Understanding corporate finance: the legal and regulatory framework: Capital Adequacy Directive and solo consolidation
The Basel Accord’s principles are implemented in the European Union through the EU’s Capital Adequacy Directives (‘CAD1’ 93/6/EEC and ‘CAD2’ 98/31/EEC) which set out uniform capital requirements for banking firms and securities firms.
A ‘CAD bank’ is a bank with a trading book above a de minimis level. Banks with a trading book below this level are known by the Financial Services Authority (FSA) as non-CAD banks. The detailed regulatory requirements differ for CAD and non-CAD banks.
Normally a bank’s capital is assessed on the basis of the individual company’s assets and liabilities so that each authorised firm has sufficient capital. Subject to certain conditions, CAD banks can assess capital adequacy on an adjusted basis sometimes referred to as solo consolidation.
In order to solo consolidate, the bank must have significant management control of the subsidiary.
The solo adjusted basis treats the group headed by the banking company and its solo consolidated subsidiaries as a single entity. In effect the legal distinction between parent and subsidiaries is ignored and the group is treated as one legal entity divided into branches. As long as there is sufficient capital in the group as a whole, the capital adequacy requirements are satisfied