June 20, 2018

ECB Banking Supervision updated its manual for the Asset Quality Review (AQR) of euro area banks. The update incorporates the implications of the entry into force of the new accounting standard IFRS 9 and takes into account the increasing importance of bank business models focused on investment services, in particular in the context of Brexit. The updated methodology will be applied in AQR exercises going forward.

The manual contains the methodology for assessing the valuations of bank assets from a prudential perspective and provides the information necessary to execute Phase 2 of AQR. The revised manual takes into account the new approach set out in IFRS 9 to impairments of bank assets and classifying financial instruments. The assessment of provision levels on credit exposures follows the IFRS 9 staging model, which introduces the concept of “significant increase in credit risk since initial recognition” of a financial instrument and the related newly introduced forward-looking approach to provisioning. To better assess risks related to bank business models focused on investment services, the updated manual broadens the scope of the fair value exposures review. Beyond level 3 assets, the manual includes complex and illiquid level 2 assets in the scope of the review and introduces some new methodological elements.

Phase 2 of AQR, which involves execution, begins in full following completion of the portfolio selection (Phase 1). This manual provides the detailed methodology for AQR execution. As a significant number of third-party providers may provide support in the execution of AQR, the methodology must be clearly passed down to all practitioners involved. Use of the same methodology for reviewing asset valuation for all institutions becoming subject to direct supervision by ECB ensures a consistent approach across the euro area.

 

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Keywords: Europe, EU, Banking, AQR, Phase 2, AQR Manual, IFRS 9, ECB

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