On-site inspections and internal model investigations

To arrive at a comprehensive assessment of banks, supervisors complement off-site analysis with on-site analysis. In Austria, the OeNB is in charge of performing on-site inspections, acting on behalf of the European Central Bank (ECB) in the case of significant banks – which have been subject to direct supervision by the ECB since the Single Supervisory Mechanism (SSM) became fully operational in November 2014. In the case of less significant banks, which are indirectly supervised by the ECB under the SSM, the OeNB continues to act on behalf of the Financial Market Authority (FMA). The findings gained from on-site inspections provide the starting point for official action taken by the ECB and the FMA. The OeNB performs two kinds of on-site inspections:

  1. on-site inspections commissioned by the ECB or the FMA and
  2. on-site investigations of internal models

On-site inspections commissioned by the ECB or the FMA cover the detailed review of the risk management systems and processes used by particular business and risk areas within banks as well as sample checks of individual transactions, such as loan cases. The purpose of on-site investigations of internal models is to assess whether banks meet the prerequisites for calculating their capital requirements with internal models. Approved internal risk models are used above all in the areas of credit and market risk. Applications for model approval are to be submitted to the ECB or the FMA; following investigation of the model the OeNB will report to the ECB or the FMA whether it found the model fit for use.

Both types of inspections differ from off-site analysis insofar as they are limited to a particular time window and to a particular area that is subjected to in-depth investigation by an independent team, typically, at the bank’s premises.

Off-site analysis and on-site inspections

Given the strong presence of Austrian banks in Central, Eastern and Southeastern Europe (CESEE), the OeNB has been involved in cross-border on-site inspections for a number of years. These inspections are performed in cooperation with the competent local supervisory authorities. OeNB experts moreover contribute to on-site inspections of the parent institutions of significant Austrian banks as members of mixed teams or cross-border teams within the SSM.

How are on-site inspections planned?

For significant Austrian banks, the annual inspection plans are developed by the ECB in cooperation with the FMA and the OeNB. The banking supervision divisions of the OeNB are closely involved in the planning of on-site inspections and internal model investigations, as OeNB supervisory resources are needed for the on-site inspection of banks in Austria also under the SSM.

For less significant banks, the annual inspection plans are developed by the FMA and the OeNB one year ahead, subject to the provisions laid down in Article 70 para. 1b Austrian Banking Act. The annual inspection plans also comprise any scheduled internal model investigations with which the OeNB has been tasked, if already known at the planning stage.

The selection of the significant and less significant banks to be included in the annual inspection plans is largely determined by risk criteria and, additionally, the systemic relevance of a credit institution.

On an ad hoc basis, the OeNB may and must ask the FMA to broaden the scope of ongoing inspections or launch unscheduled reviews if this appears necessary. The OeNB may also carry out on-site inspections on its own initiative (under Article 70 para. 1c Banking Act) if macroeconomic reasons warrant such inspections.

How do on-site inspections work?

An on-site inspection commences with the ECB or the FMA issuing an inspection mandate to the OeNB that specifies the scope of examination. Unless advance notification is expected to affect the effectiveness of the review, banks are notified of upcoming inspections and contacted by the bank examiners to discuss organizational details and the data and documentation to be prepared.

The team of OeNB bank examiners consists of a lead examiner and other examiners, whose number depends on the scope of inspection and the size of the bank. An on-site inspection typically involves an assessment of the relevant risk management systems and processes and the corresponding internal documentation as well as sample checks of individual transactions, such as loan cases. Depending on the size of a bank and the scope of examination, on-site inspections typically last a couple of weeks.

Once the inspection has been completed, the bank is informed of the results in a final meeting. The findings of the on-site inspection are documented in a comprehensive report, which is submitted to the authority that requested the inspection (ECB or FMA) and the bank itself. Both less significant and significant banks are invited to comment on the findings, but the processes differ with regard to detail.

Significant banks receive a follow-up letter from the joint supervisory team following the completion of the on-site inspection and the reporting stage, and the joint supervisory team remains in charge of monitoring the implementation of the required measures and recommendations. Less significant banks may comment on the supervisory report and are required to develop an action plan for remedying the identified deficiencies. Moreover, the FMA may take official action as required on the basis of the supervisory report, the examiners’ assessment of comments received from the bank as well as any further information provided by the competent OeNB off-site supervision division.

Process of on-site inspections

How do internal model investigations work?

Reviews of internal risk models are performed along the lines of on-site inspections. The difference is that internal model investigations happen exclusively at the request of a credit institution; the review is part of the model approval procedure. Risk models may be applied in the following risk categories:

  • credit risk (internal ratings-based approach – IRBA)
  • market risk (value-at-risk model – VaR model)
  • operational risk (advanced measurement approach – AMA)
  • own volatility estimates (comprehensive method) for credit risk mitigation techniques, and
  • internal models to determine exposure values in certain transactions

In addition to model approval procedures requested by banks, the ECB has launched a project to undertake a systematic review of all internal models currently used by banks to calculate credit risk and market risk. This major SSM-wide project, known by its acronym TRIM (targeted review of internal models), has been designed to:

  1. ensure that the internal models currently used comply with regulatory requirements and harmonize supervisory practices within the SSM,
  2. assure that banks’ risk models yield correct results as the basis for capital adequacy calculations,
  3. inform the publication of a manual, to reduce the room for interpretation when it comes to the regulation of risk models,
  4. facilitate the risk-based selection of risk models for in-depth on-site investigations.

TRIM seeks to reduce unwarranted variability in the capital requirements calculated by different banks’ internal models and serve as an effective tool for creating a level playing field across the SSM. The TRIM results will be used in the ongoing review of internal models on a sustained basis, thus further strengthening supervisory work in the area of risk models.

the development of the conceptual framework of TRIM in 2016, to which OeNB staff experts were able to make substantial contributions drawing on their modeling know-how, the focus has been on on-site missions since April 2017. In this labor-intensive stage, the OeNB’s model experts perform in-depth reviews of the internal models used by Austria’s largest banks. These reviews cover more than 50% of all internal models used by the top Austrian banks and their foreign subsidiaries.