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Capital tiers & quality
What items make up Common Equity Tier 1 (CET1)?
Capital instruments, share premium accounts, retained earnings, accumulated other comprehensive income, other reserves and funds for general banking risk. Subordinated loans are NOT CET1 — they are Tier 2.
How do Additional Tier 1 (AT1) instruments differ from CET1 instruments?
AT1 instruments may include call options exercisable only at the issuer's sole discretion. CET1 instruments cannot be called, guaranteed or secured, and must absorb losses first.
Where does Additional Tier 1 rank in insolvency?
Counterintuitively, AT1 ranks AFTER (below) Tier 2 capital in liquidation. The 'Tier 1' label refers to going-concern loss-absorption quality, not liquidation priority.
What general credit risk adjustment may Tier 2 include under each approach?
Up to 1.25% of risk-weighted exposure amounts under the standardised approach, but only up to 0.6% under the advanced (IRB) approach.
What was the central objective of the CRD IV / Basel III capital reform?
Better quality of Common Equity Tier 1 capital — improving the loss-absorbing capacity of capital, not just the quantity, so it is genuinely available before any bailout.
Minimum ratios & buffers
What are the three minimum capital ratios under Regulation 575/2013 (CRR)?
CET1 ≥ 4.5%, Total Tier 1 ≥ 6%, and Total Capital (Tier 1 + Tier 2) ≥ 8% of total risk exposure.
What is the capital conservation buffer, and in what capital must it be held?
Up to 2.5% of total risk exposure, held in CET1, on top of the minimum ratios. Breaching it triggers restrictions on distributions.
What is the maximum countercyclical capital buffer?
2.5% of risk-weighted assets — set by the national authority (from 0%) when credit growth is judged excessive. Same maximum as the conservation buffer, but a different purpose.
What restriction applies when a CIF breaches its capital conservation buffer?
It may not distribute more than the Maximum Distributable Amount (MDA) — capping dividends, buy-backs and discretionary variable remuneration until buffers are restored.
Which CIFs must maintain the capital conservation buffer?
All CIFs authorised to deal on own account (service 3) and/or to underwrite on a firm commitment basis (service 6), regardless of size — CySEC did not exempt small/medium CIFs.
Risk weights & large exposures
What risk weights apply to the credit quality steps for central government exposures?
When does a 1,250% risk weight apply to qualifying holdings?
To holdings in financial sector entities exceeding 15% of eligible capital, and to total qualifying holdings in non-financial undertakings exceeding 60% of eligible capital.
What is the large exposure limit to a single client or connected group?
25% of the CIF's eligible capital, after credit risk mitigation.
What large exposure limit applies where the counterparty is a credit institution?
The higher of 25% of eligible capital or €150 million. If €150m exceeds 25%, the CIF must set an internal limit not exceeding 100% of eligible capital.
Until when do the transitional large exposure exemptions remain fully exempt?
Until 31 December 2028, after which the large exposures regulations come fully into force.
Own funds adjustments
What percentage of unrealised fair-value losses must be included in CET1 (from 1 Jan 2015)?
100%. CySEC may also permit 100% of unrealised gains, but the percentage of losses included may never exceed the percentage of gains included.
How does the transitional CET1 deduction schedule for financial-sector holdings phase in?
40% in 2018, then +10 percentage points each year: 50% (2019), 60% (2020), 70% (2021), 80% (2022), 90% (2023).
Governance
What is the board of directors' role in risk management?
To approve and periodically review the strategies and policies for taking, managing, monitoring and mitigating risks, devoting sufficient time and ensuring adequate resources — not to run day-to-day operations.
Who sits on a significant CIF's risk committee, and what protects the head of risk?
Only non-executive members of the board of directors. The head of the risk management function may not be removed without prior approval of the board of directors.
May a non-significant CIF combine its risk committee with another committee?
Yes — with CySEC permission it may combine the risk committee with the audit committee, provided members have the appropriate knowledge and skills for both.
Remuneration
When is guaranteed variable remuneration permitted?
Only exceptionally — when hiring new staff, limited to the first year of employment, and only where the CIF has a sound and strong capital base.
What is the cap on variable remuneration relative to fixed pay?
100% of fixed pay by default (1:1). Shareholders may raise it to a maximum of 200%, requiring a 66% majority with ≥50% of shares represented (or 75% if fewer than 50% are represented).
What share and deferral rules apply to CIF variable remuneration?
At least 50% must be in shares or share-linked/CET1-equivalent instruments; at least 40% must be deferred over 3–5 years (rising to 60% for particularly high amounts).
Who composes the remuneration committee and whose pay does it specifically oversee?
Non-executive members of the board of directors. It specifically oversees the remuneration of senior risk and compliance officers, so their pay is not linked to the areas they control. Staff must also undertake not to use personal hedging that undermines risk alignment.
SREP
What is the SREP, over what horizon does it run, and what determines its intensity?
The Supervisory Review and Evaluation Process — CySEC's assessment of a CIF's capital adequacy over up to five years, based on the Basel II accord. Its intensity is proportionate to the CIF's nature, scale, complexity and systemic importance.
What are the SREP stages, and where is the Pillar 2 requirement set?
Planning (CySEC requests the ICAAP), Review and Assessment of ICAAP, Review of Additional Information, Supervisory Measures (where Pillar 2 capital requirements are set), and SREP Validation. Communication with the CIF is continuous.
What is the outcome of the SREP, and what ongoing duty does it place on the CIF?
A capital resource requirement the CIF must maintain (may exceed Pillar 1). The CIF must inform CySEC when its capital resources fall — or are expected to fall — below the SREP-set requirements.
ICAAP
What is the ICAAP designed to ensure?
Appropriate identification and measurement of risks, an appropriate level of internal capital relative to the risk profile, and suitable risk management and internal control systems. (AML compliance is governed separately.)
Who owns the ICAAP, and how often must it be reviewed?
The board of directors and senior management initiate and design it (the board owns it). It must be reviewed at least annually, and sooner on any material change in strategy, business plan or operating environment.
Who performs the independent review of the ICAAP?
A function or person not involved in the ICAAP process — typically the internal audit function. Independence is a core ICAAP principle.
What forward-looking horizon must the ICAAP cover, and what if it is outsourced?
A 3-to-5-year capital planning horizon (base case and stressed). If part or all of the ICAAP is outsourced, responsibility remains fully with the CIF.
What does it mean for the ICAAP to be 'comprehensive'?
It must capture all material risks: Pillar 1 risks, risks not fully captured under Pillar 1, and all Pillar 2 risks. It is not a box-ticking compliance exercise but an integral part of management.
What are the ICAAP roles of the risk, finance, business and internal audit functions?
Risk management identifies risks and applies the stress tests; finance prepares budgets/capital plans; the business function provides data; internal audit independently reviews the process.
Pillar taxonomy
What are the three Pillar 1 risks?
Credit risk, market risk and operational risk — and only these three under the Pillar 1 minimum capital formula.
Which risks are 'not fully covered' by Pillar 1?
Residual risk, concentration risk, securitisation risk, settlement risk and foreign exchange risk — a grey zone requiring additional Pillar 2 assessment.
Name the main Pillar 2 risks.
Liquidity risk, business risk, strategic risk, reputational risk, group risk, and legal/compliance risk — assessed in the ICAAP but outside the Pillar 1 formula.
What does the definition of operational risk include and exclude?
It includes legal risk (fines, penalties, unenforceable contracts) but explicitly excludes strategic risk and reputational risk, which are Pillar 2 categories.
What are the components of market risk?
Interest rate risk (incl. credit spreads), currency risk, equity risk and commodity risk, plus changes in volatilities and correlations.
Risk definitions
Define credit risk.
The risk of loss of principal or financial reward caused by a borrower's failure to repay a loan or otherwise meet a financial obligation. Assessed across credit limits, bond/counterparty exposures and loans.
Define residual risk.
The risk that credit risk mitigation techniques prove less effective than expected — for example, the delay or inability to realise timely payment from a client, or collateral that turns out illiquid or unenforceable.
Define settlement risk.
The risk that one party fails to deliver the asset or cash value at the time of settlement of a trade. Particularly important when a CIF transfers funds on behalf of clients; not fully covered by Pillar 1.
What is concentration risk, and at what levels is it analysed?
The risk from large exposures to a limited number of counterparties, a single large transaction, or one product/sector/geography. It must be analysed at both the local legal-entity level and on a consolidated basis.
Define liquidity risk.
The risk that a CIF has insufficient financial resources to meet its current and prospective obligations as they fall due, or can only secure them at excessive cost.
Distinguish reputational, strategic and group risk.
Reputational risk is adverse perception of the CIF by stakeholders; strategic risk arises from poor business decisions or failure to adapt; group risk emanates from the CIF's relationship with other group entities. All three are Pillar 2.
Leverage & disclosure
How is the leverage ratio calculated?
Capital measure ÷ total exposure measure, expressed as a percentage. It uses unweighted total exposures, catching risks that risk-weighted models might underestimate.
How is return on assets calculated for country-by-country reporting?
Net profit ÷ total balance sheet. Country-by-country disclosure also covers name/location, turnover, FTE employees, pre-tax profit/loss, tax, and public subsidies received.
Stress testing
Distinguish sensitivity analysis, scenario analysis and reverse stress testing.
Sensitivity analysis changes one risk factor while holding others equal; scenario analysis changes several factors simultaneously to assess combined impact; reverse stress testing starts from the outcome (an unviable business model) and works back to the causes.
How often must stress tests be reviewed, and how should results be used?
At least annually and whenever the relevant factors are expected to change. Stress testing must be forward-looking and integral to both the ICAAP and the risk management framework; after implementing management actions the CIF should re-run the test to confirm improvement.