**3.1 Business model analysis (BMA) and viability assessment**

Within the SREP process, one of the main moments of assessment is represented by the analysis of the business model of financial intermediaries and the related operational and strategic risks (Business Model Analysis) aimed at establishing the economic (viability) and strategic sustainability of the business model20 of the institution based on its ability to generate acceptable profits over the next 12 months and over a three-year horizon. With the BMA, legislators attempt to investigate in detail the profitability of the current and prospective business model, but also to assess its resilience and weaknesses, which could jeopardise the future survival of the bank and which may not be highlighted by other elements of the SREP. The business model is not to be confused with the concept of "intermediation model". On closer inspection, the former refers to a broader concept that encompasses both the issue of the intermediation model and other aspects such as the use of technology, the creation of value for the set of stakeholders and the management and operation of the most relevant processes (Maurizio [8]). The business model describes the logic with which an organisation creates, distributes and captures value [9]. However, there is no unambiguous definition of the business model in the literature, nor have European legislators ventured to define it in relation to the financial intermediation sector (Di [10]).

From this perspective, it is clear that the introduction of the BMA within the SREP process is a clear sign of the importance that European lawmakers assign to strategic planning and therefore to the choice of the intermediary's business model, which, as is well known, has a large impact on the levels of profit produced. The latter is an issue of strategic importance given the negative trend in profitability in the context of the low profitability of Italian and European banks caused by the international financial crisis and the strong tightening of prudential supervisory obligations on risk, capital and liquidity, which require a thorough review of the intermediary's strategic choices along possible lines of development of intermediation margins (Artificial Intelligence, attention to sustainable or rather ESG-oriented finance, etc.). The possibility for a bank to exploit resources with a high technological content, albeit following significant initial investments, allows it to achieve cost-reduction objectives, especially with regard to traditional credit activities, but in general for all activities whose costs (e.g. personnel costs) are not adequately remunerated by the revenues generated [11].

While it is true that business model choices have an impact on the profitability of individual banks, they also have important implications for the stability of the

<sup>20</sup> The EBA defines the concepts of economic and strategic sustainability as follows:

<sup>•</sup> The viability of the entity's business model is its ability to generate acceptable profits over the next 12 months.

<sup>•</sup> The sustainability of the institution's strategy is its ability to generate acceptable profits over a time horizon of at least three years, depending on its strategic plans and financial forecasts.

#### *Basel IV: The Challenge of II Pillar for Risk Management Function DOI: http://dx.doi.org/10.5772/intechopen.96929*

entire financial system (through funding structure,21 revenue composition, cost composition, ownership structure), which is why the BMA has been given an important role in the overall Pillar 2 prudential control process.

The BMA starts with a preliminary assessment of the environment the bank operates in, with particular reference to its core activities. In this initial step, the supervisor is required to assess a number of parameters (total revenues/costs, market position, etc.) and monitor their evolution over time in order to have a clear picture of the condition of the institution and to establish the relevance of its business areas in the context of reference. Competent authorities should use this preliminary assessment to establish the materiality of business lines/areas (i.e. determine which geographic areas, subsidiaries/branches, business lines and product lines are the most relevant based on profit contribution, risk and/or organisational/regulatory priorities -specific requirements for public sector banks to offer certain products- identify the peer group based on competing product/business lines that target the same source of profits/customers, support the application of the proportionality principle.

After the preliminary macroeconomic assessment, the competent authority should focus on the current business model, on the business lines that are most important in terms of viability or future sustainability of the current business model and/or that are most likely to increase the institution's exposure to existing or new vulnerabilities, whereby they should assess the relevance of the business lines, previous SREP findings, findings and observations of internal and external audit reports, the importance of strategic plans identifying any business lines to be substantially increased or decreased, results of topical supervisory reviews, observed changes in the business model and peer comparisons (i.e. whether a business line has performed atypically compared to peers). As outlined in the EBA guidelines on the SREP process, the areas for which authorities are tasked with conducting analysis should include, at a minimum, an assessment of the trend in profits and losses in recent years, looking at the most significant indicators of banking activity such as net interest income, net banking income, cost-to-income ratio and loan impairment rate; the composition of the balance sheet in recent years, with particular attention to the composition of liabilities; the concentration of assets by customer, sector or geographic area; an assessment of the intermediary's risk appetite, taking into account the formal definition of the current limits and the real tendency to respect them in practice; and finally an assessment that takes into account both internal and external factors capable of impacting on the functioning of the business model.

It should be made clear that the BMA has as its ultimate goal:


In other words, the supervisors' "ultimate" objective is to assess whether the financial intermediary, with its business model and strategy, is credibly capable

<sup>21</sup> As an example, as can easily be guessed the risks associated with the structure of the funding assume greater weight if the funding is wholesale, while they have less impact with reference to funding mainly based on deposits, which is more stable by definition. A market-oriented model certainly hides more pitfalls than a traditional credit intermediation model due to the greater volatility of its results. Finally, with regard to the last two points, situations of instability can certainly derive from cost inefficiency and from ownership policies oriented more towards satisfying shareholders rather than practices consistent with the objective of stability and profitability in the short and medium term. See Financial Stability Review. ECB, May 2016.

of generating acceptable returns over a short (12-month) and long-term (three-year) time horizon.

The BMA does not aim to give a rating to the possible business models since the choice of these remains the responsibility of the management body, but to assess viability and sustainability*,* therefore verifying the bank's ability to generate "acceptable returns" in the time horizons considered (12 months and 36 months). With regard to viability, having carried out the preliminary analysis*,* the Supervisor considers:


After the preliminary assessment, that of the entrepreneurial context, the detailed analysis of the current business model for the purposes of assessing the viability thereof, the Authority must **analyse the forward-looking strategy and financial plans**: the competent authorities should carry out a quantitative and qualitative analysis – over a period of at least three years – of the financial projections and the strategic plan of the entity to understand the assumptions, plausibility and riskiness of the business strategies. With regard to sustainability, the following are considered:


The most obvious problem that arises in the assessment phase of the financial intermediary's business model concerns the existence of documents capable of providing comprehensive information to the supervisory authority on the subject in question. Indeed, in many cases it is difficult to find the documentation relating to the detailed description of the business model adopted or, again, a definition of the responsibilities of the corporate functions involved in the implementation of the activities aimed at complying with the regulatory obligations on the subject. After the process described above and at the end of the BMA process, the authority will have the task of formulating an overall opinion on the business model adopted by the intermediary, highlighting any critical points identified.
