Capital requirements

Capital requirements made of financial undertakings are fundamentally the same in all European Economic Area (EEA) Member States. They fall broadly into three categories. First is the statutory minimum capital base, which equals 8% of the undertaking’s risk base. Second is the additional capital requirement, which is set by the financial supervisor (in Iceland, the Central Bank) in accordance with the risk to which each undertaking is exposed. The last category is the combined buffer requirement, which is designed to offset risk in the economy and financial system. These requirements together constitute the overall capital requirement.

Financial undertakings’ capital requirements are provided for in the Act on Financial Undertakings, no. 161/2002, and in the EU Capital Requirements Regulation, No. 575/2013, which is commonly referred to as the CRR. Below is a description of the capital requirements currently in effect for each financial undertaking.

According to Article 92(1)(c) of the CRR, financial undertakings’ capital base shall be at least 8% of their risk base (Pillar I). This is the required minimum capital requirement.

The minimum capital requirement shall comprise Tier 1 capital – i.e., common equity Tier 1 capital (CET1), additional Tier 1 capital (AT1), Tier 2 capital (T2), and deductions. CET1 capital, after deductions, shall equal at least 4.5% of the risk base, and Tier 1 capital, after deductions, shall equal at least 6% of the risk base; cf. Article 92(1)(a) and (b) of the CRR. Financial undertakings’ risk base is the sum of weighted risks entailed in their operations; cf. Paragraph 3 of the same Article.

The Central Bank’s minimum capital requirement, or total SREP capital requirement (TSCR), refers to the sum of the minimum capital requirement – i.e., the capital base equalling 8% of the risk base pursuant to Article 92(1)(c) of the CRR (Pillar I) – and the additional capital requirement as determined by the Bank’s assessment of capital adequacy (Pillar II-R). The assessment is based on the authorisation found in Article 107(a), Paragraph 3, Item 1 of the Act on Financial Undertakings, cf. Paragraph 4 of the same Article, which stipulates that the Central Bank is authorised to specify a capital requirement higher than 8% of the risk base.

At a minimum, the Pillar II-R capital requirement shall consist of 56.25% of CET1 capital and 75% of Tier 1 capital; cf. Article 107(a), Paragraph 6 of the Act on Financial Undertakings. If the Central Bank sets an additional capital requirement, the financial undertaking in question must at all times maintain a capital base sufficient to fulfil that requirement.

Further discussion of the Central Bank’s assessment of additional capital adequacy requirements can be found in the Common procedures and methodologies for the supervisory review and evaluation process (SREP Guidelines), which are based on the European Banking Authority’s (EBA) Guidelines on the same topic  (EBA/GL/2022/03).

According to Chapter X of the Act on Financial Undertakings, financial undertakings shall satisfy a combined buffer requirement in addition to the Central Bank’s minimum capital requirement. Of the combined buffer requirement, undertakings must satisfy individual buffer requirements in this order: first, the systemic risk buffer; second, the capital buffer for systemically important institutions (O-SII buffer); third, the countercyclical capital buffer (CCyB); and finally, the capital conservation buffer; cf. Article 83 of the Act on Financial Undertakings.

Only items classified as CET1 capital may be used to satisfy capital buffer requirements; cf. Article 83(a) of the Act on Financial Undertakings.

The following capital buffers have been approved by the Financial Stability Committee (FSN) and are in effect in Iceland: a 2% systemic risk buffer, cf. Rules no. 1414/2024; a 3% O-SII buffer, cf. Rules no. 1415/2024; a 2.5% CCyB, cf. Rules no. 256/2023; and the statutory 2.5% capital conservation buffer, cf. Articles 84 and 84(a) of the Act on Financial Undertakings.

The overall capital requirement (OCR) is the sum of the 8% minimum capital requirement according to the CRR and, if applicable, the Central Bank’s additional capital requirement and the combined buffer requirement.

If a financial undertaking does not satisfy precautionary requirements or is unlikely to do so, it must so notify the Central Bank, pursuant to Article 52(e) of the Act on Financial Undertakings, and must explain what measures it plans to take to remedy the situation.

Of the overall capital requirement, financial undertakings must first satisfy the combined buffer requirement. As is noted above, of the combined buffer requirement, undertakings must satisfy buffer requirements in this order: first, the systemic risk buffer; second, O-SII buffer; third, the CCyB; and finally, the capital conservation buffer. The priority assigned to the buffers reflects how seriously the matter is viewed if a financial undertaking does not satisfy them. It can be said that the systemic risk buffer is the strictest and the capital conservation buffer the least strict. Nevertheless, the Act on Financial Undertakings stipulates that if the combined buffer requirement is not satisfied, the financial undertaking concerned must conserve its capital. In that case, restrictions are placed on disposition of profits, payment of dividends, share buybacks, and bonus payments; cf. Articles 86(m)-86(o) of the Act on Financial Undertakings. Furthermore, the board of the undertaking in question shall submit to the Central Bank a capital conservation plan pursuant to Article 86(s) of the same Act. If a financial undertaking does not maintain its systemic risk buffer and if the aforementioned restrictions on disposition of capital are not considered to have delivered the intended results, the undertaking could be at risk of having its operating licence revoked; cf. Article 9, Paragraph 1, Item 10 of the Act on Financial Undertakings.

If a financial undertaking does not satisfy the Central Bank’s minimum capital requirement – i.e., if it does not maintain a capital base equal to 8% of the risk base, plus an additional capital requirement according to the Central Bank’s assessment, or if it is deemed unlikely to satisfy the requirement due to a worsening financial position – the Bank may take a decision on early intervention; cf. Articles 107(c)-107(e) of the Act on Financial Undertakings.

If a financial undertaking is failing or likely to fail, it will be placed in resolution pursuant to the Act on Resolution of Credit Institutions and Investment Firms, no. 70/2020, or, as applicable, subjected to winding-up proceedings pursuant to Chapter XII of the Act on Financial Undertakings.

[1] In calculating the combined buffer requirement, adjustments are made for the weighted average systemic risk buffer and countercyclical capital buffer due to foreign exposures as of end-2023. The information is updated annually on the website, and more frequently if warranted.

[2] Based on the results of the 2024 SREP assessment.

[3] Adjusted for the weighted average systemic risk buffer and countercyclical capital buffer due to foreign exposures as of end-2023.

[4] Based on the results of the 2022 SREP assessment.

[5] Seven investment firms are currently operating in Iceland, and all of them are exempt from capital buffer requirements; cf. Article 83(e) of the Act on Financial Undertakings. The implementation of Regulation (EU) 2019/2033 on the prudential requirements of investment firms (IFR) and Directive (EU) 2019/2034 on the prudential supervision of investment firms (IFD) will bring significant changes in the capital requirements made of investment firms.

* At this time, no decision about an additional capital requirement has been taken.

** Exempt from the combined buffer requirement pursuant to the Act on Financial Undertakings.