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Priorities

The European Central Bank and Banco de Portugal have identified, for both significant and less significant entities, five prudential supervision priorities for 2016:

Business model and profitability

The high level of impairments and the protracted period of low interest rates have challenged the business model as well as institutions’ profitability. It is therefore necessary to assess the current and future sustainability of the institutions’ business model. 

The Single Supervisory Mechanism (SSM) is launching a thematic review of banks’ profitability drivers of significant institutions, in order to identify the institutions with structurally low profitability. In this context, supervision will examine whether profitability is attained, inter alia, through a weakening of credit standards, greater reliance on short-term funding, or an increase in risk exposures not commensurate with the bank’s stated risk appetite. 

Banco de Portugal will monitor the action plans developed by less significant entities within the scope of the Supervisory Review and Evaluation Process (SREP), in order to respond to the profitability problems they are facing.

Credit

The high levels of non-performing loans (NPLs) require increased attention in terms of supervision.

The deterioration in the credit quality of loans to corporates and/or households as well as in credit standards is a source of concern in a number of countries participating in the Single Supervisory Mechanism (SSM), particularly in those countries most hit by the crisis, like Portugal.

The SSM’s supervisory action will primarily focus on institutions with high levels of NPLs and in the implementation of “IFRS 9 – Financial Instruments” (International Financial Reporting Standards).

A task force is analysing the situation of institutions with high levels of NPLs and will recommend follow-up actions. Risk position concentration in domains such as real estate will also be subject to intensified supervisory oversight. 

A thematic review will be conducted, covering significant and less significant institutions, to assess the potential impact of IFRS 9 on provisioning practices, and how banks are preparing for its introduction. 

As regards less significant institutions, similarly to developments expected for significant institutions, Banco de Portugal will coordinate a thematic review of credit portfolios containing exposures with high seniority or impairments and will recommend follow-up measures. 

With respect to provisioning, Banco de Portugal will monitor the adoption of the new model by less significant institutions, following the recent regulatory changes. 

Banco de Portugal will also assess in detail exposures to real estate, in a preventive approach, and will monitor credit portfolio exposures to emerging markets especially affected by an unfavourable macroeconomic environment.

Capital adequacy

The institutions' ability to comply with capital requirements will continue to be one of the supervisory priorities, particularly in the current context of their low ability to raise capital through profit accrued. 

Supervisors’ attention will be focused on the quality and consistency of the institutions’ internal capital adequacy assessment processes (ICAAP), the quality and composition of the institutions’ capital and their readiness to implement new regulations, namely as regards the minimum requirement for own funds and eligible liabilities (MREL), whose implementation may result in minimum requirements for ‘bail-inable’ capital instruments.

In addition, a project will be developed to review the institutions’ Targeted Review of Internal Models (TRIM), which will run over several years.

The ability of less significant institutions to comply with capital requirements will also continue to be one of the supervisory priorities.

The ICAAP will be the focus of special attention within the regular Supervisory Review and Evaluation Process (SREP), in order to ensure that the entities under supervision are able to follow a detailed and full approach in this process. Another objective refers to the monitoring of results and their appropriate use in support of management decision-making. This process is implemented across the board, but following the principle of proportionality. 

The development of stress tests based on a top-down approach in some less significant institutions will be an important aspect in assessing the institutions’ resilience.

Internal governance and risk management

Institutions’ risk governance will be assessed from a context of low profitability and wide financing, as well as the low cost offered by central banks. 

The financial crisis experience has shown that the institutions’ management boards did not always have at their disposal the risk information required to make appropriate decisions in terms of business and risk management.

One of the SSM’s priorities is to present in a clear manner the supervision expectations regarding institutions in this field. The institutions’ boards should require and receive appropriate information on risk, in order to accurately assess whether business decisions entail risk levels that are in line with the institution’s defined risk appetite standards and limits.

Data quality and firm-wide risk aggregation capabilities are an essential precondition for sound, risk-based decision-making and therefore for proper risk governance.

In this context, the SSM will undertake a thematic review of compliance by the institutions with the Basel Committee on Banking Supervision’s principles for effective risk data aggregation and risk reporting. This review will make it possible to strengthen the monitoring measures adopted in the wake of the thematic overview of risk governance and risk appetite conducted by the SSM in 2015. IT risks will be an integral part of the review, given that data quality and security depend on the IT infrastructure used by the institutions.

Banco de Portugal will undertake on-site inspections of the risk control and management functions of some less significant institutions.

Liquidity

The SSM will review the reliability of the institutions’ internal liquidity adequacy assessment processes (ILAAP).

It will examine progress made by the institutions in implementing and maintaining solid frameworks for liquidity and funding risk management, both in normal and adverse situations. 

As regards less significant institutions, the review will mainly focus on compliance with the new prudential and reporting requirements in this field.

These priorities were identified taking into account the international context of the financial sector, as well as the evaluation of the main risks faced by the institutions under supervision.

The setting of priorities is a key instrument for the implementation of supervisory measures in institutions in a harmonised, proportionate and efficient manner, thus contributing to ensuring a level-playing field across the supervised institutions and more effective supervision.

A number of initiatives will be developed for each priority, whose implementation in some cases may extend beyond 2016.