Analysis of Bank's Capital Adequacy
In the process of supervisory assessment of capital adequacy, the Bank Supervision Department determines whether the own funds held by the bank provide sound coverage of risks to which the bank is or might be exposed, if such risks are assessed as material to the bank including the adequacy of calculation of own funds requirements and available own funds of the bank. A comprehensive review of this process by the supervisor is conducted, among other, through a dialogue with the bank.
As a result of this assessment, the supervisor determines the amount (quantity) and structure (quality) of additional own funds necessary for the coverage of individual elements of risks set out by the decision governing capital adequacy of banks and risks that are not set out in the decision, and/or for the coverage of additional own funds requirements.
Supervisory assessment of the bank's own funds assumes bank's business continuity, i.e. it is applied according to the going concern principle (as opposed to resolution plans that are developed according to gone concern principle).
After considering the results of the risk assessment, the following steps are taken within the supervisory assessment of own funds: determination of the additional own funds requirements, reconciliation of additional own funds requirements with capital buffers and any macro-prudential requirements, determination and articulation of the total SREP capital requirement and overall capital requirement;
Total SREP capital requirement (TSCR) means the sum of own funds requirements for coverage of all risks the bank is or may be exposed to in its operation, determined based on the supervisory assessment.
Overall capital requirement – OCR means the sum of the total SREP capital requirement (TSCR), capital buffer requirements and macro-prudential requirements, when expressed as own funds requirements.
The supervisor determines additional own funds requirements for covering the risk of unexpected losses, and of expected losses insufficiently covered by allowances for impairment and provisions, over a 12-month period, the risk of underestimation of risk due to model deficiencies (in the context of the decision governing capital adequacy) and the risk arising from deficiencies in corporate governance, including internal controls, processes and other deficiencies.
Additional own funds requirements for covering unexpected losses are determined by using:
- the bank's ICAAP calculations;
- the outcome of supervisory benchmark calculations; and
- other relevant inputs, including those arising from dialogue with the bank.
If, during the ongoing review of application of internal models for calculation of own funds requirements in accordance with the decision governing capital adequacy, the supervisor identifies model deficiencies that could lead to underestimation of the minimum own funds requirements set out by this Decision, the supervisor shall set additional own funds requirements to cover the risk posed by model deficiencies that could lead to underestimation of risk where this is determined to be more appropriate than other supervisory measures. The supervisor shall set additional own funds requirements to cover this risk only as an interim measure while the deficiencies are addressed.
The supervisor shall set additional own funds requirements to cover the risks posed by internal controls, governance or other deficiencies identified following the risk assessment – where this is considered more appropriate than other supervisory measures. The supervisor shall set additional own funds requirements to cover these risks only as an interim measure while the deficiencies are addressed.
The supervisor shall set additional own funds requirements to cover the funding risk – identified following the risk assessment – where this is determined to be more appropriate than other supervisory measures.
The supervisor verifies the accuracy of ICAAP calculations and corrects own funds requirements, i.e. the available own funds, if it determines that the bank has not calculated them correctly, and/or has under- or overestimated them. In that sense, it is not allowed that minimum own funds requirements calculated in accordance with the decision governing capital adequacy serve as a coverage for additional own funds requirements, both on the basis of overall and individual risk exposures.
The supervisor verifies the reliability of the ICAAP calculation by assessing whether, from the standpoint of risk management, this calculation represents the link between bank's business decisions, risk management strategy and own funds planning, as well as whether it is:
- sufficiently granular: The calculations/methodologies should allow own funds requirements calculations to be broken down by risk type, rather than presenting a single own funds requirements calculation covering all risks;
- credible: The calculations/methodologies used should demonstrably cover the risk they are looking to address and should be based on recognised or appropriate models and prudent assumptions;
- understandable: The underlying elements and assumptions of the calculations/methodologies should be clearly specified. A ‘black box’ calculation is not acceptable, the bank must provide an explanation of the analysis of the fallible areas of the model used, and how these are accounted for and corrected in the final ICAAP calculation; and
- consistent and harmonised: in terms of the holding period, risk horizon and confidence levels (or equivalent factors) used in ICAAP calculations and in regular operations of the bank.
The supervisor conducts a detailed assessment of the reliability of the ICAAP calculations by comparing them against the outcome of the supervisory benchmarks for the same risks, and other relevant inputs.
If reliable or reliable to a significant degree, the bank's ICAAP calculation serves as a basis for the supervisory assessment of additional own funds requirements, and is supplemented by outcomes of supervisory benchmarks and other relevant data. Where ICAAP calculation is not considered reliable, supervisory benchmarks serve as a basis for determining additional own funds requirements, supplemented by other relevant data.
Total SREP capital requirement (TSCR) is determined as a sum of:
- minimum own funds requirements calculated in accordance with the decision governing capital adequacy of banks; and
- the sum of additional own funds requirements determined for each individual risk and any additional own funds requirements determined to be necessary to cover material inter-risk concentrations.
The supervisor sets a composition requirement for the additional own funds requirements of at least 56% Common Equity Tier 1 (CET1) and at least 75% Tier 1 (T1) to cover the following risk types:
- elements of credit, market and operational risk (that are not covered by the decision governing capital adequacy of banks);
- credit concentration risk and interest rate risk from non-trading activities; and
- the risk from model deficiencies that are likely to lead to underestimation of the appropriate level of own funds, where additional own funds requirements are used to cover this risk.
The supervisor determines the composition of additional own funds requirements to cover other risk types that are not mentioned above, including the risks arising from deficiencies in corporate governance and internal controls system and other deficiencies, taking into account the level and nature of the risk in question.
When assessing/calculating TSCR ratio (increased adequacy ratio) of a bank, the supervisor takes into account only elements which can be included in calculation of specific forms of the bank's own funds, in accordance with the decision governing capital adequacy of banks, where such calculation starts from the following formula:
OCR ratio for a bank is calculated by adding capital buffer requirements and other macro-prudential requirements to the calculated TSCR ratio.
The supervisor assesses whether the submitted capital management plan is realistic from the standpoint of the bank's ability to respond to TSCR or OCR over the assumed time period.
In analysing the bank's capital management plan, the supervisor assesses the adequacy of activities which the bank laid out in the plan, such as whether legal and reputation limitations to the implementation of those activities have been taken into account and whether the plan is aligned with the business policy and strategy, as well as the appetite for and/or tolerance to risk. Taking into account the outcomes of the bank's stress tests (that are assessed as reliable) or the supervisory stress tests, the supervisor assesses whether the bank might fail to meet TSCR or OCR ratios in the coming period.
Based on the conducted analysis, the supervisor determines capital adequacy score within SREP, in the range from 1 (the quantity and composition of own funds held pose no material risk to the bank's viability) to 4 (the quantity and composition of own funds held pose a high risk to the bank's viability).