Describe the legal and regulatory capital adequacy requirements for banks. Must banks make contingent capital arrangements?
At the EU level, there are harmonised rules on capital requirements. These are part of the Single Rulebook, which comprises the EU Capital Requirements Regulation (CRR) (575/2013) and the EU Capital Requirements Directive IV (CRD IV) (2013/36/EU). The CRR and CRD IV were transposed into the Legal Framework of Credit Institutions and Financial Companies and binding technical standards and guidelines. The CRR requires banks to have enough capital available to face losses in the event of a crisis (the so-called ‘own funds requirement’).
The own funds requirement is expressed as a percentage of risk-weighted assets according to the following rationale: the safer the asset, the lower the capital allocation.
The minimum total amount of capital that banks must maintain equals 8% of their risk-weighted assets. From the total amount indicated above, banks must hold a Common Equity Tier 1 of 4.5% of their risk-weighted assets.
How are the capital adequacy guidelines enforced?
Credit institutions must provide the Bank of Portugal (BoP) with all information necessary for the BoP to evaluate the institution’s compliance with the capital requirements. Onsite inspections may also take place.
If these requirements are not met, the BoP’s first priority will be to restore the situation, rather than penalising the credit institution. To do so, the BoP may require the institution to take corrective measures in order to reverse the situation (eg, require the institution to reinforce its internal mechanisms of self-evaluation, require it to compose special provisions, impose limitations on the institution’s activities or demand the utilisation of net profits to reinforce the institution’s own fund base)
Notwithstanding the above, failure to comply with the capital requirements is a particularly serious offence, which may result in a fine of between €10,000 and €5 million.
What happens in the event that a bank becomes undercapitalised?
If a bank becomes undercapitalised, the regulatory authorities can resort to early intervention, temporary administration or resolution measures. Depending on the severity of the undercapitalisation, the BoP can:
- sell the business;
- create a bridge institution;
- effect asset separation; or
- conduct a bail-in.
What are the legal and regulatory processes in the event that a bank becomes insolvent?
If a bank becomes insolvent, the regulatory authorities will decide whether they can determine the immediate judicial liquidation of the entity or whether the winding up of the institution will have adverse effects in terms of resolution objectives. If this is the case, the regulatory authorities will apply a resolution measure, which will automatically:
Read More: Bank capital requirements in Portugal