ECB published a report on the outcomes of the Supervisory Review and Evaluation Process (SREP) for 2019. Overall, as a result of the assessment, SREP requirements and guidance for Common Equity Tier 1 (CET1) capital in 2019 remained unchanged from 2018, at 10.6%. However, the review shows areas of notable deterioration in SREP scores, due to which supervisors will intensify assessments of the sustainability of business models and will continue to require banks to enhance the effectiveness of their management bodies and to strengthen internal controls and risk management.
The average Pillar 2 requirement, set by the supervisor for each bank, stood at 2.1% and the non-binding Pillar 2 guidance at 1.5%, both unchanged from the previous year. Most significant institutions have CET1 levels above the overall capital requirements and guidance. However, six out of the 109 banks that participated in the 2019 SREP cycle showed CET1 levels below the Pillar 2 guidance. For the banks that have not taken satisfactory measures in the last quarter of 2019, remedial actions have been requested within a precise timeline. Additionally, Internal Capital Adequacy and Assessment Process (ICAAP) and the Internal Liquidity Adequacy Assessment Process (ILAAP), which are the two key risk management processes for capital and liquidity, showed significant need for improvements.
The share of banks receiving an overall score of 3 increased to 43% in 2019 from 38% in 2018. Meanwhile, the share of banks classified as worst performers, scoring 4, decreased to 8% from 10%. The percentage of banks that scored 2 decreased to 49%, from 52%. No significant bank scored 1. The following are the three areas of notable deterioration in the SREP scores:
- An assessment of business models showed that the earnings of most significant institutions are below their cost of capital. This hampers their capacity to organically generate capital and to issue new equity. Concerned by low profitability, supervisors are increasingly focusing on banks’ future resilience and the sustainability of their business models.
- Internal governance is proving to be an area for supervisory concern, as governance scores have worsened overall over recent years. Three out of four banks (76%, up from 67% in 2018) scored 3. Only 18% of banks achieved a score of 2, down from 25% in 2018. Findings show that in a significant number of instances management bodies are not effective and internal controls are weak.
- Furthermore, some banks reported material losses, which were mostly due to conduct risk events. This is reflected in the growing number of banks that scored 3 for operational risk: 77%, up from 63% in 2018. IT/cyber risks have also been a key source of operational risk.
The SREP is an annual exercise in which the supervisor examines bank risks and subsequently determines individual capital requirements and guidance for each bank, in addition to the legally required minimum capital. For the first time, ECB also published aggregate data by business model and bank-by-bank information on Pillar 2 requirements in an effort to improve transparency. For this SREP cycle, 108 banks agreed to this disclosure. The SREP assesses four main elements: the viability and sustainability of business models, the adequacy of internal governance and risk management, the risks to capital (with its sub-components of credit risk, market risk, interest rate risk in the banking book, and operational risk) and the risks to liquidity and funding. The assessment of each element leads to an element-specific score from 1 to 4 (with 1 being the best score and 4 being the worst score) for every bank; these specific scores are then combined into an overall score from 1 to 4, in line with the EBA guidelines on SREP.
Keywords: Europe, EU, Banking, SREP, Basel III, SSM, Regulatory Capital, Credit Risk, Operational Risk, Pillar 2, Liquidity Risk, Internal Governance, ECB
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