Thematic review: Room for development in the ILAAP methodologies of banks directly supervised by the Financial Supervisory Authority

In spring 2022, the Financial Supervisory Authority (FIN-FSA) conducted a thematic review of banks under its direct supervision, concerning liquidity stress testing, funding plans and funding contingency plans. These were found not to be compliant with instructions in all aspects. The thematic review identified the following shortcomings:

Liquidity stress testing

• All time horizons are not considered.
• Stress testing does not include reverse stress tests, or they are deficient.
• The scenarios are based on historical events and they do not sufficiently take into account hypothetical, non-historical events.
• Off-balance sheet items and reductions to the value of the liquidity reserve (haircuts) are not taken into account in the calculation of the survival horizon.
• Validation of assumptions and outcomes is deficient.

Funding plans

• Deviations from the funding plan do not lead to measures.
• The adverse scenario is not taken into consideration.
• Implementation of the plan is not assessed regularly.

Liquidity contingency plans                 

• The recovery plan indicators defined in guidelines by the European Banking Authority (EBA) are not considered as early indicators included in the contingency plan.
• Instructions for the activation of measures are, as a rule, very general and they have not been specified for each measure.
• As to central bank funding, the various types of credit arrangements, eligible collateral, procedures and conditions concerning access to central bank assets in which there is a need for central bank funding have not been sufficiently documented.
• The plans do not specify whether the entity intends to use its LCR reserves even though the LCR would go below 100%, nor do they describe how liquidity would be steered towards the LCR target levels in a stress situation.
• Estimates of the amount of liquidity to be activated, the time required for implementation and the possible side effects of the measures do not sufficiently take into account the impact of the shock.
• The coverage of the testing of the plans is not sufficient.

The observations listed above differ between banks. Moreover, the scenarios applied in the banks’ own liquidity stress testing are optimistic and the results may provide a too positive picture of the adequacy of liquidity in a severe liquidity shock. The results of the liquidity stress tests conducted by banks were even in the most severe scenario clearly better than the results of the test conducted by the FIN-FSA. In the benchmark testing, the FIN-FSA used the same scenarios as the European Central Bank (ECB) in its 2019 liquidity stress test of banks under its supervision¹.

The FIN-FSA will pay attention to the identified shortcomings in the context of ongoing supervision and inspections.

For further information, please contact

Marjo Risku, Senior Risk Expert, telephone +358 9 183 5275 or marjo.risku(at)fiva.fi

¹ECB Sensitivity analysis of Liquidity Risk – Stress Test 2019