The Internal Capital Adequacy Assessment Process (ICAAP)

The Internal Capital Adequacy Assessment Process (ICAAP),

the Internal Liquidity Adequacy Assessment Process

(ILAAP)

and their supervisory review process

GUIDELINES FOR SUPERVISED INSTITUTIONS

Revised: September 2014

First version published: January 2008

Table of Contents

Table of Contents 2

I. Introduction 6

I.1 The internal capital adequacy assessment process (ICAAP) 6

I.2 Supervisory requirements for devising the ICAAP 8

I.3 The Internal Liquidity Adequacy Assessment Process (ILAAP) 11

I.4 Supervisory requirements for devising the ILAAP 12

I.5 Supervisory review and evaluation of the ICAAP and the ILAAP 12

I.6 Internationally accepted fundamental principles and criteria to be enforced in the context of the supervisory review process 13

I.7 Additional general fundamental principles applied in the context of the MNB’s review processes 14

II. Scope of the ICAAP, the ILAAP and their supervisory review process 17

II.1 ICAAP and ILAAP compliance and the supervisory review process on an individual level 17

II.2 ICAAP and ILAAP compliance and the supervisory review process on a group level 18

III. SREP grades and categories of supervised institutions 22

III.1 Complex ICAAP and ILAAP review for institutions subject to complex SREP 22

III.2 Standard ICAAP and ILAAP review for small and medium-sized institutions 23

III.3 Simplified ICAAP and ILAAP review for small and medium-sized institutions 23

IV. Steps of the ICAAP and the ILAAP 24

IV.1 Preparing the supervisory review 24

IV.2 Requesting ICAAP/ILAAP documentation 24

IV.3 Supervisory evaluation of internal capital and liquidity adequacy 25

IV.4 Risk mitigation measures and the determination of economic capital and liquidity excess reserve requirements 26

IV.5 Joint risk assessment and decision procedure 26

IV.6 Conclusion of the ICAAP and ILAAP supervisory reviews, supervisory measures 27

IV.7 Annual assessment of the findings of the ICAAP supervisory review processes among institutions subject to complex SREP 33

V. The elements of the ICAAP and their supervisory review 34

V.1 Internal governance and control systems — risk management 34

V.2 Evaluation of Material Risks 43

V.3 Calculation of Required Capital 77

VI. Components and supervisory review of ILAAP 85

VI.1 Internal assessment of liquidity and funding risks by the institution 85

VI.2 Supervisory liquidity adequacy assessment process 87

VII. Stress tests 90

VII.1 Reliability of applied risk models 91

VII.2 Enforcement of an integrated risk management approach 92

VIII. Supervisory expectations concerning the internal capital requirement calculation and liquidity adequacy assessment of small institutions and the relevant supervisory review 94

VIII.1 Application of the principle of proportionality 94

VIII.2 Definition of small institutions 94

VIII.3 Supervisory expectations concerning the ICAAP of small institutions 94

VIII.4 Methodologies applied by small institutions 95

VIII.5 Steps of internal capital requirement calculation 95

VIII.6 Typical risks of smaller credit institutions 96

VIII.7 Activities generating unusual, additional risks at investment firms are the following: 96

VIII.8 Supervisory reviews at small institutions 96

VIII.9 Supervisory measures against small institutions 97

VIII.10 Closing the supervisory review 99

IX. List of Documents 101

IX.1 Summary 101

IX.2 Presentation of actual and target financial, liquidity and capital positions 101

IX.3 Detailed presentation of capital adequacy calculations 101

IX.4 The integration of the ICAAP methodology into processes 102

IX.5 Description of the Internal Liquidity Adequacy Assessment Process 102

X. Annexes 104

Acronyms

AIRB / Advanced Internal Ratings Based Approach / belső minősítésen alapuló módszer fejlett változata (PD, LGD, CCF becslés)
AMA / Advanced Measurement Approach / fejlett mérési módszer (működési kockázat)
ALCO / Asset Liability Committee / Eszköz-Forrás bizottság a likviditási kockázat menedzselésére
ASA / Alternative Standardised Approach / alternatív sztenderd módszer (működési kockázat)
AVA / Additional Valuation Adjustments / kiegészítő értékelési korrekció
BCM / Business Continuity Management / üzletmenet-folytonosság menedzsment
BIA / Basic Indicator Approach / alapmutató módszer (működési kockázat)
BSZT / 2007. évi CXXXVIII. törvény a befektetési vállalkozásokról és az árutőzsdei szolgáltatókról, valamint az általuk végezhető tevékenységek szabályairól
CCF / Credit Conversion Factor / (hitel) egyenértékesítési (konverziós) tényező
CEBS / Committee of European Banking Supervisors / Európai Bankfelügyeleti Bizottság
CET1 / Common Equity Tier 1 / elsődleges alapvető tőke (részletesen lsd. CRR Második rész: Szavatoló tőke fejezet)
CCP / Central Counterpary / elszámolóház
CRCU / Credit Risk Control Unit / hitelkockázati kontroll egység
CRD / Capital Requirement Directives / 2006/48/EC (amending Directive 2000/12) and 2006/49/EC (amending Directive 93/6)
CRD IV / Directive 2013/36/EU of the European Parliament and of the Council on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC
CRR / Capital Requirement Regulation / Regulation (EU) No 575/2013 of the European Parliament and of the Council on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012
CRO / Chief Risk Officer / kockázati vezető
CVA / Credit Valuation Adjustment / hitelértékelési korrekció
DMM / devizafinanszírozás megfelelési mutató
DVP / Delivery Versus Payment / szállítás fizetés ellenében
EAD / Exposure At Default / nemteljesítés bekövetkezésekor a kockázati kitettség értéke
EBA / European Banking Authority / Európai Bankfelügyeleti Hatóság
EL / Expected Loss / várt veszteség
EGT / Európai Gazdasági Térség
FIRB / Foundation Internal Ratings Based Approach / belső minősítésen alapuló módszer alap változata (PD becslés)
HPT / 2013. évi CCXXXVII. törvény a hitelintézetekről és a pénzügyi vállalkozásokról
ICAAP / Internal Capital Adequacy Assessment Process / a tőkemegfelelés belső értékelési folyamata
IG / Intergiro
ILAAP / Internal Liquidity Adequacy Assessment Process / likviditás megfelelőségének belső értékelési folyamata
IRB / Internal Rating Based Approach / belső minősítésen alapuló módszer
IRRBB / Interest Rate In The Banking Book / banki könyv kamatlábkockázat
JRAD / Joint Risk Assessment and Decision / közös kockázatértékelés és együttes döntés
KRI / Key Risk Indicator / kulcskockázati mutató
LCP / Liquidity Contingency Plan / likviditási üzletfolytonossági terv
LCR / Liquidity Coverage Ratio / likviditás fedezeti követelmény
LGD / Loss Given Default / nemteljesítés esetén a veszteség átlagos mértéke
LTV / Loan To Value / hitel-fedezet arány
MNB / Magyar Nemzeti Bank
NFSR / Net Stabil Funding Ratio / nettó stabil forrás ellátottsági mutató
OCR / Overall Capital Requirement / teljes tőkekövetelményt
OTC / Over The Counter / másodlagos, más néven tőzsdén kívüli vagy származtatott értékpapírpiac
PD / Probability of Default / a nemteljesítés valószínűsége
PIT / Point-In-Time / PD modell típus, amely a gazdasági ciklus pillanatnyi helyzetét figyelembe véve ad előrejelzést a PD-re
SD / Settlement Day / teljesítési határidő
SL / Specialized Lending / speciális hitelezés
SREP / Supervisory Review and Evaluation Process / Felügyeleti felülvizsgálati és értékelési folyamat
RVP / Receive versus Payment / kézhez vétel fizetés ellenében
T1 / Tier 1 / alapvető tőke (részletesen lsd. CRR Második rész: Szavatoló tőke fejezet)
T2 / Tier 2 / járulékos tőke (részletesen lsd. CRR Második rész: Szavatoló tőke fejezet)
TSA / Standardised Approach / sztenderd módszer (működési kockázat)
TREA / Total Risk Exposure Amount / teljes kockázati kitettség érték
TSCR / Total SREP Capital Requirement / SREP tőkekövetelmény
TSCR ratio / teljes SREP tőkemutató
TTC / Through-The-Cycle / PD modell típus, amelynél a PD a hosszú távú trendeket ragadja meg, egy gazdasági ciklusra jellemző átlagos értéket ad vissza
UL / Unexpected Loss / nem várt veszteség
VAR / Value at Risk / kockáztatott érték
VIR / vezetői információs rendszer

I.  Introduction

The supervisory authority first published its methodological guidelines on the Internal Capital Adequacy Assessment Process (ICAAP) and its Supervisory Review Process (SREP) for institutions governed by the CRD in 2008, which were subsequently regularly reviewed in accordance with legislative changes and practical experience. The European-level regulations serving as the basis of the guidelines were substantially amended in 2014 with the introduction of CRD IV and CRR, therefore we radically transformed the structure of our guidelines and have compiled a guide encompassing both ICAAP, ILAAP[1] and their supervisory review process. The presentation of the supervisory review process was taken from the earlier SREP Guidelines, and unified ICAAP-ILAAP-SREP Guidelines are now being published. A key criterion in the course of the transformation was to ensure that the supervisory requirement and guidance continued to effectively support the work of institutions.

The Guidelines contain the material and temporal scope of the review process, present the fundamental review principles and address the levels of the supervisory review process. It discusses the elements of the ICAAP and ILAAP and provides guidance on the interpretation of provisions. Furthermore, the document sets out the principles and methods that the Magyar Nemzeti Bank (hereinafter: the MNB or the Supervisory Authority), proceeding within its supervisory function, intends to apply for assessing the capital and liquidity adequacy calculations of institutions.[2]

These Guidelines primarily set out basic principles, as the regulatory requirements regarding internal capital and liquidity adequacy calculation depend on the type, size and service complexity of the institution concerned. As no standardised method equally applicable to all institutions can be provided, the MNB has developed requirements for specific institutions with a view to the principle of proportionality.

I.1  The internal capital adequacy assessment process (ICAAP)

Effective domestic and EU regulations on capital adequacy assessment require all credit institutions and investment firms (hereinafter: institutions) to develop an internal capital adequacy assessment procedure. The purpose of this procedure is to assess, based on the institution’s own calculations, the adequate capital which institutions consider necessary to cover the risks they take and which they are exposed to.[3]Thus the internal capital adequacy assessment process is designed to ensure that the institution

·  operates a sufficiently sophisticated risk management system that adequately identifies, measures, summarizes and monitors all materials risks

·  has a sufficient amount of capital to cover these exposures as calculated based on the institution’s internal rules.

The internal capital adequacy assessment process applies to all institutions that are subject to the CRD. The ICAAP has been mandatory since the launch of minimum capital requirement calculation as per the CRD, i.e. since 1 January 2008. The primary responsibility for the proper implementation and quality of the internal capital adequacy assessment process rests with the top management of the institution. This responsibility is also there if the ICAAP is determined at group level.

The internal capital adequacy assessment process includes the following areas[4]:

·  comprehensive risk analysis which identifies and assesses the material risks of the institution;

·  a valid capital analysis which quantifies the extent of risks and determines the required level of risk capital;

·  adequate oversight and governance by the board of directors and top management and their involvement in capital adequacy processes;

·  establishment of an adequate monitoring and reporting structure by which the institution is able to present regularly its risk profile and capital position;

·  elaboration of adequate internal audit mechanisms, provision for independent review.

Two pivotal terms related to ICAAP in the guidelines are capital and risk. Existing regulations basically require capital adequacy at institutions for covering unexpected losses, with adequate capital also functioning as permanent collateral that enables the institution to operate prudently in any regular business and economic situation.[5] Accordingly, capital requirement refers to adequate capital that corresponds to the risks quantified by a particular method and the size of potential losses that may result from these risks.

Under the ICAAP in Pillar 2, the amount of economically needed capital is determined. Economically needed capital captures the risks deriving from the institution’s business activities through the statistical and/or probability estimate of potential future losses at a level of likelihood determined by the institution and for a certain period (usually one year).

When calculating capital adequacy, institutions could formerly also compare the aggregate economically needed capital that covered all risk types to resource elements (e.g. available capital) that were not part of regulatory (Pillar 1) capital by definition (such as future earnings). This will no longer be taken into account in the supervisory review processes conducted from 2015 based on the EBA's guidelines on the uniform supervisory review process. From 1 January 2015 onwards, the MNB will only accept regulatory (Pillar 1) capital as capital used for covering risks when calculating SREP capital adequacy. In accordance with the referenced guidelines, another key change is that diversification among risks will no longer be taken into account when defining the Pillar 2 capital requirement.

Beyond the regulatory capital requirements captured in Pillar 1, credit institutions and investment enterprises (hereinafter institutions) are also required to calculate the adequate capital under the framework of Pillar 2 along their internal procedures. Due to the differences in approach, the two calculation methodologies usually deviate from each other. As Pillar 2 requires institutions to calculate the capital requirement for all relevant risks, the figure resulting from internal capital calculation usually exceeds the regulatory minimum capital, presenting and additional capital requirement in Pillar 2. Institutions are expected to define the allocated capital requirement amount for each risk within Pillar 2. The internal capital requirement calculation may yield a lower capital requirement in Pillar 2 for Pillar 1 risks; in this case, the regulatory capital corresponds to the minimum Pillar 2 capital requirement. The MNB assesses the need for additional capital requirement in Pillar 2 for each risk in the context of the supervisory review process.

However, the purpose of Pillar 2 capital requirement calculations is not only to make the institution set up additional capital on top of the regulatory minimum level. What the MNB considers more important is the motivating effect which spurs the institution to apply more effective risk management techniques and internal procedures for better detecting, measuring and managing its exposures. Therefore, embedded into day-to-day processes, the internal capital adequacy assessment process can greatly contribute to the prudent operation of the institution.

I.2  Supervisory requirements for devising the ICAAP

I.2.1  Fundamental principles

Below we present the general ICAAP principles elaborated in CEBS recommendation GL03[6], which must serve as a guideline for all institutions for establishing their own ICAAP. Some of the fundamental principles were supplemented based on the experience drawn on by the MNB.