Recovery Planning: New guidance for the determination of the overall recovery capacity (EBA consultation)

Tim Schabert

Alexander Schiller

Stephan Egger

Recovery plans ensure that banks are prepared to restore their viability in a timely manner even in periods of severe financial distress. The overall recovery capacity (ORC) is a key measure and indicates the maximum recovery ability of a bank for certain scenarios utilizing all suitable recovery options. Until now there is no clear guidance on how banks should determine the ORC and how competent authorities should assess it.

Therefore, the European Banking Authority (EBA) launched a public consultation on draft guidelines regarding the overall recovery capacity in December 2022.

The guidelines are split into the financial institutions and the competent authorities’ point of view:

Currently banks define scenarios which would in a realistic fashion lower the institutions’ ratios to near default. After implementation of suitable recovery options, banks test their ability to recover and their viability in a timely manner. However, the recovery options are typically only calibrated to the extent that they merely bring the bank back above the regulatory minimum requirements. EBA now proposes that banks should implement all recovery options that are deemed suitable to show their overall recovery capacity for each scenario.

The scenario-specific recovery capacity then constitutes the accumulated effect over twelve months for the capital position starting with the breach of the recovery plan indicators. In addition to the capital effect, banks are required to calculate the accumulated liquidity position over a six-month time horizon. These positional effects are then to be expressed at least for all recovery indicators laid out under Article 9 Directive 2014/59/EU consisting of the CET1 Ratio, Total Capital Ratio, Leverage Ratio, NSFR and LCR. In Figure 1 to Figure 3 an exemplary development of the CET1 Ratio in three scenarios is depicted. The scenario-specific recovery capacity is indicated at the twelve month point in time as the difference between the baseline case (capital development without any recovery actions) and the capital situation after implementation of all feasible recovery options.

In a last step, financial institutions are further required to establish the ORC (or ORC range), determined by the difference between the highest and lowest scenario-specific indicators respectively (depicted in Table 1). In conclusion, an institution is to first compute its scenario-specific recovery capacity for each indicator (recovered value minus baseline scenario after effect timeframe) and then the ORC is the difference between the highest yielded scenario-specific recovery capacity and the lowest value respectively. This range is then determined for both capital and for liquidity indicators.

_{Table 1 CET1 Ratio ORC}

Also, the competent authorities currently do not have a clear guidance on how to assess a bank’s ORC. Therefore, the current consultation paper also lays out a more concrete methodology for the supervisory bodies. Authorities shall – after validating scenario and recovery option assumptions – calculate a secondary “adjusted ORC”. This assessment is to be based on all quantitative and qualitative aspects obtained from a bank’s recovery plan. Authorities are expected to yield a lower “adjusted ORC” than the bank (see Table 2).

_{Table 2 CET1 Ratio adjusted ORC expectation}

In a next step these adjusted ORCs are compared to the bank’s recovery performance indicators considering buffer requirements. Depending on the result of that comparison banks get assigned a summary ORC score ranging from “Weak” via “Adequate with potential room for improvement” to “Satisfactory”.

A satisfactory score in this case would require that a bank’s recovery plan indicators – after adding the adjusted ORC – are above their respective thresholds as defined in their recovery plan.

The summary score “Adequate with potential room for improvement” is assigned if the result is above the latest SREP requirements, including applicable regulatory buffers, but below the respective thresholds defined in the bank’s recovery plan.

Lastly, a “Weak” score corresponds to a result below the combination of SREP requirements and applicable regulatory buffers.

In addition to the consultation regarding the ORC, the European Banking Authority also offers further guidance on the severity of adverse scenarios. The EBA stipulates that scenarios should breach the minimum liquidity, capital or leverage requirements, but in exceptional cases where due to an extremely strong capital position banks are not able to design an adverse scenario that would conclude in a breach of the requirements, banks may disclose detailed explanations of that situation to the relevant authority.

Comments to the consultation paper can be submitted by 15 March 2023.

EBA