An unregulated holding company with two regulated 100% subsidiaries and one unregulated 100% subsidiary. Both regulated entities meet their solo requirements.

Unregulated Holding Company A1

Assets		Liabilities
Book-value participations in: Bank B1		Capital	300
	800	Other liabilities (long term loan)	800
Insurance company B2	200
Leasing company B3	100
Total	1,100	Total	1,100

Bank B1 (Subsidiary)

Assets		Liabilities
Loans	900	Capital	800
Other assets	400	Other liabilities	500
Total	1,300	Total	1,300

Insurance Company B2 (Subsidiary)

Assets		Liabilities
Investments	7,000	Capital	200
		General reserves	100
		Technical provisions	6,700
Total	7,000	Total	7,000

Unregulated Leasing Company B3 (Subsidiary)

Assets		Liabilities
Leases	2,000	Capital	100
		Other liabilities	1,900
Total	2,000	Total	2,000

Group (consolidated)

Assets		Liabilities
Bank loans	900	Capital	300
Other bank assets	400	General reserves	100
Insurance investments	7,000	Other bank liabilities	3,200
Leases	2,000	Technical provisions	6,700
Total	10,300	Total	10,300

(i) Assume the solo capital requirements/solvency margins of the regulated companies are as follows:

	Requirement	Actual Capital	Surplus/(Deficit)
Bank B1	100	800	700
Insurance Company B2	300	300	0
"notional" capital proxy for the Leasing Company B3	150	100	(50)

(ii) Under the building-block prudential approach, the aggregated solo capital requirements and proxies (B1 : 100; B2 : 300; B3 : proxy of 150: Total : 550) are to be compared with the consolidated capital (300 +100 = 400). The group has a solvency deficit of 550 - 400 = 150.

(iii) Under the risk-based aggregation method, the solo capital requirements and proxies are again aggregated (550); the total requirements are compared to the sum of the capital held by the parent and its subsidiaries, deducted from the amount of the intra-group holding of capital [300 (parent) + 800 (B1) + 300 (B2) + 100 (B3) - 1,100 (participations) = 400]. Again, the group has a solvency deficit of 150.

(iv) Under the risk-based deduction method, in the balance sheet of the parent the book value of each participation is replaced by its surplus or deficit value, i.e. total assets minus liabilities and minus capital requirement/proxy of the subsidiary. The book-values of B1 (800), B2 (200) and B3 (100) are replaced by the solo surplus/deficit identified under (i): B1 (700), B2 (0), B3 (-50).

The revised balance sheet of the parent holding company is then as follows:

Assets		Liabilities
Participations in:
B1	700	Capital	-150
B2	0	Other liabilities	800
B3	-50
Total	650	Total	650

Again, the result of the calculation shows a group solvency deficit of 150.

(v) When there is an unregulated holding company, the total deduction method is not applicable.

(vi) Conclusions Although both regulated entities meet their own solo or sector solvency requirements, the financial conglomerate on a group-wide basis is undercapitalised. The explanation is twofold: first, there is excessive leverage in the group, as the parent has downstreamed debt to its subsidiaries in the form of equity capital, and secondly there is an undercapitalised unregulated entity in the group. As explained in the main text, the undercapitalisation of the group is a potential risk for both regulated entities. As shown in the example, the undercapitalisation can be revealed by applying appropriate measurement techniques for the assessment of capital adequacy at group level.