The retained share, the margin over expected loss and the clearance above KIRB, worked on one fictional synthetic securitisation, with what each point of retention costs in capital.
The first-loss test is passed when the originating bank keeps no more than 20 per cent of the positions that sit at the bottom of the structure and can show that those positions exceed expected loss by a substantial margin. On the fictional Northwall 2026-1, the bank keeps 14.0 million of a 280 million junior tranche, 5 per cent against the 20 per cent limit, and the tranche covers 19.95 times one year of expected loss and 3.99 times five years of it. Every extra point retained costs 2.8 million of capital relief, and above 20 per cent the relief is zero.
Worked in full in Significant Risk Transfer by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A bank that buys protection on part of a loan portfolio can only reduce its capital if the transfer is significant. Article 245(2) of the EU Capital Requirements Regulation gives two mechanical routes for a synthetic securitisation (Article 244(2) sets the same two for a traditional one):
Passing either test is necessary, not sufficient: the supervisor can still refuse recognition if the capital reduction is not justified by a commensurate transfer of credit risk. In a two-tranche synthetic deal like Northwall's, where a junior tranche sits around KIRB and the bank keeps the senior, the first-loss test is the one the bank runs, and the companion workbook runs it. Strictly, the junior tranche straddles KIRB, so only its part below 6.51 per cent carries the 1250 per cent weight; applying the 20 per cent limit to the whole junior tranche, as here, is the conservative reading, and 5 per cent passes either way.
The figures below are those of the book's fictional transaction. Amounts in euro millions.
| Input | Value |
|---|---|
| Reference portfolio | 4,000 |
| IRB risk-weighted assets | 3,077.08 |
| Expected loss, one year | 14.03 |
| KIRB (capital at 8% plus expected loss, per euro) | 6.51% |
| Junior tranche, 0 to | 7.00% |
| Share of the junior the bank retains | 5% |
| Life of the transaction, years | 5 |
Step 1: size the positions. The junior tranche is 7.00 per cent of 4,000, or 280.0. The bank retains 5 per cent of it, 14.0, which also meets the 5 per cent risk retention rule of the Securitisation Regulation by keeping a share of every tranche sold. The fund buys 266.0.
Retained share = 14.0 / 280.0 = 5%, against a limit of 20%: pass
Step 2: the substantial margin. The regulation sets no number for it, so the bank has to show it. The book measures it two ways, against one year of expected loss and against expected loss over the life of the deal.
Expected loss per euro = 14.03 / 4,000 = 0.351%; over five years 1.754%, or 70.2
Cover, one year = 7.00% / 0.351% = 19.95 times
Cover, life = 7.00% / 1.754% = 3.99 times
Step 3: the clearance above KIRB. KIRB is 6.15 per cent of capital plus 0.351 of expected loss, 6.51 per cent. The detachment sits 0.49 points above it, 7.6 per cent of KIRB. This is not part of the legal test, but it is what puts the senior tranche above KIRB, where SEC-IRBA gives it the 35.34 per cent weight worked in how to calculate the SEC-IRBA risk weight.
Capital before the trade is 3,077.08 at a 13.50 per cent CET1 target, 415.4. After it, the senior costs 177.5 and the retained slice is deducted at par. Each point of the junior kept is 2.8 of capital that is not released.
| Retained | Kept | Sold | First-loss test | Capital released | Released per euro sold |
|---|---|---|---|---|---|
| 0% | 0.0 | 280.0 | pass, but breaches the 5% retention rule | 237.9 | 0.850 |
| 5% | 14.0 | 266.0 | pass | 223.9 | 0.842 |
| 10% | 28.0 | 252.0 | pass | 209.9 | 0.833 |
| 15% | 42.0 | 238.0 | pass | 195.9 | 0.823 |
| 20% | 56.0 | 224.0 | pass, at the limit | 181.9 | 0.812 |
| 25% | 70.0 | 210.0 | fail | 0.0 | - |
| 50% | 140.0 | 140.0 | fail | 0.0 | - |
The relief falls linearly from 223.9 to 181.9 between 5 and 20 per cent, 42.0 less, and then drops to nothing. Below the limit, the trade-off is price: a bank that keeps more of the junior pays coupon on less notional. Above it, the bank keeps the whole of its original capital charge and still pays for the protection it bought.
| Detachment | Junior tranche | Clearance above KIRB, pts | Cover, one year of EL | Cover, five years of EL |
|---|---|---|---|---|
| 5.00% | 200.0 | −1.51 | 14.25 | 2.85 |
| 6.00% | 240.0 | −0.51 | 17.10 | 3.42 |
| 6.51% (KIRB) | 260.2 | 0.00 | 18.54 | 3.71 |
| 7.00% | 280.0 | 0.49 | 19.95 | 3.99 |
| 8.00% | 320.0 | 1.49 | 22.80 | 4.56 |
| 10.00% | 400.0 | 3.49 | 28.50 | 5.70 |
On a portfolio this granular even a 5.00 per cent tranche covers expected loss many times over; the substantial margin is rarely what fails. What changes below KIRB is the senior: it now attaches inside the capital the regulation already expects to be consumed, and its weight rises steeply. The companion workbook finds that this structure keeps releasing some capital down to a detachment of 3.54 per cent, well under KIRB, but the release shrinks fast as the detachment falls.
The common mistake is to treat the 20 per cent limit as a target. It is a cliff, and every point retained above the 5 per cent the retention rule requires is deducted at par: 2.8 of capital released forgone for each point, against only the coupon saved on 2.8 of notional. The second mistake is to run the test once at closing. The positions are measured on every reporting date, and on an amortising or replenishing pool the retained share and the cover both move. The book's working documents carry the transfer tests with their quarterly monitoring, and the calculation is live in the free workbooks for Northwall 2026-1. For whether to deduct the retained slice or weight it at 1250 per cent, see deduct or risk-weight the retained sliver.
The mezzanine test caps the bank's share of the risk-weighted exposure of mezzanine positions at 50 per cent. The first-loss test applies where there are no mezzanine positions to measure: the bank may hold at most 20 per cent of the positions that would be deducted or weighted at 1250 per cent, and must show they exceed expected loss by a substantial margin. Northwall keeps 5 per cent of its junior tranche.
The regulation sets no figure, so the bank has to demonstrate it and the supervisor judges it. Two useful measures are the tranche's thickness over one year of expected loss and over the life of the deal. On Northwall a 7.00 per cent tranche against 0.351 per cent of annual expected loss is 19.95 times; against 1.754 per cent over five years it is 3.99 times.
The retained slice is deducted at par, so every point retained is lost relief. On a 280.0 million junior tranche each point is 2.8 million: relief falls from 223.9 million at 5 per cent retained to 181.9 million at 20 per cent. Above 20 per cent the first-loss test fails and the relief is zero, while the protection premium is still paid.
This article is one calculation from Significant Risk Transfer. 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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