The Importance of ICAAP

ICAAP is the means by which bank Boards approve their approach to the calculation of capital requirements. It is an important tool that regulators consider under Pillar 2 of Basel II in arriving at a prescribed level of capital for a bank.

SREP - The Supervisory Review Process

The Supervisory Review Process (SREP) is the process by which regulators assess how firms have approached the implementation of, among other things, Pillar 2.

Quadrant assists Financial Services Institutions (FSIs) throughout the preparation and submission of the ICAAP (Internal Capital Adequacy Assessment Process). This can include:

• Helping create the initial and subsequent ICAAPs
• Reviewing an ICAAP which has already been prepared
• Helping FSIs with the submission of the ICAAP to their Regulator. This can result in a smooth and successful ICAAP outcomes from their Regulator. 
• Planning any necessary remedial action and embedding the ICAAP within the institution
  Risks to Consider under Pillar 2

Pillar 2 risks, i.e. those categories of risk which must at a minimum be considered by an institution in addition to the Pillar 1 risks, may be specified differently by national regulators, but a common requirement is that each firm should consider all risk categories which may be material to that institution, whether or not those categories are specified by the regulator in question.
Pillar 2 risks commonly specified by regulators include:

• Concentration Risk
• Liquidity Risk
• Interest Rate Risk in the Non-trading Book

Some of the other risk categories which may or may not be specified include:

• Pension Fund Risk
• Reputation Risk
• Securitisation Risk
• Insurance Risk

Stress and Scenario Testing

Stress testing and scenario analysis are key tools inproducing estimates of possible future capital requirements. This has become a major area of focus for regulators in light of the significant failurs that have been seen in the financial markets in recent years. Quadrant is close to regulatory thinking, and can assist firms in developing robust approaches in this area.

Getting the most from the ICAAP

The ICAAP can be a time-consuming and confrontational process both within the institution and with their regulator, or it can be a productive and enlightening additional risk management tool, adding greatly to their risk management armoury and helping management and the supervisor to understand better the risks in their businesses and strategies.

The ICAAP needs to be embedded within the institution. Inevitably this will have implications, possibly far-reaching, for their policies, processes and systems (including the management information systems). Institutions need to recognise that the ICAAP is their own document, for their own use in managing the risks attaching to capital calculation and forecasting; it is not simply a response to a regulatory “form-filling” requirement. They should be prepared to assert why their ICAAP’s structure, assumptions, methodologies, and conclusions are valid. Among other things, this means establishing a process for effective internal challenge.