10. Case study on the assessment of capital adequacy€¦ · The case study will help you better...
Transcript of 10. Case study on the assessment of capital adequacy€¦ · The case study will help you better...
10. Case study on the assessment of capital adequacy
Alessandro Nardi, Slavka Eley, EBA, Supervisory Convergence Unit
21-22 April 2016 | EBA Seminar on SREP Guidelines
In the previous section we have learnt the main concepts and characteristics of the capital
adequacy assessment introduced by the SREP guidelines. We are now going to implement all
these in practice through a simple case study which should help fixing them in our minds.
The case study is based on a hypothetical bank with a simplified balance sheet. You will be
provided with fundamental information coming from the supervisory risk assessment and with
estimates of capital needs from the ICAAP and supervisory benchmarks.
What you’ll be asked to do is filling the table 2 of the Annex 4 of the ITS on Joint decisions on
institution specific prudential requirements based on the information provided in order to
calculate the TSCR and OCR, which will require very little computational effort.
Once initial capital requirements are determined, the next step will be analysing the outcome of
supervisory stress test and the determination of any additional measure to the requirements set
at the previous step.
The final step will the scoring of capital adequacy, which is mainly qualitative
Introduction (no to be projected but recorded as Audio)
2
The case study will help you better understanding
- The relationship between risk assessment and capital adequacy
- The use of supervisory benchmarks for determining additional capital requirements
- The application of the principles behind the determination of capital add-ons (Risk by risk
assessment, Pillar 1+ approach, treatment of inter-risk diversification)
- Interaction between micro and macro prudential requirements
- TSCR articulation
- The use of stress test in SREP
- The scoring of capital adequacy
Objective
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Euro Bank: overview
Euro Bank
Country A
Branch 1
Country B
Branch 2
Country C
Branch 3
Country D
- Retail bank, mainly focused on mortgages and financing to local SMEs active in the real estate and import/export businesses (through foreign branches)
- Trading activity limited to treasury and driven by customer needs
- Offer of investment and insurance products to customers also through external
- Funding relying on customer deposits
Business model
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Non-significant
Country A - 2 year recession - Rise in default rates
and credit spreads - Drop of real estate
market Country B, C, D Stable and strong economies not showing deterioration
Economic environment
Systemic Importance SREP category 1; O-SII
Solvency ratios CET 1: 9.37% ; TCR: 14.73%
Combined buffer Capital conservation buffer: 1% O-SII: 1% SRB:1%
Supervisory info
Assets Liabilities
Interbank loans 15
Loans to customers 55
of which: Central Bank 5
retail mortgages 25 Interbank loans 11
consumer revolving loans 5 Other debt instruments 13
other retail loans 3 Tier 1 eligible debt 4
corporate loans 22
Cash 10
Other assets 10
Total 100 100
Banking Book
Government bonds 10 Deposits from customers 60
Equity 7
Trading Book
Simplified Balance sheet
5
Concentration on Real Estate sector
Low coverage ratio 30% of NPL Material credit and operational losses
High Cost\Income Optimistic P&L forecast
Includes real estate
developers
Credit Quality
Total loans 70
Non Performing (gross) 10
Non Performing (net) 7
Current year
NIM 5
Fees 1
Costs -3.5
Credit losses -1.5
Op losses -0.5
EBT 0.5
Net profits 0.25
P&L
Forecast
NIM 8
Fees 1
Costs -4
Credit losses -1.5
Op losses -0.5
EBT 3
Net profits 1.5
P&L
Risk assessment
Business model analysis: business focused on lending to retail customers, which are now being hit by the
economic slowdown. Future strategy aimed at increasing exposure towards highly rated SMEs exporting to
stronger economies (sector with high competition) and towards local consumer revolving loans (highly
risky). Cost /income ratio above peers. Score 4
Internal governance: generally robust internal governance with regular reporting and involving of the
Board in all strategic decisions. Adequate control system, but struggling with embedding risk appetite (in
particular operational risk) in business decisions. Score 3
Credit risk: The bank’s book has experienced a material deterioration of credit quality due to prolonged recession
which led to a material increase of the NPL ratio (to 13% of total loans to customers). The coverage ratio (30%) is
lower than peers in Country A (45% on average).
High exposure concentration to real estate sector (retail mortgages and real estate developers) which
counts for 50% of the loans. Material concentration on some single names. Observed increase of exposure
to risky consumer revolving loans. Score 4
Operational risk: operational risk losses are on the rise due to litigation costs and redressing of customers’ losses
for wrong advisory on investments (+300% YoY). The number of outstanding customer complaints has increased.
The bank has reviewed its product catalogue and is undertaking a massive review of customers’ profiles for a more
consistent offer starting from the next months. The bank is subject to Standardised Capital Requirement. Score 4
Market risk and IRRBB: these risks are present but not very significant. Trading mainly aimed at covering FX risk
arising from FX lending. IRRBB risk related to mismatch between long term funding and lending. Score 2
No other material risks identified.
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ICAAP assessment (quantification only)
- The bank uses the standardised approach for P1
requirements. For ICAAP an IRB-Foundation-like
capital is adopted for performing exposures based
on ‘managerial PDs’ used for pricing and risk
monitoring
- Expected Losses > accounting provisions
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- The supervisory benchmark applies a multiplier
to P1 credit risk requirement, which takes into
account the concentration risk and the shortfall
(difference between EL and provisions)
Credit risk
ICAAP Sup Benchmarks
- The bank use IMM (internal model method) for
Pillar 1 (which entails the sum of stressed and
unstressed VaR). For Pillar 2, the max of unstressed
and stressed VaR is considered
- The bank uses the same IMM adopted for market
risk. The ICAAP covers prepayment and optionalities
and assumes a lower duration for sight deposits (2
year) compared to market convention (3.5years)
- Simplified model (duration gap) based on a 200
bps shock. Sight deposit duration equal to 3.5
years
- Judgmental capital buffer equal to 10% of P1
requirements
- Qualitative correction factor based on
Equity/Sovereign 5yCDS weighted by market/credit
exposures
- Standardised approach for P1. Scenario analysis for
ICAAP
- Peer analysis with other banks using AMA and
with similar operational risk profile
Market risk
Op Risk
IRRBB
Systemic risk
Diversification
- Systemic risk assessed in case of non-SII.
Benchmark = 1% of market share of deposit
NA
NA
Capital adequacy assessment
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Risk quantification
• Risk by risk
• Add-ons
SREP Capital
• TSCR
• OCR
Capital Adequacy
through the cycle
• Supervisory Stress Testing
• Review of TSCR/Capital plan
- Are all risks considered? - Is the Pillar 1+ approach applied?
- Is the quality and composition of own
funds adequate?
- What measures should be adopted? - Capital plan? - Increase of TSCR?
Risk Quantification
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Pillar 1 capital
requirements,
where
applicable
(in mln EUR)
ICAAP estimate
(in mln EUR)
Supervisory
benchmark
A. Business Model 0 N.A. ?
B. Internal governance arrangements 0 N.A. ?C.
C.1 Credit and counterparty risk 4.80 4.00 6.00 ?C.3 Inter-concentration risk 0.00 0.00 ?C.4 Market risk 0.80 0.40 N.A. ?C.5 IRRBB 0.20 0.30 ?C.6 Operational risk 0.375 0.25 1.00 ?E. Systemic risk 0.50 0.00 ?F. Inter-risk diversification effects -0.60 0.00 ?
G. Capital planning / stress test buffer 2.00 ?
SREP elements
Overall SREP
capital
requirement/est
imate
(in mln EUR)
Risks to solvency
Determination of TSCR and OCR and of capital adequacy (first step)
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Pillar 1 capital
requirements,
where
applicable
(in mln EUR)
ICAAP estimate
(in mln EUR)
Supervisory
benchmark
Overall SREP
capital
requirement/est
imate
(in mln EUR)
Overall capital estimate - TSCR (in mln EUR0) 5.98 6.75 7.3 ?Capital adequacy assessment (capital is assessed as
adequate/inadequate)
TSCR ratio and composition ?
H.
SREP capital outcome (preliminary proposal for joint decision discussion)
Total own funds (mln EUR) at reference date 11.00
Tier 1 own funds (mln EUR) at reference date 4.00
Common Equity Tier 1 own funds (mln EUR) at reference date 7.00
Total risk weighted assets (TREA) (mln EUR) at reference date 74.69
The level of the capital conservation buffer that the institution is
required to maintain in accordance with Article 129 of Directive
2013/36/EU
1%
The level of the institution-specific countercyclical capital buffer
to be maintained by the institution in accordance with Article 130
of Directive 2013/36/EU
0
The level of any systemic risk buffer that the institution is
required to maintain in accordance with Article 133 of Directive
2013/36/EU
1%
The level of any G-SII buffer or O-SII buffer that the institution is
required to maintain in accordance with Article 128(3) and (4) of
Directive 2013/36/EU
1%
Memoranda items (values at reference date)
HP: Pillar 2 add-ons imposed only in form
of CET1 and AT1
Capital adequacy assessment (second step)
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NB: Current macro-economic conditions do not pose a threat of imminent risk of breaching TSCR
EUROPEAN BANKING AUTHORITY
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Tel: +44 207 382 1776 Fax: +44 207 382 1771
E-mail: [email protected] http://www.eba.europa.eu