1. Field project in financial markets and services
ICAAP and ILAAP: a critical analysis 1
Introduction 2
What is ICAAP? 3
What is ILAAP? 4
Implementation 5
Review of regulators initiatives to harmonize ICAAP and ILAAP 6
Conclusion
Cabu, Jeremy
De Radiguès, Philippine
Risopoulos, Théo
13 April 2016
SBS – EM
Master in Business Economics
Field project – F. Francotte, Y. Boudghene, E. Boyer, E. De Keuleneer

2. Introduction– ICAAP and ILAAP
A. BASEL III Framework
B. Key Achievements
ICAAP
Capital Requirements
Better Capital
More Capital
Liquidity Requirements
Liquidity ratios
Leverage Requirements
Pillar I
Assessment of the risks to Capital that have been identified as material for the institution.
Supplemental Capital requirements of Pillar 2
Pillar II
Risk Management and Supervision
Supplemental requirements
ILAAP
Assessment of the risks to liquidity and funding that have been identified as material for the institution.
Supplemental Liquidity requirements of Pillar 2
Market Discipline
Revised disclosures requirement
Enhanced disclosures
Pillar III
Field project – F. Francotte, Y. Boudghene, E. Boyer, E. De Keuleneer 1

3. What is ICAAP? – Definition & Legal Basis EBA Guidelines for SREP
Definition: All the bank’s procedures and measures designed to ensure
An appropriate identification and measurement of risks
An appropriate level of internal capital in relation to the bank risk profile
the application and further development of suitable risk management systems
Rationale: Help supervisors and banks to identify additional risks that were not covered under Pillar I and that the bank is accordingly sufficiently capitalized
Distinction: Economic capital vs. Regulatory capital
ICAAP Legal Basis
ECB Guide
EBA Guidelines for SREP
CRD IV
Field project – F. Francotte, Y. Boudghene, E. Boyer, E. De Keuleneer 2

4. 2 How is ICAAP assessed? – Risk to Capital
A. ICAAP risks: Internal vs. External approach
ICAAP sub-risks
SREP?
Standard Approach
Internal Approach
Counterparty risk ✔
Risk weights based on credit assessment from external rating agencies
IRB approach
Equity risk
Risk weights based on risk indicators
Credit concentration risk -
Strict limitation or limitation by way of increased monitoring
Market risks and FX in the trading book
Sensitivities Based Methods, Default risk charge and residual risk add-on
Historical, Gaussian or Monte - Carlo VaR model
Operational Risk
Single risk weight factor
Advanced Measurement Approaches
IRRBB
Interest rate statistics, unique or combined Interest rate shift (s)
Other risks ✖
Qualitative assessment, set of rules
Source: FMA, ONB and BIS
Field project – F. Francotte, Y. Boudghene, E. Boyer, E. De Keuleneer 2

5. Why is ICAAP useful? – For banks and supervisors
A. For Credit Institutions
✔ Allow the bank to derive its risk bearing capacity
✔ Allow the bank to evaluate potential products or clients in terms of risk – adjusted capital measures rather than just in terms of risk profile
Initial investment
Annual net income
Return decision
Capital Charge
Risky capital
RORAC
RORAC decision
Equity Investment 1
1.000 €
40 € 2%
20 €
200% ✔
Equity investment 2
100 €
20%
200 €
50%
Source: FMA, ONB
B. For Supervisors
✔ Give the supervisor an exhaustive coverage of the credit institution’s risk
exposure as opposed to the risks under Pillar I 
✔ Give the opportunity to the supervisor of assessing the risk bearing capacity of the institution
✔ Help the supervisor preventing insolvency in the banking industry 
Field project – F. Francotte, Y. Boudghene, E. Boyer, E. De Keuleneer 2

6. What is ILAAP? – Definition & Legal Basis EBA Guidelines for SREP
Definition: All the bank’s procedures and measures designed to ensure
An appropriate identification and measurement, of risks to liquidity and funding
An appropriate level of internal liquidity in relation to risk profile
An appropriate management and monitoring of liquidity
Rationale: Help supervisors and banks to put LCR and NSFR (Basel III Pillar I) into a risk governance framework
Qualitative elements based on “Principles for sound liquidity risk management and supervision” (BCBS, 2008)
Liquidity risk quantification: HQLA buffers, LCF plans, maturity gap, stress testing, projected balance sheet, Funds Transfer Pricing, etc.
ILAAP Legal Basis
BASEL III
EBA Guidelines for SREP
Field project – F. Francotte, Y. Boudghene, E. Boyer, E. De Keuleneer 3

7. Why is ILAAP useful? – For banks and supervisors
A. For the banks
✔ Allow the bank to adequately determine its liquidity and funding risk- bearing capacity and risk tolerance
✔ Align the liquidity risk management with its strategic and operational processes
B. For the supervisor
✔ Allow the supervisor to assess liquidity and funding risk-bearing capacity of the supervised and assess if liquidity risks require additional risk controls
✔ Clarify the dialogue on liquidity risks between the supervised and the supervisor
Field project – F. Francotte, Y. Boudghene, E. Boyer, E. De Keuleneer 3

8. Varying implementation practices
Heterogeneity in required capitalization
Different definitions of available financial resources : use of regulatory funds vs additional adjustment such as future expected earnings
Different weights of the risks by regulators: e.g integrate business risk in stressed planning assumptions vs separate risk category
Different degrees of individual capital guidance by national superviors
Varying influence of national supervisors to integrate ICAAP on bank’s core internal management
Different use of the ICAAP results for the SREP
ILAAP
Few implementation practices (DNB, BoE). First submission of EBA templates by 30 April 2016.
Field project – F. Francotte, Y. Boudghene, E. Boyer, E. De Keuleneer

9. Review of regulators initiatives to harmonize ICAAP & ILAAP (I/III)
A. Timeline of regulatory work from supervisors
2014
2015
2016
Application of the SREP Guidelines
SREP Guidelines
Common Guidelines for ICAAP and ILAAP information collection
Provision of ICAAP and ILAAP data
Guide to Banking Supervision
Application of the ICAAP and ILAAP Guidelines
B. Key contributions
✔ Facilitating a consistent approach to ICAAP and ILAAP under the SREP
✔ Incorporating the banking industry concerns trough consultations
✔ Understanding the SSM expectations on ILAAP and ICAAP
✔ Understanding and Harmonizing information collection on ICAAP and ILAAP
Field project – F. Francotte, Y. Boudghene, E. Boyer, E. De Keuleneer 5

10. 5 Review of regulators initiatives to harmonize ICAAP & ILAAP (II/III)
A. SREP guidelines
B. Guide to banking supervision
Determine competent authority in charge of reviewing periodically the SREP framework according to the categorization of the institution
Alignment of ICAAP and ILAAP with institutions’ risk profiles and strategic management practices “
Review of soundness, effectiveness and comprehensiveness of ICAAP
ECB directly responsible for large and global credit institutions and indirectly for small institutions trough the NCA’s
C. GL on collection of information related to ICAAP and ILAAP for SREP purpose
D. Supervisory expectations on ICAAP and ILAAP and harmonized collection
Divergent requirements for the relevant information may hinder harmonization of the SREP
Review of 2015 showed that the information sent by credit institutions not in line with SSM expectations
Differences and similarities between own funds requirements and ICAAP have to be clearly stated to enable the supervisor to compare the outcomes
EBA has communicated several clarifications but also templates relating to SSM expectations on ICAAP and ILAAP
Field project – F. Francotte, Y. Boudghene, E. Boyer, E. De Keuleneer 5

11. Review of regulators initiatives to harmonize ICAAP & ILAAP (III/III)
A. Banking Industry Association issues
B. Clarification from the supervisors
✖ Deeper dialogue between supervisors and institutions throughout the SREP
✔ EBA: this was not intended and should be further clarified
✖ Clearer guidance on the assessment of ICAAP
✔ EBA clarified that the starting point of the SREP is surely the ICAAP
✖ Pillar 2 should not be considered as a kind of Pillar-1-plus
✔ EBA advocates a continuation of principles-based approach for Pillar 2
✖ Diversification benefits should be considered
✔ Intra – diversification is allowed but not inter – diversification
✖ References to ILAAP too qualitative and general
✔ The ECB published a template for sending ILAAP information
✖ Use of supervisory benchmarks
✔ Expected to continue applying benchmarks to set a level playing field
✖ Tight expected timeline and implementaton
Field project – F. Francotte, Y. Boudghene, E. Boyer, E. De Keuleneer 5

12. 6 Conclusion A. Key challenges
While banks agree on the need to harmonize ICAAP and ILAAP framework, they deem that the overall design of the guidelines still exhibited certain issues to be addressed
Find the right equilibrium between the conflicting objectives of strengthening the harmonization of regulatory procedures and reflecting adequately and proportionally institution-specific risk practices and risk profile
B. Potential recommendations
Perhaps, further develop a clearly quantified standard external ICAAP model
Draft more precise and quantitative guidelines for ILAAP
Further enhance the dialogue on the parameters of ICAAP and ILAAP risks that are still not concretely defined
Field project – F. Francotte, Y. Boudghene, E. Boyer, E. De Keuleneer 6