Topic Risk management SREP: Supervisory authorities introduce cycle for credit institutions
The Supervisory Review and Evaluation Process (SREP) is the centrepiece of banking supervision in the European Union: in this process, the national competent authorities conduct a full review and assessment of the risks to which the credit institutions are exposed. In addition, they analyse whether an institution's level of own funds is appropriate to adequately cover the capitalisable risks which the institution is or could be exposed to (SREP capital quantification).
In 2016 and 2017, BaFin and the Deutsche Bundesbank carried out the first full SREP with the new capital quantification component included in the process. To achieve this, they divided the credit institutions into two tranches for capital quantification according to proportionality and risk criteria. Henceforth they will apply the SREP at regular intervals according to a fixed cycle, which is described below. The focus rests on SREP capital quantification.
At a glance:SREP
The legal basis for the SREP is Article 97 et seq. of the Capital Requirements Directive IV (CRD IV), which the European Banking Authority (EBA) has fleshed out in the form of Guidelines. These Guidelines are addressed to the national competent authorities and had to be implemented by 1 January 2016. The SREP Guidelines set out four core elements: business model viability, governance and risk management, capital adequacy, and liquidity.
As part of the SREP, the national competent authorities assess the regulations, strategies and processes enacted by the institutions. They also evaluate the risks they are exposed to and their own funds and liquidity. It must be ensured that the capitalisable risks which the individual institutions are or could be exposed to are sufficiently covered. In that assessment, the supervisory authorities take into account proportionality criteria such as the respective institution’s size, structure, internal organisation and business activities. Capital add-ons must be determined as part of the SREP capital quantification process for any risks not sufficiently covered by own funds requirements. The process concludes with an overall assessment which forms the basis for further supervisory measures and requirements to remedy deficiencies.
EBA capital quantification requirements
In accordance with the SREP Guidelines issued by the EBA, the national competent authorities should conduct capital quantification at regular intervals – every twelve months to every three years (see "Cycle by EBA category" table below). If the supervisory authorities discover material new circumstances, they may deviate from the cycle.
The supervisory authorities must take into account proportionality criteria when setting the cycle. To that end, they classify every institution under their supervision into categories based on their size, structure and internal organisation, as well as the nature, scale and complexity of their activities. These categories should reflect the assessment of systemic risk posed by the institutions to the financial system.
The EBA's SREP Guidelines set out the following categories:
- Category 1: Global systemically important institutions (G-SIIs) and other systemically important institutions (O-SIIs) and, as appropriate, other institutions determined by competent authorities, based on an assessment of the institution's size and internal organisation and the nature, scope and complexity of its activities.
- Category 2: Medium to large institutions other than those included in Category 1 that operate domestically or with sizable cross-border activities, operating in several business lines, including non-banking activities, and offering credit and financial products to retail and corporate customers. Non-systemically important specialised institutions with significant market shares in their lines of business or payment systems, or financial exchanges.
- Category 3: Small to medium institutions that do not qualify for Category 1 or 2, operating domestically or with non-significant cross-border operations, and operating in a limited number of business lines, offering predominantly credit products to retail and corporate customers with a limited offering of financial products. Specialised institutions with less significant market shares in their lines of business or payment systems, or financial exchanges.
- Category 4: All other small non-complex domestic institutions that do not fall into Categories 1 to 3 (e.g. with a limited scope of activities and non-significant market shares in their lines of business).
These categories determine the maximum intervals between full assessments by the national competent authorities of all SREP elements and the SREP capital quantification.
|* Minimum frequency|
|Category||Assessment of all SREP elements, including capital quantification*||Summary of overall assessment|
|2||Every two years||Annually|
|3||Every three years||Annually|
|4||Every three years||Annually|
Capital quantification cycle for German institutions
According to these requirements, which the European Central Bank also uses as a guide, BaFin and the Deutsche Bundesbank have categorised the institutions which are subject to their supervision. This was based on the one hand on the importance of the respective institutions – primarily in terms of their size and complexity – and on the other on their risk situation.
The assignment of an institution to a category for the purposes of SREP capital quantification is final for the respective cycle. Early SREP capital quantification is generally not an option unless there is a significant deterioration in the respective institution's risk situation or there has been a material change in the situation, such as in the event of a merger.
At present, the vast majority of institutions are classified in categories 3 and 4, which means a three-year cycle for capital quantification. The supervisory authorities notify the institutions of their respective cycle in the course of regular communication with them.
Soft capital requirements
The information above relates solely to the determination of hard SREP capital requirements (Pillar 2 requirements). The cycle for the soft SREP capital requirements, the target equity ratio (Pillar 2 guidance), is independent of this. Previously, this cycle was two years, which the German supervisory authorities will, in general, retain. Since the soft capital requirements depend on the results of national stress testing, the supervisory authorities will generally continue to conduct the stress tests every two years. The next stress test will take place in 2019. The German supervisory authorities will then notify each of the approximately 1,600 institutions of their soft capital requirements.
Publication of the SREP capital add-on
While the institutions may publish the SREP capital add-on as a percentage or in percentage points due to the character of a hard capital requirement, the soft capital requirement is merely an indicator used internally by the supervisory authorities. This indicator has no immediate legal effect.
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