Supervisory Review and Evaluation Process (SREP)
The Supervisory Review and Evaluation Process (SREP) is a set of procedures carried out on an annual basis by the supervisory authorities to ensure each credit institution has in place the strategies, processes, capital and liquidity that are appropriate to the risks to which it is or might be exposed to. This process implements Basel Pillar 2 in European and national legislation.
The SREP also assesses the risk each institution poses to the financial system.
This process therefore makes it possible to determine capital and liquidity requirements and other supervisory measures to address the specific weaknesses of each institution.
This methodology provides for a holistic and forward-looking assessment of the viability of the supervised institution.
The SREP is conducted in a proportional manner, both to significant and less significant institutions. The frequency and intensity of the SREP assessment takes into account the potential impact each institution may have on the financial system and its specific risk profile.
The fact that this methodology is used under the Single Supervisory Mechanism (SSM) allows peer comparisons and transversal analyses on a wide scale. It follows a “constrained judgement” approach, so as to ensure consistency among analyses conducted on all institutions, while taking into account the complexity and specificities of each institution within a clear and transparent framework.
The SREP carried out on an annual basis by Banco de Portugal follows the guidelines of the European Banking Authority (EBA) in this respect, which entered into force on 1 January 2016, and the methodologies of the SSM for significant institutions and for less significant institutions.
The procedures used by Banco de Portugal under the SREP take into account the size, systemic importance, nature and complexity of the institutions’ activities, in line with the principle of proportionality.
SREP guidelines and methodologies establish that competent authorities must assess the risks institutions are exposed to, including an analysis of business models and profitability, internal governance models and controls, risks to capital, and risks to liquidity and funding.
The risk profile of supervised institutions is assessed according to four SREP elements:
The four SREP elements follow common analysis procedures, ensuring a sound and harmonised risk assessment. The assessment of risks and controls put into place is carried out in a coherent manner, taking into account a comparison between supervised institutions.
The Supervisory Review and Evaluation Process aims to determine whether the arrangements, strategies, processes and mechanisms put in place by institutions and the own funds and liquidity held by these institutions ensure a sound management and coverage of their risks.
On the basis of that review, Banco de Portugal assesses whether there is a need to require institutions to hold own funds in excess of the legally established minimum requirements and to comply with specific liquidity requirements and other measures it lays down.
The SREP approach comprises the following exercises:
The Risk Assessment System (RAS) continuously assesses the levels of risk an institution is exposed to and its internal controls.
This assessment is rooted in quantitative and qualitative analysis and relies on a wide range of backward- and forward-looking indicators.
The risks which may have an impact on capital and liquidity are assessed by risk levels and by the corresponding risk controls/risk mitigation procedures implemented. Banco de Portugal assesses institutions’ business risk and profitability, as well as their internal governance and risk management. All assessments are then integrated into an overall assessment.
The risk profile assessment may result in a wide range of supervisory actions and measures. These actions and measures may be taken immediately, may be included in the SREP decisions, or may influence the annual supervisory planning (for example, by determining that on-site inspections need to be carried out). There is a direct link between an institution’s overall risk profile assessment and the level of supervisory engagement..
The SREP includes a comprehensive analysis of Internal Capital Adequacy Assessment Processes (ICAAP) and Internal Liquidity Adequacy Assessment Processes (ILAAP). These processes are key for managing risk in institutions, contributing to the determination of capital and liquidity requirements.
Banco de Portugal constantly monitors compliance with the capital requirements laid down in Pillar 1 of the Basel Accords, which it considers to be a floor.
It also reviews the internal models that institutions – subject to supervisory approval – are allowed to use to calculate capital requirements for Pillar 1 risks.
Furthermore, institutions are required to hold additional capital and liquidity buffers for risks that are not, or not fully, covered by Pillar 1. To this end, institutions must use their internal assessment and calculation methods, specifically their ICAAP and ILAAP. Credit institutions are required to carefully document these processes and calculations. They are also required to create adequate governance structures to ensure that their ICAAP/ILAAP outcomes are reliable. A comprehensive review of the ICAAP/ILAAP is performed as part of the SREP.
In its capital and liquidity adequacy assessment, in addition to assessing the stress tests implemented by the institutions, Banco de Portugal may also conduct stress test exercises.
Stress tests are a key forward-looking tool for assessing institutions’ exposure and resilience to adverse but plausible future events. They can also be used to test the adequacy of credit institutions’ risk management procedures, their strategic and capital planning and the robustness of their business models.
The stress test exercises recently conducted by Banco de Portugal follow an approach similar to that of the European Banking Authority and the European Central Bank and do not directly influence the calculation of specific capital requirements.
As laid down in the European Banking Authority's SREP Guidelines, Banco de Portugal uses a wide range of data from different sources in the SREP, including:
- periodic reporting by credit institutions;
- internal capital and liquidity adequacy assessment processes (ICAAP and ILAAP);
- institutions’ risk appetite;
- supervisory benchmarks or proxies used to verify and test estimates by institutions;
- risk assessment outcomes (RAS);
- stress test outcomes;
- the overall priorities of Banco de Portugal in terms of risk.
On the basis of information analysed and assessed during the SREP, Banco de Portugal carries out an overall assessment of the capital and liquidity adequacy of the credit institution and prepares decisions.
SREP decisions include an overall conclusion on the adequate level of capital and liquidity for the institution under review. They may also include qualitative measures, e.g. measures addressing weaknesses in institutions’ risk management.
Findings taken from this analysis and any corrective measures that might be needed are communicated to the credit institution, which will be given the opportunity of presenting in writing to Banco de Portugal observations on facts, objections and legal grounds that may be relevant to the decision.
In accordance with applicable regulation and a clarification by EBA in an opinion issued in December 2015, additional own funds requirements laid down by Banco de Portugal should be met in addition to Pillar 1 requirements and before compliance with the capital buffer requirements. These additional requirements are essential for calculating the maximum distributable amount.