Minimum risk-based capital requirements

Banks must meet the following requirements at all times:

The components of capital referred to in RBC20.1 are defined in CAP10 and must be used net of regulatory adjustments (defined in CAP30) and subject to the transitional arrangements in CAP90. RWA are defined in RBC20.3 and RBC20.4.

Risk-weighted assets

The Basel framework describes how to calculate RWA for credit risk, market risk and operational risk. The requirements for calculating RWA allow banks to use different approaches, some of which banks may only use with supervisory approval. The nominated approaches of a bank comprise all the approaches that the bank is using to calculate regulatory capital requirements, other than those approaches used solely for the purpose of the capital floor calculation outlined below. The nominated approaches of a bank may include those that it has supervisory approval to use and those for which supervisory approval is not required.

The RWA that banks must use to determine compliance with the requirements set out in RBC20.1 (and the buffers in RBC30 and RBC40) is the higher of:

Banking book and trading book boundary

Before a bank can calculate RWA for credit risk and RWA for market risk, it must follow the requirements of RBC25 to identify the instruments that are in the trading book. The banking book comprises all instruments that are not in the trading book and all other assets of the bank (hereafter “banking book exposures”).

RWA for credit risk

RWA for credit risk (including counterparty credit risk) is calculated as the sum of:

The approaches listed in RBC20.6 specify how banks must measure the size of their exposures (ie the exposure at default) and determine their RWA. Certain types of exposures in the banking book and trading book give rise to counterparty credit risk for which the measurement of the size of the exposure can be complex (see CRE51 for an overview of the counterparty credit risk requirements). Therefore, the approaches listed above include, or refer to, the following methods available to determine the size of counterparty credit risk exposures:

For banks that have supervisory approval to use IMM, RWA for credit risk must be calculated as the higher of:

RWA for market risk

RWA for market risk are calculated as the sum of the following:

RWA for operational risk

RWA for operational risk are calculated using one or more of the following approaches:

Calculation of the capital floor

Banks using the IRB approach for credit risk or the AMA for operational risk are subject to a capital floor.

Banks must calculate the difference between

If the floor amount is larger, banks must add 12.5 times the difference in calculating RWA to the sum of RWA for credit risk, market risk and operational risk in order to determine compliance with the minimum capital requirements (as described in RBC20.4).

The floor amount is calculated as 80% of the following sum, all elements of which are calculated under the 1988 Accord:

The comparison amount is calculated as follows, with all elements calculated according to this framework:

The Committee recognises that floors based on the 1988 Accord will become increasingly impractical to implement over time and therefore believes that supervisors should have the flexibility to develop appropriate bank-by-bank floors, subject to full disclosure of the nature of the floors adopted. Such floors may be based on the approach the bank was using before adoption of the IRB approach and/or AMA.

One possible alternative floor, for banks not migrating directly to an IRB approach or AMA from rules based on the 1988 Accord, is to calculate the floor based on the non-modelling approach used prior to migration to the IRB approach or AMA. The prior non-modelling approach must be updated to reflect the prevailing Basel capital standards in force at the time of the floor calculation. The use of this alternative is subject to supervisory approval.

Under this alternative, the floor amount defined in RBC20.14 is instead calculated as 80% of:

A trading book consists of positions in financial instruments and commodities held either with trading intent or in order to hedge other elements of the trading book. To be eligible for trading book capital treatment, financial instruments must either be free of any restrictive covenants on their tradability or able to be hedged completely. In addition, positions should be frequently and accurately valued, and the portfolio should be actively managed.

A financial instrument is any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. Financial instruments include both primary financial instruments (or cash instruments) and derivative financial instruments. A financial asset is any asset that is cash, the right to receive cash or another financial asset; or the contractual right to exchange financial assets on potentially favourable terms, or an equity instrument. A financial liability is the contractual obligation to deliver cash or another financial asset or to exchange financial liabilities under conditions that are potentially unfavourable.

Positions held with trading intent are those held intentionally for short-term resale and/or with the intent of benefiting from actual or expected short-term price movements or to lock in arbitrage profits, and may include for example proprietary positions, positions arising from client servicing (eg matched principal broking) and market-making.

Banks must have clearly defined policies and procedures for determining which exposures to include in, and to exclude from, the trading book for purposes of calculating their regulatory capital, to ensure compliance with the criteria for trading book set forth in RBC25 and taking into account the bank’s risk management capabilities and practices. Compliance with these policies and procedures must be fully documented and subject to periodic internal audit.

These policies and procedures should, at a minimum, address the general considerations listed below. The list below is not intended to provide a series of tests that a product or group of related products must pass to be eligible for inclusion in the trading book. Rather, the list provides a minimum set of key points that must be addressed by the policies and procedures for overall management of a firm’s trading book:

The following will be the basic requirements for positions eligible to receive trading book capital treatment.

It is the Committee’s view that, at the present time, open equity stakes in hedge funds, private equity investments, positions in a securitisation warehouse and real estate holdings do not meet the definition of the trading book, owing to significant constraints on the ability of banks to liquidate these positions and value them reliably on a daily basis.

When a bank hedges a banking book credit risk exposure using a credit derivative booked in its trading book (ie using an internal hedge), the banking book exposure is not deemed to be hedged for capital purposes unless the bank purchases from an eligible third party protection provider a credit derivative meeting the requirements of CRE22.86 vis-à-vis the banking book exposure. Where such third party protection is purchased and is recognised as a hedge of a banking book exposure for regulatory capital purposes, neither the internal nor external credit derivative hedge would be included in the trading book for regulatory capital purposes.

Term trading-related repo-style transactions that a bank accounts for in its banking book may be included in the bank’s trading book for regulatory capital purposes so long as all such repo-style transactions are included. For this purpose, trading-related repo-style transactions are defined as only those that meet the requirements of RBC25.3 and RBC25.6 and both legs are in the form of either cash or securities includable in the trading book. Regardless of where they are booked, all repo-style transactions are subject to a banking book counterparty credit risk charge.

Capital conservation buffer

This chapter outlines the operation of the capital conservation buffer, which is designed to ensure that banks build up capital buffers outside periods of stress which can be drawn down as losses are incurred. The requirement is based on simple capital conservation rules designed to avoid breaches of minimum capital requirements.

A capital conservation buffer of 2.5%, comprised of Common Equity Tier 1 (CET1), is established above the regulatory minimum capital requirement.1 Capital distribution constraints will be imposed on a bank when capital levels fall within this range. Banks will be able to conduct business as normal when their capital levels fall into the conservation range as they experience losses. The constraints imposed only relate to distributions, not the operation of the bank.

The distribution constraints imposed on banks when their capital levels fall into the range increase as the banks’ capital levels approach the minimum requirements. By design, the constraints imposed on banks with capital levels at the top of the range would be minimal. This reflects an expectation that banks’ capital levels will from time to time fall into this range. The Basel Committee does not wish to impose constraints for entering the range that would be so restrictive as to result in the range being viewed as establishing a new minimum capital requirement.

The table below shows the minimum capital conservation ratios a bank must meet at various levels of CET1 capital ratios. The applicable conservation standards must be recalculated at each distribution date. For example, a bank with a CET1 capital ratio in the range of 5.125% to 5.75% is required to conserve 80% of its earnings in the subsequent payment period (ie pay out no more than 20% in terms of dividends, share buybacks and discretionary bonus payments). If the bank wants to make payments in excess of the constraints imposed by this regime, it would have the option of raising capital in the private sector equal to the amount above the constraint which it wishes to distribute. This would be discussed with the bank’s supervisor as part of the capital planning process. The CET1 ratio includes amounts used to meet the 4.5% minimum CET1 requirement, but excludes any additional CET1 needed to meet the 6% Tier 1 and 8% Total Capital requirements, and also excludes any CET1 needed to meet the total loss-absorbing capacity (TLAC) requirement. For example, a bank with 8% CET1 and no Additional Tier 1 or Tier 2 capital, that has 10% of non-regulatory-capital TLAC instruments, would meet its minimum risk-based capital and risk-based TLAC requirements, but would have a zero conservation buffer and therefore be subject to the 100% constraint on capital distributions.

Set out below are a number of other key aspects of the requirements:

Countercyclical buffer

Losses incurred in the banking sector can be extremely large when a downturn is preceded by a period of excess credit growth. These losses can destabilise the banking sector and spark a vicious circle, whereby problems in the financial system can contribute to a downturn in the real economy that then feeds back on to the banking sector. These interactions highlight the particular importance of the banking sector building up additional capital defences in periods where the risks of system-wide stress are growing markedly.

The countercyclical buffer aims to ensure that banking sector capital requirements take account of the macro-financial environment in which banks operate. It will be deployed by national jurisdictions when excess aggregate credit growth is judged to be associated with a build-up of system-wide risk to ensure the banking system has a buffer of capital to protect it against future potential losses. This focus on excess aggregate credit growth means that jurisdictions are likely to only need to deploy the buffer on an infrequent basis. The buffer for internationally-active banks will be a weighted average of the buffers deployed across all the jurisdictions to which it has credit exposures. This means that they will likely find themselves subject to a small buffer on a more frequent basis, since credit cycles are not always highly correlated across jurisdictions.

The countercyclical buffer regime consists of the following elements:

National countercyclical buffer requirements

Each Basel Committee member jurisdiction will identify an authority with the responsibility to make decisions on the size of the countercyclical capital buffer. If the relevant national authority judges a period of excess credit growth to be leading to the build up of system-wide risk, they will consider, together with any other macroprudential tools at their disposal, putting in place a countercyclical buffer requirement. This will vary between zero and 2.5% of risk weighted assets, depending on their judgement as to the extent of the build up of system-wide risk.2

The document entitled “ Guidance for national authorities operating the countercyclical capital buffer ”, sets out the principles that national authorities have agreed to follow in making buffer decisions. This document provides information that should help banks to understand and anticipate the buffer decisions made by national authorities in the jurisdictions to which they have credit exposures.

To give banks time to adjust to a buffer level, a jurisdiction will pre-announce its decision to raise the level of the countercyclical buffer by up to 12 months.3 Decisions by a jurisdiction to decrease the level of the countercyclical buffer will take effect immediately. The pre-announced buffer decisions and the actual buffers in place for all Committee member jurisdictions will be published on the Bank for International Settlements’ (BIS) website .

Bank specific countercyclical buffer

Banks will be subject to a countercyclical buffer that varies between zero and 2.5% to total risk weighted assets.4 The buffer that will apply to each bank will reflect the geographic composition of its portfolio of credit exposures. Banks must meet this buffer with CET1 or be subject to the restrictions on distributions set out in RBC30.17.

Internationally active banks will look at the geographic location of their private sector credit exposures (including non-bank financial sector exposures) and calculate their countercyclical capital buffer requirement as a weighted average of the buffers that are being applied in jurisdictions to which they have an exposure. Credit exposures in this case include all private sector credit exposures that attract a credit risk capital charge or the risk weighted equivalent trading book capital charges for specific risk, the incremental risk charge and securitisation.

The weighting applied to the buffer in place in each jurisdiction will be the bank’s total credit risk charge that relates to private sector credit exposures in that jurisdiction,5 divided by the bank’s total credit risk charge that relates to private sector credit exposures across all jurisdictions.

For the value-at-risk (VaR) charge for specific risk, the incremental risk charge and the comprehensive risk measurement charge, banks should work with their supervisors to develop an approach that would translate these charges into individual instrument risk weights that would then be allocated to the geographic location of the specific counterparties that make up the charge. However, it may not always be possible to break down the charges in this way due to the charges being calculated on a portfolio by portfolio basis. In such cases, the charge for the relevant portfolio should be allocated to the geographic regions of the constituents of the portfolio by calculating the proportion of the portfolio’s total exposure at default (EAD) that is due to the EAD resulting from counterparties in each geographic region.

Extension of the capital conservation buffer

The countercyclical buffer requirement to which a bank is subject is implemented through an extension of the capital conservation buffer described in RBC30.1 to RBC30.5.

The table below shows the minimum capital conservation ratios a bank must meet at various levels of the CET1 capital ratio.6 When the countercyclical capital buffer is zero in all of the regions to which a bank has private sector credit exposures, the capital levels and restrictions set out in the table are the same as those set out in RBC30.1 to RBC30.5.

For illustrative purposes, the following table sets out the conservation ratios a bank must meet at various levels of CET1 capital if the bank is subject to a 2.5% countercyclical buffer requirement.

Frequency of calculation of the countercyclical buffer requirements

Banks must ensure that their countercyclical buffer requirements are calculated and publically disclosed with at least the same frequency as their minimum capital requirements. The buffer should be based on the latest relevant jurisdictional countercyclical buffers that are available at the date that they calculate their minimum capital requirement.

Capital conservation best practice

Outside of periods of stress, banks should hold buffers of capital above the regulatory minimum. Implementation of the buffers in this chapter will help increase sector resilience going into a downturn, and provide the mechanism for rebuilding capital during the early stages of economic recovery. Retaining a greater proportion of earnings during a downturn will help ensure that capital remains available to support the ongoing business operations of banks through the period of stress.

When buffers have been drawn down, one way banks should look to rebuild them is through reducing discretionary distributions of earnings. This could include reducing dividend payments, share-backs and staff bonus payments. Banks may also choose to raise new capital from the private sector as an alternative to conserving internally generated capital. The balance between these options should be discussed with supervisors as part of the capital planning process.

Greater efforts should be made to rebuild buffers the more they have been depleted. Therefore, in the absence of raising capital in the private sector, the share of earnings retained by banks for the purpose of rebuilding their capital buffers should increase the nearer their actual capital levels are to the minimum capital requirement.

It is not acceptable for banks which have depleted their capital buffers to use future predictions of recovery as justification for maintaining generous distributions to shareholders, other capital providers and employees. These stakeholders, rather than depositors, must bear the risk that recovery will not be forthcoming. It is also not acceptable for banks which have depleted their capital buffers to try and use the distribution of capital as a way to signal their financial strength. Not only is this irresponsible from the perspective of an individual bank, putting shareholders’ interests above depositors, it may also encourage other banks to follow suit. As a consequence, banks in aggregate can end up increasing distributions at the exact point in time when they should be conserving earnings.

Higher loss absorbency requirement for G-SIBs

The aim of the higher loss absorbency requirement, as set out in the report endorsed by the Group of Twenty at its Seoul Summit in November 2010, is to ensure that global systemically important financial institutions have a higher share of their balance sheets funded by instruments which increase the resilience of the institution as a going-concern. Taking into account this going-concern objective, global systemically important banks (G-SIBs) must meet their higher loss absorbency requirement with Common Equity Tier 1 capital only.

National supervisors have implemented the higher loss absorbency requirement through an extension of the capital conservation buffer, maintaining the division of the buffer into four bands of equal size (as described in RBC30.17).

If a G-SIB breaches the higher loss absorbency requirement, it is required to agree a capital remediation plan to return to compliance over a time frame to be established by the supervisor. Until it has completed that plan and returned to compliance, it is subject to the limitations on dividend payout defined by the conservation buffer bands, and to other arrangements as required by the supervisor.

As described in SCO40.19 to SCO40.22, G-SIBs are allocated into buckets based on their scores of systemic importance, with varying levels of higher loss absorbency requirements applied to the different buckets. The cutoff score for G-SIB designation is 130 bps and the buckets corresponding to the different higher loss-absorbency requirements each have a range of 100 bps. The magnitude of the higher loss-absorbency requirement for the highest populated bucket is 2.5% of risk-weighted assets, with an initially empty top bucket of 3.5% of risk-weighted assets. The magnitude of the higher loss absorbency requirement for the lowest bucket is 1.0% of risk-weighted assets. Based on the bucketing approach set out in SCO40.19 to SCO40.22, the magnitude of the higher loss absorbency requirement for each bucket is as follows.

As noted in SCO40.22, although the bucket thresholds is set initially such that bucket 5 is empty, if this bucket should become populated in the future, a new bucket will be added to maintain incentives for banks to avoid becoming more systemically important. Each new bucket will be equal in size (in terms of scores) to each of the initially populated buckets and the minimum higher loss absorbency requirement for the new buckets will increase in increments of 1% of risk-weighted assets (eg if bucket 5 should become populated, bucket 6 would be created with a minimum higher loss absorbency requirement of 4.5%).

If a G-SIB progresses to a bucket requiring a higher loss absorbency requirement, it will be required to meet the additional requirement within a time frame of 12 months. After this grace period, if the bank does not meet the higher loss absorbency requirement, the capital retention mechanism for the expanded capital conservation buffer will be applied. If, on the other hand, the G-SIB score falls, resulting in a lower higher loss absorbency requirement, the bank should be immediately released from its previous higher loss absorbency requirement. In these circumstances, national authorities may exert discretion and require a bank to delay the release of higher loss absorbency requirements.

Higher loss absorbency for domestic systemically important banks

As described in SCO50, a domestic systemically important bank (D-SIB) framework is best understood as taking the complementary perspective to the G-SIB regime by focusing on the impact that the distress or failure of banks (including by international banks) will have on the domestic economy. The principles developed by the Committee for D-SIBs would allow for appropriate national discretion to accommodate structural characteristics of the domestic financial system, including the possibility for countries to go beyond the minimum D-SIB framework and impose additional requirements based on the specific features of the country and its domestic banking sector.

The principles set out below focus on the higher loss absorbency requirement for D-SIBs. The Committee would like to emphasise that other policy tools, particularly more intensive supervision, can also play an important role in dealing with D-SIBs.

Principle 1: documenting methodologies for calibration

The purpose of a higher loss absorbency requirement for D-SIBs is to reduce further the probability of failure compared to non-systemic institutions, reflecting the greater impact a D-SIB failure is expected to have on the domestic financial system and economy.

It is important for the application of a D-SIB higher loss absorbency, at both the parent and subsidiary level, to be based on a transparent and well articulated assessment framework to ensure the implications of the requirements are well understood by both the home and the host authorities.

The level of higher loss absorbency for D-SIBs should be subject to policy judgement by national authorities. That said, there needs to be some form of analytical framework that would inform policy judgements. This was the case for the policy judgement made by the Committee on the level of the additional loss absorbency requirement for G-SIBs.

The policy judgement on the level of higher loss absorbency requirements should also be guided by country-specific factors which could include the degree of concentration in the banking sector or the size of the banking sector relative to gross domestic product (GDP). Specifically, countries that have a larger banking sector relative to GDP are more likely to suffer larger direct economic impacts of the failure of a D-SIB than those with smaller banking sectors. While size-to-GDP is easy to calculate, the concentration of the banking sector could also be considered (as a failure in a medium-sized highly concentrated banking sector would likely create more of an impact on the domestic economy than if it were to occur in a larger, more widely dispersed banking sector).1

The use of these factors in calibrating the higher loss absorbency requirement would provide justification for different intensities of policy responses across countries for banks that are otherwise similar across the four key bank-specific factors outlined in SCO50.14 to SCO50.17.

Principle 2: calibration commensurate with systemic importance

Although the D-SIB framework does not produce scores based on a prescribed methodology as in the case of the G-SIB framework, the higher loss absorbency requirements for D-SIBs should also be decided based on the degree of domestic systemic importance. This is to provide the appropriate incentives to banks which are subject to the higher loss absorbency requirements to reduce (or at least not increase) their systemic importance over time. In the case where there are multiple D-SIB buckets in a jurisdiction, this could imply differentiated levels of higher loss absorbency between D-SIB buckets.

Principle 3: consistency between application of G-SIB and D-SIB frameworks

National authorities, including host authorities, currently have the capacity to set and impose capital requirements they consider appropriate to banks within their jurisdictions. SCO40.5 states that host authorities of G-SIB subsidiaries may apply an additional loss absorbency requirement at the individual legal entity or consolidated level within their jurisdiction. An imposition of a D-SIB higher loss absorbency by a host authority is no different (except for additional transparency) from their current capacity to impose a Pillar 1 or 2 capital charge. Therefore, the ability of the host authorities to implement a D-SIB higher loss absorbency on local subsidiaries does not raise any new home-host issues.

National authorities should ensure that banks with the same degree of systemic importance in their jurisdiction, regardless of whether they are domestic banks, subsidiaries of foreign banking groups, or subsidiaries of G-SIBs, are subject to the same higher loss absorbency requirements, ceteris paribus. Banks in a jurisdiction should be subject to a consistent, coherent and non-discriminatory treatment regardless of the ownership. The objective of the host authorities’ power to impose higher loss absorbency on subsidiaries is to bolster capital to mitigate the potential heightened impact of the subsidiaries’ failure on the domestic economy due to their systemic nature. This should be maintained in cases where a bank might not be (or might be less) systemic at home, but its subsidiary is (more) systemic in the host jurisdiction.

An action by the host authorities to impose a D-SIB higher loss absorbency requirement leads to increases in capital at the subsidiary level which can be viewed as a shift in capital from the parent bank to the subsidiary, unless it already holds an adequate capital buffer in the host jurisdiction or the additional capital raised by the subsidiary is from outside investors. This could, in the case of substantial or large subsidiaries, materially decrease the level of capital protecting the parent bank. Under such cases, it is important that the home authority continues to ensure there are sufficient financial resources at the parent level, for example through a solo capital requirement (see also SCO10.4).

Within a jurisdiction, applying the D-SIB framework to both G-SIBs and non-G-SIBs will help ensure a level playing field within the national context. For example, in a jurisdiction with two banks that are roughly identical in terms of their assessed systemic nature at the domestic level, but where one is a G-SIB and the other is not, national authorities would have the capacity to apply the same D-SIB higher loss absorbency requirement to both. In such cases, the home authorities could face a situation where the higher loss absorbency requirement on the consolidated group will be the higher of those prescribed by the G-SIB and D-SIB frameworks (ie the higher of either the D-SIB or G-SIB requirement).

Double-counting should be avoided. The higher loss absorbency requirements derived from the G-SIB and D-SIB frameworks should not be additive. This will ensure the overall consistency between the two frameworks and allows the D-SIB framework to take the complementary perspective to the G-SIB framework.

Principle 4: home and host cooperation

The Committee recognises that there could be some concern that host authorities tend not to have a group-wide perspective when applying higher loss absorbency requirements to subsidiaries of foreign banking groups in their jurisdiction. The home authorities, on the other hand, clearly need to know D-SIB higher loss absorbency requirements on significant subsidiaries since there could be implications for the allocation of financial resources within the banking group.

In these circumstances, it is important that arrangements to coordinate and cooperate on the appropriate higher loss absorbency requirement between home and host authorities are established and maintained, within the constraints imposed by relevant laws in the host jurisdiction, when formulating higher loss absorbency requirements. This is particularly important to make it possible for the home authority to test the capital position of a parent on a stand-alone basis as mentioned in RBC40.16 and to prevent a situation where the home authorities are surprised by the action of the host authorities. Home and host authorities should coordinate and cooperate with each other on any plan to impose a higher loss absorbency requirement on a subsidiary bank, and the amount of the requirement, before taking any action. The host authority should provide a rationale for their decision, and an indication of the steps the bank would need to take to avoid/reduce such a requirement. The home and host authorities should also discuss:

Principle 5: higher loss absorbency requirement met with Common Equity Tier 1 and additional requirements and policy measures to address the risks posed by a D-SIB

Higher loss absorbency requirements for D-SIBs should be fully met with Common Equity Tier 1 to ensure a maximum degree of consistency with G-SIBs in terms of effective loss-absorbing capacity. This has the benefit of facilitating direct and transparent comparability of the application of requirements across jurisdictions, an element that is considered desirable given the fact that most of these banks will have cross-border operations being in direct competition with each other. In addition, national authorities should put in place any additional requirements and other policy measures they consider to be appropriate to address the risks posed by a D-SIB.

National authorities should implement the higher loss absorbency requirement through an extension of the capital conservation buffer, maintaining the division of the buffer into four bands of equal size (as described in RBC30.17). This is in line with the treatment of the additional loss absorbency requirement for G-SIBs. The higher loss absorbency requirement for D-SIBs is essentially a requirement that sits on top of the capital buffers and minimum capital requirement, with a pre-determined set of consequences for banks that do not meet this requirement.