1. Defining ICAAP

The "ICAAP" is a comprehensive, internal process required by banking regulators (such as those following the Basel Accords) for an institution to assess the risk it faces and determine the amount of internal capital needed to cover those risks. It moves beyond the minimum regulatory capital requirements ("Pillar 1") to ensure that the bank holds sufficient capital against "all material risks" it faces.

Purpose

To ensure the bank has robust systems to identify, measure, monitor, and control risks, and maintain capital commensurate with its risk profile.

Context

It forms the core of "Pillar 2" (Supervisory Review Process) of the Basel framework, linking risk management directly to capital adequacy.

2. The Four Pillars of ICAAP Success

01

Sound Governance & Oversight

The Board of Directors and senior management must actively oversee the ICAAP. This includes defining risk appetite, approving the framework, and ensuring resources are dedicated to risk management.

02

Comprehensive Risk Identification

A rigorous process to identify and measure *all* material risks including Pillar 1 risks (Credit, Market, Operational) and Pillar 2 risks (e.g., Concentration, Liquidity, Reputational).

03

Capital Planning & Calculation

Quantifying the capital required to cover the assessed risks. This involves projecting capital needs under normal operating conditions and over various time horizons.

04

Rigorous Stress Testing

Testing the resilience of the bank's capital position under severe but plausible scenarios. This dictates whether the bank needs a 'Capital Buffer' above the minimum.

3. Material Pillar 2 Risks Addressed by ICAAP

Pillar 2 risks are those not fully captured by the standardized calculations under Pillar 1. Assessing these is where the true value of ICAAP lies.

Concentration Risk

The risk of losses arising from a large exposure to a single counterparty, industry, geographic region, or product type. ICAAP ensures diversification is measured and capitalized.

IRRBB (Interest Rate Risk in the Banking Book)

The risk to a bank's capital and earnings arising from adverse movements in interest rates that affect the value of assets and liabilities held in the banking book.

Liquidity Risk

The risk that a bank is unable to meet its cash flow obligations (both expected and unexpected) without affecting its daily operations or financial position.

Reputational & Strategic Risk

Reputational Risk: The potential for loss arising from damage to a bank’s reputation. Strategic Risk: The risk to earnings or capital arising from poor business decisions or poor implementation of strategy.

4. The Link to SREP

The ICAAP is the "bank's internal view" of its capital needs, while the "Supervisory Review and Evaluation Process (SREP)" is the "regulator's external review" of the ICAAP. The SREP assesses the bank's internal processes and results, often resulting in a "Pillar 2 Requirement (P2R)" or "Pillar 2 Guidance (P2G)".

  • "P2R" is a mandatory, legally binding capital requirement set by the supervisor.
  • "P2G" is a recommendation for a capital buffer, which is not legally binding but should be met.
  • This interaction ensures that the bank's internal assessment is rigorous and aligns with supervisory expectations.