1. An Introduction to Capital
Requirements
Dr Madhur Malik
Senior Capital Risk Manager, Aldermore Bank Plc
Disclaimer: The information in this presentation is solely the opinion and responsibility of the author. Aldermore Bank Plc (‘Aldermore’) does not
accept any liability in respect of any statements made in this presentation.

2. What is Capital?
• Capital is a source of funding
• Capital is not an asset
Assets Liabilities Assets Liabilities
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Liquid
Assets e.g.
Cash, Gilts
Net Loans
Retail
Deposits
and
Wholesale
Funds
Capital
Stress
Liquid
Assets e.g.
Cash, Gilts
Net Loans
Drop in Cash
Bad Debt
Retail
Deposits
and
Wholesale
Funds
Capital
Withdrawal
Unexpected
Loss

3. Quality of Capital
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Common
Equity Tier 1
Additional
Tier 1
Tier 2
• Fully loss absorbing. Principally comprised of ordinary shares, retained earnings and
certain reserves
• Capital instruments are perpetual (i.e. no fixed maturity)
• Coupons can be cancelled at the bank’s discretion and are non-cumulative
• AT1 instruments must either convert into ordinary shares or have their principal amount
written down if the CET1 ratio falls below 7%
• Cumulative and Non-perpetual (original maturity of at least 5 years)
• May be redeemed or repurchased after five years from its issue date with regulatory
consent
• The qualifying Tier 2 amount amortises during the final five years of maturity (CRR Art
64)
• General credit risk adjustments qualify for inclusion in Tier 2
QualityofCapital

4. Quantity of Capital
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Risks not fully captured under Pillar 1
Credit Risk (including
CCR + CVA and Securitisation)
Market Risk
Operational Risk
Credit Concentration Risk
Interest Rate Risk in the Banking
Book (IRRBB)
Pension Risk and Others Material
Risks e.g. business risk
Pillar 2B - Stress Testing
Pillar 1 Risks Pillar 2 Risks
Total Regulatory Capital Requirement

5. Trading Book vs Banking Book
According to CRR Article 4
• Trading book encompasses positions in financial instruments and
commodities held by an institution either with trading intent, or used
to hedge positions held with trading intent
• Positions held with trading intent means any of the following:
a) proprietary positions and positions arising from client servicing and
market making;
b) positions intended to be resold short term;
c) positions intended to benefit from actual or expected short-term price
differences between buying and selling prices or from other price or
interest rate variations.
• Example
a) Covered Bonds and ABS exposures held for liquidity purpose as part
of HQLA are treated for credit risk in a banking book
b) However, if the same assets are held for trading purpose market risk
capital requirements will apply
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6. Risk Weighted Assets
• RWAs are Pillar 1 risks transformation of on and off
balance sheet assets
• Capital requirements are expressed as a
percentage of RWAs
• Minimum Pillar 1 capital required is 8% of RWAs
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On and off
Balance
Sheet Assets
Pillar 1 Risk
Transformation
Pillar 1 Risk
Weighted
Assets
8% of RWAs
4.5%
1.5%
2%
CET1
AT1
Tier 2
Unexpected
Loss Estimate

7. Pillar 1 – Credit Risk
Standardised Approach – CRR Art 112
• Each exposure shall be assigned to one of the
exposure classes, e.g., retail exposures, corporates,
secured by mortgages
• RWA = Risk Wt. × Exposure × CCF
• Credit conversion factor (CCF) applies to off balance
sheet items
• Example – On balance sheet residential mortgage of
£1m with LTV of 80%
RWA = 35% (Risk Wt.) × £1m = £350k
Pillar 1 Credit Risk Cap Req.
= 8% × £350k = £28k
= 2.8% of £1m
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£16k
£5k
£7k
CET1
AT1
Tier 2

8. Pillar 1 – Credit Risk
Standardised Approach CCF – CRR Art 111
The exposure value of an off-balance sheet item
shall be the following percentage of its nominal
value:
a) 100 % if it is a full-risk item (e.g. transactions with recourse
like factoring, invoice discount facilities);
b) 50 % if it is a medium-risk item (e.g. undrawn credit facilities
with an original maturity of > 1 year);
c) 20 % if it is a medium/low-risk item (e.g. undrawn credit
facilities with an original maturity of =< 1 year);
d) 0 % if it is a low-risk item (e.g. undrawn credit facilities which
may be cancelled unconditionally at any time).
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9. Pillar 1 – Credit Risk
Internal Ratings Based Approach – CRR Art 151
• Model based approach vs. standardised risk weights
• Expected Loss – represents the average level of credit
loss expected in doing a business. It is generally
charged as part of product pricing
• Unexpected Loss (UL) – represents a loss in addition
to EL, e.g., increased losses in an economic downturn
• Capital is required to cover UL
• Unlike EL, UL is not charged to the P&L, but the cost
of capital to cover UL is charged as part of product
pricing
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10. Pillar 1 – Credit Risk
Internal Ratings Based Approach
• Each exposure shall be assigned to one of the exposure classes,
e.g., retail, corporates, equity exposures CRR Art 147
• RWA = 12.5 × Capital Required for UL
• UL = (Unexpected PD – Expected PD)× DT_LGD × EAD
• FIRB banks use CCFs provided by the regulators. AIRB banks
calculate their own CCFs (CRR Art 166)
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11. Securitisation
Traditional Securitisation
• A securitisation involves the economic transfer of the
exposures being securitised
• This is accomplished by the transfer of ownership of the
securitised exposures from the originator to a
securitisation special purpose entity (SSPE)
• The securities issued do not represent payment
obligations of the originator
Synthetic securitisation
• Transfer of risk by using credit derivatives or guarantees
• The exposures being securitised remain exposures of the
originator institution
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12. Synthetic Securitisation – Help to Buy
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Default
0%
Risk
Wt.
35%
Risk
Wt.
75%
Risk
Wt.

13. Pillar 1 – Securitisation Credit Risk
• Standardised Approach - the RWA of a rated securitisation or re-
securitisation position is calculated by applying the relevant risk
weight to the exposure value (CRR Art 251)
• IRB Approach - Institutions shall use the methods in accordance
with the following hierarchy:
– Ratings Based method for a rated position or a position in respect of which an
inferred rating may be used (CRR Art 261)
– For unrated positions, a Supervisory Formula Method (SF) may be used where it
can produce estimates of PD, and where applicable exposure value and LGD as
inputs into the SF method in accordance with the requirements for the estimation of
those parameters under the IRB approach (CRR Art 262)
• For an originator institution the RWA calculated in respect of its
securitisation positions in any one securitisation may be limited to
the RWA which would be calculated for the securitised exposures
had they not been securitised (CRR Art 252)
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14. Pillar 1 – Securitisation Credit Risk
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15. Pillar 2A/ICG - Risks not covered by Pillar 1
• Risks not fully captured under Pillar 1 – where it is considered that the
Pillar 1 capital assessments for credit, market or operational risks
underestimate those risks
• IRRBB –potential losses in the non-trading book resulting from interest
rate changes or widening of the spread between Bank Base Rate and
LIBOR rates
• Credit Concentration Risk – greater loss volatility arising from a higher
level of loan default correlation than is assumed by the Pillar 1
assessment. Such correlation can arise from, for example, geographic,
industry sector and single name concentrations
• Pension Obligation Risk – the potential for additional unplanned costs
that the Group would incur in the event of a significant deterioration in the
funding position of the Group’s defined benefit pension schemes
• Pillar 2A/Individual Capital Guidance – expressed as a % of RWAs
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16. How much Capital is required?
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Based on 2014 Pillar 3 Disclosures and own calculations

17. Leverage Ratio
• Leverage Ratio (LR) is a non-risk sensitive measure of bank’s capital
• Protect against failings in risk based capital measures, i.e., capital ratios
• Financial Policy Committee (FPC) at the Bank of England proposed a UK
leverage ratio framework and set a minimum LR of 3% plus 35% of
countercyclical buffer rate
• 75% of 3% = 2.25% and LR buffer should be met by CET1
• Up to 25% of 3% = 0.75% can be by AT1
• Legally binding from 1 January 2016 for UK banks with consolidated retail
deposits above £50 billion
• For other banks, it is expected to apply from 2017, subject to FPC review
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18. Capital Ratio and Leverage Ratio
LR = Tier 1 Capital Resources
Leverage Exposure
= Tier 1 ratio × (RWA/Leverage Exposure)
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Example
• On balance sheet residential mortgage of £1m with LTV of 80%
• RWA = 35% (Risk Wt.) × £1m = £350k
• Min Tier 1 Credit Risk Cap Req. = 6% × £350k = £21k
• Equivalent to 2.1% of £1m
• Assuming £1m also represents a leverage exposure, 3% leverage
ratio means £30k Tier 1 capital requirement
• If an asset attracts a 50% risk weight, min Tier 1 Credit Risk Cap
Req. = 6% × 50% × £1m = £30k.

19. Leverage Ratio - Peer Analysis
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Based on 2014 Pillar 3 Disclosures and own calculations

20. Forthcoming Regulatory Changes
• PRA Pillar 2 Review PS 17/15. Implementation by Jan 2016.
• FPC leverage ratio framework CP24/15. Implementation by Jan 2016.
• BCBS consultation paper in Dec 2014 on a revised standardised
approach for credit risk. No fixed timeline for implementation.
• BCBS revised securitisation framework published in Dec 2014.
– Followed by a European framework for simple and transparent securitisation in Sep
2015 with proposed amendments to the CRR.
• Bail-in Tools
– Minimum Requirement for own funds and eligible liabilities (MREL) and Total loss
absorbing capacity (TLAC)
– MREL implementation by Jan 2016. TLAC implementation is not expected before Jan
2019.
• IFRS 9 - Impact from lifetime expected loss. Implementation by Jan
2018.
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