188体育

In addition to the issue of 鈥渆xcess鈥� equity addressed at INTM267785 there are other issues that could arise where capital is actually allotted to a permanent establishment (PE). To illustrate these, a simple example is set out below.

Year 1:

A PE estimates that it will have risk-weighted assets (WRA) of 拢1000M at the year end.

Its capital requirement is agreed to be 11%, split 8% Tier 1 and 3% Tier 2. For simplicity only it is assumed that Tier 1 is all 鈥榚quity鈥� and that Tier 2 is subordinated debt.

The PE is therefore allotted non-interest bearing capital of 拢80M at the start of the year.

At the end of the year the WRA are still 拢1000m.

The accounts for the branch do not include interest at subordinated debt rates.

If the hypothetical arm鈥檚 length funding costs of the PE are compared to the actual funding costs then the only adjustment to be made in the computations for the year will be a negative one to reflect the interest rate that would be payable on an arm鈥檚 length amount of subordinated debt, in this case interest on 拢30M.

Overall there is of course a positive adjustment as the PE will have 鈥榚quity鈥� capital that it did not previously have.

Year 2:

There is a fall in WRA to 拢900M.

The PE still has allotted capital of 拢80M.

8% of 拢900M is 拢72M. Whilst there may appear to be 鈥檈xcess鈥� equity it is likely that the 拢80M is still within the arm鈥檚 length range and at arm鈥檚 length a bank is unlikely to repay equity in the short term simply as a result of a small step up in its Tier 1 ratio.

But what about the subordinated debt? Should it be assumed that the PE still carries an amount of 拢30M or should it be assumed that in view of the 鈥渆xcess鈥� equity the PE would have reduced the level of subordinated debt?

At arm鈥檚 length a bank is unlikely to maintain exactly the same capital ratio year on year and so either of the above could be realistic assumptions. One solution could be to have regard to what has happened at the entity level: how have the ratios changed, and has subordinated debt been repaid? However a more practical solution may be to reach agreements which build in 鈥榯olerances鈥� within which the capital ratios can move.

In this example it has been assumed that at arm鈥檚 length the PE would have equity capital of 8% and loan capital of 3%. This could be regarded as the 鈥榤inimum鈥� that the PE would require at arm鈥檚 length (this is not a reference to the regulatory minimum). Thus where say the amount of equity capital dropped below this level an adjustment would be required in the computations to take account of the difference between the amount of equity capital that the PE would have at arm鈥檚 length and the amount that it actually has.

If 8% and 3% are regarded as 鈥榤inimums鈥� then some kind of upward movement or tolerance could be agreed and this could be based on the movements that occur in the whole entity鈥檚 capital ratios over a period of time.

Where equity appears to be 鈥榚xcess鈥� then consideration will need to be given to whether or not the amount of equity capital has in fact moved outside an arm鈥檚 length range and this is dealt with at INTM267785 above.