CRD Pillar 2

The Supervisory Review and Evaluation Process (SREP) is the central instrument of banking supervision for assessing an institution's risk profile. In the SREP, supervisors (BaFin/Bundesbank for LSIs, ECB for SIs) assess four core areas: (1) viability of the business model, (2) internal governance and risk management, (3) capital risks and capital adequacy (ICAAP), (4) liquidity risks and liquidity adequacy (ILAAP). The result is an overall SREP score from which individual capital requirements (P2R) and capital guidance (P2G) are derived. The SREP cycle typically takes place annually, with the intensity varying proportionally to the size and complexity of the institution. ADVISORI supports institutions in systematically preparing for all four SREP elements.

P2R (Pillar 2 Requirement) is a binding capital requirement that must be met at all times. It is set individually during the SREP and covers risks not adequately captured by Pillar 1. P2G (Pillar 2 Guidance) is a non-binding capital expectation above the overall capital requirement. Falling below P2G does not automatically trigger supervisory measures but initiates intensified dialogue with the supervisor. In the buffer stacking order, CET1 capital is first used to meet Pillar 1 and P2R, then the capital conservation buffer, countercyclical buffer, systemic risk buffer, and only then P2G. The MDA trigger (Maximum Distributable Amount) is activated when the combined buffer requirement is breached.

ICAAP (Internal Capital Adequacy Assessment Process) and ILAAP (Internal Liquidity Adequacy Assessment Process) are the internal counterparts to the supervisory SREP. In the ICAAP, the institution must demonstrate that it has sufficient capital to cover all material risks – both from a normative perspective (regulatory ratios) and an economic perspective (risk coverage potential). The ILAAP analogously assesses liquidity adequacy. Both processes feed directly into the SREP assessment and are the essential basis for setting P2R and P2G. The ECB guidelines on ICAAP and ILAAP define seven principles, including the responsibility of the management body, integration into overall bank management and proportionality of methods.

The risk-bearing capacity calculation (Risikotragfähigkeit/RTF) is the centrepiece of the ICAAP. It ensures the institution always has sufficient capital to cover all material risks. Since the BaFin guidelines of 2018, the RTF is performed in two perspectives: The normative perspective checks whether regulatory capital ratios are maintained over a three-year planning horizon – in both the baseline and adverse stress scenarios. The economic perspective values risks on a present-value basis and compares them against internal capital. Both perspectives must be consistent and are assessed by supervisors in the SREP. Typical challenges include consistency between both perspectives, modelling of concentration risks, and integration of ESG risks, which are gaining importance under CRD VI.

CRD VI and CRR III bring significant changes to the Pillar 2 framework: ESG risks must be systematically integrated into ICAAP and ILAAP, including climate stress test scenarios and transition risk assessment. Proportionality is strengthened – small, non-complex institutions (SNIs) receive simplified requirements. The fit-and-proper assessment for senior managers is harmonised EU-wide. The EBA is revising its SREP guidelines to account for output floor rules and the new credit risk standardised approaches. Additionally, governance structure requirements are tightened, particularly regarding diversity and sustainability on supervisory boards. Institutions should use the CRD VI implementation deadline to adapt their Pillar 2 processes early.

ADVISORI guides institutions through the entire SREP cycle: In the preparation phase, we conduct a gap analysis of existing ICAAP/ILAAP frameworks against current supervisory expectations. We identify methodological weaknesses, revise the risk-bearing capacity calculation and develop robust stress test scenarios. For the supervisory dialogue, we prepare structured self-assessments and compile the documentation typically requested by examiners – including capital planning documents, risk appetite statements and governance evidence. Our approach is based on direct experience from over 50 Pillar 2 projects and knowledge of what examiners focus on during BaFin and ECB examinations.