Draft of revised General Guidelines and Methodology for the Supervisory Review and Evaluation Process at financial undertakings

5 February 2025
Ref.: 2502008

Circular no. 7/2025
To financial undertakings and
Association of Companies in Financial Services

Subject: Draft of revised General Guidelines and Methodology for the Supervisory Review and Evaluation Process at financial undertakings

The Central Bank of Iceland has published a new discussion paper no. 1/2025 which contains a draft of revised General Guidelines and Methodology for the Supervisory Review and Evaluation Process at financial undertakings. More specifically, it concerns a draft of the 8th edition of the general guidelines and the 6th edition of their annex.

The objective of the general guidelines is to define and present in a general manner the methodology and implementation of the Central Bank of Iceland's financial supervision's Supervisory Review and Evaluation Process. The European Banking Authority's (EBA) guidelines on the supervisory review and evaluation process and stress testing (SREP) (EBA/GL/2022/03) entail a more detailed description of the methodology that the Financial Supervisory Authority operates according to in its supervisory practice and they apply where the former is silent.

In the discussion paper, substantive changes are identified in red which can be clarified by comparison with the currently valid guidelines.

In the draft of the general part of the guidelines and the three annexes, various wording changes and corrections to the text have been made. Furthermore, various legal references have been updated, most due to changes that occurred in the Act on Financial Undertakings last year, cf. Act no. 62/1024, and new rules that took effect last year.

Several minor substantive changes have been made to the general part of the guidelines. Sustainability risk has been emphasized as a sub-risk factor of operational risk, in addition, the draft refers for consideration to EBA guidelines on sustainability risk. Changes have been made to terminology so that it is in better accordance with laws and EEA acts. Thus, the term base requirement for own funds has been replaced by the term minimum capital requirement. Furthermore, the term the Financial Supervisory Authority's minimum requirement for own funds (total SREP capital requirement, TSCR) has now been made to cover the minimum capital requirement (8%) and additional capital requirement instead of the minimum capital requirement. The term key risk measure was replaced by the term key risk indicator. At the same time, a more detailed explanation has been presented on the additional capital requirement due to the risk of excessive leverage.

In the revision of Annex 1, which deals with credit and concentration risk, in the discussion on credit risk in Chapter 2, emphasis was placed on updating the reference values for fishing quotas as collateral, as it has been some time since they were last revised. Furthermore, the Financial Supervisory Authority has considered discontinuing the supervisory loan portfolio report (LPA), but it has been relied upon in the assessment of additional capital needs due to default and forbearance. In the currently valid guidelines, a new method was introduced that looks at the set of loans of borrowers who have one or more loans classified as performing, but with forbearance. The purpose of running both methods in parallel was to verify the quality of forbearance registration, but the result of the year 2024 was that it was premature to discontinue the LPA report. After the Supervisory Review and Evaluation Process of the year 2025, the Financial Supervisory Authority will revise the reporting obligation for the LPA report for those participants who achieve acceptable comparability according to both methods.

Next, it should be mentioned that with the implementation of Regulation (EU) 2024/1623 (CRR III)1, the additional capital requirement for loans to real estate development projects will be removed, but the aim is for the implementation to be completed before the result is obtained from the Supervisory Review and Evaluation Process of the commercial banks for the year 2025.

In Chapter 3 of Annex 1, the change was made to the methodology for borrower concentration that loans that have received an additional capital requirement due to the methodology according to Chapter 2 are no longer disregarded, but only loans with 0% risk weight and loans in severe default. The calculated amount of the capital requirement will continue to be subject to expert assessment and can, for example, additional capital requirements according to Chapter 2 have an effect. Finally, an addition to Annex 1 that compares ÍSAT2008 the Statistics Iceland's industry classification with a similar classification according to FINREP has been removed because the latter classification is based on the European Union's industry classification (NACE) which ÍSAT2008 also does. Therefore, the comparison is no longer considered necessary.

Annex 2, which deals with market risk, has among other things been updated due to fixed interest rate risk. Two new benchmarks, which are based on recent EBA guidelines (EBA/GL/2022/14) and delegated regulations (EU) 2024/856 and 2024/857, cf. rules no. 1341/2024, have been added to Chapter 6.1. The first benchmark concerns EVE (economic value of equity) and is almost entirely comparable to the SOT methodology (standard outlier test) according to the aforementioned regulation. The new benchmark deviates from SOT by looking at modified duration instead of cash flow. This is because current data submissions are based on modified duration. The benchmark also deviates from SOT in that it does not include a behavioral model for assessing the duration of deposits, but such a model is still in development. In the benchmark, new values for interest rate shocks can be found that have been calculated in accordance with the methodology from Part B of the annex of the aforementioned regulation.

It is important that these interest rate shocks are correct. Therefore, the Financial Supervisory Authority will in the discussion process request that relevant financial undertakings perform their own calculations of the said interest rate shocks so that their results can be compared with the results of the Financial Supervisory Authority as they appear in the draft of the guidelines where they will, unless otherwise decided, apply in the coming years. The older EVE benchmark does not become invalid, for the time being, although a new EVE benchmark has been added. The Financial Supervisory Authority is aware of the shortcomings in the EBA's reporting format for fixed interest rate risk and is in communication with the institution's experts about solutions to the matter.

[1] The criteria will require a general review upon the implementation of Directive (EU) 2024/1619 (CRD VI) and CRR III and the adoption of the EBA guidelines on SREP, which are currently under review.

In Appendix 3, which deals with capital buffers, references to the rules on the systemic risk buffer and capital buffers for systemically important financial undertakings have been updated, along with various changes in wording. A reference to the Financial Stability Committee's criterion for determining the value of the countercyclical capital buffer has also been added.

With this consultation letter, the Central Bank gives recipients the opportunity to submit comments that are limited to the changes that have been made in the draft. The documents are also published on the Central Bank's website: https://www.fme.is/log-og-tilmaeli/umraeduskjol.

Comments from consultation parties on the attached discussion document are requested no later than 19 February next. It is requested that comments be written on the consultation form provided for that purpose, which can be found on the Central Bank's website, cf. further explanations in the discussion document. The consultation form shall be sent to the email address skjalasafn@sedlabanki.is.

Yours faithfully,
CENTRAL BANK OF ICELAND

Gísli Óttarsson managing director prudential supervision

Jónas Þór Brynjarsson head of department prudential supervision