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Banks lack adequate tools

While the supervisory review and evaluation process (SREP) of 2018 saw P2R and P2G remain largely stable, total capital needs and MDA triggers have risen. Understanding supervisory thinking is the best way for banks to reduce MDA triggers, anticipate future changes and optimise their capital management and external communications.

This is not the first time that we have noted the ECB's changing approach to regulatory capital. We've seen Pillar 2 calculations grow more transparent and risk sensitive and, more recently, looked at the proposed changes to the stacking order of regulatory capital.

So how are things evolving now? As we end the first quarter of 2019, and with SSM banks having received the outcomes of last year's SREP, we are starting to see greater clarity over the outcomes of the SREP 2018 process.

Focusing first on the quantitative outcomes of the SREP 2018, we have observed that average levels of Pillar 2 Requirement (P2R) and Pillar 2 Guidance (P2G) have remained broadly similar to those set by SREP 2017. Within that average however, it's interesting to note that the sensitivity of P2R to banks' overall SREP scores seems to have further decreased. Even though this is a minor factor relative to the increasing supervisory attention associated with weaker scores this means that banks with relatively weak scores may see a comparative reduction in P2Rs.

Given the stability of P2R and the fact that the ECB does not seem to have offset the impact of the phase-in of the Capital Conservation Buffer (CCB), or of the growing Systemic Risk Buffers (SRB) Systemic Risk Buffers are comprised of: (i) the Countercyclical Buffer and (ii) firm-specific buffers, usually G-SII or O-SII buffers., average requirements for total regulatory capital have therefore increased year-on-year. This is mirrored by the observed growth in European banks' actual average levels of Common Equity Tier 1 (CET1) ratios.

Regulatory capital demand

Regulatory capital demand and supply of SSM and European banks (CET1)

These factors also generate the second major finding of the SREP 2018: that the average level of the Maximum Distributable Amount (MDA) trigger has increased from 9% to close to 10% year-on-year. Given that around 3.2% of total regulatory capital is now driven by the `insensitive' CCB and SRB, with Pillar 1 accounting for a further 4.5% of CET1 capital requirements, it seems that:

  • 10% looks likely to represent the `new normal' level for average MDA triggers; and 
  • The ECB has limited future scope to flex P2R without pushing individual MDA triggers even higher.

Going forward, we therefore expect P2R levels to remain relatively stable. That's made even more probable by two coming changes. The first is the likelihood that Basel IV, implemented in the EU via CRR 2 and a future CRR 3, will push up banks' Pillar 1 capital demand. The second change is the ECB's plan to prevent banks from using P2G funds to make up any shortfall in Additional Tier 1 (AT1) or Tier 2 (T2) capital in line with the EBA's SREP guidelines (EBA/GL(2018/03).

What about the qualitative results of SREP 2018? Overall, our observations point to increasing harmonisation between the supervisory standards of the EBA and ECB in a number of governance-related areas. The ECB's growing focus on the Internal Governance & Risk Management (IGRM) element of SREP is apparent from the sheer number of weaknesses and remediation actions identified in this area. On the upside, we also see the ECB making an effort to boost the transparency of its communications with banks compared with previous SREP cycles, including more granular feedback and closer monitoring of remediation.

As we end the first quarter of 2019, and with SSM banks having received the outcomes of last year's SREP, we are starting to see greater clarity over the outcomes of the SREP 2018 process.

Sonia Dribek
CFO Financial Services Leader

Call for integrated solutions

Integrated solutions that combine financial and risk forecasting could help banks address these challenges on all fronts. These solutions should be capable of forecasting the impact of changes to the business strategy or the impact of external events. This offers a strong basis for decision making that can be justified internally, but also externally to the regulator or the public.

To address our clients' challenges, we launched an internal initiative called “AHEAD” which is the vision of an integrated financial and risk planning tool. This outperforms simplistic business forecasts by providing a holistic view of an institution's financial situation, including projections of: 

  • profitability
  • risk exposures
  • capital and liquidity requirements 

The ultimate goal is to provide our clients with clear and flexible forecasting at their fingertips.

KPMG insights

Many professionals latch onto blinkered viewpoints due to the amount of data and time required to perform comprehensive analyses. But there are tremendous benefits to be gained with greater accuracy, consistency and speed.

We created customized dashboards that provide features such as “zoom-in”, customization of KPIs, time series analysis, simulation and more. A key factor for success was our strategic, client-first approach which involved consultation, commitment and active participation from banks' cross-functional teams. These projects also required a clear understanding of priorities and day-to-day operations to succeed.

This tool goes further than offering substantial improvements. It also bestows a rock-solid foundation for a holistic business performance and intelligence approach, helping management better steer the organization. Management is able to effectively and efficiently respond to and align operations with the company's desired strategy. Regulators will appreciate seeing this great cockpit tool in the hands of senior management!