Guidelines on identification and management of step-in risk

The recent global financial crisis showed that banks sometimes have incentives beyond contractual obligation to support unconsolidated entities to which they are connected. In some cases, banks preferred to support certain shadow banking entities in financial distress, rather than allow them to fail and face a loss of reputation, even though they had neither ownership interests in such entities nor any contractual obligations to support them.

In this context, following the two consultation papers published in December 2015 and March 2017, the BCBS published Guidelines on the identification and management of step-in risk with the aim at mitigating potential spillover effects from the shadow banking system through the application of more generic lessons about risk related to banks’ connections with unconsolidated entities, and, as such, to identify situations where step-in risk exists and needs to be anticipated.

To this end, these Guidelines entail no automatic Pillar 1 capital or liquidity charge additional to the existing Basel standards. Rather, they provide banks and supervisors with a method for identifying step-in risk and with a list of possible responses that leverage existing prudential tools by informing or supplementing them.

This Technical Note includes an analysis of the content of these Guidelines.

Executive Summary

This conceptual framework, which is intended to enter into force no later than 2020, specifies the role of banks and supervisors for the identification and management of step-in risk.

Scope of application

These Guidelines are applicable to banks subject to the Basel framework.

Main content

• Banks should regularly assess step-in risk taking the following steps:
  • Definition of entities to be evaluated for potential step-in risk (i.e. unconsolidated entities that maintain one of the 3 types of relationships specified by the BCBS).
  • Exclusion of entities immaterial or subject to collective rebuttals
  • Assessment of the remaining entities against indicators (e.g. nature and degree of the sponsorship, degree of influence, implicit support, etc.).
  • Determination of the estimation method and appropriate actions (e.g. inclusion of an entity in the regulatory scope of consolidation, conversion approach).
  • Reporting of the self-assessment, using the templates provided by the BCBS.
• In addition to the regular self-assessment, banks must establish policies and procedures that describe the processes used to identify entities that are unconsolidated and the associated step-in risks.

• Regarding supervisors, they should review banks’ policies and procedures and their regular step-in risk self-assessments.
• Supervisors should have the authority to ask banks to remedy any deficiencies in their risk management approach.

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