# How far has the Central Bank raised the capital bar for Irish banks?



## Brendan Burgess (5 Apr 2011)

I am reading through the Central Bank's Financial Measures Programme. 

On Page 33, it has Box 2 - Developments in Capital Requirements, but the terminology doesn't seem to be consistent. 



> The current minimum capital requirements as per the Capital Requirements Directive are 4% Tier 1 and 8%Total Solvency.
> 
> Under PCAR 2010 , The Central Bank set a new target of 8% Core Tier 1 of which 7% must be Equity Core Tier 1.
> 
> PCAR 2011 are required to maintain an ongoing capital adequacy of 10.5% Core Tier 1.



So, are Irish banks now required to have 10.5% Tier 1 compared to 4% for European banks? 

Brendan


----------



## Sunny (5 Apr 2011)

Hi Brendan, even though banks are only required to hold 4% Tier 1, they would normally hold much more. The average Tier 1 ratio across Europe would range from about 5.5% to 8%. This will have to rise over the next couple of years to comply with Basle 3. I think you will see most of the 'top ranked' banks aim to have at least 9-9.5% Tier 1 which means huge sums need to be raised.

Your point that Irish banks are now well capitalised when compared to other European banks is valid. If you look at the adverse scenario of these stress tests and assume they come true, Irish banks will come out the other end with a Tier 1 ratio of about 6%.


----------



## Brendan Burgess (5 Apr 2011)

Thanks Sunny

So Basle 3 will require the banks to got to 9% by 2013, but the Central Bank are insisting that the Irish banks go to  10.5% immediately?


----------



## Sunny (5 Apr 2011)

Brendan Burgess said:


> Thanks Sunny
> 
> So Basle 3 will require the banks to got to 9% by 2013, but the Central Bank are insisting that the Irish banks go to 10.5% immediately?


 
There isn't a specific percentage target. They are changing the minimum levels, introducing a 'Buffer' and are also changing what constitutes 'risk' capital which is why banks will have a current shortfall. This starts from 2013 and I think is phased in over two years. 
When Europe announces the results of their stress tests in the next couple of months, we should have a better idea of where Irish banks are in a European context.


----------



## Brendan Burgess (5 Apr 2011)

But the Irish banks have to comply immediately with a capital requirement which will probably be higher than the European banks have to comply with?


----------



## Sunny (5 Apr 2011)

Brendan Burgess said:


> But the Irish banks have to comply immediately with a capital requirement which will probably be higher than the European banks have to comply with?


 
Yeah. For example, I think the Bank of Italy are only insisting that their major banks have a ratio of about 9.5% by 2013.

I have seen one research piece that suggests that the banks will end up only needing 10-12 billion of the 24 billion that is being pumped in. However, these research reports have been wrong before!


----------



## Chris (6 Apr 2011)

Here is something I noticed. Page 9 of the Financial Measure Programme Report summarises the percentages of impaired loans used for the stress test. The total base rate is 7.3% while the total stress rate is 10.1%. While I think the residential mortgage stress rate of 6.7% may not be a particularly stressful figure, let's just assume this is a good stress test. 
Would this not mean that if or when this apparent worst case scenario hits, and 10.1% has to be written off, that banks would effectively be back to square one? I just don't see how these provisions are in anyway securing the banking system from this worst case scenario. Maybe I am missing something.


----------



## Jim2007 (6 Apr 2011)

Brendan Burgess said:


> Thanks Sunny
> 
> So Basle 3 will require the banks to got to 9% by 2013, but the Central Bank are insisting that the Irish banks go to  10.5% immediately?



What ever about the actual requirements, most top European banks have a tier 1 ratio of about 8% or 9%.  Here in Switzerland the two largest banks have tier 1 ratios of about 12%.

After Basle III, the Swiss authorities will require a ratio 3% to 4% higher so around 15% to 17%.

Back in the days, UBS used to have a tier 1 of around 17%, but after loosing $37b, it is now down to around 13%.

Best Regards,

Jim (Switzerland)


----------



## millieforbes (7 Apr 2011)

Chris said:


> Would this not mean that if or when this apparent worst case scenario hits, and 10.1% has to be written off, that banks would effectively be back to square one? I just don't see how these provisions are in anyway securing the banking system from this worst case scenario. Maybe I am missing something.


 

If the stresses happen exactly as predicted the banks will have core tier 1 ratios of 6% plus any amount of the capital conservation buffers held as CT1 at the worst point in the stress - not exactly back to square one


----------



## Chris (7 Apr 2011)

millieforbes said:


> If the stresses happen exactly as predicted the banks will have core tier 1 ratios of 6% plus any amount of the capital conservation buffers held as CT1 at the worst point in the stress - not exactly back to square one



Could you clarify where you are getting the 6% from. The way I understood the report tier 1 capital requirements are being raised to 10.5% with a potential stress loss of 10.1%. The way I understand it that would wipe out pretty much all capital rendering the banks insolvent again, but I could be missing something.


----------



## Brendan Burgess (7 Apr 2011)

John Moran of the Department of Finance was reported in today's [broken link removed] as saying 



> There was no appreciation around Europe that the Central Bank stress tests were more severe than the EU stress tests, he said.
> 
> 
> The  Irish tests were based over three years and on capital ratios falling  to 6 per cent after a stress scenario, compared with two years and a  ratio of 5 per cent in the EU.



So if the scenarios envisaged in the stress tests happen, the banks will still have 6% Core Tier 1 capital. 

As well as that, the Irish stress tests anticipate losses which will crystalise over the next three years whereas the EU test is limited to 2 years.


----------



## Sunny (7 Apr 2011)

Brendan Burgess said:


> John Moran of the Department of Finance was reported in today's [broken link removed] as saying
> 
> 
> 
> ...


 
That's my understanding of it. I admit I haven't read the report fully yet (Have to save some fun for the weekend!). I think the Irish stress tests are also looking at the tail risk of loans and making provisions for them which is pretty unique. 

Chris, without reading the report I can't really comment but sounds like you are trying to equate 1 euro of loss with 1 euro of capital. I would imagine there is a problem with this because of a couple of things. Are they taking into account future capital generation? What about PV calculations on the losses? Where do losses already taken into account fit in? Like I say, I will have to read it properly though before commenting properly.


----------



## Brendan Burgess (7 Apr 2011)

> I think the Irish stress tests are also looking at the tail risk of  loans and making provisions for them which is pretty unique.


This is the methodology as I understand it. 

BlackRock Consultants estimated the lifetime credit losses on all loan books under the adverse scenario. 
The Central Bank incorporated these into the three year expected losses and require capital for these. (around 59% of lifetime losses)
On top of this there is a contingency capital for post 2013 losses. 
On top of this there is a buffer. 

In addition, the banks have to provide capital to absorb the forecast losses over the next three years.




> The calculation method for the capital requirements
> The final capital requirements are derived from a series of calculations which, at a high level, have required
> the following steps:
>  The estimation of loan-life and three-year losses under the base and adverse scenarios – the
> ...


----------

