CET1 Flashcards
(40 cards)
Give a summary of the CET1 ratio
The CET1 ratio is a proxy for how much of the bank’s own money (equity) it has available to absorb losses, relative to the risk on the assets it has (i.e. loans)
According to the CRR rules, Common Equity Tier 1 items of institutions consist of the following 6 items
1) Capital Instruments (i.e. Shares)
2) Share Premium
3) Retained Earnings
4) Other Comprehensive Income
5) Other reserves
6) Funds for general banking risk
What is the general principle for items counting towards CET1 per the rules?
“Only count if…”
Only where they are available to the institution for unrestricted and immediate use to cover the losses as soon as they occur
What is retained earnings?
Past profits after tax not paid out as dividends
How are dividends paid and accrued?
1) Dividends are typically paid out by the Group on a half year and full year basis
2) They are accrued on a monthly basis and deducted from capital
When are dividends deducted from capital
They are accrued on a monthly basis and deducted from capital
Give me two examples of “Other reserves” that can count towards CET1?
1) Currency translation reserve
2) IRFS2 reserve from share schemes
What is the ‘Currency Translation Reserve’?
- Barclays have to report their figures in £s
- Due to currency fluctuations, each month there will be a difference value of what $10bn of CET1 or $100bn of RWAs is worth in pounds
- This may cause volatility in the CET1 ratio as a result of CET1 & RWAs having different currency compositions
- To reduce this, a monthly ‘Hedge on net investment’ (HONI) process in implemented at Group level.
- The hedge is purchased by BBplc for Group
What does ‘HONI’ stand for?
Hedge on net investment
What is the purpose of the HONI hedge?
By buying or selling FX exposure (On CET/RWAs), the CET1 capital currency mix can be brought into line with the RWA mix
Hence, reducing volatility
What levels of capital is the HONI hedge performed for?
And why?
Although FX risks exists for leverage and lower tiers of capital, the HONI hedge is only done for CET1
This is because only one tier of capital can be hedged perfectly (Due to differing FX splits for each tier of capital and leverage and RWAs)
Other tiers of capital are dealt with via larger FX buffers in EWIs
How does IFRS 2 Share Schemes work in the context of CET1?
The delta between market share price and strike price is vested over the years
With a monthly accrual building up in the IFS 2 reserve
(Capital neutral, decrease in AP increase in IFRS 2 reserve)
Followed by a payout, and capital reduction in March
How does a firm’s pension scheme impact CET1?
The account deficit of a firm’s pension scheme is deducted from CET1
Any surpluses are de-decognized
(Risk of a material increase in pension scheme deficit under adverse conditions will negatively impact CET1)
Give the main components that are deducted from CET1
(8 of them)
1) Losses in the current financial year
2) Intangible assets
3) Loss deferred tax assets
4) Defined benefit pensions (Deficit is deducted, Surplus is removed)
5) Holdings of CET1
(Own CET1 or of a financial sector entity the bank has significant or non-significant investment)
6) Timing DTAs subject to the threshold rules
7) Prudential valuation adjustment
8) Expected Losses > Impairment
What are the two account components that are deducted from CET1?
1) Losses for the current financial year
2) Defined Benefits Pensions in deficit
What are the 4 accounting components that cannot be counted towards CET1?
i.e. they are initially on the balance sheet but are reversed out via deduction
1) Intangibles
2) Loss deferred tax assets
3) Defined benefit pensions in surplus
4) Holdings of CET1:
- Own
- Significant and non-significant investment in financial sector entities
What are the three regulatory adjustments to CET1 made based on certain accounting items?
1) Timing DTAs subject to threshold rules
2) Prudential valuation adjustment
3) Expected losses > Impairment
What is the difference between:
1) Defined benefit pensions
2) Defined contribution pensions
1) Defined benefit pensions promises to pay out a fixed return (More important from an accounting perspective)
2) Defined contribution pensions pay out based on how the assets perform
What are intangible assets?
Intangible assets are things you can’t touch
i.e. brands, software
Why are intangibles removed from CET1?
Due to the inherent risk of overstating
and hence, inflating the amount of CET1
How does the defined benefits pensions work from an accounting perspective?
The pension assets matched to the promised payout (liability) resulting in on overall asset or liability on the balance sheet
The scale of assets and liabilities are reviewed periodically by actuaries
Give me a Barclays pensions 101
- One major defined UK benefits pensions scheme
- Review triennially
- Sits in BBPLC (Most relates to BUK)
Why are loss deferred taxes deducted from CET1?
- If you make a loss you don’t pay tax
- Tax authorities allow prior losses to be offset against future profits in some cases
- This benefit can be carried as a tax asset on the B/S
- However, because it relies on the company making profits in the future, it will not absorb losses in an immediate stress
- Hence, removed from the CET1 calculation
Explain the Prudential valuation adjustment
(PVA)
The PVA mostly applies to derivatives and is based off estimated losses not yet reflected in account fair value
