The ECB requires banks to hold marginally more capital in 2022

The results of the Supervisory Review and Evaluation Process (SREP) for 2021 were published today by the European Central Bank (ECB).

The findings of this annual assessment show that key institutions have maintained sound capital and liquidity positions, as most banks operate with levels of capital exceeding those set by capital requirements and guidelines, the ECB said in a statement. Banks’ ratings remained broadly stable overall.

As he points out, the results of SREP 2021 reflect both the resilience of Europe’s banking sector, which has made a significant contribution to the economic recovery of the euro area, and the challenges on the horizon.

In particular, there is still uncertainty about the future course and development of the pandemic, at a time when disruption in supply chains is negatively affecting trade and overall economic activity. Other risks arise from a wide range of uncertainties, including possible cyber-attacks, climate risks, continuing profitability pressures, and the potential for low interest rates to emerge from the environment.

The 2021 supervisory cycle marked a return to normalcy, following the realistic approach taken in 2020 when capital requirements remained stable due to the pandemic and supervisory concerns were addressed primarily through recommendations rather than requirements.

Consequently, SREP 2021 included the assessment of banks ‘capital, the performance of SREP scores on banks’ overall risk profiles and key elements of these profiles, and the issuance of formal decisions in addition to recommendations.

On average, banks maintained robust capital and liquidity positions throughout the pandemic. Overall capital requirements and directions increased slightly for 2022 and averaged around 15.1% of risk-weighted assets (RWA), compared to 14.9% in the realistic valuation applied to SREP 2020. The average amount of total capital requirements and guidelines for Common Equity Tier 1 (CET1) capital increased to approximately 10.6% of the risk-weighted assets, from 10, 5%.

The Pillar 2 capital requirements (P2R) contributed to the marginal increase of the total capital, which increased to 2.3%, from 2.1%. This increase is mainly due to the introduction of a specific requirement (increase due to capital shortfall in the formation of provisions) imposed on banks that did not form sufficient provisions to cover the credit risk from non-performing loans (NPLs) granted before April 26, 2019 Banks that are actively facing their capital outflow forecasts in line with the ECB ‘s expectations will be able to quickly reduce this new surplus in 2022 without waiting for the next SREP rating.

Only six banks did not comply

The Pillar 2 guidance (P2G) guidelines, which reflect the risks arising from the results of extreme state simulation exercises, increased by 0.2 percentage points to 1.6%, from 1.4%.

Only six banks did not comply with their P2Gs at the end of 2021, due to pre-pandemic structural issues.

As part of the ECB’s support measures, banks can make the most of their capital safeguards or P2Gs by the end of 2022. By 1 January 2023 – as announced in a separate press release – the ECB expects banks will operate with funds that will exceed the level of their P2G.

“We are generally satisfied with the way the banks have operated so far during the pandemic. They have contributed to the resilience of the euro area economy and have continued to provide credit to households and businesses,” he said. Chairman of the Supervisory Board of the ECB, Andrea Enria. “However, the impact of the pandemic on the economy has not yet disappeared. Banks need to remain aware of the potential impact on their balance sheets and, in particular, strengthen their risk control and governance frameworks.”

The results of SREP 2021 show broad-based stability in terms of ratings. This is another indication of the resilience of the banking system, as the overall ratings of banks may indeed have deteriorated significantly during the pandemic.

Under cycle 2021, credit risk and internal governance were the two key areas for which banks sought redress.

Supervisors carefully examined the adequacy of the institutions’ credit risk controls. In several banks it was found that there were not sufficiently strong credit risk management practices, in some even insufficient forecasting procedures were identified. In these cases, the ECB downgraded its credit risk ratings and called for further action.

NPL stocks continued to decline, mainly due to the fact that banks consistently implemented plans to reduce and sell NPLs. The quality of credit on banks’ balance sheets has remained fairly strong overall, thanks in part to exceptional public support measures. However, there are also some signs of deteriorating credit quality, especially in the economic sectors that have benefited most from the support measures, and these developments should be closely monitored.

Findings in the field of internal governance show inadequacies in the management skills of administrative bodies and governance arrangements such as risk control frameworks. This can interfere with risk management and compliance functions, as well as information system transformation plans, hindering the resolution of data logging issues. Many banks also need to take steps to improve the composition and collective adequacy of their governing bodies, as they still do not place sufficient emphasis on diversity (eg gender representation and professional experience). In this context, the ECB uses operational instruments to urge banks to adopt diversity policies and set gender representation targets.

Meanwhile, the evaluation of business models shows that most banks still do not produce returns that exceed the cost of capital. Profitability recovered in 2021 but remains structurally low overall. Supervisors’ concerns in this regard relate primarily to long-standing issues that preceded the pandemic, such as unsatisfactory strategic plans and / or inadequate implementation of such plans.