Capital management and regulatory framework for risk appetite, stress testing and ICAAP

What it is about

Raúl De Gracia Saraceni and Leonidas Rey, from PwC, presented at the Fifth Breakfast Conference (July 2024) how capital management, risk appetite, stress testing and the internal capital adequacy assessment process (ICAAP) relate to one another.

The 37-slide presentation has four parts: the impact of regulatory requirements on capital management, aligning risk appetite with minimum capital requirements, best practices for designing scenarios and stress tests (with EBA and Bank of England guidance) and aspects to consider in the self-assessment of capital adequacy.

Objectives

• Explain how the Basel framework and supervisors' requirements influence capital management.
• Show how to translate risk appetite and tolerance into metrics and limits that can be monitored.
• Give guidance for designing scenarios and stress tests and for implementing the ICAAP.

Key takeaways

1. The ICAAP rests on the three Basel pillars and requires a comprehensive assessment of risks, not just of regulatory capital.
2. Risk appetite must be translated into a statement with tolerances and metrics that trigger actions when thresholds are exceeded.
3. Stress tests must coherently integrate the methodologies of support functions and rely on guidance such as that of the EBA and the Bank of England.
4. Integrating the ICAAP into the risk culture requires senior management support, training, clear policies and continuous communication.
5. Roles: senior management approves the policy and the risk and capital strategy; management implements and reports; operational areas execute and provide accurate data.