The ECB is putting the harmonisation and strengthening of Institutions' ICAAPs at the heart of its priorities for 2019 and 2020. The new ICAAP guidance is in force and already applied to the SREP 2019. The ECB's ICAAP information gathering exercise, launched in June 2019, marks a new phase in the ECB's efforts to assess the quality of the ICAAPs across Europe. Deep-dives with JSTs and on-site investigations are likely to be used by the ECB to further deepen its understanding of banks' ICAAPs.

Internal capital adequacy assessment processes (the ICAAP) are at the heart of banks' capital management. Although ICAAP is purely an internal exercise, it plays a key role in the supervision of SSM banks providing input for the assessment of risks to capital as part of the annual Supervisory Review and Evaluation Process (SREP). Significant Institutions (SIs) provide the ECB with a comprehensive annual ICAAP package, including a wide range of quantitative and qualitative data. Ongoing review of the ICAAP enables supervisors to evaluate banks' ability to identify, assess, mitigate and report on their risks.

For much of the SSM's existence, approaches to ICAAP have continued to vary significantly between member states - partially a legacy of different national supervisors' historical approaches. The ECB has always been keen to harmonise ICAAPs and make them more comparable. But it's only been during the past three years that their efforts in this area have really taken hold.

This more concerted focus on the ICAAP began in 2016, with the ECB's publication of its initial guidance on supervisory expectations. That was followed in early 2017 with the publishing of the ICAAP multi-year plan. The ECB's new ICAAP and ILAAP guidance was finalised in late 2018, and is applicable to SREPs from the beginning of the current year.

The final guidance is very clear that the ECB intends to intensify its supervisory assessments of ICAAPs, and that they will play an increasingly important role in determining the Pillar II requirements of individual banks. This message is reinforced by the ECB's review of its 2018 supervisory activities, which highlights improvements in the quality and integration of ICAAPs as a continuing priority for the coming year. As stated by the ECB:

“In the future, the ICAAP and ILAAP are to play an even bigger role in the SREP, incentivising banks to keep improving their internal processes. Among other things, both the qualitative and quantitative aspects of the ICAAP will play an enhanced role in the determination of Pillar 2 own funds requirements on a risk-by-risk basis”

The same report indicated that the ECB had found “serious shortcomings” in the ICAAPs of more than half of SIs. Clearly, the ICAAP remains a challenging area for many banks. Among other areas, the ECB is believed to have detected the following shortcomings:

  • Underdeveloped stress-testing frameworks
  • Weaknesses in risk quantification methodologies
  • Material deficiencies in the integration of the ICAAP into the management framework

To facilitate improvements in banks' ICAAPs, the ECB's has developed and published guidelines that follow a principles-based approach. The ECB's final guide is derived from the ICAAP provisions of CRD IV. Seven principles are included, covering governance, integration of ICAAP in the overall management processes, revised quantitative frameworks introducing new perspectives (normative and economic internal perspectives) and stress testing. Implementing the guide presents some potential challenges for banks, such as including the normative and economic perspectives and aligning of the different stress testing programmes.

Furthermore, the ECB has recently begun a new data gathering exercise to better understand banks' approach to the ICAAP. Launched in June 2019, this aims to collect a wide range of credit and market risk related data, together with some qualitative information on the ICAAP process. Banks should note that this process may well become an annual exercise, and that it could be supplemented by on-site investigations focused on the ICAAP.

Banks should be in no doubt that the ICAAP is moving to the centre of the ECB's agenda, and that it will play an increasingly important role in determining their levels of supervisory capital. The ECB's ultimate goal of making ICAAPs more comparable will take time to achieve. For banks, the immediate priority should be to prepare for the enhanced scrutiny and increasingly demanding data requirements that are likely to be major themes over the next two years.

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