Meeting requirements in stressed conditions – Use of P2G and P2G-LR to address the quantitative outcomes of stress testing
Competent authorities should determine by means of stress testing the adequacy of the institution’s own funds (quantity and composition) in stressed conditions and whether supervisory measures, including P2G, P2G-LR, revised capital planning and other measures are necessary to address potential inadequacies. To assess capital adequacy in stressed conditions, competent authorities should consider:
the use of the qualitative outcomes (e.g. deficiencies identified in risk management and control) of institutions’ stress tests and supervisory stress testing;
the use of the quantitative outcomes of institutions’ stress tests, if the ICAAP is deemed reliable, and of supervisory stress tests, pursuant to Article 100 of Directive 2013/36/EU as specified in Title 11, and including, for example:
Competent authorities should assess as appropriate the quantitative outcomes of stress tests with regard to the adequacy and quality of the institution’s own funds and determine whether the quantity and quality of own funds are sufficient to cover applicable capital requirements, and in particular:
Competent authorities should determine P2G and P2G-LR, and, where the determination leads to a positive value, they should set P2G or P2G-LR to address supervisory concerns about the sensitivity of the institution to the adverse scenarios used in the supervisory stress tests. P2G should not be used to cover risks or elements of risks already covered by the P2R in accordance with section 7.2. Similarly, P2G-LR should not be used to cover those aspects of risk of excessive leverage already covered by P2R-LR in accordance with section 7.3.
The level of P2G should protect against the potential breach of TSCR in an adverse scenario. Similarly, the level of P2G-LR should protect against the breach of TSLRR in an adverse scenario. Where the quantitative outcomes of the supervisory stress tests suggest that the institution is not expected to breach its TSCR under the adverse stress test scenario, competent authorities may decide not to set P2G. Similarly, competent authorities may decide not to set P2G-LR where TSLRR is not expected to be breached under the adverse stress test scenario.
Competent authorities should determine and set P2G and P2G-LR based on the outcomes of the adverse scenario of the relevant supervisory stress tests, including the EU-wide stress tests performed by the EBA or any other relevant supervisory stress tests performed on a system-wide basis over a forward-looking horizon of at least two years.
On the basis of establishing a proportionate approach for non-Category 1 institutions and subsidiaries of cross-border groups, for setting and updating P2G and P2G-LR competent authorities may consider the outcomes of simplified forms of supervisory stress tests (e.g. through the use of supervisory-prescribed ‘anchor’ scenarios, sensitivity analysis, top-down stress tests conducted by designated authorities, and portfolio level impacts from consolidated level stress tests), past supervisory stress tests or institutions’ stress tests in accordance with paragraph 340. The simplified forms of supervisory stress tests may be carried out on an individual basis rather than as part of the system-wide exercise.
Competent authorities should determine and set P2G and P2G-LR in accordance with the minimum engagement model specified in section 2.4. In particular, the minimum frequency with which P2G and P2G-LR are determined and set should be the frequency of the capital adequacy assessment under the SREP minimum-engagement model.
Notwithstanding the previous paragraph, competent authorities:
should assess whether the existing P2G and P2G-LR is still appropriate whenever the results of new supervisory stress tests are available, and revise them if necessary;
may determine P2G and P2G-LR only every second year instead of annually, including for SREP Category 1 institutions. However, in the year that follows the year of determining P2G, competent authorities should assess whether P2G and P2G-LR are still relevant or need to be updated, on the basis of all relevant information, including outcomes of past supervisory stress tests, together with additional sensitivity analysis (i.e. simplified forms of supervisory stress testing).
When calibrating the P2G, competent authorities should ensure that it is set at a level appropriate to cover at least the anticipated maximum stress impact, which should be calculated based on the changes in the CET1 ratio (i.e. considering both movements in CET1 capital and TREA) in the worst year of stress, and taking into account the level of applicable capital requirements. The maximum stress impact for the purpose of setting the P2G should be understood as the difference between the lowest CET1 ratio in the adverse scenario over the stress test horizon and the actual CET1 ratio at the starting point.
When calibrating the P2G-LR, the maximum stress impact should be calculated based on the changes in the Tier 1 capital in the worst year of stress, and taking into account the applicable leverage ratio capital requirements. The maximum stress impact for the purpose of setting the P2G-LR should be understood as the difference between the lowest leverage ratio in the adverse scenario over the stress test horizon and the actual leverage ratio at the starting point.
Competent authorities should obtain the P2G starting point specific for each institution by offsetting elements that already cover risks reflected in the maximum stress impact. In particular, competent authorities should offset the relevant measures, in particular capital conservation buffer, in accordance with paragraph 354. In addition, when setting the P2G and P2G-LR starting points, competent authorities may consider, where relevant, other adjustments to the maximum stress impact related to the static balance sheet assumption or the different time horizon between the stress test exercise and the time of the starting point.
Where setting the P2G and P2G-LR, competent authorities should ensure an adequate link between their respective starting points as well as their final values. For this purpose, they may decide to use a bucketing approach to classify institutions in accordance with P2G and P2G-LR starting points, based on the relevant supervisory stress tests set out in paragraph 344 or based on other approaches set out in paragraph 345. Consequently, competent authorities may assign a fixed range of P2G or P2G-LR levels to each bucket and set the final P2G and P2G-LR within the range of the assigned bucket or, exceptionally, outside the range of the relevant bucket, based on the institution-specific considerations. Competent authorities should aim to avoid cliff effects between buckets, for instance by allowing partial overlap between the P2G or P2G-LR levels for adjacent buckets, and they should ensure that the resulting final P2G and P2G-LR are institution-specific.
When determining the final P2G and P2G-LR, competent authorities should consider, where relevant and available, the following factors:
the year when the maximum stress impact occurs in relation to the starting point and time horizon of the scenarios used in the stress tests;
the outcome of a reliable institution stress test, taking into account the specific scenario definitions and assumptions, in particular where they are deemed more relevant for the business model and risk profile of the institution or where the internal scenarios are more severe than the supervisory scenarios;
changes occurring after the cut-off date of the stress test exercise with a material impact on the institution’s risk profile or capital position (e.g. sale of non-performing loans). These changes may include interim changes of the risk profile including structural changes in the institution’s activity or balance sheet;
relevant management mitigating actions of the institution that are deemed credible and highly certain following their supervisory assessment;
information about supervisory views on the relevance of supervisory stress testing to the institution’s strategy, financial plans and business model;
reduced certainty on the actual sensitivity of the institution to adverse scenarios;
any potential overlaps with the P2R or P2R-LR;
the quality (composition) of the institution’s available own funds, including the worst year of stress;
whether or not the institution is under restructuring or resolution.
For the purpose of determining P2G, competent authorities should also consider the extent to which stress scenarios cover all the material risks contributing to the P2R in TSCR. Competent authorities should, in particular, have regard to the fact that macroeconomic downturn scenarios may not entirely capture some risks – for example pension risk or some elements of credit concentration risk (e.g. single name concentration) – that may amplify potential losses under the tested adverse scenarios.
In addition, competent authorities should consider the extent to which the existing combined buffer requirements and other applicable measures already cover risks revealed by stress testing. In this regard, competent authorities:
should offset P2G against the capital conservation buffer (CCB), as P2G and the CCB overlap in nature;
should in exceptional cases offset P2G on a case-by-case basis against the countercyclical capital buffer (CCyB) – while no overlap is in principle expected between them – based on the consideration of underlying risks covered by the buffer and factored into the design of the scenarios used for the stress tests, after liaising with the macroprudential authority;
should not offset P2G against the systemic risk buffers (G-SII/O-SII buffers and the systemic risk buffer), as those are intended to cover the risks an institution poses to the financial system;
should not offset P2G-LR against the G-SII leverage ratio buffer requirement specified in Article 92(1a) of Regulation (EU) No 575/2013;
may review the P2G communicated to that institution to ensure that its calibration remains appropriate where an institution becomes bound by the output floor, in accordance with Article 104b(4a) of Directive 2013/36/EU.
Where competent authorities determine P2G, they should add this guidance on top of the OCR. Where competent authorities determine P2G-LR, they should add this guidance on top of OLRR. Competent authorities should consider OCR and OLRR as two separate stacks of requirements. Consequently, the available own funds can simultaneously be used to meet P2G and P2G-LR.