A consistent SREP methodology for LSIs

Banking supervision in the euro area is about to take the next important step towards a more consistent approach to supervising banks across the euro area. From 2018 onwards, smaller banks will be subject to a common methodology for the annual supervisory assessment. This methodology incorporates important proportionality elements and is being devised by ECB Banking Supervision and the National Competent Authorities (NCAs).

Supervisors regularly assess and measure risk for each bank. This core activity is called the Supervisory Review and Evaluation Process, or SREP for short. This annual assessment is the supervisors’ main toolkit and enables them to determine and adopt supervisory measures, including capital and liquidity measures.

The SREP itself is not new. The concept was first introduced in 2004 with the Basel II accords established by the Basel Committee on Banking Supervision. Updated rules were implemented across the European Union in 2006 and have been followed ever since by the different national supervisors. Since the inception of the Single Supervisory Mechanism (SSM) in 2014, a harmonised methodology has been applied for the largest banks, which are directly supervised by the ECB, while in contrast NCAs have been using their own methodologies to supervise the less significant institutions (LSIs).

Against this backdrop, the ECB and the NCAs have been jointly developing a common framework applicable for the supervision of LSIs in the euro area based on the principles and methods used in the supervision of the largest banks, but also adapted, simplified and tailored to the specificities of the LSIs. This common SREP methodology for LSIs will foster a consistent supervisory approach in the euro area and support NCAs in their day-to-day supervisory responsibilities.

Proportionality and flexibility

While it is important to promote a level playing field in the supervision of euro area banks, it is equally crucial to support a proportionate and adequate supervisory approach, in particular when it comes to smaller institutions. Therefore, the methodology will, on the one hand, allow the supervisor to adjust the intensity of the assessment according to the individual characteristics of each institution, especially to their riskiness, to allow an efficient allocation of resources at NCAs. On the other hand, it will also limit the burden for the smaller, less risky banks, for example in the area of data reporting requirements.

More precisely, the SREP methodology for LSIs offers the NCAs the possibility to adjust the intensity and frequency of supervisory activities according to the banks’ potential impact on the financial system and to their riskiness. This tailored approach includes different frequencies and different levels of granularity in the assessment of risk levels and risk controls, and in the review of the internal assessment processes with respect to the adequacy of capital and liquidity (ICAAP and ILAAP).

In addition, euro area supervisors can and do adopt a more flexible methodology, especially in their risk-by-risk assessment of how a bank quantifies its capital and liquidity needs, including in stress tests. For example, the LSI SREP methodology envisages a general stress-testing framework together with a set of minimum requirements. However, NCAs can be flexible in defining the way these are put into operation. For instance, they can choose to focus on top-down or bottom-up stress tests.

Next steps

The work on this approach began in 2015 and early 2016 with the definition and field testing of a risk assessment system (RAS) methodology for LSIs. The focus since mid-2016 has been on developing the capital and liquidity quantification methodologies, so that the NCAs can perform the SREP using a common framework from 2018 onwards. The NCAs will implement the resulting SREP methodology for LSIs and retain full responsibility, as direct supervisors, for carrying out the assessments and deciding on capital and liquidity measures.

All 19 NCAs are currently testing the methodology on a subset of LSIs in their countries. Once the trial is completed, the methodology will take into account the comments, findings and feedback gathered from supervisors as part of the trial.

NCAs will start using the methodology from the 2018 supervisory cycle onwards, possibly with a staggered approach. By 2020, all LSIs should be assessed using the SREP methodology for LSIs. In future, the methodology will be reviewed, to the extent needed, and further developed to keep pace with legislative (i.e. CRD/CRR reviews) and supervisory developments.

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