To harmonize banks’ internal practices and the criteria for assessment by supervisory authorities, the expectations relating to the determination of the ORC (overall recovery capacity of the bank) have been thoroughly reviewed by the EBA. This guideline will secure the relevance, completeness and feasibility of the various recovery options in the PRP.
1. An ORC framework within the framework of the BRRD
1.1. The ORC principles set out in the BRRD
The BRRD requires banks to develop recovery plans to enhance their ability to restore financial and economic viability in case of significant deterioration. Through recovery planning, institutions prepare in advance to be able to face a wide range of crises that may arise. The BRRD specifically requires banks to include a summary of their overall recovery capacity (ORC) in their recovery plans. The ORC is the extent to which recovery options enable a bank to recover from a range of severe macroeconomic and financial stress scenarios. In addition, the competent authorities should assess the completeness of the recovery plan, including the ORC.
1.2. Purpose of the ORC
The objective of the ORC is to provide a summary of the institution’s overall ability to recover from a material deterioration by implementing appropriate recovery options. The competent authorities’ assessment of a bank’s overall recovery capacity provides an understanding of the extent to which an institution would be able to recover from a range of potential crisis situations.
The ORC is a key outcome of recovery planning that provides an indication of the institution’s overall ability to recover from a significant deterioration in its financial condition. Determining this component of the recovery plan is equally relevant for both banks and competent authorities in their work to assess the internal bank recovery framework. In order to ensure that the ORC effectively fulfils its role as a summary of banks’ recovery capacity, it needs to be properly determined and consistently represented by the institutions.
2. The EBA approach to harmonize the framework for determination by banks and assessment of orc by supervisors
On 14 December 2022, EBA launched a consultation until 14 March 2023 on the guideline on banks’ overall recovery capacity (ORC). The guideline aims to establish a consistent framework for the determination of the ORC by banks in their recovery plans and the respective assessment by the competent authorities.
The main objective of the guidelines is to harmonise the practices observed in the determination and assessment of the ORC, in order to improve the usability of recovery plans and to make crisis preparedness more effective. This initiative is based on the EBA’s observation that there is currently a very wide disparity of practices both in the implementation of the ORC by banks and in the assessment of the ORC by supervisory authorities.
3. A guideline for both banks and supervisors
The guideline is composed of two sections.
- The first, aimed at institutions, aims to provide guidance on the relevant steps for setting up a reliable ORC framework.
- The second, addressed to the competent authorities, completes the framework by harmonising the key elements of the competent authorities’ assessment of the ORC from a quantitative and qualitative perspective.
4. Determining the ORC in four steps
The determination of the ORC is done in four steps:
4.1. Step 1: Selection of recovery options
Depending on the nature of the macroeconomic and financial stress, a bank will choose credible and feasible options that, in terms of their effect on the “relevant indicators of the recovery plan, would be most effective. These include, for example, options such as capital increase, cost reduction, non-distribution of dividends, risk reduction, issuance of subordinated debt, sale of significant assets.
4.2. Step 2: Adjusting recovery options: additional constraining factors to assess interdependencies between recovery options
When selecting recovery options, the bank should at least consider the relevant constraining factors related to the simultaneous and sequential implementation of recovery options. In particular, in each scenario, the bank should analyse the possible interactions between the selected recovery options and explain why they do not conflict with each other. It should also clarify the extent to which there are interdependencies between the recovery options.
- For example, the bank should explain why the option “Risk reduction – reduction of existing loans and creation of new activities” does not affect the feasibility and effectiveness of the option “Liability management – liability management operations directed at institutional investors”.
Where interdependencies have been detected, this analysis could either lead to the exclusion of one of the mutually exclusive options or to the adjustment of their expected impact when combined.
In addition, the bank’s analysis should show at what stage each recovery option is taken.
4.3. Step 3 – Calculation of “scenario-specific recovery capacity
Once the recovery options have been identified and selected based on the previous steps, the bank expresses the “scenario-specific recovery capacity” as the sum of their impacts over time by representing it in terms of “relevant recovery indicators”.
4.4. Step 4 – Determining the ORC range
The bank should determine the ORC as the range representing the scenario-specific recoverability. Given the nature and impact of the scenarios considered, only relevant scenarios are considered in determining the ORC range in terms of capital, including leverage (capital ORC) and liquidity (liquidity ORC). These are the scenarios in which a depletion of the financial position in terms of capital, including leverage and/or liquidity, has been observed.
The need to determine an ORC is not a new concept as it is enshrined in the BRRD. However, determining the ORC according to the EBA methodology will represent a real challenge, especially in the assessment of the interdependencies between the different recovery options, which represents a real fine-tuning exercise. It will therefore be necessary to audit the current PRPs in the light of these new expectations, to carry out the associated impact analyses in terms of own funds and liquidity and to make the inevitable adjustments in the next updates.
Abbreviations and glossary
ORC: Overall Recovery Capacity
PRP : preventive reovery Plan
BRRD: Banking Recovery and Resolution Directive