CRR Pillar 1: Own Funds Requirements and Risk-Weighted Assets

Pillar 1 of the Capital Requirements Regulation (CRR, EU Regulation 575/2013) sets the quantitative minimum capital requirements for credit institutions in the EU. Banks must maintain three capital ratios relative to their risk-weighted assets (RWA) at all times:

Common Equity Tier 1 (CET1) ratio: at least 4.5% of RWA

Tier 1 capital ratio: at least 6% of RWA

Total capital ratio: at least 8% of RWA

In addition, capital buffers apply: the capital conservation buffer (2.5%), the countercyclical capital buffer (0–2.5%, set by national authorities), and systemic buffers for globally and domestically systemically important institutions. In practice, large European banks typically maintain CET1 ratios of 10–13%. ADVISORI supports credit institutions in monitoring and optimising these ratios on an ongoing basis.

The CRR provides two approaches for calculating credit risk RWA:

1. Standardised Approach (SA, Art. 111–141 CRR): Each exposure is assigned to an exposure class (sovereigns, institutions, corporates, retail, etc.) and receives a regulatory risk weight from 0% to 150%. RWA equals the exposure amount multiplied by the risk weight.

2. Internal Ratings-Based Approach (IRB, Art. 142–191 CRR): Banks use their own risk models to estimate probability of default (PD), loss given default (LGD), exposure at default (EAD), and effective maturity (M). Under Foundation IRB, the supervisor prescribes LGD and EAD; under Advanced IRB, the bank estimates all parameters itself.

CRR III also introduces the output floor: IRB-based RWA may not fall below 72.5% of standardised approach RWA, limiting excessive model benefits. ADVISORI supports institutions in methodology selection and implementation of both approaches.

The Fundamental Review of the Trading Book (FRTB) fundamentally overhauls market risk capital requirements. Key changes under CRR III:

New boundary between trading and banking book with stricter reclassification rules

Standardised Approach (SA-TB): Sensitivity-based approach covering delta, vega, and curvature risks, replacing previous simplified methods

Internal Model Approach (IMA): Value-at-Risk replaced by Expected Shortfall (ES), supplemented by Default Risk Charge and Residual Risk Add-on

Desk-level approval: Each trading desk must pass PnL attribution tests and backtesting to use the IMA

The EU implementation timeline for FRTB includes transitional arrangements through 2027. ADVISORI supports banks in choosing between SA-TB and IMA and in implementing the required data infrastructure and risk models.

CRR III introduces the Standardised Measurement Approach (SMA) as the sole approach for operational risk, replacing all previous methods (Basic Indicator, Standardised, and AMA approaches).

The SMA calculates the capital requirement in two steps:

1. Business Indicator Component (BIC): Based on the Business Indicator (BI), a metric derived from interest income, fee income, and trading income. Marginal coefficients of 12%, 15%, or 18% apply depending on the BI level.

2. Internal Loss Multiplier (ILM): Links the BIC to actual operational losses over the past 10 years. Institutions with above-average losses face a surcharge, while those with lower losses receive relief.

For large institutions (BI > EUR 1 billion), the use of historical loss data is mandatory. ADVISORI supports SMA implementation from loss data preparation through BIC calculation to model validation.

The output floor is one of the most significant innovations of CRR III. It stipulates that RWA from internal models (IRB, IMA) may not fall below a certain percentage of standardised approach RWA.

The phase-in schedule is:

2025: 50% of standardised approach RWA 2026: 55%

2027: 60%

2028: 65%

2029: 70%

2030: 72.5% (final level)

Institutions that have previously calculated significantly lower RWA through internal models will experience material capital increases. According to EBA estimates, this primarily affects large banks with extensive IRB portfolios, whose RWA may rise by 10–20%.

ADVISORI’s output floor simulation shows institutions the impact on CET1, Tier 1, and total capital ratios early, supporting strategic capital planning.

The leverage ratio is a non-risk-based metric that serves as a backstop to risk-weighted capital requirements. It is regulated under Art. 429–429g CRR.

The minimum requirement is:

3% Tier 1 capital relative to the total exposure measure

For global systemically important institutions (G-SIIs): an additional leverage ratio buffer of 50% of the G-SII buffer

The total exposure measure comprises on-balance-sheet assets, derivative exposures (under SA-CCR), securities financing transactions, and off-balance-sheet items. Unlike RWA-based ratios, there is no risk weighting – every exposure enters at its full nominal amount.

ADVISORI advises institutions on leverage ratio calculation, total exposure measure optimisation, and minimum ratio compliance.

Pillar 1 and Pillar 2 complement each other in determining a bank’s total capital requirement:

Pillar 1 (CRR Art. 92): Quantitative minimum requirements – uniform for all institutions: 4.5% CET1, 6% Tier 1, 8% total capital relative to RWA.

Pillar 2 (CRD Art. 97–107): The supervisor sets institution-specific additional requirements through the SREP (Supervisory Review and Evaluation Process):

Pillar 2 Requirement (P2R): Binding additional requirement, typically 1–3% CET1Pillar 2 Guidance (P2G): Supervisory expectation, not legally binding but effectively required

The total requirement equals: Pillar 1 + capital buffers + P2R + P2G. For a typical large European bank, this means:

CET1 minimum: 4.5% + 2.5% (buffer) + 1.5% (P2R) + 1% (P2G) = approximately 9.5%

ADVISORI supports institutions with both Pillar 1 compliance and preparation for the SREP dialogue with supervisors.