ERM Glossary: Internal capital adequacy assessment process (ICAAP)

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Firms subject to the EU’s Capital Requirements Directive are required to review the amount of capital they internally think they need to hold to face the risks to which they are exposed. Features of an ICAAP that national supervisors such as the UK’s Prudential Regulation Authority generally expect to be present include:

(a)    Firms need to take responsibility for ensuring that the capital they have is adequate, and the ICAAP is an integral part of meeting this requirement

(b)   The ICAAP and the internal processes and systems supporting it should be proportionate to the nature, scale and complexity of the firm’s activities. It should include suitable stress testing, reverse stress testing, scenario analysis and other capital management disciplines that capture the full range of risks to which the firm is exposed. It should enable these risks to be assessed against a range of plausible yet severe scenarios. If models are used in the ICAAP then they should be appropriately conservative and have a suitable structure, parameterisation and governance.

(c)    Supervisors may also have specific expectations on how detailed an ICAAP might be for an IRB firm and in relation to its treatment of specific types of risk, such as liquidity risk, market risk, group risk, operational risk, currency risk and pension obligation risk.

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