EBF’s comments on CEBS guidelines on stress testing include that supervisors should recognise that certain concentrations of risk, especially those that arise across risk types are difficult to evaluate in a quantitative manner and consequently recognise the validity of a large array of approaches.
EBF has three main differences in the interpretation of concentration risk that CEBS should consider in general when assessing any matter related to concentration risk:
· Concentration is not a new risk type but a feature within other risks. It should be clarified that institutions are not required to identify a certain amount of their capital specifically meant to cover concentration risk, but that capital requirements are calculated as a whole against the totality of risks banks face. Therefore it should not be treated separately. We understand this rationale to be in the spirit of guideline 7 but would claim for more clarity. Moreover, the way concentrations are dealt with in economic capital models is through correlations and by estimating the sensitivity of portfolios and counterparties to a set of risk factors, whereby it is identified how much they relate to the same common factors. Where separate reporting of single name concentrations, and sector and product concentrations in absolute amounts is feasible, reporting of general intra-risk and inter-risk concentrations is challenging when these are incorporated in economic capital models because they are calculated together with diversification.
· Concentration risk and diversification should always be assessed jointly (they are heads and tails). Diversification might have been overestimated in certain asset classes in the recent past, but it is also true that a well-diversified structure makes an institution more resilient and should be incentivized as a good risk management practice. Thus we would suggest including in guideline 7 a mention to the combined assessment of both concentration risk and diversification of the bank under the ICAAP. Moreover, the CEBS is known to be preparing new guidelines on capital allocation that will cover the issue of diversification. We recall that they should be put in place at the same time as these guidelines on concentration risk.
· Concentration risk as described in the CEBS draft principles includes several distinct topics that needs to be addressed in different ways, including :
o Elements of systemic risk (as described in Appendix 1) that are the remit of macro-prudential supervision rather than pure concentration risk management at each bank level
o Complex chain-reaction type of events that involve the successive occurrence of contingent risks (e.g. liquidity risk) that can only be addressed through scenario analysis and stress-testing
Other general remarks of the EBF refer to the following matters:
· Supervisors should recognise that certain concentrations of risk, especially those that arise across risk types (i.e. inter-risk) are difficult to evaluate in quantitative manner (in particular if it has to be separated from the diversification effects) and consequently recognise the validity of a large array of approaches such as stress tests, scenario analysis backed by experts’ judgement, qualitative analysis and when possible, modelling.
· The EBF warns against the risk that the newly proposed CRD4 may drive banks to heap single asset classes or a restricted type of assets onto their balance sheets. In particular, the new liquidity standards restricting liquidity buffers to a limited group of assets and the new capital standards emphasizing the use of common shares may go against Section 4.4 of the CEBS paper.
· The industry acknowledges the need for adequate internal reporting and appreciates the flexibility offered to institutions in the design of its own reporting methods. The guidance of CEBS on reporting of concentration risk is welcome as long as it is principle-based and allows for banks to define their own reporting methods. This line should be followed by national supervisors when it comes to implement and review specific reports.
· Guidance on the measurement of concentration risk at national level has already been produced by Central Banks or Banking Associations, especially as an aid for smaller banks. We expect them to be in line with the CEBS guidelines, but there should be a call for harmonisation among European countries in order to avoid potential conflicts stemming from differing legacy norms or national guidelines.
© EBF
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