Each technique results in similar capital assessments of the financial conglomerate, although different conclusions may result if in using one technique an analyst decides to use pro rata consolidation while in employing another technique, full consolidation is used.

1. Building Block Approach

• Uses consolidated financial statement
• Divides statement into individual sectors or blocks
• Adds together solo capital requirements/proxy of each member
• Compares aggregate capital requirement/proxy to consolidated capital

2. Risk-Based Aggregation

• Uses unconsolidated statements
• Adds together the capital of each entity in the group
• Subtracts intra-group holdings of regulatory capital to adjust for double gearing
• Adds together the solo capital requirements/proxies of each entity in the group to arrive at an aggregate capital requirement
• Subtracts aggregate capital requirement/proxy from adjusted group-wide capital to calculate surplus or deficit

3. Risk-Based Deduction

• Uses unconsolidated statements
• Analysis performed from parent company perspective
• Predicated on pro rata consolidation of dependants
• Parent capital reduced by amount of investments in dependants
• Parent capital increased/(decreased) by solo capital surplus/(deficits) of dependants
• Parent's solo capital requirement subtracted from adjusted parent capital to determine group-side surplus or deficit.

Building Block Prudential Approach

• Identifies solo and group-wide capital surplus or deficit using consolidated financial statements

Summary of Method

1. Consolidated balance sheet broken down into its major firms
2. Solo capital requirement/proxy is calculated for each firm or sector
3. Requirement/proxy is deducted from each dependant's actual capital to calculate surplus/deficit
4. Items deemed non-transferable are deducted (none shown)
5. Solo capital requirements/proxies are aggregated and compared to actual group-wide capital to identify group-wide surplus or deficit

Graphic 1: Consolidated Statement Divided by ...

Variant: Modified Building Block Approach: Deduct from the capital of the parent company, the capital requirement for its regulated dependants and notional capital proxy amounts for unregulated dependants in other financial sectors. Recommended when a dominant financial activity is undertaken by the parent company.

Risk-Based Aggregation

• Similar to building block, but tailored for situations in which:
  • only unconsolidated statements are available
  • intra-group exposures cannot be readily netted out

Summary of Method:

1. Sum solo capital requirements/proxy of parent and dependants
2. Sum actual capital held by parents and dependants
3. Deduct any upstreamed or downstreamed capital
4. Eliminate any non-transferable items (none shown)
5. Compare aggregate requirement/proxy to aggregate group-wide capital to identify surplus or deficit

Graphic 2: Risk Based Aggregation - Summary

Alternative Method to Deal With Double Leverage:

• If the amounts of capital downstreamed or upstreamed within the group are unclear, an alternative technique involves identifying externally generated capital of the group
• Externally generated capital:

  • is not obtained elsewhere from the financial conglomerate
  • includes retained earnings from business conducted outside conglomerate
  • may include any equity supplied by minorities or third party debt finance

Risk-Based Deduction

• Very similar to Risk-Based Aggregation, differences include:
  • Analysis performed from perspective of parent company
  • Focuses on capital surplus or deficit of each dependant
  • Predicated on pro-rata integration

Summary of Method:

1. Start with parent's capital accounts
2. Deduct investments in dependants from parent's capital
3. Add to adjusted capital, surplus or deficit values from each dependant
   • Take into account any limits on transferability of capital
   • Use pro rata consolidation method for non-wholly-owned dependants
   • Treat any holding of the dependant in other downstream group companies in a similar manner to this calculation
   • Eliminate any reciprocal holdings of a dependant in other upstream group companies

4. Subtract parent's solo capital requirement from adjusted capital
5. Resulting figure is surplus or deficit from a group-wide perspective

Graphic 3: Risk Based Deduction

Total Deduction Method (For Double Gearing at Parent Only)

• Quick test for potential double gearing at parent level
• Not a substitute for the other three techniques
• Almost identical to Risk-Based Deduction, but no credit given for any capital surpluses of dependants and no changes made for capital deficits

Summary of Method

1. Dependant's investments are fully deducted from parent capital
2. Any solo capital deficits may also be taken into account
3. Adjusted capital is compared to the parent's solo capital requirement

Graphic 4: Total Deduction Method (For Double Gearing at Parent Only)

Appendix To Annex 2

Summary Balance Sheets of Financial Firms The example financial conglomerate is assumed to be comprised of a parent banking company with regulated insurance and securities dependants and an unregulated commercial finance firm. It is assumed that apart from the parent's investment in its dependants, there are no intra-group exposures (or that these have been netted out). For this simple example, capital is assumed to be comprised of shareholders equity and reserves.

Graphic 5: Summary Balance Sheets of Financial Firms

Appendix to Annex 2 (cont'd)

Consolidated and Unconsolidated Example Balance Sheets

Graphic 6: Consolidated and Unconsolidated Examples Balance Sheets (1)

Graphic 7: Consolidated and Unconsolidated Examples Balance Sheets (2)