INTM267720 - The attribution of capital to foreign banking permanent establishments in the UK: The approach in determining an adjustment to funding costs - STEP 2: Risk weighting the assets: large exposures

The Large Exposures regime is separate from the Capital Adequacy Directive (CAD) regime (INTM267701) and is covered by The Banking Consolidation Directive. This regime limits the amount of exposure that a bank can have to an individual counter party to a percentage of the bank’s capital (generally limited to 25% of the bank’s capital base, although there are exceptions to this and there are some other large exposure limits that apply).

The details of the large exposures regime are contained in the Interim Prudential Source Book for Banks (IPRU (Bank)) at Chapter LE. In practical terms, the large exposure limits often hit a bank harder, in terms of capital required, than the CAD requirements.

The large exposure capital base will generally be the sum of allowable Tier 1 and Tier 2 capital less any deductions. To show how the two regimes can interact it is perhaps useful to look at a very much simplified and hypothetical example.

Example

A bank has risk-weighted assets of £10m and is required to have a minimum capital ratio of 10% for CAD purposes.

It will therefore need to have a combined total of Tier 1 and Tier 2 capital of at least £1m.

The bank now wants to lend £350,000 to a company. Assume that this will be risk weighted at 50%.

For CAD purposes, the bank would need a further £350,000 x 50% x 10% = £17,500 capital.

For large exposure limit purposes the bank would need a capital base of £350,000 / 25% = £1,400,000. If it were to make this loan, the capital held by the bank would be determined by the large exposure limits rather than the CAD requirements.

The Prudential Regulation Authority (PRA) large exposures policy does not apply to a UK permanent establishment (PE) of a bank incorporated overseas, but UK PEs of banks incorporated outside the European Economic Area (EEA) do have some reporting requirements for Large Exposures and are required to report their 20 largest exposures.

Although the PRA large exposures regime does not apply to a UK PE, it can be seen that at arm’s length it will influence the amount of capital that a bank holds. Thus, to the extent that the PE is to be regarded as a separate entity trading in the UK in the same or similar activities, in the same or similar circumstances the large exposure regime, as applied by the PRA, would have an effect on the amount of capital to be attributed to the PE under ICTA88/S11AA.

During the consultation exercise on the legislation, however, it was agreed that the large exposure regime would not be taken into account in calculating the amount of capital to be attributed to a UK PE unless the company as a whole has to carry extra capital, for large exposure purposes, against that financial asset. This means that, if applying the above example to a PE, HMRC would not attribute extra capital of £382,500 to the PE (£400,000 - £17,500) in order to satisfy large exposure requirements unless as a matter of fact the company as a whole has to carry extra capital, for large exposure purposes, against that asset. If extra capital was required at the company level and that asset is correctly attributed to the PE, then the capital related to that asset should be attributed to the PE too.