HSBC 2007 Annual Report Download - page 285

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HSBC as a whole. Individual banking subsidiaries
are directly regulated by their local banking
supervisors, who set and monitor their capital
adequacy requirements. In most jurisdictions, non-
banking financial subsidiaries are also subject to the
supervision and capital requirements of local
regulatory authorities. Since 1988, when the
governors of the Group of Ten central banks agreed
to guidelines for the international convergence of
capital measurement and standards, known as
Basel I, the banking supervisors of HSBC’s major
banking subsidiaries have exercised capital adequacy
supervision within a broadly similar framework.
The FSA implements the capital adequacy
requirements issued by the Basel Committee on
Banking Supervision (‘the Basel Committee’) as
implemented by the relevant EU Directives. In June
2006, the EU Capital Requirements Directive
(‘CRD’) was formally adopted by the Council and
European Parliament and it required EU Member
States to bring implementing provisions into force
on 1 January 2007. The CRD recast the Banking
Consolidation Directive and the Capital Adequacy
Directive, which had previously applied.
In October 2006, the FSA published the General
Prudential Sourcebook (‘GENPRU’) and the
Prudential Sourcebook for Banks, Building Societies
and Investment Firms (‘BIPRU’), which took effect
from 1 January 2007 and implemented the CRD in
the UK. GENPRU introduced changes to the
definition of capital and the methodology for
calculating a firm’s capital resources requirements.
BIPRU sets out the FSA’s rules implementing the
other CRD requirements for banks, building
societies and investment firms and groups containing
such firms. Transitional provisions regarding the
implementation of capital requirements calculations
meant that, in general, unless firms notified the FSA
to the contrary, they continued to apply the existing
capital requirements calculations until 1 January
2008; changes that took effect on that date are
described below in the section ‘Basel II’.
In implementing these EU Directives, the FSA
requires each bank and banking group to maintain an
individually prescribed ratio of total capital to risk-
weighted assets, taking into account both balance
sheet assets and off-balance sheet transactions.
HSBC’s capital is divided into two tiers:
• Tier 1 capital comprises core tier 1 capital and
innovative tier 1 securities. Core tier 1 capital
comprises shareholders’ funds, and minority
interests in tier 1 capital, after adjusting for
items reflected in shareholders’ funds which are
treated differently for the purposes of capital
adequacy. The book values of goodwill and
intangible assets are deducted in arriving at core
tier 1 capital.
• Tier 2 capital comprises qualifying subordinated
loan capital, collective impairment allowances,
minority and other interests in tier 2 capital and
unrealised gains arising on the fair valuation of
equity instruments held as available-for-sale.
Tier 2 capital also includes reserves arising from
the revaluation of properties.
Various limits are applied to elements of the
capital base. The amount of innovative tier 1
securities cannot exceed 15 per cent of overall tier
1 capital, qualifying tier 2 capital cannot exceed
tier 1 capital, and qualifying term subordinated loan
capital may not exceed 50 per cent of tier 1 capital.
There are also limitations on the amount of
collective impairment allowances which may be
included as part of tier 2 capital. From the total of
tier 1 and tier 2 capital are deducted the carrying
amounts of unconsolidated investments, investments
in the capital of banks, and certain regulatory items.
Changes to the definition of capital came into
force on 1 January 2007. They include the
introduction of proportional consolidation of
banking associates, which previously were either
fully consolidated or deducted from capital, the
relaxation of rules covering the deduction of
investments in other banks’ capital, and a change for
disclosure purposes only to make certain deductions,
previously from total capital, now 50 per cent from
each of tier 1 and tier 2 capital in the published
disclosures. This applies to deductions of
investments in insurance subsidiaries and associates,
but the FSA has granted a transitional provision,
until 31 December 2012, under which any of these
insurance investments that were acquired before
20 July 2006 may be deducted from the total of tier 1
and tier 2 capital instead. HSBC has elected to apply
this transitional provision.
Banking operations are categorised as either
trading book or banking book and risk-weighted
assets are determined accordingly. Banking book
risk-weighted assets are measured by means of a
hierarchy of risk weightings classified according to
the nature of each asset and counterparty, taking into
account any eligible collateral or guarantees.
Banking book off-balance sheet items giving rise to
credit, foreign exchange or interest rate risk are
assigned weights appropriate to the category of the
counterparty, taking into account any eligible
collateral or guarantees. Trading book risk-weighted
assets are determined by taking into account market-