Determining additional own funds to cover unexpected losses
When setting additional own funds requirements for the risk of unexpected losses pursuant to point (a) of paragraph 366, competent authorities should consider each type of risk that may pose a material risk to the institution’s capital. Competent authorities should set additional own funds required 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 own funds requirements set out in Parts Three and Four of Regulation (EU) No 575/2013 and Chapter 2 of Regulation (EU) 2017/2402.
For the purpose of the previous paragraph, 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 and they should take into account the full risk profile of an institution. The determination of the amounts of capital considered adequate should include:
institution-specific risks or elements of such risks that are explicitly excluded from or not explicitly addressed by the Pillar 1 own funds requirements;
institution-specific risks or elements of such risks that are considered not to be sufficiently covered by the applicable Pillar 1 own funds requirements.
Competent authorities should ensure that the amount of capital considered adequate to cover each risk identified in accordance with Articles 79 to 85 of Directive 2013/36/EU is not lower than the relevant part of the applicable Pillar 1 own funds requirement covering that risk. In exceptional cases where it is overly burdensome, especially for small institutions, to meaningfully disentangle the amount of capital considered adequate for two or more types of risk quantified together, 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, by determining the level of additional own funds requirements in a conservative manner, having regard to paragraphs 372 to 374.
The identification, assessment and quantification of risks to which the institution is exposed should be supported by 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 375 to 377;
supervisory reporting;
the outcome of supervisory assessment and benchmarking;
the outcomes of any relevant previous supervisory activities; and
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 additional own funds requirements 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.
Competent authorities should not allow own funds held pursuant to Article 92 of Regulation (EU) No 575/2013 to be used to meet or offset additional own funds requirements both on an aggregate and on a risk-by-risk basis.
For the purposes of Article 98(1), point (f) of Directive 2013/36/EU and the determination of additional own funds requirements, 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 additional own funds requirements.
ICAAP calculations
Competent authorities should assess the reliability of the ICAAP calculations by assessing whether they are:
Granular: the calculations/methodologies should allow the calculations to be broken down by risk type, rather than presenting a single (economic capital) calculation covering all risks. This breakdown should be enabled by the ICAAP methodology itself. Risks should not be excluded from the ICAAP where they are difficult to quantify or where relevant data are not available; estimates may be provided based on available information and including expert judgement. Where deemed appropriate by the competent authority, estimates may be provided through marginal contribution calculations, for example, for risks that cannot be measured on a standalone basis (e.g. credit concentration risk).
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 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 above criteria, 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
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 additional own funds requirement, 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 type of risk.
Given the variety of different business models operated by institutions, the outcome of the supervisory benchmarks may not be appropriate in every instance for every institution. Competent authorities should address this by using the most appropriate benchmark where alternatives are available, and by applying judgement to the outcome of the benchmark to account for business-model-specific and institution-specific considerations.
When competent authorities take supervisory benchmarks into consideration for the determination of additional own funds requirements, as part of the dialogue, they should explain to the institution the rationale and general underlying principles behind the benchmarks.
Other relevant inputs
Competent authorities should use other relevant inputs to support the determination of risk-by-risk additional own funds requirements. Other relevant inputs may include the outcomes of risk assessments (following the criteria specified in Title 6), peer-group comparisons, including report(s) issued by the EBA pursuant to the requirements of Article 78 of Directive 2013/36/EU, benchmarks issued by the EBA pursuant to Article 101 of Directive 2013/36/EU, etc.
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 (e.g. where the risk score implies a significantly different level of risk relative to the calculation, or where peer reviews reveal that the institution differs significantly from peers in terms of the own funds requirement to cover a comparable risk exposure).
When competent authorities take other relevant inputs into consideration for the determination of additional own funds requirements, as part of the dialogue, they should explain to the institution the rationale and general underlying principles behind the inputs used.