Building a common supervisory approach for smaller banks

Banking supervision in the euro area has just marked another important milestone towards achieving a more consistent approach to supervising banks.

From this year onwards, a common methodology will be applied to the annual supervisory assessment of all euro area banks, including the smaller ones, operating within the Single Supervision Mechanism framework. These smaller banks – known as less significant institutions (LSIs) – are not directly supervised by the European Central Bank (ECB) but by the national competent authorities (NCAs) of the 19 member countries of the euro area. Their assessment, the Supervisory Review and Evaluation Process (SREP), is a core activity of ECB Banking Supervision and is conducted, with the necessary proportionality, by the NCAs.

Supervisors conduct the SREP on a regular basis to ensure that banks have sufficient capital and liquidity as well as adequate measures in place to mitigate any risks identified. The supervisors’ findings are documented and communicated to the banks, which are required to address any potential issues. Harmonising the SREP for smaller banks ensures that they are assessed in a similar manner irrespective of the country where they are located. This is an important step towards creating a level playing field in the euro area.

This common methodology for the SREP of LSIs is the result of a joint project by the ECB and the NCAs that started in 2015. To allow a smooth transition from national methodologies to this common one, NCAs have the option to stagger its implementation. Supervisors will apply the common SREP methodology at least to the high-priority LSIs this year and roll it out to all LSIs by 2020.

The methodology is based on the SREP Guidelines developed by the European Banking Authority. It builds on the ECB approach for significant institutions and on the existing national SREP methodologies. The methods and tools agreed by the ECB and national authorities are flexible and proportional to smaller banks. More precisely, the SREP for LSIs offers NCAs the possibility of adjusting the intensity and frequency of supervisory activities according to the banks’ riskiness and their potential impact on the financial system. This tailored approach includes different frequencies and different levels of granularity that can be applied when assessing the banks’ risk levels and risk controls or when reviewing how they assess their internal capital and liquidity needs, under both normal and stressed conditions. The SREP for LSIs is an ongoing process that is updated on a regular basis. Therefore, it will continue to evolve in the future.

Publication of the LSI SREP methodology booklet

To increase market transparency and convey supervisory expectations to the banks, the ECB has published a summary of the LSI SREP methodology. This booklet focuses on the general aspects of the methodology and on those aspects that are particularly relevant in the context of LSIs, such as proportionality.

A harmonised approach to the supervision of around 3,000 smaller banks in the euro area ensures that they are treated the same way by their supervisors and compete under the same conditions. A similar approach is also applied to the 119 bigger euro area banks the ECB supervises directly. Taken together, direct ECB supervision of large banks and a harmonised methodology for supervising smaller banks contribute to the improvements made to banking supervision in the euro area since the creation of the EU banking union.