Banks’ internal capital planning efforts are getting better, but need to keep improving, says The Office of the Superintendent of Financial Institutions (OSFI) in a letter published on Wednesday.
The letter to deposit taking institutions (DTIs) details OSFI’s observations on the December 2014 round of internal capital planning exercises, which are known as Internal Capital Adequacy Assessment Process (ICAAP) submissions, by firms that use the standardized approach to credit risk.
Although OSFI reviews these submissions and considers them as part of its supervisory work, they are not intended as a regulatory compliance exercise. Federally regulated DTIs are required to develop their own ICAAPs to help them set internal capital targets, and to develop strategies for achieving those internal targets that are consistent with their business plans, risk profile and the operating environment. OSFI uses ICAAPs to assess the quality of a bank’s risk management, but it does not approve these efforts.
OSFI observed “continued development and enhancement” of ICAAP submissions, the letter notes, however the federal regulator’s review of the ICAAPs submitted last December found a number of key areas that need further improvement. For example, a robust target leverage ratio should be part of the capital planning process along with risk-based capital targets, the OSFI letter says.
Additionally, in cases where the capital requirement determined by the ICAAP is higher than a firm’s board-approved capital target, the DTI must include a timeline for when the internal target will be raised to the level of the ICAAP target, the OSFI letter notes, or it must provide a clear rationale for why the board-approved capital target should remain below the ICAAP target.
The letter, which highlights a couple of other areas for improvement, also notes that OSFI expects to see ongoing improvement in the quality of these submissions. “Improvements should be apparent in both qualitative assessment and risk quantification, including sufficient evidence to demonstrate the use of ICAAP for business/risk management and to adequately capture the business dynamics as well as any operating environment changes,” the letter says.
Firms will next be required to submit ICAAPs by Dec. 31, 2016, the letter says. However, it suggests that firms may want to continue updating this work this year, too.
“The ICAAP is, first and foremost, an important internal process and should not be considered a ‘regulatory’ exercise,” the letter says. “OSFI believes that a robust ICAAP enhances a [firm’s] ability to manage through business cycles. As such, while the next ICAAP submission to OSFI is not due until December 2016, management may still choose to update their ICAAP as part of their annual planning process prior to year end 2015 in order to re-confirm their internal capital targets and for capital planning purposes.”