evelyne-ngnote

 

1.   The role of recovery plans

The BRRD establishes recovery plans as an important element of the European recovery and resolution framework. They are essential to ensure proper crisis preparedness.

The BRRD requires banks and investment firms to strengthen their ability to restore financial and economic viability when under stress. Through recovery plans, banks are preparing in advance to deal with a wide range of crises that could arise.

This crisis preparedness involves defining the corrective actions that they could effectively take in a stressful situation to restore their financial and commercial viability.

The main objective of recovery plans is to identify a stress or crisis situation at an early stage in order to:

  • To avoid delays in the implementation of remedial measures.
  • To enable banks to take timely and effective action to address them.

2.   The role of recovery plan indicators

A recovery plan should include a framework of indicators established by each bank to identify thresholds beyond which the escalation process should be activated and appropriate corrective actions of the recovery plan taken.

Recovery indicators are a key element of recovery plans and their main objective is to help banks strengthen their ability to monitor and respond to emerging and evolving stress.

In order for this warning mechanism to work, it must be set up properly. In the event of an inadequate warning mechanism, the effectiveness of the bank’s recovery options could be compromised by their implementation at the wrong time.

The EBA had issued a guideline in 2015 to specify the minimum list of quantitative and qualitative indicators for recovery planning purposes. These indicators established a common European standard for the development of the framework of recovery indicators, while allowing for some limited flexibility to adapt to the specificities of banks.

Each bank should include both qualitative and quantitative elements in the set of indicators most relevant to the development of its recovery plan.

3.   Purpose of the guideline

This Guideline sets out the requirements that banks must meet when developing the framework of recovery plan indicators and specifies the minimum list of indicator categories that must be included in all recovery plans. These categories include capital, liquidity, profitability and asset quality indicators as well as two additional categories of market and macroeconomic indicators, unless the bank provides explanations to the competent authorities that these additional categories are not relevant to its legal structure, risk profile, size and/or complexity.

Banks should not limit their set of indicators to the minimum list. For this reason, the Guideline includes a list of examples of additional recovery plan indicators broken down by category that banks may wish to consider in completing their framework.

The considerable practical experience in the development and evaluation of recovery plans gained since 2015 needed to be incorporated into the new guideline.

In addition,  in 2020, the EBA conducted a survey of competent authorities on the performance of recovery indicators in the context of Covid-19 and previous idiosyncratic crises. In this context, the EBA concluded:

  • That limited changes to existing guidelines are necessary.
  • There is a need to introduce additional guidance on some parts of the framework for recovery indicators, including calibration, updating of indicators and follow-up when thresholds are exceeded.

This approach has the advantage of maintaining the overall stability of the framework of recovery indicators while focusing on areas where practical experience has shown a need for further clarification and guidance.

Most of the provisions of the existing guideline remain unchanged, with the exception of the replacement or addition of some metrics to the minimum list of adjustment indicators.

Additional guidance is provided to banks on the general principles for setting thresholds for recovery plan indicators, focusing also on the treatment of recovery indicators in a crisis situation, particularly where supervisory relief measures are applied.

On this last point, the revised Guideline clarifies that, in the case of a systemic crisis, there should be no automatic recalibration of the recovery plan indicators due to supervisory relief measures, except in duly justified cases agreed with the competent authority.

4.   Changes to the existing system

4.1.   Introduction of MREL and TLAC indicators

MREL is the minimum capital and eligible liabilities requirement set for banks under the BRRD. TLAC is the total loss-absorbing capacity for global systemic banks. MREL and TLAC are important and fundamental regulatory requirements to ensure bank resolvability.

Since the publication of the previous guideline in 2015, the intermediate and target MREL requirements have been set for all banks to which they apply. For their part, G-SII banks must comply with the TLAC targets.

All these new measures were to be incorporated into the preventive recovery plan.

4.2.   Introduction of the indicator on the stock of available unencumbered assets eligible for central bank refinancing

The financial crisis has highlighted the usefulness of the stock of unencumbered assets as an indicator of liquidity. This indicator plays an important role in assessing the bank’s ability to obtain funding under stress conditions using eligible and available collateral to access standard central bank facilities.

4.3.   Introduction of the liquidity position indicator

Banks may have other sources of liquidity available beyond the HQLA stock. These include, for example, other marketable assets, committed lines that may not be eligible for central bank refinancing but are available to support stress situations.  Monitoring the liquidity position and therefore the rebalancing capacity provides a global view of any potential deterioration in the bank’s liquidity profile beyond the simple analysis of HQLA or unencumbered assets

4.4.   Removal of the indicator for the cost of wholesale funding

Practical experience has shown some limitations with this indicator in the mandatory list of minimum recovery indicators. It was often not applicable to banks that do not have access to wholesale funding due to the size of the bank, market liquidity, for example, or that have a diversified funding profile.

However, considering that this indicator may be relevant to show stress in the funding profile in some cases, it has been added to the non-exhaustive list of additional indicators to be considered at the bank’s discretion.

5.   New guidance on calibrating thresholds for recovery plan indicators

5.1.   Calibration of recovery indicators

Recovery plans should explain how the recovery plan indicators have been calibrated and demonstrate that thresholds have been set at a level that allows sufficient time to act effectively in a crisis situation. The key principle in calibrating recovery indicators is that thresholds should be set conservatively enough to provide a timely alert to the bank of potential stress and allow for effective implementation of recovery options.

Practical experience showed that recovery indicators were often triggered too late and/or did not include sufficient forward-looking elements. This could be an obstacle to the use of recovery plans. Indeed, inappropriate timing could affect the credibility of recovery options or significantly reduce their benefits.

The guideline establishes a set of general qualitative requirements (overall recovery capacity, complexity of recovery options, stage of crisis, pace of deterioration, management of the risk appetite framework) that banks should take into account when calibrating the thresholds for the indicators.

This guideline provides guidance to banks on the appropriate calibration of recovery indicator thresholds, while recognising the need to tailor calibration to each bank’s specific business and financial profile. These new requirements should be aligned with the bank’s overall risk management to achieve the objectives of the recovery plan indicator framework, and therefore lead to the timely activation of recovery plans where necessary.

5.2.   Methods for updating the calibration thresholds of indicators in crisis situations

Further clarification of the circumstances that would allow an update of the calibration of the thresholds of the recovery indicators is needed. In particular, it is necessary to determine whether temporary relief measures from regulatory requirements in times of systemic crisis should be automatically reflected in the calibration of the thresholds of the corresponding regulatory recovery indicators given their implicit link to regulatory requirements.

The recovery plan, and thus also its indicators, should be updated at least annually or more frequently due to a change in the bank’s business or financial condition. The revised guideline therefore clarifies that the granting of temporary relief from certain prudential requirements in the event of a systemic crisis, such as the Covid-19 pandemic, should not result in the automatic recalibration of regulatory indicators except in duly justified cases. In such cases, the approval of the competent authority is required.

With regard to the calibration of regulatory capital and liquidity indicators, experience has shown that banks very often set their adjustment thresholds too close to regulatory requirements, which reduces the early warning function of the indicators.

The guideline now specifies that thresholds should generally be set sufficiently above regulatory requirements, while allowing flexibility to deviate from them in justified cases. Such calibration would allow indicators to perform their warning function early enough, in particular by allowing independent action by the bank’s management prior to possible supervisory intervention and a deterioration in market confidence, which could have a negative impact on the effectiveness of remedial options.

6.   New guidance on the management of cases of breaches of indicator thresholds and their follow-up

6.1.   Actions and notifications when threshold indicators are exceeded

The revised guideline emphasises the importance of timely reporting of non-compliance with recovery indicators and frequent monitoring of indicators in crisis situations for both the bank and the competent authority.

In order to take into account the fact that, in some cases, breaches of the recovery indicators may not represent a real deterioration in the bank’s situation, the principle of non-automaticity is incorporated into the recovery indicators. Therefore, a violation of the recovery indicator does not automatically put a bank into the recovery phase.

The triggering of an indicator functions as an alarm prompting the bank to consider its situation in terms of risk and to determine whether corrective action should be taken.

In order for indicator threshold exceedances to effectively play out their warning potential, they must:

  • Quickly activate an internal bank escalation process to ensure that their violation is addressed.
  • Be communicated promptly to the supervisor so that a constructive dialogue can begin.

As timing is crucial in crisis situations, banks should ensure that both of the above processes are completed quickly, i.e. that the escalation process is completed within one business day of a breach of a recovery indicator, and notification to the relevant authority is made no later than a further business day following that internal escalation.

Following notification, the bank should maintain an active dialogue with the competent authority by providing them with the rationale for decisions taken in relation to the threshold violations identified. It is important that the bank understands that threshold exceedances are simply signals of a potential problem that may need to be addressed. Whether or not banks decide to take preventive remedial action, the competent authority should be provided with a clear and reasoned justification for the bank’s choice.

6.2.   Follow-up of recovery indicators when thresholds are exceeded

While the final decision on the potential activation of the plan rests with the bank, the role of the competent authority in this phase is not only to monitor that the process is followed correctly. Above all, the supervisor’s role will be to contribute through constructive dialogue with the bank to the most effective management of the potential crisis.

The status and evolution of recovery indicators and potential actions taken by the bank are key information for the competent authority in assessing the bank’s ability to recover independently. Therefore, even more critically in times of crisis, the bank and the competent authority should pay particular attention to monitoring the recovery indicator framework to ensure that it is appropriately set up and responding in a timely manner to the situation.

In the event of a crisis, competent authorities have the discretion to require banks to submit their full set of indicators on a regular (e.g. monthly) basis. This requirement should not represent an additional workload for banks as this list would already be available and verified internally by banks using their recovery plans as an internal governance tool.

7.   References

https://www.eba.europa.eu/sites/default/documents/files/document_library/Publications/Consultations/2021/Consultation%20on%20draft%20revised%20Guidelines%20on%20recovery%20plans%20indicators/964093/CP%20on%20draft%20revised%20GL%20on%20recovery%20plan%20indicators.pdf

Abreviations and glossary

EBA: European Banking Authority

HQLA: High Quality Liquid Assets