SREP

Definition

Supervisory Review Process (SREP) denotes the review process undertaken by a supervisory authority operating in alignment with the Basel regulatory standards in order to ensure that institutions have adequate arrangements, strategies, processes and mechanisms as well as capital and liquidity to ensure a sound management and coverage of their risks.

The second pillar of the Basel Framework is intended not only to ensure that banks have adequate Regulatory Capital to support all the risks in their business but also to encourage banks to develop and use better risk management techniques in monitoring and managing their risks. For that reason, Pillar 2 is also described as the supervisory review process.

Motivation

The regulatory framework recognises the relationship that exists between the amount of Risk Capital held by the bank against its risks and the strength and effectiveness of the bank’s Risk Management and internal control processes. However, increased capital should not be viewed as the only option for addressing increased risks confronting the bank. Other means for addressing risk, such as strengthening risk management, applying internal limits, strengthening the level of provisions and reserves, and improving internal controls, must also be considered. Furthermore, capital should not be regarded as a substitute for addressing fundamentally inadequate control or risk management processes.

Principles

• Banks should have a process for assessing their overall Capital adequacy in relation to their Risk Profile and a strategy for maintaining their capital levels.
• Supervisors should review and evaluate banks' internal capital adequacy assessments and strategies, as well as their ability to monitor and ensure their compliance with Regulatory Capital ratios. Supervisors should take appropriate supervisory action if they are not satisfied with the results of this process.
• Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to hold capital in excess of the minimum.
• Supervisors should seek to intervene at an early stage to prevent capital from falling below the minimum levels required to support the risk characteristics of a particular bank and should require rapid remedial action if capital is not maintained or restored.

Components

A typical SREP process is built around the following components (the details will vary on the basis of jurisdiction choices)

• Analysis of the viability of the Business Model of the bank or banking group and analysis of the sustainability of its Strategy.
• Assessment of the internal governance and control framework of the bank or banking group to assess whether they are adequate for its risk profile, business model, size and complexity; and to assess the degree to which the bank or banking group adheres to the requirements and standards of good internal governance, risk management and internal control arrangements.
• Assessment of each Material Risk to which the bank or banking group is exposed by assessing the inherent risk and the quality and effectiveness of risk management and controls implemented to mitigate the risk.
• Assessment of the adequacy of the bank’s or banking group’s own funds to cover the risks to capital by determining whether the quantity and quality of own funds held by the bank or banking group ensure an appropriate coverage of those risks. In particular, they assess the ability of the bank or banking group to implement risk strategies consistent with its Risk Appetite. They also determine its ability to establish sound capital plans. Supervisors examine the adequacy and allocation of internal capital, its Stress Testing capabilities, programmes and outcomes.

Process

The SREP process will involve typically the following steps:

• Collecting information from, but not limited to, results of on-site activities, data submitted by the banks (ICAAP), interviews with the banks’ employees with different levels of responsibility or functions, and public information; and evaluating the risk profile of the bank.
• Analysis and assessment of the information on the banks’ business and financial conditions.
• Identification of challenges, through analysis of findings from on-site and off-site activities, if deemed necessary.
• Proposal of measures to address the issues identified, and holding dialogues with management.
• Issuance of a supervisory letter that includes conclusions and findings.
• Following up on the actions taken by the banks to correct the identified challenges.

Scope of off-site monitoring activities

• assessing the banks’ management strategy and the sustainability of medium- to long-term business plans and strategies.
• the supervisory function of the Board of Directors
• the activities of Internal Audit,
• the governance over overseas entities and branches
• the IT governance,
• compliance ( conduct risk control),
• the banks’ risk management and financial conditions.

Role of ICAAP

When reviewing a bank’s capital adequacy assessments and strategies as reported via the ICAAP process, supervisors

• verify that the underlying methodologies and assumptions are consistent with the risks to which they are exposed
• verify that the methodologies and assumptions are based on reliable input data and robust parameter estimates
• assess the models and methodologies used for risk management and capital adequacy systems
• use outlier tests, peer analysis and benchmarks and may require further specific reporting from banks.

Binding Nature

Some jurisdictions have a concept of binding and non-binding Pillar II expectations:

• Binding Pillar II expectations are similar to those of Pillar I in that they are expected to be met at all times. They could also be disclosed publicly.
• Non-binding Pillar II expectations can be used in times of stress or other exigent circumstances and are generally not disclosed publicly.

The types of risks covered by these two components are also typically different. Binding Pillar II expectations typically include well defined and more easily measured risks. Non-binding Pillar II expectations may include ad hoc risks or concerns raised by supervisors. This bifurcation of Pillar II capital expectations is not defined in the Basel Framework; however, it is common in a number of jurisdictions under different names: binding Pillar II expectations are called “Pillar 2A” or “Pillar 2R (requirements)” and non-binding Pillar 2 expectations are called “Pillar 2B” or “Pillar 2G (guidance)” in some jurisdictions.

Corrective Actions

When banks do not address deficiencies identified under the SREP or if the deficiencies are significant and could pose significant harm to depositors and the financial system, most supervisors generally have stronger powers to try and mitigate issues. These powers include but are not limited to:

• Ability to impose limits on lending, business activities and other decisions by the bank.
• Restrictions on dividends, capital distributions and bonuses.
• Prohibitions on investing in certain instruments.
• Obligations to close specific branches.

See Also

• The SREP processes follows the submission by the institution of its own Internal Capital Adequacy Assessment ICAAP

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