ECB told not to take banks' word for it when assessing risk

FRANKFURT (Reuters) - The European Central Bank should stop relying on banks' self-assessments when setting capital requirements and do its own homework instead, independent experts said on Monday.

It was the most notable recommendation in a report commissioned by the ECB to evaluate its work on the key task as the euro zone's top financial supervisor, namely to decide how much capital banks must have to absorb losses.

The review was launched in September, well before problems at Silicon Valley Bank in the United States and Switzerland's Credit Suisse raised questions about banking watchdogs. But its findings chime with recent calls for tougher checks.

The ECB has been blending its analysis with the banks' own to come up with capital requirements.

But the five experts - all former bank supervisors from Japan, the United States, Ireland, Spain and Canada, respectively - said this approach was "conceptually weak" and banks' own Internal Capital Adequacy Assessment Process (ICAAP) was often biased, so it shouldn't be relied upon.

"Banks’ self-evaluations are often subject to biases that may become even more significant when ICAAPs play a prominent role in the determination of P2R (Pillar 2 requirements)," the experts said in the report, referring to the second of three tiers of bank capital requirements set under global rules.

"ICAAPs should be used as ancillary information, rather than the basis for the analysis."

They told the ECB to change the way it sets capital demands and focus "on specific risks requiring additional capital coverage, while significantly limiting the use of ICAAPs".

The ECB's top supervisor Andrea Enria said the recommendations strengthened his "conviction that supervision needs to become more adaptable, intrusive and risk-focused".

Fellow ECB supervisor Elizabeth McCaul welcomed a recommendation to use more "qualitative measures" with banks, which she said could include "limitations on business activity, demanding changes in the board and management, and monetary sanctions".

Euro zone banks have come out unscathed from the recent turmoil in the banking sector, with Enria recently saying they were solid, also thanks to stricter rules in the European Union than in the United States.

Still, in a podcast published on Monday, Germany's central banker Joachim Nagel said recent events should spur supervisors to address the "black spots" in their vision.

(Reporting by Francesco Canepa and Huw Jones; Editing by Susan Fenton)