FI applies the capital adequacy regulations with the aim to ensure that the Swedish banking system is more robustly equipped for withstanding future financial crises.
Because of their relatively low percentage of equity in relation to other funding, credit institution have relatively high indebtedness, which makes the risk for default more prevalent.
Pursuant to FI's assignment to maintain financial stability, these firms are therefore assigned a capital requirement in relation to their risk-weighted assets. The capital adequacy requirements are prescribed to ensure a sufficient level of capital for absorbing losses that could arise within the credit institution and thus prevent financial imbalances. The capital requirement is built on several pillars, which as of 1 January 2014 are regulated by the Capital Requirements Directive (2013/36/EU) and the Capital Requirements Regulation (575/2013/EU).
Pillar 1 capital requirements are regulated by the Capital Requirements Regulation (575/2013/EU) and ensure capital coverage for credit and counterparty risk, market risk and operational risk, which together form the minimum requirement.
Operational risk is defined as "the risk of losses arising from inadequate or failed internal processes, human error, incorrect systems or external events". This definition includes legal risk.
The capital adequacy regulations contain three approaches for calculating the capital requirement for operational risk.
The basic indicator approach applies as a rule to all firms that have not notified FI or applied for authorisation from FI to use one of the other approaches. Operating income is used as the measurement for these firms and the capital requirement is 15% of operating income.
The standardised approach is a development of the basic indicator approach and factors in that not all types of financial activities are subject to the same degree of operational risk. A firm may use the standardised approach after notifying FI of this intention. Some types of financial operations may also use the alternative standardised approach. A firm may apply for authorisation from FI to use the alternative standardised approach.
Firms may also apply for authorisation from FI to use advanced measurement approaches (AMA) to calculate the capital requirement for operational risk.
The capital adequacy regulations contain two approaches for calculating the capital requirement for credit risk.
According to the standardised approach, firms may allocate their exposures to prescribed exposure classes and assign to these exposures the risk weights attributable to each class. The risk weights can in some cases be assigned based on a credit rating from an external credit rating institution.
Firms may also apply for authorisation from FI to use the internal ratings-based approach to calculate the capital requirement for credit risk.
According to the capital adequacy regulations, firms must calculate capital requirements for interest rate risks and share price risks in the trading book, settlement risks and counterparty risks in the trading book and foreign exchange risks, commodity risks and credit valuation adjustments (CVA) risks in the entire operations.
Capital requirements can be calculated using standardised approaches and, following approval from FI, internal ratings-based approaches.
Credit institutions, pursuant to the Banking and Financing Business Act (2004:297), must identify, measure, govern, report internally and control their risks. In particular, they must also ensure that the sum of their risks does not jeopardise their ability to meet their obligations. In order to meet this requirement, they must have processes and methods for regularly measuring and maintaining capital and liquidity which – with regard to amount, type and distribution – is sufficient for covering current and future risks. FI has opted to call this process the internal capital adequacy assessment process (ICAAP). The credit institution must prepare a specific ICAAP document based on the requirement set out in Chapter 10 of Finansinspektionen's regulations (2014:12) prudential requirements and capital buffers.
As a competent authority, FI must review the ICAAP documents and assess whether they meet the requirements, and in addition to Pillar 1 conduct an total capital assessment for each individual company. The Pillar 2 requirement is an individual requirement and should cover risks that are not fully captured by the regulation's minimum and buffer requirements. This may mean a higher capital requirement for risks that are not at all covered by Pillar 1, a risk that is partly covered by Pillar 1 or an additional buffer for risks to which the credit institution exposes the financial system. In the regulation, this extra capital requirement is called the additional own funds requirement.
The Capital Buffers Act (2014:966) contains provisions regarding the maintenance of several types of capital buffers. A credit institution may use these buffers under specific circumstances and restrictions. Large buffers make the credit institution more resilient in the event of losses, which in turn decreases the probability that a credit institution would fall below the minimum requirement and problems would spread to other parts of the financial system.
Pillar 3 is the part of the Basel accord that requires credit institutions to publish additional information about their own operations. The objective of these requirements is to ensure that counterparties are better able to assess if they want to enter into a customer, lender or investor relationship with the credit institution.
A stress test is when a credit institute or parts of its operations and exposures are exposed to a hypothetical negative event. This type of test makes it possible, for example, to evaluate whether the existing own funds can adequately handle negative stresses or whether the credit institution should be instructed to increase its own funds.
FI conducts at least one stress test a year for the larger credit institutes in Supervision Categories 1 and 2, more specifically the stress test the forms the basis for the assessment of the capital planning buffer, which is a Pillar 2 capital requirement.