Statement on capital arbitrage transactions

June 2016

Since the publication of Basel III in 2010, Basel Committee members have received numerous requests to review or approve transactions that seek to alter the form or substance of items subject to regulatory adjustments, which are outlined in paragraphs 66 to 90 of the Basel III standard. These include, for example, proposals for structured transactions that result in deferred tax assets being reclassified as a way of seeking to avoid their deduction from the calculation of regulatory capital.

Transactions that are designed to offset regulatory adjustments employ a variety of strategies. For example, these may include: (1) the issuance of senior or subordinated securities with or without contingent write off mechanisms; (2) sales contracts that transfer insufficient risk to be deemed sales for accounting purposes; (3) fully-collateralised derivative contracts; and (4) guarantees or insurance policies. These types of transactions pose a number of risks. They can be complex, artificial and opaque. They can include legal risk and be untested in their ability to fully address the underlying rationale for the regulatory adjustment. Furthermore, they can have the effect of overestimating eligible capital or reducing capital requirements, without commensurately reducing the risk in the financial system, thus undermining the calibration of minimum regulatory capital requirements.

Banks should therefore not engage in transactions that have the aim of offsetting regulatory adjustments. Any such transactions will be subject to careful supervisory scrutiny in the evaluation of risk transfer and the assessment of capital adequacy.