1 It should be said that, as an inevitable corollary, the rules that have recently been enacted in this area are, likewise, more complex than ever. The present chapter should thus be seen as a very broad and general overview of an extremely detailed subject.
2 The system introduced by Basel II requires the re-assessment of risks during the life of a facility and, as the credit quality of a particular borrower or counterparty declines, it becomes necessary to ascribe additional capital to that risk. As a consequence, banks lacked the capital necessary to provide further facilities, with the result that an economy already in crisis was starved of credit.
3 Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms, OJ L 176, 27.6.2013, p 1.
4 Directive 2013/36/EU of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, OJ L 176, 27.6.2013, p 338.
5 As an EU Regulation, the CRR has direct application in the United Kingdom. In the case of the CRD, some of its provisions have been implemented by secondary legislation, but much of the task is achieved through PRA rules.
7 This point is implicitly acknowledged by the rules relating the internal ratings-based approach to capital adequacy, which allows for less capital to be held where a bank can demonstrate the sophistication of its risk management processes. On this subject, see paras 6.33–6.39 below.
8 Although not of direct relevance in the present context, it may be noted that the history and negotiation of the Concordat were considered in some depth in Three Rivers District Council v Bank of England  EWHC 816 (Comm), since the very issue of supervisory responsibility was at issue in that case. The decision is discussed in Chapter 14 below.
9 The items discussed below must clearly be applied on a uniform basis in order to achieve a code which has uniform international application.
10 However, for current proposals in this area, see ‘Reform of Basel II’, at paras 6.57–6.58 below.
11 ‘Zone A’ referred to OECD members and certain other countries.
12 Insofar as the capital requirements apply to credit institutions, the relevant rules are to be found in the Recast Banking Consolidation Directive, to which reference has already been made.
13 Principally via the BIPRU and GENPRU sections of the Handbook. For aspects of the rules which fall within the responsibility of the Treasury, see the Capital Requirements Regulations 2006 (SI 2006/3221). As will be seen below, these measures have now been superseded.
14 See para 4 of the Introduction.
15 In translation, this means that banks will need less capital if they can demonstrate that they have in place robust and effective risk management techniques. As explained above, these flexibilities were not available under the fairly rigid parameters of Basel I, and the Committee saw this particular change as one of the major benefits of Basel II.
16 Paragraph 5 of the Introduction to Basel II.
17 See para 17 of the Introduction to Basel II. This is a follow-on from the Committee’s Press Release ‘Instruments eligible for inclusion in Tier 1 capital’ (October 1998). The rules relating to the quality of capital were subsequently revised: see the discussion of Basel III at paras 6.29–6.37 below.
18 Paragraph 18 of the Introduction to Basel II. Given the nature and depth of the financial crisis, it may be inferred that a loosening of the associated risk-weighting requirements based on banks’ internal models is unlikely in the near term.
19 The internal ratings-based approach involves more sophisticated and capital-efficient methods of measuring a bank’s customer exposures. This subject is discussed at paras 6.33–6.39 below.
20 See, for example, McKnight, para 2.10.1.
22 Although it is common to refer to ‘Basel III’ as the current model, it should be appreciated that the Basel III documents adopt and build upon the ‘three pillars’ structure set out in Basel II.
23 It should be noted that Basel III Liquidity built on the Basel Committee’s 2008 document, ‘Principles for Sound Liquidity Risk Management and Supervision’.
24 On the points about to be made, see paras 48–50 of Basel III Capital.
25 See para 49 of Basel III Capital. As the alternative title suggests, this level of capital is intended to provide support when the institution is in serious difficulty.
26 The essential principles just stated are mirrored in the ‘Own Funds’ requirements set out in Art 92 of the CRR.
27 See para 52 of Basel III Capital. Minority interests in consolidated subsidiaries which are themselves banks represent external capital and may thus also be treated as Core Equity Tier Once Capital. On this subject and the various conditions, see paras 62–65 of Basel III Capital.
28 See para 54 of Basel III Capital.
29 For the complete list and explanation, see paras 66–93 of Basel III Capital.
30 The details span paras 66–93 of Basel III Capital.
31 It may be noted that Basel III Capital did not make any material changes to the computation of risk-weighted assets.
32 The standardized approach is designed for use by banks involved in less complex forms of lending and underwriting and in practice will therefore probably be used only by smaller institutions.
33 This subject is discussed at para 6.35 below.
34 Again, these are discussed at para 6.38 below.
35 On the standardized approach, see Arts 111–141 of the CRR.
36 Article 112 of the CRR.
37 Article 113 of the CRR.
38 Eg exposures to certain qualifying sovereigns and their central banks (see Art 114 of the CRR) and to the EU, the European Stability Mechanism, the International Monetary Fund and certain other institutions (Art 118 of the CRR).
39 See Arts 142–191 of the CRR.
40 See Art 151 of the CRR.
41 On the points about to be made, see Arts 142–145 of the CRR.
42 Article 145 of the CRR.
43 The methodology is set out in Art 147 of the CRR.
44 See Arts 153 and 154 of the CRR.
45 Reflecting the Recast Banking Consolidation Directive, Annex VII, Pt I.
47 On these points, see Art 160 of the CRR.
48 Credit risk mitigation is considered at para 6.40 below.
49 Article 161(1) of the CRR.
50 Article 161(3) of the CRR.
51 Article 158 of the CRR.
53 Article 194(1) of the CRR.
54 Article 194(8) of the CRR.
55 Article 196 of the CRR.
56 Article 197 of the CRR.
57 On the comprehensive approach to collateral, see para 6.46(b) below.
58 Article 198 of the CRR.
59 Article 199(1) of the CRR.
60 Article 199(5) of the CRR.
61 Article 219 of the CRR.
62 On this point and the ‘Simple Method’, see Art 222 of the CRR.
63 On the ‘financial collateral comprehensive method’, see Art 223 of the CRR.
64 On these points, see Art 220 of the CRR.
65 See, generally, BIPRU 4.10.
66 Article 236 of the CRR.
67 See Art 213 of the CRR.
68 Article 213 of the CRR.
69 Article 215 of the CRR.
70 For example, and quite apart from other considerations, the credit default swap will be written as between two institutions in the financial market and the underlying borrower will frequently be unaware of the arrangement.
71 Article 216 of the CRR.
72 Article 235 of the CRR.
73 Article 236 of the CRR.
74 This requirement was not originally a feature of Basel I but was introduced following the issue of a ‘Market Risk’ revision to Basel I in 1995. The general requirement is to be found in Art 326 of the CRR.
75 Article 328 of the CRR.
76 Article 329 of the CRR.
77 On these, points see: ‘Revisions to Basel II Market Risk Framework’: Basel Committee on Banking Supervision, July 2009, and see also ‘Guidelines for computing capital for incremental risk in the trading book’, Basel Committee, July 2009.
78 See the definition of ‘operational risk’ in the FSA Glossary, tracking the corresponding definition given in Art 4(22) of the Recast Consolidation Directive.
79 BIPRU 6 implements Arts 102–105 and Annex X of the Recast Banking Consolidation Directive.
80 Articles 315 and 316 of the CRR.
81 Article 317 of the CRR.
82 Articles 321 and 322 of the CRR.
83 Basel III Capital, paras 122–135; Art 92 of the CRR.
84 Basel III Capital, para 124. The commentary in this area makes it clear that excessive distributions have the effect of preferring the interests of shareholders over those of depositors, and that this is not an acceptable order of priorities. The emphasis is therefore very much on the retention of earnings—see the discussions on Basel III Capital, para 131.
85 A ratio of 0.625 per cent of risk-weighted assets will apply from 1 January 2016. This is subject to annual increase and the full 2.5 per cent requirement will apply from 1 January 2019.
86 Article 129 of the CRD.
87 See the Capital Requirements (Capital Buffers and Prudential Measures) Regulations 2014 (SI 2014/894).
88 PRA, 2104/9. For further guidance, see Policy Statement PS 3/14, ‘Implementing CRD IV: Capital Buffers’ (PRA, April 2014).
89 Basel III Capital, paras 136–150; CRR, Art 130. The calculation of institution-specific risk-weighting is addressed in Art 130 of the CRR and in some respects depends upon countercyclical buffer rates for the countries in which risks are located: see Art 136 of the CRR.
90 The process is described in para 138 of Basel III Capital.
91 Basel III Capital, paras 139–141.
92 See Art 130 of the CRD.
93 See Art 131 of the CRD and the PRA materials mentioned in para 6.65 above.
95 See Basel III Capital, para 132; CRR, Art 141.
96 See Basel III Capital, para 124; CRR, Art 142.
97 For the details, see Basel III Capital, paras 151–167.
98 Basel III Capital, para 153. The calculation of the ‘exposure’ side of the equation is explained in paras 157–164 of Basel III Capital.
100 The 30-day period might, of course, also provide sufficient time for the management of the bank itself to come up with a solution to the problems and thus avert the need for regulatory intervention.
101 On the points just made, see Basel III Liquidity, paras 1–13. As there noted, the liquidity requirement is to be phased in from 2015, and will become fully effective in 2019.
102 For the detailed definitions and operational requirements, see paras 23–68 of Basel III Liquidity.
103 For the details, see paras 69–160, Basel III Liquidity.
104 The liquidity coverage requirement is described in Art 412 of the CRR.
105 See Art 460 of the CRR.
106 See ‘Basel III: International framework for liquidity risk measurement, standards and monitoring’ (Basel Committee, December 2010). That publication also dealt with the Liquidity Coverage Ratio but, as has been seen, that aspect has been superseded by Basel III Liquidity.
107 On these points and for the details, see paras 119–136 of the Basel Committee paper, n 106 above.
108 Article 413 of the CRR. Again, the Commission has power to introduce implementing measures based on recommendations from the European Banking Authority: see Art 510 of the CRR.
109 The FSA Handbook refers to this process as the supervisory and evaluation process (SREP). See the description of SREP in BIPRU 2.2.9G.
111 BIPRU 2.2.16G–2.2.23G.
112 On this point, see BIPRU 2.2.15G.
113 See Arts 68(3), 72, 145–149, and Annex XII to the Recast Banking Consolidation Directive. These rules have been transposed into the United Kingdom by BIPRU 11.
116 BIPRU 11.5.3R–11.5.7R.
117 BIPRU 11.5.8R, 11.5.12R, and 11.5.14R. Further requirements applicable to specific methodologies will be found in BIPRU 11.6.
118 See PRA Handbook, PRIN 2 and PRIN 3.
119 See ‘Supervisory framework for measuring and controlling large exposures’ (Basel Committee, April 2014) (‘Large Exposure Standard’).
120 Counterparties are ‘connected’ if there is a shareholding control relationship or if there is a degree of economic inter-dependence, such that financial problems suffered by one entity is likely to ‘infect’ the other: see Large Exposure Standard, paras 19–28.
121 See Large Exposure Standard, paras 14–18. Exposures to sovereigns and their central banks are excluded from this framework; see Large Exposure Standard, para 61.
122 See Large Exposure Standard, paras 36–59.
123 See CRR, Arts 387–404.
125 See FSA Note: Bank Recapitalisation and Connected Exposures under the Large Exposure Regime.
126 See, for example, the discussion of market risk at para 6.50 above.