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    ECB Consults on Supervisory Approach to Consolidation in Banking

    July 01, 2020

    ECB launched a consultation on the guide that sets out supervisory approach to consolidation projects in the banking sector. As per the guide, the consolidation projects must be based on a credible business and integration plan, improve the sustainability of the business model, and respect high standards of governance and risk management. The guide also addresses the key issues such as Pillar 2 capital requirements of the combined entity, treatment of bad will, and permission for temporary use of the already approved internal models. The consultation on this guide ends on October 01, 2020.

    The proposed guide should enhance the transparency and predictability of supervisory actions and help credit institutions design prudentially sustainable projects. The guide covers the:

    • Overall approach to the supervisory assessment of consolidation projects
    • Supervisory expectations regarding consolidation projects
    • Supervisory approach to key prudential aspects of the consolidation transaction
    • Ongoing supervision of the newly combined entity
    • Application of this framework to consolidation transactions involving less significant institutions

    With regard to the supervisory approach to key prudential aspects of the consolidation transaction, the guide highlights that, base on past experience, three supervisory factors can play a key role in determining the feasibility of a business combination: post-merger Pillar 2 capital requirements and Pillar 2 Guidance, the prudential treatment of badwill, and the transitional arrangements for the use of internal models. ECB will not penalize credible integration plans with higher capital requirements. The starting point for capital will be the weighted average of the two banks’ Pillar 2 capital requirements and Pillar 2 guidance prior to consolidation. ECB will look to the use of badwill by banks for risk-reduction and value-added investments and accept the temporary use of existing internal models, subject to a strong roll-out plan. Past experience shows that there is no “one size fits all” approach when it comes to banking sector consolidation. Consequently, a case-by-case approach based on proportionality in the application of the principles set out in the guide should be expected.

    ECB encourages parties envisaging consolidation to engage with it early on in the process. This will allow ECB to give preliminary feedback on such projects. ECB Banking Supervision examines, from a prudential perspective, the consolidation projects brought to its attention. This assessment is aimed at ascertaining that the entity resulting from the business combination will meet all prudential requirements when the transaction is implemented. The assessment will also ensure that the business combination resulting from the transaction is sustainable and is likely to allow for permanent compliance with the prudential requirements in the future too. The profitability and sustainability of banks’ business models are among the supervisory priorities for 2020 and are important for increasing the resilience of banks and their capacity to service the economy, including in the context of COVID-19 pandemic.

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    Comment Due Date: October 01, 2020

    Keywords: Europe, EU, Banking, SSM, Pillar 2, Basel, Proportionality, Regulatory Capital, Internal Models, Banking Supervision, Consolidation of Banks, ECB

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