UK: Single Supervisory Mechanism - Taking Stock On The Asset Quality Review

Last Updated: 18 December 2013
Article by Simon Brennan and David O'Neill

Work connected to the Single Supervisory Mechanism (SSM) is demanding increasing attention and resources from banks and prudential supervisors across the Eurozone.  The European Central Bank's (ECB) comprehensive assessment exercise is up and running, and in parallel work is pushing ahead to make the new supervisor operational from November 2014.  Consequently, the SSM landscape is becoming increasingly complex.  Staying on the front foot by keeping track of developments and coordinating SSM-related work across the organisation will enable banks to manage the challenge strategically, and ultimately better control the impact on their business.  It will also support them in setting the right tone for the new supervisory relationship that needs to be established with the ECB.

In the seven weeks since the ECB published details of its comprehensive assessment exercise (which is being run to ensure the ECB has full visibility of the banks that it will supervise directly) momentum has ramped up. The ECB has held meetings with senior executives at the banks involved to provide details of the exercise.  On the ground, national supervisory authorities have requested data from banks – a mix of qualitative and quantitative information – to support the first two parts of the comprehensive assessment, the supervisory risk assessment and the asset quality review (AQR).  Details of the stress test, the third component of the exercise, is expected to be provided in January.

The first real practical challenges for banks come from preparing for the AQR.  In the first phase supervisors will select the asset portfolios to be reviewed.  Portfolio selection will draw on the experience of national supervisory authorities to identify the more risky portfolios, but the ECB will overlay its own judgement and determine the final selection.  In this connection, banks have been asked to provide balance sheet data as of June 2013 on an accounting basis, at the highest level of consolidation within their Eurozone legal-entity footprint.  The ECB's intention to be thorough is borne out up by the breadth of data being requested, segmented by asset class (according to ECB definitions) and residence of borrower/counterparty.

For some banks, depending upon the approach their national supervisory authority has taken in the past, the ECB's approach may be a departure from what they are used to.  Our experience suggests that often banks are unable to populate data templates from "business as usual" sources, and instead have to resort to an ad hoc data collection exercise.  The lack of familiarity with the ECB's approach, the absence of the type of detailed guidance that typically accompanies regulatory returns, and a tight timeline compound the difficulties.  Together, these factors increase the risk of banks making late or inaccurate submissions.

These problems are to be expected as the SSM is in the process of being operationalised.  The data requests still to come though, to support the AQR and stress test proper, will be an order of magnitude greater in terms of complexity and volume.  Banks should invest time now and build sufficient capacity to stay ahead as the tasks will become steadily more complex.

Looking forward, key questions remain regarding how the AQR will be organised, in addition to uncertainty about the data required.  For example, full details are yet to be published on the depth of the due diligence phase, the core part of the AQR involving testing of asset valuations and reference data, and related systems and processes.  Clearly there is a balance to be struck between the depth of the assessment and the time frame that has been established.

Even where details of the approach are known, the ambition of the review and timeline over which it needs to be completed present a challenge for the ECB and national supervisory authorities.  For example, in ensuring consistency of approach.  This will ultimately stem from devising the testing framework in such a manner that that the results of the exercise are comparable from bank to bank.  This is difficult to do between banks in the same country though, and harder still across the Eurozone, because of differing business practices and internal systems.  Differences in how national supervisory authorities are approaching the work add a further level of complexity.

In short, the AQR will be a significant challenge and requires strong engagement by banks.  Management should expect that elements of what supervisors require will differ from past experience and anticipate the implications for how they approach the review.  Preparation is important and can pay dividends.  In particular, preparatory work to step through the due diligence process and remediate problems where possible will mean banks have more time to implement solutions, and enable them to get on the front foot.

Click here for our previous article on SSM.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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