Financial Crime World

Tiered Capital Instruments: A Regulatory Overview

In a bid to strengthen financial stability, regulators have introduced tiered capital instruments for banks. The concept is simple: Tier 1 instruments are shares and deeply subordinated debt with automatic write-down or conversion mechanisms triggered by certain capital ratios being breached. Tier 2 instruments, on the other hand, rank ahead of Tier 1 instruments but are subordinated to unsecured senior debt.

Capital Adequacy Requirements

In Sweden, the Financial Supervisory Authority (SFSA) is responsible for overseeing compliance with capital adequacy requirements. The SFSA has set a minimum requirement of 8% for common equity tier 1 capital, which is fully binding and breaches could lead to license withdrawal. However, banks must also maintain various capital buffers, including:

  • Capital conservation buffer
  • Institution-specific countercyclical capital buffer
  • Systemic risk buffer
  • Buffers for systemically important institutions

Enforcement and Consequences of Undercapitalization

The SFSA monitors compliance through periodic reports from banks and ad hoc investigations. In cases of undercapitalization, banks must first attempt to remedy the situation by implementing recovery plans. If buffer requirements are breached, restrictions on dividend payments apply. The SFSA may also impose supervisory actions, including:

  • Orders to reduce exposures
  • Write-down debt instruments

Resolution and Insolvency

Systemically important banks face resolution procedures, while non-systemically important banks are subject to ordinary bankruptcy procedures. In the event of insolvency, shareholders may be liable for losses incurred by the company, provided they acted with intent or gross negligence.

Changes and Future Developments

The capital adequacy framework has undergone significant revisions since the financial crisis. CRD V is set to be implemented in Sweden by December 2020, while CRR II will largely apply from June 2021.

Ownership Restrictions and Responsibilities

There are no restrictions on foreign ownership of banks in Sweden. However, entities or individuals controlling a bank must be approved by the SFSA, which considers factors such as:

  • Reputation
  • Financial strength
  • Potential impact on business operations

The management of controlling entities must also be approved by the SFSA.

Implications for Controlling Entities

In the event of insolvency, controlling entities may incur losses due to share capital reduction or write-down/write-off of debt instruments. They may also be liable for company losses if they acted with intent or gross negligence. The SFSA’s powers in such cases are subject to the “no-creditor-worse-off” principle.

Conclusion

Sweden’s tiered capital instrument system aims to strengthen financial stability by requiring banks to maintain sufficient common equity tier 1 capital and various buffers. Regulators closely monitor compliance, and breaches can result in severe consequences for banks and controlling entities.