Jump to Content Jump to Main Navigation
Signed in as:

Part A Regulatory Matters, 6 Capital Adequacy, Liquidity, and Large Exposures

From: The Law and Practice of International Banking (2nd Edition)

Charles Proctor

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: null; date: 06 June 2023

Regulation of banks — Basel 1 — Basel 2 — Basel 3 — Basel committee on Banking Supervision

(p. 123) Capital Adequacy, Liquidity, and Large Exposures


6.01  Banks occupy a vital position in any modern economy. If anything, this has been emphasized by the depth of the recession which gripped the United Kingdom—and much of the rest of the world—from 2008. The recession was more pronounced in part because the banking industry was in many respects its source, and declining confidence in the stability of such institutions had a major adverse impact on public trust in the financial system as a whole.

6.02  As a result, the rules on the adequacy of the capital resources available to financial institutions, and the risks which they take with that capital, are of more importance than ever.1 It is perhaps unfortunate that the financial crisis took hold just as the new capital (p. 124) adequacy framework introduced by Basel II was being introduced—this is thought by some to have made the situation worse.2

6.03  But, however that may be, capital adequacy rules are assuming greater importance both to banks themselves and—in view of concerns about the stability of the financial system as a whole—to the wider public. The present chapter therefore examines the current capital adequacy framework and associated provisions designed to ensure that a bank’s business is managed on a prudent basis. This chapter also examines other closely allied topics which may affect the stability of the banking system namely, liquidity and large exposure requirements.

6.04  As will be noted below, the rules to be applied in this area originate with recommendations made by the Basel Committee on Banking Supervision. However, these standards do not of themselves have legally binding effect. Consequently, this chapter will refer to the Basel Committee standards but will then seek to trace the ‘trickle down’ of these recommendations into domestic law. So far as the United Kingdom is concerned, the binding force of these rules is derived from:

  1. (a)  the Capital Requirements Regulation (CRR);3 and

  2. (b)  the Capital Requirements Directive (CRD).4

The CRR and the CRD are collectively referred to as CRD4.5

6.05  Against this background, it is proposed to examine the following matters:

  1. (a)  the broad framework for capital adequacy;

  2. (b)  the origins of the Basel standards;

  3. (c)  the provisions of Basel II;

  4. (d)  the terms of Pillar One of Basel II and the composition of eligible bank capital;

  5. (e)  the calculation of a bank’s risk-weighted assets;

  6. (f)  the nature and effect of credit risk mitigation techniques;

  7. (g)  Pillar Two and Supervisory Review;

  8. (h)  Pillar Three and Market Discipline;

  9. (i)  the reform of Basel II;

  10. (j)  Basel III—Capital and Liquidity;

  11. (k)  liquidity rules;

  12. (l)  limitation and disclosure of large exposures; and

  13. (m)  the conclusions to be drawn from this chapter.

(p. 125) Capital Adequacy—The Broad Framework

6.06  At the highest level of generality, one may perhaps begin this survey by referring to two of the PRA’s Principles for Businesses,6 which set out in very broad terms the bases on which an authorized institution should operate its business. Specifically:

  1. (a)  Principle 3 states that ‘A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems’; and

  2. (b)  Principle 4 requires that ‘A firm must maintain adequate financial resources’.

6.07  It seems that these two principles must at least to some extent be linked, since the adequacy of a bank’s financial resources can only be measured against the risks which the institution takes and the effectiveness of the systems which it has in place to manage those risks.7 Nevertheless, these very general principles do not of themselves offer a sufficient basis for the supervision of large and complex financial institutions.

6.08  It thus becomes necessary to turn to the capital adequacy standards themselves, which have largely been driven by the Basel Committee on Banking Supervision.

The Basel Standards

The Basel Committee on Banking Supervision

6.09  The Basel Committee on Banking Supervision originally consisted of the governors of the central banks of the G10 although its membership subsequently expanded to include a number of other countries. The Committee meets at the Bank for International Settlements in Basel, and is an informal grouping in the sense that it does not have its basis in a treaty or agreement between the relevant States. Although therefore lacking any formal or legal authority, the standards which it sets have generally been accepted as appropriate for banks which are active in the cross-border sphere.

6.10  The Committee’s first major work resulted in the 1975 Basel Concordat on consolidated supervision and cooperation between national supervisors of international banks.8 In 1997, it also published its guidelines on an effective supervisory system as ‘Core Principles for Effective Banking Supervision’. However, the Committee is best known for its work in the field of capital adequacy.

6.11  The Committee’s first Capital Accord (‘Basel I’) was the first attempt to create a framework of international capital standards for banks. Such a framework may be said to have two advantages. First of all, the imposition of minimum standards would help to ensure the stability of the international financial system as a whole. Secondly, it would ensure that banks (p. 126) could not secure a competitive advantage as a result of the imposition of ‘softer’ capital requirements by its own, home State.

6.12  The imposition of minimum capital requirements requires a consideration of various factors, including:9

  1. (a)  What will constitute ‘capital’?

  2. (b)  What percentage of the bank’s risks (assets) should be covered by capital?

  3. (c)  How are the bank’s assets to be ‘valued’ in terms of the likelihood of loss or default?

6.13  Although Basel II (discussed below) was presented as a radical reform of capital adequacy rules for international banks, it should be borne in mind that some of the essential principles remain the same. Specifically:

  1. (a)  The rules set out in Basel I as to what constitutes a bank’s ‘capital’ did not change in any material way.10

  2. (b)  The percentage of the bank’s risks to be covered by a bank’s capital was set at a minimum of 8 per cent under both Basel I and Basel II, and—subject to various refinements—that overall figure continues to apply under Basel III.

  3. (c)  The key change introduced by Basel II related to the calculation or valuation of the assets which are subject to the capital requirement (a process known as ‘risk weighting’). As will be seen, this process has become significantly more complex under Basel II.

6.14  Since the first two items remained substantially the same, they are considered in relation to Basel II, below. But, for comparative purposes, a few points should be made about the risk-weighting provisions under Basel I. The rules in this area came to be criticized as being too simplistic. For example:

  1. (a)  exposures to (or guaranteed by) Zone A governments and central banks11 attracted a zero per cent weighting;

  2. (b)  exposures secured by cash collateral/netting arrangements likewise qualified for a zero per cent weighting;

  3. (c)  exposures secured by a charge over debt securities issued by Zone A governments/central banks took a 20 per cent weighting;

  4. (d)  exposures to residential property were weighted at 50 per cent; and

  5. (e)  other exposures—including exposures to corporate borrowers—required a risk weighting of 100 per cent.

6.15  It will immediately be seen that the risk weighting rules were something of a blunt instrument:

  1. (a)  A five year facility to a Zone A government would be risk weighted at zero per cent for the entire period of the facility, regardless of any changes in the creditworthiness of that country over that period.

  2. (p. 127) (b)  All corporate risks attracted a risk weighting of 100 per cent. This rule obviously meant that a bank could not discriminate between well-known corporate names and small borrowers.

  3. (c)  In addition, and except in limited cases involving recourse to cash balances, the fact that the bank held security for its facility did not affect the attributable risk weighting.

6.16  On the other hand, banks might be subject to risks which were not taken into account—and for which no capital was therefore needed—under Basel I, for example, market, operational, or interest rate risk.

6.17  With the benefit of this general background, it is thus now possible to turn to the revised framework.

Basel II and Basel III


6.18  The Basel Committee issued its paper, ‘International Convergence of Capital Measurement and Capital StandardsA Revised Framework’ (Basel II) in June 2004. Countries were expected to implement the new framework by January 2007, although there was a discretion to extend this for one year.

6.19  As in the case of Basel I, the European Union issued directives to Member States to implement Basel II at the national level. This was principally achieved through the Capital Requirements Directive, which was approved in 2005.12 In the case of the United Kingdom, implementation of the Directive was at the time achieved largely through the FSA Handbook.13

6.20  As the Basel Committee states in its introduction to Basel II,14 its fundamental objectives in seeking to revise Basel I were:

  1. (a)  to develop a framework that would strengthen the soundness and stability of the international banking system;

  2. (b)  to maintain sufficient consistency to ensure that capital adequacy would not be a source of competitive inequality among banks; and

  3. (c)  to promote the adoption of stronger risk management practices by the banking industry.15

6.21  In pursuance of these objectives, the Committee notes that it had ‘…sought to arrive at significantly more risk-sensitive capital requirements that are conceptually sound…’. (p. 128) Whilst recording that it had retained the key elements of Basel I in terms of the definition of eligible capital and the key 8 per cent ratio,16 it notes that it intended to review the definition of eligible capital in the longer term.17 The Committee also envisaged that further changes might be introduced at a later date to provide for a regulatory approach based on banks’ internal risk models, provided that issues about reliability, validation, and competitive equity could be met.18

6.22  By way of general overview, the Basel II framework is based on three key ‘Pillars’, as follows:

  1. (a)  The first pillar—titled ‘Minimum Capital Adequacy’—sets out the calculation of eligible capital and the quantification of counterparty and other risks which that capital must cover.

  2. (b)  The second pillar—titled ‘Supervisory Review Process’—addresses prudential supervision generally and a bank’s access to ‘higher grades’ of review under the Internal Ratings-Based approach.19

  3. (c)  The third pillar—titled ‘Market Discipline’—deals with the requirement for banks to publish information concerning their capital structures and the risks which are inherent in their businesses. This is, in a sense, a quid pro quo for the greater flexibility afforded to banks under Basel II as a whole.

6.23  As others have noted,20 Basel II dealt extensively with capital adequacy but does not really address the problems which occurred from 2007 onwards in the context of the ‘credit crunch’, namely, liquidity and the sources of funds used by a bank to run its business.21

6.24  Against this perhaps unpromising background and in the aftermath of the financial crisis, the Basel Committee published the following measures:

  1. (a)  in June 2011, ‘Basel III: A global regulatory framework for more resilient banks and banking systems’ (‘Basel III Capital’); and

  2. (b)  in January 2013, ‘Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools’ (‘Basel III Liquidity).22

6.25  Taking into account lessons drawn from the crisis, the key objectives of Basel III Capital were:

  1. (a)  to strengthen the risk coverage of the capital framework;

  2. (b)  to suppress the build-up of excessive debt within the financial system by means of a new leverage ratio;

  3. (p. 129) (c)  to promote the accumulation of capital during benign economic periods and, hence, the preservation of resources available in a downturn;

6.26  On the other hand, Basel III Liquidity23 recognized that the availability of liquidity in the financial markets can evaporate or become very expensive at short notice as market conditions deteriorate and that—quite apart from capital adequacy issues—the absence of liquidity was a source of stress for banks during the crisis and exacerbated its consequences. Basel III Liquidity thus confirms that a Liquidity Coverage Ratio will be phased in from 1 January 2015.

6.27  Against that brief introductory background, it is possible to turn to some of the details.

Pillar One—Eligible Capital

6.28  As noted earlier, the Basel II rules as to the required ratio and the ascertainment of eligible capital were not materially varied from those contained in Basel I. Indeed paragraph 40 of Basel II confirmed that the total capital ratio must be not less than 8 per cent, whilst paragraph 41 confirmed that, subject to various minor revisions, the definition of eligible regulatory capital remains as set out in Basel I. However, the crisis demonstrated a need for higher quality capital in the banking system, and the rules as to the nature of eligible capital were substantially re-written by Basel III. The subject therefore required detailed consideration.

Basel III—The Overarching Principles

6.29  At the outset, it may be helpful to note—at the highest level—the various types of bank capital and the risks that they are expected to cover.

6.30  The components or elements of regulatory capital24 consist of:

  1. (a)  Tier One Capital (or ‘going concern’) capital which, in turn, comprises (i) Common Equity Tier One and (ii) Additional Tier One; and

  2. (b)  Tier Two Capital (or ‘gone concern’ capital).25

6.31  In terms of regulatory capital and risk coverage:

  1. (a)  Common Equity Tier One must always be at least 4.5 per cent of risk-weighted assets;

  2. (b)  Tier One Capital must always be at least 6 per cent of risk-weighted assets; and

  3. (c)  Tier One plus Tier Two Capital must be at least equal to 8 per cent of risk-weighted- assets.26

It will thus be seen that a ‘waterfall’ approach is adopted with differing qualities of capital required to be available to cover different layers of risk.

6.32  This, of course, begs two questions. First of all, what type of instrument qualifies to be treated as one of the permissible levels of capital? Secondly, how is the corresponding calculation of risk-weighted assets to be made?

(p. 130) Eligible Capital

6.33  Common Equity Tier One is, in effect, the ‘highest grade’ of capital. Consequently, Common Equity Tier One capital consists of common (or ordinary) shares, and any share premium account. It must meet a number of stated criteria. For example, it must be perpetual capital which represents the most junior claim in any liquidation of the bank. Dividends must be paid only out of distributable profits and there must be no circumstances under which the payment of a dividend is obligatory.27

6.34  Additional Tier One capital includes subordinated debt which is callable by the bank after a minimum period of five years, subject to supervisory approval. Coupons must be payable only out of distributable profits and must be cancellable by the bank. The nature and scope of events of default applicable to such instruments is heavily circumscribed.28

6.35  Tier Two capital includes certain loan loss adjustments and other items.

6.36  The calculation of capital is subject to a number of ‘regulatory adjustments’ to reflect items such as goodwill, liabilities in respect of defined benefit pension schemes, deferred taxation and other matters.29

6.37  As may well be imagined, the rules as to the quality and calculation of capital are much more complex than the brief discussion just given, but this overview will suffice for present purposes.30

Risk-weighted Assets


6.38  Obviously, having calculated the eligible capital side of the equation, the question is: what is the figure to go on to the risk-weighted assets side? As noted earlier, the basis on which risk-weighted assets are to be calculated is one of the major areas of change introduced by Basel II. The search for a more risk-sensitive approach to the allocation of capital resources has inevitably resulted in a significant degree of complexity.

6.39  In order to provide for a more sophisticated approach to risk assessment and the calculation of risk-weighted assets, Basel II31 contemplates two main systems for banks:

  1. (a)  The Standardized Approach, where risk weightings are to a significant extent based on the assessments of external credit rating agencies such as Moodys or Standard & Poors;32 and

  2. (p. 131) (b)  The Internal Ratings-Based (IRB) approach, where banks can use their own assessment of borrower/counterparty risk provided that they can persuade the regulator of the quality of their risk management systems.33 The IRB approach is itself divided into a ‘foundation’ and ‘advanced’ approach.34

The Standardized Approach

6.40  The rules governing the standardized approach to credit risk are now to be found in the CRR and, as such, are directly applicable in the United Kingdom without any need for implementing legislation.35

6.41  A bank using the standardized approach is required to assign each of its exposures to a prescribed series of ‘exposure classes’, including (i) claims on central governments or central banks, (ii) claims on regional/local authorities, (iii) claims on administrative bodies, (iv) claims on international organizations, (v) claims on financial institutions, (vi) claims on corporates, (vii) retail claims, (vii) claims secured on land, and (viii) exposures in default.36 Ratings published by approved rating agencies may then be used to calculate the risk weighting applicable to particular exposures.37

6.42  The starting point for most risk weightings is a figure of 100 per cent. However, some exposures qualify for a zero per cent risk weighting.38 In addition, the risk weight of transactions in default may have to be increased up to the level of 150 per cent. This serves further to emphasize that the assessment of capital adequacy is a dynamic process under Basel II and the national legislation which has implemented it, with the result that the amount of capital to be attributed to a particular transaction may fluctuate significantly throughout its life.

The Internal Ratings-based Approach

6.43  The IRB approach is also set out in the CRR.39

6.44  In contrast to the position under the standardized approach, the level of the capital requirement for a bank using this approach is based on the bank’s own estimate of certain risk parameters.40

6.45  The use of an IRB approach is subject to the prior approval of the PRA. That consent will only be forthcoming if the bank’s internal systems for the management and rating of credit risk are sound and are implemented with integrity. They must also meet certain minimum standards. In particular:41

  1. (a)  the bank’s rating system must provide for meaningful assessment of obligor/transaction characteristics;

  2. (p. 132) (b)  the internal ratings and default/loss estimates used in the calculation of the capital requirements must play an essential role in the credit approval, capital allocation, and corporate governance of the bank;

  3. (c)  the bank’s rating systems are managed by a credit risk control unit which is appropriately independent and free from undue influence;

  4. (d)  the bank collects and stores all data necessary to provide effective support for its credit risk processes; and

  5. (e)  the rating systems are documented and validated.

6.46  A firm will only receive PRA approval for the IRB approval if it can show that it has been using essentially similar risk management processes for the three year period before the IRB permission is granted.42

6.47  Once again, a bank using the IRB approach must assign its exposures to particular exposure classes, including claims on governments, institutions, corporates and retail customers.43 There are detailed rules for the valuation of different types of exposure and the level of detail moves beyond the scope of a work of this kind. However, a brief overview may be helpful.

6.48  The formula for calculation of the risk-weighted exposure amounts for the relevant side of the capital adequacy equation44 is set out in BIPRU It is fair to say that this formula will be beyond the comprehension of many lawyers, and the present writer will certainly not attempt to explain it. But the ‘inputs’ into this formula will be more readily understandable. The nature of these definitions also helps to identify that the relevant provisions are aimed at ascertaining a satisfactory risk weighting, having regard to the likelihood of default and loss. An analysis of these factors also helps to explain the difference between the IRB foundation and the IRB advanced approaches. Thus, the inputs or factors to be taken into account in applying the formula include:

  1. (a)  Probability of Default (PD). PD represents the probability of a default by a counterparty over a one year period. A bank using either the IRB foundation or the IRB advanced approach must use its own estimate of PD, ascertained in accordance with the minimum IRB requirements discussed above.46 The PD for a corporate or institutional exposure must be at least 0.03 per cent and, if the exposure is in default, the PD must be 100 per cent.47

  2. (b)  Loss Given Default (LGD). This is defined as the ratio of the loss on an exposure due to the default of the counterparty to the amount outstanding at default. Subject to the availability of credit risk mitigation48 and certain other details, a bank using the IRB foundation approach is required to apply an LGD value of 45 per cent for senior exposures and 75 per cent for subordinated exposures,49 whilst a bank using the IRB advanced approach must use its own estimates of LGD.50

  3. (p. 133) (c)  Expected Loss (EL). The expected loss reflects the amount likely to be outstanding in the event of a default by the borrower. For a bank using the IRB foundation approach, the exposure value must be calculated in accordance with a pre-set formula, but banks using the advanced approach have the flexibility to use their own estimates of loss in certain cases.51

6.49  It will thus be seen that the key difference between the IRB foundation and the IRB advanced approaches lies in their respective number of independent ‘inputs’ into the risk-weighted asset calculation. The IRB foundation approach still depends significantly on factors prescribed by the regulator.

Credit Risk Mitigation


6.50  The foregoing parts of this chapter have considered the calculation of eligible regulatory capital and of the risk-weighted assets (or exposure) for which the capital is intended to provide cover.

6.51  However, in good times and in bad, banks will inevitably be seeking to use their capital in the most efficient and effective way. This may enable them to price their transactions more competitively or (alternatively) allow them to make enhanced profits on individual transactions. It has been noted52 that Basel I provided only very limited instances in which the availability of security or guarantees could be taken into account in reducing capital allocation requirements. This is another area in which Basel II has introduced significant reform. This is perhaps also the area in which lawyers are most likely to be involved, partly because the relevant requirements involve security or guarantees and partly because the capital mitigation effect is only achieved if the relevant arrangements are legally robust.

Common Principles

6.52  There are different types of credit mitigation techniques and their precise effect depends upon their nature and quality. There are, however, certain common strands:

  1. (a)  any technique used to provide credit protection must result in credit protection arrangements which are legally effective and enforceable under the laws of all relevant jurisdictions;53

  2. (b)  the bank must take all appropriate steps to ensure the effectiveness of the security and to address related risks.54 This presumably refers to the need to value the security from time to time, to monitor the financial position of any relevant guarantor and similar matters.

6.53  Against that brief background, it is possible to turn to the two forms of credit risk mitigation which are permitted for these purposes, namely:

(p. 134)

  1. (a)  funded credit risk mitigation, which depends primarily on the value of a package of security; and

  2. (b)  unfunded credit risk mitigation, which depends principally on the creditworthiness of a party other than the borrower or counterparty itself.

Funded Credit Protection

6.54  Funded credit protection can take one of two main forms:

  1. (a)  on balance sheet netting of mutual claims and reciprocal cash balances between the bank and the counterparty create effective security and may thus be recognized as an acceptable form of funded credit risk mitigation;55 and

  2. (b)  collateral or security over acceptable forms of assets including (i) cash or cash equivalent instruments, (ii) gold, (iii) government/central bank securities meeting stated credit quality criteria, (iv) debt securities issued by banks, local authorities and certain other entities which meet stated criteria, (v) short term debt securities with an acceptable rating, and (vi) equities/convertible bonds listed on a main index.56 An institution which adopts the comprehensive approach to collateral57 may also treat as eligible any equities or bonds which are quoted on a recognized stock exchange, and units in collective investment schemes which invest solely in such investments and have a daily price quote.58 Likewise, a bank adopting the IRB approach can treat commercial real estate as eligible collateral,59 and may adopt the same approach to receivables linked to a commercial transaction with a maturity value of less than one year.60

6.55  Assuming that the bank has taken an eligible form of collateral and has satisfied the various formal requirements noted above, what are the capital consequences for the bank? The following points may be noted:

  1. (a)  where a bank holds cash collateral in respect of a loan made by it and the two items are expressed in the same currency, the two items may be netted off to the extent of the deposit;61

  2. (b)  a bank using the ‘Simple Method’ in relation to collateral must assign a market value to the collateral which must be reviewed at least six monthly and whenever the bank believes that there may have been a significant deterioration in value.62 The risk weight to be assigned to the collateralized exposure is the weight which would be assigned to an exposure to the collateral itself, subject to a minimum weighting of 20 per cent;

  3. (c)  a bank using the ‘comprehensive approach’ to collateral63 must value the collateral in a manner which takes account of the volatility in the market value of that collateral. A volatility adjustment may also be required if the security consists of cash in a currency other than that in which the exposure is denominated. The fully adjusted exposure value taking into account both the credit risk mitigation effects of the collateral and (p. 135) the volatility adjustments is referred to as E, and that is the value to be applied to determining the exposure value for risk-weighted asset purposes under the standardized approach;64

  4. (d)  different rules apply where credit risk mitigation is being applied under the IRB approach.65 The adjusted exposure value (E) noted above will frequently not be taken into account directly as risk mitigation but will instead be taken into account in the calculation of loss given default (LGD).66

Unfunded Credit Mitigation

6.56  As the terminology implies, unfunded credit protection depends not upon recourse to an asset by way of security, but upon the unsecured undertaking of a third party to pay a specified amount under the terms of a guarantee or credit default swap.67

6.57  The recognition of unfunded credit protection for the purpose of calculating risk-weighted assets is subject to a number of requirements:

  1. (a)  once again, the documentation creating the undertaking must be legally enforceable in all relevant jurisdictions. In addition, (i) the credit protection must be direct, (ii) the scope of the credit protection must be clearly defined, and (iii) the credit protection must not include unilateral rights of termination or any right to increase the cost of protection in the event of a deterioration in the borrower’s credit quality;68

  2. (b)  where the undertaking consists of a guarantee, (i) the bank must have the right to pursue the guarantor promptly following default, (ii) prior proceedings against the main borrower must not be a condition to a claim under the guarantee, and (iii) the guarantee must be an explicit and documented obligation assumed by the guarantor;69

  3. (c)  where the mitigation consists of a credit derivative or credit default swap, the bank will generally have the right to ‘put’ the relevant debt instrument or obligation onto the writer of the derivative at its face value on the occurrence of stated credit events. For that reason, a credit derivative has an economic effect which is similar to a guarantee, even though the overall structure is different in many respects.70 In order to qualify as eligible credit protection, the credit events which will trigger the bank’s right to exercise its rights must include as a minimum (i) failure to pay, (ii) bankruptcy or insolvency, and (iii) restructuring of the underlying debt obligation.71

6.58  What then, is the effect of taking unfunded credit mitigation which meets these criteria? In this context:

  1. (a)  under the standardized approach, the risk weighting of the protection provider is effectively substituted for the weighting applied to the borrower itself;72

  2. (p. 136) (b)  under the IRB approach, in the calculation of risk-weighted assets, the PD (probability of default) attributable to the protection provider may be substituted for that of the primary obligor.73

Market Risk

6.59  Banks are also required to take account of market risk in calculating their capital adequacy requirements.74 This requires banks to ascertain a position risk requirement in relation to all of their trading book positions.

6.60  In essence, a bank is required to ascribe capital to the risk of loss through fluctuations in interest rates,75 options,76 and certain other instruments. In the light of the financial market turmoil which began in 2007, it was realized that the ‘market risk’ rules failed to capture some of the key risks in a bank’s trading book. The Basel Committee has thus introduced an incremental capital change for unsecuritized credit products and new ‘stress-testing’ requirements. The latter stems from the fact that losses in bank’s trading books have significantly exceeded the minimum capital requirements under the existing market risk provisions under Pillar I. These rules are due to be implemented by the end of 2010.77

Operational Risk

6.61  The requirement to apply capital to account for operational risk is a new aspect of the capital adequacy regime introduced by Basel II. ‘Operational Risk’ is defined as the risk of loss resulting from the inadequate or failed internal processes, people and systems or from external events, including legal risk.78 The operational risk capital requirements are set out in BIPRU 6.79

6.62  The capital requirement in this area must be calculated in accordance with:

  1. (a)  the ‘basic indicator’ approach;

  2. (b)  the ‘standardized’ approach; or

  3. (c)  the advanced measurement approach.

6.63  In relation to these three approaches:

  1. (a)  the basic indicator approach is the most straightforward, and is calculated as 15 per cent of the bank’s interest and commission income;80

  2. (p. 137) (b)  a bank using the standardized approach must use a calculation segregated along business lines, where the indicator percentage varies according to the business line involved (for example, the percentage for corporate finance and trading/sales business is as high as 18 per cent, whilst the corresponding percentage for retail brokerage and asset management is 12 per cent);81 and

  3. (c)  a bank using the advanced measurement approach may base its capital requirement on the bank’s own assessment of its operational risks.82

Additional Capital Buffers

6.64  It is also necessary to consider the requirements for additional capital ‘buffers’ and the leverage ratios that were imposed pursuant to Basel III Capital. It should be appreciated that each of these requirements apply over and above the basic, minimum capital requirement discussed earlier in this chapter.

6.65  First of all, credit institutions must maintain a ‘capital conservation buffer’ consisting of Common Equity Tier One capital and equal to 2.5 per cent of their risk-weighted assets.83 The buffer requirement is designed to ensure that banks build up capital outside periods of loss and which can be drawn down as losses are incurred. In other words, in more benign economic conditions, banks should build up additional capital, as an umbrella against the rainy day. It is contemplated that this would be achieved in part through both dividend and pay restraint.84 It will be apparent that the capital conservation buffer is a significant item, and it is thus to be phased in over a period.85 The requirement to maintain such a buffer is reflected in the CRD,86 and this requirement has been implemented in the United Kingdom through secondary legislation87 and, more substantively, through the PRA Rulebook Capital Buffers Instrument 2014.88

6.66  Secondly, banks will be required to maintain a ‘countercyclical capital buffer’ in an amount equal to their total risk exposure multiplied by an institution specific risk-weighting.89 As its name implies, the buffer is designed to recognize the fact—emphasized by the financial crisis—that very large losses can be incurred in the banking sector when a period of excessive credit growth is followed by a severe downturn. It is not intended that the countercyclical buffer should be a permanent feature. Rather, national authorities will monitor credit growth and other factors that may be indicative of system-wide risk. If it is determined that (p. 138) risk is indeed building up within the system, then the authority will put in place a buffer requirement, and may correspondingly release it as the risk is perceived to have diminished.90 The buffer may be an amount up to 2.5 per cent of risk-weighted assets, and banks will have a period of 12 months to make the necessary adjustments.91 Again, the obligation to maintain institution-specific countercyclical capital buffers is contained in the CRD,92 and is implemented in part through the PRA rules mentioned para above.

6.67  Certain institutions will also be required to maintain a ‘G-SII Buffer’. The authorities will be required to identify those institutions authorized by it and which it classifies as (i) a global systemically important institution (G-SII) or (ii) another systemically important institution (O-SII). An institution is to be classified as a G-SII by reference to its size, interconnectedness with the financial system, the sustainability of its financial infrastructure, its complexity, the extent of its cross-border activities and similar factors. An O-SII is identified by reference to a similar, but slightly attenuated set of factors.93

6.68  A G-SII will be required to maintain a G-SII Buffer. The calculation of the amount of the buffer depends upon a sub-categorization of the G-SII but the general intent is that a higher G-SII buffer will be required taking into account the need to ensure the soundness of the institution in the context of its significance to the international financial system. In contrast, the supervisor has a discretion to require an O-SII to hold a countercyclical capital conservation buffer of up to 2 per cent of its total risk exposure amount.

6.69  The detailed calculation of this buffer is a matter of some complexity that goes beyond the scope of this work, but the underlying intent is clear. An institution is required to hold additional capital if, as a result of its size or the nature of its business, its failure would be likely to have a ‘ripple’ effect throughout the wider financial system.

6.70  Supervisory authorities are permitted—although not required—to introduce a systemic risk buffer consisting of Common Equity Tier One Capital in order to prevent or mitigate the risks of disruption to the financial system. Whilst this power is discretionary as far as the supervisor is concerned, it may not set a buffer rate in excess of 3 per cent of the bank’s total risk exposure unless it has consulted with other supervisors.94

6.71  The buffers are supported by various additional requirements. For example, dividends and other distributions are prohibited where Core Equity Tier One Capital would fall below the required buffer levels.95 Further, where a bank is not meeting its buffer requirements, it must prepare a ‘capital conservation plan’, which is likely to restore the situation within an acceptable period of time. If the supervisor is not satisfied with the plan, it may instead issue a direction requiring the bank to increase own funds to a stated level within a specified period.96

Leverage Ratio

6.72  One of the causes of the financial crisis was the build-up of leverage in the system, and the need to de-leverage on an urgent basis once the crisis took hold. This had the result of (p. 139) depressing asset prices and thus exacerbated the impact of the crisis. The dangers caused by such leverage were not in any sense addressed or mitigated by capital adequacy requirements. The Basel Committee has thus introduced a leverage ratio that is designed to prevent the build-up of excessive debt within the system.97

6.73  The counter to excessive leverage is to require that a stated, minimum proportion of a bank’s assets must be funded by equity, rather than by debt. Subject to various transitional arrangements, banks will thus be required to ensure that their Tier One capital represents at least 3 per cent of their total exposures.98

Liquidity Coverage/Net Stable Funding Ratios

6.74  One of the many challenges of the financial crisis lay in the realization that financial institutions can fail quickly and on short notice. This, in turn, meant that rescue measures had to be put in place on a ‘crisis’ basis, making it difficult to fashion the best solutions and increasing the cost to public funds. Further, as will be shown at a later stage,99 new legislation has been introduced to provide resolution mechanisms for failing institutions. But even these measures will be ineffective if the speed of the collapse gives insufficient time for a proper assessment of the situation. The Liquidity Coverage Ratio is thus designed to ensure that a troubled institution could continue its business for a minimum period of 30 days, thus providing the necessary breathing space for regulators and the government to do their job.100 The essence of the liquidity coverage requirement is that a bank should hold a stock of unencumbered, high quality liquid assets (HQLA) to enable it to meet its liabilities during such 30-day period.101

6.75  As with all of these matters, the general principle is relatively easy to state but the details are rather more challenging. However, in brief, the Liquidity Coverage Ratio inevitably consists of two elements. First of all, what are the HQLAs and how will they be valued? Secondly, what is the scale of the liabilities that the HQLA will have to cover during the assumed 30-day period? In essence, the value of the HQLAs has to equal or exceed total net cash outflows during that period.

6.76  The definition of HQLAs is extensive and divided into sub-classes. However, the essential requirements are that the assets must be low-risk, low-volatility, readily valued and traded on a recognized exchange where there is an active and sizeable market. The HQLAs must be free of any security interests and there must be no contractual or regulatory restriction against their disposal—ie it must be possible for the bank to ‘monetize’ the asset at short notice.102

6.77  It is also necessary to calculate the total cash outflows during the 30-day period. The outflows are to be calculated on a ‘net’ basis, so that expected repayments from borrowers and similar revenues are deducted from the overall figure. Again, the relevant provisions are (p. 140) detailed but the calculation must take account of likely withdrawals by depositors in a crisis situation, and the fact that wholesale market funding may likewise have to be repaid as a result of the institution’s loss of access to those markets. It must also take account of the fact that customers may seek to draw down on existing, committed facilities that have not been fully utilized.103

6.78  Whilst the Liquidity Coverage Ratio is designed to cover short term problems, the Net Stable Funding Ratio looks to the longer term stability of the bank’s funding base. It must be said that ‘maturity transformation’ —the process of making long-term loans out of short-term deposits—is one of the important roles of a bank in the economy. But this clearly creates potential problems for a bank, in the sense that its liabilities cannot be repaid from its assets.

6.79  The provisions described above are in general terms reflected in the CRR, which in turn requires institutions to cover the 30-day period that has been discussed.104 The EU Commission is empowered to adopt detailed implementing measures to be phased in between 2015 and 2019.105

6.80  The Net Stable Funding Ratio was thus put forward by the Basel Committee in 2010.106 The objective is to ensure that at least a proportion of the bank’s assets are financed by stable funding arrangements. To this end, banks are required to maintain stable funding at lease equal to 100 per cent of its stable funding requirement. In summary, ‘stable funding’ refers to forms of equity and debt finance that can be expected to be a reliable source of funding over a one year time horizon. The required level of stable funding will be determined in part by reference to the liquidity characteristics of the bank’s own assets, with a higher level of stable funding required if the asset portfolio is illiquid.107

6.81  Again, the CRR mirrors the provisions just described and requires that institutions ensure that their obligations are adequately funded by a diversity of stable funding instruments.108

Pillar Two—Supervisory Review

6.82  Pillar Two of Basel II creates a requirement for a supervisory review process, under which national regulators are required to verify the sufficiency of a bank’s systems and controls for the measurement and management of its exposures. The supervisory process rests on the following provisions:

  1. (a)  an ongoing, internal capital assessment by the bank itself. In the United Kingdom, this is referred to as the ‘Internal Capital Adequacy Assessment Process’ (ICAAP). This (p. 141) requires a continuous review of the bank’s financial resources and of the risks to which it is exposed, and includes an obligation to conduct periodic stress testing;

  2. (b)  in line with Basel II, the FSA will review109 the bank’s ICAAP processes and may require adjustments to them if necessary.110 It may also give guidance to a bank on the level of capital which the FSA believes should be required in the circumstances of that particular institution;111 and

  3. (c)  in the event that a bank is unable or is unwilling to bring its capital into line with the FSA’s position on that subject, then the ultimate sanction is the variation of that bank’s deposit-taking permission so as to compel compliance.112

Pillar Three—Market Discipline

6.83  As noted previously, transparency requirements are also introduced by Basel II and from ‘Pillar Three’.113 In essence, in return for the flexibilities afforded to the banks by the capital adequacy rules contained in Basel II—and in order to reinforce the supervisory review process contemplated by Pillar Two—banks are required to disclose certain details of their internal and technical processes and policies. In particular, a bank must publicize:

  1. (a)  its management objectives and policies for each separate category of risk to which the bank is exposed, including details of strategies, processes, reporting, and management systems;114

  2. (b)  certain accounting details with respect to capital adequacy;115

  3. (c)  details of the calculation of the bank’s capital resources;116

  4. (d)  information regulating audit risk, dilution risk, market, and operational risk.117

As will be apparent, Pillar Three of Basel II involves a series of disclosure rules but does not involve any use or attribution of the bank’s capital resources.

Large Exposures

6.84  The rules on large exposures are in many respects separate from the capital adequacy and liquidity frameworks. Nevertheless, avoidance of excessive levels of exposure to single customers is a natural feature of prudent banking, and the rules prohibiting large exposures may thus be said to be consistent with the high level obligations to conduct business with (p. 142) skill, care, and diligence and to take reasonable care to organize and control its affairs responsibly and efficiently, with adequate risk management systems.118

6.85  A restriction on exposures to individual customers or counterparties is not of itself a capital adequacy requirement, but it plays an important supporting role to the capital adequacy regime. In the aftermath of the crisis, this area also engaged the attention of the Basel Committee.119

6.86  The starting point is that the total of the exposure values to a counterparty or to a group of connected counterparties120 is a ‘large exposure’ if it exceeds 10 per cent of the bank’s eligible capital base. Banks must report large exposures to their supervisors. In addition, a large exposure in excess of 25 per cent of the capital base is prohibited.121 Some (but not all) of the credit risk mitigation techniques discussed earlier in this chapter may be applied in calculating the total exposure for these purposes.122

6.87  Essentially similar rules on large exposures, including the regulatory reporting requirement and the 25 per cent limit, are likewise to be found in the CRR.123 Again, these rules are directly applicable in the United Kingdom.

6.88  As noted above, the large exposure rules may appear to be an integral part of prudent bank risk management. Yet the implementation and monitoring of this requirement is an ongoing obligation and a breach would not necessarily be indicative of recklessness or risk management oversight. For example:

  1. (a)  a breach of the limit could occur as a result of one large customer of the bank making a successful takeover of another, so that previously separate exposures have to be aggregated for large exposure purposes;

  2. (b)  a breach of the large exposure rules may also occur as a result of events affecting the bank itself. For example, significant losses may have the effect of eroding the bank’s capital resources so that, whilst the exposure itself remains unchanged, the limits are exceeded because the capital available to cover the exposure have diminished; and

  3. (c)  in view of the definition of ‘group of connected clients’,124 the acquisition of a significant shareholding stake in the bank itself could affect its large exposure position. For example, in the context of the government’s acquisition of Northern Rock and the recapitalization of banks in 2008 the question arose whether banks with exposures to entities which had the UK Government as a common shareholder should treat those entities as ‘a group of connected clients’ for large exposure purposes. However, the FSA concluded that such entities should not be considered (p. 143) as ‘connected’ merely because common ownership could be traced back to the UK Government.125

6.89  It will thus be seen that the large exposure regime is not merely an issue which needs to be considered at the initial, credit approval stage. Ongoing monitoring is required and a breach of the large exposure rules can be triggered by events which, at the initial approval stage, are entirely unforeseen. That a breach arises through unfortunate circumstances does not affect the fact that the breach must be remedied.


6.90  It is difficult to say much by way of general conclusion on the various prudential issues discussed in this chapter, save to remark that:

  1. (a)  as noted at various points, it has been the misfortune of Basel II that it came into effect when the world was on the cusp of its most serious recession for many years. A measure that was intended to provide a more risk-sensitive basis for capital adequacy arrived at a time of deteriorating credit qualitatively, thus further constraining the ability of the banks to write new business at a time when credit conditions were already challenging;

  2. (b)  some aspects of the framework were found to be inadequate to cover risks which arose in admittedly very extreme circumstances;126 and

  3. (c)  the difficulties which hit the financial markets in 2008 were borne out of a lack of liquidity—an issue which was not directly addressed by the Basel II framework at all.

6.91  All of these issues have been, or are in the course of being, addressed. As has been shown, additional capital buffers have been introduced, alongside new liquidity and stable funding ratios. Since these are to be phased in over a period, the success of these measures remains a matter for future assessment, although plainly they are a step in the right direction. Nevertheless, in one sense, the discussion illustrates the perennial difficulty with prudential rules of this kind, in that the regulations will always be trying to make provision for crises which have not yet occurred and will display unique features which had not previously occurred to anyone.(p. 144)


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.

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.

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.

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.

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.

PRA Handbook, PRIN.

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.

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 [2006] EWHC 816 (Comm), since the very issue of supervisory responsibility was at issue in that case. The decision is discussed in Chapter 14 below.

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.

21  On liquidity more generally, see paras 6.59–6.61 below.

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.

46  See para 6.35 above.

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.

52  See para 6.14 above.

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.

94  See CRR, Art 133.

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.

99  See the discussion at paras 11.26–11.112 below.

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.

110  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.

114  BIPRU 11.5.1R.

115  BIPRU 11.5.2R.

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.

124  See n 120 above.

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.