1.In December 2013, the Basel Committee on Banking Supervision (BCBS) published a revised framework for calculating the capital requirements for banks’ equity investments in funds held in the banking book. This followed a BCBS review of the risk-based capital requirements for banks’ exposures to funds, undertaken as part of the work of the Financial Stability Board (FSB) to strengthen the oversight and regulation of shadow banking. The BCBS review was undertaken to clarify the existing treatment of such exposures in the Basel II capital adequacy framework and to achieve a more internationally consistent and risk-sensitive capital treatment for banks’ investments in the equity of funds, reflecting both the risk of the fund’s underlying investments and its leverage.

2.Following the approach developed by the BCBS in Capital requirements for banks’ equity investments in funds, (BCBS 266, published December 2013), the Central Bank Standards for minimum required capital for banks’ equity investments in funds relies on a hierarchy of three successive approaches to risk weighting of fund assets, with varying degrees of risk sensitivity and conservatism:

1. •The “look-through approach” (LTA): The LTA is the most granular approach. Subject to meeting the conditions set out for its use, banks employing the LTA must apply the risk weight of the fund’s underlying exposures as if the exposures were held directly by the bank;
2. •The “mandate-based approach” (MBA): The MBA provides a degree of risk sensitivity, and can be used when banks do not meet the conditions for applying the LTA. Banks employing the MBA assign risk weights on the basis of the information contained in a fund’s mandate or in relevant regulations, national legislation, or other similar rules under which the fund is required to operate; and
3. •The “fall-back approach” (FBA): When neither of the above approaches is feasible, the FBA must be used. The FBA applies a 1250 percent risk weight to a bank’s equity investment in the fund.

To ensure that banks have appropriate incentives to enhance the risk management of their exposures, the degree of conservatism increases with each successive approach.

3.The capital framework for banks’ equity investments in funds also incorporates a leverage adjustment to the risk-weighted assets derived from the above approaches to appropriately reflect a fund’s leverage.