SREP – Quality, not quantity

The SREP continues to evolve, and while the fifth iteration may not see many quantitative changes from 2018, the qualitative aspects could be more intriguing. The ECB is developing a more mechanistic approach to its work, with a particular focus on harnessing the outcomes of its thematic reviews and horizontal benchmarking.

Every year since the inauguration of the SSM, banks have faced an annual challenge to understand the shifting quantitative and qualitative features of the annual SREP process.

It seems safe to assume that SREP 2019, the fifth banks have undergone, will be no different. Banks in the SSM have already received their draft SREP decision letters, and after responding to the ECB they can expect their final SREP decisions to arrive in December.

Unlike previous years, however, it’s likely that 2019 will only see relatively minor changes to the quantitative outcomes of the SREP, and therefore to overall levels of Pillar 2 capital. 

One factor here is that the Liquidity Stress Test (LiST) is the only major stress test the ECB has carried out this year. By its nature, LiST can have no direct impact on capital assessments (only indirectly via the SREP score for risk management & governance that informs P2R). That means that levels of Pillar 2 Guidance (P2G) are likely to be rolled forwards from 2018 virtually unchanged, although there may of course be some variations between individual institutions.

Instead, we expect the most significant changes of ‘SREP 5.0’ to affect the qualitative aspects of Pillar 2. From a technical standpoint, this will reflect the ECB’s first full application of the EBA’s SREP guideline (EBA/GL 2018/03), which introduces further clarifications on how to assess the SREP elements. Those clarifications cover the risk scores applied to individual risks to capital, liquidity and funding; and the viability scores applied to the four SREP elements and the overall SREP score.

In practical terms, banks are likely to see this manifested in the ECB’s growing focus on Internal Governance and Risk Management topics, and its increasing use of benchmarking as a key driver of supervisory scores. In both cases, an increasingly technical approach to the qualitative aspects of the SREP means that 2019’s motto may be ‘the devil is in the detail’. 

In one sense, this represents the continuation of a well-established trend. Faced with banks’ long-standing complaints that the SREP decision-making process can be something of a ‘black box’, the ECB has worked to make its decisions more transparent, risk sensitive and consistent across the SSM. Over time, these efforts have led to the emergence of ever-clearer links between the annual SSM priorities, the ECB’s year-round programme of work, and the judgements it makes during the annual SREP process.

In 2019, the most obvious illustration of this linkage will be the increasing influence of the ECB’s horizontal benchmarking and thematic reviews on its SREP decisions. Examples could come from LiST itself, from the ECB’s review of credit underwriting, or from its pan-European benchmarking of banks’ approaches to the ICAAP’s new risk-by-risk assessments.

Even if overall levels of Pillar 2 capital are unlikely to change much from those of 2018, banks will inevitably still have their concerns about the transparency of the 2019 SREP. Even so, we see a clear trend towards the application of an increasingly formalised, technical SREP framework. The more that the ECB examines key areas of risk, and the more it compares these issues between individual banks, the greater the impact these findings will have on its SREP decisions.

KPMG ECB Office will soon be publishing a piece of thought-leadership on five years of SREP. For further information on SREP, please contact the team or subscribe here for our quarterly newsletter.