UK: A Drive To Harmonise | EBA Consults On SREP Guidelines

Last Updated: 23 July 2014
Article by Vishwas Khanna and Dea Markova

Most Read Contributor in UK, August 2017

On 7 July, the European Banking Authority (EBA) began a consultation on guidelines for common procedures and methodologies for the supervisory review and evaluation process (SREP) as provided for in the Capital Requirements Directive (CRD IV).

This is the most comprehensive document on how EU banking supervisors should assess risk issued to date - it extends the focus of the SREP from capital risk and adequacy to a much more comprehensive assessment of a bank's business and risk profile. To put this in context the Guidelines are almost 5 times longer than those previously issued at an EU level. By providing a risk-by-risk approach, the Guidelines are intended to drive significant convergence in micro-prudential supervision across the EU. They should form the basis for SREP under the Eurozone's Single Supervisory Mechanism (SSM), thus providing one of the first tangible insights into the practical application of supervision under the SSM.

Overall, the Guidelines advance the SREP framework and focus on a range of areas which not only include the Internal Capital Adequacy Assessment Process (ICAAP) but also the underlying business model characteristics and risks, financial resources, governance and controls, using a scoring based-approach which enables peer comparison.

The four key elements upon which the individual institution will be scored are:

  1. Business Model Analysis (BMA)
  2. Assessment of internal governance and institution-wide controls 
  3. Assessment of risk to capital (including inherent risks and controls, determination of own funds and stress testing, and capital adequacy assessment) 
  4. Assessment of risks to liquidity and funding (including inherent risks and controls, determination of liquidity requirements and stress testing, and liquidity adequacy assessment)

Banks are to be assessed on a proportionate basis, being assigned to one of four categories based on their potential impact on the financial system. National Competent Authorities (NCAs) then have to assess and score (again on a 1 to 4 scale) each element of the SREP framework, before forming an overall SREP assessment and an overall SREP score. These would then determine both a view of the viability of the bank and the supervisory measures that may need to be taken. The Guidelines link into recovery and resolution requirements as per the Bank Recovery and Resolution Directive (BRRD), as the SREP evaluation should take into consideration recovery planning and form the basis for determining any early intervention measures.

A Deloitte summary of the proposed assessment and scoring approach is available here:
Download Deloitte EBA draft SREP guidelines_An overview - July 2014

Key observations

Both in terms of the risks assessed and the controls considered, the scope of the Guidelines is significantly broader and deeper than what has hitherto been the norm for a SREP in most EU countries. With supervisors now expected to analyse business models and internal governance, the Guidelines seem to move towards a wider canvas for supervision, not dissimilar in scope to the Prudential Regulation Authority's (PRA) risk framework. Furthermore, the assessment expands into what may be new or previously less prioritised areas in prudential supervision, such as business model analysis, conduct risk and risk culture. Importantly, viability evaluations are a key output of the SREP process, thus linking a supervisor's risk assessment framework with its responsibilities in the areas of recovery and resolution. Again, this is strongly reminiscent of the PRA's "forward-looking, judgement-based" approach.

Looking at the Guidelines in more depth, a number of issues stand out:

  • Risk Appetite Framework (RAF) expectations: There is a clear expectation that banks develop, document and embed a RAF and that risk exposures are made with regard to the bank's risk appetite. When assessing RAFs, supervisors should consider their comprehensiveness and consistency with risk strategy and with the bank's financial resources. This is clearly part of the trend which has been evident in the post-crisis years for supervisors to give increasing prominence to RAFs. (Read our in-depth analysis of RAFs here).
  • Reliance on peer-group analysis: The Guidelines provide insights into the use of peer-group analysis, a tool often referenced in the context of the SSM and the ECB's objective to provide consistent supervision of banks of similar business models and risk profiles across the Eurozone. While many supervisors will have used peer-group analysis previously, the key change here is the move from national to Eurozone peer-groups. The Guidelines highlight that NCAs should pay close attention to atypical performance compared to peers when conducting BMA. Peer-group analysis is also given a role in capital and liquidity risk assessment, where comparability is emphasized as a key consideration of a bank's ICAAP as well as in setting quantitative liquidity requirements.
  • Clearer articulation of Pillar 2 capital requirements: The Guidelines introduce the concepts of Total SREP Capital Requirements (TSCR) and Overall Capital Requirement (OCR) which will be fundamental to the assessment of capital adequacy of firms under base and stress cases (1), with the Guidelines clarifying that firms should operate above OCR under the base case and TSCR in the stress case. This means that the EBA expects firms to operate above both Pillar 1 and Pillar 2 capital requirements under stressed conditions. This effectively crystallises the nature of Pillar 2 requirements as being binding constraints rather than 'guidance'. The Guidelines also provide details around expectations relating to the composition of capital for Pillar 2 risks – effectively stating that all Pillar 2 risks identified in the Guidelines should be covered by the same quality of capital as Pillar 1 and at least in the same proportion (with some scope for supervisory discretion over any other Pillar 2 risks).
  • Focus on liquidity: The Guidelines have a strong focus on liquidity risk management and the role of Internal Liquidity Adequacy Assessment Processes (ILAAP). CRD IV requirements highlighted the need for firms to develop robust liquidity risk management frameworks. Within the EU, countries such as the Netherlands have already outlined their requirements concerning ILAAPs. The Guidelines build on this narrative and place the ILAAP at the centre of the assessment of liquidity and funding risks.
  • The supervisory toolkit: Finally, the Guidelines spell out the broad set of supervisory measures available to address concerns discovered during the SREP under CRD IV – ranging from requiring banks to apply specific provisioning policy to mitigate credit risk to making changes to their overall business strategy. Given the significant supervisory measures outlined in the guidelines, firms will need to consider the breadth of supervisory actions and their direct and indirect implications on strategy, business model, internal governance and risk frameworks. Regulatory communication strategies and procedures will assume even more critical importance.
  • The importance of data: The Guidelines place significant emphasis on the importance of effective risk data aggregation and reporting by banks. This is proving a significant challenge for Global Systemically Important Banks as they seek to comply with the Basel Committee's Principles for Effective Risk Data Aggregation and Reporting by the start of 2016. We expect similar challenges for EU banks generally. The principles should no longer be view as directed mainly towards the larger institutions, but as universal in nature.

Implications for banks

UK-based banks may find the Guidelines a familiar read, as a number of their elements are not dissimilar to the current SREP and Supervisory Liquidity Review Process (SLRP) approach. In particular, UK firms are already categorised by reference to their potential systemic impact albeit in five, not four, groups. Additionally, the EBA's TSCR requirements are comparable to the UK's Individual Capital Guidance (ICG) regime based on Pillar 1 plus scaling factors which capture Pillar 2 based capital requirements and weaknesses in governance and controls. Overall, the combination of a broad based SREP evaluation process and an underlying concern with viability resonate with the UK's risk assessment framework as well as its Proactive Intervention Framework (PIF).

However, banks elsewhere in the EU may see a (much) greater change in the supervisory assessments they receive. The Guidelines should feed into the ECB's approach to supervision, on which more clarity is expected with the publication of a Guide to supervisory practices and methodologies before November this year. The Guidelines also give clues on the granularity of information, and the drive to convergence, which Eurozone supervisors in particular could see under the SSM.

Overall, equipping supervisors with a tool which facilitates scoring and comparing banks' risk profiles and risk management across peer groups could have significant implications for the industry – potentially establishing current best practices as the benchmark for supervision.

Open questions

By formalising a score-based SREP framework, the EBA is aiming to improve the consistency of how Pillar 2 is applied in the EU. However, the Guidelines are not intended to establish granular-level procedures and methodologies, and as such some scope for supervisory discretion, and divergence, remains. But this scope is clearly less under the SSM and, over time, the SSM approach should converge across all SSM members. In other words, national supervisory discretion should become increasingly constrained, or at least more consistently exercised.

However, the Guidelines do not give all the answers, nor do they cover all the relevant risks. For example, the treatment of reputational risk remains somewhat vague, which is surprising given how much attention this issue is currently receiving. Moreover, there is no mention of pension scheme risk which has been a big topic for some banks.

The implications and costs associated with the modification of ICAAP and supporting processes may represent an important area of investment for individual firms. In the extreme, the new ICAAP and SREP process, to the extent that it uncovers new risks, may have consequences for a firm's business model.

Overall, the Guidelines represent a major shift in terms of breath of risk coverage in the SREP and the detail of the approach for carrying it out. Taken at face value, the Guidelines will require a significant increase in the resources dedicated to the SREP, both by banks and, in some cases, by supervisors too.

Footnote

(1) TSCR = own funds requirements as set out in the Capital Requirements Regulation + additional own fund requirements; OCR = TSCR + capital buffers + macro-prudential requirements

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.