Eligible own funds for prudential purposes are defined in section 10 of the Banking Act (Kreditwesengesetz). They consist of tier 1 capital, tier 2 capital and tier 3 capital.
Tier 1 and tier 2 capital, after deducting certain equity exposures to other institutions, constitute liable capital. Liable capital is, among other things, the key element in calculating the large exposure limit in the banking book.
Tier 1 capital is comprised of core tier 1 capital and hybrid tier 1 components. Core tier 1 capital largely consists of the paid-up capital and the reserves of an institution and comprises the capital components listed in section 10 (2a) sentence 1 numbers 1 to 9 of the Banking Act. The requirements for hybrid tier 1 components are set out in section 10 (2a) sentence 1 number 10 in conjunction with section 10 (4) of the Banking Act. Depending on their features, hybrid tier 1 instruments may be included in tier 1 capital up to a maximum of 15%, 35% or 50% of tier 1 capital.
Transitional provisions govern the recognition of tier 1 components which were issued before 31 December 2010 (when the CRD II requirements entered into force) and do not (or no longer) meet the requirements for tier 1 capital under the rules which entered into force on 31 December 2010. These components are recognised as hybrid tier 1 capital until the end of 2040. The share of capital which is recognised under this transitional provision may not exceed 20% from 2021 until 2030 and 10% of tier 1 capital from 2031 until 2040. There is no restriction on recognition until the end of 2020. Nevertheless, it must be borne in mind that the share of eligible capital under the transitional provision is counted against the 50% limit that applies to hybrid capital. For example, if at a credit institution the share of the capital which after 30 December 2010 is eligible only under the transitional provision amounts to 60% of tier 1 capital, no new hybrid tier 1 instruments could be eligible because the 50% limit has already been exceeded. New issues cannot be eligible as tier 1 capital until the old capital has “disappeared”.
Tier 2 capital and tier 3 capital are likewise eligible to only a limited extent when calculating eligible own funds. Tier 2 capital is recognised only up to 100% of tier 1 capital as liable capital, and the amount consisting of longer-term subordinated liabilities and the uncalled commitments of members may not exceed 50% of tier 1 capital. To avoid the double use of capital, liable capital that has been used to back other risks (eg large exposure excess amounts pursuant to sections 13, 13a and 13b of the Banking Act, qualified participating interests pursuant to section 12 of the Banking Act, loans to management pursuant to section 15 of the Banking Act and items pursuant to section 10 (6a) of the Banking Act) may no longer be used to back risk positions pursuant to the Solvency Regulation (Solvabilitätsverordnung). These positions therefore need to be deducted from liable capital. The remaining tier 1 and tier 2 capital is modified available capital, which is the basis for calculating the adequacy of own funds pursuant to the Solvency Regulation.
The amount of available tier 1 capital and tier 2 capital imposes limits on the amount of tier 3 capital that can be allocated to own funds (eligible tier 3 capital). Available tier 1 and tier 2 capital is calculated by deducting the capital charges for counterparty credit risk and operational risk, which are calculated according to the provisions of the Solvency Regulation, from modified available capital. Deducting large exposure excess amounts in the trading book from eligible tier 3 funds results in available tier 3 funds. Pursuant to the Solvency Regulation, available tier 3 funds may only be used to back capital charges for market risks.
The sum of the available tier 3 capital used to back capital charges for market risk and modified available capital corresponds to the eligible own funds used as the basis for calculating the overall ratio pursuant to the Solvency Regulation.
In the case of groups of institutions and financial holding groups (section 10a of the Banking Act), their superordinated institutions must ensure that sufficient own funds are also held at the consolidated level.