Leases and the impact on credit institutions
Under EU regulations, credit institutions are required to hold a certain amount of capital as part of their licensing conditions. One of the key measures of the capital requirements for a credit institution is the Total Capital Ratio.
This is the ratio of credit institution’s capital to risk and it is used by regulatory authorities to ensure that it can absorb a reasonable amount of loss and ensure viability of the institution.
Under the requirements of Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD IV), banks must have top quality capital equivalent to at least 10.5 per cent (10.5%) of their risk-weighted assets which is defined as the total capital ratio of 8% plus 2,5% countercyclical buffer plus any additional Pillar 2 Capital Requirements.
The Total Capital Ratio (“TCR”) is defined as TCR = Total Capital / Risk Weighted Assets:
•• Total Capital is the total of the Bank’s eligible Capital and Reserves;
•• Risk Weighted Assets are the credit institution’s assets or off-balance sheet exposures weighted according to risk.
IFRS 16 is expected to have an impact on both the numerator and the denominator of the TCR.
The effect of any new accounting requirements on regulatory capital depends on the actions of prudential regulators which is yet unclear both locally, in Cyprus, and across Europe as no transitional rules have been announced by the ECB or the EBA.
Separate (and in addition) to the direct impact on key metrics, IFRS 16 is expected to have an indirect impact Credit Institutions in the form of affecting debt covenants within credit granting facilities. As is customary with the granting of credit facilities to corporates and project finance, lending facilities are subject to debt covenants.
Our latest publication explores the direct and indirect effects on Credit Institutions of adopting IFRS 16.