The capital analysis computes the shortfall and the buffer analysis computes the trigger, and no report in the bank carries the first number into the second.
Yes. Northbank plc is required to hold 560.8 million of additional tier 1 and holds 520.0 million, so 40.8 million of common equity fills the gap — and common equity used to meet a capital requirement cannot also count towards the combined buffer. On risk-weighted assets of 29 908.9 million that is 13.6 basis points. Headroom to the distribution trigger is 2.8432 per cent, or 850.4 million, not the 2.9796 per cent and 891.2 million the board pack reports.
Worked in full in Financial Regulation by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The level at which distributions are restricted is not a supervisory opinion. It is an addition. Northbank plc, a European bank of national systemic importance, faces a Pillar 1 common equity minimum of 4.5 per cent and a Pillar 2 requirement of 2.00 per cent that must be met 56.25 per cent in common equity. That is 1.1250 per cent, so the requirement before any buffer is 5.6250 per cent. The combined buffer sits on top, built layer by layer.
| Component | Per cent of risk-weighted assets |
|---|---|
| Pillar 1, common equity | 4.5000 % |
| Pillar 2 requirement, common equity portion | 1.1250 % |
| Requirement before buffers | 5.6250 % |
| Capital conservation buffer | 2.5000 % |
| Countercyclical buffer, weighted | 0.9700 % |
| Systemic institution buffer | 1.0000 % |
| Sectoral systemic risk buffer | 0.5000 % |
| Combined buffer requirement | 4.9700 % |
| Distribution trigger | 10.5950 % |
Ten point five nine five zero. Below that ratio distributions are restricted by operation of law. No supervisor writes a letter and no board votes. The restriction is arithmetic on a regulatory return.
Northbank reports a common equity tier 1 ratio of 13.5746 per cent. Subtract the trigger and headroom is 2.9796 per cent, or 891.2 million. That is the figure in the board pack, rounded up in conversation to three points.
It is too large, and the reason sits in the capital table one page earlier. Northbank is required to hold 560.8 million of additional tier 1 and holds 520.0 million. It holds 910.0 million of tier 2 against a requirement of 747.7 million, a surplus of 162.3 million, and that surplus is of no use here: tier 2 is not in the numerator of the tier 1 ratio, so it cannot fill a tier 1 hole in any amount, ever. The two lines do not net to 121.5 million ahead. One is a shortfall of 40.8 million, and the only instrument left that counts is common equity.
Then read the buffer rule slowly, because everything turns on one clause in it. The common equity counted towards the combined buffer requirement is the common equity that is not already being used to meet a capital requirement. Common equity conscripted to plug an additional tier 1 hole is doing a job. It cannot do that job and count as buffer as well.
| Measure | % | EUR m |
|---|---|---|
| Headroom as the board reads it | 2.9796 | 891.2 |
| Additional tier 1 shortfall, plugged with common equity | 0.1364 | 40.8 |
| Headroom to the distribution trigger | 2.8432 | 850.4 |
Thirteen point six basis points. It is not a large error and it is not offered as one. It is made of a number the bank has already computed, in its own capital analysis, that has never been carried into the distribution calculation. The two figures live one page apart in the same pack and nothing joins them. The direction never varies either: a shortfall in a lower tier is always plugged from a higher one, the higher tier is always common equity, and the plug always comes out of the buffer.
The quantity being mismeasured is the distance to a discontinuity. Below the trigger the combined buffer of 4.9700 per cent divides into four quarters of 1.2425 per cent, and each quarter carries its own cap on distributable profits.
| Quarter of the combined buffer met | Common equity ratio | Distribution factor |
|---|---|---|
| Buffer fully met, or better | 10.5950 % and above | 100 % |
| Fourth quarter | 9.3525 % to 10.5950 % | 60 % |
| Third quarter | 8.1100 % to 9.3525 % | 40 % |
| Second quarter | 6.8675 % to 8.1100 % | 20 % |
| First quarter | 5.6250 % to 6.8675 % | 0 % |
Read the top two rows together. A bank at 10.5951 per cent distributes everything. A bank at 10.5949 per cent distributes 60 per cent of distributable profits and no more. One basis point of ratio costs 40 percentage points of the payout, and every step below that one costs 20. The first step is the tallest, and it is triggered by crossing a line rather than by falling some distance past it. A capital plan that models the restriction as a gradual squeeze has modelled the wrong shape.
The cap covers more than the ordinary dividend. Buybacks, variable remuneration and the coupon on additional tier 1 instruments compete for the same capped amount, and Northbank holds 520.0 million of those instruments. A bank that crosses the trigger is choosing, inside 60 per cent of distributable profits, between the dividend, the bonus pool and the coupon on the very instruments it was already short of.
Above the trigger sits supervisory guidance of 1.25 per cent, an expected level of 11.8450 per cent. Guidance restricts nothing automatically. It starts a conversation, and a supervisor who has opened one usually has views on the dividend that are accommodated without any rule being invoked. Headroom to guidance reads 1.7296 per cent, and 1.5932 per cent once the same shortfall is deducted. Four quantities therefore circulate under one word: 2.9796 and 2.8432 per cent to the automatic trigger, 1.7296 and 1.5932 to the level the supervisor expects. The board was told three points. Nobody lied; four correct calculations exist and one of them was reported.
Recompute it in this order, on paper. Take the common equity tier 1 ratio. Deduct, explicitly and as a separate line, the common equity filling a shortfall in any other tier — Northbank’s line is 40.8 million, from 560.8 required against 520.0 held. Then subtract the trigger. Then subtract guidance. Two headrooms result, one automatic and one negotiated, standing on the reported basis 284.32 and 172.96 basis points away. Then label the page: a line reading “to the automatic distribution trigger, after deducting common equity used to meet the additional tier 1 requirement” removes the ambiguity permanently. And put the staircase in the pack once, as a table. A board that has seen the step from 100 per cent to 60 per cent happen at a single point never again asks whether a small breach is a small problem.
It is a sum of published terms. Pillar 1 common equity of 4.5 per cent, plus the common equity portion of the Pillar 2 requirement — 56.25 per cent of Northbank’s 2.00 per cent, or 1.1250 per cent — gives 5.6250 per cent. Add the combined buffer of 4.9700 per cent and the trigger is 10.5950 per cent.
No, in any amount. Northbank is 40.8 million short of additional tier 1 and 162.3 million long in tier 2, and the two do not net to 121.5 million ahead. Tier 2 is not in the numerator of the tier 1 ratio, so the ratio that is short does not contain the instrument that is long.
The payout falls by 40 percentage points at a single point. A bank at 10.5951 per cent distributes 100 per cent of distributable profits; a bank at 10.5949 per cent distributes 60 per cent. Every further quartile of the 4.9700 per cent buffer costs 20 points more, down to nothing in the bottom quarter.
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