ECB: Judgement shapes bank capital, smooths SREP scores
A new European Central Bank working paper finds that supervisory judgement significantly influences banks' overall SREP scores and Pillar 2 capital requirements. This judgement helps adapt supervisory frameworks to evolving risks and systemic conditions.
Judgement smooths SREP scores
The study empirically analyzes how euro area supervisors apply judgement when setting the overall Supervisory Review and Evaluation Process (SREP) score.
This process starts with an automatic score, which supervisors then adjust based on qualitative insights and specific vulnerabilities.
The findings show that supervisory judgement significantly influences changes in the overall SREP score, contributing almost as much as the automatic score.
Supervisors actively adjust the weights of SREP elements to dampen fluctuations in the overall score, directly incorporating relevant information and preventing its impact from being diluted during aggregation.
This highlights the non-linear nature of bank viability evaluations, where certain risks, such as credit risk, can play a decisive role in the overall assessment of a bank's viability.
Common channel, P2R impact
The analysis reveals a common supervisory judgement channel across the euro area, reflecting shared priorities and concerns like systemic vulnerabilities or macroeconomic conditions.
This commonality in adjustments can vary with the direction of SREP score changes (upgrades or downgrades).
Beyond the overall SREP score, supervisory judgement is also evident in setting Pillar 2 capital requirements (P2R), which address additional risks not covered by minimum capital requirements.
The study identifies the business model assessment as a key driver of P2R changes, interpreting this as evidence of common supervisory judgement.
This flexibility helps supervisors adapt evaluations to individual banks and systemic conditions without frequently revising methodologies.