Basel Committee on Banking Supervision

Banks must meet the following requirements at all times:

1. Common Equity Tier 1 must be at least 4.5% of risk-weighted assets (RWA).
2. Tier 1 capital must be at least 6% of RWA.
3. Total capital must be at least 8.0% of RWA.¹

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.

The Basel framework describes how to calculate RWA for credit risk, market risk and operational risk. The requirements for calculating RWA for credit risk and market risk 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 output 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:

1. the sum of the following three elements, calculated using the bank’s nominated approaches:
   1. RWA for credit risk (as calculated in RBC20.6 to RBC20.8);
   2. RWA for market risk (as calculated in RBC20.9); and
   3. RWA for operational risk (as calculated in RBC20.10); and
2. 72.5% of the sum of the elements listed in point (1) above, calculated using only the standardised approaches listed in RBC20.11. This element of this requirement is referred to as the output floor, and the RWA amount that is multiplied by 72.5% is referred to as the base of the output floor. This requirement is subject to transitional arrangements set out in RBC90.

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

1. Credit RWA for banking book exposures, except the RWA listed in (2) to (6) below, calculated using:
   1. The standardised approach, set out in CRE20 to CRE22; or
   2. The internal ratings-based (IRB) approach, set out in CRE30 to CRE36.
2. RWA for counterparty credit risk arising from banking book exposures and from trading book instruments (as specified in CRE55), except the exposures listed in (3) to (6) below, using the methods outlined in CRE51.
3. Credit RWA for equity investments in funds that are held in the banking book calculated using one or more of the approaches set out in CRE60:
   1. The look-through approach.
   2. The mandate-based approach.
   3. The fall-back approach.
4. RWA for securitisation exposures held in the banking book, calculated using one or more of the approaches set out in CRE40 to CRE45:
   1. Securitisation Standardised Approach (SEC-SA).
   2. Securitisation External Ratings-Based Approach (SEC-ERBA).
   3. Internal Assessment Approach (IAA).
   4. Securitisation Internal Ratings-Based Approach (SEC-IRBA).
   5. A risk weight of 1250% in cases where the bank cannot use (a) to (d) above.
5. RWA for exposures to central counterparties in the banking book and trading book, calculated using the approach set out in CRE54.
6. RWA for the risk posed by unsettled transactions and failed trades, where these transactions are in the banking book or trading book and are within scope of the rules set out in CRE70.

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 transactions in the banking book and trading book (such a derivatives and securities financing transactions) give rise to counterparty credit risk, for which the measurement of the size of the exposure can be complex. Therefore, the approaches listed in RBC20.6 include, or cross refer to, the following methods available to determine the size of counterparty credit risk exposures (see CRE51 for an overview of the counterparty credit risk requirements including the types of transactions to which the methods below can be applied):

1. The standardised approach for measuring counterparty credit risk exposures (SA-CCR), set out in CRE52.
2. The comprehensive approach, set out in CRE22.40 to CRE22.65.
3. The value at risk (VaR) models approach, set out in CRE32.39 to CRE32.41.
4. The internal models method (IMM), set out in CRE53.

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

1. the sum of elements (1) to (6) in RBC20.6 calculated using IMM with current parameter calibrations; and
2. the sum of the elements in RBC20.6 using IMM with stressed parameter calibrations.

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

1. RWA for market risk for instruments in the trading book and for foreign exchange risk and commodities risk for exposures in the banking book, calculated using one or more of the following approaches:
   1. The standardised approach for market risk, set out in MAR20 to MAR23;
   2. The internal models approach (IMA) for market risk, set out in MAR30 to MAR33; or
   3. The simplified standardised approach for market risk, set out in MAR40.
2. RWA for credit valuation adjustment (CVA) risk in the banking and trading book, calculated using one of the following methods set out in MAR50:
   1. The basic approach to CVA risk (BA-CVA).
   2. The standardised approach to CVA risk (SA-CVA).
   3. 100% of the bank’s RWA for counterparty credit risk, for banks that have exposures below a materiality threshold (see MAR50.9).

RWA for operational risk is calculated using the standardised approach for operational risk, set out in OPE25.

To reduce excessive variability of RWA and to enhance the comparability of risk-based capital ratios, banks are subject to a floor requirement that is applied to RWA. The output floor ensures that banks' capital requirements do not fall below a certain percentage of capital requirements derived under standardised approaches. The standardised approaches to be used to calculate the base of the output floor referenced in RBC20.4(2) are as follows:

1. The standardised approach for credit risk.
2. The bank's nominated approach for equity investments in funds.
3. For securitisation exposures in the banking book and when determining the default risk charge component for securitisation exposures in the trading book:
   1. if a bank does not use SEC-IRBA or SEC-IAA, its nominated approach; or
   2. if a bank does use SEC-IRBA or SEC-IAA, then the SEC-ERBA, SEC-SA or a risk-weight of 1250% as determined per the hierarchy of approaches.
4. For counterparty credit risk exposure measurement:
   1. if a bank does not use IMM or the VaR models approach, then its nominated approach; or
   2. if a bank does use IMM or the VaR models approach, then the SA-CCR or the comprehensive approach.
5. For market risk:
   1. If a bank uses the IMA for market risk, then the standardised approach for market risk; or
   2. If a bank does not use the IMA for market risk, then its nominated approach.
6. The bank's nominated approach for CVA risk.
7. The standardised approach for operational risk.

RBC20.11 above means that the following approaches are not permitted to be used, directly or by cross reference,² in the calculation of the base of the output floor:

1. IRB approach to credit risk;
2. SEC-IRBA;
3. the IMA for market risk;
4. the VaR models approach to counterparty credit risk; and
5. the IMM for counterparty credit risk.

The table below provides a simple example of how the capital floor must be calculated.

While the Basel framework permits the use of internally modelled approaches for certain risk categories, subject to supervisory approval, a jurisdiction which does not implement some or all of the internally modelled approaches but instead only implements the basic or standardised approaches is compliant with the Basel framework.

A trading book consists of all instruments that meet the specifications for trading book instruments set out in RBC25.2 through RBC25.13. All other instruments must be included in the banking book.

Instruments comprise financial instruments, foreign exchange (FX), and commodities. 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 a commodity, or an equity instrument. A financial liability is the contractual obligation to deliver cash or another financial asset or a commodity. Commodities also include non-tangible (ie non-physical) goods such as electric power.

Banks may only include a financial instrument, instruments on FX or commodity in the trading book when there is no legal impediment against selling or fully hedging it.

Banks must fair value daily any trading book instrument and recognise any valuation change in the profit and loss (P&L) account.

Any instrument a bank holds for one or more of the following purposes must, when it is first recognised on its books, be designated as a trading book instrument, unless specifically otherwise provided for in RBC25.3 or RBC25.8:

1. short-term resale;
2. profiting from short-term price movements;
3. locking in arbitrage profits; or
4. hedging risks that arise from instruments meeting (1), (2) or (3) above.

Any of the following instruments is seen as being held for at least one of the purposes listed in RBC25.5 and must therefore be included in the trading book, unless specifically otherwise provided for in RBC25.3 or RBC25.8:

1. instruments in the correlation trading portfolio;
2. instruments that would give rise to a net short credit or equity position in the banking book;³ or
3. instruments resulting from underwriting commitments, where underwriting commitments refer only to securities underwriting, and relate only to securities that are expected to be actually purchased by the bank on the settlement date.

Any instrument which is not held for any of the purposes listed in RBC25.5 at inception, nor seen as being held for these purposes according to RBC25.6, must be assigned to the banking book.

The following instruments must be assigned to the banking book:

1. unlisted equities;
2. instruments designated for securitisation warehousing;
3. real estate holdings, where in the context of assigning instrument to the trading book, real estate holdings relate only to direct holdings of real estate as well as derivatives on direct holdings;
4. retail and small or medium-sized enterprise (SME) credit;
5. equity investments in a fund, unless the bank meets at least one of the following conditions:
   1. the bank is able to look through the fund to its individual components and there is sufficient and frequent information, verified by an independent third party, provided to the bank regarding the fund’s composition; or
   2. the bank obtains daily price quotes for the fund and it has access to the information contained in the fund’s mandate or in the national regulations governing such investment funds;
6. hedge funds;
7. derivative instruments and funds that have the above instrument types as underlying assets; or
8. instruments held for the purpose of hedging a particular risk of a position in the types of instrument above.

There is a general presumption that any of the following instruments are being held for at least one of the purposes listed in RBC25.5 and therefore are trading book instruments, unless specifically otherwise provided for in RBC25.3 or RBC25.8:

1. instruments held as accounting trading assets or liabilities;⁴
2. instruments resulting from market-making activities;
3. equity investments in a fund excluding those assigned to the banking book in accordance with RBC25.8(5);
4. listed equities;⁵
5. trading-related repo-style transaction;⁶ or
6. options including embedded derivatives⁷ from instruments that the institution issued out of its own banking book and that relate to credit or equity risk.

Banks are allowed to deviate from the presumptive list specified in RBC25.9 according to the process set out below.⁸

1. If a bank believes that it needs to deviate from the presumptive list established in RBC25.9 for an instrument, it must submit a request to its supervisor and receive explicit approval. In its request, the bank must provide evidence that the instrument is not held for any of the purposes in RBC25.5.
2. In cases where this approval is not given by the supervisor, the instrument must be designated as a trading book instrument. Banks must document any deviations from the presumptive list in detail on an on-going basis.

Notwithstanding the process established in RBC25.10 for instruments on the presumptive list, the supervisor may require the bank to provide evidence that an instrument in the trading book is held for at least one of the purposes of RBC25.5. If the supervisor is of the view that a bank has not provided enough evidence or if the supervisor believes the instrument customarily would belong in the banking book, it may require the bank to assign the instrument to the banking book, except if it is an instrument listed under RBC25.6.

The supervisor may require the bank to provide evidence that an instrument in the banking book is not held for any of the purposes of RBC25.5. If the supervisor is of the view that a bank has not provided enough evidence, or if the supervisor believes such instruments would customarily belong in the trading book, it may require the bank to assign the instrument to the trading book, except if it is an instrument listed under RBC25.8.

A bank must have clearly defined policies, procedures and documented practices for determining which instruments to include in or to exclude from the trading book for the purposes of calculating their regulatory capital, ensuring compliance with the criteria set forth in this section, and taking into account the bank’s risk management capabilities and practices. A bank’s internal control functions must conduct an ongoing evaluation of instruments both in and out of the trading book to assess whether its instruments are being properly designated initially as trading or non-trading instruments in the context of the bank’s trading activities. Compliance with the policies and procedures must be fully documented and subject to periodic (at least yearly) internal audit and the results must be available for supervisory review.

Apart from moves required by RBC25.5 through RBC25.10, there is a strict limit on the ability of banks to move instruments between the trading book and the banking book by their own discretion after initial designation, which is subject to the process in RBC25.15 and RBC25.16. Switching instruments for regulatory arbitrage is strictly prohibited. In practice, switching should be rare and will be allowed by supervisors only in extraordinary circumstances. Examples are a major publicly announced event, such as a bank restructuring that results in the permanent closure of trading desks, requiring termination of the business activity applicable to the instrument or portfolio or a change in accounting standards that allows an item to be fair-valued through P&L. Market events, changes in the liquidity of a financial instrument, or a change of trading intent alone are not valid reasons for reassigning an instrument to a different book. When switching positions, banks must ensure that the standards described in RBC25.5 to RBC25.10 are always strictly observed.

Without exception, a capital benefit as a result of switching will not be allowed in any case or circumstance. This means that the bank must determine its total capital requirement (across the banking book and trading book) before and immediately after the switch. If this capital requirement is reduced as a result of this switch, the difference as measured at the time of the switch will be imposed on the bank as a disclosed Pillar 1 capital surcharge. This surcharge will be allowed to run off as the positions mature or expire, in a manner agreed with the supervisor. To maintain operational simplicity, it is not envisaged that this additional capital requirement would be recalculated on an ongoing basis, although the positions would continue to also be subject to the ongoing capital requirements of the book into which they have been switched.

Any reassignment between books must be approved by senior management and the supervisor as follows. Any reallocation of securities between the trading book and banking book, including outright sales at arm's length, should be considered a reassignment of securities and is governed by requirements of this paragraph.

1. Any reassignment must be approved by senior management thoroughly documented; determined by internal review to be in compliance with the bank's policies; subject to prior approval by the supervisor based on supporting documentation provided by the bank; and publicly disclosed.
2. Unless required by changes in the characteristics of a position, any such reassignment is irrevocable.
3. If an instrument is reclassified to be an accounting trading asset or liability there is a presumption that this instrument is in the trading book, as described in RBC25.9. Accordingly, in this case an automatic switch without approval of the supervisor is acceptable.

A bank must adopt relevant policies that must be updated at least yearly. Updates should be based on an analysis of all extraordinary events identified during the previous year. Updated policies with changes highlighted must be sent to the appropriate supervisor. Policies must include the following:

1. The reassignment restriction requirements in RBC25.14 through RBC25.16, especially the restriction that re-designation between the trading book and banking book may only be allowed in extraordinary circumstances, and a description of the circumstances or criteria where such a switch may be considered.
2. The process for obtaining senior management and supervisory approval for such a transfer.
3. How a bank identifies an extraordinary event.
4. A requirement that re-assignments into or out of the trading book be publicly disclosed at the earliest reporting date.

An internal risk transfer is an internal written record of a transfer of risk within the banking book, between the banking and the trading book or within the trading book (between different desks).

There will be no regulatory capital recognition for internal risk transfers from the trading book to the banking book. Thus, if a bank engages in an internal risk transfer from the trading book to the banking book (eg for economic reasons) this internal risk transfer would not be taken into account when the regulatory capital requirements are determined.

For internal risk transfers from the banking book to the trading book, RBC25.21 to RBC25.27 apply.

When a bank hedges a banking book credit risk exposure or equity risk exposure using a hedging instrument purchased through its trading book (ie using an internal risk transfer),

1. The credit exposure in the banking book is deemed to be hedged for capital requirement purposes if and only if:
   1. the trading book enters into an external hedge with an eligible third-party protection provider that exactly matches the internal risk transfer; and
   2. the external hedge meets the requirements of CRE22.74 to CRE22.75 and CRE22.77 to CRE22.78 vis-à-vis the banking book exposure.⁹
2. The equity exposure in the banking book is deemed to be hedged for capital requirement purposes if and only if:
   1. the trading book enters into an external hedge from an eligible third-party protection provider that exactly matches the internal risk transfer; and
   2. the external hedge is recognised as a hedge of a banking book equity exposure.
3. External hedges for the purposes of RBC25.21(1) can be made up of multiple transactions with multiple counterparties as long as the aggregate external hedge exactly matches the internal risk transfer, and the internal risk transfer exactly matches the aggregate external hedge.

Where the requirements in RBC25.21 are fulfilled, the banking book exposure is deemed to be hedged by the banking book leg of the internal risk transfer for capital purposes in the banking book. Moreover both the trading book leg of the internal risk transfer and the external hedge must be included in the market risk capital requirements.

Where the requirements in RBC25.21 are not fulfilled, the banking book exposure is not deemed to be hedged by the banking book leg of the internal risk transfer for capital purposes in the banking book. Moreover, the third-party external hedge must be fully included in the market risk capital requirements and the trading book leg of the internal risk transfer must be fully excluded from the market risk capital requirements.

A banking book short credit position or a banking book short equity position created by an internal risk transfer¹⁰ and not capitalised under banking book rules must be capitalised under the market risk rules together with the trading book exposure.

When a bank hedges a banking book interest rate risk exposure using an internal risk transfer with its trading book, the trading book leg of the internal risk transfer is treated as a trading book instrument under the market risk framework if and only if:

1. the internal risk transfer is documented with respect to the banking book interest rate risk being hedged and the sources of such risk;
2. the internal risk transfer is conducted with a dedicated internal risk transfer trading desk which has been specifically approved by the supervisor for this purpose; and
3. the internal risk transfer must be subject to trading book capital requirements under the market risk framework on a stand-alone basis for the dedicated internal risk transfer desk, separate from any other GIRR or other market risks generated by activities in the trading book.

Where the requirements in RBC25.25 are fulfilled, the banking book leg of the internal risk transfer must be included in the banking book’s measure of interest rate risk exposures for regulatory capital purposes.

The supervisor-approved internal risk transfer desk may include instruments purchased from the market (ie external parties to the bank). Such transactions may be executed directly between the internal risk transfer desk and the market. Alternatively, the internal risk transfer desk may obtain the external hedge from the market via a separate non-internal risk transfer trading desk acting as an agent, if and only if the GIRR internal risk transfer entered into with the non-internal risk transfer trading desk exactly matches the external hedge from the market. In this latter case the respective legs of the GIRR internal risk transfer are included in the internal risk transfer desk and the non-internal risk transfer desk.

Internal risk transfers between trading desks within the scope of application of the market risk capital requirements (including FX risk and commodities risk in the banking book) will generally receive regulatory capital recognition. Internal risk transfers between the internal risk transfer desk and other trading desks will only receive regulatory capital recognition if the constraints in RBC25.25 to RBC25.27 are fulfilled.

The trading book leg of internal risk transfers must fulfil the same requirements under RBC25 as instruments in the trading book transacted with external counterparties.

Eligible external hedges that are included in the credit valuation adjustment (CVA) capital requirement must be removed from the bank’s market risk capital requirement calculation.

Banks may enter into internal risk transfers between the CVA portfolio and the trading book. Such an internal risk transfer consists of a CVA portfolio side and a non-CVA portfolio side. Where the CVA portfolio side of an internal risk transfer is recognised in the CVA risk capital requirement, the CVA portfolio side should be excluded from the market risk capital requirement, while the non-CVA portfolio side should be included in the market risk capital requirement.

In any case, such internal CVA risk transfers can only receive regulatory capital recognition if the internal risk transfer is documented with respect to the CVA risk being hedged and the sources of such risk.

Internal CVA risk transfers that are subject to curvature, default risk or residual risk add-on as set out in MAR20 through MAR23 may be recognised in the CVA portfolio capital requirement and market risk capital requirement only if the trading book additionally enters into an external hedge with an eligible third-party protection provider that exactly matches the internal risk transfer.

Independent from the treatment in the CVA risk capital requirement and the market risk capital requirement, internal risk transfers between the CVA portfolio and the trading book can be used to hedge the counterparty credit risk exposure of a derivative instrument in the trading or banking book as long as the requirements of RBC25.21 are met.

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.¹¹ 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:

1. Elements subject to the restriction on distributions: Items considered to be distributions include dividends and share buybacks, discretionary payments on other Tier 1 capital instruments and discretionary bonus payments to staff. Payments that do not result in a depletion of CET1, which may for example include certain scrip dividends, are not considered distributions. The distribution restrictions do not apply to dividends which satisfy all three of the following conditions:
   1. the dividends cannot legally be cancelled by the bank;
   2. the dividends have already been removed from CET1; and
   3. the dividends were declared in line with the applicable capital conservation standards (as set out in RBC30.4) at the time of declaration.
2. Definition of earnings: Earnings are defined as distributable profits calculated prior to the deduction of elements subject to the restriction on distributions. Earnings are calculated after the tax which would have been reported had none of the distributable items been paid. As such, any tax impact of making such distributions are reversed out. Where a bank does not have positive earnings and has a CET1 ratio less than 7% (or higher if the capital conservation buffer has been expanded by other buffers), it would be restricted from making positive net distributions.
3. Solo or consolidated application: The framework should be applied at the consolidated level, ie restrictions would be imposed on distributions out of the consolidated group. National supervisors would have the option of applying the regime at the solo level to conserve resources in specific parts of the group.
4. Additional supervisory discretion: Although the buffer must be capable of being drawn down, banks should not choose in normal times to operate in the buffer range simply to compete with other banks and win market share. To ensure that this does not happen, supervisors have the additional discretion to impose time limits on banks operating within the buffer range on a case-by-case basis. In any case, supervisors should ensure that the capital plans of banks seek to rebuild buffers over an appropriate timeframe.

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:

1. National authorities will monitor credit growth and other indicators that may signal a build up of system-wide risk and make assessments of whether credit growth is excessive and is leading to the build up of system-wide risk. Based on this assessment they will put in place a countercyclical buffer requirement when circumstances warrant. This requirement will be released when system-wide risk crystallises or dissipates.
2. Internationally active banks will look at the geographic location of their private sector credit exposures and calculate their bank specific countercyclical capital buffer requirement as a weighted average of the requirements that are being applied in jurisdictions to which they have credit exposures.
3. The countercyclical buffer requirement to which a bank is subject will extend the size of the capital conservation buffer. Banks will be subject to restrictions on distributions if they do not meet the requirement.

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.¹²

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.¹³ 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 .

Banks will be subject to a countercyclical buffer that varies between zero and 2.5% to total risk weighted assets.¹⁴ 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,¹⁵ 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.

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.¹⁶ 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.

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.

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.

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.

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.

1. National authorities should document the methodologies and considerations used to calibrate the level of higher loss absorbency that the framework would require for D-SIBs in their jurisdiction. The level of higher loss absorbency calibrated for D-SIBs should be informed by quantitative methodologies (where available) and country-specific factors without prejudice to the use of supervisory judgement.
2. The higher loss absorbency requirement imposed on a bank should be commensurate with the degree of systemic importance, as identified under SCO50.14 to SCO50.17.
3. National authorities should ensure that the application of the G-SIB and D-SIB frameworks is compatible within their jurisdictions. Home authorities should impose higher loss absorbency requirements that they calibrate at the parent and/or consolidated level, and host authorities should impose higher loss absorbency requirements that they calibrate at the sub-consolidated/subsidiary level. The home authority should test that the parent bank is adequately capitalised on a standalone basis, including cases in which a D-SIB higher loss absorbency requirement is applied at the subsidiary level. Home authorities should impose the higher of either the D-SIB or G-SIB higher loss absorbency requirements in the case where the banking group has been identified as a D-SIB in the home jurisdiction as well as a G-SIB.
4. In cases where the subsidiary of a bank is considered to be a D-SIB by a host authority, home and host authorities should make arrangements to coordinate and cooperate on the appropriate higher loss absorbency requirement, within the constraints imposed by relevant laws in the host jurisdiction.
5. The higher loss absorbency requirement should be met fully by Common Equity Tier 1. 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.

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).¹⁷

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.

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.

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.

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:

1. the resolution regimes (including recovery and resolution plans) in both jurisdictions,
2. available resolution strategies and any specific resolution plan in place for the firm, and
3. the extent to which such arrangements should influence higher loss absorbency requirements.

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.

The output floor will be implemented as of 1 January 2023, based on the following calibration phase-in arrangement:

During the phase-in period, supervisors may exercise national discretion to cap the incremental increase in a bank’s total risk-weighted assets (RWA) that results from the application of the floor. This transitional cap will be set at 25% of a bank’s RWA before the application of the floor. In the example shown in RBC20.13, the application of this national discretion by the supervisor would cap the bank’s RWA to 95 (ie a 25% increase of its pre-floor RWA of 76).