What counts as own funds, and which capital ratios and buffers must be met?

The definitions in this note come from the CRR. They matter for every CIF, because the IFR defines CET1, AT1 and Tier 2 capital by reference to the CRR. Own funds add Tier 2 capital to Tier 1 capital, and Tier 1 is CET1 plus AT1. CET1 items are capital instruments, share premium accounts, retained earnings, accumulated other comprehensive income, other reserves and funds for general banking risk. The last four count only if the firm can use them freely and at once to absorb losses when they arise. Interim or year-end profits count early only with CySEC's permission, after independent verification and the deduction of foreseeable charges and dividends.

CET1 instruments are fully paid up and perpetual, and they are neither secured nor guaranteed. They absorb the first and proportionally largest share of losses, and they rank below every other claim if the firm is wound up. AT1 instruments are similar, but they may include call options that only the issuer can choose to exercise; in insolvency AT1 ranks below Tier 2. Tier 2 holds capital instruments and subordinated loans with their share premium. A firm on the standardised approach may add general credit risk adjustments, before tax, up to 1.25% of its risk-weighted exposure amounts, and a firm using internal ratings may add its IRB excess up to 0.6% of its risk-weighted exposure amounts under that approach. The CRR sets the strictest conditions for CET1, the highest-quality capital.

The exam material says firms must at all times hold CET1 of at least 4.5%, Tier 1 of at least 6% and total own funds of at least 8% of the total risk exposure amount. These are the ratios of CRR Article 92, which has also required a leverage ratio of at least 3% since 28 June 2021. Today they bind only banks and Class 1-minus CIFs.

Since 26 June 2021 Class 2 and Class 3 CIFs have applied IFR Article 9 instead. Their benchmark is their own funds requirement, the highest of fixed overheads, permanent minimum capital and, for Class 2 only, K-factors: CET1 must be at least 56% of it, CET1 and AT1 together at least 75%, and total own funds at least 100%. They must also hold liquid assets worth at least one third of their fixed overheads requirement. See Which prudential rules apply to a Cypriot investment firm, and how are groups supervised?.

The exam material describes a capital conservation buffer of CET1, held above the minimum, of up to 2.5% of the total risk exposure amount. It adds that, as the macroprudential authority did not exempt smaller firms, every CIF licensed to deal on own account or to underwrite with a firm commitment had to hold it, however small. Since 1 January 2019, when the phase-in ended, the CRD and Law 6(I)/2015 have set the buffer at exactly 2.5%. Since 5 November 2021 the buffers have applied only to banks and Class 1-minus CIFs: CySEC's practical guide to the IFR and IFD confirms that Class 2 dealing firms are no longer subject to Law 6(I)/2015, whose small-firm exemption Law 161(I)/2021 deleted on that date.

The countercyclical buffer is set by the designated authority, the Central Bank of Cyprus, normally between 0% and 2.5% in steps of 0.25 percentage points, and higher only where it is justified. A firm that does not meet its combined buffer requirement may not distribute more than its maximum distributable amount (MDA). That limits dividends, variable pay and payments on AT1 instruments until the buffer is rebuilt.

The exam material says a 1,250% risk weight applies to the greater of two amounts: qualifying holdings in financial sector entities, together with those in certain banking-related undertakings, above 15% of eligible capital; and other qualifying holdings above 60%.

CRR Article 89 concerns holdings in undertakings that are not financial sector entities: a single holding above 15% of eligible capital, or all such holdings together above 60%. For the greater excess the authority chooses between a 1,250% risk weight and a ban; CySEC chose 1,250% (Directive DI97-01, now for Class 1-minus CIFs), and a firm may deduct the excess from CET1 instead. Holdings in financial sector entities have never fallen under this rule; they are dealt with by CET1 deductions. Since 26 June 2021, IFR firms have deducted from CET1 the excess over 15% (one holding) or 60% (all holdings) of own funds, unless CySEC prohibits such holdings.