On the 28th January 2020, the European Central Bank (ECB) published its annual Supervisory Review and Evaluation Process (SREP), which provides guidance on banks' capital requirements based on an assessment of four elements: (i) the viability and sustainability of business models, (ii) the adequacy of internal governance and risk management, (iii) the risks to capital, and (iv) the risks to liquidity and funding. For the first time, the ECB has also published aggregate data by business model and bank-by-bank information on Pillar 2 requirements in an effort to improve transparency.
The overall SREP requirements and guidance for Common Equity Tier 1 (CET1) capital remained stable at 10.6% in 2019, the same level as in 2018. Based on a rating of between 1 and 4, the share of banks receiving an overall score of 3 increased to 43% in 2019 from 38% in 2018. Meanwhile, the share of banks classified as worst performers, scoring 4, decreased to 8% from 10%. At the same time, the percentage of banks that scored 2 decreased to 49%, from 52%. No significant bank scored 1.
The SREP, however, notes three areas of notable deterioration, namely (i) most significant institutions' earnings are below their cost of capital, (ii) lack of adequate management bodies and internal controls, and (iii) material losses being reported mostly due to conduct risk events. In response to the deterioration in scores, supervisors will intensify assessments of the sustainability of business models and will continue to require banks to enhance the effectiveness of their management bodies and to strengthen internal controls and risk management.
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