3 July 2025

In 2024 the European Central Bank (ECB) announced its decision to simplify its Supervisory Review and Evaluation Process (SREP). The SREP gives banking supervisors a methodological framework for assessing the soundness of supervised banks and their risk management procedures in a regular, uniform and structured manner. Specifically, the process applies to 114 significant banks across the 20 euro area countries and Bulgaria, which has established close cooperation with the ECB. Together, these banks represent 82% of total banking assets across all 21 countries.

When conducting the SREP, supervisors focus on the banks’ business models, internal governance and risks to their capital and liquidity positions. This process is part of the European framework of rules and regulations, specifically the guidelines issued by the European Banking Authority.^[1]

The SREP assessment gives supervisors an overview of each bank in addition to a more in-depth evaluation of their strengths and weaknesses with respect to the main types of risk, which also makes it possible to fine-tune the level of scrutiny required. It also facilitates comparison across institutions or peer groups.

Lastly, the SREP serves as the basis for determining Pillar 2 requirements, i.e. the capital requirements which complement the minimum regulatory requirements to address the specific risks of each bank which are not, or not adequately, covered under Pillar 1. As a reminder, Pillar 1 covers only the minimum capital requirements for credit risk, market risk and operational risk based on standardised methodologies or internal models validated by the supervisor.

Since the establishment of the Single Supervisory Mechanism in 2014, the SREP has evolved significantly to adapt to new risks and regulatory developments. In a report published in April 2023, a group of international, independent experts set out their analysis of how the SREP operates^[2]. Recommendations made in the report include streamlining processes, enhancing risk prioritisation and using qualitative measures more systematically to remedy weaknesses in banks’ business models and internal governance. These recommendations were incorporated into the review of supervisory processes launched in 2024.

The reform presented in May 2024 by the Chair of the Supervisory Board of the ECB, Claudia Buch, encourages supervision to focus more on the most significant risks, while promoting qualitative judgement tailored to each bank. It is structured around several main themes.

First and foremost, supervisory activities are now more closely aligned to the ECB’s annual supervisory priorities^[3] so that inspections taking into account the business environment and bank-specific risks can be planned throughout the year. The multi-year assessment introduced in 2023 has now been fully implemented. In practice, bank risks are still assessed holistically, but Joint Supervisory Teams comprising ECB staff and supervisors from the relevant national prudential authorities focus their attention each year on specific risks and assess the remaining risks in more detail at a later stage. In this way, supervisory resources are allocated on the basis of actual developments in the risks identified.

The SREP timeline has been shortened. Risk assessments that are not related to the publication of annual financial statements in the first quarter – mainly those of business models, internal governance and other qualitative issues – are now performed throughout the year at the discretion of the supervisory teams. As of this year, the draft SREP decisions will be shorter in order to focus on the ECB’s main concerns. They will spell out exactly what remedial actions the banks are expected to undertake. Proportionality has been stepped up, especially for smaller banks. For banks with a stable risk profile, SREP decisions will be updated every two years, unless there has been a material change in their situation.

Finally, greater integration of the different supervisory activities – on-site inspections, in-depth analyses and thematic reviews –will enable better coordination, giving supervised banks a clearer picture of the supervisory priorities and what they are expected to improve. The adoption of advanced digital tools and the use of more sophisticated analytical systems, including artificial intelligence, will make it possible to optimise data management and resource allocation.

These changes will be fully implemented in the 2026 SREP cycle.

As announced on 11 March 2025^[4]. the methodology for setting Pillar 2 requirements has also been revised to make it simpler and more transparent. The strong link between the SREP and the Pillar 2 requirements has not only been maintained but strengthened.

It should be noted that this methodology has always been fundamental to ensuring that banks are adequately capitalised. This financial strength has enabled European banks to withstand the economic shocks of recent years, be it the COVID-19 pandemic, the volatility caused by the US regional bank crisis in early 2023 or the macroeconomic uncertainties stemming from current geopolitical tensions.

This review had two main objectives: to make the approach more robust and ensure that risks are not counted twice, and to simplify procedures to take better account of the main risks as well as supervisory judgement.

The new approach still relies on an overall assessment of each bank’s risk profile, as reflected in their overall risk score, which is both the basis for the Pillar 2 calculation and the main focus of discussions with bank management teams.

The previous method was based directly on the findings of the internal capital adequacy assessment process (ICAAP), which consists of banks assessing their own internal capital requirement over and above the Pillar 1 requirement through, for example, comprehensive stress tests and internal capital planning.

The revised methodology distinguishes between the initial quantitative Pillar 2 value and the quantitative outcome from the ICAAP. The focus will now be placed on supervisors using their judgement if necessary to adjust the quantitative requirements based on their assessment of the specific risks not covered under Pillar 1.

This approach will result in fewer intermediate steps, making it easier to prioritise the various types of risk (credit, market, operational, etc.) while ensuring they are not counted twice.

In practice, the Pillar 2 requirements are now driven more directly by the most relevant risk areas identified by the SREP. The highest risks will result in less favourable SREP scores and consequently a higher Pillar 2 requirement. This change will make determining the capital add-on more transparent.

These changes will enable banks to better understand their Pillar 2 requirements and therefore take more targeted action.

In addition, given that the new methodology is embedded in the wider SREP process, which is still based on supervisors’ assessment of each bank’s risk profile, it is not expected to result in significant changes to the average Pillar 2 capital requirements.

Complying with prudential requirements is a fundamental principle which underpins the stability of the European financial system. The ECB has a duty to act quickly as soon as a supervised entity is found to have weaknesses or inadequate practices. To deal with banks that are slow to remedy these deficiencies, legislators have equipped the ECB with a full set of supervisory tools which it uses in a proportionate manner.
Article 16 of the SSM Regulation^[5]confers a wide range of “supervisory powers” on the ECB, which are tailored to each bank’s specific situation when addressing deficiencies or non-compliance with prudential requirements. These powers include, for example, a requirement for banks to hold supplementary capital, reinforce arrangements and strategies, present a plan to comply with supervisory requirements, apply a specific provisioning policy, restrict certain businesses or operations, and limit variable remuneration and distributions to shareholders.

These tools are particularly useful for addressing the root causes of deficiencies, notably in banks’ internal governance or risk management procedures.

International reports written about the March 2023 banking crises recommended the extensive use of these tools to encourage banks to take remedial action as quickly as possible. In the same vein, the report by a group of international, independent experts, consulted before the reform was undertaken, encouraged the ECB to use all its supervisory tools more systematically as part of the SREP, which is one of the focus areas of the current reform.

The ECB escalation framework is designed to be flexible and relies on the judgement of the supervisory teams while adapting to the severity of the findings. This approach includes the wider use of binding qualitative requirements, such as enforcement measures.

The enforcement measures directly available to the ECB include periodic penalty payments imposed on banks that consistently fail to meet the requirements set out in the regulations or ECB decisions. The aim is to encourage banks to meet requirements as quickly as possible. For each day that they are in breach of these requirements, they have to pay an amount equivalent to up to 5% of their average daily turnover for a maximum period of six months, at the end of which other measures can be taken. The penalties imposed on banks are published on the ECB’s website.

The supervision of climate-related and environmental risks is a good example of this approach. The ECB has set deadlines for banks to improve their practices to meet the expectations outlined by supervisors in this area. It has issued binding decisions coupled with potential periodic penalty payments for 18 of the 23 banks that have still not met the requirements with an initial deadline of March 2023. A new assessment is ongoing.

The SREP is central to ECB Banking Supervision. The systematic assessment of risks that banks face, along with how they manage them, is not new. Similar arrangements have existed for many years in other parts of the world. In the United States, for example, the CAMELS (capital adequacy, asset quality, management, earnings, liquidity, and then later sensitivity to market risk) rating system was introduced in 1979. These types of assessment also existed in most European countries, but the decision to entrust the ECB with the role of single supervisor has made it possible to harmonise the approach taken on the basis of the EBA Guidelines on SREP^[6].

In 2025, the ECB continues to update its methodology. The SREP reform proposes a more flexible, targeted and transparent approach. The review of Pillar 2 requirements will help to ensure even closer alignment between the level of risks identified and the level of capital required, thus ensuring greater resilience when faced with potential crises.

In addition, the increased use of supervisory powers has strengthened the SREP’s ability to turn the detection of deficiencies into timely and proportionate remedial action. Modernising the SREP is therefore part of an ongoing effort to simplify and improve the efficiency of European banking supervision and should help to promote clearer and more constructive communication between supervisors and banks.