Final EBA Guidelines on Overall Recovery Capacity in Recovery Planning

With European Banking Authority’s (EBA) final Guidelines on the determination and assessment of the overall recovery capacity (ORC) in recovery planning coming into force on 27 October 2023, this blog builds on our previous article published when the guidelines were still under consultation.

As part of developing firms’ further thinking and work around enhancing their overall recovery capacity, the present blog reflects emerging good practice and key implementation considerations.

Firms now need to develop a more detailed and credible assessment of their recovery capacity, ensuring a more realistic picture of what could be achieved in a severe stress. This would entail, for instance, performing an accurate ORC calculation, assessing market-appetite, considering additional recovery options and addressing any capacity insufficiencies.

The Guidelines give the authorities a much more prominent role in evaluating the overall ORC and determining the ORC score which could also have significant implications for firms’ capital and liquidity requirements.

Ultimately, the supervisory authority will likely provide more challenge to a number of the key judgements within the recovery planning, by reviewing banks’ self-assessed recovery capacity, grading them, and where necessary, adjusting the score for ORC to avoid overestimations of financial resilience. Essentially, the new approach seeks to standardize recovery capacity assessment across firms, and regulators but may make judgements in areas like operational capabilities and timeframes, potentially through peer comparisons.

In response to the new requirements, our previous blog provided more detail on the purpose and technicalities from the regulatory perspective. As a summary, the diagram below sets out an outline of the approach and methodology as per the Guidelines:

Key Considerations within the Guidelines:

1. To assess the ability of an institution to recover, scenarios need to be sufficiently severe to lead the institution to the 'near-default' point if no recovery options are implemented. This may include breaching relevant capital, leverage, or liquidity regulatory requirements.
   Reverse stress testing is suggested as a tool to identify suitable scenarios, so this may require enhancing this capability in parallel to recovery planning.
2. In the feasibility assessment, firms must take into account a range of qualitative factors that might pose obstacles to the effective execution of recovery strategies. These obstacles encompass: (i) operational factors, (ii) reputational concerns, (iii) legal considerations, (iv) financial implications, (v) business model and profitability and (vi) market situation.
   
3. In cases where a bank's ORC score is insufficient, they must implement appropriate corrective actions, considering recovery thresholds and potential mitigating factors. This may involve the need for additional recovery options to address the quantitative difference between the adjusted ORC and the recovery threshold. This activity could also assess the appropriateness of recovery options based on their impact on longer-term liquidity and capital raising opportunities beyond recovery.

A potential consideration for financial institutions with insufficient ORC is that it may result in a need to increase financial BAU requirements.

Based on emerging good practice: “As a bank, what do I need to do?”

1. First, it is important for banks to develop a robust method for calculating their overall recovery capacity, as posed by the diagram above. While the EBA suggested methodology comprises a good validation approach, firms could question whether this is the appropriate one to calculate their ORC based on their distinctive nuances.

2. In ensuring that the severity of scenarios reflect the challenges and risks brought by an unprecedented crisis, firms could consider further indicators and actions when developing a fully-fledged approach on ORC, based on lessons learnt from recent events.

• Consider potential additional options:
  Based on Deloitte’s extensive experience in supporting clients in their recovery planning, as well as the testing and operationalisation of such plans, one common observed challenge has been optionality and a lack of an ‘outside-in’ view of the recovery options. Through the application of an external lens and leveraging valuation capabilities, an exhaustive search of options can provide banks with a broader set of tools and strategies to navigate through financial stress, ensuring a viable outcome for the business.
• Ensure coordinated effort between Group and subsidiaries:
  Scenarios should include other considerations beyond the level of the parent entity, especially in terms of quantification of recovery capacity – i.e. effectively assessing the quantity and availability of critical resources across the entire group, estimating the time required to reach objectives, the ability to access funding sources and central bank facilities, ensuring sufficient scenario and risk analysis etc.
  
  Firms can also further challenge the credibility of their identified options to substantiate these in terms of the interplay between the parent entity and subsidiaries. This can be achieved by considering the coordinated action that needs to be taken at a parent-level in order to support to its subsidiaries, such as the feasibility of deploying multiple options.

3. Solve the executability challenge:
Another important consideration is the removal of impediments and increasing capacity as regards the executability of the identified recovery options. Firms are encouraged to ensure they have the bandwidth to actually implement these actions, especially when the entire market is under pressure. By reducing operational capacity concerns, overall recovery capacity can be calculated more accurately, also demonstrating to the regulators that the executability of options is feasible.

Firms are also encouraged to include time constraints considerations in their ORC assessments so as to reflect any changes in capabilities and prove workable even in fast-burn situations.

Additional operational considerations could include the cost of executing the options, given the expected increased costs of specialist support, retaining key staff and the impact which this may have on navigating through recovery.

4. Consider external support:
Other support from outside the organisation could be brought in to mitigate the above challenges, and validate steps and executability based on how recovery would work practically.

5. Firms could also consider running ‘walkthroughs’ to help identify bottlenecks and enhance confidence in existing options or identify new options. Through these exercises, firms can adjust their strategy and approach using an existing scenario and test the decision-making and capabilities in their recovery capacity, while recognising and discussing impediments which could lead to identifying further actions.

6. An additional consideration may include ensuring alignment between recovery and resolution planning and demonstration of sufficient capabilities. ORC could be utilised as a basis for supporting resolution execution beyond recovery. For example, those recovery actions not completed during recovery may continue during resolution or post-resolution restructuring. This approach could enhance the understanding of the entire capacity that could be deployed during any stressful period, surpassing the minimum needed to recover from a hypothetical recovery plan stress scenario.

In terms of implementation, the expectation is that all new recovery plans post-implementation date (i.e. 27 of October 2023) should contain overall recovery capacity assessments and have regard to the finalised guidelines. This updated approach of determining the ORC should ultimately be helpful for both firms and Boards in successfully navigating out of recovery and ensuring that what remains is a viable business.