Methodology for Supervisory Examination and Assessment of Commercial, Associating, and Cooperative Banks (BION Methodology)

UKNF – BION Methodology
METHODOLOGY FOR SUPERVISORY EXAMINATION AND ASSESSMENT OF COMMERCIAL, ASSOCIATING, AND COOPERATIVE BANKS (BION Methodology) OFFICE OF THE FINANCIAL SUPERVISION AUTHORITY 26 April 2017

UKNF – BION Methodology
Table of Contents
I. PURPOSE OF INTRODUCING THE BION METHODOLOGY........................................................................4
II. CONTENT OF THE BION METHODOLOGY......................................................................................................4
II.1 Formal Conditions for the BION Process ...........................................................4
II.1.1 SCOPE OF SUPERVISORY EXAMINATION AND ASSESSMENT – EU DOCUMENTS..............................................4
II.1.2 NATIONAL FORMAL CONDITIONS FOR THE BION PROCESS ...........................................7
II.2 ORGANIZATION OF THE BION PROCESS .....................................................................10
II.2.1 COURSE OF THE BION PROCESS .................................................................................................10
II.2.2 SUPERVISORY DIALOGUE WITH BANKS DURING THE BION PROCESS .............................................12
II.2.3 APPLICATION OF THE PRINCIPLE OF PROPORTIONALITY................................................................13
II.2.3.1 Principles of bank categorization.................................................................................................. 14
II.2.3.2 Mode of assigning BION assessment.................................................................................................. 15
II.2.3.3 Intensity of the BION process ................................................................................................... 16
II.2.4 SUPERVISORY ASSESSMENT PROGRAM .........................................................................................17
II.2.4. 1 Scope of areas/types of risk subject to examination in a given BION cycle............... 19
II.2.5 SOURCES OF INFORMATION USED IN THE BION PROCESS........................................20
II.2.5.1 Materials for bank assessment in BION_full mode.................................................................... 21
II.2.5.2 Materials for bank assessment in BION_simplified mode......................................................... 23
II.2.5.3 Materials obtained for the purpose of reviewing the ICAAP and ILAAP process............................... 23
II.2.5.4 Inclusion of information about entities within the bank's capital group in the BION process.................................................................................................................... 24
II.3 SCOPE OF SUPERVISORY EXAMINATION AND ASSESSMENT................................................................26
II.3.1 INTRODUCTION.................................................................................................................26
II.3.2 BUSINESS MODEL ANALYSIS......................................................................................28
II.3.2.1 Scope of bank business model analysis ............................................................................ 30
II.3.2.2 Identification of key elements/areas of the business model (profiling)............... 31
II.3.2.3 Qualitative analysis of the bank's business model and strategy......................................... 33
II.3.2.4 Quantitative analysis of the bank's business model ....................................................................... 34
II.3.2.5 Guidelines for assessing the bank's business model ..................................................................... 34
II.3.3 CREDIT RISK.........................................................................................................34
II.3.3.1 Quality of credit risk management .............................................................................. 37
II.3.3.2 Foreign currency lending risk ............................................................................... 37
II.3.3.3 Guidelines for assessing credit risk .................................................................................. 39
II.3.4 MARKET RISK AND GENERAL INTEREST RATE RISK IN THE BANKING BOOK .......................................................................................................................39
II.3.4.1 Quality of market risk management and general interest rate risk in the banking book. ................................................................................................................. 43
II.3.4.2 Guidelines for assessing market risk and general interest rate risk.................................. 44
II.3.5 OPERATIONAL RISK ........................................................................................................45
II.3.5.1 Quality of operational risk management............................................................................. 47
II.3.5.2 Guidelines for assessing operational risk................................................................................. 48
II.3.6 LIQUIDITY AND FUNDING RISK...............................................................................48
II.3.6.1 Quality of liquidity and funding risk management ......................................................... 53
II.3.6.3 Guidelines for assessing liquidity and funding risk .................................................................. 54
II.3.7 CAPITAL ADEQUACY AREA ...........................................................................54
II.3.7.1 Quality of management................................................................................................... 56
II.3.7.2 Guidelines for assessing management quality .................................................................................. 57
II.3.8 BANK MANAGEMENT.....................................................................................................57
II.3.8.1 Quality of bank management ................................................................................................... 60
II.3.8.2 Guidelines for assessing the bank management area.................................................................. 61
II.3.9 SYSTEMIC RISK .........................................................................................................61

UKNF – BION Methodology
II.4 DETERMINING THE BION ASSESSMENT ................................................................................63
II.4.1 ASSESSMENT SCALE........................................................................................................63
II.4.2 TYPES OF ASSESSMENTS ASSIGNED TO AREAS IN THE BION PROCESS AND THEIR INTERPRETATION ...63
II.4.3 ALGORITHM FOR ASSIGNING BION ASSESSMENT .............................................................65
II.4.3.1 Mechanism for calculating assessments for Groups of areas..................................................... 66
II.4.3.2 Additional risk assessment.......................................................................................... 68
II.4.4 CORRECTIVE FACTORS .....................................................................................................69
II.4.5 FINAL BION ASSESSMENT....................................................................................................69
II.4.6 COOPERATION WITH THE HOME SUPERVISOR ON JOINT CAPITAL AND LIQUIDITY DECISIONS ....................................................................................................70
II.5 SUPERVISORY ACTIONS.................................................................................................71
II.5.1 LINKING BION ASSESSMENT WITH SUPERVISORY ACTIONS.............................................71
II.5.2 INTENSITY OF SUPERVISORY ACTIONS .........................................................................72
APPENDIX 1. GUIDELINES FOR ASSESSING AREAS EXAMINED IN THE BION PROCESS REGARDING MANAGEMENT QUALITY...................................................................76
PART A – BUSINESS MODEL ANALYSIS .............................................................................76
PART B – CREDIT RISK, CREDIT CONCENTRATION RISK, SETTLEMENT/DELIVERY RISK ....................................................................................................77
PART C – MARKET RISK ....................................................................................................84
PART D – GENERAL INTEREST RATE RISK IN THE BANKING BOOK.......................................88
PART E – OPERATIONAL RISK................................................................................................90
PART F – LIQUIDITY AND FUNDING RISK ........................................................................98
PART G – CAPITAL ADEQUACY ........................................................................................102
PART H – BANK MANAGEMENT ..........................................................................................108
APPENDIX 2. GUIDELINES FOR ASSESSING AREAS EXAMINED IN THE BION PROCESS REGARDING RISK LEVEL............................................................................112
PART A – BUSINESS MODEL ANALYSIS ...........................................................................112
PART B – CREDIT RISK, CREDIT CONCENTRATION RISK, SETTLEMENT/DELIVERY RISK .................................................................................................112
PART C – MARKET RISK ..................................................................................................114
PART D – GENERAL INTEREST RATE RISK IN THE BANKING BOOK.....................................114
PART E – OPERATIONAL RISK..............................................................................................115
PART F – LIQUIDITY AND FUNDING RISK ......................................................................115
PART G – CAPITAL ADEQUACY .................................................PHASE 116
PART H – EXCESSIVE LEVERAGE RISK ........................................................................117
APPENDIX 3. CORRECTIVE FACTORS FOR BION ASSESSMENTS..............................................118
APPENDIX 4. FRAMEWORK PRINCIPLES FOR CALCULATING ADDITIONAL CAPITAL REQUIREMENTS FOR FOREIGN CURRENCY HOUSING LOANS, TAKING INTO ACCOUNT RECOMMENDATION 2 POINT 1 OF KSF RESOLUTION NO. 14/2017 OF 13.01.2017....................................................................................................................121
APPENDIX 5. DETERMINING THE RISK LEVEL ASSESSMENT DURING THE BION PROCESS ..............................................................................................................................126

UKNF – BION Methodology
I. PURPOSE OF INTRODUCING THE BION METHODOLOGY
The purpose of the supervisory examination and assessment process (BION process) is to identify the size and nature of risks to which a bank is exposed, to assess the quality of risk management processes, to assess the level of capital covering risks arising from the bank's operations and bank management, including the bank's compliance with legal provisions regulating banking activities, its articles of association, and decisions on issuing permits for the establishment of the bank and commencement of its operations, as well as to assess actions taken by the bank following the application of measures referred to in Article 138, Article 138c, and Article 141 of the Act of 29 August 1997 – Banking Law1 (hereinafter the Banking Law Act). The purpose of the BION Methodology is to indicate the method of conducting the BION process, the scope of supervisory examination and assessment, and the principles for assigning BION assessments within the scope of supervisory activities performed. The BION Methodology applies to commercial banks, associating banks, and cooperative banks.
II. CONTENT OF THE BION METHODOLOGY
II.1 Formal Conditions for the BION Process
II.1.1 Scope of Supervisory Examination and Assessment – EU Documents In accordance with applicable EU regulations, the Supervisory Review and Evaluation Process (SREP) covers the requirements of:
 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC (hereinafter CRD IV Directive),  Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 (hereinafter CRR Regulation). The obligation for supervision to conduct a cyclical supervisory review and assessment is set out in Article 97 of the CRD IV Directive. This Article states, among other things, that the supervisory authority:
 reviews the arrangements, strategies, processes, and mechanisms implemented by institutions to comply with the provisions of the CRD IV Directive and the CRR Regulation,  assesses: the risks to which institutions are or might be exposed, the risks that an institution poses to the financial system, and the risks revealed by stress tests,

1 Consolidated text, Journal of Laws of 2016, item 1988, as amended.

UKNF – BION Methodology
 determines – based on the review and assessment – whether the arrangements, strategies, processes, and mechanisms implemented by institutions, as well as the own funds and liquidity of these institutions, ensure proper risk management and protection against it,  determines the frequency and intensity of supervisory reviews and assessments, taking into account the size, systemic importance, nature, scale, and complexity of the institution's activities and the principle of proportionality. To ensure consistency of reviews, assessments, and supervisory measures within EU member states, the European Banking Authority (hereinafter EBA2) – in accordance with Article 107(3) of the CRD IV Directive – issued Guidelines on common procedures and methodologies for the supervisory review and evaluation process of 19 December 2014 (hereinafter SREP Guidelines).
Article 113(1) of the CRD IV Directive sets out the requirement for a joint capital and liquidity decision for cross-border capital groups. The rules of procedure and the scope of required information aimed at ensuring a joint decision on the adequacy of own funds, supervisory measures concerning liquidity supervision, and the level of liquidity and capital requirements applied to each institution belonging to the group and to the entire capital group, have been specified in Commission Implementing Regulation (EU) No 710/2014 of 23 June 2014 laying down implementing technical standards with regard to the conditions for the application of the joint decision procedure on institution-specific prudential requirements in accordance with Directive 2013/36/EU of the European Parliament and of the Council (hereinafter JRAD3 Regulation).
The JRAD Regulation specifies, among other things, the template for the supervisory review and evaluation report containing a list of examined risks/areas for the purposes of the joint capital and liquidity decision, and templates for risk assessment reports indicating the requirement for supervisory authorities to assess the specified risks/areas respectively for entities within the capital group and at the consolidated level. Issues concerning the transmission of information for the purpose of conducting a joint group assessment and the joint decision-making process have also been included in:
 Commission Delegated Regulation (EU) 2016/98 of 16 October 2015 supplementing Directive 2013/36/EU of the European Parliament and of the Council with regard to regulatory technical standards for the general conditions for the functioning of colleges of supervisors, and  Commission Implementing Regulation (EU) 2016/99 of 16 October 2015 laying down implementing technical standards for determining the operational functioning of colleges of supervisors in accordance with Directive 2013/36/EU of the European Parliament and of the Council, (hereinafter College Regulations).

2 EBA - European Banking Authority
3 JRAD – Joint Decision Regarding the Capital Adequacy

UKNF – BION Methodology
Subject to applicable national provisions, this BION Methodology has been developed taking into account the requirements of the CRD IV Directive and with a view to maintaining consistency with the principles of supervisory review and assessment set out in the SREP Guidelines. At the same time, due to the direct applicability of the provisions of the regulations in each Member State, the BION Methodology refers to the provisions of the CRR Regulation, the JRAD Regulation, and the College Regulations as elements of the national legal system. The SREP Guidelines should be applied from 1 January 2016, taking into account a transitional period with regard to:
 provisions concerning the net stable funding ratio and the leverage ratio until the issuance of binding regulations concerning these ratios,  provisions concerning the linkage of SREP analyses with activities resulting from Directive (EU) No 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms (hereinafter BRRD Directive),  implementation of the risk diversification model and the shaping of the own funds structure, which is required from 1 January 2019 (the date of achieving the target amount of own funds specified in Article 92 of the CRR Regulation). Taking into account the entry into force on 9 October 2016 of the provisions of the Act of 10 June 2016 on the Bank Guarantee Fund, deposit guarantee scheme, and compulsory restructuring4 (hereinafter: BFG Act) implementing the provisions of the BRRD Directive into the national legal order, this BION Methodology has been re-amended. The implementation of the SREP Guidelines into UKNF processes and procedures has not been completed. In subsequent years, amendments will include, among others, the remaining issues indicated for implementation with a transitional period, and changes to the SREP Guidelines resulting from the European Commission's work on revising the provisions of the CRD IV Directive and the CRR Regulation. Provisions/guidelines relating to the SREP process will be successively implemented into the BION process conducted at UKNF and will be reflected in subsequent amendments to the BION Methodology. A special approach applies to Bank Gospodarstwa Krajowego (BGK), which has been excluded from the CRD IV Directive in accordance with the provisions of Article 2 of that directive5. However, given that Article 3 of the Act of 14 March 2003 on Bank Gospodarstwa Krajowego states that the provisions of the Banking Law Act apply to BGK – unless legal provisions state otherwise – this means that it is subject to banking supervision to the extent specified in the Banking Law Act. Thus, for Bank Gospodarstwa Krajowego, analysis and supervisory examination are conducted on the principles set out in this BION Methodology. The scope of requirements specified in the CRR Regulation, which BGK is obliged to comply with, is precisely defined in Article 70(1) of the Act of 5 August 2015 on macroprudential supervision over the financial system and crisis management in the financial system6 (hereinafter the Macroprudential Supervision Act). II.1.2 National Formal Conditions for the BION Process In the BION process, the following are taken into account:
 national legal acts concerning banks,
 KNF resolutions (to the extent not inconsistent with the CRR Regulation),  KNF recommendations and other documents indicating good banking practices, issued by the KNF.
The legal framework for the supervisory examination and assessment or review and verification of the results of previous supervisory examination and assessment of banks is set out in Article 133a -133e of the Banking Law Act. Such an examination must be conducted by the supervision at least once a year. The aforementioned provisions constitute the transposition of most of the provisions of Section III (supervisory review and evaluation process) of Title VII (prudential supervision) of the CRD IV Directive. Article 133e of the Banking Law Act constitutes a statutory delegation for the minister responsible for financial institutions to issue a regulation specifying the criteria and method for conducting supervisory examination and assessment by the supervision, in order to implement the provisions of Article 99 and Article 101(2-5) of the CRD IV Directive. As part of the implementation of the above-mentioned statutory delegation, the Regulation of the Minister of Development and Finance of 06.03.2017 on the criteria and method for conducting supervisory examination and assessment in banks (hereinafter RMRiF on BION) was issued, effective from 1 May 2017. The RMRiF on BION specifies in detail the scope of supervisory examination and assessment, clarifying the provisions of Article 133a(2), (3) and (4) of the Banking Law Act. In accordance with Article 133a(2) of the Banking Law Act, the supervisory examination and assessment includes:
a) identification of the size and nature of risks to which the bank is exposed, b) assessment of the quality of the risk management process, c) assessment of the level of capital covering risks arising from the bank's operations and bank management, d) within the activities indicated in points a), b) and c), the bank's compliance with the provisions of the Banking Law Act, the CRR Regulation, the Act on the National Bank of Poland, its articles of association, and decisions on issuing permits for the establishment of the bank and commencement of its operations is examined, e) assessment of actions taken by the bank following the application of supervisory measures referred to in Article 138, Article 138c, and Article 141 of the Banking Law Act.

4 Journal of Laws of 2016, item 996, as amended.
5 In accordance with Article 2(5)(18) of the CRD IV Directive, effective from 01.01.2014, this directive does not apply to Bank Gospodarstwa Krajowego.

UKNF – BION Methodology
In accordance with Article 133a(3) and (4), during the supervisory examination and assessment, the supervision takes into account:
a) the results of supervisory stress tests and stress tests conducted in accordance with Article 177 of the CRR Regulation by a bank applying the internal ratings method or the internal models method, b) the systemic risk that the bank may pose and the results of the identification, assessment, and monitoring of systemic risk arising in the financial system or its environment, as well as actions to eliminate or reduce this risk using macroprudential instruments, introduced by the Financial Stability Committee in accordance with the Macroprudential Supervision Act. The organization and tasks of macroprudential supervision are defined by the Macroprudential Supervision Act. In accordance with this Act, macroprudential supervision includes the identification, assessment, and monitoring of systemic risk and actions aimed at reducing this risk through the application of macroprudential instruments. The Financial Stability Committee acts as the competent authority for macroprudential supervision in Poland. By Resolution No. 14/2017 of 13 January 2017, the Financial Stability Committee issued recommendations concerning the restructuring of the portfolio of foreign currency housing loans, addressed to the Ministry of Finance, the Bank Guarantee Fund, and the Financial Supervision Commission. As part of the recommendations addressed to the Financial Supervision Commission, it was recommended to update the BION Methodology and expand it to include principles allowing for the assignment of an appropriate level of capital surcharge to further risk factors related to foreign currency housing loans (operational risk, market risk, and collective default risk by borrowers). In compliance with the recommendations of the Financial Stability Committee F