Principle I.

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The Principle I (also: equity-Solvabilitätsgrundsatz) was until 2006 a valid development of the German regulatory for banks by the BaFin and an important part of own funds requirements for credit institutions. By decree of December 14, 2006, Principle I was replaced by the Solvency Ordinance on January 1, 2007 (and by the Capital Adequacy Ordinance on January 1, 2014 ).

Principle I specified § 10 , § 10a of the Banking Act (KWG) by defining a risk limitation standard. Principle I set out in detail the criteria according to which the adequacy of the equity base is usually assessed. According to Principle I, the own funds had to be greater than the sum of all risk capitalization amounts (the overall risk position).

In Section 1 (12) KWG, trading book risk positions are recorded as financial instruments and related hedging transactions. These are counterparty default risks and interest rate and share price-related risks.

Origin and period of validity

In Section 10 of the KWG and in Principle I, the European minimum equity standards specified in the Banking Law Directive (2000/12 / EC) and the Capital Adequacy Directive (93/6 / EEC) have been implemented in national law. The regulations of the Basle Equity Recommendation of 1988 ( Basel I ) were largely incorporated.

Principle I applied until the end of 2006 for institutions that wanted to introduce the simple standard approach (Basel II) in 2007. Institutes that wanted to use the more complex IRB approach (Basel II) in 2008 could use Principle I until the end of 2007.

Limitation of risk

According to the provisions of Principle I, the credit institutions had to quantify their risks and back them up with their own funds. The aim was to limit credit and market risks, considering the following sub-risks:

  • Credit risk
    • Counterparty default risks , material value default risks for all positions in the banking book (balance sheet assets, traditional and innovative off-balance sheet transactions)
    • Delivery and settlement risks only for positions in the trading book
  • Market risk
    • Interest rate risk and share price risk only for positions in the trading book
    • Foreign currency risk and raw material risk for all positions, d. H. Positions in the investment and trading book

Own funds requirement

The capital requirement was calculated as follows:

Own funds requirement = weighted risk-weighted assets * 0.08 + capital charge market risk position

At least 8% of weighted risk assets had to be backed by liable equity. The capital charge for market risk positions had to be backed by at least 2/7 core capital and a maximum of 5/7 third tier funds.

Measures in the event of insufficient core capital:

  • Increase core capital
  • Lower risk-weighted assets capital charge
  • Lower the capital charge for market risk positions

Risk weights

A distinction was made between two zones of preference . The countries that belong to the OECD formed preference zone A when determining the risk weights, and the rest of the world formed preference zone B. All non-banks were uniformly assigned 100%.

The probability of default was determined on the basis of a general classification into three groups of debtors:

  • Public bodies
  • Financial services or credit institute (institute)
  • Others

In the case of public authorities and banks, claims from preference zone A were given a lower risk weight (20%) than claims from preference zone B. In the case of claims against central governments in preference zone A, the risk weight was 0%.

Central banks were better off than commercial banks. The capital backing then resulted as a basis of assessment * creditworthiness weight * 8%.

Regulation of credit default risks

Principle I wrote the equity capital adequacy of credit risk from balance sheet assets and off-balance sheet transactions that are not in the trading book published before. The regulations corresponded to those of the standardized approach . The level of default risk was only recorded in a very general way.

The default volume (EaD for short, Exposure at Default ) was determined as follows:

  • In the case of balance sheet assets , the default volume was the book value plus the contingent reserves recognized as liable equity after value adjustment (individual and general value adjustment ).
  • In traditional off-balance sheet transactions , the default volume was the product of the amount and the CCF ( credit conversion factor , risk class factor ). Risk class factors were either 100%, 50% or 20%. Loan commitments were eligible.
  • For innovative off-balance sheet transactions , either the maturity method or the market valuation method was used:
    • The maturity method was only allowed to be used with non-trading book institutions . The calculation was made using the product of the contract volume and the term-related credit rate.
    • With the market valuation method, the default volume was derived from the “current exposure ” and the “potential exposure”.

Regulation of market risks

Market risks included foreign currency risk , commodity risk and interest rate risk and equity price risk in the trading book. These were all financial instruments, including hedging transactions and guarantees, that were subject to interest rate and share price-related risks. The capital adequacy regulations also applied to pure investment firms . The trading book risk positions were recorded separately so that the same rules applied to similar transactions.

The credit amount was the amount that actually had to be kept in equity for market price risk positions or risks from option transactions.

Principle I made a distinction between states, credit institutions (qualified assets) and companies with regard to the credit rates for capital adequacy requirements for special exchange rate risks. Public bodies in preference zone A and derivatives on interest rates were subject to 0%.

For the credit institutions in preference zone A as well as exchange-traded securities with good credit ratings , the following maturity-dependent regulations applied:

  • Term of less than 6 months: Credit rate 3.125% (× 8% = 0.25%)
  • Duration between 6 months and 2 years: Credit rate 12.5% ​​(× 8% = 1%)
  • Duration over 2 years: Credit rate: 20% (× 8% = 1.6%)
  • Other: 8%

Credit collateralization

The required backing with own funds could be reduced by means of loan collateral. This included loans that are secured with a mortgage. Claims could for example be secured with guarantees or by depositing securities. This led to lower credit rates. Overall, the credit protection was limited in Principle I.

See also