Determining additional own funds to cover unexpected losses
When setting P2R for the risk of unexpected losses pursuant to point (a) of the following paragraph, competent authorities should consider each type of risk that may jeopardise the institution’s capital position. Competent authorities should set P2R to cover the risk of unexpected losses by determining the capital considered adequate to cover the type of risk and deducting the relevant part of P1R.
Competent authorities should determine on a risk-by-risk basis, the amounts of capital considered adequate, by identifying, assessing and quantifying the risks to which the institution is exposed, taking into account its full risk profile. The determination of the amounts of capital considered adequate should include:
Competent authorities should ensure that the amount of capital considered adequate to cover each risk identified in accordance with Articles 79 to 85 and 87a of Directive 2013/36/EU is not lower than the relevant part of the applicable P1R covering that risk. In exceptional cases where it is overly burdensome, especially for small institutions, to meaningfully disentangle the amount of capital considered adequate on a risk-by-risk basis, competent authorities should comply with the first sentence of this paragraph on a best-effort basis, using the ICAAP calculations, supervisory judgement and other sources of information.
When identifying, assessing and quantifying risks to which the institution is exposed, competent authorities should rely on the following sources of information:
the ICAAP and the outcomes of its assessment by the competent authority, including the ICAAP calculations where deemed reliable or partially reliable in accordance with paragraphs 3066 to 308;
supervisory reporting;
the outcome of supervisory assessment, including any relevant previous supervisory activities, and benchmarking, as well as other relevant inputs, including those arising from interaction and dialogue with the institution.
The ICAAP and outcomes of its assessment should be taken into account by competent authorities as one of the key inputs for the identification and assessment of risks relevant for the institution. The determination of the amount of capital considered adequate and P2R on a risk-by-risk basis should take into account the ICAAP calculations if deemed reliable or partially reliable, as well as the outcomes of supervisory benchmarking and other relevant inputs as appropriate, including the supervisory judgement.
For the purposes of Article 98(1), point (f) of Directive 2013/36/EU and the determination of P2R, competent authorities should assess and consider diversification effects arising from geographical, sectoral or any other relevant drivers within each material risk category (intra-risk diversification). For each of the risks to capital covered by Regulation (EU) No 575/2013, such diversification effects should not reduce the minimum own funds requirements calculated in accordance with Article 92 of Regulation (EU) No 575/2013.
However, diversification between risks in different categories, including those covered by Regulation (EU) No 575/2013 (inter-risk diversification) should not be considered as part of the determination of P2R.
ICAAP calculations
Competent authorities should assess the reliability of the ICAAP calculations by assessing whether they are:
granular: the calculations/methodologies should allow calculations to be broken down by risk type, rather than presenting a single (economic capital) calculation covering all risks;
credible: the calculations/methodologies used should demonstrably cover the risk they are looking to address (e.g. the credit concentration risk calculation should use appropriate sector breakdowns that reflect actual correlations and portfolio compositions) and should be sufficiently robust, stable, risk sensitive and conservative to adequately quantify losses associated with the risks. Such calculations/methodologies should be consistent with the institutions’ strategic processes, including the institutions’ risk appetite;
understandable: the underlying drivers and key assumptions of the calculations/methodologies should be clearly specified. A ‘black box’ calculation should not be acceptable. Competent authorities should ensure that the institution provides an explanation of the key assumptions used, including at least time horizon, confidence levels, correlation assumptions, key parameters, the most fallible areas of the models used, and how these are accounted for and corrected in the final ICAAP calculation;
comparable: the calculations/methodologies should clearly mention the main assumptions in terms of the overall level of conservatism, the holding periods/risk horizons and confidence levels (or equivalent measurement) in order to allow the adjustment that may be requested or enacted by competent authorities in order to facilitate comparability with peers and supervisory benchmarking.
Competent authorities should further assess the reliability of the ICAAP calculations by comparing them against the outcome of the supervisory benchmarks for the same risks, and other relevant inputs.
An ICAAP calculation should be considered partially reliable where, despite not meeting all the criteria of paragraph 3066, the calculation still seems highly credible, though this should be on an exceptional basis and accompanied by steps to improve deficiencies identified in the ICAAP calculation.
Supervisory benchmarks and other relevant inputs
Competent authorities should develop and apply risk-specific supervisory benchmarks as a means to challenge ICAAP calculations for those material risks, or elements of such risks, that are not covered or not sufficiently covered by Regulation (EU) No 575/2013, or to further support the determination of risk-by-risk P2R, especially where ICAAP calculations for those material risks, or elements of such risks, are deemed unreliable or are unavailable.
The supervisory benchmarks should be developed to provide a prudent, consistent (i.e. as applicable, calibrated to equivalent holding periods/risk horizons and confidence levels as required by Regulation (EU) No 575/2013), transparent and comparable measure with which to calculate and compare across institutions the capital considered adequate for a given risk.
When applying supervisory benchmarks, competent authorities should consider the business model of institutions and, to the extent appropriate, complement these with the application of supervisory judgement to account for business-model-specific and institution-specific considerations.
Competent authorities should use other relevant inputs to support the determination of risk-by-risk P2R. Other relevant inputs may include the outcomes of risk assessments (following the criteria specified in Title 6), peer-group comparisons, including report(s) and benchmarks issued by the EBA.
Other relevant inputs should prompt the competent authority to reassess the appropriateness/reliability of an ICAAP/supervisory benchmarks for a specific risk, and/or make adjustments to the outcome, where they prompt doubts about its accuracy.
When competent authorities take supervisory benchmarks as well as other relevant inputs into consideration for the determination of P2R, as part of the dialogue with the institution, they should explain the rationale and general underlying principles behind the inputs used.