1. A revision of the SREP framework in line with the CRR2/CRDV package
The guideline is addressed to competent authorities. It aims to promote common procedures and methodologies for the Supervisory Review and Evaluation Process (SREP). This ongoing supervisory process brings together the findings of all supervisory activities into a comprehensive overview of the bank. The guideline also aims to achieve convergence of supervisory stress testing practices across the EU.
In this context, the SREP framework is being revised in order to implement the changes brought by the CRR2/CDRV package. The main amendments are the following:
- The categorization of institutions and the application of the minimum commitment model have been revised to reflect the new definitions of small and non-complex and large institutions to better reflect the proportionality principle.
- The assessment of the risk of money laundering and terrorist financing has been integrated throughout the text.
- The P2R and P2G provisions have been reviewed in line with the CRDV to ensure that they reflect a purely micro-prudential perspective.
- Introduction of the capital requirements based on the leverage ratio separate from other capital requirements. They are embodied in specific requirements P2R-LR and P2G-LR to address excessive leverage risk.
- The requirements for the assessment of interest rate risk in the banking book as well as the ILAAP assessment have been adjusted to align with the current regulatory framework.
In addition, EBA has identified a number of supervisory best practices that were considered appropriate to improve the overall SREP process and, as such, have been included in this revised version of the Guideline. These include the following aspects:
- Application of the principle of proportionality.
- Consideration of AML/CFT risk within the SREP.
- Evaluation of internal governance.
- Capital risk assessment (credit risk, operational risk, market risk and IRRBB)
- Determination of P2R for risks other than excessive leverage risk.
- Assessment of excessive leverage risk and determination of P2R-LR requirements to address this risk.
- Assessment of liquidity and funding risk and application of associated monitoring measures.
- Communication and justification of P2R .
- P2G implementation methodology.
2. Application of the principle of proportionality
The application of the proportionality principle in the SREP is driven by the categorization of banks and the minimum audit engagement model, i.e. the minimum frequencies of supervisory audit engagements with banks. The revisions to these elements are intended to allow a more proportionate approach to the assessment and appropriate allocation of supervisory resources. The flexibility given to supervisors in assigning banks to categories allows supervision to focus on important institutions, taking into account both their size and their risk profile.
In addition, the categorization criteria incorporate the definitions of small and non-complex institutions and large institutions, as set out in CRR2, to ensure consistency in the scope of proportionality across the pillars.
3. Money laundering and terrorist financing risk assessment
The guideline provides details on how to take into account AML/CFT aspects in the SREP.
This is important aspect to be considered, given that the absence of AML/CFT arrangements can have adverse effects on the financial soundness of these institutions, the integrity of the internal market and financial stability as a whole.
Therefore, prudential supervisors should consider, to the extent that information is available, the AML/CFT risks within the SREP and cooperate with the supervisors responsible for ensuring compliance with AML/CFT requirements.
Institutions must have policies, controls and procedures to effectively mitigate and manage money laundering and terrorist financing risks. Therefore, AML/CFT supervisors are responsible for monitoring banks’ compliance with these requirements. In addition, AML/CFT supervisors are also required to conduct their own AML/CFT risk assessments of the industry as well as individual institutions within the industry.
The relevant supervisory authorities are responsible within the SREP for examining the arrangements, strategies, processes and mechanisms implemented by banks and assessing, inter alia, the risks to which the institution is or may be exposed.
Without duplicating the tasks of AML/CFT supervisors, prudential supervisors should also take into account AML/CFT risk information and other relevant data received from AML/CFT supervisors insofar as they affect compliance with the requirements set out in the CRR2/CRDV Package.
Breaches of governance requirements, discovered by prudential supervisors, may also involve deficiencies in AML/CFT policies, controls and procedures. This may as a consequence, be relevant to AML/CFT supervision. Therefore, cooperation between AML/CFT supervisors and prudential supervisors is crucial
The SREP is thus an example where information from AML/CFT supervision can also be beneficial to prudential supervisors and vice versa.
Therefore, the findings of inspections conducted by AML/CFT supervisors should be incorporated into the SREP, where they relate to requirements assessed by the prudential supervisors in line with the CRR2/CRDV package.
In the meantime, where the SREP assessment of business models, operational risk, credit risk, liquidity and funding, and internal governance and bank-wide controls reveal information about banks’ exposure to AML/CFT risk, the relevant information should be shared with AML/CFT supervisors. This includes the imposition of AML/CFT supervisory measures or sanctions when relevant.
In addition, the competent authorities must notify the EBA and the relevant AML/CFT supervisory authorities where their supervisory review gives the competent authorities reasonable grounds to suspect that, in the context of that institution:
- Money laundering or terrorist financing is or has been committed or attempted.
- Or there is an increased risk in this regard.
In the event of a potential increase in the risk of money laundering or terrorist financing, the competent authorities and AML/CFT supervisors must consult each other and immediately notify their joint assessment to the EBA.
4. Evaluation of internal governance
As part of the overall assessment, the competent authorities should determine whether the governance framework of an institution is sufficiently adequate given its nature and complexity.
In this context, the objective of the guideline is to align the governance assessment criteria with the requirements set out in the CRDV, the EBA guidelines on internal governance, remuneration, outsourcing arrangements, assessment of the suitability of members of the management body, suitability of key function holders and financial disclosure requirements.
The competent authorities should take into account new key aspects such as diversity policy, non-discrimination policy (including gender neutrality) and code of conduct when reviewing the internal governance framework of the institutions.
In order to better define the scope of controls, the guideline has also been amended to ensure that competent authorities include significant changes to products, systems and processes in the assessment of the approval process for new products.
5. Changes in the framework for conducting stress tests
There have been significant changes in supervisory expectations on the framework for bank stress tests, notably with the introduction of the revised EBA guideline on bank stress tests.
This new SREP guideline aims to provide additional clarification on issues such as proportionality and the assessment of the adequacy of stress test programs, their scenarios and assumptions. In addition, the text has been streamlined to avoid repetition and overlap with other existing guidelines.
6. the Capital Risk Assessment Framework
With regard to capital risks, the SREP guideline has been amended to include recent regulatory developments. In addition, to facilitate supervisors’ risks assessment, the scope of each risk category has been clearly defined by providing details on the sub-categories of risks to be considered and the risk rating guidance tables have been updated for all risk categories to introduce additional details for scores 3 and 4.
6.1. The credit risk assessment framework
The credit risk assessment framework has been adapted to take into account the expectations set out in the guidelines on loan origination and on the management of the stock of non-performing loans.
It was important to clarify the interaction between the SREP and the provisions in these guidelines to ensure overall consistency.
6.2. The Operational Risk Assessment Framework
The operational risk expectations have been updated to identify appropriate assessment criteria while taking into account the latest key regulatory developments arising from the Information and Communication Technology and IT Security Risk Management Guidelines.
6.3. The framework for assessing interest rate risk in the banking book
The expectations for interest rate risk in the banking book now include credit spread risk in the banking book (CSRBB). The latter has been identified as a separate risk category that the competent authorities must take into account while making their assessment.
Among other things, the SREP guideline incorporates the opportunity for banks to use standardised methodologies to calculate the impact on the net interest margin and the economic value of equity resulting from a change in interest rates.
7. Liquidity and funding risk assessment
Clarifications and references to the relevant legal provisions on LCR and NSFR have been added. In addition, in order to facilitate the work of the competent authorities, clearer expectations for the liquidity and funding risk management framework of banks have been defined in relation to their internal limits on:
- Concentration of liquid assets.
- Currency mismatches.
- The concentration of outflows deadlines.
- Concentration of funding sources and products.
8. Determining P2R Requirements
As a bank may face risks that are not covered or not fully covered by the capital requirements set out in the solvency ratio, the SREP guideline now includes details on determining the amount and composition of P2R needed to cover these risks.
This guideline aims to align with the requirements of the CRDV. This includes the requirement for P2R requirements to be institution-specific in a micro prudential sense without taking into account macro prudential factors. The CRDV also requires that the minimum composition of capital be defined with the possibility of requiring a higher quality of capital in certain bank-specific circumstances.
The guidance also provides clarification on the application of the risk-based approach to P2R determination, the use of ICAAP in risk identification and assessment, and the quantification of P2R.
This will include ensuring that ICAAP is recognized as an important risk management tool for banks that is always taken into account at least in the identification and assessment of risks. However, ICAAP calculations submitted by banks do not always provide a sufficiently reliable basis for determining P2R. Thus, competent authorities should consider the consistency of results across banks, using relevant supervisory benchmarks and other available information.
9. Assessment of excessive leverage risk
With the entry into force of the Pillar 1 leverage ratio requirement and the clear separation of the leverage ratio from the risk-based solvency ratio, competent authorities are expected to assess the risk posed by the bank’s leverage on its own funds separately from other types of risk. The guideline aims to define the criteria on which competent authorities should base their assessment.
In addition, to promote comparability and a level playing field among banks, as well as to facilitate supervisory assessment, clarification on the determination of the level and composition of additional capital to address excessive leverage risk has been included. In this context, it was particularly important to clarify the treatment of exposures excluded from the calculation of the leverage ratio.
The purpose of the clarifications in this guideline is to avoid a total switch of exclusions granted by CRR2 to Pillar 2. At the same time, it will ensure that the significant risks of each bank are adequately addressed by capital.
The guideline thus introduces the concepts of P2R-LR and P2G-LR, which are respectively the additional capital requirements and the additional capital recommendations specifically for excessive leverage risk.
10. Communication of P2R requirements
The CRDV sets out extensive requirements for the responsibility of supervisors to justify their decisions on the quantity and composition of P2R. It was therefore necessary to clarify the scope of the required communication on SREP results to banks.
The decision on the quantity and quality of capital instruments and the related justifications must be provided separately for P2R-LR and for P2R based on risks other than excessive leverage risk.
11. P2G Implementation Methodology
The methodology for defining P2G has been modified to align it with the CRDV. The guideline aims to ensure greater consistency in supervisory practices by identifying a number of factors that must be taken into account when defining P2G. Competent authorities will be able to classify banks into several categories with different P2G levels depending on the outcome of the adverse stress test scenario considered. In this way, errors in the estimation of P2G can be avoided.
Similarly, flexibility is given to competent authorities to apply certain adjustments to reflect both the limitations of the stress tests and the specific circumstances of individual institutions.
Finally, it was also necessary to introduce a separate P2G-LR determination on the leverage ratio to align with the requirements introduced in the CRDV.
Abreviations and glossary
EBA: European Banking Authority
SREP: Supervisory Review Evaluation Process
P2R: Pillar 2 request
P2G: Pillar 2 Guidance