The formula is a lookup. The work is in measuring how much CET1 actually sits in the buffer once every other requirement has taken its share.
The maximum distributable amount is a bank's distributable profits multiplied by a factor set by where its CET1 sits inside the combined buffer requirement: 0 in the lowest quartile, 0.2 in the second, 0.4 in the third and 0.6 in the top one. An illustrative bank with 2.700 per cent of CET1 available against a 4.000 per cent buffer is in the third quartile, so on 240 million of profit its MDA is 96 million. Planned payouts of 225 million must be cut by 129, and ignoring an additional tier 1 shortfall would have put the limit at 144.
Worked in full in Financial Regulation by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The bank is illustrative, in millions of euros, under the EU rules: the restriction sits in Article 141 of the Capital Requirements Directive, and the Pillar 2 requirement is met at least 56.25 per cent in CET1 and 75 per cent in tier 1.
| Item | Value |
|---|---|
| Risk-weighted assets | 30,000 |
| CET1 ratio | 8.700% |
| Pillar 1 CET1 minimum | 4.500% |
| Pillar 2 requirement (56.25% CET1, 18.75% AT1) | 2.000% |
| AT1 requirement: Pillar 1 1.500% plus P2R share 0.375% | 1.875% |
| AT1 held | 1.500% |
| Capital conservation buffer | 2.500% |
| Countercyclical buffer | 0.500% |
| Systemic (O-SII) buffer | 1.000% |
| Combined buffer requirement | 4.000% |
| Interim profit after tax, not yet in CET1 | 240 |
Only CET1 not used for any other requirement counts toward the buffer. That excludes the Pillar 1 and Pillar 2 CET1, and also any CET1 standing in for missing additional tier 1 or tier 2.
CET1 for Pillar 1 and P2R = 4.500% + 2.000% × 56.25% = 5.625%
AT1 shortfall = 1.875% − 1.500% = 0.375%, or 112.5 million, filled with CET1
CET1 available for the buffer = 8.700% − 5.625% − 0.375% = 2.700%, or 810 million
Combined buffer = 4.000%, so each quartile is 1.000% (300 million)
2.700% / 4.000% = 67.5% of the buffer: third quartile, factor 0.4
| Quartile of the buffer | CET1 above 5.625% plus shortfalls | Factor |
|---|---|---|
| First (lowest) | 0 to 1.000% | 0.0 |
| Second | 1.000% to 2.000% | 0.2 |
| Third | 2.000% to 3.000% | 0.4 |
| Fourth | 3.000% to 4.000% | 0.6 |
MDA = distributable profits × factor = 240 × 0.4 = 96 million
Excel: =Profit*LOOKUP(Avail/CBR,{0,0.25,0.5,0.75},{0,0.2,0.4,0.6}), applied only while Avail < CBR
Distributable profits are interim and year-end profits not yet included in CET1, net of the tax that would be due if they were retained. The MDA caps the total of three kinds of payment: dividends and buybacks, variable remuneration and discretionary pension benefits, and coupons on AT1 instruments.
| Distribution | Planned |
|---|---|
| AT1 coupons | 45 |
| Ordinary dividend | 120 |
| Variable remuneration | 60 |
| Total | 225 |
| MDA | 96 |
| Required cut | 129 |
Cancelling the dividend is not enough: coupons and bonuses alone come to 105, 9 million over the limit. Something else has to give, and AT1 coupons are fully discretionary. This is the point at which coupon risk on AT1, normally a footnote, becomes the investor's question.
Two procedural consequences follow the moment the buffer is breached, before any payment decision. The bank must calculate the MDA and notify its supervisor, and under Article 142 it must submit a capital conservation plan showing how it will rebuild the buffer and by when. Until the MDA is calculated and notified, no distribution of any of the three kinds may be made. In practice the calculation is run on every capital projection, not only after a breach, because a bank that sits a few tenths of a point above a quartile boundary carries the risk of falling into the one below with a single quarter of losses or a rise in risk-weighted assets.
| CET1 ratio | CET1 for the buffer | Share of buffer | Factor | MDA, million |
|---|---|---|---|---|
| 6.5% | 0.500% | 12.5% | 0.0 | 0 |
| 7.4% | 1.400% | 35.0% | 0.2 | 48 |
| 8.7% | 2.700% | 67.5% | 0.4 | 96 |
| 9.3% | 3.300% | 82.5% | 0.6 | 144 |
| 10.2% | 4.200% | 105.0% | none | no limit |
The function is a staircase, not a slope. Moving from the third to the fourth quartile needs CET1 of 9.000 per cent, 90.0 million more, and raises permitted distributions by 48 million. Issuing 112.5 million of AT1 does the same by curing the shortfall, which is usually the cheaper route.
Measuring the buffer from the 5.625 per cent CET1 line and forgetting the AT1 shortfall. That puts available CET1 at 3.075 per cent, the fourth quartile, and an MDA of 144 million, 48 million more than the bank may pay. The effective trigger is 10.000 per cent, not 9.625. The same mechanism, worked on the book's own bank, is in whether an additional tier 1 shortfall cuts headroom.
The three capital compartments, the buffer stack and the trigger with its quartile boundaries are live in the free workbook for this book.
Dividends and share buybacks, variable remuneration and discretionary pension benefits, and coupons on additional tier 1 instruments, all together. In the illustrative case, planned payouts of 225 million face an MDA of 96 million; cancelling the 120 million dividend still leaves 105 million of coupons and bonuses, 9 million over the limit.
When the bank does not meet its combined buffer requirement, meaning its CET1, after covering Pillar 1, Pillar 2 and any AT1 or tier 2 shortfall, is below the buffer. For the illustrative bank the trigger is 10.000 per cent: 5.625 per cent for the minimum and Pillar 2, a 0.375 per cent AT1 shortfall and a 4.000 per cent buffer.
The combined buffer requirement is split into four equal parts. With a 4.000 per cent buffer each is 1.000 per cent of risk-weighted assets, 300 million on 30,000. CET1 in the lowest quartile gives a factor of 0, then 0.2, 0.4 and 0.6. A bank with 2.700 per cent in the buffer is in the third, at 0.4.
This article is one calculation from Financial Regulation. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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