Brexit: preparing for supervision in the euro area

With the United Kingdom’s exit from the European Union fast approaching, the time for banks to put their Brexit plans into action is drawing near. As a result of the relocation of activities from the UK, some euro area banks will become significant institutions and will be supervised directly by ECB Banking Supervision.

Reviews of banks’ Brexit plans by the ECB and national competent authorities (NCAs) are ongoing. The ECB and NCAs assess whether the proposed plans meet supervisory expectations. Jointly prepared by the ECB and NCAs, these supervisory expectations have been approved by the Supervisory Board of ECB Banking Supervision and shared externally since early 2017, giving banks the opportunity to incorporate them into their preparations in a timely manner. Banks have also received verbal and written feedback on their plans.

Several banks in the euro area, which are growing as a result of the transfer of large amounts of activity from the UK, will be assessed as significant and will therefore come under the direct supervision of the ECB. Others will be assessed as less significant. A key component of the significance assessment is the measure of a bank’s total assets (on a consolidated level). Other criteria considered include the bank’s economic importance and cross-border activities. While the significance assessment is usually conducted from early June until September-October, the ECB can also carry out ad hoc assessments of significance whenever needed. This may be especially relevant for euro area banks that are substantially expanding their activities in the context of Brexit.

All banks which are expected to come under direct supervision by the ECB will be subject to a comprehensive assessment. This exercise usually takes place before a bank comes under ECB supervision, but may also be conducted later on. The comprehensive assessment is a financial health check to ensure that banks are adequately capitalised and can withstand potential financial shocks. It is composed of two parts: an asset quality review (AQR) and a stress test.

The AQR comprises ten work blocks, including reviews of banks’ processes, policies and accounting practices, a credit file review and a review of fair values. Once the process is complete, an AQR-adjusted CET1 ratio and a set of remedial actions for banks are determined. The ECB’s AQR manual, which contains the methodology for assessing the valuations of bank assets from a prudential perspective, may be helpful for banks which expect to undergo the assessment.

Conducted at the same time as the AQR, the stress test is based on the methodology for EU-wide stress tests published by the European Banking Authority. The purpose is to test the resilience of banks’ balance sheets under adverse conditions. At the end of the whole process, the stress test results are joined up with the outcome of the AQR to finalise the comprehensive assessment.

The ECB conducts the comprehensive assessment in cooperation with NCAs and external experts such as auditors. Each comprehensive assessment is conducted by a central ECB project team and individual bank-specific teams. These bank-specific teams include the supervisors who will be responsible for the future day-to-day supervision of their bank. They use the time before the ECB assumes responsibility for supervision to familiarise themselves with the bank, collect information from NCAs and contribute to the comprehensive assessment.

The ECB usually assumes direct supervision on 1 January of the year following the regular assessment of significance. In the case of an ad hoc significance decision, it takes over supervision shortly afterwards. Banks receive information on their change of supervisor at least one month in advance. When the ECB is the direct supervisor, each significant bank is supervised on a day-to-day basis by a Joint Supervisory Team (JST). This team is composed of ECB and NCA staff. JSTs carry out activities such as the Supervisory Review and Evaluation Process (SREP) and may initiate on-site inspections. In addition, JSTs will closely follow the implementation of banks’ Brexit plans and how they meet the supervisory expectations defined by the ECB and NCAs.