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Bank Supervision | Supervisory Review and Evaluation Process (SREP)

Analysis of Solvency Risks

Within the SREP, the Bank Supervision Department analyses risks which impact solvency of the bank and which were assessed as material.

The key risks that impact the bank's solvency are the following:

  1. credit and counterparty risk;
  2. market risk;
  3. operational risk; and
  4. interest rate risk.

Also, when assessing risks to solvency, the sub-categories within each of the above risk categories need to be taken into account. Depending on the materiality of any of these sub-categories of risk to a particular bank, they should also be assessed and scored individually. The decision on materiality of each of the sub-categories of risk depends on the supervisory judgement.

In addition to the above, the supervisor also assesses other risks that are considered material in case of a particular bank.

For each material risk, the supervisor assesses:

  1. level of risk (exposure to risk),
  2. the quality and effectiveness of risk management and controls.

When performing the assessment, the supervisor uses all available information sources, including regular and ad-hoc regulatory reporting, the bank’s internal indicators and reports (e.g. internal audit reports, risk management reports, information from the ICAAP), on-site examination reports and external reports (e.g. the bank’s communications to investors, reports complying with the NBS's regulations and guidelines about the disclosure of data and information by banks).

When assessing risks that affect solvency, the supervisor also assesses the accuracy and reliability of the calculation of minimum own fund requirements to identify situations where additional own funds requirements are needed.

The supervisor determines a score for every material risk primarily based on the assessment of the risk level, but also reflects considerations and findings about risk management and controls, such as the fact that the adequacy of management and controls may increase or – in exceptional cases – reduce the impact of the observed risk on the bank.

In order to produce a comprehensive assessment of the risks to the bank's solvency, the supervisor assesses whether an adequate risk management system has been set up, particularly: a strategy for the management of the given risk and appetite for and/or tolerance toward that risk, organisational structure, policies, procedures and other internal acts, the process of identification, measurement, monitoring and reporting about that risk and the system of internal controls.

Based on the conducted assessment, the supervisor determines a score for each material risk, ranging from 1 (considering the level of a particular risk and the system of management and controls of that risk, the bank is not materially exposed to this risk) to 4 (considering the level of a particular risk and the system of management and controls of that risk, the bank is highly exposed to that risk).

In assessing credit and counterparty risk, the supervisor considers all the elements that determine potential credit losses, and in particular: the probability of default, or relevant credit events, that mainly concern the borrowers and their ability to repay obligations; the size of exposures to credit risk; and the recovery rate of the credit exposures in the event of borrower's defaulting. Through the assessment of the level of credit risk, the supervisor determines the main drivers of the bank’s credit risk exposure. Credit risk assessment includes: assessment of the characteristics and composition of the credit portfolio, assessment of credit portfolio quality, assessment of the amount and quality of credit protection instruments, and assessment of allowances for impairment to balance sheet assets and provisions for losses on off-balance sheet items. The supervisor assesses credit risk in both current and prospective terms. In assessing the types of credit risk, at least the following sub-categories of credit risk are considered: credit concentration risk, counterparty credit risk and settlement risk, country risk, credit risk from securitisations, FX lending risk; and specialised lending risk.

The supervisor assesses market risk which arises from all exposures in the trading book, as a minumum, the following sub-categories of market risk: position risk, foreign-exchange risk, commodities risk and credit valuation adjustment risk. The assessment of market risk concerns those on- and off-balance-sheet positions subject to losses arising from movements in market prices and includes: assessment of the nature and composition of the bank’s positions subject to market risk, assessment of profitability, assessment of market concentration risk and assessment of the outcome of stress testing.

In view of the fact that operational risk is inherent to all banking products, activities, processes and systems, the supervisor takes into account all findings from the assessment of corporate governance and the system of internal controls. The supervisory assessment of the level of operational risk determines how operational risk may materialise and also considers potential impacts in terms of other risks (e.g. credit-operational risk, market-operational risk ‘boundary cases’). The supervisor additionally assesses the materiality of operational risk arising from outsourced activities, and whether these could affect the bank’s ability to process transactions and/or provide services, or cause legal liabilities for damage to third parties (e.g. customers and other persons). When assessing operational risk, competent authorities should also consider: reputational risk, risk of money laundering and terrorism financing, legal risk, conduct risk, information system risk and model risk. When assessing the risk of money laundering and terrorism financing, the supervisor takes into account the main sources of bank's exposure to this risk, namely: business network size, structure of client base, products and services, executed transactions, outsourcing of customer due diligence actions and measures to other persons and correspondent relations.

When assessing interest rate risk, the supervisor identifies the main sources of exposure to interest rate risk and assesses potential impact of this risk to the bank from the standpoint of its income statement and bank's economic value. When assessing the level of interest rate risk, the supervisor takes into account the following forms of interest rate risk: repricing risk, yield curve risk, basis risk and optionality risk. The supervisory assessment includes: assessment of the nature and structure of the interest rate risk profile and results of the stress testing.