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ECB guides to ICAAP and ILAAP

Inadequate and low-quality capital and liquidity in banks often increase the severity of financial shocks in the banking sector. Two important processes are central to making banks more resilient and avoiding adverse situations: the internal capital adequacy assessment process (ICAAP) and the internal liquidity adequacy assessment process (ILAAP). The aim of the ICAAP and ILAAP is to encourage banks to reflect on their capital and liquidity risks in a structured way, using bank-specific approaches to measure and manage these risks. Both processes should ensure that banks identify, effectively manage and cover their capital and liquidity risks at all times. Implementing the ICAAP and ILAAP proportionately is the responsibility of the banks themselves. In other words, each bank must ensure that its ICAAP and ILAAP are commensurate with its business model, size, complexity, riskiness and market expectations.

The ECB multi-year plan

In January 2016, with a view to encouraging banks to develop and maintain high-quality ICAAPs and ILAAPs, the ECB published its supervisory expectations on the ICAAP and ILAAP for significant banks. These expectations set out the ECB’s understanding of the ICAAP and ILAAP requirements in the Capital Requirements Directive (CRD) and their publication was a first major step towards convergence in these important areas. However, even after these new expectations had been published, further improvements across banks were still needed on several fronts. In particular, the concept of ensuring capital and liquidity adequacy from two different perspectives – normative and economic – and the interplay between the ICAAP and ILAAP posed challenges for many banks. Further clarification was needed and, as a result, the ECB launched a multi-year project to develop comprehensive guides to the ICAAP and ILAAP for significant banks. The expectations published in 2016 were revised as part of this project.

First drafts of the guides to the ICAAP and ILAAP were made available in February 2017 alongside an informal call for comments. This was followed by a public consultation in March 2018. The guides were amended and refined on the basis of the comments received.

The final guides to the ICAAP and ILAAP were published in November 2018, replacing the expectations published in 2016. While the overall direction of the expectations did not change (for example, in terms of the nature of ICAAP perspectives or the assumption of the continuity of operations), the ECB set out more detailed ICAAP and ILAAP principles and provided further explanations and examples. Significant banks are now encouraged to follow the supervisory expectations set out in these guides, which the ECB has been using in its assessment of banks’ ICAAPs and ILAAPs since January 2019.

The role of the ICAAP and ILAAP in the SREP

ECB Banking Supervision’s supervisory priorities for 2017 and 2018 highlighted the fundamental importance of the ICAAP and ILAAP in helping banks manage their capital and liquidity adequacy. The Supervisory Review and Evaluation Process, or SREP, recognises that good ICAAPs and ILAAPs reduce uncertainty for both banks and supervisors about the actual risks that banks are or may be exposed to. They also give supervisors an increased level of confidence in a bank’s ability to remain viable by maintaining adequate capitalisation and effectively managing its risks. The insights from both processes feed into all SREP assessments and supervisors’ decisions about capital and liquidity requirements.

The ICAAP and ILAAP are expected to play an even greater role in the SREP in the future, which should encourage banks to continuously improve these processes. Among other things, both the qualitative and quantitative aspects of the ICAAP – the latter focusing on identifying and quantifying risks – could play an enhanced role in the calculation of additional capital requirements on a risk-by-risk basis.

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