CAPITAL REQUIREMENTS DIRECTIVE (CRD)
The Capital Requirements Directive (CRD) comes into full force on 1st January 2008 and has significant implications for firms that fall within its scope. It is divided into three so called ‘Pillars’ as follows:
Pillar I deals with the calculation of a firm's regulatory capital using a series of accounting definitions and set mathematical ratios to arrive at the firm’s ‘minimum capital requirement’. The FSA requires firms to hold this minimum level of capital, primarily in order to protect it from losses incurred in the normal course of business. In calculating the minimum capital requirement, key areas of risk are taken into account, primarily Credit, Operational and Market Risk.
Pillar II of the CRD introduces a methodology for calculating the capital requirement having regard to the particular risks to which a firm is exposed and which may not be adequately captured in the Pillar I capital component. This methodology is the Internal Capital Adequacy Assessment Process (ICAAP). This process requires senior management to identify all the risks the firm faces and to calculate a level of capital to be held in order to ensure the firm can withstand the impact of these risks arising. This subjective process is designed to catch any risks Pillar I has missed or not given enough weighting to. Once identified, the ICAAP requires key risks to be subject to stress and scenario testing. It may also be reviewed by the FSA through their Supervisory Review and Evaluation Process (SREP). Should it be found to be deficient in the opinion of the FSA, they will consult with the firm and possibly instruct it to adjust its capital accordingly through issuing Individual Guidance.
Pillar III of the CRD is concerned with disclosure and Integrated Regulatory Reporting (IRR).
