The Financial Stability Institute (FSI) of BIS published a paper that surveys 16 jurisdictions on their Pillar 2 implementation approaches, including the application of proportionality. The focus of the paper is on whether, and how, the supervisory authorities apply proportionality in tailoring risk management expectations and supervisory practices according to the size, complexity, and risk profile of regulated entities. The analysis reveals that, while all surveyed jurisdictions have a process that incorporates the key elements of Pillar 2, their implementation approaches vary. Differences include variations in the methods used to determine Pillar 2 capital add-ons and what these add-ons are intended to cover.
The paper specifies that diverging Pillar 2 approaches can also be attributed to the role of supervisory judgment in applying proportionality and in assessing an institution's risk profile. The study finds that some authorities provide explicit guidance to support the judgments of supervisors, while others allow greater discretion to supervisory teams to fulfill their Pillar 2 responsibilities. This paper reveals that, while all surveyed jurisdictions have a process that incorporates the four principles of Pillar 2, their application varies. For example, some jurisdictions require all banks to submit a self-assessment of their own risk profile and internal capital adequacy assessments, while other jurisdictions impose such requirements on only a subset of banks. In addition, there is limited consensus on what Pillar 2 capital add-ons, if imposed, should cover, including how these capital add-ons interact with the new Basel III buffer requirements. The process used to determine Pillar 2 capital add-ons, if warranted, also differs.
Another insight is that authorities apply proportionality in supervision through one (or a combination) of two methods. The proportionality approaches used in supervision involve trade-offs. The principles-based proportionality methods allow supervisory teams flexibility in tailoring supervisory assessments to institution-specific circumstances. The guided discretion approaches eliminate some of the judgment required from supervisory teams by hard-wiring certain proportionality elements into applicable guidance. Almost all jurisdictions apply proportionality when adopting rules for internal capital adequacy assessment process (ICAAP), stress testing, and recovery plans. Nearly all tailor rules and supervisory expectations according to size, risk and complexity. In addition, some countries exempt smaller and less complex banks from applicable requirements, especially from developing recovery plans.
The paper concludes that supervisors may benefit if Pillar 2 implementation becomes the central area of focus, following the finalization of Basel III. With the post-crisis regulatory reforms now complete, there is value for the supervisory community to pay even more attention to Pillar 2. The expansion of Pillar 1 requirements under Basel III, including new global liquidity rules and the introduction of various capital buffers, has expanded the supervisory review process and its interactions with Pillar 1. In addition, new sources of risk such as cyber and climate-related risk, together with a greater focus on a firm’s conduct and culture, pose fresh challenges for banks and supervisors. In this context, continued collaboration between jurisdictions, through the ongoing exchange of experience on the various methods used to implement Pillar 2, can facilitate a robust implementation of the post-crisis reforms while taking into account the evolution of bank risk management and supervisory practices.
Keywords: International, Banking, Proportionality, Basel III, Pillar 2, Supervisory Approach, FSI, BIS
Previous ArticleIMF Report Examines Developments in Banking Sector in Ghana
PRA published the policy statement PS8/21, which contains the final supervisory statement SS3/21 on the PRA approach to supervision of the new and growing non-systemic banks in UK.
EBA published a report that sets out the final draft regulatory technical standards specifying the conditions according to which consolidation shall be carried out in line with Article 18 of the Capital Requirements Regulation (CRR).
EBA updated the list of other systemically important institutions (O-SIIs) in EU.
BCBS published two reports that discuss transmission channels of climate-related risks to the banking system and the measurement methodologies of climate-related financial risks.
UK Authorities (FCA and PRA) welcomed the findings of FSB peer review on the implementation of financial sector remuneration reforms in the UK.
PRA and FCA jointly issued a letter that highlights risks associated with the increasing volumes of deposits that are placed with banks and building societies via deposit aggregators and how to mitigate these risks.
MFSA announced that amendments to the Banking Act, Subsidiary Legislation, and Banking Rules will be issued in the coming months, to transpose the Capital Requirements Directive (CRD5) into the national regulatory framework.
EC finalized the Delegated Regulation 2021/598 that supplements the Capital Requirements Regulation (CRR or 575/2013) and lays out the regulatory technical standards for assigning risk-weights to specialized lending exposures.
OSFI launched a consultation to explore ways to enhance the OSFI assurance over capital, leverage, and liquidity returns for banks and insurers, given the increasing complexity arising from the evolving regulatory reporting framework due to IFRS 17 (Insurance Contracts) standard and Basel III reforms.
ECB published results of the benchmarking analysis of the recovery plan cycle for 2019.