SREP and Pillar 2 Capital Buffers

The SREP consists of four assessment segments:

• business model,
• internal governance and risk management,
• risks to capital (credit, market, operational risk, etc.) and
• liquidity and funding (liquidity stress, requirements, etc.)

In general, any information received by the JST during the review period may be taken into account for the SREP decision. The basis for the review are the regular reportings of banks, like the Common Reporting (COREP) and financial reporting (FINREP). Additionally, supervisors use data from short term exercises (e.g. on credit risk, profitability, etc.), external audit reports, information from the Internal Capital Adequacy Assessment Process (ICAAP) and Internal Liquidity Adequacy Assessment Process (ILAAP), results of stress tests, etc. Finally, there are also On-Site Inspections where the supervisory review can deep-dive into any relevant topics.

After the information collection, an automated SREP anchoring score is calculated. This result is then adjusted, based on e.g. complexity of the institute, other bank specific information and peer group indicators. For each of the four categories a score between, 1 (low risk) and 4 (high risk) is assigned and then combined into the overall SREP score.

With this overall SREP score the JST presents its results, explains its decision and discusses where it sees room for improvements within the bank and its processes. Additionally, capital requirements, the so called Pillar 2 Requirement (P2R) and the capital guidance to cover potential stress events, the so called Pillar 2 Guidance (P2G) are specified.

The intention behind the P2R, is to cover risks that are not addressed by the own funds requirement (Article 92 CRR) or the buffer regime. The P2R needs to be covered with 56,25% Common Equity Tier1 capital (CET1) and at least 75% need to be made up of Tier1 capital (CET1 + Additional Tier1 capital (AT1). This requirement is legally binding, this means, that if banks fall below this obligation, they may be subject to supervisory measures (e.g. restrictions on dividend payments, bonus payments, etc.)

In comparison the P2G, is not legally binding, but banks need to inform its supervisor if the guidance is violated. In general, the P2G is determined by the results of the stress test exercise which is part of the SREP. Depending on the level of capital depletion in the exercise, banks are categorised into four buckets. They range from bucket 1 with a P2G between 0% and 1% of CET1 capital guidance to bucket 4 with a P2G starting at 1,75% CET1 capital guidance. However, bucket 4 is not capped in its capital guidance.

Furthermore, the SREP may include a so called Pillar 2 Requirement and Pillar 2 Guidance with respect to the Leverage Ratio of a bank (P2R LR and P2G LR). The goal is to give regulators a tool to introduce additional capital requirements for addressing risks regarding excessively leveraged banks. However, this plan is currently (09/2022) in a draft status and still needs to be implemented.

In summary the SREP gives the authorities the opportunity to assess each bank individually and cover risks that cannot be included in the own funds framework or the buffer regime with the capital requirements of P2R and P2G.