An Ideal ICAAP - UK ALMA

An Ideal ICAAP

ALMA Presentation

12 November 2015

An Ideal ICAAP – ALMA Presentation

Agenda

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What is the ICAAP?

Capital management fundamentals and Pillar 2

Chapter-by-chapter guidance

Recap of key messages

Questions

Team biographies and contact details

What is the ICAAP?


ICAAP – Internal Capital Adequacy Assessment Process

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► ICAAP ► An integrated risk and capital management process ► Owned by the Board ► Not just a “tick-box” regulatory exercise ► Not just a document refreshed annually

► Aims: ► To demonstrate sufficient protection for the deposit base ► To provide confidence that taxpayer bail-outs will not be required ► To gain the “investment” of the regulator ► To deliver a sustainable, capital-generating business within a robust risk appetite


Purpose of the ICAAP document and key considerations

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The ICAAP document is dual purpose: ► It is a communication document within the business, to facilitate and evidence Board and Senior

Management involvement in review, challenge and approval of the internal capital assessment and its approach to capital management

► It is also used to demonstrate, and communicate, the firm’s internal capital assessment to the regulator

The following considerations will impact how well the document fulfils these two purposes:

► The ICAAP must be a self-contained document owned by the Board

► The ICAAP must be comprehensive and well-structured to facilitate Board and regulator review

► It should ‘tell the story’ of the capital and risk management approaches of the bank

► An external reviewer with limited/no knowledge of the firm should be able to understand the ICAAP

► It should be considered similar to a prospectus document in that it is ultimately seeking the ‘investment’ of the regulator/central bank


Integrating ICAAP, Strategy, Risk appetite, and stress testing

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► ICAAP underpinned by an effective risk management framework, fully integrated with overall capital management processes

► Clear and robust linkages between risk and capital management frameworks

► Risk appetite clearly quantified. High-level qualitative requirements translated into granular measures and limits, with explicit risk, capital and profitability metrics

► Robust bespoke stress testing with stressed risk appetite metrics

► Reverse stress testing should be conducted in order to identify scenarios that would cause the firm to fail, enabling the identification of key vulnerabilities within a firm’s business model

Risk AppetiteICAAP

Financial/ Capital Planning

Risk Limits

Stress Testing/ReverseStress Testing

Actuals Reporting

Strategic Planning

Capital Management Fundamentals and Pillar 2


Capital Fundamentals

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► Capital held to absorb expected and unexpected losses ► Too little capital may lead to bank failures and/or sustained bail out requirements ► Too much capital, may lead to unprofitable banking businesses

► Regulators require banks to hold minimum levels of capital resources based on the risks of the business and its balance sheet size

► Capital resources of appropriate quantity and quality ► Tiers of capital:

► Common Equity Tier 1 (CET1) – shareholders’ funds, the primary ratio ► Tier 1 – including ‘equity-like’ convertible Additional Tier 1 securities ► Tier 2 subordinated debt ► Total Loss Absorbing Capacity (TLAC)/Minimum Requirement for own funds and Eligible

Liabilities (MREL) – ‘bail-inable’ senior unsecured debt


The three Pillars

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Pillar 1 Minimum Capital

Requirements

(RWA, EEL and other capital adjustments)

Pillar 3 Disclosure and

Market Discipline

(Pillar 3 document and other related

publications)

Pillar 2 Supervisory

Review Process

(ICAAP and SREP – resulting in ICG and

buffers)


Pillar 2 Capital Framework

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PRA buffer assessment binding PRA buffer assessment not binding

PRA Buffer PRA buffer assessment (Pillar 2B)Capital conversion

buffer

Systemic bufferMacroprudential tools (countercyclical buffers and sectoral capital requirements)Pillar 2A (risks not covered in pillar 1)Pillar 1

Capital conversion buffer

PRA buffer assessment (Pillar 2B)

Systemic bufferMacroprudential tools (countercyclical buffers and sectoral capital requirements)Pillar 2A (risks not covered in pillar1)Pillar 1

The PRA buffer is set as the excess capital over and above the systemic buffer and capital conservation buffer if the SREP concludes that the CRD IV buffers are not adequate for a given institution

Chapter-by-Chapter Guidance


Chapter-by-chapter guidance

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► Executive summary ► Governance: capital management in the firm ► Comprehensive situation assessment ► Pillar 1 and Pillar 2a risks ► Pillar 2b/stress testing ► Conclusion

ICAAP chapter list


Executive Summary

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► Assumed audience – Governor of the Bank of England ► Comprehensive summary to give full picture:

► No requirement to read on ► ‘Tells the story’ of capital and risk management ► Strongly supports robust conclusion


Governance: capital management in the firm

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► ICAAP governance framework ► Ultimate responsibility for the ICAAP document and process should rest with the Board ► Integrated capital management governance:

► Structure of key legal entities/business lines ► Key personnel across legal entities and business lines ► Committee structures and participants ► Key capital management policies and procedures

► Risk appetite and its application: link to P1, P2a, P2b risks and reverse stress testing


Comprehensive situation assessment

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► Background – recent strategy and performance ► Current position ► Approach to strategy generation and latest strategy ► Resultant medium term financial and operating plans ► Detailed financials for each stage to include:

► Full financials – P&L, Balance Sheet, etc. ► Capital and leverage supply and demand ► Internal/external capital plans – including dividend strategy ► Liquidity and asset encumbrance ► Developments: approach to sustainable capital generation


Pillar 1 and Pillar 2a Risk Assessment

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Pillar 1 Risks ► Credit, Counterparty Credit, Market and

Operational ► Regulatory capital requirements

Pillar 2a Risks ► Not covered adequately by Pillar 1 ► Credit, Counterparty … ► Pension, IRRBB, concentration ► Economic capital and other internal capital

models ► Regulator approaches – e.g., CP1/15 ► Clear and transparent

1► Identification

2► Measurement

3► Monitoring

4► Management/Mitigation

5► Residual within RAS


Pillar 2b Stress Testing Assessment

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Firms should define a bespoke/internal stress testing exercise and explain: ► Why it is a meaningful scenario ► The capital, leverage and liquidity results ► How capital would be dynamically managed to deliver it efficiently to the entities in which it is

required (or held at the centre) ► Calculation of bespoke internal capital planning buffer and comparison to current PRA buffer and

CRD IV buffers Within the section, firms should also detail: ► Overview of reverse stress testing across the Group – with reference to reverse stress testing for key

legal entities and the links to their individual RRPs


Conclusion

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The ultimate conclusion must be a numeric answer representing the level of capitalisation that the Group believes to be correct for its current operations and risks faced. Link that number to the following considerations: ► Under the business plan, can the shareholder targets be achieved? ► Are the dividend and issuance policies in line with the overall ICAAP conclusion? ► Is consolidated Group ICAAP capital demand equal to or larger than the sum of ICAAP capital

demand of subsidiary entities?


Recap of key messages

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► ICAAP ► An integrated risk and capital management process ► Owned by the Board ► Not just a “tick-box” regulatory exercise ► Not just a document refreshed annually

► Aims: ► To demonstrate sufficient protection for the deposit base ► To provide confidence that taxpayer bail-outs will not be required ► To gain the “investment” of the regulator ► To deliver a sustainable, capital-generating business within a robust risk appetite

► Document: ► Consider from an investor perspective ► To tell the full story of risk and capital management ► Comprehensive and standalone

Questions

Thank you

Team biographies and contact details


Richard Brown

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Richard is Partner in Ernst & Young’s Financial Services practice based in London and leads the Prudential Regulation and Treasury Advisory team.

Richard has significant experience in Basel II across UK banks and building societies as well as international firms covering the definition and implementation of reporting requirements, design and implementation of governance frameworks, specifications and review of IRB requirements for rating systems, design and implementation of operational risk frameworks and review and development of ICAAPs.

Richard holds a BSc in Banking and International Finance and is a regular author of articles in industry journals.

E-mail: [email protected] Telephone: +44 7917 171 913


Doug Vick

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Doug joined EY in October 2014 as a Senior Manager in the Edinburgh office. His two most recent previous roles were at Lloyds Banking Group as Head of Capital Planning & Regulatory Advice and Head of Regulatory Reporting.

Doug has experience advising a number of firms across the UK and Europe on industry best practice regarding ICAAP documents and processes and regulator expectations.

Doug is a CIMA qualified accountant and holds a Masters degree in Mechanical Engineering.

E-mail: [email protected] Telephone: +44 7825 658 973

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An Ideal ICAAP - UK ALMA

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