Close to 400 participants from across the German banking sector joined the event in the Maritim Hotel in Bonn in order to learn first-hand how BaFin intends to incorporate the European Banking Authority’s Guidelines in its supervision of less significant institutions (LSIs).

The EBA Guidelines, which came into force on 1 January, require the German supervisors to impose capital requirements tailored to individual banks for the first time within the framework of the SREP. This is supposed to ensure that there is enough capital to cover risks that are not included in the minimum requirements of Pillar I of the European Capital Requirements Regulation, the CRR.

Calculating additional capital requirements

The BaFin and Bundesbank representatives outlined the contents of the EBA Guidelines and explained how BaFin and Bundesbank were going to implement them. The participants were particularly interested in the method of calculating additional capital requirements based on individual banks’ risks and the quality of their risk management systems.

For most institutions, the relevant factor is the assessment of interest rate risk in the banking book, which, though to date not covered by a Pillar I minimum requirement, is often of significance as a “by-product” of maturity transformation. On the basis of the “Basel 200-basis-point interest rate shock” and taking into account individual banks’ risk management systems, the determination of capital will on average factor in half of the change in present value. The result will be assigned to a matrix segment, defined via threshold values, which will then reveal the individual additional capital requirement (the “bucket approach”).

In addition to the interest rate risk, the internal capital adequacy assessment process (ICAAP) will also be used to identify further material risks which will be derived from internal capital adequacy reporting.

The additional capital requirements to be imposed by BaFin in addition to the Pillar I minimum requirement (“hard” capital requirement) are composed of these two elements: the interest rate risk and other significant risks. Individual cases may warrant additional requirements, mainly due to deficient internal organisation.

Low interest rate environment

The results of the survey on the impact of low interest rates (only available in German), conducted by BaFin and the Bundesbank last year, are also taken into account in the SREP. This self-estimate by the German credit institutions gives an idea of how a persistent low interest rate environment would affect their earnings. The simulation is rounded off by stress scenarios involving both the institutions’ credit and market risks.

In accordance with the recent considerations on the part of the European Commission and the EBA, the results of the survey will feed into a stress buffer, which extends the additional capital requirement by a supervisory target figure, the so-called “soft” capital requirement (capital guidance). It may also be covered by internal capital (“340f reserves”), which naturally needs to be identified accordingly.

Röseler: “Not a purely mechanistic assessment”

At the same time though, as Chief Executive Director of Banking Supervision, Raimund Röseler, stressed, the SREP should not be reduced to solely determining the capital. Thanks to their experience, BaFin and the Bundesbank have the established expertise needed to prepare individual banks’ risk profiles. They have both been dealing with individual risks, risk management, capital adequacy and institutions’ earnings positions, to name just a few examples Röseler mentioned. “The SREP is always an individual assessment of a bank, which cannot and must not be done in a purely mechanistic manner”, he said.

In order to ensure that the supervisors’ knowledge of the institutions’ individual situation can contribute to the process, it will affect the mechanistic capital calculations by updating or correcting the reported figures (expert judgement). Moreover, in order to make sure that the decisions remain consistent, BaFin and the Bundesbank will check the individual additional capital requirements against each other within a peer group comparison. In Röseler’s view, this concept is robust enough to capture the material risks of German institutions and, at the same time, set additional capital requirements using sound judgement. “They will be noticeable, but won’t cause major upheavals”, Röseler added.

Next steps

BaFin intends to start sending out the first notices of hearing as early as the end of June. At first, around 330 institutions will be subjected to SREP capital determination. The remaining close to 1,300 institutions will be receiving their SREP notification gradually until the end of 2017, but will already need to cover at least their interest rate risk with capital before. BaFin is to consult on a relevant general administrative act in the third quarter of 2016.

LSI SREP method

Graphic: LSI SREP method Source: BaFin/Bundesbank