Recovery planning: the ECB experience
Recovery plans are a key element of the new European crisis management framework. They are intended to ensure that banks are prepared to restore their viability in a timely manner even in periods of severe financial stress. Within this framework, banks are required to draft and maintain recovery plans and to submit them annually to the European Central Bank (ECB). Having assessed three cycles of recovery plans, from 2015 to 2017, the ECB is now sharing with the banking industry the best practices it has identified in five key areas:
- recovery options
- overall recovery capacity
- recovery indicators
- playbooks (implementation guides for recovery plans)
- dry runs
In a recently published report on recovery plans, the ECB provides for the first time a system-wide view, and in doing so aims to help euro area banks improve their own recovery plans.
First comparisons show that while most banks have already achieved a lot in this area, there is still room for improvement, especially when it comes to providing feasible and credible recovery options and developing indicator frameworks covering the most relevant risks and vulnerabilities. In addition, some banks do not yet fully comply with all legal requirements, such as the specification that all indicators from the European Banking Authority’s list of minimum required indicators should be included in their recovery frameworks.
The ECB’s report highlights how banks’ overall recovery capacity (ORC) can best be presented. An adequate estimation of ORC is crucial for supervisors to enable them to assess whether a bank can actually overcome a crisis situation by implementing its recovery plan. However, experience from the previous assessment cycles has shown that banks tend to largely overestimate their ORC. The report shows that banks claim that, by implementing their recovery options, they could increase their CET1 ratio by an average of 13 percentage points over the course of one year and their liquidity coverage ratio (LCR) by an average of 220 percentage points. However, this expected capital increase is close to banks’ current average CET1 level and the expected liquidity increase is equal to almost 1.5 times their current LCR level.
To realistically estimate ORC, it is important to assess whether some recovery options are mutually exclusive or whether they are interdependent, thereby affecting their overall impact. Moreover, implementing several options, e.g. the sale of several subsidiaries or a substantial share of assets, might have market signalling effects which should be taken into account. The same is true for possible constraints on banks' operational capacity to implement several recovery options simultaneously.
Another key issue is whether banks can implement their recovery plans in a timely and effective manner in situations of stress. The report identifies two best practices for achieving this goal: namely, playbooks and dry runs. Playbooks serve as concise implementation guides and enable banks to quickly implement their recovery plans during crises. Dry runs are “live” simulation exercises that help banks test key parts of their recovery plans, train staff to react in crises and identify areas for improvement. Going forward, the ECB’s main focus when assessing recovery plans will be to ensure that the plans are operational and can be implemented in an effective and timely manner.
As outlined in the European Union’s legal framework, recovery planning is designed to be an ongoing process that does not end once the bank’s management has approved the plan. Moreover, it should be an iterative process whereby banks and their supervisors constantly interact and banks regularly test their plans to ensure they remain operational and effective. Only then can banks be adequately prepared for crises.