One of the most significant announcements each year from the ECB is the formal confirmation of the supervisory priorities. Understanding these priorities, that were are approved by the Supervisory Board, is essential to know where the ECB will direct their efforts in 2016. The list for this year shows significant continuity with the 2015 focus areas.
The five key supervisory priorities, with clear interlinkages, identified for 2016 are:
- Business models: Since its inception, the SSM has focused on business models. The ECB has asked banks to justify and provide evidence of the viability and sustainability of their own business models. In 2016, the ECB will gain deeper insights, by looking at profitability drivers at the level of individual banks but also across business models. The ECB has confirmed this as the highest priority for 2016. Click here to read for further details on business model analysis.
- Credit risk: Elevated levels of non-performing loans (NPLs) still represent a serious prudential challenge in some European countries. A SSM Task Force has been established to develop consistent approaches on this issue. The Task Force will analyse current national regulations, legal frameworks, accounting regimes and supervisory practices relating to NPLs. Ultimately, the ECB is aiming for consistent supervisory practice in the area of NPL recognition, coverage and write-offs. This work may result in intrusive guidance from regulators on how to tackle NPLs at individual bank level. Click here for further details on non performing exposures in this newsletter.
An associated topic is the implementation of ‘IFRS 9 – Financial Instruments’ (International Financial Reporting Standards). A thematic review will assess the potential impact of IFRS 9 on banks’ provisioning practices and how banks are preparing for its introduction.
- Capital adequacy: The ECB will focus on assessing the quality of capital that banks have. The harmonisation of options and national discretions will be part of this work as well as the introduction of minimum requirement of own funds and eligible liabilities and Total Loss-Absorbing Capacity (TLAC) requirements. In this vein, the internal capital adequacy assessment process (ICAAP) of banks will remain a focus as well. The recent EBA draft guideline on ICAAP and internal liquidity adequacy assessment process (ILAAP) information alongside the recent clarifications that banks have received directly from the ECB give a clearer view of work needed. The planned targeted review of internal models that banks use to calculate their risk-weighted assets will commence in 2016.
- Governance and risk appetite: In 2015, the ECB performed a review of banks’ governance, for which the Joint Supervisory Teams assessed the organisation and composition of the management of the banks. As part of this, the sophistication of the risk appetite framework was under scrutiny. This theme is further developed in 2016 with the ECB choosing to focus on whether banks’ management boards have at their disposal the risk information required to make sound business and risk management decisions. In addition, the ECB has formally indicated that it will carry out a thematic review of banks’ compliance with the Basel Committee on Banking Supervision’s principles for effective risk data aggregation and risk reporting. Finally, assessment of IT infrastructure will also feature under this area.
- Liquidity risk and its management is the fifth priority for 2016. This was an area that surprisingly did not feature to date. The SSM will focus on the reliability of banks’ ILAAP. Banks vary considerably in the sophistication of their ILAAP processes and this may require significant effort from some institutions. Greater clarity on the ECB's expectation of an ILAAP was delivered directly to banks in January alongside the communication on supervisory expectations of ICAAP.
The list of priorities is wide and encompassing. The ECB’s use of on-site inspections and thematic reviews brings it into the position to ‘back-test’ individual bank’s standards versus a market standard. This horizontal view of supervisory issues is a key feature of SSM supervision. The challenge for banks is to ensure that they are aware of best practice in the industry, benchmark themselves against such practices and to integrate the resulting agenda into their own strategic planning and business initiatives.