ECB Updates Capital Requirements for Banks Post SREP Exercise

ECB will now expect banks to operate below the level of capital defined by Pillar 2 Guidance from January 01, 2023 and reinclude central bank exposures in leverage ratio from April 01, 2022. ECB had, in March 2020, allowed banks to operate below the level of capital defined by the Pillar 2 Guidance and the capital conservation buffer while, in July 2020, ECB had committed to maintaining this full buffer flexibility until at least the end of 2022. Additionally, in September 2020, ECB had allowed banks to exclude certain central bank exposures from the denominators of their leverage ratios owing to the exceptional macroeconomic circumstances while, in June 2021, ECB had extended that measure until the end of March 2022. Although there is still some uncertainty regarding the impact of the pandemic, banks have ample headroom above their capital requirements and above the leverage ratio requirement. At the end of September 2021, the aggregate Common Equity Tier 1 ratio of banks under direct ECB supervision stood at 15.47% while their aggregate leverage ratio stood at 5.88%.

The 2021 SREP cycle involved the assessment of banks’ capital, the assignment of SREP scores to banks’ overall risk profiles and their main elements, and the issuance of formal decisions in addition to recommendations. The SREP results show that banks have solid capital and liquidity positions, with scores that are broadly stable; this is another sign of the resilience of the banking system, given that the overall scores of banks might well have deteriorated significantly during the pandemic. In the 2021 cycle, credit risk and internal governance were the two main areas in terms of remedial measures requested of banks. Supervisors looked closely at the adequacy of credit risk controls of institutions. Several banks were found to have insufficiently strong credit risk management practices, with some having inadequate provisioning processes; in such cases, ECB downgraded credit risk scores and required more follow-up actions. Findings in the area of internal governance point to weakness in boards’ steering capabilities and governance arrangements such as risk control frameworks. This can hamper risk management and compliance functions as well as information technology transformation plans, impeding the resolution of data aggregation issues. Many banks also need to take steps to improve the composition and collective suitability of their management bodies, as they continue to place insufficient emphasis on diversity. With that in mind, ECB is using operational acts to require banks to establish diversity policies and set gender-related targets.

The ECB Banking Supervision assessed the risks and vulnerabilities faced by significant institutions and established the following three supervisory priorities for 2022‑24:

• To make sure banks emerge healthy from the pandemic. Supervisors will continue to address shortcomings in the credit risk management practices of banks, with a focus on the identification and classification of distressed borrowers, the valuation of collateral, and the adequacy of provisioning practices.
• Address structural weaknesses via effective digitalization strategies and enhanced governance. Supervisors will assess digitalization strategies of banks to ensure that institutions have adequate arrangements in place—in terms of governance, resources, skills, and risk management, among others—to make them sustainable in the long term.
• Tackle emerging risks. ECB Banking Supervision will design targeted and staggered supervisory responses to ensure that vulnerabilities related to these emerging risks are tackled; the responses would, for example,  include a thematic review and a bottom-up stress test for climate‑related and environmental risks and a targeted review and onsite inspections for counterparty credit risk.

Related Links

• Press Release on SREP Results
• Pillar 2 Requirements
• Press Release on COVID Measures
• Frequently Asked Questions
• SREP Methodology
• Aggregated Results of SREP 2021

Keywords: Europe, EU, Banking, Basel, Pillar 2 Guidance, SREP, Credit Risk, Operational Risk, Governance, Regulatory Capital, Pillar 2, ECB, Headline