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FBE Summary of CEBS Consultation Paper on the Application of the Supervisory Review Process (SRP) under Pillar 2

Core Content

The European Banking Federation (FBE) has responded to the CEBS consultation paper on the application of the Supervisory Review Process (SRP) under Pillar 2 of the Basel II framework. The paper outlines the principles and considerations for implementing the SRP, emphasizing the need for a more holistic and dynamic approach to risk management in the EU banking sector.

Main Views and Key Points

1. Consolidated Group Level Application

• The FBE emphasizes that the SRP should be applied at the consolidated group level to ensure consistency and a comprehensive understanding of the institution’s overall risk profile.
• Applying the SRP at the sub-consolidated or solo level would lead to double counting of risks and hinder the implementation of the Internal Capital Adequacy Assessment Process (ICAAP).

2. Home/Host Supervisor Coordination

• The FBE suggests that Pillar 2 should be primarily applied at the top European consolidated level, with supervisory responsibilities exercised by the home state supervisor.
• In case of disputes between home and host supervisors, the home supervisor’s requirements should take precedence, provided a resolution is not reached within six months.

3. Scope of Application

• The FBE supports the idea that supervisory authorities must fulfill their legal responsibility, but clarifies that this responsibility should not extend to the host level unless specific criteria are not met.
• These criteria include inadequate capital distribution, lack of integrated risk management, and absence of a financial support policy within the group.

4. SRP as a Firm-Driven Process

• The SRP should be a dialogue between the firm and the supervisor, with the firm responsible for explaining its risk assessment and capital planning.
• The supervisor's role is to challenge the firm's risk assessment, not to impose rigid compliance measures.

5. Tailored and Flexible Approach

• The FBE welcomes the flexibility in Pillar 2 capital measurement but stresses that it should not be treated as a compliance exercise.
• The SRP should allow for tailored approaches and avoid the risk of becoming a "box-ticking" process.

6. Stress and Scenario Testing

• The FBE recommends that stress and scenario testing should consider mild recession scenarios rather than worst-case scenarios.
• This aligns with the Basel Revised Framework, which emphasizes the use of realistic and integrated risk assessments.

7. Additional Capital as an Exception

• Additional capital requirements under Pillar 2 should not be automatic and should be based on the effectiveness of risk mitigation strategies.
• The FBE argues that the quality of management, systems, and controls can be as important as capital itself in maintaining financial soundness.

8. Proportionality Principle

• The FBE supports the inclusion of the proportionality principle in the ICAAP and stresses that it applies equally to large and small institutions.
• Supervisors should consider both the size of the institution and the complexity of its management structures when determining the scope of supervision.

9. Risk Taxonomy and ICAAP

• The FBE is concerned about the introduction of a new risk taxonomy in Annex B, as it may lead to overlap with Pillar 1 and reduce the flexibility of the SRP.
• It also suggests that the ICAAP should not be overemphasized and should remain a part of a broader risk management strategy.

10. Confidentiality and Peer Comparisons

• The FBE insists that the SRP must remain confidential and should not involve peer comparisons.
• Disclosures of ICAAP models for comparison purposes could lead to competitive disadvantages and undermine the systemic value of Pillar 2.

11. Communication Between Supervisors

• In jurisdictions without a single supervisor, banking supervisors must coordinate with other regulators (e.g., securities and insurance supervisors) to avoid overlapping supervision of financial conglomerates.

Conclusion

The FBE supports the general direction of the CEBS consultation paper but calls for further refinements to ensure that the SRP is applied consistently, flexibly, and in a manner that reflects the true risk profile of financial institutions. The SRP should be a dynamic and firm-driven process, focused on enhancing risk understanding and management rather than on imposing additional capital requirements.