Enhancing the second line of defense framework
Over the past several years, the Federal Reserve Board (FRB) and the Federal Deposit Insurance Corporation (FDIC) (collectively, “the Agencies”) have shifted their focus on resolution planning, now emphasizing the capabilities that banks must demonstrate in order to have a credible plan. Through their feedback letters to institutions, guidance, and FAQs, it is evident that the Agencies are emphasizing plan execution rather than conceptual strategy.
Banks’ first lines of defense (FLOD) should demonstrate that they can execute the plan to the Agencies. By using the second lines of defense (SLOD) to review controls, manage internal testing, and provide credible challenge, banks may be able to reduce the chances of the Agencies finding a firm’s plan “non-credible.” Ultimately, banks should demonstrate that required actions are replicable in order to reduce exposure to agency criticism.
One key to success? Accurate and precise data. Banks have the opportunity to leverage data to improve resolution planning processes continuously, which captures data that demonstrates they can execute their preferred resolution strategy. That same data can be used to improve efficiencies and avoid potential identified shortfalls or deficiencies.
By embracing resolution planning’s complexity, banks can accelerate their performance to lead the industry and better navigate resolution planning challenges, especially as changes occur.
Resolution planning SLOD framework considerations
The SLOD should have accountability and responsibility for comprehensively testing all key components pertaining to resolution plan submissions. By leveraging the SLOD to test plans in their entirety, banks can gain a wealth of data that can drive efficiencies and effectiveness in the resolution planning process.
Considerations for each of the areas the SLOD should test in their resolution plans include:
Resolution Planning plan sections
- Review of compliance with Agencies requirements under the capital section, liquidity section, narrative, public section, etc.
- Assessment of methodology for estimating the amount of capital that may be needed to support each material entity after the bankruptcy filing
- Review of existing process and internal controls to identify missing risk points, missing process/control activities
- Analysis of required board actions tied to pre-action triggers/existing agreements
- Assessment of the integration/alignment with bank’s multiple concurrent regulatory programs
- Operating effectiveness testing of key resolution planning controls
Playbook & assumptions
- Review of current governance playbook against Agencies requirements and industry leading practices
- Review of how the trigger framework and escalation protocols have been incorporated into the playbook and aligned with Enhanced Prudential Standards requirements
- End-to-end process assessment around the development, review, and challenge of resolution planning assumptions
- Credible challenge to strategy assumptions
Robotic process automation
- Analysis of existing manual processes and error logs
- Deployment of automation to gain efficiency in the process, where applicable
- Detection of errors earlier through automation, boosting the testing effectiveness
- Building out predictive analytics to assist with the monitoring program and financial statements review
- Identification of affected areas by resolution plan scenarios and assumptions for testing, and any preceding upstream workstreams, functions, and product groups; assess the integration/alignment with the bank’s multiple concurrent regulatory programs
- Validation of the data used for generating the resolution plan’s financial projections
- Identification and categorization of issues based on materiality threshold and management reporting framework after confirmation of issues; develop remediation roadmap
Legal entity rationalization
- Assessment and validation of current legal entity alignment; recommend changes for improved resolvability
- Review of corporate governance documents to assess integrating resolution planning in operating processes
- Validation of the legal entity assumptions/outcomes and business-as-usual (BAU) controls
- Assessment of critical services mapping data
- Review of taxonomy for critical operations (COs) and mapping of critical services between COs
- Review of critical non-financial assets (people, real estate, etc.) and third parties required to support critical services; assess the cost allocation/calculation process
- Evaluation of accuracy and completeness of identified critical services and essential critical components, service-level Agreements (SLA)
- Validation of critical services assumptions/outcomes and BAU controls
- Assessment of the inventory of key management information systems and other capabilities supporting the covered company’s core business lines and critical operations, mapped to the legal ownership
- Identification of weaknesses/deficiencies in these capabilities and processes to collect, maintain, and report information, and review plans to remedy any such deficiencies (ex-ante actions)
Institutions that aim to develop or enhance their SLOD capabilities should consider the typical challenges associated with standing up the second line function around resolution planning, including:
- New second line resources may encounter steep learning curves of the organizations, the SLOD processes, as well as knowledge of resolution planning areas
- Roles of FLOD and SLOD are often still being determined, thus limiting the development of the functions, and potentially resulting in redundancy, overlap, and an increased burden on the business
- FLOD responsibilities and capabilities may still be under development and don’t allow complete coverage from testing perspective
- New systems and processes are being developed, which may not represent the assumptions (plan vs. reality)
- Lack of well-defined, end-to-end process over reporting, data accuracy, and effectiveness of underlying controls, inclusive of self-assessment, validation and reporting
- Cost constraints can extend implementation timelines for the buildout of the second line while Agencies are focusing more on their ability to execute
Preparing the SLOD and broader resolution planning team to overcome these challenges is a daunting task. Deloitte’s deep experience in resolution planning can help organizations with the development and execution of independent testing activities. For more information on how we can assist, please contact:
Managing Director | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP
Principal | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP
Independent Senior Advisor to Deloitte & Touche LLP
Deloitte & Touche LLP
Senior Manager| Deloitte Risk and Financial Advisory
Deloitte & Touche LLP
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