As of 1 January 2017, banks are subject to Pillar 2 requirements determined by the ECB’s new SREP methodology (see also our previous article). As part of their year-end audit, banks are required to ensure a sound capital planning process based on their Pillar 2 expectations for the following years, which also includes the derivation of a reasonable minimum distributable amount (MDA) for each of the coming years. The increased complexity of Pillar 2 capital components frequently poses a challenge to banks, requiring a deep understanding of the reasons and dynamics of each component of regulatory capital requirements to ensure robust estimates of their future capital requirements and MDA. Here we highlight some of KPMG’s observations from the SREP 2016 decisions and capital planning processes.
2016 marked the second time the SREP has been executed under a common methodology that have allowed for peer comparisons and transversal analyses; this is likely to have increased peer pressure for some banks. Although, according to the ECB, the overall SREP CET1 demand for 2017 remained broadly unchanged compared to the previous year, the composition of the Pillar 2 requirements (P2R) changed (see Figure 1). While P2R decreased from an average 3.1% in SREP 2015 to 2.0% in SREP 2016, a Pillar 2 Guidance (P2G) has been introduced with an average of 2.1%.1 Part of the decrease in P2R is also explained by the countercyclical capital buffer (CCB) for which the ECB has eliminated the frontloading in Pillar 2 in SREP 2016.
Looking at the overall SREP scores, only minor changes can be observed (see Figure 2). Similar to last year’s SREP, nearly 87 percent of banks received an overall SREP score of 2 or 3 (often referred as “broadly in line” or “broadly not in line” or “similar”); on average, this translates into CET1 requirements of 9.4 or 10.3 percent respectively.2
At a country level, using publicly available P2R figures from banks, large country differences can be observed (see figure 3). For example, the average P2R for Belgian banks equals 119 basis points (bps) while for Irish banks it ranks close to 300 bps. Of course, this benchmark is biased by the fact that not all banks publish P2R figures.3
To ensure a sound capital planning process, banks must reflect some key facts of the MDA components. From a quantitative point of view, the average MDA trigger for SREP 2016 is 8.3 percent.4 This reflects a decrease from 10.2 percent compared to SREP 2015 due to a capital shift to (non-MDA relevant) Pillar 2 Guidance (P2G); also, the inclusion of the non-phased-in part of the CCB in Pillar 2 was excluded in SREP 2016. From a qualitative point of view, it should be noted that P2R is the only MDA-relevant component which is entirely at the discretion of the ECB (for significant institutions).5 Given the fact that ECB considers banks profitability to be a priority, which is also reflected in P2R, banks should take into consideration various assumptions around their profitability or the success of cost-cutting measures and the implications this may have on the ECB’s SREP decision. Additional volatility in MDA-approximations in future months are likely to result from MDA-relevant changes in the MREL framework (see our article ), the separation of macro- and micro-prudential risks (as suggested in CRD V) or the Pillar 1 implications from Basel IV.6 Furthermore, as P2R increases, P2G will most likely counterbalance this, i.e. the MDA is expected to increase again over time.
Many SSM banks have experienced a considerable increase in complexity around capital planning, recently. In fact, KPMG’s ECB Office is hearing from banks that the need for explanations and discussions to make key stakeholders fully aware of the various capital requirement components and their dynamics are increasing. Banks therefore should not underestimate the complexity within their capital planning processes, including the need for intense communication with key stakeholders and investors. By benchmarking the SREP decision and its components banks are better able to identify weaknesses in business model or business organization, and are better positioned to ensure robust estimates of future capital requirements.
KPMG Peer Bank can help banks to run such benchmarking exercises by facilitating the construction of customized peer groups that allows each Significant Institution to select banks for its group that meet a similar profile. Banks can then run their own SREP analysis among a peer group, similar to what ECB is currently doing.
1P2G captures the supervisory risk concerns from the outcome of stress tests. Note that in the EBA 2016 stress test, a 380 bps CET1 depletion has been observed on average to an adverse scenario.
2Note that, according to the ECB, the correlation between P2R and overall SREP scores has increased to 76% (compared to 68% in SREP 2015). However, including other components like combined buffer and P2G, the correlation is likely to be significantly lower.
3Note that as per end of January, almost one third of the SSM banks have published their P2R figures on their webpage. Since we are considering only public information, the analysis may be biased.
5Pillar 1 requirements are determined by the Single Rulebook, buffer requirements generally by NCAs. P2G is not MDA relevant.
6For the MREL-implications, see e.g. EBA’s final report on the implementation and design of the MREL framework (December 2016).