Critical Functions: SRB Approach

Context

  1. The identification of critical functions is a key element of the resolution planning activity, since it has consequences for many aspects of resolution plans.
  2. First, the presence of critical functions is one of the criteria to consider when performing the Public Interest Assessment (PIA), in which Resolution Authorities (RAs) assess whether normal insolvency proceedings would or would not achieve the desired outcome to the same extent as resolution action. This paper focuses on critical functions only and a separate document on the approach followed by the SRB on the PIA will be published later this year.
  3. Second, the identification of critical functions is relevant for the selection of the preferred resolution strategy, which should be designed to maintain critical functions through resolution. Key elements of that strategy, such as the separability analysis and the determination of loss-absorbing capacity, should preserve the institution’s critical functions and take into account the internal and external services, systems and infrastructure necessary for the provision of such functions.
  4. Critical functions are defined in Article 2(1)(35) of Directive 2014/59/EU (the Bank Recovery and Resolution Directive, BRRD[1]) as “activities, services or operations the discontinuance of which is likely in one or more Member States, to lead to the disruption of services that are essential to the real economy or to disrupt financial stability due to the size, market share, external and internal interconnectedness, complexity or cross-border activities of an institution or group, with particular regard to the substitutability of those activities, services or operations”.
  5. Critical functions hence play an important role in the real economy and/or in the financial system. They are not only important for the institutions providing the services, but also for the broader economy of a particular region or Member State (MS). This distinguishes such functions from critical services, which are the “underlying operations, activities and services performed for one (dedicated services) or more business units or legal entities (shared services) within the group which are needed to provide one or more critical functions”.[2]
  6. For the 2017 resolution planning cycle, the SRB developed – in close collaboration with NRAs and with the participation of the ECB and the EBA – a common approach for Banking Union (BU) headquartered significant and cross-border less significant institutions to guide them when assessing the criticality of their functions. This approach, which is in line with the EU regulatory framework (BRRD, Regulation (EU) 806/2014 (SRMR[3]), Commission Delegated Regulation (DR) 2016/778) and the FSB Guidance on the Identification of Critical Functions and Critical Shared Services (2013), also includes policy guidance and tools to support IRTs in making the final call on whether a function should be considered critical or not.

SRB Approach

  1. In the European Union (EU), institutions are required to self-assess critical functions when drawing-up their recovery plans (“bottom-up approach”). This self-assessment is also reported to and reviewed by RAs (“top-down approach”), with a view to achieving an appropriate and consistent identification of critical functions.[4] The conclusions of this review feed into the resolution plan.
  2. The Single Resolution Mechanism (SRM) developed a common approach to enhance consistency in the identification of critical functions in resolution plans. The approach consists of a standardised template (i.e. the Critical Functions Template) with a common set of indicators and assessment fields, and associated guidance for institutions (these two documents are published on the SRB’s website), complemented by policy guidance for use within the SRM.
  3. The Critical Functions Template specifies five economic functions, as identified by the FSB, for which an assessment needs to be undertaken: 1) deposits, 2) lending, 3) payment, cash, settlement, clearing and custody (PCSCC) services, 4) capital markets and 5) wholesale funding. The Critical Functions Template breaks these five functions down further into sub-functions to better inform the SRB’s analysis.
  4. The SRB assesses the criticality of each economic function, based on reported data, comparisons with peers and expert judgement, taking into account available institution-specific and market-wide information. In 2017, the SRB collected data from all institutions under its remit, at individual legal entity or at (sub-) consolidated level, depending on the structure of the banking group. The SRB also developed a benchmarking tool to enable internal resolution teams (IRTs)[5] to compare the reported data by country and by function. In 2018, the SRB is collecting data at country level, aggregating all the activities of entities within that country. In addition, Critical Functions Reports[6] continue to be required at the level of the EU ultimate parent undertaking as well as at sub-consolidated and individual level, as appropriate.

Steps in the criticality assessment

  1. Whether a function is considered critical or not rests on an assessment of impact and substitutability. DR 2016/778 specifies that RAs should assess the impact on third parties of the disruption in the activity and the degree of substitutability of the function in the market where it is provided.
  2. When assessing the impact, the SRB makes the following assumptions, among others:
  • The critical functions analysis should focus on the impact (on the real economy and/or on financial stability) of a sudden disruption of a specific function (e.g. lending to SMEs) and not of the whole bank.
  • For deposits, the value on covered deposits and the Deposit Guarantee Scheme (DGS) are not considered relevant.
  • For lending, determining the impact of potential new lending is more important than the current stock of outstanding loans.
  • For capital markets, the SRB mostly focuses on the role of institutions as liquidity providers to the market at national and/or EU level. In the same vein, when assessing wholesale funding, the SRB considers the importance of institutions for the smooth functioning of interbank funding markets.
  1. In the supply-side or substitutability analysis, the SRB aims to ensure similar outcomes across institutions operating in the same market. This consistency is pursued through benchmarking of individual responses from institutions.

Geographical level

  1. The SRB considers the national level as the “relevant market” by default. Nevertheless, it also allows for assessing the impact at a different geographical level (regional/EU/global) in the rare cases in which the default option is not considered appropriate.
  2. Ultimately, the SRB assesses the impact of the disruption at the national level. Without such impact, it cannot be concluded that a function would be critical at the level of “one MS or higher”, in line with the BRRD.

Next steps

  1. The critical functions analysis is an ongoing process, which also depends on complete and accurate data obtained from institutions. The methodology behind the identification of critical functions will be refined over time in light of experience. The SRB intends to continue enhancing its guidance for institutions, as published on its website. The SRB will also further develop the tools for benchmarking the institutions’ self-assessments and IRT’s conclusions, to ensure a high degree of consistency in the BU as well as the understanding of specific markets.

Furthermore, the Critical Functions Template and data collection process will be aligned with the new EBA ITS on resolution reporting. The EBA is in the process of updating the ITS on the provision of information for resolution plans (Commission Implementing Regulation (EU) 2016/1066[7]), commonly referred to as the “EBA templates”. The SRB will (slightly) adjust its template and guidance accordingly to make sure that the EBA and SRB templates are fully compatible.

[4] EBA/Op/2015/05, Technical advice on the delegated acts on critical functions and core business lines.

[5] IRTs are responsible for preparing resolution plans for banks under the SRB’s remit. They consist of experts from the SRB as well as relevant NRAs.

[6] Banks fill the Critical Functions Template. Once the template is filled and reported, it becomes the Critical Functions Report.

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