Capital requirements of credit institutions
Credit institutions must have appropriate capital. One of BaFin's primary functions is to ensure that institutions are adequately endowed with capital. What counts towards eligible capital, i.e. the sum of Common Equity Tier 1 capital, Additional Tier 1 capital and Tier 2 capital, is governed by Part Two of the Capital Requirements Regulation (CRR).
The German Solvency Regulation (Solvabilitätsverordnung – SolvV), in the version applicable as from 1 January 2014, contains additional provisions on the procedures relating to the application and notification requirements stipulated by the CRR, including the periodical reporting requirements and the transitional provisions of the CRR.
The CRR has replaced the earlier German Solvency Regulation governing the capital adequacy of institutions, groups of institutions and financial holding groups, which was applicable until 31 December 2013. The CRR not only governs what is recognised as regulatory capital, but also the minimum amounts of capital that must be held to cover the risks. The CRR specifies in Part Three (Articles 107 to 386) in detail how the minimum capital requirements for the individual types of risk, in particular credit risks, market risks and operational risks, are to be determined. In addition, the CRR also contains in Part Eight (Articles 431 to 455) disclosure requirements which institutions have to meet.
Credit risk (counterparty risk)
The CRR contains two alternative approaches for calculating adequate own funds for credit risk positions, the so-called credit risk standardised approach (CRSA) and an internal ratings-based approach (IRBA). Institutions operating within the IRBA may, subject to certain conditions, estimate not only the probability of default (PD) themselves but also the loss given default (LGD) and the conversion factor.
Under the CRR, market risks also have to be backed by capital. In order to determine their own funds capital requirements, institutions can make use of either standardised approaches or their own internal risk models. The use of internal models requires the authorisation of the supervisors.
The CRR lays down explicit capital requirements for operational risk as well. It provides for three different options for determining the capital charge for operational risk: the Basic Indicator Approach, the Standardised Approach and the Advanced Measurement Approach (AMA). The capital charge for operational risk under the Basic Indicator Approach and the Standardised Approach is determined based on a procedure stipulated by BaFin. Institutions adopting an AMA, on the other hand, are able to calculate their capital requirement using internal risk measurement systems.