The Internal Capital Adequacy Assessment Process (ICAAP),
                the Internal Liquidity Adequacy Assessment Process (ILAAP)
            and their supervisory review, and the Business Model Analysis (BMA)
                     METHODOLOGY MANUAL FOR SUPERVISED INSTITUTIONS1
        Revised: December 2021
        1 This is the English version of MNB’s handbook with the following title: „A tőkemegfelelés belső értékelési folyamata (ICAAP), a likviditás
        megfelelőségének belső értékelési folyamata (ILAAP) és felügyeleti felülvizsgálatuk, valamint az üzleti modell elemzés (BMA) módszertani
        kézikönyv a felügyelt intézmények részére” (“Internal Capital Adequacy Assessment Process (ICAAP), Internal Liquidity Adequacy Assessment
        Process (ILAAP), and their Supervisory Review Process and Business Model Analysis (BMA) Methodology Manual for Supervised Institutions.”).
        This translation is not official, the Hungarian manual shall be considered as normative text. 
                                                                                           Contents
                        Contents..................................................................................................................................................2
                    I.      Introduction...................................................................................................................................9
                        I.1        ICAAP/ILAAP reviews and BMAs as reflected in the SREP.............................................................9
                        I.2        The Internal Capital Adequacy Assessment Process (ICAAP)......................................................10
                            I.2.1     Supervisory principles for ICAAP design.................................................................................12
                        I.3        The Internal Liquidity Adequacy Assessment Process (ILAAP)....................................................15
                            I.3.1     Supervisory principles for ILAAP design.................................................................................16
                        I.4        Business Model Analysis (BMA).................................................................................................16
                        I.5        General principles to be applied in ICAAP/ILAAP reviews..........................................................17
                            I.5.1     Internationally accepted principles........................................................................................17
                            I.5.2     General principles applied in the context of the MNB’s review processes.............................18
                    II.     Scope of the ICAAP, the ILAAP, and their supervisory review........................................................20
                        II.1       ICAAP and ILAAP compliance and the supervisory review process on an individual level..........20
                        II.2       ICAAP and ILAAP compliance and the supervisory review process on a group level..................21
                    III.    Grades of ICAAP review and categorisation of supervised institutions.........................................24
                    IV.     Conduct of ICAAP/ILAAP reviews and BMAs.................................................................................24
                        IV.1       Preparations for ICAAP/ILAAP reviews and BMAs......................................................................24
                        IV.2       Requests for documentation to support ICAAP/ILAAP reviews and BMAs.................................25
                        IV.3       Supervisory evaluation of ICAAP/ILAAP reviews and BMAs.......................................................26
                        IV.4       Risk mitigation measures and the determination of economic capital and liquidity excess
                        reserve requirements............................................................................................................................26
                        IV.5       Joint risk assessment and decision process................................................................................27
                        IV.6       Closure of ICAAP/ILAAP reviews and BMAs, supervisory measures...........................................28
                            IV.6.1        Cases in which measures related to the overall supervisory review and evaluation process
                            (SREP) are applicable against credit institutions................................................................................29
                            IV.6.2        Cases in which measures related to the overall supervisory review and evaluation process
                            (SREP) are applicable against investment firms.................................................................................32
                        IV.7       Annual evaluation for institutions on the lessons learned from the overall SREP......................34
                    V.      The elements and supervisory review of the ICAAP......................................................................35
                        V.1        ICAAP governance and control systems – risk management......................................................35
                            V.1.1         ICAAP awareness................................................................................................................35
                            V.1.2         Level of ICAAP regulation, governance and internal audit.................................................36
                            V.1.3         Framework set up for the internal capital adequacy assessment process.........................37
                            V.1.4         Integration of ICAAP...........................................................................................................38
                            V.1.5         Risk strategy.......................................................................................................................38
                                V.1.5.1          Risk-taking policy........................................................................................................39
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                      V.1.5.2     Setting risk appetite and the willingness to take risks................................................39
                      V.1.5.3     Target risk structure...................................................................................................40
                      V.1.5.4     Stages of risk management:.......................................................................................40
                 V.2    Assessment of material risks......................................................................................................42
                   V.2.1     Credit risk...........................................................................................................................43
                      V.2.1.1     Assumptions of the credit risk model.........................................................................45
                      V.2.1.2     Fundamental expectations for models and rating systems........................................46
                      V.2.1.3     Rating models............................................................................................................47
                      V.2.1.4     Estimating the probability of default..........................................................................48
                      V.2.1.5     TTC (Through-the-Cycle) PD.......................................................................................49
                      V.2.1.6     Retail TTC PD – supervisory benchmark.....................................................................51
                      V.2.1.7     Corporate PD – supervisory benchmark.....................................................................52
                      V.2.1.8     Applying EU benchmark PDs......................................................................................52
                      V.2.1.9     Application of a sovereign floor.................................................................................52
                      V.2.1.10    Capital requirement of securities issued under the MNB’s Bond Funding for Growth
                      Scheme      52
                      V.2.1.11    Estimation of the loss given default ratio...................................................................53
                      V.2.1.12    Retail mortgage LGD – supervisory benchmark.........................................................54
                      V.2.1.13    Non-performing items, expected loss and provisions................................................55
                      V.2.1.14    Holdings (Equity exposures).......................................................................................56
                      V.2.1.15    Specialised lending exposures....................................................................................58
                      V.2.1.16    Income producing real estate projects’ capital requirement and expected loss
                      calculation – supervisory benchmark...........................................................................................60
                      V.2.1.17    Treatment of off-balance sheet items........................................................................61
                      V.2.1.18    Counterparty risk.......................................................................................................62
                      V.2.1.19    Counterparty credit risk from White Label contracts in investment firms.................65
                      V.2.1.20    Credit valuation adjustment risk (CVA)......................................................................66
                      V.2.1.21    FX lending risk............................................................................................................66
                      V.2.1.22    Residual risks..............................................................................................................68
                      V.2.1.23    Settlement risk...........................................................................................................69
                      V.2.1.24    Free deliveries............................................................................................................71
                      V.2.1.25    Securitisation risk.......................................................................................................72
                      V.2.1.26    Concentration risks....................................................................................................74
                      V.2.1.27    Country risks..............................................................................................................80
                      V.2.1.28    Risk of other assets....................................................................................................81
                      V.2.1.29    Calculation of capital requirements for credit risk.....................................................81
                      V.2.1.30    Preferential capital requirements prescribed by the MNB.........................................82
                   V.2.2     Operational risks................................................................................................................85
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                   V.2.2.1 Operational risk.....................................................................................................................85
                   V.2.2.1.1 Legal and conduct risk........................................................................................................91
                   V.2.2.1.2 Information and communications technology (ICT) risk.....................................................94
                   V.2.2.2 Reputational risks..................................................................................................................95
                   V.2.3     Market risk.........................................................................................................................97
                   V.2.4     Interest rate risk in the banking book...............................................................................101
                   V.2.5     Model risks.......................................................................................................................107
                   V.2.6     High-risk portfolios...........................................................................................................109
                   V.2.7     Other relevant risks..........................................................................................................110
                      V.2.7.1     Risks of the regulatory environment........................................................................110
                V.3     Stress tests...............................................................................................................................111
                   V.3.1     Reliability of the risk models applied...............................................................................113
                   V.3.2     Adoption of an integrated risk management approach....................................................113
                   V.3.3     The practical application of the principle of proportionality at small institutions............115
                V.4     Description of the stress-testing framework used to determine capital guidance...................116
                V.5     Determination of capital requirement.....................................................................................121
                   V.5.1     Differences concerning the degree of sophistication of applied methods.......................121
                   V.5.2     Potential differences between Pillar 1 and 2....................................................................121
                   V.5.3     Allocation of capital..........................................................................................................123
                   V.5.4     Determining the required capital after the supervisory review.......................................123
                      V.5.4.1     Determination of additional own funds requirements.............................................123
                      V.5.4.2     SREP capital requirement (TSCR)..............................................................................125
                      V.5.4.3     Total SREP capital requirement ratio........................................................................125
                      V.5.4.4     Combined capital buffer requirement......................................................................126
                      V.5.4.5     Overall capital requirement (OCR)...........................................................................127
                      V.5.4.6     Pillar 2 capital guidance (P2G)..................................................................................127
              VI.  Components and supervisory review of ILAAP...........................................................................128
                VI.1    The institution’s internal assessment of liquidity and funding risks.........................................128
                VI.2    Supervisory liquidity adequacy assessment process................................................................131
                   VI.2.1    Comprehensive assessment of liquidity and financing risks.............................................131
                   VI.2.2    Additional Requirements due to risk management deficiencies......................................132
                   VI.2.3    Key aspects of calculating Pillar 1 requirements..............................................................133
                   VI.2.4    Portfolios that are risky in terms of liquidity....................................................................133
                   VI.2.5    Calculation and compliance with Pillar 2 liquidity requirements.....................................133
              VII.    Business model analysis.........................................................................................................134
              I.   Business model analysis.............................................................................................................134
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