This credit FAQ discusses the effects of capitalization reliefs on bank and bancassurance groups. It also explains how and why our analytical approach may differ from bank regulations, how that can influence our ratings, and what challenges investors may face when they analyze this topic.

Frequently Asked Questions

For some people, it's double counting; for others, a pragmatic and justified capital efficiency. Bank regulations in some jurisdictions offer complex banking groups some key reliefs that ease the regulatory capital requirements related to their investments in subsidiaries.

• For banking groups, capital requirements on bank parents typically allow them to part-fund their capital investments in financial sector entities with weaker forms of capital or debt. This is known as "double leverage"--borrowing higher up the group to leverage investments in subsidiaries.
• For bancassurance groups, the EU-specific implementation of the Basel accords allows a bank parent to hold considerably less capital for insurance-related risks than it has invested in its insurance subsidiary--potentially as low as 20% of the investment.

These capitalization reliefs create capital efficiency and improve earnings capacity. They can also give European bancassurers a competitive advantage over pure insurance groups, which face a stricter regulatory approach.

Taken to extremes, however, these reliefs can distort resource allocation and promote chronic under-capitalization, which can become evident in a stress scenario. A case in point was the collapse of Credit Suisse in 2023 that was aggravated by high double leverage.

We consider these risks in our methodologies, which take a more cautious analytical approach than some regulatory standards. Among others, this affects our view of European banking groups' capitalization and broader credit strength. Occasionally, it results in the notching down of certain entities in these groups, relative to our view of the broader group.

Double Leverage Of Investments In Financial Sector Entities

What's the regulatory background to double leverage at the level of operating banks?

The Basel standards for regulatory capital consider that banks deduct from their own capital base investments in financial sector entities (including banking, financial, and insurance entities), which are outside the scope of regulatory consolidation. This is subject to certain thresholds (see annex).

Banking groups must meet regulatory capital requirements at a consolidated group-wide level. Typically, they must also meet them at the entity (solo) level for the subsidiaries and the parent bank, and on a sub-consolidated level for certain subgroups.

As a result, a parent bank's investments in financial sector entities need not be deducted from regulatory capital on the consolidated level. Subject to national laws and their implementation of Basel standards, however, the investments will need to be deducted from the regulatory capital of entities, including the parent bank.

Capital requirements on the subsidiary level can lead to further inefficiency due to:

• Intragroup balances between affiliates. These require the backing of regulatory capital at the entity level but are not considered in the balance sheet on consolidation;
• Differences in the quantification of regulatory capital requirements. For example, the parent bank's or consolidated group's approach may be models-based, while the subsidiary uses a standardized approach; and
• Substantial minimum regulatory and management buffers at the subsidiary level.

In the case of a multi-jurisdictional banking group, this means the group's regulatory capital requirements based on a sum of the parts calculation (that is, the sum of the solo requirements applicable to each subsidiary and the parent bank ) would typically be larger--sometimes considerably so--than the calculation based on the consolidated balance sheet.

That said, a key lever enables a parent bank to improve, via double leverage, the capital efficiency of its investments in financial sector entities.

A parent bank's solo capital requirement may allow it to risk-weight its investments in its financial subsidiaries, rather than fully deduct them.

Indeed, the Basel standards envisage that jurisdictions may allow banks to risk-weight investments in financial sector entities if they represent less than 10% of the bank's common equity. This figure is considerably higher in some jurisdictions.

Removing the requirement to fully deduct these investments allows the parent bank to partly double-count some of its equity toward the risks in its own operations and those in its subsidiaries. This double counting is commonly referred to as double leverage.

What's the regulatory background to double leverage at the level of non-operating holding companies (NOHCs)?

In certain key jurisdictions, the ultimate banking group holding company is not the main operating bank but a NOHC, which is essentially an investment vehicle. NOHCs are typically not subject to solo capital requirements. Similarly to operating banks, however, they can create double leverage by using debt to part-fund equity investments in subsidiaries, be it financial institutions or insurers.

Even within the debt stack, a NOHC or parent bank can downstream more subordinated forms of debt internally versus its external funding. For example, it can issue senior debt and downstream it as senior nonpreferred, tier 2, or additional tier 1 (AT1) debt.

Why can double leverage pose a risk?

If a banking group performs well and all key subsidiaries are profitable, double leverage is likely not an issue. New capital is generated, entities can easily meet their regulatory capital needs, and any excess resources can be redeployed within the group. There may be some misallocation of capital to business lines whose profitability is flattered by the favorable regulatory capital treatment. In and of itself, however, this may not be a big risk.

The problem starts when key subsidiaries come under stress. In this case, the regulator could curtail capital flows between subsidiaries and operating companies to prevent the latter from making discretionary payments, such as dividends and AT1 coupons. This can place liquidity strain on the parent, especially if it is a NOHC and relies on discretionary income to service "must pay" or non-discretionary obligations.

What's more, the parent bank or parent NOHC may have to write down substantial amounts of its investments in a key subsidiary. These write-downs could cause solvency pressure.

In a worst-case scenario, these pressures can contribute to the collapse of the banking group, as happened in the case of Credit Suisse.

How do bank regulations on double leverage differ among major jurisdictions?

Operating banks, particularly bank parents: 

• Australia: The Australian Prudential Regulation Authority (APRA) requires deduction for holdings of equity, AT1 capital, and T2 capital in financial institutions and insurance companies that exceed 10% of the bank's capital. Exposures below 10% are risk-weighted. For example, the proportion of equity exposures below 10% is risk-weighted at 250%.
• Canada: Under the parental stand-alone (solo) total loss-absorbing capacity (TLAC) framework, domestic systemically important banks in Canada are required to risk weight equity and debt investments in foreign-regulated subsidiaries at 325%.
• EU: The capital requirements regulation (CRR), mainly articles 36 and 48.1/2, substantially applies the Basel standards; that is, it deducts investments in financial sector entities from regulatory capital. EU law also applies the possibility to not deduct significant investments when equal to or less than 10% of the bank's CET1 capital, but this non-deduction is subject to a cap of 17.65% of the bank's CET 1 capital.
• Switzerland: Policymakers are currently updating the requirements for systemically important banks. It appears that investments in domestic financial institution subsidiaries will remain risk-weighted at only 250%. The Federal Council appears minded to impose a full deduction for investments in overseas financial institution subsidiaries, but the final proposed may differ. It is due in June.
• U.K.: The rulebook mirrors the EU's CRR and the Basel standards.
• U.S.: Regulatory capital rules require commercial banks--but not bank holding companies--to fully deduct equity investments in financial subsidiaries.

NOHCs:  NOHCs are a common feature in major bank or financial conglomerate groups in the U.S., the U.K., Ireland, Japan, South Korea, Taiwan, Switzerland, the Netherlands, and Belgium. Since Basel standards do not exist in this area, it is up to national supervisors decide how to control and monitor the associated risks.

• U.K.: The Prudential Regulation Authority (PRA) expects U.K. banking groups to quantify their use of double leverage. If the double leverage ratio exceeds 100%, they must explain how they manage the related risks, including the mismatch between cash and capital inflows, and the parent's capital outflows. The PRA has not set a general limit for the double leverage ratio since it does not constitute a risk-sensitive measure--that is, two banks could have the same ratio but very different risk profiles. However, if it sees the attendant risk as insufficiently mitigated, it could apply a pillar 2 capital add-on for this risk or exert other supervisory powers.
• Taiwan: The regulatory capital ratio for the financial holding company aggregates banking, insurance, and other subsidiary risk-weighted capital requirements under the respective capital framework requirement. Additionally, the capital ratio must reach at least 100%. Financial holding companies' double leverage generally ranges between 110% and 120%.
• South Korea: The regulator closely monitors double leverage. If the double leverage ratio exceeds 130%, holding companies could receive a lower assessment score for regulatory management and risk assessment. Therefore, banking groups aim for a ratio below 130%, with some buffer.
• EU, Japan, and Switzerland: NOHCs' double leverage is not subject to a formal supervisory cap. Even so, we understand that banking groups with double leverage ratios above 100% aim to maintain the ratio below 120%.
• U.S.: The Federal Reserve generally considers double leverage ratios above 120% as high, inviting additional scrutiny by supervisors.

What analytical approach do you take and why?

Our financial institutions rating methodology and group rating methodology acknowledge that material double leverage increases the default risk for financial institutions. Double leverage that is used to capitalize banking groups' financial institution subsidiaries can influence our bank ratings in five main ways:

1 – Capital and earnings assessment--step 1:  We determine whether the bank is at risk of breaching regulatory capital requirements. Even though we mainly focus on the consolidated group's requirements, we also assess its compliance with entity-level capital requirements.

2 – Capital and earnings assessment--step 2:  We then calculate the bank's risk-adjusted capital (RAC) ratio under our RAC framework. This includes our measure of adjusted common equity (ACE), where we deduct the bank's significant minority investments in financial institutions and risk-weight investments below this threshold, on average at about 750%. Significant minority investments typically mean that the bank owns at least 10% of the financial institution. This analysis is normally based on our view of the consolidated group's capital. Therefore, we calculate ACE and the RAC ratio only at the consolidated level, not at the solo level. Consequently, issues related to the solo level capitalization do not directly affect the RAC ratio.

3 – Capital and earnings assessment--step 3:  In the final step of our capital and earnings assessment, we may apply a negative overlay, even if the consolidated ratios appear healthy. A bank's substantial use of double leverage could impair our assessment.

4 – Specifically for NOHCs:  As per our group rating methodology, the rating on an investment-grade bank NOHC is typically one notch lower than our assessment of the group's intrinsic credit strength. This reflects the incremental default risk from the structural subordination of the group's senior creditor claims, relative to the claims of the key operating companies' creditors. We may lower the rating by multiple notches if we think this risk is accentuated, for example due to an unmitigated liquidity risk from high double leverage. We generally regard NOHCs' double leverage as high if it exceeds 120%. We define double leverage for financial institution groups as the holding company's investments in subsidiaries, divided by the holding company's unconsolidated shareholder equity.

5 – Uplift for additional loss-absorbing capacity (ALAC):  Specifically for multiple-point-of-entry resolution groups, the parent subgroup's high double leverage can lead to an over-optimistic view of its recapitalization capacity under our standard ALAC calculation. We may therefore apply an above-standard threshold to that subgroup when considering ALAC uplift.

In practice, most banking groups tend to deploy modest double leverage for their financial institution subsidiaries. This means negative rating implications are rare.

Double Leverage Of Investments In Insurance Entities

How do EU bank regulations support the bancassurance model?

The EU has a dedicated framework for financial conglomerates (FiCos) in the region. A directive from 2002 defines FiCos as "groups led by a regulated entity, in which the consolidated activities within the insurance, banking, and investment services sectors are significant." This means that:

• The activities of the FiCo's leading regulated entity should mainly occur within the financial services sector;
• The financial sector entities' balance sheet contribution should exceed 40% of the consolidated balance sheet; and
• For each financial sector in the conglomerate, the average of the ratio of the balance sheet total of that financial sector to the balance sheet total of the financial sector entities in the group should exceed 10%. Similarly, the ratio of the solvency requirements of the same financial sector to the total solvency requirements of the financial sector entities in the group should also exceed 10%.

While FiCos must adhere to the following strict requirements, they are not rare--there are currently 63 of them in the EU and EEA combined:

• Activities must stretch across various financial sectors;
• Risk management frameworks, internal control systems, and the related governance and oversight must meet certain quality standards; and
• The so-called financial conglomerate ratio (FCR) must be met. The FCR is calculated as the total capital resources available to the conglomerate (including tier 1 and tier 2 capital), divided by the aggregate of the capital requirements of each financial sector where the FiCo is active. The FCR serves as a backstop to the application of the "Danish compromise."

The EU adopted the Danish compromise (article 49.1 of the CRR) in 2012. It enables FiCos to reduce the absorption of their regulatory capital. Under certain conditions, investments in the insurance undertaking can be risk-weighted as an equity exposure instead of being deducted from the bank's regulatory capital.

Until December 2024, the corresponding risk weight was either 100% or 370%, depending on whether the banking group applied a standard or an internal rating-based approach for risk quantification. This offered a substantial benefit to full deduction, which would be akin to a 1,250% risk weight.

Initially considered as a temporary measure, CRR3, which was implemented on Jan. 1, 2025, has since become permanent and led to a harmonized risk-weight requirement of 250% across the EU. In effect, however, a bank has to hold capital against only 20% of its investments in an insurance undertaking (see chart 1).

Chart 1

This approach is markedly different to the EU's insurance regulation, which is now under the Solvency II directive. Solvency II stipulates that an insurer who owns a material stake in a financial institution must deduct the investment from its regulatory capital.

How do EU regulations on financial conglomerates differ from those on bancassurers in other major jurisdictions?

The Basel standards do not foresee that the treatment of insurance subsidiaries that are outside the scope of regulatory consolidation should differ from that of other financial sector entities. That said, Basel standard 30.5 recognizes the possibility for deviation as long as capital is not double-counted and disclosures are appropriate.

Bancassurance--the integration of a bank and an insurance underwriter within the same group--is a feature in a relatively small number of markets outside Europe, for example in South Korea and Taiwan. The commercial partnership model--where a bank sells a third party insurer's products--is generally more prevalent elsewhere.

• Australia: APRA requires deduction for holdings of equity, AT1 capital, and T2 capital in financial institutions and insurance companies that exceed 10% of the bank's capital. Exposures below 10% are risk-weighted. For example, the proportion of equity exposures below 10% is risk-weighted at 250%.
• South Korea: Similar to the Basel standards, the regulator requires a bank to deduct equity investments in an insurance company that exceed 10% of the bank's capital from their regulatory capital. Exposures below 10% are risk-weighted at 250%.
• U.K.: In line with the Basel standards, the PRA requires a bank to deduct any stake in an insurance company from its regulatory capital if the stake exceeds 10% of the bank's capital. The rest is risk-weighted at 250%.
• U.S.: In a variation on the Basel standards, a bank must deduct the insurance regulatory capital requirement from its regulatory capital, not the actual capital investment. A bank is therefore not penalized if it chooses to allocate excess capital to the insurance subsidiary. However, this excess could become trapped by insurance regulators in a stress scenario.

What analytical approach do you take and why?

When we analyze bancassurers, we undertake a separate capital analysis of the two arms as they face very different risks.

We acknowledge that banks' and insurers' risks are not 100% correlated. Hence, we often recognize the credit benefits of earnings and risk diversification for bancassurance groups in our assessments of their business position or risk position. When these groups have come under stress in the past, normally through the bank arm, the insurance business has rarely been meaningfully affected.

Nevertheless, we consider it prudent to avoid double-counting of capital, which is in line with the Basel standards. Similar to the standards, we deduct a bank's capital investment in any insurance subsidiary or affiliate when we calculate a bank's ACE.

This approach also acknowledges that capital fungibility between these entities is likely to be unreliable in a stress period. In effect, the capital at the insurance subsidiary could be trapped as the insurer needs it to meet its own regulatory capital requirements and regulators may be reluctant to divert resources from policyholders to support other parts of the group. We mirror this approach in our insurance capital framework and deduct in full an insurer's investments in a bank subsidiary or affiliate from the insurer's TAC.

Where we consider that this standard calculation of a bank's RAC ratio is overly cautious or not prudent enough, we can adapt the third and final step of our capital and earnings assessment. Specifically, if a bank has a sizeable exposure to an insurance business, we assess whether the insurance subsidiary is over- or under-capitalized relative to the 99.8% confidence interval (a substantial stress scenario), which is defined in our risk-based capital model. We quantify exposure as material when the bank's implied S&P Global Ratings RWAs increase by more than 10% when incorporating the RWA equivalent of the exposure to insurance investees.

The outcome of the assessment can suggest whether a capital transfer--upstream to the benefit of the bank or downstream to the detriment of the bank--may be possible or necessary. We quantify this transfer as a risk-weighted asset of 375% of the under/over-capitalization amount.

Since our RAC approach leads to a more demanding—but, we believe, more risk-reflective--capital treatment than the EU regulations, our RAC ratios for EU bancassurance groups tend to be markedly lower than their regulatory tier 1 ratios.

Which transparency issues do investors face?

Banks in major jurisdictions provide lengthy disclosures through their annual reports, pillar 3 reports, and other ad-hoc regulatory information.

Insurance subsidiaries:  An EU bancassurer that applies the Danish compromise for its insurance investments usually provides sufficient transparency for external investors. This is because it is part of the European Banking Authority's list of FiCos and because the bank's pillar 3 report includes, among others, quantitative information on the FCR.

Financial institution subsidiaries:  An NOHC's double leverage can typically be calculated if the banking group publishes the NOHC's unconsolidated balance sheet. If related disclosures do not exist, however, it is difficult to determine whether the NOHC uses AT1 capital to invest in subsidiaries' CET1 capital.

If double leverage occurs further down the group or the ultimate parent is an operating bank, any use of double leverage tends to be considerably less transparent. This may be because:

• The group does not publish unconsolidated accounts for the operating bank(s);
• The group does not publish unconsolidated/solo capital ratios, including the calculation of those ratios and requirements for the bank; or
• The assessment of double leverage is not as straightforward as it is for NOHCs, even if the group publishes an unconsolidated balance sheet.

Alternative disclosures could provide some useful insights for investors, for example if they quantify and explain the difference between group capital required under the sum-of-the-parts approach and group capital required under the consolidated approach. That said, to be truly useful, bank reporting would be standardized to allow comparison.

Annex

Under the Basel standards, the capital treatment of investments in the capital of TLAC liabilities of banking, financial, or insurance entities that are outside of the scope of regulatory consolidation differs. The Basel standards distinguish between two situations:

The bank owns no more than 10% of the issued common share capital of the entity.  In this case, only investments that exceed 10% of the bank's own common equity are deducted. The deduction needs to be made from CET1 if it is an equity investment, from tier 2 if it is a TLAC-instrument investment, and from AT1 if it is an AT1 investment.

The bank owns more than 10% of the issued common share capital of the entity.  In this case, full investments that are not common shares must be deducted. CET1 investments are deducted from CET1, TLAC liabilities from tier 2, and AT1 from AT1.

However, the Basel standards include an option for national laws, which could result in non-deductions of up to 10% of the bank's common equity. This non-deduction option also applies to deferred tax assets that arise from temporary differences and for mortgage servicing rights. Yet the combined amounts must not exceed 15% of the bank's CET1 capital.

The amounts that are not deducted in both scenarios should be risk-weighted.

Related Criteria And Research

• Risk-Adjusted Capital Framework Methodology, April 30, 2024
• Insurer Risk-Based Capital Adequacy--Methodology And Assumptions, Nov. 15, 2023
• Financial Institutions Rating Methodology, Dec. 9, 2021
• Insurers Rating Methodology, July 1, 2019
• Group Rating Methodology, July 1, 2019

External Research

• "Basel framework," published by the Bank for International Settlements on Dec. 15, 2019 (https://www.bis.org/basel_framework/chapter/CAP/30.htm?inforce=20191215&published=20191215)