Supervisory priorities: What to expect for 2017

Supervisory priorities: What to expect for 2017

The 2017 ECB priorities will largely stay the same compared to 2016.

henning dankenbring

Partner, Head of KPMG ECB Office

KPMG in Germany

Business people meeting outside modern building

With continuity and stability remaining a primary goal of the SSM, we expect most of the supervisory priorities for the next year to remain broadly unchanged from the 2016 priorities. During 2016, several supervisory initiatives that were undertaken have been successfully addressed, and such priorities have obvious future relevance into 2017 and beyond. In addition, new priorities derive mainly from changes in the economic environment and regulatory developments expected in 2017 (such as review of CRR/ CRD IV package and completion of Basel III package). This article discusses these priorities in conjunction with our informal conversations with the ECB as an indicator to draw some conclusions.

Firstly, the challenging macroeconomic environment ensures that business model and profitability is one of the key priorities. SSM banks are facing a challenging environment: a combination of the fragile economic recovery in most SSM countries, the high structural unemployment, the slow pace of structural reforms in some SSM countries and low growth and low interest rates mean that banks face low profitability, sometimes even below their estimated cost of capital, all of which create pressure on net interest margins. The challenging macroeconomic environment together with the evolution on Regulatory framework are decisive factors for the bank’s profitability. Resolution plans and MREL are also important factors to bring into the equation, since such decisions affect the capital structure and funding models of banks. In addition, banks face new competition in various ways. Non-bank competitors such as insurances or FinTech companies are clearly challenging the established business models. The ECB aims to assess these risks as well.

In conjunction with the business model assessment, the result of the Brexit referendum in the UK may also have an impact on several SSM banks. Given the uncertainty on the outcome of the Brexit negotiations, the concrete effect on banks is not yet clear. The preparations and respective plans of affected institutions will be an area of focus for the SSM. Affected institutions must draft proper contingency plans considering different scenarios.

Credit Risk with a particular focus on Non-Performing Loans (NPLs) remains a key Supervisory Priority. A number of institutions continue to exhibit a high stock of NPLs. A Task Force on NPLs, whose goal is to implement a consistent supervisory approach to banks with high levels of NPLs is already in place and is mainly concerned with high levels of exposure to corporate credit and to banks in SSM jurisdictions that have been particularly hit by crises, such as Greece and Italy. The implementation of a consistent approach by the supervisor for the recognition and treatment of forborne exposures, given the heterogeneity of practices between jurisdictions, is of great interest.

The introduction of the accounting standard “IFRS 9 Financial Instruments”, effective 1 January 2018, will have an impact on the measurement of credit impairments as well as on the valuation of financial instruments and own funds. Management discretion allowed by the high degree of management judgement, implemented by the new impairment model, represents a challenge to both banks and supervisors. The effects of IFRS 9 for banks and the assessment of banks’ preparations for IFRS 9 are the topic of the thematic review that was launched last year and is still ongoing.

In the context of credit risk, exposure concentrations in specific asset classes that could have a high impact will also be under the spotlight. The SSM will examine exposure concentrations where increased levels of risk are perceived, such as in shipping and real estate.

The Targeted Review of Internal Models (TRIM) started in 2016 as a multi-year project with the goal of restoring the credibility, adequacy and appropriateness of approved Pillar 1 internal models. The project’s main objective is the reduction of unwarranted RWA variability and the consistency in the model outputs, through the harmonization in the use of internal models.

At the beginning of 2016, the SSM published ‘Supervisory expectations on ICAAP and ILAAP and harmonized information collection on ICAAP and ILAAP’ (PDF 237 KB) outlining the guidance on ICAAP and ILAAP minimum reporting requirements. In 2017, the SSM will likely prioritize the continuous improvement of banks’ ICAAP and ILAAP. These processes are critical to manage capital and liquidity adequacy. During the SREP process, the SSM assesses the adequacy of such processes and uses these results as metrics for determining capital and liquidity requirements.

The way banks are managing the risks in connection to the outsourcing of activities is likely a worry for the SSM. Outsourcing is no longer limited to back-office activities and IT services as before; currently it involves risk management activities and even complex data storage solutions. On the banks’ side, optimization of cost may dominate proper risk assessment, which in the eyes of the supervisor clearly triggers the emergence of risks connected to outsourcing.

In 2016, a thematic review covering compliance with BCBS 239 (principles for effective risk data aggregation and risk reporting) was kicked off. Given the current context of low bank profitability and inexpensive central bank funding, the consequent search-for-yield behavior requires prudent risk management. High data quality is essential to ensure sound risk management and accurate risk information.

To sum it up: We anticipate that the list of supervisory priorities for 2017 shows continuity with the priorities of 2016. The number of affected units within a bank remains high, including but not limited to Strategy, Credit Operations, Risk Management, Finance, Organization and IT. Consistent, proper and sound management of all supervisory act.

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