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Deposit taking institution, such as banks and building societies are required to hold sufficient regulatory capital to ensure that they can at all times cover unexpected losses, for instance if borrowers fail to repay their loans, and keep themselves solvent during a period of severe financial stress, so they can at all times repay their depositors.
Firms can use either core equity tier one (CET1), additional tier one or tier two capital, to satisfy their regulatory capital minima. These different types of capital have different loss-absorbing characteristics and funding costs. The most loss absorbing CET1 is understandably the most expensive for a bank to access
This capital ensures the safety and soundness of individual firms and the stability of the financial system as a whole.
The UK Finance Prudential, Reporting and Tax team works with members to ensure that the Prudential Regulation Authority, which implements international standards set by the Basel Committee on Banking Supervision (BCBS) are proportionate and can be operationalised. The BCBS Framework sets requirements in relation to the three ‘Pillar One’ risk categories. These are credit risk, market risk and operational risk, which represent the most significant risk that banks face.
Banks calculate the capital requirements for each category of risk either using a ‘standardised’ approach, or alternatively and subject to regulatory approval, an approach which allows them to use their own internal estimates to determine capital requirements.
Banks are also required to hold capital against ‘Pillar 2’ risks which are underestimated or not covered by Pillar 1 such as such as strategic risk, business model risk and reputational risk, which are captures and assessed, alongside Pillar 1 risks in a firms Independent Capital Adequacy assessment Process.
For more information on the team’s work in bank capital contact either:
simon.hills@ukfinance.org.uk
or
nala.worsfold@ukfinance.org.uk
UK Finance has partnered with the Institute of Risk Management (IRM) - the leading international professional body for risk management - to equip our members with the skills to better manage organisational risks.
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