have a detrimental impact on the estimated future cash flows of the asset. Evidence that a financial asset is credit-impaired includes observable data about the following events:
  • Significant financial difficulty of the issuer or the borrower.
  • A breach of contract (e.g. a default or past due event).
  • A lender having granted a concession to the borrower – for economic or contractual reasons relating to the borrower’s financial difficulty – that the lender would not otherwise consider.
  • It becoming probable that the borrower will enter bankruptcy or other financial reorganization.
  • The disappearance of an active market for that financial asset because of financial difficulties.
  • The purchase or origination of a financial asset at a deep discount that reflects the incurred credit losses.

It may not be possible to identify a single discrete event. Instead, the combined effect of several events may cause financial assets to become credit-impaired.

  • The definition of impaired financial assets in the Group is aligned with the definition of default explained in the above paragraphs.
  • Significant increase in credit risk

The objective of the impairment requirements is to recognize lifetime expected credit losses for financial instruments for which there have been significant increases in credit risk since initial recognition considering all reasonable and supportable information, including that which is forward-looking.

The model developed by the Group for assessing the significant increase in credit risk has a two-prong approach that is applied globally, although the specific characteristics of each geographic area are respected:

  • Quantitative criterion: the Group uses a quantitative analysis based on comparing the current expected probability of default over the life of the transaction with the original adjusted expected probability of default, so that both values are comparable in terms of expected default probability for their residual life. The thresholds used for considering a significant increase in risk take into account special cases according to geographic areas and portfolios. Depending on how old current transactions are, at the time implementation of the standard, some simplification were made to compare the probabilities of default between the current and the initial moment, based on the best information available at that moment.
  • Qualitative criterion: most indicators for detecting significant risk increase are included in the Group's systems through rating/scoring systems or macroeconomic scenarios, so the quantitative analysis covers the majority of circumstances. The Group will use additional qualitative criteria when it considers it necessary to include circumstances that are not reflected in the rating/score systems or macroeconomic scenarios used.
  • Additionally, instruments under one of the following circumstances are considered Stage 2:
  • More than 30 days past due. According to IFRS 9, default of more than 30 days is a presumption that can be rebutted in those cases in which the entity considers, based on reasonable and documented information, that such non-payment does not represent a significant increase in risk. As of December 31, 2018, the Group has not considered periods higher than 30 days for any of the significant portfolios.
  • Watch list: They are subject to special watch by the Risks units because they show negative signs in their credit quality, even though there may be no objective evidence of impairment.
  • Refinance or restructuring that does not show evidence of impairment.

Although the standard introduces a series of operational simplifications or practical solutions for analyzing the increase in significant risk, the Group does not use them as a general rule. However, for high-quality assets, mainly related to certain government institutions and bodies, the standard allows for considering that their credit risk has not increased significantly because they have a low credit risk at the presentation date.

Thus the classification of financial instruments subject to impairment under the new IFRS 9 is as follows:

  • Stage 1– without significant increase in credit risk
  • Financial assets which are not considered to have significantly increased in credit risk have loss allowances measured at an amount equal to 12 months expected credit losses.
  • Stage 2– significant increases in credit risk
  • When the credit risk of a financial asset has increased significantly since the initial recognition, the impairment losses of that financial instrument is calculated as the expected credit loss during the entire life of the asset.
  • Stage 3 – Impaired
  • When there is objective evidence that the instrument is credit impaired, the financial asset is transferred to this category in which the provision for losses of that financial instrument is calculated as the expected credit loss during the entire life of the asset.
Definition of impaired financial assets under IAS 39 applicable in the financial years 2017 and 2016

A financial asset is considered impaired – and therefore its carrying amount is adjusted to reflect the effect of impairment – when there is objective evidence that events have occurred, which:

  • In the case of debt instruments (loans and advances and debt securities), reduce the future cash flows that were estimated at the time the instruments were acquired. So they are considered impaired when there are reasonable doubts that the carrying amounts will be recovered in full and/or the related interest will be collected for the amounts and on the dates initially agreed.
  • In the case of equity instruments, it means that their carrying amount may not be fully recovered.

As a general rule, the carrying amount of impaired financial assets is adjusted with a charge to the consolidated income statement for the year in which the impairment becomes known. The recoveries of previously recognized impairment losses are reflected, if appropriate, in the consolidated income statement for the year in which the impairment is reversed or reduced, with an exception: any recovery of previously recognized impairment losses for an investment in an equity instrument classified as financial assets at fair value through other comprehensive income is not recognized in the consolidated income statement, but under the heading " Accumulated other comprehensive income - Items that may be reclassified to profit or loss - financial assets at fair value through other comprehensive income" in the consolidated balance sheet (see Note 30).

In general, amounts collected on impaired loans and receivables are used to recognize the related accrued interest and any excess amount is used to reduce the unpaid principal.

When the recovery of any recognized amount is considered remote, such amount is written-off on the consolidated balance sheet, without prejudice to any actions that may be taken in order to collect the amount until the rights extinguish in full either because it is time-barred debt, the debt is forgiven, or other reasons.

Method for calculating expected credit loss under IFRS 9
Method for calculating expected loss

In accordance with IFRS 9, the measurement of expected losses must reflect:

  • A considered and unbiased amount, determined by evaluating a range of possible results.
  • The time value of money.
  • Reasonable and supportable information that is available without undue cost or effort and that reflects current conditions and forecasts of future economic conditions.

The Group measures the expected losses both individually and collectively. The purpose of the Group's individual measurement is to estimate expected losses for significant impaired instruments, or instruments classified in Stage 2. In these cases, the amount of credit losses is calculated as the difference between expected discounted cash flows at the effective interest rate of the transaction and the carrying amount of the instrument.

For the collective measurement of expected losses the instruments are grouped into groups of assets based on their risk characteristics. Exposure within each group is segmented according to the common credit risk characteristics, similar characteristics of the credit risk, indicative of the payment capacity of the borrower in accordance with their contractual conditions. These risk characteristics have to be relevant in estimating the future flows of each group. The characteristics of credit risk may consider, among others, the following factors:

  • Type of instrument.
  • Rating or scoring tools.
  • Credit risk scoring or rating.
  • Type of collateral.
  • Amount of time at default for stage 3.
  • Segment.
  • Qualitative criteria which can have a significant increase in risk.
  • Collateral value if it has an impact on the probability of a default event.

The estimated losses are derived from the following parameters:

  • PD: estimate of the probability of default in each period.
  • EAD: estimate of the exposure in case of default at each future period, taking into account the changes in exposure after the presentation date of the financial statements.
  • LGD: estimate of the loss in case of default, calculated as the difference between the contractual cash flows and receivables, including guarantees.

In the case of debt securities, the Group supervises the changes in credit risk through monitoring the external published credit ratings.

To determine whether there is a significant increase in credit risk that is not reflected in the published ratings, the Group also revises the changes in bond yields, and when they are available, the prices of CDS, together with the news and regulatory information available on the issuers.

Use of present, past and future information

IFRS 9 requires incorporation of present, past and future information to detect any significant increase in risk and measure expected loss.

The standard does not require identification of all possible scenarios for measuring expected loss. However, the probability of a loss event occurring and the probability it will not occur have to be considered, even though the possibility of a loss may be very small. Also, when there is no linear relation between the different future economic scenarios and their associated expected losses, more than one future economic scenario must be used for the measurement.

The approach used by the Group consists of using first the most probable scenario (baseline scenario) consistent with that used in the Group's internal management processes, and then applying an additional adjustment, calculated by considering the weighted average of expected losses in other economic scenarios (one more positive and the other more negative). The main macroeconomic variables that are valued in each of the scenarios for each of the geographies in which the Group operates are Gross Domestic Product (GDP), tax rates, unemployment rate and loan to value (LTV).

Method for calculating the impairment on financial assets under IAS 39 applicable in the financial years 2017 and 2016

The impairment on financial assets is determined by type of instrument and other circumstances that could affect it, taking into account the guarantees received to assure (in part or in full) the performance of the financial assets. The BBVA Group recognizes impairment charges directly against the impaired financial asset when the likelihood of recovery is deemed remote, and uses an offsetting or allowance account when it recognizes non-performing loan provisions for the estimated losses.

Impairment of debt instruments measured at amortized cost

With regard to impairment losses arising from insolvency risk of the obligors (credit risk), a debt instrument, mainly Loans and receivables, is impaired due to insolvency when a deterioration in the ability to pay by the obligor is evidenced, either due to past due status or for other reasons.

The BBVA Group has developed policies, methods and procedures to estimate incurred losses on outstanding credit risk. These policies, methods and procedures are applied in the due diligence, approval and execution of debt instruments and commitments and guarantees given; as well as in identifying the impairment and, where appropriate, in calculating the amounts necessary to cover estimated losses.

The amount of impairment losses on debt instruments measured at amortized cost is calculated based on whether the impairment losses are determined individually or collectively. First it is determined whether there is objective evidence of impairment individually for individually significant debt instrument, and collectively for debt instrument that are not individually significant. If the Group determines that there is no objective evidence of impairment, the assets are classified in groups of debt instrument based on similar risk characteristics and impairment is assessed collectively.

In determining whether there is objective evidence of impairment the Group uses observable data in the following aspects:

  • Significant financial difficulties of the obligors.
  • Ongoing delays in the payment of interest or principal.
  • Refinancing of credit due to financial difficulties by the counterparty.
  • Bankruptcy or reorganization / liquidation are considered likely.
  • Disappearance of the active market for a financial asset because of financial difficulties.
  • Observable data indicating a reduction in future cash flows from the initial recognition such as adverse changes in the payment status of the counterparty (delays in payments, reaching credit cards limits, etc.).
  • National or local economic conditions that are linked to "defaults" in the financial assets (unemployment rate, falling property prices, etc.).
Impairment losses on financial assets individually evaluated for impairment

The amount of the impairment losses incurred on financial assets represents the excess of their respective carrying amounts over the present values of their expected future cash flows. These cash flows are discounted using the original effective interest rate. If a financial asset has a variable interest rate, the discount rate for measuring any impairment loss is the current effective rate determined under the contract.

As an exception to the rule described above, the market value of listed debt instruments is deemed to be a fair estimate of the present value of their expected future cash flows.

The following is to be taken into consideration when estimating the future cash flows of debt instruments:

  • All amounts that are expected to be recovered over the remaining life of the debt instrument; including, where appropriate, those which may result from the collateral and other credit enhancements provided for the debt instrument (after deducting the costs required for foreclosure and subsequent sale). Impairment losses include an estimate for the possibility of collecting accrued, past-due and uncollected interest.
  • The various types of risk to which each debt instrument is subject.
  • The circumstances in which collections will foreseeably be made.
Impairment losses on financial assets collectively evaluated for impairment

With regard to the collective impairment analysis, financial assets are grouped by risk type considering the debtor's capacity to pay based on the contractual terms. As part of this analysis, the BBVA Group estimates the impairment loan losses that are not individually significant, distinguishing between those that show objective evidence of impairment, and those that do not show objective evidence of impairment, as well as the impairment of significant loans that the BBVA Group has deemed as not showing an objective evidence of impairment.

With respect to financial assets that have no objective evidence of impairment, the Group applies statistical methods using historical experience and other specific information to estimate the losses that the Group has incurred as a result of events that have occurred as of the date of preparation of the Consolidated Financial Statements but have not been known and will be apparent, individually after the date of submission of the information. This calculation is an intermediate step until these losses are identified on an individual level, at which time these financial instruments will be segregated from the portfolio of financial assets without objective evidence of impairment.

The incurred loss is calculated taking into account three key factors: exposure at default, probability of default and loss given default.

  • Exposure at default (EAD) is the amount of risk exposure at the date of default by the counterparty.
  • Probability of default (PD) is the probability of the counterparty failing to meet its principal and/or interest payment obligations. The PD is associated with the rating/scoring of each counterparty/transaction.
  • Loss given default (LGD) is the estimate of the loss arising in the event of default. It depends mainly on the characteristics of the counterparty, and the valuation of the guarantees or collateral associated with the asset.

In order to calculate the LGD at each balance sheet date, the Group evaluates the whole amount expected to be obtained over the remaining life of the financial asset. The recoverable amount from executable secured collateral is estimated based on the property valuation, discounting the necessary adjustments to adequately account for the potential fall in value until its execution and sale, as well as execution costs, maintenance costs and sale costs.

  • In addition, to identify the possible incurred but not reported losses (IBNR) in the unimpaired portfolio, an additional parameter called "LIP" (loss identification period) has to be introduced. The LIP parameter is the period between the time at which the event that generates a given loss occurs and the time when the loss is identified at an individual level.
  • When the property right is contractually acquired at the end of the foreclosure process or when the assets of distressed borrowers are purchased, the asset is recognized in the consolidated balance sheets (see Note 2.2.4).
  • Impairment of other debt instruments classified as financial assets available for sale

    The impairment losses on other debt instruments included in the “Available-for-sale financial asset” portfolio are equal to the excess of their acquisition cost (net of any principal repayment), after deducting any impairment loss previously recognized in the consolidated income statement over their fair value.

    When there is objective evidence that the negative differences arising on measurement of these debt instruments are due to impairment, they are no longer considered as “Accumulated other comprehensive income - Items that may be reclassified to profit or loss - financial assets at fair value through other comprehensive income” and are recognized in the consolidated income statement.

    If all, or part of the impairment losses are subsequently recovered, the amount is recognized in the consolidated income statement for the year in which the recovery occurred, up to the amount previously recognized in the income statement.

    Impairment of equity instruments

    The amount of the impairment in the equity instruments is determined by the category where they are recognized:

    • Equity instruments classified at available for sale at fair value: When there is objective evidence that the negative differences arising on measurement of these equity instruments are due to impairment, they are no longer registered as “Accumulated other comprehensive income - Items that may be reclassified to profit or loss - Financial assets available for sale” and are recognized in the consolidated income statement. In general, the Group considers that there is objective evidence of impairment on equity instruments classified as available-for-sale when significant unrealized losses have existed over a sustained period of time due to a price reduction of at least 40% or over a period of more than 18 months.
    • When applying this evidence of impairment, the Group takes into account the volatility in the price of each individual equity instrument to determine whether it is a percentage that can be recovered through its sale in the market; other different thresholds may exist for certain equity instruments or specific sectors.
    • In addition, for individually significant investments, the Group compares the valuation of the most significant equity instruments against valuations performed by independent experts.
    • Any recovery of previously recognized impairment losses for an investment in an equity instrument classified at fair value through other comprehensive income is not recognized in the consolidated income statement, but under the heading "Accumulated other comprehensive income - Items that may be reclassified to profit or loss - financial assets available for sale" in the consolidated balance sheet (see Note 30).
    • Equity instruments measured at cost: The impairment losses on equity instruments measured at acquisition cost are equal to the excess of their carrying amount over the present value of expected future cash flows discounted at the market rate of return for similar equity instruments. In order to determine these impairment losses, unless there is better evidence, an assessment of the equity of the investee is carried out (excluding Accumulated other comprehensive income due to cash flow hedges) based on the last approved (consolidated) balance sheet, adjusted by the unrealized gains at measurement date.

    Impairment losses are recognized in the consolidated income statement in the year in which they arise as a direct reduction of the cost of the instrument. These impairment losses may only be recovered subsequently in the event of the sale of these assets.

    2.2.2 Transfers and derecognition of financial assets and liabilities

    The accounting treatment of transfers of financial assets is determined by the form in which risks and benefits associated with the financial assets involved are transferred to third parties. Thus the financial assets are only derecognized from the consolidated balance sheet when the cash flows that they generate are extinguished, when their implicit risks and benefits have been substantially transferred to third parties or when the control of financial asset is transferred even in case of no physical transfer or substantial retention of such assets. In the latter case, the financial asset transferred is derecognized from the consolidated balance sheet, and any right or obligation retained or created as a result of the transfer is simultaneously recognized.

    Similarly, financial liabilities are derecognized from the consolidated balance sheet only if their obligations are extinguished or acquired (with a view to subsequent cancellation or renewed placement).

    The Group is considered to have transferred substantially all the risks and benefits if such risks and benefits account for the majority of the risks and benefits involved in ownership of the transferred financial assets. If substantially all the risks and benefits associated with the transferred financial asset are retained:

    • The transferred financial asset is not derecognized from the consolidated balance sheet and continues to be measured using the same criteria as those used before the transfer.
    • A financial liability is recognized at the amount equal to the amount received, which is subsequently measured at amortized cost or fair value with changes in the income statement, whichever the case.
    • Both the income generated on the transferred (but not derecognized) financial asset and the expenses of the new financial liability continue to be recognized.

    2.2.3 Financial guarantees

    Financial guarantees are considered to be those contracts that require their issuer to make specific payments to reimburse the holder of the financial guarantee for a loss incurred when a specific borrower breaches its payment obligations on the terms – whether original or subsequently modified – of a debt instrument, irrespective of the legal form it may take. Financial guarantees may take the form of a deposit, bank guarantee, insurance contract or credit derivative, among others.

    In their initial recognition, financial guarantees are recognized as liabilities in the consolidated balance sheet at fair value, which is generally the present value of the fees, commissions and interest receivable from these contracts over the term thereof, and the Group simultaneously recognize a corresponding asset in the consolidated balance sheet for the amount of the fees and commissions received at the inception of the transactions and the amounts receivable at the present value of the fees, commissions and interest outstanding.

    Financial guarantees, irrespective of the guarantor, instrumentation or other circumstances, are reviewed periodically so as to determine the credit risk to which they are exposed and, if appropriate, to consider whether a provision is required for them. The credit risk is determined by application of criteria similar to those established for quantifying impairment losses on debt instruments measured at amortized cost (see Note 2.2.1).

    The provisions recognized for financial guarantees considered impaired are recognized under the heading “Provisions - Provisions for contingent risks and commitments” on the liability side in the consolidated balance sheets (see Note 24). These provisions are recognized and reversed with a charge or credit, respectively; to “Provisions or reversal of provision” in the consolidated income statements (see Note 46).

    Income from financial guarantees is recorded under the heading “Fee and commission income” in the consolidated income statement and is calculated by applying the rate established in the related contract to the nominal amount of the guarantee (see Note 40).

    2.2.4 Non-current assets and disposal groups held for sale and liabilities included in disposal groups classified as held for sale and Liabilities included in disposal groups classified as held for sale

    The headings “Non-current assets and disposal groups held for sale” and “Liabilities included in disposal groups classified as held for sale” in the consolidated balance sheets includes the carrying amount of assets that are not part of the BBVA Group's operating activities. The recovery of this carrying amount is expected to take place through the price obtained on its disposal (see Note 21).

    These headings include individual items and groups of items (“disposal groups”) and disposal groups that form part of a major operating segment and are being held for sale as part of a disposal plan (“discontinued operations”). The heading “Non-current assets and disposal groups held for sale” include the assets received by the subsidiaries from their debtors, in full or partial settlement of the debtors’ payment obligations (assets foreclosed or received in payment of debt and recovery of lease finance transactions), unless the Group has decided to make continued use of these assets. The BBVA Group has units that specialize in real estate management and the sale of this type of asset.

    Symmetrically, the heading “Liabilities included in disposal groups classified as held for sale” in the consolidated balance sheets reflects the balances payable arising from disposal groups and discontinued operations.

    Non-current assets and disposal groups classified as held for sale are generally measured, at the acquisition date and at any later date deemed necessary, at either their carrying amount or the fair value of the property (less costs to sell), whichever is lower.

    In the case of real estate assets foreclosed or received in payment of debts, they are initially recognized at the lower of: the restated carrying amount of the financial asset and the fair value at the time of the foreclosure or receipt of the asset less estimated sales costs. The carrying amount of the financial asset is updated at the time of the foreclosure, treating the real property received as a secured collateral and taking into account the credit risk coverage that would correspond to it according to its classification prior to the delivery. For these purposes, the collateral will be valued at its current fair value (less sale costs) at the time of foreclosure. This carrying amount will be compared with the previous carrying amount and the difference will be recognized as a provision increase, if applicable. On the other hand, the fair value of the foreclosed asset is obtained by appraisal, evaluating the need to apply a discount on the asset derived from the specific conditions of the asset or the market situation for these assets, and in any case, deducting the company’s estimated sale costs.

    At the time of the initial recognition, these real estate assets foreclosed or received in payment of debts, classified as “Non-current assets and disposal groups held for sale” and “liabilities included in disposal groups classified as held for sale” are valued at the lower of: their restated fair value less estimated sale costs and their carrying amount; a deterioration or impairment reversal can be recognized for the difference if applicable.

    Non-current assets and disposal groups held for sale groups classified as held for sale are not depreciated while included under the heading “Non-current assets and disposal groups held for sale”.

    Fair value of non-current assets held for sale from foreclosures or recoveries is based, mainly, in appraisals or valuations made by independent experts on an annual basis or more frequently, should there be indicators of impairment.

    Gains and losses generated on the disposal of assets and liabilities classified as non-current held for sale, and liabilities included in disposal groups classified as held for sale as well as impairment losses and, where pertinent, the related recoveries, are recognized in “Profit or loss from non-current assets and disposal groups classified as held for sale not qualifying as discontinued operations” in the consolidated income statement (see Note 50). The remaining income and expense items associated with these assets and liabilities are classified within the relevant consolidated income statement headings.

    Income and expenses for discontinued operations, whatever their nature, generated during the year, even if they have occurred before their classification as discontinued operations, are presented net of the tax effect as a single amount under the heading “Profit from discontinued operations” in the consolidated income statement, whether the business remains on the consolidated balance sheet or is derecognized from the consolidated balance sheet. As long as an asset remains in this category, it will not be amortized. This heading includes the earnings from their sale or other disposal.

    2.2.5 Tangible assets

    Property, plant and equipment for own use

    This heading includes the assets under ownership or acquired under finance lease, intended for future or current use by the BBVA Group and that it expects to hold for more than one year. It also includes tangible assets received by the consolidated entities in full or partial settlement of financial assets representing receivables from third parties and those assets expected to be held for continuing use.

    Property, plant and equipment for own use are presented in the consolidated balance sheets at acquisition cost, less any accumulated depreciation and, where appropriate, any estimated impairment losses resulting from comparing this net carrying amount of each item with its corresponding recoverable amount (see Note 17).

    Depreciation is calculated using the straight-line method, on the basis of the acquisition cost of the assets less their residual value; the land is considered to have an indefinite life and is therefore not depreciated.

    The tangible asset depreciation charges are recognized in the accompanying consolidated income statements under the heading "Depreciation and Amortization" (see Note 45) and are based on the application of the following depreciation rates (determined on the basis of the average years of estimated useful life of the various assets):

    Depreciation Rates for Tangible Assets

    Type of Assets Annual Percentage
    Buildings for own use 1% - 4%
    Furniture 8% - 10%
    Fixtures 6% - 12%
    Office supplies and hardware 8% - 25%

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    At each reporting date, the Group entities analyze whether there are internal or external indicators that a tangible asset may be impaired. When there is evidence of impairment, the Group analyzes whether this impairment actually exists by comparing the asset’s net carrying amount with its recoverable amount (as the higher between its recoverable amount less disposal costs and its value in use). When the carrying amount exceeds the recoverable amount, the carrying amount is written down to the recoverable amount and depreciation charges going forward are adjusted to reflect the asset’s remaining useful life.

    Similarly, if there is any indication that the value of a tangible asset is now recoverable, the consolidated entities will estimate the recoverable amounts of the asset and recognize it in the consolidated income statement, recording the reversal of the impairment loss registered in previous years and thus adjusting future depreciation charges. Under no circumstances may the reversal of an impairment loss on an asset raise its carrying amount above that which it would have if no impairment losses had been recognized in prior years.

    In the BBVA Group, most of the buildings held for own use are assigned to the different Cash-Generating-Units (CGU) to which they belong. The corresponding impairment analysis are performed for these CGUs to check whether sufficient cash flows are generated to support the value of the assets comprised within.

    Running and maintenance expenses relating to tangible assets held for own use are recognized as an expense in the year they are incurred and recognized in the consolidated income statements under the heading "Administration costs - Other administrative expenses - Property, fixtures and equipment" (see Note 44.2).

    Other assets leased out under an operating lease

    The criteria used to recognize the acquisition cost of assets leased out under operating leases, to calculate their depreciation and their respective estimated useful lives and to recognize the impairment losses on them, are the same as those described in relation to tangible assets for own use.

    Investment properties

    The heading “Tangible assets - Investment properties” in the consolidated balance sheets reflects the net values (purchase cost minus the corresponding accumulated depreciation and, if appropriate, estimated impairment losses) of the land, buildings and other structures that are held either to earn rentals or for capital appreciation through sale and that are neither expected to be sold off in the ordinary course of business nor are destined for own use (see Note 17).

    The criteria used to recognize the acquisition cost of investment properties, calculate their depreciation and their respective estimated useful lives and recognize the impairment losses on them, are the same as those described in relation to tangible assets held for own use.

    The BBVA Group determines periodically the fair value of its investment properties in such a way that, at the end of the financial year, the fair value reflects the market conditions of investment property assets’ market at this date. This fair value will be determined taking as references the valuations performed by independent experts.

    2.2.6 Inventories

    The balance under the heading “Other assets - Inventories” in the consolidated balance sheets mainly includes the land and other properties that the BBVA Group's real estate entities hold for development and sale as part of their real estate development activities (see Note 20).

    The cost of inventories includes those costs incurred in their acquisition and development, as well as other direct and indirect costs incurred in getting them to their current condition and location.

    In the case of the cost of real estate assets accounted for as inventories, the cost is comprised of: the acquisition cost of the land, the cost of urban planning and construction, non-recoverable taxes and costs corresponding to construction supervision, coordination and management. Financing cost incurred during the year form part of cost, provided that the inventories require more than a year to be in a condition to be sold.

    Properties purchased from customers in distress, which the Group manages for sale, are measured at the acquisition date and any subsequent time, at either their related carrying amount or the fair value of the property (less costs to sell), whichever is lower. The carrying amount at acquisition date of these properties is defined as the balance pending collection on those assets that originated said purchases (net of provisions).

    Impairment

    The amount of any subsequent adjustment due to inventory valuation for reasons such as damage, obsolescence, reduction in sale price to its net realizable value, as well as losses for other reasons and, if appropriate, subsequent recoveries of value up to the limit of the initial cost value, are registered under the heading "Impairment or reversal of impairment on non-financial assets” in the accompanying consolidated income statements (see Note 48) for the year in which they are incurred.

    In the case of the above mentioned real-estate assets, if the fair value less costs to sell is lower than the carrying amount of the loan recognized in the consolidated balance sheet, a loss is recognized under the heading "Impairment or reversal of impairment on non-financial assets" in the consolidated income statement for the year. In the case of real-estate assets accounted for as inventories, the BBVA Group's criterion for determining their net realizable value is mainly based on independent appraisals no more than one year old, or less if there are indications of impairment.

    Inventory sales

    In sale transactions, the carrying amount of inventories is derecognized from the consolidated balance sheet and recognized as an expense under the income statement heading "Other operating expenses – Changes in inventories” in the year in which the income from its sale is recognized. This income is recognized under the heading “Other operating income – Financial income from non-financial services” in the consolidated income statements (see Note 42).

    2.2.7 Business combinations

    A business combination is a transaction, or any other deal, by which the Group obtains control of one or more businesses. It is accounted for by applying the acquisition method.

    According to this method, the acquirer has to recognize the assets acquired and the liabilities and contingent liabilities assumed, including those that the acquired entity had not recognized in the accounts. The method involves the measurement of the consideration received for the business combination and its allocation to the assets, liabilities and contingent liabilities measured according to their fair value, at the purchase date, as well as the recognition of any non-controlling participation (minority interests) that may arise from the transaction.

    In a business combination achieved in stages, the acquirer shall remeasure its previously held equity interest in the acquiree at its acquisition-date fair value and recognize the resulting gain or loss, if any, in profit or loss under the heading “Gains (losses) on derecognition of non-financial assets and subsidiaries, net” of the consolidated income statements. In prior reporting periods, the acquirer may have recognized changes in the value of its equity interest in the acquiree in other comprehensive income. If so, the amount that was recognized in other comprehensive income shall be recognized on the same basis as would be required if the acquirer had disposed directly of the previously held equity interest.

    In addition, the acquirer shall recognize an asset in the consolidated balance sheet under the heading “Intangible asset - Goodwill” if on the acquisition date there is a positive difference between:

    • the sum of the consideration transferred, the amount of all the non-controlling interests and the fair value of stock previously held in the acquired business; and
    • the net fair value of the assets acquired and liabilities assumed.

    If this difference is negative, it shall be recognized directly in the income statement under the heading “Negative goodwill recognized in profit or loss”.

    Non-controlling interests in the acquired entity may be measured in two ways: either at their fair value; or at the proportional percentage of net assets identified in the acquired entity. The method of valuing non-controlling interest may be elected in each business combination. BBVA Group has always elected for the second method.

    2.2.8 Intangible assets

    Goodwill

    Goodwill represents a portion of consideration transferred in advance by the acquiring entity for the future economic benefits from assets that cannot be individually identified and separately recognized. Goodwill is never amortized. It is subject periodically to an impairment analysis, and is written off if there has been impairment (see Note 18).

    Goodwill is assigned to one or more cash-generating units that expect to be the beneficiaries of the synergies derived from the business combinations. The cash-generating units represent the Group's smallest identifiable asset groups that generate cash flows for the Group and that are largely independent of the flows generated from the Group's other assets or groups of assets. Each unit or units to which goodwill is allocated:

    • Is the lowest level at which the entity manages goodwill internally.
    • Is not larger than an operating segment.

    The cash-generating units to which goodwill has been allocated are tested for impairment (including the allocated goodwill in their carrying amount). This analysis is performed at least annually or more frequently if there is any indication of impairment.

    For the purpose of determining the impairment of a cash-generating unit to which a part of goodwill has been allocated, the carrying amount of that cash-generating unit, adjusted by the theoretical amount of the goodwill attributable to the non-controlling interests, in the event they are not valued at fair value, is compared with its recoverable amount.

    The recoverable amount of a cash-generating unit is equal to the fair value less sale costs or its value in use, whichever is greater. Value in use is calculated as the discounted value of the cash flow projections that the unit’s management estimates and is based on the latest budgets approved for the coming years. The main assumptions used in its calculation are: a sustainable growth rate to extrapolate the cash flows indefinitely, and the discount rate used to discount the cash flows, which is equal to the cost of the capital assigned to each cash-generating unit, and equivalent to the sum of the risk-free rate plus a risk premium inherent to the cash-generating unit being evaluated for impairment.

    If the carrying amount of the cash-generating unit exceeds the related recoverable amount, the Group recognizes an impairment loss; the resulting loss is apportioned by reducing, first, the carrying amount of the goodwill allocated to that unit and, second, if there are still impairment losses remaining to be recognized, the carrying amount of the remainder of the assets. This is done by allocating the remaining loss in proportion to the carrying amount of each of the assets in the unit. In the event the non-controlling interests are measured at fair value, the deterioration of goodwill attributable to non-controlling interests will be recognized. In any case, an impairment loss recognized for goodwill shall not be reversed in a subsequent period.

    Goodwill impairment losses are recognized under the heading "Impairment or reversal of impairment on non-financial assets – Intangible assets” in the consolidated income statements (see Note 48).

    Other intangible assets

    These assets may have an indefinite useful life if, based on an analysis of all relevant factors, it is concluded that there is no foreseeable limit to the period over which the asset is expected to generate net cash flows for the consolidated entities. In all other cases they have a finite useful life (see Note 18).

    Intangible assets with a finite useful life are amortized according to the duration of this useful life, using methods similar to those used to depreciate tangible assets. The defined useful life intangible asset is made up mainly of IT applications acquisition costs which have a useful life of 3 to 5 years. The depreciation charge of these assets is recognized in the accompanying consolidated income statements under the heading "Depreciation and amortization" (see Note 45).

    The consolidated entities recognize any impairment loss on the carrying amount of these assets with charge to the heading “Impairment or reversal of impairment on non - financial assets- Intangible assets” in the accompanying consolidated income statements (see Note 48). The criteria used to recognize the impairment losses on these assets and, where applicable, the recovery of impairment losses recognized in prior years, are similar to those used for tangible assets.

    2.2.9 Insurance and reinsurance contracts

    The assets and liabilities of the BBVA Group's insurance subsidiaries are recognized according to their nature under the corresponding headings of the consolidated balance sheets, and the initial recognition and valuation is carried out according to the criteria set out in IFRS 4.

    The heading “Insurance and reinsurance assets” in the accompanying consolidated balance sheets includes the amounts that the consolidated insurance subsidiaries are entitled to receive under the reinsurance contracts entered into by them with third parties and, more specifically, the reinsurer´s share of the technical provisions recognized by the consolidated insurance subsidiaries.

    The heading “Liabilities under insurance and reinsurance contracts” in the accompanying consolidated balance sheets includes the technical provisions for direct insurance and inward reinsurance recognized by the consolidated insurance subsidiaries to cover claims arising from insurance contracts open at period-end (see Note 23).

    The income or expenses reported by the BBVA Group's consolidated insurance subsidiaries on their insurance activities is recognized, in accordance with their nature, in the corresponding items of the consolidated income statements.

    The consolidated insurance entities of the BBVA Group recognize the amounts of the premiums written and a charge for the estimated cost of the claims that will be incurred at their final settlement to their consolidated income statements. At the close of each year the amounts collected and unearned, as well as the costs incurred and unpaid, are accrued.

    The most significant provisions registered by consolidated insurance entities with respect to insurance policies issued by them are set out by their nature in Note 23.

    According to the type of product, the provisions may be as follows:

    • Life insurance provisions:
    • Represents the value of the net obligations undertaken with the life insurance policyholder. These provisions include:
    • Provisions for unearned premiums. These are intended for the accrual, at the date of calculation, of the premiums written. Their balance reflects the portion of the premiums received until the closing date that has to be allocated to the period from the closing date to the end of the insurance policy period.
    • Mathematical reserves: Represents the value of the life insurance obligations of the insurance entities at year-end, net of the policyholder’s obligations, arising from life insurance contracted.
    • Non-life insurance provisions:
    • Provisions for unearned premiums. These provisions are intended for the accrual, at the date of calculation, of the premiums written. Their balance reflects the portion of the premium received until year-end that has to be allocated to the period between the year-end and the end of the policy period.
    • Provisions for unexpired risks: The provision for unexpired risks supplements the provision for unearned premiums by the amount by which that provision is not sufficient to reflect the assessed risks and expenses to be covered by the consolidated insurance subsidiaries in the policy period not elapsed at year-end.
    • Provision for claims:
    • This reflects the total amount of the outstanding obligations arising from claims incurred prior to year-end. Insurance subsidiaries calculate this provision as the difference between the total estimated or certain cost of the claims not yet reported, settled or paid, and the total amounts already paid in relation to these claims.
    • Provision for bonuses and rebates:
    • This provision includes the amount of the bonuses accruing to policyholders, insurees or beneficiaries and the premiums to be returned to policyholders or insurees, as the case may be, based on the behavior of the risk insured, to the extent that such amounts have not been individually assigned to each of them.
    • Technical provisions for reinsurance ceded:
    • Calculated by applying the criteria indicated above for direct insurance, taking account of the assignment conditions established in the reinsurance contracts in force.
    • Other technical provisions:
    • Insurance entities have recognized provisions to cover the probable mismatches in the market reinvestment interest rates with respect to those used in the valuation of the technical provisions.

    The BBVA Group controls and monitors the exposure of the insurance subsidiaries to financial risk and, to this end, uses internal methods and tools that enable it to measure credit risk and market risk and to establish the limits for these risks.

    2.2.10 Tax assets and liabilities

    Expenses on corporate income tax applicable to the BBVA Group's Spanish entities and on similar income taxes applicable to consolidated foreign entities are recognized in the consolidated income statement, except when they result from transactions on which the profits or losses are recognized directly in equity, in which case the related tax effect is also recognized in equity.

    The total corporate income tax expense is calculated by aggregating the current tax arising from the application of the corresponding tax rate as per the tax base for the year (after deducting the tax credits or discounts allowable for tax purposes) and the change in deferred tax assets and liabilities recognized in the consolidated income statement.

    Deferred tax assets and liabilities include temporary differences, defined as the amounts to be payable or recoverable in future years arising from the differences between the carrying amount of assets and liabilities and their tax bases (the “tax value”), and tax loss and tax credit or discount carry forwards (see Note 19).

    The "Tax Assets" line item in the accompanying consolidated balance sheets includes the amount of all the assets of a tax nature, broken down into: "Current” (amounts of tax recoverable in the next twelve months) and "Deferred" (which includes the amount of tax to be recovered in future years, including those arising from tax losses or credits for deductions or rebates that can be compensated). The "Tax Liabilities" line item in the accompanying consolidated balance sheets includes the amount of all the liabilities of a tax nature, except for provisions for taxes, broken down into: "Current” (income tax payable on taxable profit for the year and other taxes payable in the next twelve months) and "Deferred" (the amount of corporate tax payable in subsequent years).

    Deferred tax liabilities attributable to taxable temporary differences associated with investments in subsidiaries, associates or joint venture entities are recognized as such, except where the Group can control the timing of the reversal of the temporary difference and it is unlikely that it will reverse in the future. Deferred tax assets are recognized to the extent that it is considered probable that the consolidated entities will have sufficient taxable profits in the future against which the deferred tax assets can be utilized and are not from the initial recognition (except in the case of a business combination) of other assets or liabilities in a transaction that does not affect the fiscal outcome or the accounting result.

    The deferred tax assets and liabilities recognized are reassessed by the consolidated entities at each balance sheet date in order to ascertain whether they still qualify as deferred tax assets and liabilities, and the appropriate adjustments are made on the basis of the findings of the analyses performed. In those circumstances in which it is unclear how a specific requirement of the tax law applies to a particular transaction or circumstance, and the acceptability of the definitive tax treatment depends on the decisions taken by the relevant taxation authority in future, the entity recognizes current and deferred tax liabilities and assets considering whether it is probable or not that a taxation authority will accept an uncertain tax treatment. Thus, if the entity concludes that it is not probable that the taxation authority will accept an uncertain tax treatment, the entity uses the amount expected to be paid to (recovered from) the taxation authorities.

    The income and expenses directly recognized in consolidated equity that do not increase or decrease taxable income are accounted for as temporary differences.

    2.2.11 Provisions, contingent assets and contingent liabilities

    The heading “Provisions” in the consolidated balance sheets includes amounts recognized to cover the BBVA Group's current obligations arising as a result of past events. These are certain in terms of nature but uncertain in terms of amount and/or settlement date. The settlement of these obligations is deemed likely to entail an outflow of resources embodying economic benefits (see Note 24). The obligations may arise in connection with legal or contractual provisions, valid expectations formed by Group entities relative to third parties in relation to the assumption of certain responsibilities or through virtually certain developments of particular aspects of the regulations applicable to the operation of the entities; and, specifically, future legislation to which the Group will certainly be subject. The provisions are recognized in the consolidated balance sheets when each and every one of the following requirements is met:

    • They represent a current obligation that has arisen from a past event. At the date of the Consolidated Financial Statements, there is more probability that the obligation will have to be met than that it will not.
    • It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation.
    • The amount of the obligation can be reasonably estimated.

    Among other items, these provisions include the commitments made to employees by some of the Group entities (mentioned in Note 2.2.12), as well as provisions for tax and legal litigation.

    Contingent assets are possible assets that arise from past events and whose existence is conditional on, and will be confirmed only by, the occurrence or non-occurrence of events beyond the control of the Group. Contingent assets are not recognized in the consolidated balance sheet or in the consolidated income statement; however, they will be disclosed, should they exist, in the Notes to the Consolidated Financial Statements, provided that it is probable will give rise to an increase in resources embodying economic benefits.

    Contingent liabilities are possible obligations of the Group that arise from past events and whose existence is conditional on the occurrence or non-occurrence of one or more future events beyond the control of the Group. They also include the existing obligations of the Group when it is not probable that an outflow of resources embodying economic benefits will be required to settle them; or when, in extremely rare cases, their amount cannot be measured with sufficient reliability.

    Contingent liabilities are not recognized in the consolidated balance sheet or the income statement (excluding contingent liabilities from business combination) but are disclosed in the Notes to the Consolidated Financial Statements, unless the possibility of an outflow of resources embodying economic benefits is remote.

    2.2.12 Pensions and other post-employment commitments

    Below we provide a description of the most significant accounting policies relating to post-employment and other employee benefit commitments assumed by BBVA Group entities (see Note 25).

    Short-term employee benefits

    Benefits for current active employees which are accrued and settled during the year and for which a provision is not required in the entity´s accounts. These include wages and salaries, social security charges and other personnel expenses.

    Costs are charged and recognized under the heading “Administration costs – Personnel expenses – Other personnel expenses” of the consolidated income statement (see Note 44.1).

    Post-employment benefits – Defined-contribution plans

    The Group sponsors defined-contribution plans for the majority of its active employees. The amount of these benefits is established as a percentage of remuneration and/or as a fixed amount.

    The contributions made to these plans in each year by BBVA Group entities are charged and recognized under the heading “Administration costs – Personnel expenses – Defined-contribution plan expense” of the consolidated income statement (see Note 44.1).

    Post-employment benefits – Defined-benefit plans

    Some Group entities maintain pension commitments with employees who have already retired or taken early retirement, certain closed groups of active employees still accruing defined benefit pensions, and in-service death and disability benefits provided to most active employees. These commitments are covered by insurance contracts, pension funds and internal provisions.

    In addition, some of the Spanish entities have offered certain employees the option to retire before their normal retirement age, recognizing the necessary provisions to cover the costs of the associated benefit commitments, which include both the liability for the benefit payments due as well as the contributions payable to external pension funds during the early retirement period.

    Furthermore, certain Group entities provide welfare and medical benefits which extend beyond the date of retirement of the employees entitled to the benefits.

    All of these commitments are quantified based on actuarial valuations, with the amounts recorded under the heading “Provisions – Provisions for pensions and similar obligations” in the consolidated balance sheet and determined as the difference between the value of the defined-benefit commitments and the fair value of plan assets at the date of the Consolidated Financial Statements (see Note 25).

    Current service cost are charged and recognized under the heading “Administration costs – Personnel expenses – Defined-benefit plan expense” of the consolidated income statement (see Note 44.1).

    Interest credits/charges relating to these commitments are charged and recognized under the headings “Interest and other income” and “Interest expense” of the consolidated income statement (see Note 37).

    Past service costs arising from benefit plan changes as well as early retirements granted during the year are recognized under the heading “Provisions or reversals of provisions” of the consolidated income statement (see Note 46).

    Other long-term employee benefits

    In addition to the above commitments, certain Group entities provide long-term service awards to their employees, consisting of monetary amounts or periods of vacation granted upon completion of a number of years of qualifying service.

    These commitments are quantified based on actuarial valuations and the amounts recorded under the heading “Provisions – Other long-term employee benefits” of the consolidated balance sheet (see Note 24).

    Valuation of commitments: actuarial assumptions and recognition of gains/losses

    The present value of these commitments is determined based on individual member data. Active employee costs are determined using the “projected unit credit” method, which treats each period of service as giving rise to an additional unit of benefit and values each unit separately.

    In establishing the actuarial assumptions we take into account that:

    • They should be unbiased, i.e. neither unduly optimistic nor excessively conservative.
    • Each assumption does not contradict the others and adequately reflect the existing relationship between economic variables such as price inflation, expected wage increases, discount rates and the expected return on plan assets, etc. Future wage and benefit levels should be based on market expectations, at the balance sheet date, for the period over which the obligations are to be settled.
    • The interest rate used to discount benefit commitments is determined by reference to market yields, at the balance sheet date, on high quality bonds.

    The BBVA Group recognizes actuarial gains/losses relating to early retirement benefits, long service awards and other similar items under the heading “Provisions or reversal of provisions” of the consolidated income statement for the period in which they arise (see Note 46). Actuarial gains/losses relating to pension and medical benefits are directly charged and recognized under the heading "Accumulated other comprehensive income – Items that will not be reclassified to profit or loss – Actuarial gains or losses on defined benefit pension plans" of equity in the consolidated balance sheet (see Note 30).

    2.2.13 Equity-settled share-based payment transactions

    Provided they constitute the delivery of such equity instruments following the completion of a specific period of services, equity-settled share-based payment transactions are recognized as an expense for services being provided by employees, by way of a balancing entry under the heading “Shareholders’ funds – Other equity instruments” in the consolidated balance sheet. These services are measured at fair value for the employees services received, unless such fair value cannot be calculated reliably. In such case, they are measured by reference to the fair value of the equity instruments granted, taking into account the date on which the commitments were granted and the terms and other conditions included in the commitments.

    When the initial compensation agreement includes what may be considered market conditions among its terms, any changes in these conditions will not be reflected in the consolidated income statement, as these have already been accounted for in calculating the initial fair value of the equity instruments. Non-market vesting conditions are not taken into account when estimating the initial fair value of equity instruments, but they are taken into account when determining the number of equity instruments to be issued. This will be recognized on the consolidated income statement with the corresponding increase in total consolidated equity.

    2.2.14 Termination benefits

    Termination benefits are recognized in the financial statements when the BBVA Group agrees to terminate employment contracts with its employees and has established a detailed plan.

    2.2.15 Treasury shares

    The value of common stock issued by the BBVA Group's entities and held by them - basically, shares and derivatives on the Bank’s shares held by some consolidated entities that comply with the requirements to be recognized as equity instruments - are recognized as a decrease to net equity, under the heading "Shareholders’ funds - Treasury stock" in the consolidated balance sheets (see Note 29).

    These financial assets are recognized at acquisition cost, and the gains or losses arising on their disposal are credited or debited, as appropriate, to the heading “Shareholders’ funds - Retained earnings” in the consolidated balance sheets (see Note 28).

    2.2.16 Foreign-currency transactions and exchange differences

    The BBVA Group's functional currency, and thus the currency in which the Consolidated Financial Statements are presented, is the euro. As such, all balances and transactions denominated in currencies other than the euro are deemed to be denominated in “foreign currency”.

    Conversion to euros of the balances held in foreign currency is performed in two consecutive stages:

    • Conversion of the foreign currency to the entity’s functional currency (currency of the main economic environment in which the entity operates); and
    • Conversion to euros of the balances held in the functional currencies of the entities whose functional currency is not the euro.
    Conversion of the foreign currency to the entity’s functional currency

    Transactions denominated in foreign currencies carried out by the consolidated entities (or entities accounted for using the equity method) are initially accounted for in their respective currencies. Subsequently, the monetary balances in foreign currencies are converted to their respective functional currencies using the exchange rate at the close of the financial year. In addition,

    • Non-monetary items valued at their historical cost are converted to the functional currency at the exchange rate applicable on the purchase date.
    • Non-monetary items valued at their fair value are converted at the exchange rate in force on the date on which such fair value was determined.
    • Income and expenses are converted at the period’s average exchange rates for all the operations carried out during the year. When applying this criterion the BBVA Group considers whether significant variations have taken place in exchange rates during the year which, owing to their impact on the statements as a whole, may require the application of exchange rates as of the date of the transaction instead of such average exchange rates.

    The exchange differences produced when converting the balances in foreign currency to the functional currency of the consolidated entities are generally recognized under the heading "Exchange differences, net" in the consolidated income statements (see Note 41). However, the exchange differences in non-monetary items, measured at fair value, are recognized temporarily in consolidated equity under the heading “Accumulated other comprehensive income - Items that may be reclassified to profit or loss - Exchange differences” in the consolidated balance sheets (see Note 30).

    Conversion of functional currencies to euros

    The balances in the financial statements of consolidated entities whose functional currency is not the euro are converted to euros as follows:

    • Assets and liabilities: at the closing spot exchange rates as of the date of each of the consolidated balance sheets.
    • Income and expenses and cash flows are converted by applying the exchange rate applicable on the date of the transaction, and the average exchange rate for the financial year may be used, unless it has undergone significant variations.
    • Equity items: at the historical exchange rates.

    The exchange differences arising from the conversion to euros of balances in the functional currencies of the consolidated entities whose functional currency is not the euro are recognized under the heading “Accumulated other comprehensive income – Items that may be reclassified to profit or loss - Exchange differences” in the consolidated balance sheets (Notes 30 and 31 respectively). Meanwhile, the differences arising from the conversion to euros of the financial statements of entities accounted for by the equity method are recognized under the heading " Accumulated other comprehensive income - Items that may be reclassified to profit or loss - Entities accounted for using the equity method" (Note 30) until the item to which they relate is derecognized, at which time they are recognized in the income statement.

    The financial statements of companies of hyperinflationary economies are restated for the effects of changes in prices before their conversion to euros following the provisions of IAS 29 "Financial information in hyperinflationary economies" (see note 2.2.20). Both these adjustments for inflation and the exchange differences that arise when converting the financial statements of companies into hyperinflationary economies are accounted for in Reserves.

    The breakdown of the main consolidated balances in foreign currencies, with reference to the most significant foreign currencies, is set forth in Appendix VII.

    Venezuela

    Local financial statements of the Group subsidiaries in Venezuela are expressed in Venezuelan Bolivar, and converted into euros for the consolidated financial statements, since Venezuela is a country with strong exchange restrictions and has different rates officially published. Since December 31, 2015, the Board of Directors considers that the use of the Venezuelan official exchanges rates for converting bolivars into euros in preparing the Consolidated Financial Statements does not reflect the true picture of the financial statements of the Group and the financial position of the Group subsidiaries in Venezuela. Therefore, since the year ended December 31, 2015, the exchange rate for converting bolivars into euros is an estimation taking into account the lack of official data and the evolution of the estimated inflation in Venezuela.

    As of December 31, 2018, 2017 and 2016, the impact on the financial statements that would have resulted by applying the last published official exchange rate instead of the exchange rate estimated by BBVA Group was not significant.

    2.2.17 Recognition of income and expenses

    The most significant policies used by the BBVA Group to recognize its income and expenses are as follows.

    • Interest income and expenses and similar items:

    • As a general rule, interest income and expenses and similar items are recognized on the basis of their period of accrual using the effective interest rate method.
    • They shall be recognized within the consolidated income statement according to the following criteria, independently from the financial instruments’ portfolio which generates the income or expenses:
    • The interest income past-due before the initial recognition and pending to be received will form part of the gross carrying amount of the debt instrument.
    • The interest income accrued after the initial recognition will form part of the gross carrying amount of the debt instrument until it will be received.
    • The financial fees and commissions that arise on the arrangement of loans and advances (basically origination and analysis fees) are deferred and recognized in the income statement over the expected life of the loan. From that amount, the transaction costs identified as directly attributable to the arrangement of the loans and advances will be deducted. These fees are part of the effective interest rate for the loans and advances.
    • Once a debt instrument has been impaired, interest income is recognized applying the effective interest rate used to discount the estimated recoverable cash flows on the carrying amount of the asset.
    • Income from dividends received:
    • Dividends shall be recognized within the consolidated income statement according to the following criteria, independently from the financial instruments’ portfolio which generates this income:
    • When the right to receive payment has been declared before the initial recognition and when the payment is pending to be received, the dividends will not form part of the gross carrying amount of the equity instrument and will not be recognized as income. Those dividends are accounted for as financial assets separately from the net equity instrument.
    • If the right to receive payment is received after the initial recognition, the dividends from the net equity instruments will be recognized within the consolidated income statement. If the dividends correspond indubitable to the profits of the issuer before the date of initial recognition, they will not be recognized as income but as reduction of the gross carrying amount of the equity instrument because it represents a partly recuperation of the investment. Amongst other circumstances, the generation date can be considered to be prior to the date of initial recognition if the amounts distributed by the issuer as from the initial recognition are higher than its profits during the same period.
    • Commissions, fees and similar items:
    • Income and expenses relating to commissions and similar fees are recognized in the consolidated income statement using criteria that vary according to the nature of such items. The most significant items in this connection are:
    • Those relating to financial assets and liabilities measured at fair value through profit or loss, which are recognized when collected/paid.
    • Those arising from transactions or services that are provided over a period of time, which are recognized over the life of these transactions or services.
    • Those relating to a singular transaction, which are recognized when this singular transaction is carried out.
    • Non-financial income and expenses:
    • These are recognized for accounting purposes on an accrual basis.
    • Deferred collections and payments:
    • These are recognized for accounting purposes at the amount resulting from discounting the expected cash flows at market rates.

    2.2.18 Sales of assets and income from the provision of non-financial services

    The heading “Other operating income” in the consolidated income statements includes the proceeds of the sales of assets and income from the services provided by the Group entities that are not financial institutions. In the case of the Group, these entities are mainly real estate and service entities (see Note 42).

    2.2.19 Leases

    Lease contracts are classified as finance leases from the inception of the transaction if they substantially transfer all the risks and rewards incidental to ownership of the asset forming the subject-matter of the contract. Leases other than finance leases are classified as operating leases.

    When the consolidated entities act as the lessor of an asset under finance leases, the aggregate present values of the lease payments receivable from the lessee plus the guaranteed residual value (normally the exercise price of the lessee’s purchase option on expiration of the lease agreement) are recognized as financing provided to third parties and, therefore, are included under the heading “Loans and receivables” in the accompanying consolidated balance sheets (see Note 14).

    When the consolidated entities act as lessors of an asset in operating leases, the acquisition cost of the leased assets is recognized under "Tangible assets – Property, plant and equipment – Other assets leased out under an operating lease" in the consolidated balance sheets (see Note 17). These assets are depreciated in line with the criteria adopted for items of tangible assets for own use, while the income arising from the lease arrangements is recognized in the consolidated income statements on a straight-line basis within "Other operating expenses" (see Note 42).

    If a fair value sale and leaseback results in an operating lease, the profit or loss generated from the sale is recognized in the consolidated income statement at the time of sale. If such a transaction gives rise to a finance lease, the corresponding gains or losses are accrued over the lease period.

    The assets leased out under operating lease contracts to other entities in the Group are treated in the Consolidated Financial Statements as for own use, and thus rental expense and income is eliminated in consolidation and the corresponding depreciation is recognized.

    2.2.20 Entities and branches located in countries with hyperinflationary economies

    In accordance with the IFRS-EU criteria, to determine whether an economy has a high inflation rate the country's economic situation is examined, analyzing whether certain circumstances are fulfilled, such as whether the population prefers to keep its wealth or save in non-monetary assets or in a relatively stable foreign currency, whether prices can be set in that currency, whether interest rates, wages and prices are pegged to a price index or whether the accumulated inflation rate over three years reaches or exceeds 100%. The fact that any of these circumstances is fulfilled will not be a decisive factor in considering an economy hyperinflationary, but it does provide some reasons to consider it as such.

    Argentina

    In 2018, the Argentinian economy was considered to be hyperinflationary as defined by the aforementioned criteria. Accordingly, as of December 31, 2018, it was necessary to adjust the financial statements of the Group's subsidiaries based in Argentina to correct for the effect of inflation.

    Pursuant to the requirements of IAS 29, the monetary headings (mainly loans and credits) have not been re-expressed, while the non-monetary headings (mainly tangible fixed assets and equity) have been re expressed in accordance with the change in the country's Consumer Price Index.

    The accumulated historical differences between the re-expressed costs and the previous costs in the non-monetary headings as of December 31, 2017 were credited to “Equity” in the balance sheet, effective on January 1, 2018, while the differences corresponding to 2018, and the re-expression of results were recognized in the consolidated income statement for 2018 in accordance with the nature of the income and expenses.

    During the year ended December 31, 2018 there was a reclassification in “Transfers within total equity” of the Consolidated Statements of Changes in Equity between “Accumulated other comprehensive income” and “Shareholders’ funds – Retained earnings” for €1,096 million, and from “Non-controlling interest – Accumulated other comprehensive income (loss)” to “Non-controlling interest – Other” for €540 million in accordance with IAS 29 and to the accounting policy approved by the Group in relation to the hyperinflation (see Note 1.3).

    During 2018, the increase in the reserves of Group entities located in Argentina derived from the re-expression for hyperinflation (IAS 29) amounts to €703 million, of which €463 million have been registered within “Shareholders’ funds - Retained earnings” and €240 million within “Minority interests – Other”. Furthermore, during the financial year 2018 the decrease in the reserves of Group entities located in Argentina derived from conversion (IAS 21) amounts to €-773 million, of which €-515 million have been registered within “Shareholders’ funds - Retained earnings”, and €-258 million within “Minority interests – Other”. The net impact of both effects is presented under the caption “Other increases or (-) decreases in equity” in the consolidated Statement of Changes in Equity for the year ended December 31, 2018. The net loss in the profit attributable to the parent company of the Group in 2018 derived from the application of IAS 29 amounted to €209 million. In addition, there is a net loss in the profit attributable to the parent company of the Group in 2018 derived from the application of IAS 21 which amounted to €57 million.

    The breakdown of the General Price Index (“GPI”) and the inflation index used as of December 31, 2018 for the inflation restatement of the financial statements of the Group companies located in Argentina is as follows:

    General Price Index

    2018
    GPI 184
    Average GPI 152
    Inflation of the period 48%

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    Venezuela

    Since 2009, the economy of Venezuela can be considered hyperinflationary under the above criteria. As a result, the financial statements of the BBVA Group’s entities located in Venezuela have therefore been adjusted to correct for the effects of inflation in accordance with IAS 29 “Financial Reporting in Hyperinflationary Economies“. As stated in Note 1.3, BBVA has restated prior year information.

    The losses recognized under the heading “Profit attributable to the parent company” in the accompanying consolidated income statement as a result of the adjustment for inflation on net monetary position of the Group entities in Venezuela amounted to €12, €13 and €28 million in 2018, 2017 and 2016 respectively (see Note 2.2.16).

    2.3 Recent IFRS pronouncements

    Changes introduced in 2018

    The following amendments to the IFRS standards or their interpretations (hereinafter “IFRIC”) became effective on or after January 1, 2018.

    IFRS 9 - “Financial instruments”

    IFRS 9 replaced IAS 39 for financial statements from January 1, 2018 onwards and includes new classification and measurement requirements for financial assets and liabilities and impairment requirements for financial assets (see Note 2.2.1).

    Regarding the hedge accounting, the Group has elected to continue applying IAS 39 to its hedge accounting as permitted by IFRS 9.

    Amended IFRS 9 – Prepayment Features with Negative Compensation

    The amendments to IFRS 9 allow entities to measure certain prepayable financial assets with negative compensation at amortized cost or at fair value through other comprehensive income if a specified condition is met, instead of at fair value through profit or loss. The condition is that the financial asset would otherwise meet the criteria of having contractual cash flows that are solely payments of principal and interest but do not meet that condition only as a result of that prepayment feature.

    The amendments should be applied to the accounting periods beginning on or after January 1, 2019, although early application is permitted. The Group has applied this amendment to the accounting period beginning on January 1, 2018 and it has not had a significant impact on the Group´s financial statements.

    Amended IFRS 7 - “Financial instruments: Disclosures”

    The IASB modified IFRS 7 in December 2011 to include new disclosures on financial instruments that entities will have to provide in the period that they apply IFRS 9 for the first time.

    IFRS 15 - “Revenue from contracts with customers”

    IFRS 15 contains the principles that an entity shall apply to account for revenue and cash flows arising from a contract with a customer (see Note 2.2.17).

    The core principle of IFRS 15 is that a company should recognize revenue to depict the transfer of promised goods or services to the customer in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services, in accordance with contractual agreements (either over time or at a certain time). It is considered that the good or service is transferred when the customer obtains control over it.

    The new Standard replaces IAS 18 – Revenue, IAS 11 - Construction Contracts, IFRIC 13 - Customer Loyalty Programmes, IFRIC 15 - Agreements for the Construction of Real Estate, IFRIC 18 - Transfers of Assets from Customers and SIC 31 – Revenue-Transactions Involving Advertising Services.

    This standard has not had a significant impact on the Group's Consolidated Financial Statements.

    IFRS 2 – “Classification and Measurement of Share-based Payment Transactions”

    The amendments made to IFRS 2 provide requirements on three different aspects:

    • When measuring the fair value of a cash-settled share-based payment vesting conditions, other than market conditions, the conditions for the irrevocability shall be taken into account by adjusting the number of awards included in the measurement of the liability arising from the transaction.
    • A transaction in which an entity settles a share-base payment arrangement net by withholding a specified portion of the equity instruments to meet a statutory tax withholding obligation will be classified as equity settled in its entirety if, without the net settlement feature, the entire share-based payment would otherwise be classified as equity-settled.
    • In case of modification of a share-based payment from cash-settled to equity-settled, the modification will be accounted for derecognizing the original liability and recognizing in equity the fair value of the equity instruments granted to the extent that services have been rendered up to the modification date; any difference will be recognized immediately in profit or loss.

    This standard has not had a significant impact on the Group's Consolidated Financial Statements.

    Amended IFRS 4 – “Insurance Contracts”

    The amendments made to IFRS 4 address the temporary accounting consequences of the different effective dates of IFRS 9 and the forthcoming insurance contracts standard, by introducing two optional solutions:

    • The deferral approach or temporary exemption, that gives entities whose predominant activities are connected with insurance the option to defer the application of IFRS 9 and continue applying IAS 39 until 2021.
    • The overlay approach, that gives all issuers of insurance contracts the option to recognize in other comprehensive income, rather than profit or loss, the additional accounting volatility that may arise from applying IFRS 9 compared to applying IAS 39 before applying the forthcoming insurance contracts standard.

    This standard has not had a significant impact on the Group's Consolidated Financial Statements.

    Annual improvements cycle to IFRSs 2014-2016 – Minor amendments to IFRS 1 and IAS 28

    The annual improvements cycle to IFRSs 2014-2016 includes minor changes and clarifications to IFRS 1- First-time Adoption of International Financial Reporting Standards and IAS 28 – Investments in Associates and Joint Ventures, which should be applied to the accounting periods beginning on or after January 1, 2018, although early application was permitted for modifications to IAS 28.

    This standard has not had a significant impact on the Group's Consolidated Financial Statements.

    IFRIC 22 – Foreign Currency Transactions and Advance Consideration

    The Interpretation addresses how to determine the date of the transaction, and thus, the exchange rate to use to translate the related asset, expense or income on initial recognition, in circumstances in which a non-monetary prepayment asset or a non-monetary deferred income liability arising from the payment or receipt of advance consideration is recognized in advance of the related asset, income or expense. It requires that the date of the transaction will be the date on which an entity initially recognizes the non-monetary asset or non-monetary liability.

    If there are multiple payments or receipts in advance, the entity shall determine a date of the transaction for each payment or receipt of advance consideration.

    This standard has not had a significant impact on the Group's consolidated financial statements.

    Amended IAS 40 – Investment Property

    The amendment states that an entity shall transfer a property to, or from, investment property when, and only when, there is evidence of a change in use. A change in use occurs when the property meets, or ceases to meet, the definition of investment property.

    This standard has not had a significant impact on the Group's financial statements.

    Standards and interpretations issued but not yet effective as of December 31, 2018

    The following new International Financial Reporting Standards together with their interpretations had been published at the date of preparation of the accompanying consolidated financial statements, but are not mandatory as of December 31, 2018. Although in some cases the IASB allows early adoption before their effective date, the BBVA Group has not proceeded with this option for any such new standards.

    Amended IFRS 10 – “Consolidated financial statements” and IAS 28 amended

    The amendments to IFRS 10 and IAS 28 establish that when an entity sells or transfers assets which are considered a business (including its consolidated subsidiaries) to an associate or joint venture of the entity, the latter will have to recognize any gains or losses derived from such transaction in its entirety. Notwithstanding, if the assets sold or transferred are not considered a business, the entity will have to recognize the gains or losses derived only to the extent of the interests in the associate or joint venture with unrelated investors.

    These changes will be applicable to accounting periods beginning on the effective date, still to be determined, although early adoption is allowed.

    IFRS 16 – “Leases”

    On January 13, 2016, the IASB issued IFRS 16 which will replace IAS 17 “Leases” for financial statements from January 1, 2019 onwards. The new standard introduces a single lessee accounting model and will require a lessee to recognize assets and liabilities for all leases. The only exceptions are short-term contracts and those in which the underlying assets have low value. A lessee will be required to recognize a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments.

    With regard to lessor accounting, IFRS 16 substantially carries forward the lessor accounting requirements in IAS 17. Accordingly, a lessor will continue to classify its leases as operating leases or finance leases, and account for those two types of leases differently.

    During the financial years 2017 and 2018 the Group has carried out a project to implement IFRS 16 with the participation of all affected areas. The standard will mainly affect the accounting of operating leases of the Group.

    With regard to the estimated impact on the Consolidated Financial Statements, at the transition date, the Group has decided to apply the modified retrospective approach which requires recognition of a lease liability equal to the present value of the future payments committed on January 1, 2019. Regarding the measurement of the right-of-use asset, the Group has elected to record an amount equal to the lease liability. As a result of this approach, the Group expects to recognize assets for the right-of-use and lease liabilities for an approximate amount of 3,600 million euros mainly coming from the Group's activity in Spain as well as from bank branches leases. The estimated impact in terms of capital (CET1) for the Group amounts to -12 basis points.

    The final impact of adopting the standard as of January 1, 2019 may change because:

    • the Group has not concluded the tests;
    • the new accounting policies, methodologies and parameters may be subject to changes until the Group presents its financial statements that include the final impact as of the date of initial application.
    IFRS 17 – Insurance Contracts

    IFRS 17 establishes the principles for the accounting for insurance contracts and supersedes IFRS 4. The new standard introduces a single accounting model for all insurance contracts and requires the entities to use updated assumptions.

    An entity shall divide the contracts into groups and recognize and measure groups of insurance contracts at the total of:

    • the fulfilment cash flows, that comprises the estimate of future cash flows, an adjustment to reflect the time value of money and the financial risk associated with the future cash flows and a risk adjustment for non-financial risk; and
    • the contractual service margin that represents the unearned profit.

    The amounts recognized in the consolidated income statement shall be disaggregated into insurance revenue, insurance service expenses and insurance finance income or expenses. Insurance revenue and insurance service expenses shall exclude any investment components. Insurance revenue shall be recognized over the period the entity provides insurance coverage and in proportion to the value of the provision of coverage that the insurer provides in the period.

    This Standard will be applied to the accounting years starting on or after January 1, 2021.

    IFRIC 23 - Uncertainty over Income Tax Treatments

    IFRIC 23 provides guidance on how to apply the recognition and measurement requirements in IAS 12 when there is uncertainty over income tax treatments.

    If the entity considers that it is probable that the taxation authority will accept an uncertain tax treatment, the Interpretation requires the entity to determine taxable profit (tax loss), tax bases, unused tax losses, unused tax credits or tax rates consistently with the tax treatment used or planned to be used in its income tax filings.

    If the entity considers that it is not probable that the taxation authority will accept an uncertain tax treatment, the Interpretation requires the entity to use the most likely amount or the expected value (sum of the probability. weighted amounts in a range of possible outcomes) in determining taxable profit (tax loss), tax bases, unused tax losses, unused tax credits and tax rates. The method used should be the method that the entity expects to provide the better prediction of the resolution of the uncertainty.

    The interpretation will be applied to the accounting periods beginning on or after January 1, 2019.

    Amended IAS 28 – Long-term Interests in Associates and Joint Ventures

    The amendments to IAS 28 clarify that an entity is required to apply IFRS 9 to long term interests in an associate or joint venture that, in substance, form part of the net investment in the associate or joint venture but to which the equity method is not applied.

    The amendments will be applied to the accounting periods beginning on or after January 1, 2019.

    Annual improvements cycle to IFRSs 2015-2017

    The annual improvements cycle to IFRSs 2015-2017 includes minor changes and clarifications to IFRS 3- Business Combinations, IFRS 11 – Joint Arrangements, IAS 12 – Income Taxes and IAS 23 – Borrowing Costs, which will be applied to the accounting periods beginning on or after January 1, 2019, although early application is permitted.

    Amended IAS 19 – Plan Amendment, Curtailment or Settlement

    The small amendments in IAS 19 concern the cases if a plan is amended, curtailed or settled during the period. In these cases, an entity should ensure that the current service cost and the net interest for the period after the remeasurement are determined using the assumptions used for the remeasurement. In addition, amendments have been included to clarify the effect of a plan amendment, curtailment or settlement on the requirements regarding the asset ceiling.

    The amendments will be applied to the accounting periods beginning on or after January 1, 2019.

    Amended IFRS 3 – Definition of a business

    The amendments clarify the difference between the acquisition of a business or the acquisition of a set of assets. To determine whether a transaction is an acquisition of a business, an entity should evaluate and conclude if the two following conditions are fulfilled:

    • the fair value of the acquired assets is not concentrated in one single asset or group of similar assets.
    • the entirety of acquired activities and assets includes, as a minimum, an input and a substantial process which, together, contribute to the capacity to create products.

    The amendments will be applied to the accounting periods beginning on or after January 1, 2020, although early application is permitted.

    Amended IAS 1 and IAS 8 – Definition of material

    The amendments clarify the definition of material in the elaboration of the financial statements by aligning the definition of the conceptual framework, IAS 1 and IAS 8 (which, before the amendments, included similar but not identical definitions). The new definition of material is the following: “Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity”.

    The amendments will be applied to the accounting periods beginning on or after January 1, 2020, although early application is permitted.

    2.4 Transition to IFRS 9 and condensed consolidated opening balance sheet as of January 1, 2018

    2.4.1 Transition to IFRS 9

    As mentioned in the Notes 1.3, 2.2.1 and 2.3, IFRS 9 replaced IAS 39 for financial statements from January 1, 2018 onwards and includes new classification and measurement requirements for financial assets and liabilities, impairment requirements for financial assets and hedge accounting policy.

    The application of this standard on January 1, 2018, had a significant impact on the consolidated financial statements of the Group at that date.

    Classification and measurement of financial instruments
    Financial assets

    IFRS 9 has a new approach to classification and measurement of financial assets which is a mirror of the business model used for asset management purposes and its cash flow characteristics.

    IFRS 9 contains three main categories for financial assets classification: valued at amortized cost, valued at fair value with changes in other accumulated comprehensive income, and valued at fair value through profit or loss. The standard eliminates the IAS 39 categories of held-to-maturity investments, loans and receivables, and available-for-sale financial assets.

    The classification of financial instruments measured at amortized cost or fair value must be carried out on the basis of: the entity's business model and the assessment of the contractual cash flow, commonly known as the "solely payments of principle and interest" criterion (hereinafter, the SPPI). The purpose of the SPPI test is to determine whether in accordance with the contractual characteristics of the instrument its cash flows only represent the return of the principal and interest, basically understood as consideration for the time value of money and the debtor's credit risk.

    A financial instrument will be classified in the amortized cost portfolio when it is managed with a business model whose purpose is to maintain the financial assets to receive contractual cash flows, and passes the SPPI test. They will be classified in the portfolio of financial assets at fair value with changes in other comprehensive income if they are managed with a business model whose purpose combines collection of the contractual cash flows and sale of the assets, and meets the SPPI test. They will be classified at fair value with changes in profit and loss provided that the entity's business model for their management or the contractual characteristics of its cash flows do not require classification into one of the portfolios described above.

    The Group reviewed the existing business models in the geographic areas where it operates to establish classification in accordance with IFRS 9, taking into account the special characteristics of the local structures and organizations, as well as the type of products.

    The Group has defined criteria to determine the acceptable frequency and reasons for sales so that the instrument can remain in the category of held to collect contractual cash flows.

    Regardless of the frequency and importance of the sales, some types of sales are not incompatible with the category of held to collect contractual flows: sales due to reduction in credit quality; sales close to the maturity of transactions so that variations in market prices will not have a significant effect on the cash flows of the financial asset; sales in response to a change in regulations or in taxation; sales in response to an internal restructuring or significant business combination; sales derived from the execution of a liquidity crisis plan when the crisis event is not reasonably foreseeable.

    The Group segmented the portfolio of instruments for carrying out the SPPI test by differentiating products with standard contracts (all the instruments have identical contractual characteristics and are broadly used), for which the Group has carried out the SPPI test by reviewing the standard framework contract. For those products with similar, but not identical characteristics compliance has been assessed through a sampling exercise of contracts. All the financial instruments with specific contractual characteristics have been analyzed individually.

    As a result of the analyses carried out on both the business model and the contractual characteristics, certain accounting reclassifications resulted affecting both financial assets and, as the case may be, financial liabilities related to those assets. In general, there is a greater volume of assets valued at fair value with changes in the income statement and the valuation method of some instruments has also been changed according to the one that best reflects the business model to which they belong. Changes in the valuation model to avoid exceeding the criterion of solely payment of principal and interest are not significant.

    As of December 31, 2017, the Group had certain investments in financial instruments classified as available-for-sale which, in accordance with IFRS 9, the Group designated as financial assets at fair value through other comprehensive income. As a result, all the gains and losses at fair value of these instruments are now reported in accumulated other comprehensive income. Impairment losses would not be recognized to profit and loss, and gains or losses would not be reclassified to the income statement in the case of divestment. The remaining investments held by the Group as of December 31, 2017 in equity instruments classified as available-for-sale are now accounted for as fair value through changes in profit or loss.

    Financial liabilities

    IFRS 9 largely maintains the requirements under IAS 39 for classifying financial liabilities. However, a new aspect introduced by IFRS 9 is the recognition of changes in the fair value of the financial liabilities to which the fair value option is applied. In this case, the changes in the fair value attributable to the credit risk itself are recognized as other comprehensive income, while the rest of the variation is recognized in the income statement. In any case, the variation of credit risk itself may be recognized in the income statement if the treatment described above generates accounting asymmetry.

    Financial assets impairments

    IFRS 9 replaced the "incurred loss" model in IAS 39 with one of "expected credit loss". The IFRS 9 impairment model is applied to financial assets valued at amortized cost and to financial assets valued at fair value through other comprehensive income, except for investments in equity instruments and contracts for financial guarantees and loan commitments unilaterally revocable by BBVA. Likewise, all the financial instruments valued at fair value with change through profit and loss are excluded from the impairment model.

    The new standard classifies financial instruments into three categories, which depend on the evolution of their credit risk from the moment of initial recognition. The first category includes the transactions when they are initially recognized (Stage 1); the second comprises the financial assets for which a significant increase in credit risk has been identified since its initial recognition (Stage 2) and the third one, the impaired financial assets (Stage 3).

    The calculation of the provisions for credit risk in each of these three categories must be done differently. In this way, expected loss up to 12 months for the financial assets classified in the first of the aforementioned categories must be recorded, while expected losses estimated for the remaining life of the financial assets classified in the other two categories must be recorded. Thus, IFRS 9 differentiates between the following concepts of expected loss:

    • Expected loss at 12 months: expected credit loss that arises from possible default events within 12 months following the presentation date of the financial statements; and
    • Expected loss during the life of the transaction: this is the expected credit loss that arises from all possible default events over the remaining life of the financial instrument.

    All this requires considerable judgment, both in the modeling for the estimation of the expected losses and in the forecasts, on how the economic factors affect such losses, which must be carried out on a weighted probability basis.

    The BBVA Group has applied the following definitions in accordance with IFRS 9:

    • Default

    BBVA has applied a definition of default for financial instruments that is consistent with that used in internal credit risk management, as well as the indicators under applicable regulation at the date of implementation of IFRS 9. Both qualitative and quantitative indicators have been considered.

    The Group has considered there is a default when one of the following situations occurs:

    • payment past-due for more than 90 days; or
    • there are reasonable doubts regarding the full reimbursement of the instrument.

    In accordance with IFRS 9, the 90-day past-due stipulation may be waived in cases where the entity considers it appropriate, based on reasonable and documented information that it is appropriate to use a longer term. As of December 31, 2018, the Group has not considered periods higher than 90 days for any of the significant portfolios.

    • Credit impaired asset

    An asset is credit-impaired according to IFRS 9 if one or more events have occurred and they have a detrimental impact on the estimated future cash flows of the asset. Evidence that a financial asset is credit-impaired includes observable data about the following events:

    • Significant financial difficulty of the issuer or the borrower.
    • A breach of contract (e.g. a default or past due event).
    • A lender having granted a concession to the borrower – for economic or contractual reasons relating to the borrower’s financial difficulty – that the lender would not otherwise consider.
    • It becoming probable that the borrower will enter bankruptcy or other financial reorganization.
    • The disappearance of an active market for that financial asset because of financial difficulties.
    • The purchase or origination of a financial asset at a deep discount that reflects the incurred credit losses.

    It may not be possible to identify a single discrete event. Instead, the combined effect of several events may cause financial assets to become credit-impaired.

    The definition of impaired financial assets in the Group is aligned with the definition of default explained in the above paragraphs.

    • Significant increase in credit risk

    The objective of the impairment requirements is to recognize lifetime expected credit losses for financial instruments for which there have been significant increases in credit risk since initial recognition considering all reasonable and supportable information, including that which is forward-looking.

    The model developed by the Group for assessing the significant increase in credit risk has a two-prong approach that is applied globally, although the specific characteristics of each geographic area are respected:

    • Quantitative criterion: the Group uses a quantitative analysis based on comparing the current expected probability of default over the life of the transaction with the original adjusted expected probability of default, so that both values are comparable in terms of expected default probability for their residual life. The thresholds used for considering a significant increase in risk take into account special cases according to geographic areas and portfolios. Depending on how old current financial assets are, at the time implementation of the standard, some simplification has been made to compare the probabilities of default between the current and the original moment, based on the best information available at that moment.
    • Qualitative criterion: most indicators for detecting significant risk increase are included in the Group's systems through rating/scoring systems or macroeconomic scenarios, so quantitative analysis covers the majority of circumstances. The Group will use additional qualitative criteria when it considers it necessary to include circumstances that are not reflected in the rating/score systems or macroeconomic scenarios used.
    • Additionally, instruments under one of the following circumstances are considered Stage 2:
    • More than 30 days past due. According to IFRS 9, default of more than 30 days is a presumption that can be rebutted in those cases in which the entity considers, based on reasonable and documented information, that such non-payment does not represent a significant increase in risk. As of December 31, 2018, the Group has not considered periods superior to 30 days for any of the significant portfolios.
    • Watch list: They are subject to special watch by the Risks units because they show negative signs in their credit quality, even though there may be no objective evidence of impairment.
    • Refinance or restructuring that does not show evidence of impairment.

    Although the standard introduces a series of operational simplifications or practical solutions for analyzing the increase in significant risk, the Group does not expect to use them as a general rule. However, for high-quality assets, mainly related to certain government institutions and bodies, the standard allows for considering that their credit risk has not increased significantly because they have a low credit risk at the presentation date.

    Thus the classification of financial instruments subject to impairment under the new IFRS 9 is as follows:

    • Stage 1– without significant increase in credit risk
    • Financial assets which are not considered to have significantly increased in credit risk have loss allowances measured at an amount equal to 12 months expected credit losses.
    • Stage 2– significant increases in credit risk
    • When the credit risk of a financial asset has increased significantly since the initial recognition, the impairment losses of that financial instrument is calculated as the expected credit loss during the entire life of the asset.
    • Stage 3 - Impaired
    • When there is objective evidence that the instrument is credit impaired, the financial asset is transferred to this category in which the provision for losses of that financial instrument is calculated as the expected credit loss during the entire life of the asset.
    Method for calculating expected loss

    In accordance with IFRS 9, the measurement of expected losses must reflect:

    • A considered and unbiased amount, determined by evaluating a range of possible results.
    • The time value of money.
    • Reasonable and supportable information that is available without undue cost or effort and that reflects current conditions and forecasts of future economic conditions.

    The Group measures the expected losses both individually and collectively. The purpose of the Group's individual measurement is to estimate expected losses for significant impaired instruments, or instruments classified in Stage 2. In these cases, the amount of credit losses is calculated as the difference between expected discounted cash flows at the effective interest rate of the transaction and the carrying amount of the instrument.

    For the collective measurement of expected losses the instruments are grouped into groups of assets based on their risk characteristics. Exposure within each group is segmented according to the common credit risk characteristics, similar characteristics of the credit risk, indicative of the payment capacity of the borrower in accordance with their contractual conditions. These risk characteristics have to be relevant in estimating the future flows of each group. The characteristics of credit risk may consider, among others, the following factors:

    • Type of instrument
    • Rating or scoring tools.
    • Credit risk scoring or rating.
    • Type of collateral.
    • Amount of time at default for stage 3.
    • Segment.
    • Qualitative criteria which can have a significant increase in risk.

    Collateral value if it has an impact on the probability of a default event.

    • The estimated losses are derived from the following parameters:
    • PD: estimate of the probability of default in each period.
    • EAD: estimate of the exposure in case of default at each future period, taking into account the changes in exposure after the presentation date of the financial statements.
    • LGD: estimate of the loss in case of default, calculated as the difference between the contractual cash flows and receivables, including guarantees.

    In the case of debt securities, the Group supervises the changes in credit risk through monitoring the external published credit ratings.

    To determine whether there is a significant increase in credit risk that is not reflected in the published ratings, the Group has also revised the changes in bond yields, and when they are available, the prices of CDS, together with the news and regulatory information available on the issuers.

    Use of present, past and future information

    IFRS 9 requires incorporation of present, past and future information to detect any significant increase in risk and measure expected loss.

    The standard does not require identification of all possible scenarios for measuring expected loss. However, the probability of a loss event occurring and the probability it will not occur will also have to be considered, even though the possibility of a loss may be very small. Also, when there is no linear relation between the different future economic scenarios and their associated expected losses, more than one future economic scenario must be used for the measurement.

    The approach used by the Group consists of using first the most probable scenario (baseline scenario) consistent with that used in the Group's internal management processes, and then applying an additional adjustment, calculated by considering the weighted average of expected losses in other economic scenarios (one more positive and the other more negative). The main macroeconomic variables that are valued in each of the scenarios for each of the geographies in which the Group operates are GDP, tax rates, unemployment rate and LTV.

    2.4.2 Condensed consolidated opening balance sheet as of January 1, 2018

    Condensed Consolidated balance sheets (Millions of euros)

    ASSETS December 2017 IAS 39 Classification and
    measurement of
    financial
    instruments
    Impairment Opening
    balance sheet
    2018
    Cash, cash balances at central banks and other demand deposits 42,680 - - 42,680
    Financial assets held for trading 64,695 27,159 - 91,854
    Derivatives 35,265 - - 35,265
    Equity instruments 6,801 48 - 6,849
    Debt securities 22,573 - - 22,573
    Loans and advances to central banks - 245 - 245
    Loans and advances to credit institutions - 14,895 - 14,895
    Loans and advances to customers 56 11,970 - 12,026
    Non-trading financial assets mandatorily at fair value through profit or loss 4,451 - 4,451
    Financial assets designated at fair value through profit or loss 2,709 (1,690) - 1,019
    Financial assets at fair value through other comprehensive income 62,107 8 62,115
    Equity instruments 2,761 - 2,761
    Debt securities 59,293 8 59,301
    Loans and advances 140 - 140
    Available for sale financial assets 69,476 (69,476) -
    Financial assets at amortized cost 431,521 (8,680) (1,158) 421,685
    Debt securities 10,339 19,623 (3) 29,959
    Loans and advances to central banks 7,300 (245) - 7,055
    Loans and advances to credit institutions 26,261 (15,622) 22 10,661
    Loans and advances to customers 387,621 (12,435) (1,177) 374,009
    Held to maturity investments 13,754 (13,754) -
    Hedging derivatives 2,485 - - 2,485
    Fair value changes of the hedged items in portfolio hedges of interest rate risk (25) - - (25)
    Joint ventures, associates and unconsolidated subsidiaries 1,588 1 - 1,589
    Insurance and reinsurance assets 421 - - 421
    Tangible assets 7,191 - - 7,191
    Intangible assets 8,464 - - 8,464
    Tax assets 16,888 8 400 17,296
    Other assets 4,359 - - 4,359
    Non-current assets and disposal groups held for sale 23,853 (1) (21) 23,832
    TOTAL ASSETS 690,059 125 (770) 689,414

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    The change registered in the heading “Financial assets held for trading” is mainly due to financial assets affected by the activity of Global Markets, which are reclassified from "Financial assets at amortized cost".

    The change registered in the heading "Available for sale financial assets" are mainly due to the reclassification to the new heading "Financial assets at fair value through other comprehensive income".

    The change registered in the heading “Financial assets at amortized cost” is mainly due to the reclassification to the item "Financial assets held for trading".

    LIABILITIES AND EQUITY December 2017 IAS 39 Classification and
    measurement of
    financial
    instruments
    Impairment Opening
    balance sheet
    2018
    Financial liabilities held for trading 46,182 34,601 - 80,783
    Financial liabilities designated at fair value through profit or loss 2,222 3,273 - 5,495
    Financial liabilities at amortized cost 543,713 (37,595) - 506,118
    Deposits from central banks 37,054 (3,261) - 33,793
    Deposits from credit institutions 54,516 (19,381) - 35,135
    Customer Deposits 376,379 (12,690) - 363,689
    Debt certificates 63,915 (2,266) - 61,649
    Other financial liabilities 11,850 1 - 11,851
    Hedging derivatives 2,880 (112) - 2,768
    Fair value changes of the hedged items in portfolio hedges of interest rate risk (7) - - (7)
    Liabilities under insurance and reinsurance contracts 9,223 - - 9,223
    Provisions 7,477 - 125 7,602
    Tax liabilities 3,298 (24) 17 3,291
    Share capital repayable on demand - - - -
    Other liabilities 4,550 - - 4,550
    Liabilities included in disposal groups classified as held for sale 17,197 1 (10) 17,188
    TOTAL LIABILITIES 636,736 142 132 637,010
    SHAREHOLDERS’ FUNDS 53,283 71 (923) 52,432
    Capital 3,267 - - 3,267
    Share premium 23,992 - - 23,992
    Equity instruments issued other than capital - - - -
    Other equity 54 - - 54
    Retained earnings 23,612 71 (923) 22,760
    Revaluation reserves 12 - - 12
    Other reserves (35) - - (35)
    Less: Treasury shares (96) - - (96)
    Profit or loss attributable to owners of the parent 3,519 - - 3,519
    Less: Interim dividends (1,043) - - (1,043)
    ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (6,939) (109) 13 (7,036)
    MINORITY INTERESTS (NON-CONTROLLING INTEREST) 6,979 21 8 7,008
    TOTAL EQUITY 53,323 (17) (902) 52,404
    TOTAL EQUITY AND TOTAL LIABILITIES 690,059 125 (770) 689,414

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    The change registered in the heading “Financial liabilities held for trading” is mainly due to financial liabilities affected by the activity of Global Markets, which are reclassified from "Financial liabilities at amortized cost".

    The change registered in the heading “Financial liabilities at amortized cost” is mainly due to the reclassification to "Liabilities held for trading".

    3. BBVA Group

    The BBVA Group is an international diversified financial group with a significant presence in retail banking, wholesale banking, asset management and private banking. The Group also operates in other sectors such as insurance, real estate, operational leasing, etc.

    The following information is detailed in the Appendices of the Consolidated Financial Statements of the Group:

    • Appendix I shows relevant information related to the consolidated subsidiaries and structured entities.
    • Appendix II shows relevant information related to investments in subsidiaries, joint ventures and associates accounted for using the equity method.
    • Appendix III shows the main changes and notification of investments and divestments in the BBVA Group.
    • Appendix IV shows fully consolidated subsidiaries with more than 10% owned by non-Group shareholders.

    The following table sets forth information related to the Group's total assets as of December 31, 2018, 2017 and 2016, broken down by the Group's entities according to their activity:

    Contribution to Consolidated Group Total Assets. Entities by Main Activities (Millions of euros)

    2018 2017 2016
    Banks and other financial services 647,164 659,414 699,592
    Insurance and pension fund managing companies 26,732 26,134 26,831
    Other non-financial services 2,793 4,511 5,433
    Total 676,689 690,059 731,856

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    The total assets and results of operations broken down by the geographical areas, in which the BBVA Group operates, are included in Note 6.

    The BBVA Group's activities are mainly located in Spain, Mexico, South America, the United States and Turkey, with active presence in other countries, as shown below:

    • Spain
    • The Group's activity in Spain is mainly through Banco Bilbao Vizcaya Argentaria, S.A., which is the parent company of the BBVA Group. The Group also has other entities that operate in Spain’s banking sector, insurance sector, real estate sector, services and as operational leasing entities.
    • Mexico
    • The BBVA Group operates in Mexico, not only in the banking sector, but also in the insurance sector through Grupo Financiero Bancomer.
    • South America
    • The BBVA Group's activities in South America are mainly focused on the banking and insurance sectors, in the following countries: Argentina, Chile, Colombia, Peru, Paraguay, Uruguay and Venezuela. It has a representative office in Sao Paulo (Brazil).
    • The Group owns more than 50% of most of the entities based in these countries. Appendix I shows a list of the entities which, although less than 50% owned by the BBVA Group as of December 31, 2017, are consolidated (see Note 2.1).
    • The United States
    • The Group's activity in the United States is mainly carried out through a group of entities with BBVA Compass Bancshares, Inc. at their head, as well as, the New York BBVA branch and a representative office in Silicon Valley (California)
    • Turkey
    • The Group's activity in Turkey is mainly carried out through the Garanti Group.
    • Rest of Europe
    • The Group's activity in Europe is carried out through banks and financial institutions in Ireland, Switzerland, Italy, Netherlands, Romania and Portugal, branches in Germany, Belgium, France, Italy and the United Kingdom, and a representative office in Moscow.
    • Asia-Pacific
    • The Group's activity in this region is carried out through branches (in Taipei, Tokyo, Hong Kong Singapore and Shanghai) and representative offices (in Beijing, Seoul, Mumbai, Abu Dhabi and Jakarta).
    Main transactions in the Group in 2018
    Divestitures
    Sale of BBVA’s stake in BBVA Chile

    On November 28, 2017, BBVA received a binding offer (the “Offer”) from The Bank of Nova Scotia group (“Scotiabank”) for the acquisition of BBVA’s stake in Banco Bilbao Vizcaya Argentaria Chile, S.A. (“BBVA Chile”) as well as in other companies of the Group in Chile with operations that are complementary to the banking business (amongst them, BBVA Seguros Vida, S.A.). BBVA owned approximately, directly and indirectly, 68.19% of BBVA Chile share capital. On December 5, 2017, BBVA accepted the Offer and entered into a sale and purchase agreement and the sale was completed on July, 6, 2018.

    The consideration received in cash by BBVA as consequence of the referred sale amounts to, approximately, USD 2,200 million. The transaction results in a capital gain, net of taxes, of €633 million, which was recognized in 2018.

    Agreement for the creation of a joint-venture and transfer of the Real - Estate business in Spain

    On November 29, 2017, BBVA reached an agreement with a subsidiary of Cerberus Capital Management, L.P. (“Cerberus”) for the creation of a “joint venture” to which an important part of the real estate business of BBVA in Spain is transferred (the “Business”).

    The Business comprises: (i) foreclosed real estate assets (the “REOs”), with a gross book value of approximately €13,000 million, taking as starting point the position of the REOs as of June 26, 2017; and (ii) the necessary assets and employees to manage the Business in an autonomous manner. For the purpose of the agreement with Cerberus, the whole Business was valued at approximately €5,000 million.

    On October 10, 2018, after obtaining all required authorizations, BBVA completed the transfer of the real estate business in Spain. Closing of the transaction has resulted in the sale of 80% of the share capital of the company Divarian Propiedad, S.A. to an entity managed by Cerberus.

    Divarian is the company to which the BBVA Group has previously contributed the Business provided that the effective transfer of several real estate assets (REO´s) remains subject to the fulfilment of certain conditions precedent, as stated in the referred relevant event. The final price payable by Cerberus will be adjusted depending on the volume of REO´s effectively contributed.

    As of December 31, 2018, the transaction did not have a significant impact on BBVA Group's attributable profit or the Common Equity Tier 1 (fully loaded).

    Main transactions in the Group in 2017
    Investments

    On February 21, 2017, BBVA Group entered into an agreement for the acquisition from Dogus Holding A.S. and Dogus Arastirma Gelistirme ve Musavirlik Hizmetleri A.S of 41,790,000,000 shares of Turkiye Garanti Bankasi, A.S. (“Garanti Bank”), amounting to 9.95% of the total issued share capital of Garanti Bank. On March 22, 2017, the sale and purchase agreement was completed, and therefore BBVA´s total stake in Garanti Bank as of December 31, 2017 amounts to 49.85% (See Note 31).

    Main transactions in the Group in 2016
    Mergers

    The BBVA Group, at its Board of Directors meeting held on March 31, 2016, adopted a resolution to begin a merger process of BBVA S.A. (absorbing company), Catalunya Banc, S.A., Banco Depositario BBVA, S.A. y Unoe Bank, S.A.

    This transaction was part of the corporate reorganization of its banking subsidiaries in Spain, was successfully completed throughout 2016 and has no impact in the Consolidated Financial Statements both from the accounting and the solvency stand points.

    4. Shareholder remuneration system

    BBVA’s shareholder remuneration policy communicated in October 2013 established the distribution of an annual pay-out of between 35% and 40% of the profits earned in each year and the progressive reduction of the remuneration via “Dividend Options”, so that the shareholders’ remuneration would ultimately be fully in cash. As announced on February 1, 2017, BBVA’s Board of Directors executed a capital increase to be charged to voluntary reserves for the instrumentation of the last “Dividend Option”, being the subsequent shareholders’ remunerations fully in cash, dated March 29, 2017.

    This fully – in - cash shareholders’ remuneration policy would be composed, for each year, of a distribution on account of the dividend of such year (expected to be paid in October) and a final dividend (which would be paid once the year has ended and the profit allocation has been approved, expected for April), subject to the applicable authorizations by the competent governing bodies.

    Shareholder remuneration scheme “Dividend Option”

    During 2012, 2013, 2014, 2015, 2016 and 2017, the Group implemented a shareholder remuneration system referred to as “Dividend Option”.

    Under such remuneration scheme, BBVA offered its shareholders the possibility to receive all or part of their remuneration in the form of newly-issued BBVA ordinary shares, whilst maintaining the possibility for BBVA shareholders to receive their entire remuneration in cash by selling the rights of free allocation assigned either to BBVA (in execution of the commitment assumed by BBVA to acquire the rights of free allocation at a guaranteed fixed price) or by selling the rights of free allocation on the market at the prevailing market price at that time. However, the execution of the commitment assumed by BBVA was only available to whoever had been originally assigned such rights of free allocation and only in connection with the rights of free allocation initially allocated at such time.

    On March 29, 2017, BBVA’s Board of Directors resolved to execute the capital increase to be charged to voluntary reserves approved by the Annual General Meeting (“AGM”) held on March 17, 2017, under agenda item three, to implement a “Dividend Option” this year. As a result of this increase, the Bank’s share capital increased by €49,622,955.62 through the issuance of 101,271,338 newly-issued BBVA ordinary shares at 0.49 euros par value, given that 83.28% of owners of the rights of free allocation opted to receive newly issued BBVA ordinary shares. The remaining 16.72% of the owners of the rights of free allocation exercised the commitment assumed by BBVA, and as a result, BBVA acquired 1,097,962,903 rights (at a gross price of €0.131 each) for a total amount of €143,833,140.29. This amount is recorded in “Total Equity-Dividends and Remuneration” of the consolidated balance sheet as of December 31, 2017 (see Note 26).

    On September, 28 2016, BBVA’s Board of Directors resolved to execute the second of the share capital increases to be charged to voluntary reserves, as agreed by the AGM held on March 11, 2016. As a result of this increase, the Bank’s share capital increased by €42,266,085.33 through the issuance of 86,257,317 newly-issued BBVA ordinary shares at 0.49 euros par value, given that 87.85% of owners of the rights of free allocation opted to receive newly-issued BBVA ordinary shares. The remaining 12.15% of the owners of the rights of free allocation exercised the commitment assumed by BBVA, and as a result, BBVA acquired 787,374,942 rights (at a gross price of €0.08 each) for a total amount of €62,989,995.36. This amount is recorded in “Total Equity-Dividends and Remuneration” of the consolidated balance sheet as of December 31, 2016 (see Note 26).

    On March 31, 2016, BBVA’s Board of Directors resolved to execute the first of the share capital increases to be charged to voluntary reserves, as agreed by the AGM held on March 11, 2016 for the implementation of the shareholder remuneration system called the “Dividend Option”. As a result of this increase, the Bank’s share capital increased by €55,702,125.43 through the issuance of 113,677,807 newly-issued BBVA ordinary shares at a €0.49 par value, given that 82.13% of owners of the rights of free allocation opted to receive newly-issued BBVA ordinary shares. The remaining 17.87% of the owners of the rights of free allocation exercised the commitment assumed by BBVA, and as a result, BBVA acquired 1,137,500,965 rights (at a gross price of €0.129 each) for a total amount of €146,737,624.49. This amount is recorded in “Total Equity- Dividends and Remuneration” of the consolidated balance sheet as of December 31, 2016 (see Note 26).

    Cash Dividends

    Throughout 2016, 2017 and 2018, BBVA’s Board of Directors approved the payment of the following dividends (interim or final dividends) fully in cash, recorded in “Total Equity- Interim Dividends” of the consolidated balance sheet of the relevant year:

    • The Board of Directors, at its meeting held on June 22, 2016, approved the payment in cash of €0.08 (€0.0648 net of withholding tax) per BBVA share as the first gross interim dividend against 2016 results. The total amount paid to shareholders on July 11, 2016, after deducting treasury shares held by the Group's companies, amounted to €517 million and is recognized under the headings “Total Equity- Interim Dividends” of the consolidated balance sheet as of December 31, 2016.
    • The Board of Directors, at its meeting held on December 21, 2016, approved the payment in cash of €0.08 (€0.0648 withholding tax) per BBVA share, as the second gross interim dividend against 2016 results. The total amount paid to shareholders on January 12, 2017, after deducting treasury shares held by the Group's Companies, amounted to €525 million and is recognized under the heading “Total Equity- Interim Dividends” of the consolidated balance sheet as of December 31, 2016.
    • The Board of Directors, at its meeting held on September 27, 2017, approved the payment in cash of €0.09 (€0.0729 net of withholding tax) per BBVA share, as the first gross interim dividend against 2017 results. The total amount paid to shareholders on October 10, 2017, after deducting treasury shares held by the Group's companies, amounted to €599 million and is recognized under the heading “Total Equity- Interim Dividends” of the consolidated balance sheet as of December 31, 2017.
    • The Annual General Meeting of BBVA held on March 16, 2018 approved, under item 1 of the Agenda, the payment of a final dividend for 2017, in addition to other dividends previously paid, in cash for an amount equal to €0.15 (€0.1215 net of withholding tax) per BBVA share. The total amount paid to shareholders on April 10, 2018, after deducting treasury shares held by the Group's companies, amounted €996 million and is recognized under heading “Total Equity- Final Dividends” of the consolidated balance sheet as of December 31, 2018.
    • The Board of Directors, at its meeting held on September 26, 2018, approved the payment in cash of €0.10 (€0.081 net of withholding tax rate of 19%) per BBVA share, as gross interim dividend based on 2018 results. The total amount paid to shareholders on October 10, 2018, after deducting treasury shares held by the Group´s companies, amounted €663 million and is recognized under heading “Total Equity- Interim Dividends” of the consolidated balance sheet as of December 31, 2018.

    The interim accounting statements prepared in accordance with legal requirements evidencing the existence of sufficient liquidity for the distribution of the amounts agreed on September 26, 2018, mentioned above are as follows:

    Available Amount for Interim Dividend Payments (Millions of euros)

    August 31, 2018
    Profit of BBVA, S.A. after the provision for income tax 2,462
    Additional Tier I capital instruments remuneration 236
    Maximum amount distributable 2,226
    Amount of proposed interim dividend 667
    BBVA cash balance available to the date 4,577

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    Proposal on allocation of earnings for 2018

    The allocation of earnings for 2018 subject to the approval of the Board of Directors at the Annual Shareholders Meeting is presented below:

    Allocation of Earnings (Millions of euros)

    2018
    Profit for year (*) 2,316
    Distribution:
    Interim dividends 667
    Final dividend 1,067
    Additional Tier 1 securities 313
    Voluntary reserves 269
    • (*) Net Income of BBVA, S.A. (see Appendix IX).

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    5. Earnings per share

    Basic and diluted earnings per share are calculated in accordance with the criteria established by IAS 33. For more information see Glossary of terms.

    The calculation of earnings per share is as follows:

    Basic and Diluted Earnings per Share

    2018 2017 (*) 2016 (*)
    Numerator for basic and diluted earnings per share (millions of euros)
    Profit attributable to parent company 5,324 3,519 3,475
    Adjustment: Additional Tier 1 securities (1) (313) (301) (260)
    Profit adjusted (millions of euros) (A) 5,011 3,218 3,215
    Profit from discontinued operations (net of non-controlling interest) (B) - - -
    Denominator for basic earnings per share (number of shares outstanding) - - -
    Weighted average number of shares outstanding (2) 6,668 6,642 6,468
    Weighted average number of shares outstanding x corrective factor (3) 6,668 6,642 6,592
    Adjusted number of shares - Basic earning per share (C) 6,636 6,642 6,592
    Adjusted number of shares - diluted earning per share (D) 6,636 6,642 6,592
    Earnings per share(*) 0.76 0.48 0.49
    Basic earnings per share from continued operations (Euros per share)A-B/C 0.76 0.48 0.49
    Diluted earnings per share from continued operations (Euros per share)A-B/D 0.76 0.48 0.49
    Basic earnings per share from discontinued operations (Euros per share)B/C - - -
    Diluted earnings per share from discontinued operations (Euros per share)B/D - - -
    • (1) Remuneration in the year related to contingent convertible securities, recognized in equity (see Note 22.4).
    • (2) Weighted average number of shares outstanding (millions of euros), excluding weighted average of treasury shares during the period.
    • (3) Corrective factor, due to the capital increase with pre-emptive subscription right, applied for the previous years.
    • (*) As of December 31, 2018 the weighted average number of shares outstanding was 6,668 million(6,642 and 6,468 million
      as of December 31, 2017 and 2016, respectively) and the adjustment of additional Tier 1 securities amounted to €313
      million (€301 and €260 million as of December 31, 2017 and 2016, respectively).

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    As of December 31, 2018, 2017 and 2016, there were no other financial instruments or share option commitments to employees that could potentially affect the calculation of the diluted earnings per share for the years presented. For this reason, basic and diluted earnings per share are the same.

    6. Operating segment reporting

    Operating segment reporting represents a basic tool in the oversight and management of the BBVA Group's various activities. The BBVA Group compiles reporting information on disaggregated business activities. These business activities are then aggregated in accordance with the organizational structure determined by the BBVA Group and, ultimately, into the reportable operating segments themselves.

    During 2018, there have not been significant changes in the reporting structure of the operating segments of the BBVA Group, although its composition is different from the close of 2017, as a result of the agreement of the sale of BBVA Chile (see Note 3). This transaction, which has affected South America´s area composition, is presented as follows, as well as the other operating segments within the BBVA Group:

    • Banking activity in Spain
    • Includes, as in previous years, the Retail Network in Spain, Corporate and Business Banking (CBB), Corporate & Investment Banking (CIB), BBVA Seguros and Asset Management units in Spain. It also includes the loans to developers that are granted new or that are no longer in difficult conditions, as well as the portfolios, finance and structural interest-rate positions of the euro balance sheet.
    • Non Core Real Estate
    • It manages loans in Spain to developers who were in difficulty and real estate assets, mainly from foreclosed properties, both residential mortgages and developers. On November 29, 2017, the BBVA Group signed a sale agreement with Cerberus for the subsequent sale of 80% of the company created to a subsidiary of Cerberus (see Note 3). The effective transfer of some real estate owned assets are subject to the fulfillment of certain conditions and in the meanwhile, BBVA will continue to manage those assets.
    • The United States
    • Includes the Group's business activity in the country through the BBVA Compass Group and the BBVA New York branch.
    • Mexico
    • Basically includes all the banking and insurance businesses carried out by the Group in the country. Since 2018 it has also included the BBVA Bancomer branch in Houston (in previous years located in the United States). Consequently, the figures from previous years have been reworked to incorporate this change and show comparable series.
    • Turkey
    • Includes the activity of the BBVA Group business in Turkey through Garanti Group.
    • South America
    • Includes BBVA’s banking and insurance businesses in the region. On July 6, 2018, the sale of BBVA Chile to The Bank of Nova Scotia (Scotiabank) (see Note 3) was completed which affects the comparability of the results, the balance sheet, the activity and the most significant ratios of this business area with prior periods.
    • Rest of Eurasia
    • Includes business activity in the rest of Europe and Asia, i.e. the Group´s retail and wholesale businesses in the area.

    Lastly, the Corporate Center is comprised of the rest of the assets and liabilities that have not been allocated to the operating segments, as it corresponds to the Group's holding function. It includes: the costs of the head offices that have a corporate function; management of structural exchange-rate positions; specific issues of capital instruments to ensure adequate management of the Group's global solvency; portfolios and their corresponding results, whose management is not linked to customer relations, such as industrial holdings; certain tax assets and liabilities; funds due to commitments with employees; goodwill and other intangibles. As of December 31, 2018, it contains the 20% stake of BBVA in Divarian´s share capital (see Note 3).

    The breakdown of the BBVA Group's total assets by operating segments as of December 31, 2018, 2017 and 2016, is as follows:

    Total Assets by Operating Segments (Millions of euros)

    2018 2017 (1) 2016 (1)
    Banking Activity in Spain 335,294 319,417 335,847
    Non Core Real Estate 4,163 9,714 13,713
    United States 82,057 75,775 88,902
    Mexico 96,455 94,061 93,318
    Turkey 66,250 78,694 84,866
    South America 52,385 74,636 77,918
    Rest of Eurasia 18,000 17,265 19,106
    Subtotal Assets by Operating Segments 654,605 669,563 713,670
    Corporate Center 22,084 20,497 18,186
    Total Assets BBVA Group 676,689 690,059 731,856
    • (1) The figures corresponding to 2017 and 2016 have been restated (see Note 1.3).

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    The attributable profit and main earning figures in the consolidated income statements for the years ended December 31, 2018, 2017 and 2016 by operating segments are as follows:

    Main Margins and Profits by Operating Segments (Millions of euros)

    Operating Segments
    BBVA Group Spain Non Core Real Estate United Sates Mexico Turkey South America Rest of Eurasia Corporate Center
    2018 Notes
    Net interest income 17,591 3,672 32 2,276 5,568 3,135 3,009 175 (276)
    Gross income 23,747 5,943 38 2,989 7,193 3,901 3,701 415 (432)
    Operating profit /(loss) before tax 7,580 2,017 (129) 919 3,294 1,448 1,307 144 (1,420)
    Profit 55.2 5,324 1,522 (78) 735 2,384 569 591 93 (494)
    2017 (1)
    Net interest income 17,758 3,738 71 2,119 5,476 3,331 3,200 180 (357)
    Gross income 25,270 6,180 (17) 2,876 7,122 4,115 4,451 468 73
    Operating profit /(loss) before tax 6,931 1,854 (656) 784 2,948 2,147 1,691 177 (2,013)
    Profit 55.2 3,519 1,374 (490) 486 2,187 826 861 125 (1,848)
    2016 (1)
    Net interest income 17,059 3,877 60 1,953 5,126 3,404 2,930 166 (455)
    Gross income 24,653 6,416 (6) 2,706 6,766 4,257 4,054 491 (31)
    Operating profit /(loss) before tax 6,392 1,268 (743) 612 2,678 1,906 1,552 203 (1,084)
    Profit 55.2 3,475 905 (595) 459 1,980 599 771 151 (794)
    • (1)The figures corresponding to 2017 and 2016 have been restated (see Note 1.3).

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    The accompanying Consolidated Management Report presents the consolidated income statements and the balance sheets by operating segments.



    7. Risk management

    7.1 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.

    7.1.1 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

    The 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 their statements) 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 integration of the Risk Appetite Framework into management, on the basis established by the Board of Directors, the Executive Committee approves the metrics by type of risk in relation to profitability and income recurrence 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 adequate 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 is supported in the exercise of his 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. The aim of this dual reporting system is 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.

    • 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.
    • 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 are 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, the Heads of the main Areas of the GRM Front, the Heads of GRM Corporate Discipline Units and the Head of Risk Management Group of GRM.

    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 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 Watch List, entries and exits in non-performing unlikely to pay and turns to written off.
    • 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 return on equity.
    • Risk Models Management Committee: It ensures an appropriate decision-making process regarding the planning, development, implementation, use, validation and monitoring of the models required to achieve an appropriate management of the Model Risk in the BBVA Group.
    • 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.
    • Operational Risk and Product Governance Corporate Admission Committee: It identifies, analyzes and assesses the operational risks associated initiatives related with new business, products or services, outsourcing, process transformation and new systems, prior to its launch. As well, it will verify that Product Governance normative requirements are met and will decide about the insurance scheme (global policies).
    • Retail Credit Risk Committee: It ensures for the analysis, discussion and decision support on all issues regarding the retail credit risk management that impact or potentially do in the practices, processes and corporate metrics established in the Policies, Rules and Operating Frameworks.
    • 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 and promote 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 that 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 that 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 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 Risks 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.

    7.1.2 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 and liquidity and funding, 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 2018 Group's Risk appetite statement is as follows:

    BBVA Group's Risk Policy is aimed to promote a multichannel and responsible universal banking model, based on principles, targeting sustainable growth, risk adjusted profitability and recurrent value creation. To achieve these objectives, the Risk Management Model is oriented to maintain a moderate risk profile that allows the Group to keep strong financial fundamentals in adverse environments preserving our strategic goals, maintaining a prudent management, an integral view of risks, and a portfolio diversification by geography, asset class and client segment, focusing on keeping a long term relationship with our customers.

    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 2018 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. The metrics by type of risk 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 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 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 2018, the Group risk profile evolved in line with the Risk Appetite metrics.

    7.1.3 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 is the responsibility of 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.

    7.1.4 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.

    7.1.5 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.

    7.1.6 Risk culture

    The BBVA Group promotes the development of a risk culture based on the observance and understanding of values, attitudes, and behaviors that allow the compliance with the regulations and frameworks that contribute to an appropriate risk management.

    At BBVA the Risk Governance Model is characterized by a special involvement of social bodies, as they define the risk culture that permeates the rest of the organization and has the following main elements:

    • Our Purpose which defines our reason to be and with our values and behaviors guide the performance of our organization and the people who are part of it.
    • The Risk Appetite Framework which determines the risks and levels of risks that the Group is willing to assume in order to fulfill its goals.
    • The Code of Conduct establishes the behavior guidelines that we must follow to adjust our behavior to the BBVA values.

    The Risk Culture at BBVA is based on these levers:

    • Communication: The BBVA Group promotes the dissemination of the principles and values that should govern the conduct and risk management in a comprehensive and consistent manner. To do this, the most appropriate channels of communication are used, to allow for the Risk culture to be integrated into the business activities at all levels of the organization.
    • Training: The BBVA Group favors the understanding of the values, risk management model, and the code of conduct in all scenarios, ensuring standards in skills and knowledge.
    • Motivation: The BBVA Group aims to define incentives for BBVA employees that support the risk culture at all levels. Among these incentives, the role of the Compensation policy and incentive programs stand out, as well as implementation of risk culture control mechanisms, including the complaint channels and the disciplinary committees.
    • Monitoring: The BBVA Group pursues at the highest levels of the organization a continuous evaluation and monitoring of the risk culture to guarantee its implementation and identification of areas for improvement.

    7.2 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 sections:

    • Macroeconomic and geopolitical risks
    • Global economic growth maintained robust in 2018 even if it slowed down more than expected during the second half of the year as a result of the worse development of the trade and the industrial sector as well as the strong increase in financial tensions, especially in developed economies due to the rise of uncertainties. To the worse economic development in Europe and in China, it has to be added the downturn in Asian countries and the deterioration in the expansive cycle of the United States. In this context, both the Federal Reserve (Fed) and the ECB have demonstrated to be more prudent and patient at the time of advancing with the normalization of their monetary policies and their future decisions will depend on the economic evolution. The main risk at sort-term continues to be protectionism not only for the direct effect on global trade, but also for the indirect impact of lower confidence and financial volatility. To this, it has to be added the concerns about the degree of the impact on the economic activities in the United States and China in the following quarters have to be added as well as the increased political uncertainty in Europe.
    • In summary, the uncertainty related to the economic perspectives continues to be elevated due to the fear of a protectionist escalation and a higher perception of the risk related to the global economic growth.
    • 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.
    • 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 of every kind, civil, criminal, administrative, litigation, as well as investigations from the supervisor, along several jurisdictions, which consequences are difficult to determine (including those procedures in which an undetermined number of applicants is involved, in which damages claimed are not easy to estimate, in which an exorbitant amount is claimed, in which new jurisdictional issues are introduced under creative non – contrasted legal argument and those which are at a very initial stage).
    • In Spain, in many of the existing procedures, applicants claim, both at Spanish courts and through prejudicial issues towards the European Union Court of Justice, that various clauses usually included under a mortgage loan with credit institutions are stated abusive (mortgage fees clauses, early redemption right clause, referenced interest rate type, opening fee, etc.). Resolutions for these types of procedures against the Group or banking entities might affect the Group directly or indirectly.
    • The BBVA Group is under authority and competence investigations in various countries which may give raise to damage penalties and claims on behalf of third parties.
    • As explained in section Other Non - Financial Risks of the Non-Financial Information Report within the Management Report, the Group might be equally subject to investigations by the legal authorities with no further formal requirement received until present times, related to the hire of of allegedly irregular activities which might have a negative impact, both reputational and economic for the Bank. The Bank is carrying out a forensic investigation led by PwC through the Bank’s external legal counsel Garrigues, along with Uría, not being yet predictable the scope or the duration of those investigations or any carried out by the legal authorities, or even its possible outcome or implications for the Group.
    • The BBVA Group manages and keeps constant follow up of legal and regulatory investigations, procedures and actions which can occur for the defense of its interests, charging (regarding the number of litigations from the legal pronouncements and the state of procedure or action) the corresponding provisions for its coverage if necessary. Even though, the result of the referred actions and procedures, both in which the Bank is already part of, as well as those that may raise in the future or at pronouncements in which other credit entities are part of, is difficult to predict, so in case of modification of the jurisprudential criteria or unexpected results of any of such litigation, charged provisions may be not sufficient.

    7.3 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.

    7.3.1 Measurement Expected Credit Loss (ECL)

    IFRS 9 requires determining the expected credit loss of a financial instrument in a way that reflects an unbiased estimation removing any conservatism or optimism, the time value of money and a forward looking perspective (including the economic forecast).

    Therefore the recognition and measurement of expected credit losses (ECL) is highly complex and involves the use of significant analysis and estimation including formulation and incorporation of forward-looking economic conditions into ECL.

    Risk Parameters Adjusted by Macroeconomic Scenarios

    Expected Credit Loss must include forward looking information, in accordance with IFRS 9, which states that the comprehensive credit risk information must incorporate not only historical information but also all relevant credit information, including forward-looking macroeconomic information. BBVA uses the classical credit risk parameters PD, LGD and EAD in order to calculate the ECL for the credit portfolios.

    BBVA´s methodological approach in order to incorporate the forward looking information aims to determine the relation between macroeconomic variables and risk parameters following three main steps:

    • Step 1: Analysis and transformation of time series data.
    • Step 2: For each dependent variable find conditional forecasting models that are economically consistent.
    • Step 3: Select the best conditional forecasting model from the set of candidates defined in Step 2, based on their out of sample forecasting performance.
    How economic scenarios are reflected in calculation of ECL

    The forward looking component is added through the introduction of macroeconomic scenarios as an input. Inputs would highly depend on the particular combination of region and portfolio, so inputs are adapted to available data.

    Based on economic theory and analysis, the macroeconomic variables most directly relevant for explaining and forecasting the selected risk parameters (PD, LGD) are:

    • a) The net income of families, corporates or public administrations.
    • b) The payment amounts on the principal and interest on the outstanding loans.
    • c) The value of the collateral assets pledge to the loan.

    BBVA Group approximates these variables by using a proxy indicator from the set included in the macroeconomic scenarios provided by the economic research department.

    Only a single specific indicator for each of the three categories can be used and only core macroeconomic indicators should be chosen as first choice: for a) using Real GDP Growth for the purpose of conditional forecasting can be seen as the single sufficient “factor” required for capturing the influence of all potentially relevant macro-financial scenario on internal PDs and LGD ; for b) using the most representative short term interest rate (typically the policy rate or the most liquid sovereign yield or interbank rate or EMBI) or exchange rates expressed in real terms and for c) using a comprehensive index of the price of real estate properties also expressed in real terms in the case of mortgage loans and a representative index of the price of the relevant commodity (in real terms) for corporate loan portfolios concentrated in exporters or producer of such commodity.

    Real GDP growth is given priority over any other indicator not only because it is the most comprehensive indicator of income and economic activity but also because it is the central variable in the generation of macroeconomic scenarios.

    Multiple scenario approach under IFRS 9

    IFRS 9 requires calculating an unbiased probability weighted measurement of expected credit losses (“ECL”) by evaluating a range of possible outcomes, including forecasts of future economic conditions.

    The BBVA Research teams within the BBVA Group produce forecasts of the macroeconomic variables under the baseline scenario, which are used in the rest of the related processes of the bank, such as budgeting, ICAAP and risk appetite framework, stress testing, etc.

    Additionally, the BBVA Research teams produced alternative scenarios to the baseline scenario so as to meet the requirements under the IFRS 9 standard.

    Alternative macroeconomic scenarios
    • For each of the macro-financial variables, BBVA Research produces three scenarios.
    • Each of these scenarios corresponds to the expected value of a different area of the probabilistic distribution of the possible projections of the economic variables.

    The approach in BBVA consists on using the scenario that is the most likely scenario, which is the baseline scenario, consistent with the rest of internal processes (ICAAP, Budgeting…) and then applying an overlay adjustment that is calculated by taking into account the weighted average of the ECL determined by each of the scenarios.

    It is important to note that in general, it is expected that the effect of the overlay is to increase the ECL. It is possible to obtain an overlay that does not have that effect, whenever the relationship between macro scenarios and losses is linear. However, the overlay is not expected to reduce the ECL.

    7.3.2 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, 2018 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)

    Notes 2018
    Financial assets held for trading 59,581
    Debt securities 10 25,577
    Equity instruments 10 5,254
    Loans and advances 10 28,750
    Non-trading financial assets mandatorily at fair value through profit or loss 5,135
    Loans and advances 11 1,803
    Debt securities 11 237
    Equity instruments 11 3,095
    Financial assets designated at fair value through profit or loss 12 1,313
    Derivatives (trading and hedging) 38,249 Stage 1 Stage 2 Stage 3
    Financial assets at fair value through other comprehensive income 56,332 56,329 3 -
    Debt securities 13.1 53,737 53,734 3 -
    Equity instruments 13.1 2,595 2,595 - -
    Financial assets at amortized cost 431,927 384,632 30,902 16,394
    Loans and advances to central banks   3,947 3,947 - -
    Loans and advances to credit institutions   9,175 9,131 34 10
    Loans and advances to customers   386,225 339,204 30,673 16,348
    Debt securities   32,580 32,350 195 35
    Total financial assets risk 592,538 440,960 30,905 16,394
    Total loan commitments and financial guarantees 33 170,511 161,404 8,120 987
    Total maximum credit exposure 763,049
    • There was no similar breakdown before the implementation of IFRS 9 on January 1, 2018 (see Note 2,1),

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    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 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).
    • 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, as well as the gross carrying amount by type of product, classified in the different headings of the assets, as of December 31, 2018, 2017 and 2016 is shown below:

    December 2018 (Millions of euros)

    Central banks General governments Credit institutions Other financial corporations Non-financial corporations Households Total Provisions Gross
    carrying
    amount
    By product
    On demand and short notice - 10 - 151 2.833 648 3.641 (193) 3.834
    Credit card debt - 8 1 2 2.328 13.108 15.446 (1,048) 16.495
    Trade receivables 948 - 195 16.190 103 17.436 (280) 17.716
    Finance leases - 226 - 3 8.014 406 8.650 (427) 9.077
    Reverse repurchase loans - 293 477 - - - 770 (1) 772
    Other term loans 3.911 26.839 2.947 7.030 133.573 157.760 332.060 (10,204) 342.264
    Advances that are not loans 29 1.592 5.771 2.088 984 498 10.962 (63) 11.025
    Loans and advances 3.941 29.917 9.196 9.468 163.922 172.522 388.966 (12,217) 401.183
    By secured loans
    of which: mortgage loans collateralized by immovable property 1.056 15 219 26.784 111.809 139.883 (4,122) 144.005
    of which: other collateralized loans - 7.179 285 1.389 31.393 6.835 47.081 (774) 47.855
    By purpose of the loan
    of which: credit for consumption 40.124 40.124 (2,613) 42.736
    of which: lending for house purchase 111.007 111.007 (1,945) 112.952
    By subordination
    of which: project finance loans 13.973 13.973 (312) 14.286

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    December 2017 (Millions of euros)

    Central banks General governments Credit institutions Other financial corporations Non-financial corporations Households Total
    On demand and short notice - 222 - 270 7,663 2,405 10,560
    Credit card debt - 6 - 3 1,862 13,964 15,835
    Trade receivables 1,624 - 497 20,385 198 22,705
    Finance leases - 205 - 36 8,040 361 8,642
    Reverse repurchase loans 305 1,290 13,793 10,912 - - 26,300
    Other term loans 6,993 26,983 4,463 5,763 125,228 155,418 324,848
    Advances that are not loans 2 1,964 8,005 1,044 1,459 522 12,995
    Loans and advances 7,301 32,294 26,261 18,525 164,637 172,868 421,886
    of which: mortgage loans [Loans collateralized by immovable property] 998 - 308 37,353 116,938 155,597
    of which: other collateralized loans 7,167 13,501 12,907 24,100 9,092 66,767
    of which: credit for consumption 40,705 40,705
    of which: lending for house purchase 114,709 114,709
    of which: project finance loans 16,412 16,412

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    December 2016 (Millions of euros)

    Central banks General governments Credit institutions Other financial corporations Non-financial corporations Households Total
    On demand and short notice - 373 - 246 8,125 2,507 11,251
    Credit card debt - 1 - 1 1,875 14,719 16,596
    Trade receivables 2,091 - 998 20,246 418 23,753
    Finance leases - 261 - 57 8,647 477 9,442
    Reverse repurchase loans 81 544 15,597 6,746 - - 22,968
    Other term loans 8,814 29,140 7,694 6,878 136,105 167,892 356,524
    Advances that are not loans - 2,410 8,083 2,082 1,194 620 14,389
    Loans and advances 8,894 34,820 31,373 17,009 176,192 186,633 454,921
    of which: mortgage loans [Loans collateralized by immovable property] 4,722 112 690 44,406 132,398 182,328
    of which: other collateralized loans 3,700 15,191 8,164 21,863 6,061 54,979
    of which: credit for consumption 44,504 44,504
    of which: lending for house purchase 127,606 127,606
    of which: project finance loans 19,269 19,269

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    7.3.3 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 received must be correctly assigned 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:

    • 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.
    • 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.
    • The summary of the compensation effect (via netting and collateral) for derivatives and securities operations is presented in Note 7.4.3.
    • Other financial assets designated at fair value through profit or loss and financial assets at fair value through other comprehensive income: The guarantees or credit enhancements obtained directly from the issuer or counterparty are inherent to the structure of the instrument.
    • At December 31, 2018, BBVA Group had no credit risk exposure of impaired financial assets at fair value through other comprehensive income at December 31, 2018 (see Note 7.3.2).
    • Financial assets at amortized cost:
    • 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 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.

    The disclosure of impaired financial assets at amortized cost covered by collateral (see Note 7.3.2), by type of collateral, at December 31, 2018, is the following:

    Diciembre 2018 (Millions of euros)

    Maximum
    exposure to credit
    risk
    Of which secured by collateral
    Residential
    properties
    Commercial
    properties
    Cash Others Financial
    Impaired financial assets at amortized cost 16,394 3,484 1,255 13 317 502
    Total 16,394 3,484 1,255 13 317 502

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    • Financial guarantees, other contingent risks and drawable by third parties: These have the counterparty’s personal guarantee.
    • The maximum credit risk exposure of impaired financial guarantees and other commitments at December 31, 2018 amounts to €987 million (see Note 7.3.2).

    7.3.4 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 transactions 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. These tools can 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, 2018:

    External rating nternal rating Probability of default
    (basic points)
    Standard&Poor's List Reduced List (22 groups) Average Minimum from
    >=
    Maximum
    AAA AAA 1 - 2
    AA+ AA+ 2 2 3
    AA AA 3 3 4
    AA- AA- 4 4 5
    A+ A+ 5 5 6
    A A 8 6 9
    A- A- 10 9 11
    BBB+ BBB+ 14 11 17
    BBB BBB 20 17 24
    BBB- BBB- 31 24 39
    BB+ BB+ 51 39 67
    BB BB 88 67 116
    BB- BB- 150 116 194
    B+ B+ 255 194 335
    B B 441 335 581
    B- B- 785 581 1,061
    CCC+ CCC+ 1,191 1,061 1,336
    CCC CCC 1,500 1,336 1,684
    CCC- CCC- 1,890 1,684 2,121
    CC+ CC+ 2,381 2,121 2,673
    CC CC 3,000 2,673 3,367
    CC- CC- 3,780 3,367 4,243

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    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 by probability of default within 12 months and stages of the gross carrying amount of loans and advances to customers in percentage of BBVA Group as of December 31, 2018 is shown below:

    December 2018
    Subject to 12 month ECL
    (Stage1)
    Subject to lifetime ECL
    (Stage 2)
    Probability of default
    (basis points)
    % %
    0 to 2 9.6 -
    2 to 5 10.8 0.1
    5 to 11 6.3 -
    11 to 39 20.9 0.4
    39 to 194 30.1 1,8
    194 to 1,061 12.2 3.6
    1,061 to 2,121 1.6 1.2
    > 2,021 0.2 1.2
    Total 91,7 8,3
    • There was no similar breakdown before the implementation of IFRS 9 on January 1, 2018 (see Note 2.1).

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    7.3.5 Past due but not impaired and impaired secured loans risks

    The tables below provides details by counterpart and by product of past due risks but not considered to be impaired, as of December 31, 2018, 2017 and 2016, listed by their first past-due date; as well as the breakdown of the debt securities and loans and advances individually and collectively estimated (see Note 2.2.1):

    December 2018 (Millions of euros)

    Assets without significant increase in creditrisk since
    initial recognition (Stage 1)
    Assets with significantincrease in creditrisk since initial
    recognition but not credit-impaired (Stage 2)
    Credit-impaired assets (Stage 3)
    <= 30 days > 30 days <= 90
    days
    > 90 days <= 30 days > 30 days <= 90
    days
    > 90 days <= 30 days > 30 days <= 90
    days
    > 90 days
    Debt securities - - - - - - - - 5
    Loans and advances 4,191 454 - 4,261 3,228 - 407 900 2,769
    Central banks - - - - - - - - -
    General governments 95 7 - 5 1 - 5 5 26
    Credit institutions 3 - - - - - - - -
    Other financial corporations 117 224 - 2 - - - - 5
    Non-financial corporations 1,140 158 - 1,282 1,180 - 149 276 1,333
    Households 2,835 64 - 2,971 2,047 - 254 618 1,404
    TOTAL 4,191 454 - 4,261 3,228 - 407 900 2,774
    Loans and advances by product, by collateral and by subordination
    On demand (call) and short notice (current account) 127 - - 25 47 - 3 4 52
    Credit card debt 182 10 - 598 102 - 24 25 120
    Trade receivables 46 12 - 20 106 - 2 11 50
    Finance leases 307 16 - 43 102 - 10 20 110
    Reverse repurchase loans - - - - - - - - -
    Other term loans 3,421 325 - 3,575 2,869 - 369 840 2,433
    Advances that are not loans 108 89 - - 1 - - - 4
    of which: mortgage loans collateralized by immovable property 1,681 38 - 1,598 1,745 - 251 712 1,365
    of which: other collateralized loans 255 14 - 742 99 - 22 21 103
    of which: credit for consumption 910 27 - 1,278 424 - 49 49 281
    of which: lending for house purchase 1,365 24 - 1,394 1,404 - 170 507 839
    of which: project finance loans 1 - - - 382 - - - 71

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    December 2017 (Millions of euros)

    Past due but not impaired Impaired assets Carrying amount of the impaired assets Specific allowances for financial assets, individually and collectively estimated Collective allowances for incurred but not reported losses Accumulated write-offs
    ≤ 30 days > 30 days ≤ 60 days > 60 days ≤ 90 days
    Debt securities - - - 66 38 (28) (21) -
    Loans and advances 3,432 759 503 19,401 10,726 (8,675) (4,109) (29,938)
    Central banks - - - - - - - -
    General governments 75 3 13 171 129 (42) (69) (27)
    Credit institutions - - - 11 5 (6) (30) (5)
    Other financial corporations 2 - - 12 6 (7) (19) (5)
    Non-financial corporations 843 153 170 10,791 5,192 (5,599) (1,939) (18,988)
    Households 2,512 603 319 8,417 5,395 (3,022) (2,052) (10,913)
    TOTAL 3,432 759 503 19,467 10,764 (8,703) (4,130) (29,938)
     
    Loans and advances by product, by collateral and by subordination
    On demand (call) and short notice (current account) 77 12 11 389 151 (238)
    Credit card debt 397 66 118 629 190 (439)
    Trade receivables 115 8 9 515 179 (336)
    Finance leases 138 66 47 431 155 (276)
    Reverse repurchase loans - - - - - -
    Other term loans 2,705 606 317 17,417 10,047 (7,370)
    Advances that are not loans 1 - 1 20 3 (16)
    of which: mortgage loans (Loans collateralized by immovable property) 1.345 360 164 11.388 7.630 (3.757)
    of which: other collateralized loans 592 137 43 803 493 (310)
    of which: credit for consumption 1.260 248 207 1.551 457 (1.093)
    of which: lending for house purchase 1.034 307 107 5.730 4.444 (1.286)
    of which: project finance loans 13 - 25 1.165 895 (271)
    • (*) Figures originally reported in the year 2017 in accordance to the applicable regulation, without restatements.

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    December 2016 (Millions of euros)

    Past due but not impaired Impaired assets Carrying amount of the impaired assets Specific allowances for financial assets, individually and collectively estimated Collective allowances for incurred but not reported losses Accumulated write-offs
    ≤ 30 days > 30 days ≤ 60 day > 60 days ≤ 90 days
    Debt securities - - - 272 128 (144) (46) (1)
    Loans and advances 3,384 696 735 22,925 12,133 (10,793) (5,224) (29,346)
    Central banks - - - - - - - -
    General governments 66 - 2 295 256 (39) (13) (13)
    Credit institutions 3 - 82 10 3 (7) (36) (5)
    Other financial corporations 4 7 21 34 8 (25) (57) (6)
    Non-financial corporations 968 209 204 13,786 6,383 (7,402) (2,789) (18,020)
    Households 2,343 479 426 8,801 5,483 (3,319) (2,329) (11,303)
    TOTAL 3,384 696 735 23,197 12,261 (10,937) (5,270) (29,347)
    Loans and advances by product, by collateral and by subordination
    On demand (call) and short notice (current account) 79 15 29 562 249 (313)
    Credit card debt 377 88 124 643 114 (529)
    Trade receivables 51 15 13 424 87 (337)
    Finance leases 188 107 59 516 252 (264)
    Reverse repurchase loans - - 82 1 - (1)
    Other term loans 2,685 469 407 20,765 11,429 (9,336)
    Advances that are not loans 5 - 21 14 2 (12)
    of which: mortgage loans (Loans collateralized by immovable property) 1,202 265 254 16,526 9,008 (5,850)
    of which: other collateralized loans 593 124 47 1,129 656 (275)
    of which: credit for consumption 1,186 227 269 1,622 455 (1,168)
    of which: lending for house purchase 883 194 105 6,094 4,546 (1,548)
    of which: project finance loans 138 - - 253 105 (147)
    • (*) Figures originally reported in the year 2016 in accordance to the applicable regulation, without restatements.

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    The breakdown of loans and advances, within financial assets at amortized cost, impaired and accumulated impairment by sectors as of December 31, 2018, 2017 and 2016 is as follows:

    December 2018 (Millions of euros)

    Non-performing loans and advances Accumulated impairment or Accumulated changes in fair value due to credit risk Nonperforming loans and advances as a % of the total
    General governments 128 (84) 0.4%
    Credit institutions 10 (12) 0.1%
    Other financial corporations 11 (22) 0.1%
    Non-financial corporations 8,372 (6,260) 4.9%
    Agriculture, forestry and fishing 122 (107) 3.3%
    Mining and quarrying 96 (70) 1.9%
    Manufacturing 1,695 (1,134) 4.6%
    Electricity, gas, steam and air conditioning supply 585 (446) 4.2%
    Water supply 19 (15) 1.8%
    Construction 1,488 (1,007) 12.5%
    Wholesale and retail trade 1,624 (1,259) 6.3%
    Transport and storage 459 (374) 4.7%
    Accommodation and food service activities 315 (204) 4.0%
    Information and communication 113 (72) 2.1%
    Financial and insurance activities 147 (128) 2.1%
    Real estate activities 834 (624) 4.8%
    Professional, scientific and technical activities 204 (171) 4.0%
    Administrative and support service activities 128 (125) 4.0%
    Public administration and defense, compulsory social security 5 (7) 1.6%
    Education 31 (31) 3.4%
    Human health services and social work activities 63 (63) 1.4%
    Arts, entertainment and recreation 59 (41) 4.5%
    Other services 386 (382) 3.9%
    Households 7,838 (5,833) 4.4%
    LOANS AND ADVANCES 16,359 (12,211) 4.1%

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    December 2017 (Millions of euros)

    Non-performing loans and advances Accumulated impairment or Accumulated changes in fair value due to credit risk Nonperforming loans and advances as a % of the total
    General governments 171 (111) 0.5%
    Credit institutions 11 (36) -
    Other financial corporations 12 (26) 0.1%
    Non-financial corporations 10,791 (7,538) 6.3%
    Agriculture, forestry and fishing 166 (123) 4.3%
    Mining and quarrying 177 (123) 3.7%
    Manufacturing 1,239 (955) 3.6%
    Electricity, gas, steam and air conditioning supply 213 (289) 1.8%
    Water supply 29 (11) 4.5%
    Construction 2,993 (1,708) 20.1%
    Wholesale and retail trade 1,706 (1,230) 5.9%
    Transport and storage 441 (353) 4.2%
    Accommodation and food service activities 362 (222) 4.3%
    Information and communication 984 (256) 17.0%
    Real estate activities 1,171 (1,100) 7.9%
    Professional, scientific and technical activities 252 (183) 3.8%
    Administrative and support service activities 188 (130) 6.3%
    Public administration and defense, compulsory social security 4 (6) 1.9%
    Education 31 (25) 3.4%
    Human health services and social work activities 75 (68) 1.7%
    Arts, entertainment and recreation 69 (38) 4.6%
    Other services 690 (716) 4.3%
    Households 8,417 (5,073) 4.7%
    LOANS AND ADVANCES 19,401 (12,784) 4.5%

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    December 2016 (Millions of euros)

    Non-performing Accumulated impairment or Accumulated changes in fair value due to credit risk Nonperforming loans and advances as a % of the total
    General governments 295 (52) 0.8%
    Credit institutions 10 (42) -
    Other financial corporations 34 (82) 0.2%
    Non-financial corporations 13,786 (10,192) 7.4%
    Agriculture, forestry and fishing 221 (188) 5.1%
    Mining and quarrying 126 (83) 3.3%
    Manufacturing 1,569 (1,201) 4.5%
    Electricity, gas, steam and air conditioning supply 569 (402) 3.2%
    Water supply 29 (10) 3.5%
    Construction 5,358 (3,162) 26.3%
    Wholesale and retail trade 1,857 (1,418) 6.2%
    Transport and storage 442 (501) 4.5%
    Accommodation and food service activities 499 (273) 5.9%
    Information and communication 112 (110) 2.2%
    Real estate activities 1,441 (1,074) 8.7%
    Professional, scientific and technical activities 442 (380) 6.0%
    Administrative and support service activities 182 (107) 7.3%
    Public administration and defense, compulsory social security 18 (25) 3.0%
    Education 58 (31) 5.4%
    Human health services and social work activities 89 (88) 1.8%
    Arts, entertainment and recreation 84 (51) 5.1%
    Other services 691 (1,088) 4.2%
    Households 8,801 (5,648) 4.6%
    LOANS AND ADVANCES 22,925 (16,016) 5.0%

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    The changes during the years 2018, 2017 and 2016 of impaired financial assets and contingent risks are as follow:

    Changes in Impaired Financial Assets and Contingent Risks (Millions of euros)

    2018 2017 2016
    Balance at the beginning 20,590 23,877 26,103
    Additions 9,792 10,856 11,133
    Decreases (*) (6,909) (7,771) (7,633)
    Net additions 2,883 3,085 3,500
    Amounts written-off (5,076) (5,758) (5,592)
    Exchange differences and other (1,264) (615) (134)
    Balance at the end 17,134 20,590 23,877
    • (*) Reflects the total amount of impaired loans derecognized from the consolidated balance sheet throughout the year as a result of mortgage foreclosures and real estate assets received in lieu of payment as well as monetary recoveries (see Notes 19 and 20 to the Consolidated Financial Statement for additional information).

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    The changes during the years 2018, 2017 and 2016 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)

    Notes 2018 2017 2016
    Balance at the beginning 30,139 29,347 26,143
    Acquisition of subsidiaries in the year - - -
    Increase: 6,164 5,986 5,699
    Decrease: (4,210) (4,442) (2,384)
    Re-financing or restructuring (10) (9) (32)
    Cash recovery 47 (589) (558) (541)
    Foreclosed assets (625) (149) (210)
    Sales of written-off (1,805) (2,284) (45)
    Debt forgiveness (889) (1,121) (864)
    Time-barred debt and other causes (292) (321) (692)
    Net exchange differences 250 (752) (111)
    Balance at the end 32,343 30,139 29,347

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    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.

    7.3.6 Impairment losses

    Below are the changes in the years ended December 31, 2018, 2017 and 2016, in the provisions recognized on the accompanying consolidated balance sheets to cover estimated impairment losses in loans and advances and debt securities measured at amortized cost and financial assets at fair value through other comprehensive income as well as the loan commitment and financial guarantees:

    Financial assets at amortized cost. December 2018 (Millions of Euros)

    Not credit-impaired Credit-impaired
    Stage 1 Stage 2 Credit-impaired (Stage 3) Purchased/originated
    credit-impaired
    (Stage 3)
    Total
    Loss allowances Loss allowances
    (collectively assessed)
    Loss allowances (individually
    assessed)
    Loss allowances Loss allowances Loss allowances
    Opening balance (under IFRS 9) (2,237) (1,827) (525) (9,371) - (13,960)
    Transfers of financial assets: - - - - - -
    Transfers from Stage 1 to Stage 2 (not credit-impaired) 208 (930) (218) - - (940)
    Transfers from Stage 2 (not credit - impaired) to Stage 1 (125) 619 50 - - 544
    Transfers to Stage 3 55 282 564 (2,127) - (1,226)
    Transfers from Stage 3 to Stage 1 or 2 (7) (126) (68) 333 - 132
    Changes without transfers between Stages 358 (53) (260) (3,775) - (3,730)
    New financial assets originated (1,072) (375) (244) - - (1,692)
    Purchased - - - - - -
    Disposals 2 3 - 110 - 115
    Repayments 641 432 118 1,432 - 2,623
    Write-offs 13 14 2 4,433 - 4,461
    Changes in model/ methodology - - - - - -
    Foreign exchange (84) 72 (93) 343 - 239
    Modifications that result in derecognition 5 10 25 98 - 138
    Modifications that do not result in derecognition 3 (8) 1 (362) - (366)
    Other 135 133 20 1,111 - 1,399
    Closing balance (2,106) (1,753) (628) (7,777) - (12,264)

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    Financial assets at fair value through other comprehensive income. December 2018 (Millions of Euros)

    Not credit-impaired Credit-impaired
    Stage 1 Stage 2 Credit-impaired (Stage 3) Purchased/originated
    credit-impaired
    (Stage 3)
    Total
    Loss allowances Loss allowances
    (collectively assessed)
    Loss allowances (individually
    assessed)
    Loss allowances Loss allowances Loss allowances
    Opening balance (under IFRS 9) (20) (1) - (14) - (35)
    Transfers of financial assets: - - - - - -
    Transfers from Stage 1 to Stage 2 (not credit-impaired) - - - - - -
    Transfers from Stage 2 (not credit - impaired) to Stage 1 - - - - - -
    Transfers to Stage 3 - - - - - -
    Transfers from Stage 3 to Stage 1 or 2 - - - - - -
    hanges without transfers between Stages (7) - - 16 - 9
    New financial assets originated (3) - - - - (3)
    Purchased - - - - - -
    Disposals - - - - - -
    Repayments 5 - - - - 5
    Write-offs - - - - - -
    Changes in model/ methodology - - - - - -
    Foreign exchange 2 - - - - 2
    Modifications that result in derecognition - - - - - -
    Modifications that do not result in derecognition - - - (11) - (11)
    Other (5) 1 - 8 - 4
    Closing balance (28) - - - - (28)

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    Loan commitments and financial guarantees. December 2018 (Millions of euros)

    Not credit-impaired Credit-impaired
    Stage 1 Stage 2 Credit-impaired (Stage 3) Purchased/originated
    credit-impaired
    (Stage 3)
    Total
    Loss allowances Loss allowances
    (collectively assessed)
    Loss allowances (individually
    assessed)
    Loss allowances Loss allowances Loss allowances
    Opening balance (under IFRS 9) (200) (135) (84) (285) - (704)
    Transfers of financial assets: - - - - - -
    Transfers from Stage 1 to Stage 2 (not credit-impaired) 14 (84) (11) - - (81)
    Transfers from Stage 2 (not credit - impaired) to Stage 1 (8) 65 1 - - 58
    Transfers to Stage 3 1 4 16 (48) - (27)
    Transfers from Stage 3 to Stage 1 or 2 (3) (3) - 20 - 14
    Changes without transfers between Stages 14 12 6 35 - 67
    New financial assets originated (102) (32) (20) - - (154)
    Purchased - - - - - -
    Disposals - - - 1 - 1
    Repayments 47 58 24 73 - 202
    Write-offs - - - - - -
    Changes in model/ methodology - - - - - -
    Foreign exchange 11 1 (2) 6 - 16
    Modifications that result in derecognition - - - - - -
    Modifications that do not result in derecognition - - - (32) - (32)
    Other (6) (13) 10 13 - 4
    Closing balance (232) (127) (60) (217) - (636)

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    December 2017 (Millions of euros)(*)

    Opening balance Increases due to amounts set aside for estimated loan losses during the period Decreases due to amounts reversed for estimated loan losses during the period Decreases due to amounts taken against allowances Transfers between allowances Other adjustments Closing balance Recoveries recorded directly to the statement of profit or loss
    Equity instruments
    Specific allowances for financial assets, individually and collectively estimated (10,937) (7,484) 2,878 4,503 1,810 526 (8,703) 558
    Debt securities (144) (26) 6 - 123 13 (28) -
    Central banks - - - - - - - -
    General governments - - - - - - - -
    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) 2,872 4,503 1,687 513 (8,675) 558
    Central banks - - - - - - - -
    General governments (39) (70) 37 14 1 15 (42) 1
    Credit institutions (7) (2) 2 - - 1 (6) -
    Other financial corporations (25) (287) 3 38 227 38 (7) -
    Non-financial corporations (7,402) (3,627) 1,993 3,029 (228) 636 (5,599) 345
    Households (3,319) (3,472) 837 1,422 1,687 (177) (3,022) 212
    Collective allowances for incurred but not reported losses on financial assets (5,270) 1,783 2,159 1,537 (1,328) 557 (4,130) -
    Debt securities (46) (8) 30 1 - 3 (21) -
    Loans and advances (5,224) (1,776) 2,128 1,536 (1,328) 554 (4,109) -
    Total (16,206) (9,267) 5,037 6,038 482 1,083 (12,833) 558
    • (*) Figures originally reported in the year 2017 in accordance to the applicable regulation, without restatements.

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    December 2016 (Millions of euros)

    Opening balance Increases due to amounts set aside for estimated loan losses during the period Decreases due to amounts reversed for estimated loan losses during the period Decreases due to amounts taken against allowances Transfers between allowances Other adjustments Closing balance Recoveries recorded directly to the statement of profit or loss
    Equity instruments
    Specific allowances for financial assets, individually and collectively estimated (12,866) (6,912) 2,708 5,673 (123) 583 (10,937) 540
    Debt securities (35) (167) 6 64 (10) (2) (144) -
    Central banks - - - - - - - -
    General governments - - - - - - - -
    Credit institutions (20) - - 5 - - (15) -
    Other financial corporations (15) (29) 3 26 (10) (1) (26) -
    Non-financial corporations - (138) 3 33 - (1) (103) -
    Loans and advances (12,831) (6,745) 2,702 5,610 (113) 585 (10,793) 540
    Central banks - - - - - - - -
    General governments (37) (2) 20 6 (27) 2 (39) 1
    Credit institutions (17) (2) 3 - 10 (3) (7) -
    Other financial corporations (38) (34) 9 22 10 6 (25) -
    Non-financial corporations (9,225) (3,705) 2,158 3,257 (278) 391 (7,402) 335
    Households (3,514) (3,002) 511 2,325 172 189 (3,319) 205
    Collective allowances for incurred but not reported losses on financial assets (6,024) (1,558) 1,463 88 775 (15) (5,270) 1
    Debt securities (113) (11) 15 1 64 - (46) -
    Loans and advances (5,911) (1,546) 1,449 87 711 (15) (5,224) -
    Total (18,890) (8,470) 4,172 5,762 652 568 (16,206) 541
    • (*) Figures originally reported in the year 2016 in accordance to the applicable regulation, without restatements.

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    7.3.7 Refinancing and restructuring operations

    Group policies and principles with respect to refinancing and restructuring operations

    Refinancing and restructuring transactions (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 "significant increase in credit risk" to outstanding risk. The reclassification to the "significant increase in credit risk" 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 unlikely to pay when there are significant doubts that the terms of their refinancing may not be met; or
    • "Significant increase in credit risk" until the conditions established for their consideration as normal risk are met.

    The conditions established for assets classified as “Significant increase in credit risk” 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; none of its exposures is more than 30 days past-due; and
    • At least two years must have elapsed since completion of the renegotiation or restructuring of the loan and regular payments must have been made during at least half of his probation period;
    • 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 XII.

    7.4 Market risk

    7.4.1 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 as well as 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, 2018, 2017 and 2016 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 2018 December 2017 December 2016
    Main market risk metrics - VaR Main market risk metrics - Others(*) Main market risk metrics - VaR Main market risk metrics - Others(*) Main market risk metrics - VaR Main market risk metrics - Others(*)
    Assets subject to market risk
    Financial assets held for trading 57,486 28,459 59,008 441 64,623 1,480
    Financial assets at fair value through other comprehensive income 5,652 19,125 5,661 24,083 7,119 28,771
    Of which: Equity instruments - 2,046 - 2,404 - 3,559
    Derivatives - Hedging accounting 688 1,061 829 1,397 1,041 1,415
    Liabilities subject to market risk
    Financial liabilities held for trading 38,844 40,026 42,468 2,526 47,491 2,223
    Derivatives - Hedging accounting 550 910 1,157 638 1,305 689
    • (*) Includes mainly assets and liabilities managed by ALCO.

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    Although the prior table shows details of 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 76%, 70% and 66% of the Group's trading-book market risk as of December 31, 2018, 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 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 Global Markets Argentina and Global Markets Peru 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 2018

    The Group's market risk remains at low levels compared to other risks managed by BBVA, particularly in terms of credit risk. This is due to the nature of the business. During the financial year 2018 the average VaR was €21 million, below the figure of 2017, with a high on March 16, 2018 of €26 million. The evolution in the BBVA Group's market risk during 2018, 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 decreased, with a weight of 38% at the close of 2017 (vs. 29% at the close of 2016).

    As of December 31, 2018, 2017 and 2016 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 Risk Currency Risk Stock-market Risk Vega/CorrelationRisk Diversification Effect(*) Total
    December 2018
    VaR average in the year 20 6 4 9 (20) 21
    VaR max in the year 23 7 6 11 (21) 26
    VaR min in the year 17 6 4 7 (18) 16
    End of period VaR 19 5 3 7 (17) 17
    December 2017
    VaR average in the year 25 10 3 13 (23) 27
    VaR max in the year 27 11 2 12 (19) 34
    VaR min in the year 23 7 4 14 (26) 22
    End of period VaR 23 7 4 14 (26) 22
     
    December 2016
    VaR average in the year 28 10 4 11 (23) 29
    VaR max in the year 30 16 4 11 (23) 38
    VaR min in the year 21 10 1 11 (20) 23
    End of period VaR 29 7 2 12 (24) 26
     
    • (*) 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.

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    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 2018, 2017 and 2016:

    • "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 year ended December 31, 2017 and the year ended December 31, 2018, the backtesting of the internal VaR calculation model was carried out, comparing the daily results obtained to the estimated risk level by the internal VaR calculation model. At the end of the year 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, 2018 is as follows:

    Millions of Euros

      Europe Mexico Peru Venezuela Argentina Colombia Turkey Compass
    Expected Shortfall (99) (33) (11) - (5) (6) (6) (1)

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    7.4.2 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 (“IRRBB”) 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 IRRBB, 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.

    In order to evaluate its effectiveness, the model is subjected to regular internal validation. 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 Non Maturity Deposits, 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 assumptions 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 with a static model (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 banks in BBVA Group in 2018:

    Sensitivity to Interest-Rate Analysis - December 2018

    Impact on Net Interest Income (*) Impact on Economic Value (**)
    100 Basis-Points Increase 100 Basis-Points Decrease 100 Basis-Points Increase 100 Basis-Points Decrease
    Europe (***) + (5% - 10%) - (5% - 10%) + (0% - 5%) - (0% - 5%)
    Mexico + (0% - 5%) - (0% - 5%) + (0% - 5%) - (0% - 5%)
    USA + (5% - 10%) - (5% - 10%) - (5% - 10%) + (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 including rates below the current ones.

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    In 2018 in Europe monetary policy has remained expansionary, maintaining rates at 0% and the deposit rate at -0.4%. In USA the rising rate cycle initiated by the Federal Reserve in 2015 has continued. In Mexico and Turkey, the upward cycle has continued because of volatility of their currencies and inflation prospects. In South America, monetary policy has continued to be expansive in most of the economies where the Group operates, with the exception of Argentina, where rates increased and actions were taken not to increase the monetary basis and slow the inflation.

    The BBVA Group maintains, overall a positive and moderate sensitivity in its net interest income to an increase in interest rates. The higher relative net interest income sensitivities are observed in, particularly Euro and USD. In Europe however, the 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 Global ALM 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.

    2018 has been characterized by higher volatility levels of FX rates in emerging markets. As for the main currencies of the geographies where the Group operates, it is worth mentioning the appreciation of Mexican peso and US Dollar against the euro (around 5% in both cases), while Turkish lira and Argentinian peso have strongly depreciated (25% and 48%, respectively) affected by idiosyncratic factors.

    The Group's structural exchange-rate risk exposure level has remained fairly stable since the end of 2017. 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 2018, CET1 ratio sensitivity to the appreciation of 1% in the euro exchange rate for each currency is: US Dollar +1.1 bps; Mexican peso -0.2 bps; Turkish Lira -0.2 bps; other currencies -0.2 bps. On the other hand, hedging of emerging-currency denominated earnings of 2018 has reached a 82%, concentrated in Mexican peso, Turkish lira and the main Latin American currencies.

    Structural equity risk

    BBVA Group's exposure to structural equity risk stems basically from minority shareholdings in industrial and financial companies held with long or medium-term investment horizons. This exposure is modulated in some portfolios with positions held in derivative instruments on the same underlying assets, in order to adjust the portfolio sensitivity to potential changes in equity prices.

    The management of structural equity portfolios is a responsibility of the Group's units specialized in this area. Their activity is subject to the risk management corporate policy on structural equity risk management, complying with the defined management principles and Risk Appetite Framework.

    The Group's risk management systems also make it possible to anticipate potential 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 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 2018 with generalized falls and volatility surges in a macro environment of global growth slowdown, increase of the political uncertainty and normalization of the monetary policies.

    Structural equity risk, measured in terms of economic capital, has decreased in the period mainly due to lower exposure. 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 €-28 million as of December 31, 2018 and €-32 million as of December 31, 2017. This estimation 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 and the net delta-equivalent positions in derivatives on the same underlyings.

    7.4.3 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 repurchase 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, 2018, 2017 and 2016:

    December 2018 (Millions of euros)

    Gross Amounts Not Offset in the Consolidated Balance Sheets (D)
    Notes Gross Amounts Recognized (A) Gross Amounts Offset in the Consolidated Balance Sheets (B) Net Amount Presented in the Consolidated Balance Sheets (C=A-B) Financial Instruments Cash Collateral Received/ Pledged Net Amount (E=C-D)
    Trading and hedging derivatives 10, 15 49,908 16,480 33,428 25,024 7,790 613
    Reverse repurchase, securities borrowing and similar agreements 28,074 42 28,032 28,022 169 (159)
    Total Assets 77,982 16,522 61,460 53,046 7,959 454
    Trading and hedging derivatives 10, 15 51,596 17,101 34,494 25,024 6,788 2,682
    Repurchase, securities lending and similar agreements 43,035 42 42,993 42,877 34 82
    Total liabilities - 94,631 17,143 77,487 67,901 6,822 2,765

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    December 2017 (Millions of euros)

    Gross Amounts Not Offset in the Consolidated Balance Sheets (D)
    Notes Gross Amounts Recognized (A) Gross Amounts Offset in the Consolidated Balance Sheets (B) Net Amount Presented in the Consolidated Balance Sheets (C=A-B) Financial Instruments Cash Collateral Received/ Pledged Net Amount (E=C-D)
    Trading and hedging derivatives 10, 15 49,333 11,584 37,749 27,106 7,442 3,202
    Reverse repurchase, securities borrowing and similar agreements 26,426 56 26,369 26,612 141 (384)
    Total Assets 75,759 11,641 64,118 53,717 7,583 2,818
    Trading and hedging derivatives 10, 15 50,693 11,644 39,049 27,106 8,328 3,615
    Repurchase, securities lending and similar agreementss 40,134 56 40,078 40,158 21 (101)
    Total liabilities 90,827 11,701 79,126 67,264 8,349 3,514

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    December 2016 (Millions of euros)

    Gross Amounts Not Offset in the Consolidated Balance Sheets (D)
    Notes Gross Amounts Recognized (A) Gross Amounts Offset in the Consolidated Balance Sheets (B) Net Amount Presented in the Consolidated Balance Sheets (C=A-B) Financial Instruments Cash Collateral Received/ Pledged INet Amount (E=C-D)
    Trading and hedging derivatives 10, 15 59,374 13,587 45,788 32,146 6,571 7,070
    Reverse repurchase, securities borrowing and similar agreements 25,833 2,912 22,921 23,080 174 (333)
    Total Assets 85,208 16,499 68,709 55,226 6,745 6,738
    Trading and hedging derivatives 10, 15 59,545 14,080 45,465 32,146 7,272 6,047
    Repurchase, securities lending and similar agreements 49,474 2,912 46,562 47,915 176 (1,529)
    Total liabilities 109,019 16,991 92,027 80,061 7,448 4,518

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    7.5 Liquidity risk

    7.5.1 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.

    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 Liquidity Management Units (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 was applicable as from October 1, 2015. With an initial 60% minimum requirement, progressively increased (phased-in) up to 100% in 2018. Throughout the year 2018, LCR level at BBVA Group has been above 100%. As of December 31, 2018, the LCR ratio at Group level is 127%.

    Although this regulatory requirement is mandatory at a Group level and Eurozone banks, all subsidiaries are 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 154%, which is +27% above the Group's LCR.

    LCR main LMU

    December 2018 December 2017
    Group 127% 128%
    Eurozone (*) 145% 151%
    Bancomer 154% 148%
    Compass (*) 143% 144%
    Garanti 209% 134%
    • (*) Compass LCR calculated according to local regulation (Fed Modified LCR).

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    The LtSCD measures the relation between the net loans credit investment and stable customer deposits. 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.

    Stable customer deposits are defined as the customer funds captured and managed by business units among their target customers. These funds usually show little sensitivity to market changes and are largely non-volatile in terms of aggregate amounts per transaction, 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 retail 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 2018, 2017 and 2016, 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 2018 December 2017 December 2016
    Group (average) 106% 110% 113%
    Eurozone 101% 108% 113%
    Bancomer 114% 109% 113%
    Compass 119% 109% 108%
    Garanti 110% 122% 124%
    Other LMUs 99% 108% 107%

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    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 funding comprising both wholesale funding as well as funds from less stable 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 to one year, with special relevance being given to 30 and 90-day maturities.

    Each entity maintains an individual liquidity buffer, both Banco Bilbao Vizcaya Argentaria, S.A. 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, 2018 and 2017 for the most significant entities based on prudential supervisor’s information (Commission Implementing Regulations (EU) 2017/2114 of November 9, 2017):

    December 2018 (Millions of euros)

    BBVA Eurozone BBVA Bancomer BBVA Compass Garanti Bank Other
    Cash and withdrawable central bank reserves 26,506 7,666 1,667 7,633 6,677
    Level 1 tradable assets 29,938 4,995 10,490 6,502 3,652
    Level 2A tradable assets 449 409 510 - -
    Level 2B tradable assets 4,040 33 - - -
    Other tradable assets 5,661 1,372 1,043 499 617
    Non tradable assets eligible for central banks - - 2,314 - -
    Cumulated Counterbalancing Capacity 66,594 14,475 16,024 14,634 10,946

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    December 2017 (Millions of euros)

    BBVA Eurozone (1) BBVA Bancomer BBVA Compass Garanti Bank Other
    Cash and withdrawable central bank reserves 15,634 8,649 2,150 6,692 6,083
    Level 1 tradable assets 38,954 3,805 9,028 5,705 6,141
    Level 2A tradable assets 386 418 753 - 10
    Level 2B tradable assets 4,995 69 - - 21
    Other tradable assets 6,734 1,703 1,252 962 1,573
    Non tradable assets elegible for central banks - - 2,800 - -
    Cumulated Counterbalancing Capacity 66,703 14,644 15,983 13,359 13,828
    • (1)It includes Spain, Portugal and Rest of Eurasia.

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    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, 2018, 2017 and 2016:

    December 2018. Contractual Maturities (Millions of euros)

    Demand Up to 1
    Month
    1 to 3
    Months
    3 to 6
    Months
    6 to 9
    Months
    9 to 12
    Months
    1 to 2 Years 2 to 3 Years 3 to 5 Years Over 5
    Years
    Total
    ASSETS
    Cash, cash balances at central banks and other
    demand deposits
    9,550 40,599 - - - - - - - - 50,149
    Deposits in credit entities 801 3,211 216 141 83 152 133 178 27 1,269 6,211
    Deposits in other financial institutions 1 1,408 750 664 647 375 1,724 896 1,286 2,764 10,515
    Reverse repo, securities borrowing and margin
    lending
    - 21,266 1,655 1,158 805 498 205 1,352 390 210 27,539
    Loans and Advances 132 19,825 25,939 23,265 15,347 16,433 42,100 32,336 53,386 120,571 349,334
    Securities' portfolio settlement - 1,875 4,379 5,990 2,148 6,823 8,592 12,423 11,533 42,738 96,501

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    December 2018. Contractual Maturities (Millions of euros)

    Demand Up to 1
    Month
    1 to 3
    Months
    3 to 6
    Months
    6 to 9
    Months
    9 to 12
    Months
    1 to 2 Years 2 to 3 Years 3 to 5 Years Over 5
    Years
    Total
    LIABILITIES
    Wholesale funding 1 2,678 1,652 2,160 2,425 2,736 7,225 8,578 16,040 26,363 69,858
    Deposits in financial institutions 7,107 5,599 751 1,992 377 1,240 1,149 229 196 904 19,544
    Deposits in other financial institutions and
    international agencies
    10,680 4,327 1,580 458 302 309 781 304 825 1,692 21,258
    Customer deposits 252,630 44,866 18,514 10,625 6,217 7,345 5,667 2,137 1,207 1,310 350,518
    Security pledge funding 40 46,489 2,219 2,274 114 97 22,911 526 218 1,627 76,515
    Derivatives, net - (75) (523) (68) (5) (117) 498 (91) (67) (392) (840)

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    December 2017. Contractual Maturities (Millions of euros)

    Demand Up to 1
    Month
    1 to 3
    Months
    3 to 6
    Months
    6 to 9
    Months
    9 to 12
    Months
    1 to 2 Years 2 to 3 Years 3 to 5 Years Over 5
    Years
    Total
    ASSETS
    Cash, cash balances at central banks and other demand
    deposits
    8,179 31,029 - - - - - - - - 39,208
    Deposits in credit entities 252 4,391 181 169 120 122 116 112 157 1,868 7,488
    Deposits in other financial institutions 1 939 758 796 628 447 1,029 681 806 1,975 8,060
    Reverse repo, securities borrowing and margin lending 18,979 2,689 1,921 541 426 815 30 727 226 - 26,354
    Loans and Advances 267 21,203 26,323 23,606 15,380 17,516 43,973 35,383 50,809 123,568 358,028
    Securities' portfolio settlement 1 1,579 4,159 4,423 2,380 13,391 5,789 11,289 12,070 44,666 99,747

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    December 2017. Contractual Maturities (Millions of euros)

    Demand Up to 1
    Month
    1 to 3
    Months
    3 to 6
    Months
    6 to 9
    Months
    9 to 12
    Months
    1 to 2 Years 2 to 3 Years 3 to 5 Years Over 5
    Years
    Total
    LIABILITIES
    Wholesale funding - 3,648 4,209 4,238 1,227 2,456 5,772 6,432 18,391 30,162 76,535
    Deposits in financial institutions 6,831 5,863 1,082 2,335 392 1,714 930 765 171 1,429 21,512
    Deposits in other financial institutions and international
    agencies
    10,700 4,827 3,290 1,959 554 1,328 963 286 355 1,045 25,307
    Customer deposits 233,068 45,171 18,616 11,428 8,711 10,368 7,607 2,612 1,833 2,034 341,448
    Security pledge funding - 35,502 2,284 1,405 396 973 64 23,009 338 1,697 65,668
    Derivatives, net - (18) (110) (116) (135) (117) (336) (91) (106) (419) (1,448)

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    December 2016. Contractual Maturities (Millions of euros)

    Demand Up to 1
    Month
    1 to 3
    Months
    3 to 6
    Months
    6 to 9
    Months
    9 to 12
    Months
    1 to 2 Years 2 to 3 Years 3 to 5 Years Over 5
    Years
    Total
    ASSETS
    Cash, cash balances at central banks and other demand
    deposits
    23,191 13,825 - - - - - - - - 37,016
    Deposits in credit entities 991 4,068 254 155 48 72 117 87 122 4,087 10,002
    Deposits in other financial institutions 1 1,192 967 675 714 532 1,330 918 942 336 7,608
    Reverse repo, securities borrowing and margin lending - 20,232 544 523 - 428 500 286 124 189 22,826
    Loans and Advances 591 20,272 25,990 22,318 16,212 15,613 44,956 35,093 55,561 133,589 370,195
    Securities' portfolio settlement - 708 3,566 3,688 2,301 4,312 19,320 10,010 16,662 51,472 112,039

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    December 2016. Contractual Maturities (Millions of euros)

    Demand Up to 1
    Month
    1 to 3
    Months
    3 to 6
    Months
    6 to 9
    Months
    9 to 12
    Months
    1 to 2 Years 2 to 3 Years 3 to 5 Years Over 5
    Years
    Total
    LIABILITIES
    Wholesale funding 419 7.380 2.943 5.547 3.463 5.967 7.825 5.963 14.016 31.875 85.397
    Deposits in financial institutions 6.762 5.365 1.181 2.104 800 2.176 746 1.156 859 3.714 24.862
    Deposits in other financial institutions and international
    agencies
    15.375 6.542 8.624 3.382 2.566 1.897 1.340 686 875 2.825 44.114
    Customer deposits 206.140 49.053 25.522 15.736 11.863 11.343 8.619 5.060 781 936 335.052
    Security pledge funding - 38.153 3.561 1.403 1.004 912 1.281 640 23.959 1.712 72.626
    Derivatives, net - (2.123) (95) (190) (111) (326) (132) (82) (105) (47) (3.210)

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    The matrix shows the retail nature of the funding structure, with a loan portfolio being mostly funded by customer deposits (66%). On the outflows side of the matrix, the “demand” maturity bucket mainly contains the retail customer sight accounts whose behavior historically showed a high level of stability and little concentration. According to an behavior analysis which is done every year in every entity, this type of account is considered to be stable and for liquidity risk purposes, it is estimated that 78% have a maturity of more than 5 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. In addition, during 2018 the Euro LMU made 3 issues in the public market for €3,500 million; Senior Non Preferred (“SNP”) at 5 years for €1,500 million, Green bond SNP at 7 years for €1,000 million and AT1 for €1,000 million, which have allowed it to obtain long-term funding at favorable price conditions. These public operations have been complemented by a private issue T2 for USD 300 million.

    In Mexico, sound liquidity position despite the market volatility, the Credit Gap has increased in 2018 due to a minor increase in deposits mainly because of the outflows of non-profitable USD deposits. During the financial year 2018, BBVA Bancomer made a local Tier II issuance on international markets for USD 1,000 million as well as an issuance on the local market for 7,000 million of Mexican pesos in 2 tranches: at 3 and 5 years, being the 3 years tranche the first Green Bond issued by a private bank.

    In the United States, the containment of the cost of liabilities has led to a slightly increase in the credit gap. During the financial year 2018, BBVA Compass successfully issued 3 year senior debt for USD 1,150 million.

    In Turkey an adequate liquidity situation is maintained, after having been affected by the currency volatility at the beginning of the second semester. Despite this, Garanti showed a good performance with the roll-over of the 2018 maturities of corporate funding. The main operations during the year were two syndicated loans for USD 2,300 million, the first Green Bond at 6 years for USD 75 million and future flows securitization (Diversified Payment Rights) for USD 375 million at 7 years.

    Argentina was affected by the market volatility but no relevant impact on the liquidity situation of the entity has been noted. BBVA Francés maintains a solid liquidity situation distinguished by a major volume of cash reserves.

    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.

    7.5.2 Asset encumbrance

    As of December 31, 2018, 2017 and 2016, the encumbered (those provided as collateral for certain liabilities) and unencumbered assets are broken down as follows:

    December 2018 (Millions of euros)

    Encumbered assets Non-Encumbered assets
    Book value of Encumbered assets Market value of Encumbered assets Book value of non-encumbered assets Market value of non-encumbered assets
    Assets
    Equity instruments 1,864 1,864 6,485 6,485
    Debt Securities 31,157 32,216 82,209 82,209
    Loans and Advances and other assets 74,928 478,880

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    December 2017 (Millions of euros)

    Encumbered assets Non-Encumbered assets
    Book value of Encumbered assets Market value of Encumbered assets Book value of non-encumbered assets Market value of non-encumbered assets
    Assets
    Equity instruments 2,297 2,297 9,616 9,616
    Debt Securities 28,700 29,798 84,391 84,391
    Loans and Advances and other assets 79,604 485,451

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    December 2016 (Millions of euros)

    Encumbered assets Non-Encumbered assets
    Book value of Encumbered assets Market value of Encumbered assets Book value of non-encumbered assets Market value of non-encumbered assets
    Assets
    Equity instruments 2,214 2,214 9,022 9,022
    Debt Securities 40,114 39,972 90,679 90,679
    Loans and Advances and other assets 94,718 495,109

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    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 correspond 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 transactions is also included as committed assets.

    As of December 31, 2018, 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 2018. Collateral received (Millions of euros)

    Fair value of encumbered collateral received or own debt securities issued Fair value of collateral received or own debt securities issued available for encumbrance Nominal amount of collateral received or own debt securities issued not available for encumbrance
    Collateral received 27,474 5,633 319
    Equity instruments 89 82 -
    Debt securities 27,385 5,542 300
    Loans and Advances and other assets - 8 19
    Own debt securities issued other than own covered bonds
    or ABSs
    78 87 -

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    December 2017. Collateral received (Millions of euros)

    Fair value of encumbered collateral received or own debt securities issued Fair value of collateral received or own debt securities issued available for encumbrance Nominal amount of collateral received or own debt securities issued not available for encumbrance
    Collateral received 23,881 9,630 201
    Equity instruments 103 5 -
    Debt securities 23,715 9,619 121
    Loans and Advances and other assets 63 6 80
    Own debt securities issued other than own covered bonds or ABSs 3 161 -

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    December 2016. Collateral received (Millions of euros)

    Fair value of encumbered collateral received or own debt securities issued Fair value of collateral received or own debt securities issued available for encumbrance Nominal amount of collateral received or own debt securities issued not available for encumbrance
    Collateral received 19,921 10,039 173
    Equity instruments 58 59 -
    Debt securities 19,863 8,230 28
    Loans and Advances and other assets - 1,750 144
    Own debt securities issued other than own covered bonds or ABSs 5 - -

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

    As of December 31, 2018, 2017 and 2016, financial liabilities issued related to encumbered assets in financial transactions as well as their book value were as follows:

    December 2018. Sources of encumbrance (Millions of euros)

    Matching liabilities, contingent liabilities or securities lent Assets, collateral received and own debt securities issued other than covered bonds and ABSs encumbered
    Book value of financial liabilities 113,498 131,172
    Derivatives 8,972 11,036
    Loans and Advances 85,989 97,361
    Outstanding subordinated debt 18,538 22,775
    Otras Other sources 3,972 4,330

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    December 2017. Sources of encumbrance (Millions of euros)

    Matching liabilities, contingent liabilities or securities lent Assets, collateral received and own debt securities issued other than covered bonds and ABSs encumbered
    Book value of financial liabilities 118,704 133,312
    Derivatives 11,843 11,103
    Loans and Advances 87,484 98,478
    Outstanding subordinated debt 19,377 23,732
    Other sources 305 1,028

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    December 2016. Sources of encumbrance (Millions of euros)

    Matching liabilities, contingent liabilities or securities lent Assets, collateral received and own debt securities issued other than covered bonds and ABSs encumbered
    Book value of financial liabilities 134,387 153,632
    Derivatives 9,304 9,794
    Loans and Advances 96,137 108,268
    Outstanding subordinated debt 28,946 35,569
    Other sources - 2,594

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    7.6 Operational Risk

    BBVA defines operational risk (“OR”) as any risk that could result in losses caused by human errors, inadequate or faulty internal processes, misconduct with clients or in the markets, failures, disruptions or deficiencies of systems or communications, inadequate data management, legal risks and, lastly, from external events, including cyberattacks, frauds committed by third parties, disasters and an unsatisfactory service provided by suppliers.

    Operational risk management is oriented towards the identification of the root causes to avoid their occurrence and mitigate possible consequences. This is carried out through the establishment of mitigation plans and control frameworks aimed at minimizing resulting losses and their impact on the recurrent generation of income and the profit of the Group. Operational risk management is integrated into the global risk management structure of the BBVA Group.

    This section addresses general aspects of operational risk management as the main component of non-financial risks. However, sections devoted to conduct and compliance risk and to cybersecurity risk management are also included in this report.

    Operational Risk Management Principles

    The BBVA Group is committed to preferably applying advanced operational risk management models, regardless of the capital calculation regulatory model applicable at the time. Operational risk management at the BBVA Group shall:

    • Be in line with the Risk Appetite Framework approved by BBVA's Board of Directors.
    • Meet BBVA’s management needs arising from compliance with rules, regulation, industry standards and from decisions or positions taken by the governing bodies of the Group.
    • Predict potential operational risks to which the Group shall be exposed as a result of the emergence or changes on new products, activities, processes or systems and services procurement or outsourcing decisions; and establish mechanisms to achieve a reasonable assessment and mitigation before implementation, in addition to a regular review on all existing processes.
    • Establish methodologies, procedures and indicators to regularly reassess the relevant operational risks to which the Group is exposed to implement the most appropriate mitigation measures in each case, once the identified risk and the mitigation cost have been considered (cost-benefit analysis) and preserving the solvency of the Group at all times.
    • Seek the causes behind the operational events suffered by the Group and establish the appropriate redressing measures (always considering the cost-benefit analysis). To that end, procedures for analyzing operational events must be in place, in addition to mechanisms to capture the potential operational losses resulting from those events.
    • Analyze the public events with significant operational risk in other entities and to promote, if applicable, the implementation of the appropriate measures to avoid its occurrence in the Group.
    • Identify, analyze and try to quantify events with a low probability of occurrence and a high impact that, due to their exceptional nature, may not be included in the loss database or, if included, with not highly representative impacts, in order to assess possible mitigation measures.
    • Have an effective governance on which the functions and responsibilities of the Areas and Bodies intervening in OR management are clearly defined.

    Irrespective of the implementation of all the possible measures and controls designed to avoid or mitigate the frequency and severity of OR events, BBVA ensures at all times the capital required to face potential expected or unexpected losses.

    Operational risk control and management model

    The operational risk management cycle at BBVA is similar to the one implemented for the rest of risks. Its elements are:

    Planning

    Operational risk forms part of the risk appetite framework of the Group and includes three types of metrics:

    • Economic capital calculated with the operational losses database of the Group and the industry, considering the corresponding diversification effects and the additional estimation of potential and emerging risks through stress scenarios designed for the main types of risks. The economic capital is regularly calculated for the main banks of the group and simulation capabilities are available to anticipate the impact of changes on the risk profile or new potential events.
    • IRO metrics (operational risk losses vs. gross income) broken down by geography, business area and type of risk.
    • In addition, work is in progress on the implementation in the entire group of a common and more granular scheme of metrics that covers the main types of operational risks.
    Operational risk admission

    The main purposes of the operational risk admission phase are the following:

    • Anticipate potential operational risks to which the Group would be exposed with the emergence of new initiatives (new business, product, outsourcing, process transformation, new systems, etc.) or changes in those initiatives in place.
    • Ensure that the implementation is carried out once the appropriate mitigation measures have been adopted, among others risk insurance, where appropriate.

    The Corporate Policy on Operational Risk Management and Control sets out the specific operational risk admission framework through different committees, at a corporate and Business Area level, that follow a delegation structure based on the risk level of proposed initiatives.

    Operational risk monitoring

    The purpose of this phase is to check that the target operational risk profile of the group is within the authorized limits. Operational risk monitoring considers 2 scopes:

    • Monitoring the operational risk admission process, oriented towards checking that accepted risks levels are within the limits and that defined controls are effective.
    • Monitoring the operational risk “stock” linked to the processes, in order to carry out a regular reassessment to confirm that residual risks and target risk are reasonably aligned and, if not, to implement action plans to redress gaps to the desired level.

    This process is supported by a corporate Governance, Risk & Compliance tool that monitors OR at a local level and its aggregation at a corporate level.

    In addition, and in line with the best practices and recommendations provided by the BIS, BBVA has procedures to collect the operational losses occurred in the different entities of the Group and in other financial groups, with the appropriate level of detail to carry out an effective analysis that provides useful information for management purposes. To that end, a corporate tool implemented in all the countries of the Group is used.

    Operational risk mitigation

    Several cross-sectional operational risk plans have been promoted over the last two years for the entire BBVA Group to encourage a forward-looking management of these risks. To that end, focuses have been identified from events, self-assessments and recommendations from auditors and supervisors in different geographies, both in the Group and the industry, thereby analyzing the best practices and fostering comprehensive action plans to strengthen and standardize the control environment.

    One of the core plans is outsourcing management, which is an increasingly important subject in the Group, the industry and the regulatory environment. Some of the different initiatives launched under this scheme are summarized below:

    • Strengthening the admission process of these initiatives and their control and monitoring frameworks.
    • New internal regulation comprising the best practices of the industry.
    • Integration in the 3 lines of defense control model: roles and responsibilities in each phase of its life cycle.
    • Risk management of the service and the supplier.
    • Review of its governance process, which is included in operational risk governance, and escalation criteria.
    • Adaptation of the management tool to the new requirements.
    • Internal communication process and training between outsourcing units and senior management, including these issues on the agenda of the main control committees of the Group.

    This plan will still be promoted in the year 2019 with a focus on a review of the most significant outsourcing stock.

    Governance of Non-financial risks

    The non-financial risks governance model at the BBVA Group is based on two components:

    • The three lines of defense control model, in accordance with the best practices of the industry and through which compliance with the most advanced standards in terms of operational risk internal control is ensured.
    • Scheme of Corporate Assurance Committees and Operational Risk and Internal Control Committees at the level of the different business areas.

    Corporate Assurance establishes a structure of corporate and local committees that provides Senior Management with a comprehensive and consistent view of the most relevant non-financial risks. The purpose is to ensure a forward-looking and prompt decision-making process for the mitigation or taking of the major risks both at a local level and at the level of the consolidated Group.

    In addition, the Non-Financial Risks unit periodically reports the Risk Committee of the Board on the situation of non-financial risks management in the Group.

    7.7. Risk concentration

    Policies for preventing excessive risk concentration

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

    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 XII.

    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 XII.

    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

    The relative weight of the investment in Real Estate developments has dramatically decreased during the last years, especially since 2014. A corporate sales policy has been rolled out to eliminate those real estate assets from the balance sheet which have been most difficult to be commercialized. The sales of 80% of the Group's share in Divarian and of other performing and NPL wholesale portfolios to Funds and specialized investors have been some of the most relevant transactions (see Note 3).

    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.

    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 within a sector is highly cyclic.

    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.

    The monitoring of the work, the sales and the legal situation of the project are essential aspects for the admission and follow-up of new real estate operations. With regard the participation of the Risk Acceptance teams, they have a direct link and participate in the committees of areas such as Valuation, Legal, Research and Recoveries. 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. Additionally, very restrictive limits have been established for the second-home market and for the of land operations. Feasibility studies, at project level, are performed by doing a contrast analysis in the pre-commercialization phase, with an appropriate funding cycle and in locations with low commercialization risk.

    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. This implies a comparison of the progress of the work and the sales, including a scoreboard which enables the persons in charge to detect timely any deviation from the project’s initial plan.

    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, improved collateral and rate review (repricing. Since 2013, there are no threats of new defaults in the portfolio).

    Proper management of the relationship with each customer requires knowledge of various aspects such as 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.

    The volume of restructurings during the last period has been very low, being close to 0.

    Policies applied in the management of real estate assets in Spain

    Regarding the financing of real estate, a new regulation has been updated in 2018 in which recommendations for the promotion of residential real estate are established.

    The recommendations represent guidelines about how to manage the credit admission activity of BBVA Group entities based on best practices of markets in which this activity is performed. It is expected that a high percentage of the current transactions will be in compliance with the latter.

    The guidelines apply to new transactions with clients which are not classified as impaired or Watchlist (WL1 or WL2).

    The policies deriving from the guidelines foresee a prudential intervention in a market which has changed its cycle in almost all of the geographies and which is showing a more sustainable behavior in terms of demography, employment and economic and investment capacities.

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

    8. Fair Value of financial instruments

    Framework and processes control

    As part of the process established in the Group for determining the fair value in order to ensure that financial assets and liabilities are properly valued, BBVA has established, at a geographic level, a structure of Risk Operational Admission and Product Governance Committees responsible for validating and approving new products or types of financial assets and liabilities before being contracted. Local management responsible for valuation, which are independent from the business (see Note 7) are members of these committees.

    These areas are required to ensure, prior to the approval stage, the existence of not only technical and human resources, but also adequate informational sources to measure the fair value of these financial assets and liabilities, in accordance with the rules established by the Group and using models that have been validated and approved by the responsible areas.

    Fair value hierarchy

    The fair value of financial instrument is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is therefore a market-based measurement and not specific to each entity.

    All financial instruments, both assets and liabilities are initially recognized at fair value, which at that point is equivalent to the transaction price, unless there is evidence to the contrary in the market. Subsequently, depending on the type of financial instrument, it may continue to be recognized at amortized cost or fair value through adjustments in the consolidated income statement or equity.

    When possible, the fair value is determined as the market price of a financial instrument. However, for many of the financial assets and liabilities of the Group, especially in the case of derivatives, there is no market price available, so its fair value is estimated on the basis of the price established in recent transactions involving similar instruments or, in the absence thereof, by using mathematical measurement models that are sufficiently tried and trusted by the international financial community. The estimates of the fair value derived from the use of such models take into consideration the specific features of the asset or liability to be measured and, in particular, the various types of risk associated with the asset or liability. However, the limitations inherent in the measurement models and possible inaccuracies in the assumptions and parameters required by these models may mean that the estimated fair value of an asset or liability does not exactly match the price for which the asset or liability could be exchanged or settled on the date of its measurement.

    Additionally, for financial assets and liabilities that show significant uncertainty in inputs or model parameters used for valuation, criteria is established to measure said uncertainty and activity limits are set based on these. Finally, these measurements are compared, as much as possible, against other sources such as the measurements obtained by the business teams or those obtained by other market participants.

    The process for determining the fair value requires the classification of the financial assets and liabilities according to the measurement processes used as set forth below:

    • Level 1: Valuation using directly the quotation of the instrument, observable and readily and regularly available from independent price sources and referenced to active markets that the entity can access at the measurement date. The instruments classified within this level are fixed-income securities, equity instruments and certain derivatives.
    • Level 2: Valuation of financial instruments with commonly accepted techniques that use inputs obtained from observable data in markets.
    • Level 3: Valuation of financial instruments with valuation techniques that use significant unobservable inputs in the market. As of December 31, 2018, the affected instruments at fair value accounted for approximately 0.56% of financial assets and 0.46% of the Group's financial liabilities registered at fair value. Model selection and validation is undertaken by control areas outside the business areas.

    8.1 Fair value of financial instrument

    Below is a comparison of the carrying amount of the Group's financial instruments in the accompanying consolidated balance sheets and their respective fair values.

    Fair Value and Carrying Amount (Millions of euros)

    2018
    Notes Carrying Amount Fair Value
    ASSETS
    Cash, cash balances at central banks and other demand deposits 9 58,196 58,196
    Financial assets held for trading 10 90,117 90,117
    Non-trading financial assets mandatorily at fair value through profit or loss 11 5,135 5,135
    Financial assets designated at fair value through profit or loss 12 1,313 1,313
    Financial assets at fair value through other comprehensive income 13 56,337 56,337
    Financial assets at amortized cost 14 419,660 419,857
    Hedging derivatives 15 2,892 2,892
    LIABILITIES
    Financial liabilities held for trading 10 80,774 80,774
    Financial liabilities designated at fair value through profit or loss 12 6,993 6,993
    Financial liabilities at amortized cost 22 509,185 510,300
    Hedging derivatives 15 2,680 2,680

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    Fair Value and Carrying Amount (Millions of euros)

    2017 2016
    Notes Carrying Amount Fair Value Carrying Amount Fair Value
    ASSETS
    Cash, cash balances at central banks and other demand deposits 9 42,680 42,680 40,039 40,039
    Financial assets held for trading 10 64,695 64,695 74,950 74,950
    Financial assets designated at fair value through profit or loss 12 2,709 2,709 2,062 2,062
    Available-for-sale financial assets 69,476 69,476 79,221 79,221
    Loans and receivables 431,521 438,991 465,977 468,844
    Held-to-maturity investments 13,754 13,865 17,696 17,619
    Derivatives – Hedge accounting 15 2,485 2,485 2,833 2,833
    LIABILITIES
    Financial liabilities held for trading 10 46,182 46,182 54,675 54,675
    Financial liabilities designated at fair value through profit or loss 12 2,222 2,222 2,338 2,338
    Financial liabilities at amortized cost 22 543,713 544,604 589,210 594,190
    Derivatives – Hedge accounting 15 2,880 2,880 2,347 2,347

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    The years 2017 and 2016 are presented for comparison purpose separately due to the implementation of IFRS 9.

    Not all financial assets and liabilities are recorded at fair value, so below we provide the information on financial instruments recorded at fair value and subsequently the information of those recorded at amortized cost (including their fair value), although this value is not used when accounting for these instruments.

    8.1.1 Fair value of financial instrument recognized at fair value, according to valuation criteria

    Below are the different elements used in the valuation technique of financial instruments.

    Active Market

    BBVA considers active market as “a market that allows the observation of bid and offer prices representative of the levels to which the market participants are willing to negotiate an asset, with sufficient frequency and volume”.

    By default, BBVA would consider all internally approved “Organized Markets” as active markets, without considering this an unchangeable list.

    Furthermore, BBVA would consider as traded in an “Organized Market” quotations for assets or liabilities from OTC markets when they are obtained from independent sources, observable on a daily basis and fulfil certain conditions.

    The following table shows the financial instruments carried at fair value in the accompanying consolidated balance sheets, broken down by the measurement technique used to determine their fair value:

    Fair Value of financial Instruments by Levels

    2018
    Notes Level 1 Level 2 Level 3
    ASSETS
    Financial assets held for trading 10 26,730 62,983 404
    Loans and advances to customers 47 28,642 60
    Debt securities 17,884 7,494 199
    Equity instruments 5,194 - 60
    Derivatives 3,605 26,846 85
    Non-trading financial assets mandatorily at fair value through profit or loss 11 3,127 78 1,929
    Loans and advances 25 - 1,778
    Debt securities 90 71 76
    Equity instruments 3,012 8 75
    Financial assets designated at fair value through profit or loss 12 1,313 - -
    Loans and advances - - -
    Debt securities 1,313 - -
    Equity instruments - - -
    Financial assets at fair value through other comprehensive income 13 45,824 9,323 1,190
    Debt securities 33 - -
    Debt securities 43,788 9,211 711
    Equity instruments 2,003 113 479
    Hedging derivatives 15 7 2,882 3
    LIABILITIES
    Financial liabilities held for trading 10 22,932 57,573 269
    Deposits 7,989 29,945 0
    Trading derivatives 3,919 27,628 267
    Other financial liabilities 11,024 - 1
    Financial liabilities designated at fair value through profit or loss 12 - 4,478 2,515
    Customer deposits - 976 -
    Debt certificates - 2,858 -
    Other financial liabilities - 643 2,515
    Derivatives – Hedge accounting 15 223 2,454 3

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    Fair Value of financial Instruments by Levels

    2017 2016
    Notes Level 1 Level 2 Level 3 Level 1 Level 2 Level 3
    ASSETS
    Financial assets held for trading 10 29,057 35,349 289 32,544 42,221 184
    Loans and advances to customers - 56 - - 154 -
    Debt securities 21,107 1,444 22 26,720 418 28
    Equity instruments 6,688 33 80 4,570 9 96
    Derivatives 1.262 33,815 187 1,254 41,640 60
    Financial assets designated at fair value through profit or loss 11 2,061 648 - 2,062 - -
    Loans and advances to customers - 648 - - -
    Loans and advances to credit institutions - - - - - -
    Debt securities 174 - - 142 - -
    Equity instruments 1,888 - - 1,920 - -
    Available-for-sale financial assets 57,381 11,082 544 62,125 15,894 637
    Debt securities 54,850 10,948 454 58,372 15,779 429
    Equity instruments 2,531 134 90 3,753 115 208
    Hedging derivatives 15 - 2,483 2 41 2,792 -
    LIABILITIES
    Financial liabilities held for trading 10 11,191 34,866 125 12,502 42,120 53
    Derivatives 1.183 34,866 119 952 42,120 47
    Short positions 10,008 - 6 11,550 - 6
    Financial liabilities designated at fair value through profit or loss 12 - 2,222 - - 2,338 -
    Derivatives – Hedge accounting 15 274 2,606 - 94 2,189 64

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    The years 2017 and 2016 are presented separately due to the implementation of IFRS 9.

    Financial instruments carried at fair value corresponding to the companies that belong to Banco Provincial Group in Venezuela whose balance is denominated in “bolivares fuertes” are classified under Level 3 in the above tables (see Note 2.2.20).

    The following table sets forth the main valuation techniques, hypothesis and inputs used in the estimation of fair value of the financial instruments classified under Levels 2 and 3, based on the type of financial asset and liability and the corresponding balances as of December 31, 2018:

    Fair Value of financial Instruments by Levels. December 2018 (Millions of euros)

    Level 2 Level 3 Valuation technique(s) Observable inputs Unobservable inputs
    ASSETS
    Financial assets held for trading 62,983 404
    Loans and advances 28,642 60 Present-value method
    (Discounted future cash flows)
    - Issuer's credit risk
    - Current market interest rates
    - Prepayment rates
    - Issuer´s credit risk
    - Recovery rates
    Debt securities 7,494 199 Present-value method (Discounted future cash flows)
    Observed prices in non active markets
    - Issuer's credit risk
    - Current market interest rates
    - Non active makets prices
    - Prepayment rates
    - Issuer's credit risk
    - Recovery rates
    Equity instrument - 60 Comparable pricing (Observable price in a similar market)
    Present-value method
    - Brokers quotes
    - Market operations
    - NAVs published
    - NAV provided by the administrator of the fund
    Derivatives 26,846 85
    Interest rate Interest rate products (Interest rate swaps, Call money Swaps y FRA): Discounted cash flows
    Caps/Floors: Black, Hull-White y SABR
    Bond options: Black
    Swaptions: Black, Hull-White y LGM
    Other Interest rate options: Black, Hull-White y LGM
    Constant Maturity Swaps: SABR
    - Exchange rates
    - Market quoted future prices
    - Market interest rates
    - Underlying assets prices: shares, funds, commodities
    - Market observable volatilities
    - Issuer credit spread levels
    - Quoted dividends
    - Market listed correlations
    - Beta
    - Implicit correlations between tenors
    - Interest rates volatility
    Equity Future and Equity Forward: Discounted future cash flows
    Equity Options: Local Volatility, Momentum adjustment
    - Volatility of volatility
    - Implicit assets correlations
    - Long term implicit correlations
    - Implicit dividends and long term repos
    Foreign exchange and gold Future and Equity Forward: Discounted future cash flows
    Foreign exchange Options: Local Volatility, moments adjustment
    - Volatility of volatility
    - Implicit assets correlations
    - Long term implicit correlations
    Credit Credit Derivatives: Default model and Gaussian copula - Correlation default
    - Credit spread
    - Recovery rates
    - Interest rate yield
    - Default volatility
    Commodities Commodities: Momentum adjustment and Discounted cash flows
    Non-trading financial assets mandatorily at fair value through profit or
    loss
    78 1,929
    Loans and advances - 1,778 Present-value method
    (Discounted future cash flows)
    Specific criteria for the liquidation of losses established by the EPA protocol
    - Prepayment rates
    - Issuer credit risk
    - Recovery rates
    - PD and LGD
    Debt securities 71 76 Present-value method
    (Discounted future cash flows)
    - Issuer credit risk
    - Current market interest rates
    - Prepayment rates
    - Issuer credit risk
    - Recovery rates
    Equity instruments 8 75 Present-value method
    (Discounted future cash flows)
    - Issuer credit risk
    - Current market interest rates
    - Prepayment rates
    - Issuer credit risk
    - Recovery rates
    Financial assets designated at fair value through profit or loss 9,323 1,190
    Debt securities 9,211 711 Present-value method
    (Discounted future cash flows)
    Observed prices in non active markets
    - Issuer´s credit risk
    - Current market interest rates
    - Non active market prices
    - Prepayment rates
    - Issuer credit risk
    - Recovery rates
    Equity instruments 113 479 Comparable pricing (Observable price in a similar market)
    Present-value method
    - Brokers quotes
    - Market operations
    - NAVs published
    - NAV provided by the administrator of the fund
    Hedging derivatives 2,882 3
    Interest rate Interest rate products (Interest rate swaps, Call money Swaps y FRA): Discounted cash flows
    Caps/Floors: Black, Hull-White y SABR
    Bond options: Black
    Swaptions: Black, Hull-White y LGM
    Other Interest rate options: Black, Hull-White y LGM
    Constant Maturity Swaps: SABR
    - Exchange rates
    - Market quoted future prices
    - Market interest rates
    - Underlying assets prices: shares, funds, commodities
    - Market observable volatilities
    - Issuer credit spread levels
    - Quoted dividends
    - Market listed correlations
    Equity Future and Equity Forward: Discounted future cash flows
    Equity Options: Local Volatility, Momentum adjustment
    Foreign exchange and gold Future and Equity Forward: Discounted future cash flows
    Foreign exchange Options: Local Volatility, moments adjustment
    Credit Credit Derivatives: Default model and Gaussian copula
    Commodities Commodities: Momentum adjustment and Discounted cash flows

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    Fair Value of financial Instruments by Levels. December 2018 (Millions of euros)

    Level 2 Level 3 Valuation technique(s) Observable inputs Unobservable inputs
    LIABILITIES
    Financial assets held for trading 57,573 269
    Deposits 29,945 -
    Derivatives 27,628 267
    Interest rate Interest rate products (Interest rate swaps, Call money Swaps y FRA): Discounted cash flows
    Caps/Floors: Black, Hull-White y SABR
    Bond options: Black
    Swaptions: Black, Hull-White y LGM
    Other Interest rate options: Black, Hull-White y LGM
    Constant Maturity Swaps: SABR
    - Exchange rates
    - Market quoted future prices
    - Market interest rates
    - Underlying assets prices: shares, funds, commodities
    - Market observable volatilities
    - Issuer credit spread levels
    - Quoted dividends
    - Market listed correlations
    - Beta
    - Implicit correlations between tenors
    - Interest rates volatility
    Equity Future and Equity Forward: Discounted future cash flows
    Equity Options: Local Volatility, Momentum adjustment
    - Volatility of volatility
    - Implicit assets correlations
    - Long term implicit correlations
    - Implicit dividends and long term repos
    Foreign exchange and gold Future and Equity Forward: Discounted future cash flows
    Foreign exchange Options: Local Volatility, moments adjustment
    - Volatility of volatility
    - Implicit assets correlations
    - Long term implicit correlations
    Credit Credit Derivatives: Default model and Gaussian copula - Correlation default
    - Credit spread
    - Recovery rates
    - Interest rate yield
    - Default volatility
    Commodities Commodities: Momentum adjustment and Discounted cash flows
    Short positions - 1 Present-value method
    (Discounted future cash flows)
    - Correlation default
    - Credit spread
    - Recovery rates
    - Interest rate yield
    Financial assets designated at fair value through profit or loss 4,478 2,515 Present-value method
    (Discounted future cash flows)
    - Prepayment rates
    - Issuer´s credit risk
    - Current market interest rates
    - Prepayment rates
    - Issuer´s credit risk
    - Current market interest rates zzzzz
    Derivatives – Hedge accounting 2,454 3
    Interest rate Interest rate products (Interest rate swaps, Call money Swaps y FRA): Discounted cash flows
    Caps/Floors: Black, Hull-White y SABR
    Bond options: Black
    Swaptions: Black, Hull-White y LGM
    Other Interest rate options: Black, Hull-White y LGM
    Constant Maturity Swaps: SABR
    - Exchange rates
    - Market quoted future prices
    - Market interest rates
    - Underlying assets prices: shares, funds, commodities
    - Market observable volatilities
    - Issuer credit spread levels
    - Quoted dividends
    - Market listed correlations
    - Beta
    - Implicit correlations between tenors
    - interest rates volatility
    Equity Future and Equity Forward: Discounted future cash flows
    Equity Options: Local Volatility, Momentum adjustment
    - Volatility of volatility
    - Assets correlation
    Foreign exchange and gold Future and Equity Forward: Discounted future cash flows
    Foreign exchange Options: Local Volatility, moments adjustment
    Volatility of volatility
    - Assets correlation
    Credit Credit Derivatives: Default model and Gaussian copula - Correlations default
    - Credit spread
    - Recovery rates
    - Interest rate yield
    - Default volatility
    Commodities Commodities: Momentum adjustment and Discounted cash flows

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    Main valuation techniques

    The main techniques used for the assessment of the majority of the financial instruments classified in Level 3, and its main unobservable inputs, are described below:

    • The net present value (net present value method): This technique uses the future cash flows of each debt security, which are established in the different contracts, and discounted to their present value. This technique often includes many observable inputs, but may also include unobservable inputs, as described below:
    • Credit Spread: This input represents the difference in yield of a debt security and the reference rate, reflecting the additional return that a market participant would require to take the credit risk of that debt security. Therefore, the credit spread of the debt security is part of the discount rate used to calculate the present value of the future cash flows.
    • Recovery rate: This input represents the percentage of principal and interest recovered from a debt instrument that has defaulted.
    • Comparable prices (similar asset prices): This input represents the prices of comparable financial instruments and benchmarks used to calculate a reference yield based on relative movements from the entry price or current market levels. Further adjustments to account for differences that may exist between financial instrument being valued and the comparable financial instrument may be added. It can also be assumed that the price of the financial instrument is equivalent to the comparable instrument.
    • Net asset value: This input represents the total value of the financial assets and liabilities of a fund and is published by the fund manager thereof.
    • Gaussian copula: This model is used to integrate default probabilities of credit instruments referenced to more than one underlying CDS. The joint density function used to value the instrument is constructed by using a Gaussian copula that relates the marginal densities by a normal distribution, usually extracted from the correlation matrix of events approaching default by CDS issuers.
    • Black 76: variant of Black Scholes model, whose main application is the valuation of bond options, cap floors and swaptions where the behavior of the Forward and not the Spot itself, is directly modeled.
    • Black Scholes: The Black Scholes model postulates log-normal distribution for the prices of securities, so that the expected return under the risk neutral measure is the risk free interest rate. Under this assumption, the price of vanilla options can be obtained analytically, so that inverting the Black- Scholes formula, the implied volatility for process of the price can be calculated.
    • Heston: This model, typically applied to equity OTC options, assumes stochastic behavior of volatility. According to which, the volatility follows a process that reverts to a long-term level and is correlated with the underlying equity instrument. As opposed to local volatility models, in which the volatility evolves deterministically, the Heston model is more flexible, allowing it to be similar to that observed in the short term today.
    • Libor market model: This model assumes that the dynamics of the interest rate curve can be modeled based on the set of forward contracts that compose the underlying interest rate. The correlation matrix is parameterized on the assumption that the correlation between any two forward contracts decreases at a constant rate, beta, to the extent of the difference in their respective due dates. The input “Credit default volatility” is a volatility input of the credit factor dynamic. The multifactorial frame of this model makes it ideal for the valuation of instruments sensitive to the slope or curve, including interest rate option.
    • Local Volatility: In the local volatility models of the volatility, instead of being static, evolves over time according to the level of moneyness of the underlying, capturing the existence of smiles. These models are appropriate for pricing path dependent options when use Monte Carlo simulation technique is used.
    Adjustments to the valuation for risk of default

    Under IFRS 13 the credit risk valuation adjustments must be considered in the classification of assets and liabilities within fair value hierarchy, because of the absence of observables data of probabilities of default used in the calculation.

    The credit valuation adjustments (“CVA”) and debit valuation adjustments (“DVA”) are a part of derivative instrument valuations, both financial assets and liabilities, to reflect the impact in the fair value of the credit risk of the counterparty and BBVA, respectively.

    These adjustments are calculated by estimating Exposure At Default, Probability of Default and Loss Given Default, for all derivative products on any instrument at the legal entity level (all counterparties under a same ISDA / CMOF) in which BBVA has exposure.

    As a general rule, the calculation of CVA is done through simulations of market and credit variables to calculate the expected positive exposure, given the Exposure at Default and multiplying the result by the Loss Given Default of the counterparty. Consequently, the DVA is calculated as the result of the expected negative exposure given the Exposure at Default and multiplying the result by the Loss Given Default of the counterparty. Both calculations are performed throughout the entire period of potential exposure.

    The information needed to calculate the exposure at default and the loss given default come from the credit markets (Credit Default Swaps or iTraxx Indexes), where rating is available. For those cases where the rating is not available, BBVA implements a mapping process based on the sector, rating and geography to assign probabilities of both probability of default and loss given default, calibrated directly to market or with an adjustment market factor for the probability of default and the historical expected loss.

    The amounts recognized in the consolidated balance sheet as of December 31, 2018 and 2017 related to the valuation adjustments to the credit assessment of the derivative asset as “Credit Valuation Adjustments” (“CVA”) was €-163 million and €-153 million respectively, and the valuation adjustments to the derivative liabilities as “Debit Valuation Adjustment” (DVA) was €214 million and €138 million respectively . The impact recorded under “Gains or (-) losses on financial assets and liabilities held for trading, net” in the consolidated income statement as for the years ended 2018 and 2017 corresponding to the mentioned adjustments was a net impact of €-24 million and €-23 million respectively. Additionally, as of December 31, 2018, €-12 million related to the “Funding Valuation Adjustments” (“FVA”) were recognized in the consolidated balance sheet.

    Unobservable inputs

    Quantitative information of unobservable inputs used to calculate Level 3 valuations is presented below as of December 31, 2018:

    Financial instrument Valuation technique(s) Significant unobservable inputs Min Average Max Units
     
    Debt Securities Net Present Value Credit Spread 37 152.22 385.00 b.p.
    Recovery Rate 0.00% 32.06% 40.00% %
    Comparable pricing 1.00% 88.00% 275.00% %
    Equity instruments Net Asset Value
    Comparable pricing
    Credit Option Gaussian Copula Correlation Default 0.00% 37.98% 60.26% %
    Corporate Bond Option Black 76 Price Volatility - - - vegas
    Equity OTC Option Heston Forward Volatility Skew 47.05 47.05 47.05 Vegas
    Local Volatility Dividends
    Volatility 13.79 27.24 65.02 vegas
    FX OTC Options Black Scholes/Local vol Volatility 5.05 7.73 9.71 vegas
    Interest Rate Option Libor Market Model Beta 0.25 9.00 18.00 %
    Correlation Rate/Credit (100) - 100 %
    Credit Default Volatility - - - Vegas

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    Financial assets and liabilities classified as Level 3

    The changes in the balance of Level 3 financial assets and liabilities included in the accompanying consolidated balance sheets during 2018, 2017 and 2016, are as follows:

    Financial Assets Level 3: Changes in the Period (Millions of euros)

    2018 2017 2016
    Assets Liabilities Assets Liabilities Assets Liabilities
    Balance at the beginning 835 125 822 116 463 182
    Group incorporations - - - - - -
    Changes in fair value recognized in profit and loss (*) (167) (95) (24) (21) 33 (86)
    Changes in fair value not recognized in profit and loss (4) - (45) - (81) (3)
    Acquisitions, disposals and liquidations (**) 2,102 2,710 32 320 438 (25)
    Net transfers to Level 3 761 47 106 (39) 16 -
    Exchange differences and others - - (55) (250) (47) 49
    Balance at the end 3,527 2,787 835 125 822 116
    • (*) Profit or loss that is attributable to gains or losses relating to those financial assets and liabilities held as of December 31, 2018, 2017 and 2016. Valuation adjustments are recorded under the heading “Gains (losses) on financial assets and liabilities, net”.
    • (**) Of which, in 2018, the assets roll forward is comprised of €2,400 million of acquisitions, €254 millions of disposals and €44 millions of liquidations. The liabilities roll forward is comprised of €2,716 million of acquisitions and €5 millions of liquidations.

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    As of December 31, 2018, the profit/loss on sales of financial instruments classified as Level 3 recognized in the accompanying consolidated income statement was not material.

    Transfers between levels

    The Global Valuation Area, in collaboration with the Group, has established the rules for a proper financials instruments held for trading classification according to the fair value hierarchy defined by international accounting standards.

    On a monthly basis, any new assets added to the portfolio are classified, according to this criterion, by the accounting subsidiary. Then, there is a quarterly review of the portfolio in order to analyze the need for a change in classification of any of these assets.

    The financial instruments transferred between the different levels of measurement for the year ended December 31, 2018 are recorded at the following amounts in the accompanying consolidated balance sheets as of December 31, 2018:

    Transfer Between Levels. December 2018 (Millions of euros)

    From: Level 1 Level 2 Level 3
    To: Level 2 Level 3 Level 1 Level 3 Level 1 Level 2
    ASSETS
    Financial assets held for trading 1,171 2 2 6 - 2
    Non-trading financial assets mandatorily at fair value through profit or loss - - 9 67 - 24
    Financial assets at fair value through other comprehensive income 134 72 - 515 - -
    Derivatives - - - 52 118 49
    Total 1,305 74 11 641 118 75
    LIABILITIES
    Financial liabilities held for trading - - - 138 - 37
    Total - - - 138 - 37

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    The amount of financial instruments that were transferred between levels of valuation for the year ended December 31, 2018 is not material relative to the total portfolios, and corresponds to the above changes in the classification between levels these financial instruments modified some of their features, specifically:

    • Transfers between Levels 1 and 2 represent mainly debt and equity instruments, which are either no longer listed on an active market (transfer from Level 1 to 2) or have just started to be listed (transfer from Level 2 to 1).
    • Transfers from Level 2 Level 3 are mainly due to financial assets at fair value through other comprehensive income and trading liabilities.
    • Transfers from Level 3 to Level 2 generally affect derivative and debt instruments transactions, for which inputs observable in the market have been obtained.
    Sensitivity Analysis

    Sensitivity analysis is performed on financial instruments with significant unobservable inputs (financial instruments included in level 3), in order to obtain a reasonable range of possible alternative valuations. This analysis is carried out on a monthly basis, based on the criteria defined by the Global Valuation Area taking into account the nature of the methods used for the assessment and the reliability and availability of inputs and proxies used. In order to establish, with a sufficient degree of certainty, the valuating risk that is incurred in such assets without applying diversification criteria between them.

    As of December 31, 2018, the effect on profit for the period and total equity of changing the main unobservable inputs used for the measurement of Level 3 financial instruments for other reasonably possible unobservable inputs, taking the highest (most favorable input) or lowest (least favorable input) value of the range deemed probable, would be as follows:

    Financial Assets Level 3: Sensitivity Analysis (Millions of euros)

    Potential Impact on Consolidated Income Statement Potential Impact on Total Equity
    Most Favorable Hypothesis Least Favorable Hypothesis Most Favorable Hypothesis Least Favorable Hypothesis
    ASSETS - - - -
    Financial assets held for trading 6 (13) - -
    Loans and Advances - - - -
    Debt securities 2 (3) - -
    Equity instruments 3 (9) - -
    Derivatives 1 (1) - -
    Non-trading financial assets mandatorily at fair
    value through profit or loss
    291 (181) - -
    Loans and Advances 285 (161) - -
    Debt securities 3 (12) - -
    Equity instruments 3 (8) - -
    Financial assets designated at fair value through
    profit or loss
    - - - -
    Financial assets at fair value through other
    comprehensive income
    - - 1 (1)
    LIABILITIES - - - -
    Financial liabilities held for trading 1 (1) 1 (1)
    Total 297 (194) 1 (1)

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    8.2 Fair value of financial instruments carried at cost

    The valuation technique used to calculate the fair value of financial assets and liabilities carried at cost as of December 31, 2018, are presented below:

    Financial assets
    • Cash, balances at central banks and other demand deposits / loans to central banks / short-term loans to credit institutions / Repurchase agreements: in general, their fair value is assimilated to their book value, due to the nature of the counterparty and because they are mainly short-term balances in which the book value is the most reasonable estimation of the value of the asset.
    • Loans to credit institutions which are not short-term and loans to customers: In general, the fair value of these financial assets is determined by the discount of expected future cash flows, using market interest rates at the time of valuation adjusted by the credit spread and taking all kind of behavior hypothesis if it is considered to be relevant (prepayment fees, optionality, etc.).
    • Debt securities: Fair value estimated based on the available market price or by using internal valuation methodologies.
    Financial liabilities
    • Deposits from central banks: for recurrent liquidity auctions and other monetary policy instruments of central banks, / short-term deposits from credit institutions / repurchase agreements / short-term customer deposits: their book value is considered to be the best estimation of their fair value.
    • Deposits of credit institutions which are not short-term and term customer deposits: these deposits will be valued by discounting future cash flows using the interest rate curve in effect at the time of the adjustment adjusted by the credit spread and incorporating any behavioral assumptions if this proves relevant (early repayments , optionalities, etc.).
    • Debt certificate (Issuances): The fair value estimation of these liabilities depend on the availability of market prices or by using the present value method: discount of future cash flows, using market interest rates at valuation time and taking into account the credit spread.

    The following table presents the fair value of key financial instruments carried at amortized cost in the accompanying consolidated balance sheets as of December 31, 2018, 2017 and 2016, broken down according to the method of valuation used for the estimation:

    Fair Value of financial Instruments at amortized cost by Levels (Millions of euros)

    2018
    Notes Level 1 Level 2 Level 3
    ASSETS
    Cash, cash balances at central banks and other demand deposits 9 58,024 - 172
    Financial assets at amortized cost 14 21,419 204,619 193,819
    LIABILITIES
    Financial liabilities at amortized cost 22 58,225 269,128 182,948

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    The main valuation techniques and inputs used to estimate the fair value of financial instruments accounted for at cost and classified in levels 2 and 3 is shown below. These are broken down by type of financial instrument and the balances correspond to those as of December 31, 2018:

    Fair Value of financial Instruments at amortized cost by valuation technique. December 2018 (Millions of euros)

    Level 2 Level 3 Valuation technique(s) Main inputs used
    ASSETS
    Financial assets at amortized cost 204,619 193,819 Present-value method
    (Discounted future cash flows)
    Central Banks - 1 - Credit spread
    - Prepayment rates
    - Interest rate yield
    Loans and advances to credit institutions 4,934 4,291 - Credit spread
    - Prepayment rates
    - Interest rate yield
    Loans and advances to customers 190,666 183,645 - Credit spread
    - Prepayment rates
    - Interest rate yield
    Debt securities 9,019 5,881 - Credit spread
    - Interest rate yield
    LIABILITIES
    Financial liabilities at amortized cost 269,128 182,948
    Central Banks 196 - Present-value method
    (Discounted future cash flows)
    - Issuer´s credit risk
    - Prepayment rates
    - Interest rate yield
    Loans and advances to credit institutions 22,281 9,852
    Loans and advances to customers 240,547 135,270
    Debt securities 6,104 25,096
    Other financial liabilities - 12,730

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    Equity instruments at cost

    Until 2017, there were equity instruments and discretionary profit-sharing arrangements in some entities which were recognized at cost in the Group's consolidated balance sheets because their fair value could not be estimated in a sufficiently reliable manner for the amount of €469 and €565 million, as of December 31, 2017 and 2016, respectively.

    9. Cash, cash balances at central banks and other demands deposits

    The breakdown of the balance under the heading “Cash, cash balances at central banks and other demands deposits” in the accompanying consolidated balance sheets is as follows:

    Cash, cash balances at central banks and other demand deposits (Millions of euros)

    2018 2017 2016
    Cash on hand 6,346 6,220 7,413
    Cash balances at central banks 43,880 31,718 28,671
    Other demand deposits 7,970 4,742 3,955
    Total 58,196 42,680 40,039

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    10. Financial assets and liabilities held for trading

    10.1 Breakdown of the balance

    The breakdown of the balance under these headings in the accompanying consolidated balance sheets is as follows:

    Financial Assets and Liabilities Held-for-Trading (Millions of euros)

    Notes 2018 2017 2016
    ASSETS
    Derivatives 30,536 35,265 42,955
    Debt securities 7.3.2 25,577 22,573 27,166
    Loans and advances 7.3.2 28,750 56 154
    Equity instruments 7.3.2 5,254 6,801 4,675
    Total 90,117 64,695 74,950
    LIABILITIES
    Derivatives 31,815 36,169 43,118
    Short positions 11,025 10,013 11,556
    Deposits 37,934
    Total Liabilities 80,774 46,182 54,675

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    As of December 31, 2018 “Short positions” include €10,255 million held with General governments.

    10.2 Debt securities

    The breakdown by type of issuer of the balance under this heading in the accompanying consolidated balance sheets is as follows:

    Financial Assets Held-for-Trading. Debt securities by issuer (Millions of euros)

    2018 2017 2016
    Issued by Central Banks 1,001 1,371 544
    Issued by public administrations 22,950 19,344 23,621
    Issued by financial institutions 790 816 1,652
    Other debt securities 836 1,041 1,349
    Total 25,577 22,573 27,166

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    10.3 Loans and advances

    The breakdown of the balance under this heading in the accompanying consolidated balance sheets is as follows:

    Financial Assets Held-for-Trading: Equity instruments by Issuer (Millions of euros)

    Notes 2018 2017 2016
    Loans and advances to central banks 2,163 - -
    Reverse repurchase agreements 35 2,163 - -
    Loans and advances to credit institutions 14,566 - -
    Reverse repurchase agreements 35 13,305 - -
    Loans and advances to customers 12,021 56 154
    Reverse repurchase agreements 35 11,794 - -
    Total 28,750 56 154

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    10.4 Equity instruments

    The breakdown of the balance under this heading in the accompanying consolidated balance sheets is as follows:

    Financial Assets Held-for-Trading. Equity instruments by Issuer (Millions of euros)

    2018 2017 2016
    Shares of Spanish companies
    Credit institutions 576 617 781
    Other sectors 536 603 956
    Subtotal 1,112 1,220 1,737
    Shares of foreign companies
    Credit institutions 304 345 220
    Other sectors 3,838 5,236 2,718
    Subtotal 4,142 5,581 2,938
    Total 5,254 6,801 4,675

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    10.5 Deposits

    The breakdown of the balance under this heading in the accompanying consolidated balance sheets is as follows:

    Financial Liabilities Held-for-Trading. Deposits (Millions of euros)

    Notes 2018 2017 2016
    Deposits from central banks (*) 10,511
    Repurchase agreement 35 10,511
    Deposits from credit institutions (*) 15,687
    Repurchase agreement 35 14,839
    Deposits from customers (*) 11,736
    Repurchase agreement 35 11,466
    Total 37,934

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    10.6 Derivatives

    The derivatives portfolio arises from the Group's need to manage the risks it is exposed to in the normal course of business and also to market products amongst the Group's customers. As of December 31, 2018, 2017 and 2016, trading derivatives were mainly contracted in over-the-counter (OTC) markets, with counterparties, consisting primarily of foreign credit institutions, and are related to foreign-exchange, interest-rate and equity risk.

    Below is a breakdown of the net positions by transaction type of the fair value and notional amounts of derivatives recognized in the accompanying consolidated balance sheets, divided into organized and OTC markets:

    Derivatives by type of risk / by product or by type of market - December 2018 (Millions of Euros)

    Assets Liabilities Notional amount - Total
    Interest rate 19,147 18,769 2,929,371
    OTC options 1,940 2,413 207,107
    OTC other 17,206 16,356 2,702,909
    Organized market options - - 6,092
    Organized market other - - 13,263
    Equity 2,799 2,956 114,184
    OTC options 400 341 32,906
    OTC other 230 123 6,693
    Organized market options 2,168 2,492 72,062
    Organized market other - - 2,524
    Foreign exchange and gold 8,355 9,693 432,283
    OTC options 226 309 21,293
    OTC other 8,118 9,329 405,659
    Organized market options - 1 45
    Organized market other 11 54 5,286
    Credit 232 393 25,452
    Credit default swap 228 248 22,791
    Credit spread option 2 - 500
    Total return swap 2 145 2,161
    Other - - -
    Commodities 3 3 67
    Other - - -
    DERIVATIVES 30,536 31,815 3,501,358
    of which: OTC - credit institutions 16,979 18,729 897,384
    of which: OTC - other financial corporations 7,372 7,758 2,355,784
    of which: OTC - other 4,005 2,780 148,917

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    Derivatives by type of risk / by product or by type of market - December 2017 (Millions of Euros)

    Assets Liabilities Notional amount - Total
    Interest rate 22,606 22,546 2,152,490
    OTC options 2,429 2,581 212,554
    OTC other 20,177 19,965 1,916,920
    Organized market options - - 600
    Organized market other - - 22,416
    Equity 1,778 2,336 95,573
    OTC options 495 1,118 34,140
    OTC other 83 90 8,158
    Organized market options 1,200 1,129 48,644
    Organized market other - - 4,631
    Foreign exchange and gold 10,371 10,729 380,404
    OTC options 245 258 24,447
    OTC other 10,092 10,430 348,857
    Organized market options - 3 104
    Organized market other 34 37 6,997
    Credit 489 517 30,181
    Credit default swap 480 507 27,942
    Credit spread option - - 200
    Total return swap 9 9 2,039
    Other - - -
    Commodities 3 3 36
    Other 18 38 561
    DERIVATIVES 35,265 36,169 2,659,246
    of which: OTC - credit institutions 21,016 22,804 898,209
    of which: OTC - other financial corporations 8,695 9,207 1,548,919
    of which: OTC - other 4,316 2,986 128,722

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    Derivatives by type of risk / by product or by type of market - December 2016 (Millions of Euros)

    Assets Liabilitiess Notional amount - Total
    Interest rate 25,770 25,322 1,556,150
    OTC options 3,331 3,428 217,958
    OTC other 22,339 21,792 1,296,183
    Organized market options 1 - 1,311
    Organized market other 100 102 40,698
    Equity 2,032 2,252 90,655
    OTC options 718 1,224 44,837
    OTC other 109 91 5,312
    Organized market options 1,205 937 36,795
    Organized market other - - 3,712
    Foreign exchange and gold 14,872 15,179 425,506
    OTC options 417 539 27,583
    OTC other 14,436 14,624 392,240
    Organized market options 3 - 175
    Organized market other 16 16 5,508
    Credit 261 338 19,399
    Credit default swap 246 230 15,788
    Credit spread option - - 150
    Total return swap 2 108 1,895
    Other 14 - 1,565
    Commodities 6 6 169
    Other 13 22 1,065
    DERIVATIVES 42,955 43,118 2,092,945
    of which: OTC - credit institutions 26,438 28,005 806,096
    of which: OTC - other financial corporations 8,786 9,362 1,023,174
    of which: OTC - other 6,404 4,694 175,473

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    11. Non-trading financial assets mandatorily at fair value through profit or loss

    The breakdown of the balance under this heading in the accompanying consolidated balance sheets is as follows:

    Financial assets and liabilities designated at fair value through profit or loss (Millions of euros)

    Notes 2018
    Equity instruments 7.3.2 3,095
    Debt securities 7.3.2 237
    Loans and advances 7.3.2 1,803
    Total 5,135

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    This heading is included with the implementation of IFRS 9 on January 1, 2018. Previously, this category did not exist in IAS 39 (see Note 2.2.1 and 2.3).

    12. Financial assets and liabilities designated at fair value through profit or loss

    The breakdown of the balance under these headings in the accompanying consolidated balance sheets is as follows:

    Financial assets and liabilities designated at fair value through profit or loss (Millions of euros)

    Notes 2018 2017 2016
    ASSETS
    Equity instruments 1,888 1,920
    Unit-linked products 1,621 1,749
    Other securities 266 171
    Debt securities 1,313 174 142
    Loans and advances - 648 -
    Total Assets 7.3.2 1,313 2,709 2,062
    LIABILITIES-
    Deposits 976 - -
    Debt certificates 2,858 - -
    Other financial liabilities 3,159 2,222 2,338
    Unit-linked products 3,159 2,222 2,338
    Total 6,993 2,222 2,338

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    With the implementation of IFRS 9 on January 1, 2018, equity instruments under this heading have been reclassified to the heading: “Non-trading financial assets mandatorily at fair value through profit or loss” (see Note 11).

    As of December 31, 2018, 2017 and 2016, the most significant balances within financial liabilities designated at fair value through profit or loss related to assets and liabilities linked to insurance products where the policyholder bears the risk ("Unit-Link"). This type of product is sold only in Spain, through BBVA Seguros S.A., insurance and reinsurance and in Mexico through Seguros Bancomer S.A. de CV.

    Since the liabilities linked to insurance products in which the policyholder assumes the risk are valued the same way as the assets associated to these insurance products, there is no credit risk component borne by the Group in relation to these liabilities.

    13. Financial assets at fair value through other comprehensive income

    13.1 Balance details

    The breakdown of the balance by the main financial instruments in the accompanying consolidated balance sheets is as follows:

    Financial assets designated at fair value through other comprehensive income (Millons of euros)

    Notes 2018 2017 2016
    Debt securities 7.3.2 53,737 66,273 74,739
    Impairment losses (28) (21) (159)
    Subtotal 53,709 66,251 74,580
    Equity instruments 7.3.2 2,595 4,488 4,814
    Impairment losses - (1,264) (174)
    Subtotal 2,595 3,224 4,641
    Loans and advances to credit entities 33 - -
    Total 56,337 69,476 79,221

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    13.2 Debt securities

    The breakdown of the balance under the heading “Debt securities” of the accompanying consolidated financial statements, broken down by the nature of the financial instruments, is as follows:

    Financial assets designated at fair value through other comprehensive income: Debt Securities. December 2018 (Millions of euros)

    Amortized Cost (*) Unrealized Gains Unrealized Losses Book Value
    Domestic Debt Securities
    Spanish Government and other general governments agencies debt securities 17,205 661 (9) 17,857
    Other debt securities 1,597 100 (1) 1,696
    Issued by Central Banks - - - -
    Issued by credit institutions 793 63 - 855
    Issued by other issuers 804 37 (1) 841
    Subtotal 18,802 761 (10) 19,553
    Foreign Debt Securities
    Mexico 6,299 6 (142) 6,163
    Mexican Government and other general governments agencies debt securities 5,286 4 (121) 5,169
    Other debt securities 1,013 2 (21) 994
    Issued by Central Banks - - - -
    Issued by credit institutions 35 - (1) 34
    Issued by other issuers 978 2 (20) 961
    The United States 14,507 47 (217) 14,338
    Government securities 11,227 37 (135) 11,130
    US Treasury and other US Government agencies 7,285 29 (56) 7,258
    States and political subdivisions 3,942 8 (79) 3,872
    Other debt securities 3,280 10 (82) 3,208
    Issued by Central Banks - - - -
    Issued by credit institutions 49 1 - 50
    Issued by other issuers 3,231 9 (82) 3,158
    Turkey 4,164 20 (269) 3,916
    Turkey Government and other general governments agencies debt securities 4,007 20 (256) 3,771
    Other debt securities 157 - (13) 145
    Issued by Central Banks - - - -
    Issued by credit institutions 157 - (13) 145
    Issued by other issuers - - - -
    Other countries 9,551 319 (130) 9,740
    Other foreign governments and other general governments agencies debt securities 4,510 173 (82) 4,601
    Other debt securities 5,041 146 (48) 5,139
    Issued by Central Banks 987 2 (4) 986
    Issued by credit institutions 1,856 111 (20) 1,947
    Issued by other issuers 2,197 33 (25) 2,206
    Subtotal 34,521 392 (758) 34,157
    Total 53,323 1,153 (768) 53,709
    • (*) The amortized cost includes portfolio gains/losses linked to insurance contracts in which the policyholder assumes the risk in case of redemption.

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    Available-for-sale financial assets: Debt Securities. December 2017 (Millions of euros)

    Amortized Cost (*) Unrealized Gains Unrealized Losses Book Value
    Domestic Debt Securities
    Spanish Government and other general governments agencies debt securities 22,765 791 (17) 23,539
    Other debt securities 1,951 114 - 2,066
    Issued by Central Banks - - - -
    Issued by credit institutions 891 72 - 962
    Issued by other issuers 1,061 43 - 1,103
    Subtotal 24,716 906 (17) 25,605
    Foreign Debt Securities
    Mexico 9,755 45 (142) 9,658
    Mexican Government and other general governments agencies debt securities 8,101 34 (120) 8,015
    Other debt securities 1,654 11 (22) 1,643
    Issued by Central Banks - - - -
    Issued by credit institutions 212 1 (3) 209
    Issued by other issuers 1,442 10 (19) 1,434
    The United States 12,479 36 (198) 12,317
    Government securities 8,625 8 (133) 8,500
    US Treasury and other US Government agencies 3,052 - (34) 3,018
    States and political subdivisions 5,573 8 (99) 5,482
    Other debt securities 3,854 28 (65) 3,817
    Issued by Central Banks - - - -
    Issued by credit institutions 56 1 - 57
    Issued by other issuers 3,798 26 (65) 3,759
    Turkey 5,052 48 (115) 4,985
    Turkey Government and other general governments agencies debt securities 5,033 48 (114) 4,967
    Other debt securities 19 1 (1) 19
    Issued by Central Banks - - - -
    Issued by credit institutions 19 - (1) 19
    Issued by other issuers - - - -
    Other countries 13,271 533 (117) 13,687
    Other foreign governments and other general governments agencies debt securities 6,774 325 (77) 7,022
    Other debt securities 6,497 208 (40) 6,664
    Issued by Central Banks 1,330 2 (1) 1,331
    Issued by credit institutions 2,535 139 (19) 2,654
    Issued by other issuers 2,632 66 (19) 2,679
    Subtotal 40,557 661 (572) 40,647
    Total 65,273 1,567 (589) 66,251
    • (*) The amortized cost includes portfolio gains/losses linked to insurance contracts in which the policyholder assumes the risk in case of redemption.

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    Available-for-sale financial assets: Debt Securities. December 2016 (Millions of euros)

    Amortized Cost (*) Unrealized Gains Unrealized Losses Book Value
    Domestic Debt Securities
    Spanish Government and other general governments agencies debt securities 22,427 711 (18) 23,119
    Other debt securities 2,305 117 (1) 2,421
    Issued by Central Banks - - - -
    Issued by credit institutions 986 82 - 1,067
    Issued by other issuers 1,319 36 (1) 1,354
    Subtotal 24,731 828 (19) 25,540
    Foreign Debt Securities
    Mexico 11,525 19 (343) 11,200
    Mexican Government and other general governments agencies debt securities 9,728 11 (301) 9,438
    Other debt securities 1,797 8 (42) 1,763
    Issued by Central Banks - - - -
    Issued by credit institutions 86 2 (1) 87
    Issued by other issuers 1,710 6 (41) 1,675
    The United States 14,256 48 (261) 14,043
    Government securities 8,460 9 (131) 8,337
    US Treasury and other US Government agencies 1,702 1 (19) 1,683
    States and political subdivisions 6,758 8 (112) 6,654
    Other debt securities 5,797 39 (130) 5,706
    Issued by Central Banks - - - -
    Issued by credit institutions 95 2 - 97
    Issued by other issuers 5,702 37 (130) 5,609
    Turkey 5,550 73 (180) 5,443
    Turkey Government and other general governments agencies debt securities 5,055 70 (164) 4,961
    Other debt securities 495 2 (16) 482
    Issued by Central Banks - - - -
    Issued by credit institutions 448 2 (15) 436
    Issued by other issuers 47 - (1) 46
    Other countries 17,923 634 (203) 18,354
    Other foreign governments and other general governments agencies debt securities 7,882 373 (98) 8,156
    Other debt securities 10,041 261 (105) 10,197
    Issued by Central Banks 1,657 4 (2) 1,659
    Issued by credit institutions 3,269 96 (54) 3,311
    Issued by other issuers 5,115 161 (49) 5,227
    Subtotal 49,253 773 (987) 49,040
    Total 73,985 1,601 (1,006) 74,580
    • (*) The amortized cost includes portfolio gains/losses linked to insurance contracts in which the policyholder assumes the risk in case of redemption.

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    The credit ratings of the issuers of debt securities as of December 31, 2018, 2017 and 2016, are as follows:

    Debt Securities by Rating

    December 2018 December 2017 December 2016
    Fair Value (Millions of Euros) % Fair Value (Millions of Euros) % Fair Value (Millions of Euros) %
    AAA 531 1.0% 687 1.0% 4,922 6.6%
    AA+ 13,100 24.4% 10,738 16.2% 11,172 15.0%
    AA 222 0.4% 507 0.8% 594 0.8%
    AA- 409 0.8% 291 0.4% 575 0.8%
    A+ 632 1.2% 664 1.0% 1,230 1.6%
    A 687 1.3% 683 1.0% 7,442 10.0%
    A- 18,426 34.3% 1,330 2.0% 1,719 2.3%
    BBB+ 9,195 17.1% 35,175 53.1% 29,569 39.6%
    BBB 4,607 8.6% 7,958 12.0% 3,233 4.3%
    BBB- 1,003 1.9% 5,583 8.4% 6,809 9.1%
    BB+ or below 4,453 8.3% 1,564 2.4% 2,055 2.8%
    Without rating 445 0.8% 1,071 1.6% 5,261 7.1%
    Total 53,709 100% 66,251 100.0% 74,580 100.0%

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    13.3 Equity instruments

    The breakdown of the balance under the heading "Equity instruments" of the accompanying consolidated financial statements as of December 31, 2018, 2017 and 2016, are as follows:

    Financial assets designated at fair value through other comprehensive income: Equity Instruments. December 2018(Millions of euros)

    Amortized Cost Unrealized Gains Unrealized Losses Fair Value
    Equity instruments listed
    Listed Spanish company shares 2,172 - (210) 1,962
    Credit institutions - - - -
    Other entities 2,172 - (210) 1,962
    Listed foreign company shares 90 43 (12) 121
    United States 20 17 - 37
    México 1 25 - 26
    Turkey 3 - (1) 2
    Other countries 66 1 (11) 56
    Subtotal 2,262 43 (222) 2,083
    Unlisted equity instruments
    Unlisted Spanish company shares 6 1 - 7
    Credit institutions - - - -
    Other entities 6 1 - 7
    Unlisted foreign companies shares 453 54 (1) 506
    United States 388 23 - 411
    México - - - -
    Turkey 6 4 - 10
    Other countries 59 27 (1) 85
    Subtotal 459 55 (1) 513
    Total 2,721 98 (223) 2,595

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    Available-for-sale financial assets: Equity Securities. December 2017 (Millions of euros)

    Amortized Cost Unrealized Gains Unrealized Losses Fair Value
    Equity instruments listed
    Listed Spanish company shares 2,189 - (1) 2,188
    Credit institutions - - - -
    Other entities 2,189 - (1) 2,188
    Listed foreign company shares 215 33 (7) 241
    United States 11 - - 11
    México 8 25 - 33
    Turkey 4 1 - 5
    Other countries 192 7 (7) 192
    Subtotal 2,404 33 (8) 2,429
    Unlisted equity instruments
    Unlisted Spanish company shares 33 29 - 62
    Credit institutions 4 - - 4
    Other entities 29 29 - 58
    Unlisted foreign companies shares 453 77 (8) 734
    United States 498 40 (6) 532
    México 1 - - 1
    Turkey 15 6 (2) 19
    Other countries 151 31 - 182
    Subtotal 698 106 (8) 796
    Total 3,102 139 (16) 3,224

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    Available-for-sale financial assets: Equity Securities. December 2016 (Millions of euros)

    Amortized Cost Unrealized Gains Unrealized Losses Fair Value
    Equity instruments listed
    Listed Spanish company shares 3,690 17 (944) 2,763
    Credit institutions - - - -
    Other entities 3,690 17 (944) 2,763
    Listed foreign company shares 793 289 (15) 1,066
    United States 16 22 - 38
    México 8 33 - 41
    Turkey 5 1 - 6
    Other countries 763 234 (15) 981
    Subtotal 4,483 306 (960) 3,829
    Unlisted equity instruments
    Unlisted Spanish company shares 57 2 (1) 59
    Credit institutions 4 - - 4
    Other entities 53 2 (1) 55
    Unlisted foreign companies shares 708 46 (2) 752
    United States 537 13 - 550
    México 1 - - 1
    Turkey 18 7 (2) 24
    Other countries 152 26 - 178
    Subtotal 766 48 (3) 811
    Total 5,248 355 (962) 4,641

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    13.4 Gains/losses

    Debt securities

    The changes in the gains/losses, net of taxes, recognized in 2018 under the equity heading “Accumulated other comprehensive income – Items that may be reclassified to profit or loss - Financial assets at fair value through other comprehensive income” in the accompanying consolidated balance sheets are as follows:

    Accumulated other comprehensive income-Items that may be reclassified to profit or loss - Financial assets at fair value through other comprehensive income (Millions of euros)

    Notes 2018
    Balance at the beginning 1,557
    Effect of changes in accounting policies (IFRS 9) (58)
    Valuation gains and losses (640)
    Amounts transferred to income (137)
    Other reclassifications -
    Income tax 221
    Balance at the end 30 943

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    In 2018, the debt securities impaired recognized in the heading “Impairment or reversal of impairment on financial assets not measured at fair value through profit or loss - Financial assets at fair value through other comprehensive income” in the accompanying consolidated income statement amounted to €1 million. In 2017 the recovery registered amounted €4 million; meanwhile, in 2016 the impairment registered amounted €157 million (see Note 47).

    Equity instruments

    The changes in the gains/losses, net of taxes, recognized under the equity heading “Accumulated other comprehensive income – Items that will not be reclassified to profit or loss - Fair value changes of equity instruments measured at fair value through other comprehensive income” in the accompanying consolidated balance sheets are as follows:

    Accumulated other comprehensive income-Items that may be reclassified to profit or loss - Financial assets at fair value through other comprehensive income (Millions of euros)

    Notes 2018
    Balance at the beginning 84
    Effect of changes in accounting policies (IFRS 9) (40)
    Valuation gains and losses (174)
    Amounts transferred to income -
    Other reclassifications -
    Income tax (25)
    Balance at the end 30 (155)

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    In 2018, there has been no impairment registered under the heading “Impairment or reversal of impairment on financial assets not measured at fair value through profit or loss - Financial assets at fair value through other comprehensive income” in the accompanying consolidated income statement. In 2017 and 2016 the impairment registered were €1,131 and €46 million, respectively (see Note 47).

    Years 2017 and 2016

    2017 and 2016 are presented separately due to the implementation of IFRS 9:

    Accumulated other comprehensive income-Items that may be reclassified to profit or loss - Available-for-Sale Financial Assets (Millions of euros)

    Notas 2017 2016
    Balance at the beginning 947 1,674
    Valuation gains and losses 321 400
    Amounts transferred to income 356 (1,181)
    Other reclassifications (10) 116
    Income tax 27 (62)
    Balance at the end 30 1,641 947
    Of which: - -
    Debt securities 1,557 1,629
    Equity instruments 84 (682)

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    14. Financial assets at amortized cost

    14.1 Balance details

    The breakdown of the balance under this heading in the accompanying consolidated balance sheets, according to the nature of the financial instrument, is as follows:

    Financial assets at amortized cost (Millions of euros)

    Diciembre 2018 Diciembre 2017 Diciembre 2016
    Debt securities 32,530 24,093 28,905
    Loans and advances to central banks 3,941 7,300 8,894
    Loans and advances to credit institutions 9,163 26,261 31,373
    Loans and advances to customers 374,027 387,621 414,500
    Government 28,114 31,645
    Other financial corporations 9,468 18,173
    Non-financial corporations 163,922 164,510
    Other 172,522 173,293
    Total 419,660 445,275 483,672

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    During financial year 2018, there have been no significant reclassifications neither from “Financial assets at amortized cost” to other headings or from other headings to “Financial assets at amortized cost”.

    14.2 Loans and advances to central banks and credit institutions

    The breakdown of the balance under this heading in the accompanying consolidated balance sheets, according to their nature, is as follows:

    Loans and Advances to Central Banks and Credit Institutions (Millions of euros)

    Notes 2018 2017 2016
    Loans and advances to central banks 7.3.2 3,941 7,300 8,894
    Loans and advances to credit institutions 7.3.2 9,163 26,261 31,373
    Reverse repurchase agreements 35 478 13,861 15,561
    Other loans 8,685 12,400 15,812
    Total 13,104 33,561 40,267
    Of which:
    Impairment losses 7.3.5 / 7.3.2 (18) (36) (43)

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    14.3 Loans and advances to customers

    The breakdown of the balance under this heading in the accompanying consolidated balance sheets, according to their nature, is as follows:

    Loans and Advances to Customers (Millions of euros)

    Notes 2018 2017 2016
    On demand and short notice 3,641 10,560 11,251
    Credit card debt 15,445 15,835 16,596
    Trade receivables 17,436 22,705 23,753
    Finance leases 8,650 8,642 9,442
    Reverse repurchase loans 35 294 11,554 7,291
    Other term loans 324,767 313,336 339,862
    Advances other than not loans 3,794 4,989 6,306
    Total 7.3.2 374,027 387,621 414,500
    Of which: - - -
    Impaired assets 7.3.5 16,349 19,390 22,915
    Impairment losses 7.3.5 / 7.3.2 (12,199) (12,748) (15,974)

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    As of December 31, 2018, 2017 and 2016, 38%, 38% and 34%, respectively, of "Loans and advances to customers" with maturity greater than one year have fixed-interest rates and 62%, 62% and 66%, respectively, have variable interest rates.

    The heading “Financial assets at amortized cost – Loans and advances to customers” in the accompanying consolidated balance sheets also includes certain secured loans that, as mentioned in Appendix X and pursuant to the Mortgage Market Act, are linked to long-term mortgage-covered bonds.

    This heading also includes some loans that have been securitized. The balances recognized in the accompanying consolidated balance sheets corresponding to these securitized loans are as follows:

    Securitized Loans (Millions of euros)

    2018 2017 2016
    Securitized mortgage assets 26,556 28,950 29,512
    Other securitized assets 3,221 4,143 3,731
    Total 29,777 33,093 33,243

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    14.4 Debt securities

    The breakdown of the balance under this heading in the accompanying