• Archived Part A

    • Introduction

      • UG UG Users Guide

        • UG-A UG-A Introduction

          • UG-A.1 UG-A.1 Purpose

            • UG-A.1.1

              The Bahrain Monetary Agency ("the BMA"), in its capacity as the regulatory and supervisory authority for all financial institutions in Bahrain, issues regulations that licensees are legally obliged to comply with. These regulations are contained in the BMA Rulebook.

            • UG-A.1.2

              The Rulebook is divided into 5 Volumes, covering different areas of financial services activity. Volume 1 (Conventional Banks) covers all conventional banks licensed by the Agency. Islamic banks are covered in Volume 2. Volume 3, covering insurance licensees, was issued in April 2005. Volume 4 is being issued in two phases, starting in April 2006. Representative offices of banks and specialised licensees are in Volume 5, which will be issued in 2007.

            • UG-A.1.3

              This Users' Guide provides guidance on:

              (a) the status and application of the Rulebook, with specific reference to Volume 1 (Conventional Banks);
              (b) the structure and design of the Rulebook; and
              (c) its maintenance and version control.

          • UG-A.2 UG-A.2 Module history

            • UG-A.2.1

              This User's Guide — Module UG — was first issued in July 2004 together with the rest of Volume 1 (Conventional Banks). All subsequent changes to this Module are dated with the month and year at the base of the relevant page and in the Table of Contents: Chapter UG-3 of this Module provides further details on Rulebook maintenance and version control.

            • UG-A.2.2

              A list of recent changes made to this Module are detailed in the table below:

              Module Ref. Change Date Description of Changes
              UG-A.2 1/2005 Update of changes to Module
              UG-1.2 1/2005 Clearer wording on rules and guidance
              UG-2.2 1/2005 Sections and paragraphs explained more fully
              UG-2.3 1/2005 Footers explained more fully
              UG-3.1 1/2005 Contents pages explained more fully
              UG-2.3 & UG-3.1 4/2006 Revised dating and update system

        • UG-1 UG-1 Rulebook status and application

          • UG-1.1 UG-1.1 Legal basis

            • UG-1.1.1

              Volume 1 (Conventional Banks) of the BMA Rulebook is issued by the BMA pursuant to Amiri Decree Law No. 23 of 1973 (the "BMA Law").

          • UG-1.2 UG-1.2 Status of provisions

            • UG-1.2.1

              The contents of the Rulebook have the formal status either of Rules or Guidance.

            • UG-1.2.2

              Rules have a binding effect. If a licensee breaches a Rule to which it is subject, it is liable to enforcement action by the BMA and, in certain cases, criminal proceedings by the Office of the Public Prosecutor.

            • UG-1.2.3

              Guidance is not binding. It is material that helps inform a particular Rule or set of Rules, or provides other general information. Where relevant, compliance with Guidance will generally lead the BMA to assess that the business has complied with the rule(s) to which the Guidance relates. Conversely, failure to comply with Guidance will generally be viewed by the BMA as tending to suggest breach of a Rule.

            • UG-1.2.4

              The status of each paragraph within the Rulebook can be identified by its text format, as follows:

              (a) Rules are in bold, font size 12. The paragraph reference number is also highlighted in a coloured box.
              (b) Guidance is in normal type, font size 11.

            • UG-1.2.5

              The Agency's interpretation of all Rules and Guidance in this Volume is final.

          • UG-1.3 UG-1.3 Application

            • UG-1.3.1

              Rules and Guidance contained in Volume 1 of the BMA Rulebook apply to all conventional licensed banks subject to the provisions of the BMA Law, except for representative offices of banks which are subject to the relevant requirements contained in Volume 5 (Specialised Firms) and Islamic banks which are covered in Volume 2.

            • UG-1.3.2

              Where relevant, individual sections of Volume 1 may identify which specific Rules and Guidance apply to particular types of banking licensee.

          • UG-1.4 UG-1.4 Effective date

            • UG-1.4.1

              Volume 1 (Conventional Banks) of the BMA Rulebook was first issued in July 2004. It replaces all regulations previously issued with respect to conventional banks.

            • UG-1.4.2

              For reference, these superseded regulations are listed in the Rulebook, under the 'Regulation history' section of the appropriate Module in each Volume. The list includes the reference number of the previously superseded circular or regulation, its date and subject heading.

        • UG-2 UG-2 Rulebook structure and format

          • UG-2.1 UG-2.1 Rulebook structure

            • Rulebook Volumes

              • UG-2.1.1

                The Rulebook is divided into 5 Volumes, covering different areas of financial services activity, as follows:

                Volume 1 Conventional Banks
                Volume 2 Islamic Banks
                Volume 3 Insurance
                Volume 4 Investment Business
                Volume 5 Specialised Activities

              • UG-2.1.2

                Volume 5 (Specialised Activities) covers money changers; leasing firms; factoring firms; representative offices; finance companies; mono-line credit card companies and providers of ancillary services to the financial sector.

            • Rulebook contents (overview)

              • UG-2.1.3

                Except for Volume 5, the basic structure of each Rulebook is the same. Each Volume starts with a contents page and User's Guide. Subsequent material is organised underneath the following headings:

                (a) High Level Requirements
                (b) Business Requirements
                (c) Reporting Requirements and
                (d) Enforcement and Redress

              • UG-2.1.4

                Volume 5 is organised by the category of specialised firm concerned.

              • UG-2.1.5

                The material in Volumes 1–4 is contained in Modules, each covering a specific area of requirements (e.g. High-level Controls). In turn, each Module is divided into Chapters, Sections and Paragraphs, as detailed below.

              • UG-2.1.6

                Each Volume has its own appendix Volume containing relevant reporting forms and a glossary.

          • UG-2.2 UG-2.2 Volume structure

            • Modules

              • UG-2.2.1

                Rulebook Volumes are subdivided into Modules, arranged in groups according to their subject matter, underneath the headings listed in paragraph UG-2.1.3 above.

              • UG-2.2.2

                Each Module in a Volume is referenced using a two-letter code which is usually a contraction or abbreviation of its title. These codes are used for cross-referencing within the text.

            • Chapters

              • UG-2.2.3

                Each Module consists of chapters, categorised into two types:

                (a) A standard introductory chapter (referenced with a letter: e.g. UG-A); and
                (b) Chapters containing the substantive content of the Module (referenced with a number: e.g. CA-1, CA-2, etc.)

              • UG-2.2.4

                The introductory chapter summarises the purpose of the Module, its history (in terms of changes made to its contents) and, where applicable, lists previously issued circulars and regulations that were replaced by the Rulebook Module.

            • Sections and paragraphs

              • UG-2.2.5

                Chapters are further sub-divided into Sections (numbered consecutively after the Chapter number: e.g. FC-1.1, FC-1.2, FC-1.3 etc). In turn, Sections are sub-divided into Paragraphs (numbered consecutively after the Chapter and Section numbers: e.g. FC-1.1.1, FC-1.1.2, FC-1.1.3 etc.). Where appropriate, sub-section headings may be used, to guide the reader through a Section: sub-section headings are italicised and unnumbered, and act purely as an indicator (without limitation as to the status of the paragraphs that follow.

            • Table of contents

              • UG-2.2.6

                Each Volume's contents page lists all the Modules contained within it (Part A), and the information contained in the relevant appendix Volume (Part B).

              • UG-2.2.7

                The contents page of each Module lists the chapters, section and, in some Modules, sub-sections it contains, and the latest date of each section in issue.

          • UG-2.3 UG-2.3 Format and page layout

            • Headers

              • UG-2.3.1

                The top of each page in the Rulebook identifies the Volume, Module and Chapter in question. Each Module is a separate document. New Chapters start on a fresh page.

            • Footers

              • UG-2.3.2

                The bottom of each page in the Rulebook (on the left hand side) identifies the Module in question, its section and page number. Page numbering starts afresh for each Section: the total number of pages in each respective Section is shown as well as the individual page number. The bottom right hand side shows an issue date. The Contents Page for each Module is given its own separate version number. In addition, the Contents page lists the latest issue date for each Section in that Module. The Contents page thus acts as a summary checklist of the current version in force for each section. Further explanation is provided in Section UG-3.1 below.

            • Defined terms

              • UG-2.3.3

                Defined terms used in the Rulebook are underlined. Each Volume has its own glossary listing defined terms and giving their meaning. Definitions of terms used apply only to the Volume in question. It is possible for the same term to be used in a different Volume with a different meaning.

            • Cross-references

              • UG-2.3.4

                Cross-references are highlighted in yellow. Two active cross-references are shown in Paragraph UG-2.3.5 below. Any cross-references given in a text state the Module code, followed by the numbering convention for the chapter and section being referred to. For example, the cross-reference FC-1.2.3 refers to the first Paragraph in the second Section of the first Chapter of the Financial Crimes Module. Many references will be quite general, referring to a Module or Chapter rather than a specific Paragraph.

            • Text format

              • UG-2.3.5

                Each paragraph is assigned a complete reference to the Module, Chapter, and Section, as well as its own paragraph number, as explained in UG-2.3.4 above. The format of the paragraph reference and paragraph text indicates their status as either a Rule or Guidance, as explained in UG-1.2.4 above.

        • UG-3 UG-3 Rulebook maintenance and availability

          • UG-3.1 UG-3.1 Maintenance

            • Quarterly Updates

              • UG-3.1.1

                Changes to the Rulebook are made quarterly. After the end of each calendar quarter, the BMA automatically reissues the contents page of each Module. Users can thus determine whether they have access to the latest version of these pages, by checking that they have those marked with the most recent date.

              • UG-3.1.2

                The contents page of each Module lists the current date of each Section. The Module contents pages thus act as a checklist for users to verify that they have the current requirements.

              • UG-3.1.3

                Where changes to the regulations are required, then the affected pages are re-issued, alongside the contents pages for each Module. Where possible, only the relevant Section or Chapter is re-issued, rather than the whole Module.

              • UG-3.1.4

                A summary of any changes made to a Module is included in the 'Regulation history' section of each Module. The table summarises the nature of the change made, the date of the change and the Module components affected.

              • UG-3.1.5

                The updates are posted to the BMA website, together with a summary of changes for that quarter. Licensees are in addition e-mailed the summary of each quarter's changes. Hard-copy users are required to print off the updated pages from the website to incorporate in their Rulebook in order to keep it current. The website version of the Rulebook acts at all times as the definitive version of the Rulebook.

          • UG-3.2 UG-3.2 Rulebook availability and ordering details

            • Ordering details

              • UG-3.2.2

                Order forms for CD-ROMs and hard copies are included in an annexure to the Users' Guide (please refer to the end of this module).

              • UG-3.2.3

                Please complete all relevant boxes on the order form, taking particular care to provide full contact and address details. The completed form should be sent (accompanied with the appropriate payment) to:

                Rulebook Section
                Rulebook Section — Licensing & Policy Directorate
                Bahrain Monetary Agency
                PO Box 27
                Manama
                Kingdom of Bahrain

                Tel: + 973 - 17 54 7413
                Fax: + 973 - 17 53 0228
                E-mail: rulebook@bma.gov.bh
                Web: www.bma.gov.bh

            • UG-3.2.1

              The Rulebook is available on the BMA website, on CD-ROM-and in hard copy.

        • ANNEXURE — BMA Rulebook Order Form

          View PDF

          INSTRUCTIONS
          Please complete all relevant boxes, taking particular care to provide full contact and address details. The completed form should be sent (accompanied with the appropriate payment) to:
            Bahrain Monetary Agency
          (Rulebook Section, Licensing & Policy Directorate)
          PO Box 27
          Manama
          Kingdom of Bahrain

          For enquiries, please contact:
          Phone: +973 - 17 547 413
          E-mail: rulebook@bma.gov.bh
          ORDER REQUIREMENT
          Rulebook Volume Number Hard-Copy1: number required (at BD 110 each) CD-ROM2: number required (at BD 5 each) Cost:
          1 — Parts A & B Conventional Banks      
          2 — Parts A & B Islamic Banks      
          3 — Parts A & B Insurance Licensees      
          4 — Parts A & B Investment Business Licensees (Due 2006)      
          5 — Parts A & B Specialised Licensees (Due 2006)      
          POSTAGE The above prices include postage for delivery within the Kingdom of Bahrain. Postage for international orders will be charged at cost: please contact the BMA (see above) for details of rates and delivery options.  
          1: Hard copy subscribers are provided the latest version of the Rulebook Volume(s) ordered, which they can then keep up to date by printing off new or amended pages from the BMA website (www.bma.gov.bh).
          2: CD-ROM subscribers are sent the latest available version of the complete Rulebook (i.e. the CD-ROM contains all Volumes that have been issued).
          Total Cost:
          ADDRESS / PAYMENT DETAILS
          Name  
          Institution (if applicable)  
          Full Postal Address

           
          Contact e-mail / telephone / fax E-mail:

          Telephone:

          Fax:
          Please remember to enclose your payment with the order Payment should be by cheque drawn on a Bahraini-licensed bank, payable in Bahraini Dinars. Cheques should be made out to "Bahrain Monetary Agency". Persons ordering from outside Bahrain should contact the BMA (see above) for postage rates and payment options.

    • High Level Standards

      • LR LR Licensing Requirements

        • LR-A LR-A Introduction

          • LR-A.1 LR-A.1 Purpose

            • LR-A.1.1

              The Licensing Requirements Module sets out the BMA's approach to licensing conventional bank licensees.

            • LR-A.1.2

              The Module builds on the legal requirements contained in Decree Law No. (23) of 1973 (the BMA Law 1973). The Module is issued under legal powers granted to the BMA under the BMA Law 1973, notably Articles 56 to 69.

            • Licensing Requirement

              • LR-A.1.3

                Persons wishing to undertake regulated banking services are required to be licensed by the BMA as a conventional bank licensee. Regulated banking services consist of two determinant activities undertaken in combination — deposit-taking and providing credit. In addition, various supplementary regulated activities may also be undertaken. These activities are defined in Rule LR-1.3.1.

              • LR-A.1.4

                In other words, persons wishing to undertake deposit taking must also undertake the activity of providing credit. In addition, they may undertake any of the other activities falling within the definition of regulated banking services. Deposit taking may not be undertaken on its own, without the activity of providing credit also being undertaken. Persons wishing to provide credit without undertaking deposit taking may qualify as a finance company, a category of specialised licensee (see separate regulations regarding these: they will fall under Volume 5 of the BMA Rulebook, when issued in 2007).

            • License Categories

              • LR-A.1.5

                Conventional bank licensees are divided into two sub-categories: conventional retail bank licensees and conventional wholesale bank licensees. Certain specific regulatory requirements may differ between these two sub-categories, where appropriate to address their different risk profiles.

              • LR-A.1.6

                Conventional retail bank licensees may undertake transactions in any currency, with both Bahraini residents and non-residents. To qualify as a conventional retail bank licensee, the activity of providing credit must account for a significant portion of the institution's business (defined, broadly, as accounting for over 20% of an institution's assets).

              • LR-A.1.7

                Conventional wholesale bank licensees may also undertake transactions without restriction, when dealing with the Government of Bahrain and its agencies; BMA bank licensees; and non-residents. However, they may only undertake transactions denominated in Bahraini Dinar and/or with a resident of the Kingdom of Bahrain, if these are wholesale in nature. Wholesale transactions are defined in terms of transaction size (broadly, BD 7 million or more for a credit or deposit transaction, and US$ 250,000 or more for an investment transaction).

              • LR-A.1.8

                Collectively, licensed providers of regulated banking services are called conventional bank licensees. Bahrain-incorporated conventional bank licensees are called Bahraini conventional bank licensees. Conventional bank licensees that are incorporated in an overseas jurisdiction and operate via a branch presence in the Kingdom of Bahrain are called overseas conventional bank licensees. The same naming convention applies to the two sub-categories of conventional bank license: thus, Bahraini conventional retail bank licensees and Bahraini conventional wholesale bank licensees are those incorporated in Bahrain, whilst overseas conventional retail bank licensees and overseas conventional wholesale bank licensees are those incorporated in an overseas jurisdiction and operating in Bahrain via a branch presence.

            • Islamic transactions

              • LR-A.1.9

                Conventional bank licensees may not hold themselves out as an Islamic bank. They may nonetheless enter into Shari'a compliant transactions, subject to certain restrictions. Thus, conventional bank licensees may only undertake transactions that are based on Shari'a compliant contracts, when dealing with governments, public sector entities and other licensed financial institutions. Shari'a compliant contracts may not be undertaken with resident corporates or individuals. (See Paragraphs LR-1.2.27 to LR-1.2.30.)

            • Licensing Conditions

              • LR-A.1.10

                Conventional bank licensees are subject to 8 licensing conditions, mostly specified at a high level in Module LR, and further expanded in underlying subject Modules (such as Module CA). These licensing conditions are broadly equivalent to the standards applied in other Volumes of the BMA Rulebook, to other license categories, and are consistent with international good practice, such as relevant Basel Committee standards.

            • Retaining Licensed Status

              • LR-A.1.11

                The requirements contained in Chapter LR-2 represent the minimum conditions that have to be met in each case, both at the point of licensing and on an on-going basis thereafter, in order for licensed status to be retained.

            • Information Requirements and Processes

              • LR-A.1.12

                Chapter LR-3 specifies the processes and information requirements that have to be followed for applicants seeking a conventional bank license, as well as existing licensees seeking to vary the scope of their license, by adding new regulated activities. It also covers the voluntary surrender of a license, or its cancellation by the BMA.

            • Representative Offices and Ancillary Services Providers

              • LR-A.1.13

                Representative offices of overseas conventional bank licensees are not covered in Volume 1 (Conventional Banks) of the Rulebook. Requirements covering Representative Offices (for all financial services firms) will instead be included in Volume 5, to be issued in 2007.

              • LR-A.1.14

                Until such time as Volume 5 (Specialised Activities) of the BMA Rulebook is issued, representative offices of overseas conventional bank licensees remain subject to the requirements contained in the BMA's "Standard Conditions and Licensing Criteria" applicable to representative offices of foreign banks, and relevant existing Circulars.

              • LR-A.1.15

                Providers of ancillary services to the financial sector are not covered in Volume 1 (Conventional Banks) of the Rulebook. Requirements covering ancillary services providers will instead be included in Volume 5, to be issued in 2007.

              • LR-A.1.16

                Until such time as Volume 5 (Specialised Activities) of the BMA Rulebook is issued, ancillary services providers remain subject to the requirements contained in the BMA's "Standard Conditions and Licensing Criteria" applicable to providers of ancillary services to the financial sector, and relevant existing Circulars.

            • Updating the BMA Rulebook

              • LR-A.1.17

                Unless the context suggests otherwise, references elsewhere in Volume 1 to Full Commercial Bank(s) should be taken as referring to conventional retail bank licensees, and references to Offshore Banking Units and Investment Bank Licensees should be taken as referring to conventional wholesale bank licensees. References to the previous bank license categories that applied prior to 1 July 2006 will be gradually updated over time, across the rest of Volume 1.

          • LR-A.2 LR-A.2 Module History

            • Evolution of Module

              • LR-A.2.1

                This Module (Module LR — "Licensing and Authorisation Requirements") was first issued in July 2004, as part of the initial release of Volume 1 of the BMA Rulebook. It was subsequently reissued in full in July 2006 (and renamed "Licensing Requirements").

              • LR-A.2.2

                The reissued Module was one of several Modules modified to reflect the introduction of the BMA's new integrated license framework. Module LR was amended to reflect the new conventional bank licenses introduced by the framework, and to more closely align its presentation with that found in other BMA Rulebook volumes.

              • LR-A.2.3

                The reissued Module is dated July 2006. All subsequent changes are dated with the month and year when the change was made, at the base of the relevant page and in the Table of Contents. Chapter UG-3 of Module UG provides further details on Rulebook maintenance and control.

              • LR-A.2.4

                A list of recent changes made to this Module is provided below:

                Module Reference Change Date Description of Changes
                LR-6 01/2005 New guidance on record keeping.
                Whole Module 07/2006 Whole Module reissued to reflect integrated license framework: new license categories and updated licensing conditions introduced.
                     

            • Superseded Requirements

              • LR-A.2.5

                The initial July 2004 version of this Module superseded various circulars and other requirements relating to licensing. Some of these circulars were combined in 1997 into a licensing folder ("Part 1: Licensing", which formed part of the three volume information pack, "The Establishment, regulations and supervision of banks and other financial institutions in Bahrain"). The requirements contained in these circulars were transposed into the initial July 2004 version of this Module unchanged, as follows:

                Circular Ref. Date of Issue Module Ref. (July 2004 version) Circular Subject
                5/77 08/03/77 LR-B.1.1, LR-3.3 Permitted Business Transactions with residents
                OG/16/90 10/01/90 LR-2.3, LR-3.3 Dealing with Residents
                OG/192/98 16/06/98 LR-4 Financial Trust Regulation
                No reference 04/81 LR-5 Precious Metals and Commodities
                       

        • LR-B LR-B Scope of Application

          • LR-B.1 LR-B.1 General Prohibitions

            • LR-B.1.1

              The licensing requirements in Chapter LR-1 have general applicability, in that they prevent any person from providing (or seeking to provide) regulated banking services within or from the Kingdom of Bahrain, unless they have been licensed as a conventional bank licensee by the BMA (see Rule LR-1.1.1).

            • LR-B.1.2

              In addition, no one may use the term 'bank' in their trading or corporate name, or otherwise hold themselves out to be a bank in Bahrain, unless they hold the appropriate license from BMA (see Rule LR-1.1.2).

            • LR-B.1.3

              The Rules referred to above are supported by statutory restrictions contained in the BMA Law 1973 (cf. Articles 60 and 61).

          • LR-B.2 LR-B.2 Licensed Persons

            • LR-B.2.1

              The remaining requirements in Chapters LR-1 to LR-3 (besides those mentioned in Section LR-B.1 above) apply to all those licensed by the BMA as a conventional bank licensee, or which are in the process of seeking such a license. They apply regardless of whether the person concerned is incorporated in the Kingdom of Bahrain, or in an overseas jurisdiction, unless otherwise specified.

            • LR-B.2.2

              These remaining requirements prescribe the types of license offered; their associated operating conditions; the licensing conditions that have to be satisfied in order to secure and retain a license; and the processes to be followed when applying or varying a license, or when a license is withdrawn.

        • LR-1 LR-1 Requirement to Hold a License

          • LR-1.1 LR-1.1 Conventional Bank Licensees

            • General Prohibitions

              • LR-1.1.1

                No person may:

                (a) undertake (or hold themselves out to undertake) regulated banking services within or from the Kingdom of Bahrain unless duly licensed by the BMA; or
                (b) hold themselves out to be licensed by the BMA unless they have as a matter of fact been so licensed.

              • LR-1.1.2

                Only persons licensed to undertake regulated banking services (or regulated Islamic banking services), may use the term 'bank' in their corporate or trading names, or otherwise hold themselves out to be a bank.

              • LR-1.1.3

                Licensees are not obliged to include the word 'bank' in their corporate or trading names; however, they may be required to make clear their regulatory status in their letter heads, customer communications, website and so on.

              • LR-1.1.4

                For the purposes of Rule LR-1.1.2, persons will be considered in breach of this requirement if they attempt to operate as, or incorporate a bank in Bahrain with a name containing the word "bank" (or the equivalents in any language), without holding the appropriate BMA license or obtaining the prior approval of the BMA.

            • Licensing

              • LR-1.1.5

                Persons wishing to be licensed to undertake regulated banking services within or from the Kingdom of Bahrain must apply in writing to the BMA.

              • LR-1.1.6

                An application for a license must be in the form prescribed by the BMA and must contain:

                (a) a business plan specifying the type of business to be conducted;
                (b) application forms for all controllers; and
                (c) application forms for all controlled functions.

              • LR-1.1.7

                The BMA will review the application and duly advise the applicant in writing when it has:

                (a) granted the application without conditions;
                (b) granted the application subject to conditions specified by the BMA; or
                (c) refused the application, stating the grounds on which the application has been refused and the process for appealing against that decision.

              • LR-1.1.8

                Detailed rules and guidance regarding information requirements and processes for license applications can be found in Section LR-3.1. As specified in Paragraph LR-3.1.14, the BMA will provide a formal decision on a Phase 1 license application within 60 calendar days of all required documentation having been submitted in a form acceptable to the BMA.

              • LR-1.1.9

                In granting new licenses, the BMA will specify the specific types of regulated banking service for which a license has been granted, and on what basis (i.e. conventional retail bank licensee or conventional wholesale bank licensee).

              • LR-1.1.10

                All applicants for conventional bank licenses must satisfy the BMA that they meet, by the date of their license, the minimum conditions for licensing, as specified in Chapter LR-2. Once licensed, conventional bank licensees must maintain these criteria on an ongoing basis.

              • LR-1.1.11

                Conventional bank licensees must not carry on any commercial business in the Kingdom of Bahrain or elsewhere other than banking business and activities directly arising from or incidental to that business.

              • LR-1.1.12

                Rule LR-1.1.11 is intended to restrict bank licensees from undertaking any material non-financial business activities. The Rule does not prevent a bank undertaking commercial activities if these directly arise from their financial business: for instance, in the context of Islamic contracts, such as murabaha, ijara and musharaka, where the bank may hold the physical assets being financed or leased. Nor does it restrict a bank from undertaking commercial activities if, in the judgment of the BMA, they are incidental and do not detract from the financial nature of the bank's operations: for example, a bank may rent out spare office space in its own office building, and provide services associated with the rental (e.g. office security or cleaning).

              • LR-1.1.13

                Rule LR-1.1.11 applies to the legal entity holding the bank license. A bank may thus own subsidiaries that undertake non-financial activities, although the BMA generally does not support the development of significant commercial activities within a banking group. Capital invested in such subsidiaries by a bank would be deducted from the bank's capital base under the BMA's capital rules (see Module CA). In addition, the BMA may impose restrictions — such as dealings between the bank and its commercial subsidiaries — if it was felt necessary to limit the bank's exposure to non-financial risks.

          • LR-1.2 LR-1.2 License Sub-Categories

            • Retail vs. Wholesale

              • LR-1.2.1

                Depending on the nature of activities undertaken, conventional bank licensees must be licensed either as a conventional retail bank licensee or as a conventional wholesale bank licensee. The same legal entity may not hold both types of license.

              • LR-1.2.2

                The nature of activities allowed under each license sub-category is specified below (cf. Rule LR-1.2.4ff). The conventional retail bank licensee category replaces the Full Commercial Bank (conventional principles) category that existed prior to July 2006; the conventional wholesale bank licensee category replaces the Offshore Banking Unit and Investment Bank License (conventional principles) categories.

              • LR-1.2.3

                Banks licensed prior to the introduction of these new license categories in July 2006 are not required to reapply for their license. Rather, their new license category is to be confirmed by an exchange of letters with the BMA, and the issuance of a new license certificate. Where (prior to July 2006) the same legal entity holds multiple licenses, the BMA will agree transitional measures aimed at rationalizing the number of licenses held.

            • Conventional Retail Banks

              • LR-1.2.4

                Conventional retail bank licensees are allowed to transact with both residents and non-residents of the Kingdom of Bahrain, and in both Bahraini Dinar and foreign currencies.

              • LR-1.2.5

                To qualify as a conventional retail bank licensee, the person concerned must undertake (as a minimum), the activities of deposit-taking and providing credit (as defined in Rules LR-1.3.16 and LR-1.3.18). The activity of providing credit must be a significant part of the bank's business, relative to other activities.

              • LR-1.2.6

                When assessing the significance of credit-related activities, in the context of Rule LR-1.2.5, the BMA would normally expect to see loans and other credit-related activity (such as overdraft facilities, loan commitments, letters of credit, guarantees and other activities falling under the definition of providing credit), to constitute at least 20% of the total assets of the institution. Other activities and criteria may also be taken into account, if the BMA believes they are of a credit-related nature, and that such activities constitute a significant share of the bank's overall business.

              • LR-1.2.7

                In the case of new applicants, the above assessment is made based on the financial projections and business plan provided as part of the license application. Where existing licensees fail to satisfy the condition contained in Rule LR-1.2.5, the BMA will initiate discussion with the licensee as to the appropriateness of their license category: this may result in the licensee being required to change its license category. A branch of an overseas bank may nonetheless be allowed to hold a bank license in Bahrain, even if it fails to undertake the activities specified in Rule LR-1.2.5, providing that it undertakes other regulated banking services in Bahrain and its head office is licensed as a bank in its home country.

              • LR-1.2.8

                The purpose of Rule LR-1.2.5 is to ensure that, besides deposit-taking, the core banking activity of providing credit forms part of the definition of conventional retail bank licensees, and accounts for a significant share of their business, in keeping with their intermediation function.

            • Conventional Wholesale Banks

              • LR-1.2.9

                Conventional wholesale bank licensees are allowed to transact with residents of the Kingdom of Bahrain (irrespective of currency), and in Bahraini Dinar (irrespective of the location of the counterparty), subject to the conditions and exemptions specified in Rules LR-1.2.13, LR-1.2.16 and LR-1.2.18. Foreign currency transactions with non-residents are not subject to these conditions.

              • LR-1.2.10

                The effect of Rule LR-1.2.9 is to limit the on-shore/Bahraini Dinar customer business of conventional wholesale bank licensees to larger transactions. By definition, their on-shore client base is therefore wholesale in nature (i.e. other banks, large corporates and high net-worth individuals).

              • LR-1.2.11

                To qualify as a conventional wholesale bank licensee, the person concerned must undertake (as a minimum), the activities of deposit-taking and providing credit (as defined in Rules LR-1.3.16 and LR-1.3.18).

              • LR-1.2.12

                The purpose of Rule LR-1.2.11 is to ensure that the core banking activities of deposit taking and providing credit form part of the definition of conventional wholesale bank licensees. However, unlike conventional retail bank licensees, there is no requirement that the activity of providing credit must be a significant part of the bank's business, relative to other activities. This is to allow conventional wholesale bank licensees greater flexibility as to the nature of their activities; it also recognises that, because of the wholesale nature of their client base, there is less need to limit the scale of non-credit related risks to which their depositors may be exposed. Rule LR-1.2.11 does not in any way prevent conventional wholesale bank licensees from developing the provision of credit as a major activity, should they wish to. The Guidance provided in Paragraph LR-1.2.7 with regards to overseas banks is also applicable to Rule LR-1.2.11.

              • LR-1.2.13

                Conventional wholesale bank licensees may transact with residents of Bahrain and/or in Bahrain Dinar, with respect to the activities (a) to (e) listed in Rule LR-1.3.1, only where the individual transaction is BD 7 million or above (or its foreign currency equivalent).

              • LR-1.2.14

                To comply with Rule LR-1.2.13, the initial amount taken as a deposit must be BD 7 million or above (or its equivalent in foreign currency); however, subsequent additions and withdrawals from that deposit account may be for any amount. The initial amount taken as deposit may be split between different types of accounts (e.g. call, 3-month and 6-month accounts) — providing at least BD 7 million is taken from the customer on the same day and the bank's records can demonstrate this. Where subsequent withdrawals lead to a zero balance on an account (or the aggregate of accounts where more than one was originally opened), then a further BD 7 million must be deposited to re-start the 'wholesale' relationship, before additional deposits for smaller amounts may be made.

              • LR-1.2.15

                Similarly, with respect to credit-related transactions, the initial facility amount advised must be for BD 7 million or above (or its equivalent); but drawdowns (and repayments) under the facility may be for any amount, as may any subsequent changes to the facility amount. If the facility is fully repaid, then a further BD 7 million transaction must be agreed in order to re-start the 'wholesale' relationship.

              • LR-1.2.16

                Conventional wholesale bank licensees may transact with residents of Bahrain and/or in Bahrain Dinar, with respect to the activities (f) to (l) listed in Rule LR-1.3.1, only where the individual transaction is US$ 250,000 or above (or its foreign currency equivalent).

              • LR-1.2.17

                With respect to activities (f) and (g) (dealing in financial instruments as principal / agent), the threshold refers to the individual transaction size. With respect to activities (h) and (i) (managing / safeguarding financial instruments), the threshold refers to the initial investment amount. With respect to activity (j) (operating a Collective Investment Undertaking), the threshold refers to the minimum investment required for participation in the scheme. With respect to activities (k) and (l) (arranging deals in / advising on financial instruments), the threshold refers to the size of the deal arranged or of the investment on which advice is being given.

              • LR-1.2.18

                Note that the threshold with respect to activities (h) and (i) applies to the initial investment amount: where a subsequent distribution to a client or a reduction in the mark to market value of the investment reduces the initial investment amount below US$ 250,000 it is still considered a wholesale transaction. The threshold in Rule LR-1.2.16 applies to a client even if the same client satisfies the BD 7m threshold in Rule LR-1.2.13, with respect to deposit/credit activities. Finally, the initial amount taken as an investment may be split between two or more investment products — providing at least US$ 250,000 is taken from the customer on the same day and the bank's records can demonstrate this.

              • LR-1.2.19

                Conventional wholesale bank licensees may only undertake activities (m) and (n) listed in Rule LR-1.3.1, on behalf of residents of Bahrain and/or in Bahrain Dinar, where the customer concerned meets either of the thresholds specified in LR-1.2.13 or LR-1.2.16 (in which case, activities (m) and (n) may be undertaken for any amount).

              • LR-1.2.20

                Notwithstanding Rules LR-1.2.13, LR-1.2.16 and LR-1.2.19, conventional wholesale bank licensees are allowed to transact in Bahraini Dinar (or any other currency) for any amount with the Government of Bahrain, Bahrain public sector entities (as defined in the Guidelines for completion of the Prudential Information Reports), and BMA bank licensees. Conventional wholesale bank licensees may also transact in Bahraini Dinar for any amount, where required to fund their normal operating expenses; or when investing for their own account in securities listed on the Bahrain Stock Exchange.

              • LR-1.2.21

                Any transactions entered into prior to 1 July 2006 which may be in breach of the conditions specified in Rules LR-1.2.13, LR-1.2.16 and LR-1.2.19 must be notified to the BMA. These transactions will be allowed to mature.

              • LR-1.2.22

                Since the conventional wholesale bank licensee regime represents an easing of the restrictions on on-shore business that previously applied to offshore bank licensees (i.e. OBUs and IBLs), there should be few transactions of the type specified in Rule LR-1.2.21 — they are likely to exist only where individual ad-hoc exemptions may have been previously granted by the BMA, and these exemptions went further than those now being applied across the Board to all conventional wholesale bank licensees.

              • LR-1.2.23

                Conventional wholesale bank licensees wishing to undertake transactions of the type specified in Rules LR-1.2.13, LR-1.2.16 and LR-1.2.19 must seek prior written BMA approval.

              • LR-1.2.24

                The approval requirement in Rule LR-1.2.23 only has to be made once, prior to the licensee starting to undertake such transactions. Its purpose is to allow the BMA to monitor the initiation of such business by conventional wholesale bank licensees, and to check that adequate systems and controls have been in place, so that such transactions are likely to be well managed. In addition, it is to allow, where relevant, for the necessary arrangements to be made to ensure that conventional wholesale bank licensees comply with the BMA's reserve requirements (which apply to deposit liabilities denominated in Bahraini Dinars — see LR-2.5.10).

              • LR-1.2.25

                Conventional wholesale bank licensees that are unclear about the interpretation of the conditions specified in Rules LR-1.2.13, LR-1.2.16 or LR-1.2.19 must consult the BMA prior to undertaking the transaction concerned.

              • LR-1.2.26

                The BMA may publish additional interpretative guidance on the above conditions, in response to licensees' queries. The minimum thresholds specified under Rules LR-1.2.13 and LR-1.2.16 will be kept under review by the BMA and may be amended in response to market developments.

            • Shari'a compliant transactions

              • LR-1.2.27

                Conventional bank licensees may not hold themselves out as an Islamic bank. Conventional bank licensees may only enter into activities (c) to (e) listed in Rule LR-1.3.1, when dealing with governments, public sector entities and other licensed financial institutions. Conventional bank licensees may not undertake these activities with individual or corporate clients (whether resident or non-resident).

              • LR-1.2.28

                As an exception to the restriction in Rule LR-1.2.27, conventional bank licensees may invest for their own account in sukuks.

              • LR-1.2.29

                Conventional bank licensees may also freely deal in financial instruments or operate a Collective Investment Undertaking that happens to be Shari'a compliant (because of the nature of the financial instruments concerned).

          • LR-1.3 LR-1.3 Definition of Regulated Banking Services

            • LR-1.3.1

              Regulated banking services are any of the following activities, carried on by way of business:

              (a) Deposit-taking
              (b) Providing Credit
              (c) Accepting Shari'a money placements/deposits
              (d) Managing Shari'a profit/loss sharing investment accounts
              (e) Offering Shari'a Financing Contracts
              (f) Dealing in financial instruments as principal
              (g) Dealing in financial instruments as agent
              (h) Managing financial instruments
              (i) Safeguarding financial instruments
              (j) Operating a Collective Investment Undertaking
              (k) Arranging deals in financial instruments
              (l) Advising on financial instruments
              (m) Providing money exchange/remittance services
              (n) Issuing/administering means of payment.

            • LR-1.3.2

              Upon application, the BMA may exclude specific transactions from the definition of regulated banking services.

            • LR-1.3.3

              The BMA will normally only consider granting such an exemption when a Bahrain resident is unable to obtain a specific product in Bahrain and it would be unreasonable to require the overseas provider of that product to be licensed for that specific transaction, and the provider has no intention of regularly soliciting such business in Bahrain.

            • LR-1.3.4

              For the purposes of Rule LR-1.3.1, carrying on a regulated banking service by way of business means:

              (a) undertaking the regulated banking service of (a), plus any of the activities (b) to (n), as defined in Section LR-1.3, for commercial gain;
              (b) holding oneself out as willing and able to engage in such activities; or
              (c) regularly soliciting other persons to engage in transactions constituting such activities.

            • LR-1.3.5

              Licensees should note that they may still undertake activities falling outside the definition of regulated banking services, such as investing in physical commodities — subject to Rule LR-1.1.11. The fact that an activity is not included in the definition of regulated banking services does not mean that it is prohibited. In transitioning to the new licensing framework, the BMA will be closely liaising with licensees to ensure that no disruption occurs to their legitimate business activities.

            • LR-1.3.6

              Licensees should note that the same legal entity cannot combine regulated banking services with other regulated services, such as regulated insurance services. However, different legal entities within the same group may of course each hold a different license (e.g. banking and insurance).

            • General exclusions

              • LR-1.3.7

                A person does not carry on an activity constituting a regulated banking service if the activity:

                (a) is carried on in the course of a business which does not ordinarily constitute the carrying on of financial services;
                (b) may reasonably be regarded as a necessary part of any other services provided in the course of that business; and
                (c) is not remunerated separately from the other services.

              • LR-1.3.8

                For example, the taking of a deposit in connection with the rental of a property would not be considered a regulated banking service, since it satisfies the criteria in Rule LR-1.3.7.

              • LR-1.3.9

                A person does not carry on an activity constituting a regulated banking service if the person is a body corporate and carries on that activity solely with or for other bodies corporate that are members of the same group.

              • LR-1.3.10

                A person does not carry on an activity constituting a regulated banking service if such person carries on an activity with or for another person, and they are both members of the same family.

              • LR-1.3.11

                A person does not carry on an activity constituting a regulated banking service if the sole or main purpose for which the person enters into the transaction is to limit any identifiable risks arising in the conduct of his business, providing the business conducted does not itself constitute a regulated activity.

              • LR-1.3.12

                For example, an industrial company entering into an interest rate swap to switch floating-rate borrowings for fixed rate borrowings, in order to manage interest rate risk, would not be considered to be dealing in financial instruments as principal, and would not therefore be required to be licensed as an investment firm.

              • LR-1.3.13

                A person does not carry on an activity constituting a regulated banking service if that person enters into that transaction solely as a nominee for another person, and acts under instruction from that other person.

              • LR-1.3.14

                A person does not carry on an activity constituting a regulated banking service if that person is a government body charged with the management of financial instruments on behalf of a government or public body.

              • LR-1.3.15

                A person does not carry on an activity constituting a regulated banking service if that person is an exempt person, as specified by Royal decree.

            • Deposit-taking

              • LR-1.3.16

                Deposit-taking is defined as receiving a sum of money paid on terms under which it will be repaid in full, with or without interest or a premium, and either on demand or in circumstances agreed by the parties involved. It excludes sums referable to the giving of security or as a fee paid in advance for goods or services. It also excludes money received by a person in consideration for debt instruments issued by the same person, or money received by a person entering into a loan or other financing agreement.

              • LR-1.3.17

                The above definition, therefore, includes savings, current, notice, fixed and time deposits.

            • Providing credit

              • LR-1.3.18

                Providing credit is defined as the provision of credit to a person in his capacity as borrower or potential borrower. This includes consumer and mortgage credit; and providing credit by way of finance leases, factoring, forfeiting, and reverse repo transactions. It also includes the issuance or endorsement of letters of credit; the issuance of letters of guarantee and other contingent credit activities (such as the underwriting of loans); the purchase on the secondary market of loans and other contracts of credit (that do not otherwise fall under the definition of financial instruments); and the provision of ancillary credit-related activities, such as advising on or arranging loans. It excludes money advanced to a person in consideration for debt instruments issued by the same person.

            • Accepting Shari'a money placements/deposits

              • LR-1.3.19

                Accepting Shari'a money placements is defined as the acceptance of sums of money for safe-keeping) in a Shar'ia compliant framework, under which it will be repaid, either on demand or in circumstances agreed by the parties involved, and which is not referable to the giving of security.

            • Offering Shari'a Financing Contracts

              • LR-1.3.20

                Offering Shari'a financing contracts is defined as entering into, or making arrangement for another person to enter into, a contract to provide finance in accordance with Shari'a principles, such as murabaha, bay muajjal, bay salam, ijara wa iktina and istisna'a contracts.

            • Managing Shari'a profit sharing investment accounts

              • LR-1.3.21

                Managing a Shari'a profit sharing investment account is defined as managing an account, portfolio or fund, whereby a sum of money is placed with the service provider on terms that a return will be made according to an agreed Shari'a compliant profit-sharing arrangement, based either on a mudaraba or musharaka partnership.

            • Dealing in financial instruments as principal

              • LR-1.3.22

                Dealing in financial instruments as principal means buying, selling, subscribing for or underwriting any financial instrument on one's own account.

              • LR-1.3.23

                Rule LR-1.3.22 includes the underwriting of equity and other financial instruments. The underwriting of loans comes under the activity of providing credit (see Rule LR-1.3.18). It also includes the temporary sale of a financial instrument through a repo transaction.

              • LR-1.3.24

                A person does not carry on an activity specified in Rule LR-1.3.22 if the activity relates to the person issuing his own shares/debentures, warrants or bonds.

            • Dealing in financial instruments as agent

              • LR-1.3.25

                Dealing in financial instruments as agent means buying, selling, subscribing for or underwriting financial instruments on behalf of a client.

              • LR-1.3.26

                A licensee that carries on an activity of the kind specified by Rule LR-1.3.25 does not determine the terms of the transaction and does not use its own financial resources for the purpose of funding the transaction. Such a licensee may however receive or hold assets in connection with the transaction, in its capacity as agent of its client.

            • Managing Financial Instruments

              • LR-1.3.27

                Managing financial instruments means managing on a discretionary basis financial instruments on behalf of another person.

              • LR-1.3.28

                The activities included under the definition of Rule LR-1.3.27 include activities such as asset management.

            • Safeguarding Financial Instruments (i.e. Custodian)

              • LR-1.3.29

                Safeguarding financial instruments means the safeguarding of financial instruments for the account of clients.

              • LR-1.3.30

                A person does not carry on an activity specified in Rule LR-1.3.29 if the person receives documents relating to a financial instrument for the purpose of onward transmission to, from, or at the direction of the person to whom the financial instrument belongs; or else is simply providing a physical safekeeping service such as a deed box.

              • LR-1.3.31

                A person does not carry on an activity specified in Rule LR-1.3.29 if a third person, namely a qualifying custodian, accepts responsibility with regard to the financial instrument.

              • LR-1.3.32

                A "qualifying custodian" means a person who is:

                (a) a licensee who has permission to carry on an activity of the kind specified in Rule LR-1.3.29; or
                (b) an exempt person in relation to activities of that kind.

              • LR-1.3.33

                A person does not carry on an activity specified in Rule LR-1.3.29 if they are managing a central depository, which is part of an exchange recognised by the BMA.

              • LR-1.3.34

                The following are examples of activities, which when taken in isolation, are unlikely to be regarded as an activity of the kind specified under Rule LR-1.3.29:

                (a) providing information as to the number of units or the value of any assets safeguarded; and
                (b) converting currency.

              • LR-1.3.35

                A person undertaking an activity of the kind specified under Rule LR-1.3.29 may also be engaged in the administration of the financial instruments, including related services such as cash/collateral management.

            • Operating a Collective Investment Undertaking

              • LR-1.3.36

                Operating a Collective Investment Undertaking means operating, establishing or winding up a Collective Investment Undertaking.

              • LR-1.3.37

                For the purposes of LR-1.3.36, a Collective Investment Undertaking means any arrangements, authorised by or registered with the BMA, with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements to participate in or receive profits or income arising from the acquisition, holding or disposal of the property or sums paid out of such profits or income.

              • LR-1.3.38

                A person does not carry on an activity specified in Rule LR-1.3.36 if the activity relates to the person establishing or winding up a Collective Investment Undertaking, and that activity may be reasonably regarded as necessary in the course of providing legal services or providing accounting services.

              • LR-1.3.39

                Collective investment undertakings of the kind specified in Rule LR-1.3.36 may be open-ended (i.e. with shares continuously issued and redeemed to meet investor demand) or close-ended (where there is a single issue of shares and investors can only realise their investments on the winding-up of the fund).

            • Arranging deals in financial instruments

              • LR-1.3.40

                Arranging deals in financial instruments means making arrangements with a view to another person, whether as principal or agent, buying, selling, subscribing for or underwriting deals in financial instruments.

              • LR-1.3.41

                A person does not carry on an activity specified in Rule LR-1.3.40 if the arrangement does not bring about the transaction to which the arrangement relates.

              • LR-1.3.42

                A person does not carry on an activity specified in Rule LR-1.3.40 if a person's activities are limited solely to introducing clients to licensees.

              • LR-1.3.43

                The exclusion in Rule LR-1.3.42 does not apply if the agent receives from any person, other than the client, any pecuniary reward or other advantage, which he does not account to the client, arising out of his entering into the transaction. Thus, if A receives a commission from B for arranging credit or deals in investment for C, the exclusion in Rule LR-1.3.42 does not apply.

              • LR-1.3.44

                A person does not carry on an activity specified in Rule LR-1.3.40 merely by providing the means of communication between two parties to a transaction.

              • LR-1.3.45

                A person does not carry on an activity specified in Rule LR-1.3.40 if they operate an exchange, duly recognised and authorised by the BMA.

              • LR-1.3.46

                Negotiating terms for an investment on behalf of a client is an example of an activity which may be regarded as an activity of the kind specified in Rule LR-1.3.40.

              • LR-1.3.47

                The following are examples of activities, which when taken in isolation, are unlikely to be regarded as an activity of the kind specified in Rule LR-1.3.40:

                (a) appointing professional advisers;
                (b) preparing a prospectus/business plan;
                (c) identifying potential sources of funding;
                (d) assisting investors/subscribers/borrowers to complete and submit application forms; or
                (e) receiving application forms for processing/checking and/or onward transmission.

            • Advising on deals in financial instruments

              • LR-1.3.48

                Advising on financial instruments means giving advice to an investor or potential investor (or a person in his capacity as an agent for an investor or potential investor) on the merits of buying, selling, subscribing for or underwriting a particular financial instrument or exercising any right conferred by such a financial instrument.

              • LR-1.3.49

                The following are examples of activities, which may be regarded as an activity as defined by Rule LR-1.3.48:

                (a) a person may offer to tell a client when shares reach a certain value on the basis that when the price reaches that value it would be a good time to buy or sell them;
                (b) recommendation on the size or timing of transactions; and
                (c) advice on the suitability of the financial instrument, or on the characteristics or performance of the financial instrument concerned.

              • LR-1.3.50

                A person does not carry on an activity specified in Rule LR-1.3.48 by giving advice in any newspaper, journal, magazine, broadcast services or similar service in any medium if the principal purpose of the publication or service, taken as a whole, is neither:

                (a) that of giving advice of the kind mentioned in Rule LR-1.3.48; nor
                (b) that of leading or enabling persons to buy, sell, subscribe for or underwrite a financial instrument.

              • LR-1.3.51

                The following are examples of activities, which when taken in isolation, are unlikely to be regarded as an activity as defined by Rule LR-1.3.48:

                (a) explaining the structure, or the terms and conditions of a financial instrument;
                (b) valuing financial instruments for which there is no ready market;
                (c) circulating company news or announcements;
                (d) comparing the benefits and risks of one financial instrument to another; and
                (e) advising on the likely meaning of uncertain provisions in an agreement relating to, or the terms of, a financial instrument or on the effect of contractual terms and their commercial consequences or on terms that are commonly accepted in the market.

            • Providing money exchange / remittance services

              • LR-1.3.52

                Means providing exchange facilities between currencies, and the provision of wire transfer or other remittance services.

            • Issuing / administering means of payment

              • LR-1.3.53

                Means the selling or issuing of payment instruments, or the selling or issuing of stored value (e.g. credit cards, travellers' cheques, electronic purses).

        • LR-2 LR-2 Licensing Conditions

          • LR-2.1 LR-2.1 Condition 1: Legal Status

            • LR-2.1.1

              The legal status of a conventional bank licensee must be:

              (i) a Bahraini joint stock company (BSC); or
              (ii) a branch resident in Bahrain of a conventional bank incorporated under the laws of its territory of incorporation and authorized as a bank in that territory.

            • LR-2.1.2

              Where the conventional bank licensee is a branch of an overseas bank, in deciding whether to grant a license, the BMA will pay close regard to its activities elsewhere and how these activities are regulated. If the conventional bank licensee is not regulated elsewhere or in a jurisdiction not substantially compliant with Basel Core Principles or FATF standards, then an application for licensing can only be considered after exhaustive enquiries into the bank's shareholders, management structure and financial position.

          • LR-2.2 LR-2.2 Condition 2: Mind and Management

            • LR-2.2.1

              Conventional bank licensees with their Registered Office in the Kingdom of Bahrain must maintain their Head Office in the Kingdom. Overseas conventional bank licensees must maintain a local management presence and premises in the Kingdom appropriate to the nature and scale of their activities.

            • LR-2.2.2

              In assessing the location of a conventional bank licensee's Head Office, the BMA will take into account the residency of its Directors and senior management. The BMA requires the majority of key decision makers in executive management — including the Chief Executive Officer — to be resident in Bahrain. In the case of overseas conventional bank licensees, the BMA requires the branch or subsidiary of a foreign owned company to have a substantive presence, demonstrated by a level of staff and other resources sufficient to ensure adequate local scrutiny and control over business booked in the Bahrain branch or subsidiary.

          • LR-2.3 LR-2.3 Condition 3: Controllers

            • LR-2.3.1

              Conventional bank licensees must satisfy the BMA that their controllers are suitable and pose no undue risks to the licensee. Conventional bank licensees must also satisfy the BMA that their group structures do not prevent the effective supervision of the conventional bank licensee by the BMA and otherwise pose no undue risks to the licensee.

            • LR-2.3.2

              Chapter GR-5 contains the BMA's requirements and definitions regarding controllers.

            • LR-2.3.3

              In summary, controllers are persons who directly or indirectly are significant shareholders in a conventional bank licensee, or who are otherwise able to exert significant influence on the conventional bank licensee. The BMA seeks to ensure that controllers pose no significant risks to the licensee. In general terms, controllers are assessed in terms of their financial standing, their judicial and regulatory record, and standards of business and (where relevant) personal probity.

            • LR-2.3.4

              As regards group structures, the BMA seeks to ensure that these do not prevent adequate consolidated supervision being applied to financial entities within the group, and that other group entities do not pose any material financial, reputational or other risks to the licensee.

            • LR-2.3.5

              In all cases, when judging applications from existing groups, the BMA will have regard to the reputation and financial standing of the group as a whole. Where relevant, the BMA will also take into account the extent and quality of supervision applied to overseas members of the group and take into account any information provided by other supervisors in relation to any member of the group.

          • LR-2.4 LR-2.4 Condition 4: Board and Employees

            • LR-2.4.1

              Those nominated to carry out controlled functions must satisfy the BMA's approved persons requirements.

            • LR-2.4.2

              The definition of controlled functions is contained in HC-2.1, whilst HC-2.2 sets out the BMA's approved persons requirements.

            • LR-2.4.3

              The conventional bank licensee's staff, taken together, must collectively provide a sufficient range of skills and experience to manage the affairs of the licensee in a sound and prudent manner. Conventional bank licensees must ensure their employees meet any training and competency requirements specified by the BMA.

          • LR-2.5 LR-2.5 Condition 5: Financial Resources

            • Capital Adequacy

              • LR-2.5.1

                Conventional bank licensees must maintain a level of financial resources, as agreed with the BMA, adequate for the level of business proposed. The level of financial resources held must at all times meet the minimum risk-based requirements contained in Module CA (Capital Adequacy), as specified for the category of banking license held.

              • LR-2.5.2

                Conventional bank licensees must maintain a minimum level of paid-up capital of BD 20,000,000 (or its equivalent in foreign currency, where legally permitted and agreed with the BMA).

              • LR-2.5.3

                Persons seeking a license as a conventional bank licensee must submit a 3-year business plan, with financial projections. Their proposed level of paid-up capital must be sufficient to cover expected regulatory capital requirements over that period, based on projected activities.

              • LR-2.5.4

                In practice, applicants seeking a conventional bank license are likely to be required to hold significantly more capital than the minimum paid-up capital specified in Rule LR-2.5.2.

              • LR-2.5.5

                Overseas banking applicants are required to provide written confirmation from their head office that the head office will provide financial support to the branch sufficient to enable it to meet its obligations as and when they fall due. Overseas banking applicants must also demonstrate that the bank as a whole is adequately resourced for the amount of risks underwritten, and that it and its group meet capital adequacy standards applied by its home supervisor.

              • LR-2.5.6

                For Bahraini conventional bank licensees, deposit liabilities must not exceed 20 times their capital and reserves. For overseas conventional wholesale bank licensees, endowment capital may be required.

              • LR-2.5.7

                Factors taken into account in setting endowment capital for branches includes the financial strength of the parent company, the quality of its risk management, and the nature and scale of the Bahrain operations of the branch.

            • Liquidity

              • LR-2.5.8

                Conventional bank licensees must maintain sufficient liquid assets to meet their obligations as they fall due in the normal course of their business. Conventional bank licensees must agree a liquidity management policy with the BMA.

              • LR-2.5.9

                The BMA would normally expect the mark-to-market value of assets that could be readily realized at short-notice to exceed 25% of deposit liabilities at all times. Liquidity arrangements may vary, however, particularly for overseas conventional banks, as agreed with the BMA and documented in the liquidity management policy.

            • Reserve Requirements

              • LR-2.5.10

                Conventional bank licensees must maintain a minimum daily cash reserve balance with the BMA, equivalent to 5% of its total non-bank Bahraini Dinar deposits and Bahraini Dinar denominated Certificates of Deposit.

          • LR-2.6 LR-2.6 Condition 6: Systems and Controls

            • LR-2.6.1

              Conventional bank licensees must maintain systems and controls that are, in the opinion of the BMA, adequate for the scale and complexity of their activities. These systems and controls must meet the minimum requirements contained in Modules HC and OM.

            • LR-2.6.2

              Conventional bank licensees must maintain systems and controls that are, in the opinion of the BMA, adequate to address the risks of financial crime occurring in the licensee. These systems and controls must meet the minimum requirements contained in Module FC, as specified for the category of license held.

            • LR-2.6.3

              Applicants will be required to demonstrate in their business plan (together with any supporting documentation) what risks their business would be subject to and how they would manage those risks. Applicants may be asked to provide an independent assessment of the appropriateness of their systems and controls to the BMA, as part of the license approval process.

          • LR-2.7 LR-2.7 Condition 7: External Auditors

            • LR-2.7.1

              Conventional bank licensees must appoint external auditors, subject to the BMA's prior approval. The minimum requirements regarding auditors contained in Module AU (Auditors and Accounting Standards) must be met.

            • LR-2.7.2

              Applicants must submit details of their proposed external auditors to the BMA as part of their license application.

          • LR-2.8 LR-2.8 Condition 8: Other Requirements

            • Books and Records

              • LR-2.8.1

                Conventional bank licensees must maintain comprehensive books of accounts and other records, and satisfy the minimum record keeping requirements contained in Module GR. Books of accounts must comply with IAS. Audited accounts must be submitted to the BMA within 3 months of the licensee's financial year-end.

            • Provision of Information

              • LR-2.8.2

                Conventional bank licensees must act in an open and cooperative manner with the BMA. Conventional bank licensees must meet the regulatory reporting and public disclosure requirements contained in Modules BR and PD respectively.

            • General Conduct

              • LR-2.8.3

                Conventional bank licensees must conduct their activities in a professional and orderly manner, in keeping with good market practice. Conventional bank licensees must comply with the general standards of business conduct contained in Module PB, as well as the standards relating to treatment of customers contained in Modules BC and CM.

            • License fees

              • LR-2.8.4

                Conventional bank licensees must comply with any license fee requirements applied by the BMA.

              • LR-2.8.5

                The BMA's license fees are set out in Chapter GR-8.

            • Additional conditions

              • LR-2.8.6

                Conventional bank licensees must comply with any other specific requirements or restrictions imposed by the BMA on the scope of their license.

              • LR-2.8.7

                Bank licensees are subject to the provisions of the BMA Law 1973. These include the right of the BMA to impose such terms and conditions, as it may deem necessary when issuing a license. Thus, when granting a license, the BMA specifies the regulated banking services that the licensee may undertake. Licensees must respect the scope of their license. LR-3.2 sets out the process for varying the scope of an authorisation, should a licensee wish to undertake new activities.

              • LR-2.8.8

                In addition, the BMA may impose additional restrictions or requirements, beyond those already specified in Volume 1, to address specific risks. For instance, a license may be granted subject to strict limitations on intra-group transactions.

              • LR-2.8.9

                Conventional retail bank licensees are subject to the deposit protection scheme of eligible deposits held with the Bahrain offices of the licensee (see Chapter CP-2).

        • LR-3 LR-3 Information Requirements and Processes

          • LR-3.1 LR-3.1 Licensing

            • LR-3.1.1

              The application process for a conventional bank license consists of two parts: Phase 1 and Phase 2. For Phase 1, applicants for a license must submit a duly completed Form 1 (Phase 1) (Application for a License), under cover of a letter signed by an authorized signatory of the applicant marked for the attention of the Director, Licensing and Policy Directorate. The application must be accompanied by the documents listed in Paragraph LR-3.1.5, unless otherwise directed by the BMA.

            • LR-3.1.2

              If, after submission of a duly completed Form 1 (Phase 1) and associated documents, an applicant is granted a conditional (in principle) approval for a license, the applicant must submit Form 1 (Phase 2), together with the documents referred to in Paragraph LR-3.1.10.

            • LR-3.1.3

              When referring to the applicant, reference is made to the proposed licensee seeking a conventional bank license. The applicant may choose to have an authorized representative acting on its behalf. In instances where an authorized representative is used by the applicant, the application form should provide all details regarding the authorized representative and is to be signed by both the applicant and authorized representative.

            • LR-3.1.4

              Conventional bank licensees who were licensed prior to the publication of the new LR Module of Volume 1 Rulebook do not need to resubmit an application for a license. Their license category, and the scope of their authorization, will be confirmed in an exchange of letters, and by re-issuing their license certificate.

            • LR-3.1.5

              Unless otherwise directed by the BMA, the following documents must be provided as Part of Phase 1 in support of a license application:

              (a) a duly completed Form 2 (Application for Authorisation of Controller) for each controller of the proposed licensee;
              (b) a duly completed Form 3 (Application for Approved Person status), for each proposed Director of the proposed licensee;
              (c) a comprehensive business plan for the application, addressing the matters described in LR-3.1.6;
              (d) for overseas banks, a copy of the bank's current commercial registration or equivalent documentation;
              (e) where the applicant is a registered institution, a copy of the applicant's commercial registration;
              (f) where the applicant is a corporate body, a certified copy of a Board resolution of the applicant, confirming its decision to seek a BMA conventional bank license;
              (g) in the case of applicants that are part of a regulated group, a letter of non-objection to the proposed license application from the applicant's home supervisor, together with confirmation that the group is in good regulatory standing and is in compliance with applicable supervisory requirements, including those relating to capital adequacy and solvency requirements;
              (h) in the case of overseas branch applicants, a letter of non-objection to the proposed license application from the applicant's home supervisor, together with confirmation that the applicant is in good regulatory standing and is in compliance with applicable supervisory requirements, including those relating to capital adequacy requirements;
              (i) in the case of branch applicants, copies of the audited financial statements of the applicant (head office) for the three years immediately prior to the date of application; and
              (j) in the case of other applicants, copies of the audited financial statements of the applicant's major shareholder and/or group (as directed by the BMA), for the three years immediately prior to the date of application.

            • LR-3.1.6

              The business plan submitted in support of an application should explain:

              (a) an outline of the history of the applicant and its shareholders;
              (b) the reasons for applying for a license, including the applicant's strategy and market objectives;
              (c) the proposed type of activities to be carried on by the applicant in/from the Kingdom of Bahrain;
              (d) the proposed Board and senior management of the applicant and the proposed organisational structure of the applicant;
              (e) an assessment of the risks that may be faced by the applicant, together with the proposed systems and controls framework to be put in place for addressing those risks and to be used for the main business functions; and
              (f) an opening balance sheet for the applicant, together with a three-year financial projection, with all assumptions clearly outlined, demonstrating that the applicant will be able to meet applicable capital adequacy and liquidity requirements.

            • LR-3.1.7

              The applicant's memorandum and articles of association must explicitly provide for it to undertake the activities proposed in the licensed application, and must preclude the applicant from undertaking other commercial activities, unless these arise out of its banking activities or are incidental to those.

            • LR-3.1.8

              In the case of a new bank's capital being financed by a private placement, the Private Placement Memorandum must also be submitted to the BMA for its approval as part of the Phase 1 documentation.

            • LR-3.1.9

              The purpose of Rule LR-3.1.8 is to allow the BMA to verify that the contents of the Private Placement Memorandum are consistent with other information supplied to the BMA, notably in the business plan, and otherwise meets any applicable regulatory requirements with respect to PPM documents. The BMA's review of the PPM does not in any way constitute an approval or endorsement as to any claims it may contain as to the future value of the proposed bank.

            • LR-3.1.10

              As part of Phase 2 of the licensing application process, unless otherwise directed by the BMA, the following documents and information must be provided:

              (a) a duly completed Form 3 (Application for Approved Person status), for each individual, (other than for Directors, submitted as part of Phase 1) applying to undertake controlled functions in the applicant;
              (b) a draft copy of the applicant's memorandum and articles of association, addressing the matters described in LR-3.1.7;
              (c) a letter of guarantee from the applicant's major shareholder, confirming its willingness to support the proposed licensee in case of need; and
              (d) in the case of overseas branch applicants, a letter of guarantee from the applicant's head office, confirming responsibility for all of the liabilities of the proposed branch, together with evidence of the power to give such a guarantee.

            • LR-3.1.11

              All documentation provided to the BMA as part of an application for a license must be in either the Arabic or English language. Any documentation in a language other than English or Arabic must be accompanied by a certified English or Arabic translation thereof.

            • LR-3.1.12

              Any material changes or proposed changes to the information provided to the BMA in support of an authorisation application that occurs prior to authorisation must be reported to the BMA.

            • LR-3.1.13

              Failure to inform the BMA of the changes specified in LR-3.1.12 is likely to be viewed as a failure to provide full and open disclosure of information, and thus a failure to meet licensing condition LR-2.8.2.

            • LR-3.1.14

              As part of the Phase 1 review of application process, the BMA will provide a formal decision on a license application within 60 calendar days of all required documentation having been submitted in a form acceptable to the BMA. Once an "in principle" approval has been granted for Phase 1, the applicant must submit within 6 months of the "in principle" approval, all requirements for Phase 2 as outlined in Paragraph LR-3.1.10. The BMA will provide a final decision within 30 calendar days of all Phase 2 documentation having been submitted in a form acceptable to the BMA. Applicants are encouraged to approach the BMA to discuss their application at an early stage, so that any specific questions can be dealt with prior to the finalisation of the application.

            • LR-3.1.15

              Within 6 months of the license being issued, the new licensee must provide to the BMA:

              (a) a detailed action plan for establishing the operations and supporting infrastructure of the bank, such as the completion of written policies and procedures, and recruitment of remaining employees (having regard to the time limit set by Article 66 of the BMA Law 1973);
              (b) the registered office address and details of premises to be used to carry out the business of the proposed licensee;
              (c) the address in the Kingdom of Bahrain where full business records will be kept;
              (d) the licensee's contact details including telephone and fax number, e-mail address and website;
              (e) a description of the business continuity plan;
              (f) a description of the IT system that will be used, including details of how IT systems and other records will be backed up;
              (g) a copy of the auditor's acceptance to act as auditor for the applicant;
              (h) a copy of the Ministry of Industry & Commerce commercial registration certificate; and
              (i) other information as may be specified by the BMA.

            • LR-3.1.16

              Applicants issued new licenses by the BMA must start operations within 6 months of the license being issued, as per Article 66 of the BMA Law 1973.

            • LR-3.1.17

              Applicants who are refused a license have a right of appeal under the provisions contained in Article 68 of the BMA Law 1973.

          • LR-3.2 LR-3.2 Variations to a License

            • LR-3.2.1

              Conventional bank licensees must seek prior BMA approval before undertaking new regulated banking services.

            • LR-3.2.2

              Failure to secure BMA approval prior to undertaking a new regulated activity may lead to enforcement action being taken against the licensee concerned.

            • LR-3.2.3

              In addition to any other information requested by the BMA, and unless otherwise directed by the BMA, a conventional bank licensee requesting BMA approval to undertake a new regulated banking service must provide the following information:

              (a) a summary of the rationale for undertaking the proposed new activities;
              (b) a description of how the new business will be managed and controlled;
              (c) an analysis of the financial impact of the new activities; and
              (d) a summary of the due diligence undertaken by the Board and management of the conventional bank licensee on the proposed new activities.

          • LR-3.3 LR-3.3 Withdrawal of a License

            • Voluntary Surrender

              • LR-3.3.1

                All requests for the voluntary surrender of a license are subject to BMA approval. Such requests must be made in writing to the Executive Director of Banking Supervision, setting out in full the reasons for the request and how the voluntary surrender is to be carried out.

              • LR-3.3.2

                Conventional bank licensees must satisfy the BMA that their customers' interests are to be safeguarded during and after the proposed voluntary surrender.

              • LR-3.3.3

                The BMA will only approve a voluntary surrender where it has no outstanding regulatory concerns and any relevant customers' interests would not be prejudiced. A voluntary surrender will not be accepted where it is aimed at pre-empting supervisory actions by the BMA. Also, a voluntary surrender will only take effect once the licensee, in the opinion of the BMA, has discharged all its regulatory responsibilities to customers.

            • Cancellation

              • LR-3.3.4

                Cancellation of a license requires the BMA to issue a formal notice of cancellation to the person concerned. The notice of cancellation must describe the BMA's rationale for the proposed cancellation.

              • LR-3.3.5

                Failure to meet the relevant conditions contained in Chapter LR-2 can lead to cancellation of a license. The BMA generally views cancellation of a license as appropriate only in the most serious of circumstances, and generally tries to address supervisory concerns through other means beforehand. Further guidance is contained in Module EN (Enforcement), regarding the BMA's approach to enforcement and on the process for issuing a notice of cancellation and the recipient's right to appeal the notice.

              • LR-3.3.6

                Normally, where cancellation of a license has been confirmed by the BMA, the BMA will only effect the cancellation once a licensee has discharged all its regulatory responsibilities to customers. Until such time, the BMA will retain all its regulatory powers with regards to the licensee, and will direct the licensee such that no new regulated banking activity may be undertaken whilst the licensee discharges its obligations to customers.

      • PB PB Principles of Business

        • PB-A PB-A Introduction

          • PB-A.1 PB-A.1 Purpose

            • PB-A.1.1

              The principles are a general statement of the fundamental obligations of all banks.

            • PB-A.1.2

              This module requires banks to establish adequate systems and procedures to ensure:

              (a) compliance to the guidance set forth in this module, and
              (b) that the personnel responsible for maintaining such systems and controls are adequately qualified and competent in discharging their duties.

            • PB-A.1.3

              This module provides support to all regulations provided in this Rulebook.

          • PB-A.2 PB-A.2 Module history

            • PB-A.2.1

              This module was first issued in July 2004 as part of the conventional principles volume. All regulations in this volume have been effective since this date. All subsequent changes are dated with the month and year at the base of the relevant page and in the Table of Contents. Chapter UG-3 of Module UG provides further details on Rulebook maintenance and control.

            • PB-A.2.2

              The most recent changes made to this module are detailed in the table below:

              Summary of changes

              Module Ref. Change Date Description of Changes
                   
                   
                   
                   
                   

        • PB-B PB-B Non-compliance with the principles

          • PB-B.1 PB-B.1 Non-compliance

            • PB-B.1.1

              A breach of the principles outlined in this module may call into question whether the Board and management of a licensee with a BMA license are still fit and proper, and whether the licensee may continue to be licensed.

            • PB-B.1.2

              Breaching a principle makes a licensee liable to disciplinary sanctions. In determining whether a principle has been breached it is necessary to look to the standard of conduct required by the principle in question. The BMA will determine, after collating all the relevant information required (through its regulatory reporting authority), whether a licensee is in breach of these principles.

        • PB-1 PB-1 Principles

          • PB-1.1 PB-1.1 Integrity

            • PB-1.1.1

              All relevant persons should be straightforward and honest in their services and conduct. Integrity is not just limited to honesty but also includes fair dealing and full disclosure of all relevant information.

          • PB-1.2 PB-1.2 Objectivity

            • PB-1.2.1

              All relevant persons should be fair and should not allow prejudice, bias, conflict of interest or influence to override their objectivity.

          • PB-1.3 PB-1.3 Competence, skill care and due diligence

            • PB-1.3.1

              All relevant persons should perform services with competence, due care and diligence and have a continuing duty to maintain professional knowledge and skill at a level required to ensure that a client or employer receives the advantage of competent professional services based on up-to-date developments in practice, legislation and techniques.

          • PB-1.4 PB-1.4 Confidentiality

            • PB-1.4.1

              All relevant persons should treat client information with the strictest of confidentiality unless disclosure is warranted under specific authority or there is a legal or professional duty to disclose.

          • PB-1.5 PB-1.5 Management and control

            • PB-1.5.1

              The Board and management must take reasonable care to organise and control the affairs of the licensee responsibly and effectively with adequate risk management systems.

          • PB-1.6 PB-1.6 Market conduct

            • PB-1.6.1

              All relevant persons should observe proper standards of market conduct.

          • PB-1.7 PB-1.7 Communications with client

            • PB-1.7.1

              All relevant persons must pay due regard to the information needs of their clients and communicate information to them in a manner which is clear, fair and not misleading.

          • PB-1.8 PB-1.8 Relationship of trust

            • PB-1.8.1

              All relevant persons must take reasonable care to ensure the suitability of their advice and discretionary decisions for any customer who is entitled to rely upon their judgment.

      • HC HC High-Level Controls

        • HC-A HC-A Introduction

          • HC-A.1 HC-A.1 Purpose

            • HC-A.1.1

              This Module presents requirements that have to be met by conventional bank licensees with respect to:

              a) the role and composition of their Boards and Board Committees; and
              b) related high-level controls and policies.

            • HC-A.1.2

              In addition, this Module contains requirements for the notification and pre-approval of individuals, undertaking certain designated functions with respect to conventional bank licensees. These functions (called "controlled functions"), include Directors and members of senior management. The controlled functions regime supplements the BMA's corporate governance requirements by ensuring that key persons involved in the running of conventional bank licensees are fit and proper. Those approved by the BMA to undertake controlled functions are called approved persons.

            • HC-A.1.3

              Finally, this Module contains certain notification and approval requirements regarding the use of Special Purpose Vehicles ("SPVs"; see Section HC-1.5).

            • HC-A.1.4

              This Module supplements various provisions relating to corporate governance contained in Legislative Decree No. 21 of 2001, with respect to promulgating the Commercial Companies Law ("Commercial Companies Law 2001"). In case of conflict, the Commercial Companies Law shall prevail. The Module also supplements (for companies listed on the Bahrain Stock Exchange), Stock Exchange regulations that are relevant to corporate governance and high-level controls. Compliance with this Module does not guarantee compliance with either the Commercial Companies Law 2001 or the BSE regulations.

          • HC-A.2 HC-A.2 Key requirements

            • Corporate governance

              • HC-A.2.1

                The Chairman of the Board should preferably be non-executive and independent. The role of Chairman and Chief Executive may not be exercised by the same person. (See Rule HC-1.3.9.)

              • HC-A.2.2

                The Board must approve a code of conduct for itself, senior management and employees, and define the responsibilities of itself and senior management. This should include procedures for dealing with conflicts of interest, and a prohibition on insider trading. (See Paragraphs HC-1.2.9 to HC-1.2.13.)

              • HC-A.2.3

                The Board should meet at least four times per year. (see Paragraph HC-1.3.3).

              • HC-A.2.4

                Boards must have an adequate number of members that are "independent" and "non-executive" to serve the interests of minority shareholders and other stakeholders. (See Paragraphs HC-1.3.5 and HC-1.3.6.)

              • HC-A.2.5

                The Board should consider the setting up of committees to assist it in fulfilling its responsibilities. The setting up of an Audit Committee is mandatory. (See Paragraphs HC-1.3.10 to HC-1.3.13.)

              • HC-A.2.6

                Conventional bank licensees are required to notify the BMA, in writing, of all major changes (regardless of type and/or effect) proposed to the strategy and/or corporate plan of the bank prior to implementation, as well as of any Special Purpose Vehicle they intend to establish as a subsidiary, or with respect to which they intend to act as sponsor or manager (see Section HC-1.5).

            • Approved Persons

              • HC-A.2.7

                Conventional bank licensees are required to secure prior BMA approval for those persons wishing to undertake a controlled function. Such persons are assessed against BMA's "fit and proper" requirements. Conventional bank licensees must also notify the BMA of any changes in their approved persons. (See Chapter HC-2)

            • Compliance officer/manager

              • HC-A.2.8

                Conventional bank licensees must appoint a senior member of staff with responsibility for compliance. The Compliance Officer is a controlled function. (See Chapter HC-3.)

          • HC-A.3 HC-A.3 Module history

            • Evolution of the Module

              • HC-A.3.1

                This Module was first issued in July 2004, as part of the initial release of Volume 1 of the BMA Rulebook. It was dated July 2004. All subsequent changes to this Module are shown with the month and year in which the change was made, at the base of the relevant page and in the Table of Contents. Chapter UG-3 provides further details on Rulebook maintenance and version control.

              • HC-A.3.2

                A list of recent changes made to this Module is shown below:

                Module Ref. Change Date Description of Changes
                HC-1.5 01/04/05 Transparency requirements formalised
                HC-1.6 01/04/05 Notification requirements formalised
                HC-1.1, HC-1.2 & HC-1.4 01/10/05 High level controls
                HC-1.5 01/10/05 New SPV requirements
                HC-3.1HC-3.2 01/10/05 Revised compliance function requirements
                HC-1.5.3, HC-1.5.5 & HC-4.1 01/01/06 Revised notification requirements for SPVs and dealing staff
                HC-2, HC-3 and HC-4 01/07/06 Requirements relating to controllers moved to Module GR; Remaining requirements relating to "fit and proper" re-drafted to ensure consistent terminology and procedures with other Rulebook Volumes (without changing the substance of the previous 'fit and proper' requirements); Requirements relating to dealers incorporated into the 'fit and proper' requirements.

            • Superseded Requirements

              • HC-A.3.3

                Prior to the development of this Rulebook, the BMA issued various circulars covering different aspects of corporate governance. These circulars were consolidated into the first version of this Module as shown below:

                Circular Ref. Date of Issue Module Ref. (July 2004 version) Circular Subject
                BC/23/99 8 Nov 1999 HC-1 'Enhancing Corporate Governance in Banking Organisations'
                BC/904/95 24 Jul 1995 HC-1.6 Notification to, and approval from the Agency for certain matters
                ODG/329/03 10 Sep 2003 HC-1.6 Corporate Governance Reporting
                BC/11/98 27 Jul 1998 HC-2 Terms and Definitions Applying to the Management of Banks and Financial Institutions
                BC/8/00 24 May 2000 HC-2 Controllers of, and holdings and transfers of significant ownership or controlling interests in, Agency licensees
                BC/13/99 15 Jun 1999 HC-3 Compliance, Risk Management and Internal Controls
                BMA/1287/94 6 Nov 1994 HC-4 Foreign Exchange, Securities and Other Dealers

              • HC-A.3.4

                The contents in this Module are effective from the dates depicted in HC-A.3.2 and HC-A.3.3, from which the requirements are compiled. Section HC-1.3 is effective from January 2007.

        • HC-B HC-B General guidance and best practice

          • HC-B.1 HC-B.1 Guidance provided by other international bodies

            • Basel Committee: Enhancing Corporate Governance in Banking Organisations and High Level Controls for Banks

              • HC-B.1.1

                These papers (see www.bis.org/publ/bcbs56.pdf) issued in September 1998 and September 1999 provide guidance on corporate governance and high-level controls in banks. These papers form part of an ongoing effort by the Committee to strengthen procedures for risk management and disclosure in banks.

              • HC-B.1.2

                The papers draw on supervisory experience with corporate governance problems at banking organisations and suggest the types of practices that could help to avoid such problems. They identify a number of practices as critical elements of any financial institution's corporate governance process.

              • HC-B.1.3

                The BMA draws banks' attention to the Basel papers as benchmarks of best practice for corporate governance standards and high-level controls to be followed by banks operating in the Kingdom of Bahrain.

          • HC-B.2 HC-B.2 Enforceability

            • HC-B.2.1

              The requirements of Chapter HC-1, Sections HC-1.1HC-1.4 are binding requirements, which banks and their Boards should follow on an "apply or explain" basis. If a Board or a bank elects not to follow these requirements, they must explain why to the Agency and document the reasons for not applying the concerned requirements in the Minutes of the Board. The remaining chapters are binding requirements except where shown as guidance.

            • HC-B.2.2

              This Module and Chapter HC-1 in particular supplements various provisions relating to Corporate Governance contained in Legislative Decree No. 21 of 2001 with respect to promulgating the Commercial Companies Law. In any cases of potential conflict, the Commercial Companies Law shall prevail. Compliance with this Module does not guarantee compliance with the Commercial Companies Law.

        • HC-1 HC-1 Corporate Governance

          • HC-1.1 HC-1.1 Scope

            • HC-1.1.1

              The contents of this Chapter are applicable to locally incorporated banks. Bahrain branches of foreign banks must satisfy the Agency that equivalent arrangements are in place at the parent level and that these arrangements provide for effective high level controls over activities conducted under the Bahrain licence.

            • HC-1.1.2

              This Chapter covers the high level controls aspects of corporate governance of banks, and therefore focuses on the functions of the constituent parts of high level controls, starting with the respective roles and responsibilities of the Board and senior management.

            • HC-1.1.3

              This Chapter therefore does not cover matters of corporate governance relating to the Commercial Companies Law (e.g. General Meetings, the role of shareholders and other administrative matters) or Listing Requirements.

            • HC-1.1.4

              The BMA has historically pursued a "best practice" guidance approach to high level controls and corporate governance, rather than a prescriptive rules-based approach. The Agency has chosen to notify licensees of international best practice standards, and allowed banks to interpret these, according to the scope of operations of the concerned bank. This Chapter blends a best practice-based approach with minimum requirements.

            • HC-1.1.5

              Banks must satisfy the BMA that financial services activities conducted in subsidiaries and other group members including foreign branches are subject to the same or equivalent arrangements for ensuring effective high-level controls over their activities. In instances where local jurisdictional requirements are more stringent than those applicable in this Module, the local requirements are to be applied.

            • HC-1.1.6

              Where a bank is unable to satisfy the BMA that its subsidiaries and other group members or foreign branches are subject to the same or equivalent arrangements, the BMA will assess the potential impact of risks — both financial and reputational — to the bank arising from inadequate high-level controls in the rest of the group of which it is a member. In such instances, the BMA may impose restrictions on dealings between the bank and other group members. Where weaknesses in controls are assessed by the BMA to pose a major threat to the stability of the bank, then its authorisation may be called into question.

          • HC-1.2 HC-1.2 The Board of Directors — Its Functions and Responsibilities

            • Strategy

              • HC-1.2.1

                In most banks, shareholders, creditors, employees, depositors and investment account holders ("stakeholders") are unable to closely monitor management, its strategies and the bank's performance due to a lack of information and resources. A key responsibility of the Board is to fill the gap between uninformed stakeholders to whom it owes a duty of care, and the more fully informed executive management by monitoring management closely on behalf of stakeholders.

              • HC-1.2.2

                The Board is ultimately accountable and responsible for the affairs and performance of the bank. The Board must establish the objectives of the bank and develop the strategies that direct the ongoing activities of the bank to achieve these objectives. The strategies should be communicated throughout the bank, and be disclosed publicly (e.g. via the website or in the annual report in an abbreviated form as applicable). In its strategy document, the Board must demonstrate that it is able to proactively identify and understand the significant risks that the bank faces in achieving its business objectives through its business strategies and plans.

              • HC-1.2.3

                The precise functions reserved for the Board, and those delegated to management and committees will vary, dependent upon the business of the institution, its size and ownership structure. However, at a minimum, the Board must establish and maintain a statement of its responsibilities for:

                a) The adoption and annual review of strategy;
                b) The adoption and review of management structure and responsibilities;
                c) The adoption and review of the systems and controls framework; and
                d) Monitoring the implementation of strategy by management.

              • HC-1.2.4

                In its strategy review process, the Board should:

                a) Review the bank's business plans and the inherent level of risk in these plans;
                b) Assess the adequacy of capital to support the business risks of the bank;
                c) Set performance objectives;
                d) Review the performance of executive management; and
                e) Oversee major capital expenditures, divestitures and acquisitions.

              • HC-1.2.5

                The BMA expects the Board to have effective policies and processes in place for:

                a) Ensuring a formal and transparent Board nomination process;
                b) Appointing senior managers, and ensuring that they have the necessary integrity, technical and managerial competence, and experience;
                c) Overseeing succession planning and replacing key executives when necessary, and ensuring appropriate resources are available, and minimising reliance on key individuals;
                d) Reviewing the remuneration and incentive packages of the executive management and members of the Board of Directors and ensuring that such packages are consistent with the corporate values and strategy of the bank;
                e) Effectively monitoring and making formal (annual) evaluations of senior management's performance in implementing agreed strategy and business plans;
                f) Approving budgets and reviewing performance against those budgets and key performance indicators; and
                g) The management of the bank's compliance risk.

            • Risk Recognition and Assessment

              • HC-1.2.6

                The Board is responsible for ensuring that the systems and controls framework, including the Board structure and organisational structure of the bank is appropriate for the bank's business and associated risks (see HC-1.2.3 c)). The Board must ensure that collectively it has sufficient expertise to identify, understand and measure the significant risks to which the bank is exposed in its business activities.

                In assessing the systems and controls framework, the BMA expects the Board to demonstrate that the bank's operations, individually and collectively:

                a) Are measured, monitored and controlled by appropriate, effective and prudent risk management systems commensurate with the scope of the bank's activities. The Board should ensure that senior management have put in place appropriate systems of control for the business of the bank and the information needs of the Board; in particular, there should be appropriate systems and functions for identifying as well as for monitoring risk, the financial position of the bank, and compliance with applicable laws, regulations and best practice standards. The systems should produce information on a timely basis; and
                b) Are supported by an appropriate control environment. The compliance, risk management and financial reporting functions must be adequately resourced, independent of business lines and must be run by individuals not involved with the day-to-day running of the various business areas. The Board must additionally ensure that management develops, implements and oversees the effectiveness of comprehensive know your customer standards, as well as ongoing monitoring of accounts and transactions, in keeping with the requirements of relevant law, regulations and best practice (with particular regard to anti-money laundering measures). The control environment should maintain necessary client confidentiality and ensure that the privacy of the bank is not violated, and ensure that client's rights and assets are properly safeguarded.

              • HC-1.2.7

                In its review of the systems and controls framework, the Board should:

                a) Effectively make use of the work of internal and external auditors. The Board should ensure the integrity of the bank's accounting and financial reporting systems through regular independent review (by internal and external audit). Audit findings should be used as an independent check on the information received from management about the bank's operations and performance and the effectiveness of internal controls; and
                b) Identify any significant issues related to the bank's adopted governance framework, processes and practices and ensure that appropriate and timely action is taken to address identified adverse deviations from the requirements of this Module.

                The determinations under HC-1.2.6 and this paragraph might be made through the use of self-assessments, stress/scenario tests, and/or independent judgments made by external advisors. The Board may appoint supporting committees, and engage senior management to assist it in the oversight of risk management, but the Board may not delegate its ultimate responsibility to ensure that an adequate, effective, comprehensive and transparent corporate governance process is in place.

            • Corporate Ethics, Conflicts of Interest and Code of Conduct

              • HC-1.2.8

                Banks are subject to a wide variety of laws, regulations and codes of best practice that directly affect the conduct of business. Such laws involve the Bahraini Stock Exchange Law, the Labour Law, the Commercial Companies Law, occupational health and safety, even environment and pollution laws, as well as codes of conduct and regulations of the Agency. The Board sets the "tone at the top" of a bank, and has a responsibility to oversee compliance with these various requirements. The Board should ensure that the staff conduct their affairs with a high degree of integrity, taking note of applicable laws, codes and regulations.

              • HC-1.2.9

                The Board should establish corporate standards for itself, senior management, and employees. This requirement should be met by way of a documented and published code of conduct or similar document. These values should be communicated throughout the bank, so that the Board and senior management and staff understand the importance of conducting business based on good corporate governance values and understand their accountabilities to the various stakeholders of the licensee. Banks' Boards, senior management and staff must be informed of and be required to fulfil their fiduciary responsibilities to the bank's stakeholders.

              • HC-1.2.10

                An internal code of conduct is separate from the business strategy of a bank. A code of conduct should outline the practices that Directors, senior management and staff should follow in performing their duties. Banks may wish to use procedures and policies to complement their codes of conduct. The suggested contents of a code of conduct are covered below:

                a) Commitment by the Board and management to the code. The code of conduct should be linked to the objectives of the bank, and its responsibilities and undertakings to customers, shareholders, staff and the wider community (see HC-1.2.8 and HC-1.2.9). The code should give examples or expectations of honesty, integrity, leadership and professionalism;
                b) Commitment to the law and best practice standards. This commitment would include commitments to following accounting standards, industry best practice (such as ensuring that information to clients is clear, fair, and not misleading), transparency, and rules concerning potential conflicts of interest (see HC-1.2.11);
                c) Employment practices. This would include rules concerning health and safety of employees, training, policies on the acceptance and giving of business courtesies, prohibition on the offering and acceptance of bribes, and potential misuse of company assets;
                d) How the company deals with disputes and complaints from clients and monitors compliance with the code; and
                e) Confidentiality. Disclosure of client or bank information should be prohibited, except where disclosure is required by law (see HC-1.2.6 b).

              • HC-1.2.11

                The Board must establish and disseminate to its members and management, policies and procedures for the identification, reporting, disclosure, prevention, or strict limitation of potential conflicts of interest. It is senior management's responsibility to implement these policies. Rules concerning connected party transactions and potential conflicts of interest may be dealt with in the Code of Conduct (see HC-1.2.9). In particular, the Agency requires that any decisions to enter into transactions, under which Board members or any member of management would have conflicts of interest that are material, should be formally and unanimously approved by the full Board. Best practice would dictate that a Board member or member of senior management should:

                a) Not enter into competition with the bank;
                b) Not demand or accept substantial gifts from the bank for himself or his associates;
                c) Not misuse the banks' assets;
                d) Not use company privileged information or take advantage of business opportunities to which the company is entitled for himself or his associates;
                e) Report to the Board any (potential) conflict of interest in their activities with, and commitments to other organisations. In any case, all Board members and members of senior management must declare in writing all of their other interests in other enterprises or activities (whether as a shareholder of more than 5% of the voting capital of a company, a manager, or other form of significant participation) to the Board (or the Nominations or Audit Committees) on an annual basis; and
                f) Absent themselves from any discussions or decision-making that involves a subject where they are incapable of providing objective advice, or which involves a subject or (proposed) transaction where a conflict of interest exists.

              • HC-1.2.12

                The Agency expects that the Board and its members individually and collectively:

                a) Act with honesty, integrity and in good faith, with due diligence and care, with a view to the best interest of the bank and its shareholders and other stakeholders (see paragraphs HC-1.2.8 to HC-1.2.11);
                b) Act within the scope of their responsibilities (which should be clearly defined — see HC-1.3.7 and HC-1.3.8 below) and not participate in the day-to-day management of the bank;
                c) Have a proper understanding of, and competence to deal with the affairs and products of the bank and devote sufficient time to their responsibilities;
                d) To independently assess and question the policies, processes and procedures of the bank, with the intent to identify and initiate management action on issues requiring improvement. (i.e. to act as checks and balances on management).

              • HC-1.2.13

                All Directors whether non-executive or executive should exercise independence in their decision-making. To facilitate independence, the Board should agree procedures whereby the Board or its individual members (or committees) may take independent professional advice at the bank's expense.

          • HC-1.3 HC-1.3 Board Composition and The Role of Committee

            • Board Composition & Frequency of Meetings

              • HC-1.3.1

                To fulfil its responsibility for the review of the systems and controls framework (HC-1.2.3 c), the Board must periodically assess its composition and size and, where appropriate, reconstitute itself and its committees by selecting new Directors to replace long-standing members or those members whose contribution to the bank or its committees (such as the audit committee) is not adequate.

              • HC-1.3.2

                No Board member may have more than one directorship of a Full Commercial Bank and an Offshore Banking Unit or Investment Bank. This would mean an effective cap of a maximum of two directorships of financial institutions inside Bahrain. Two directorships of licensees within the same category (e.g. "OBU") would not be permitted. Banks may approach the Agency for exemption from this limit where the directorships concern banks or financial institutions within the same group.

              • HC-1.3.3

                The Board must meet sufficiently often to enable it to discharge its responsibilities effectively, taking into account the bank's scale and complexity. The full Board should meet preferably no less than four times per year. The Agency recommends that meetings should take place once every quarter to address the Board's responsibilities for management oversight and performance monitoring.

              • HC-1.3.4

                Board rules should require members to step down if they are not actively participating in Board meetings.

            • Independent and Non-Executive Directors

              • HC-1.3.5

                Where there is the potential for conflict of interest, or there is a need for impartiality, the Board must assign a sufficient number of independent non-executive Board members capable of exercising independent judgment. The Board should outline its criteria and materiality thresholds in the annual report for the definition of "independence". The Directors should be identified in the annual report as executive, non-executive, and independent non-executive, as follows:

                a) Executive Director (or "Managing Director" under the Commercial Companies Law "CCL") — A person who is involved in the day-to-day management and/or is in full-time employment of the bank and/or any of its affiliates or subsidiaries or parent companies. An executive Director may not occupy the post of "Chairman";
                b) Non-Executive Director — A person not involved in the day-to-day management and/or is not a full-time salaried employee of the bank and/or any of its affiliates, or subsidiaries or parent companies; and
                c) Independent Non-Executive Director — A non-executive Director (as defined above), who also:
                • Is not a "controller" of the bank (see Section HC-2.1).
                • Is not an Associate (see paragraph HC-2.1.4 (g)) of a Director or a member of senior management of the bank.
                • Is not a professional advisor to the bank or group (A partner or member of senior management of an accountancy or law firm that provides services to the bank would not be perceived by the Agency as an independent non-executive Director).
                • Is not a large depositor with, or large borrower from the bank (i.e. whose deposits or credit facilities exceed 10% of the capital base of the bank).
                • Has no significant contractual or business relationship with the bank or group which could be seen to materially interfere with the person's capacity to act in an independent manner.

              • HC-1.3.6

                Independent non-executive Directors should be permitted to meet periodically (for example at separate meetings from the main Board) without executive management present.

            • Checks and Balances

              • HC-1.3.7

                To ensure a clear segregation of duties, the Board should clearly define, document and enforce its own responsibilities, including those of its Chairman, as well as the delegated authorities, responsibilities and accountabilities of the Board and management committees, the bank's Chief Executive and senior management to the stakeholders of the bank.

              • HC-1.3.8

                In particular, the Board should issue formal letters of appointment both to senior management and Board members, outlining their specific responsibilities and accountabilities. Wherever possible, these documents or a summary of responsibilities should be disclosed publicly, for example in the annual report. Letters of appointment facilitate better understanding of the respective accountabilities of the Board and management.

            • Responsibilities of the Chairman

              • HC-1.3.9

                The Chairman is responsible for the leadership of the Board, and for the efficient functioning of the Board. The Chairman is responsible for ensuring that Board members are adequately briefed in sufficient time for issues arising at Board meetings; therefore it is vital that the Chairman commit sufficient time to perform his role effectively, taking into account the points below:

                a) First, the Chairman of the Board preferably should be non-executive and independent (see HC-1.3.5 for the definitions of "non-executive" and "independent");
                b) Also, the role of Chairman and Chief Executive may not be exercised by the same person; and
                c) Furthermore, there needs to be a clear division of responsibility between these two positions (see also HC-1.3.8 in this regard).

            • The benefits and functions of committees

              • HC-1.3.10

                In order to perform its duties more efficiently, the Board may set up committees where it feels appropriate with specific responsibilities, which must be documented. Where committees are set up, they should keep full minutes of their activities and meet regularly to fulfil their mandates. In particular, there are three areas where there is a need for checks and balances within the Board itself:

                a) The nomination of Directors;
                b) The remuneration of Directors; and
                c) The audit of the bank's financial performance.

                In these areas, executive Directors have clear potential conflicts of interest. Nomination is all about the continuation of their own jobs and the jobs of their colleagues and potential new colleagues. Remuneration is all about the rewards that executive Directors and/or senior management receive for their services to the bank. Audit concerns the probity of the financial and non-financial reporting of the performance of the company by the very same persons who are responsible for its performance.

                For larger banks that deal with the general public, committees can be a more efficient mechanism to assist the main Board in its monitoring and control of the activities of the bank. The establishment of committees should not mean that the role of the Board is diminished, or that the Board becomes fragmented. Each Committee must have a clear written mandate outlining its purpose, objectives and responsibilities, including composition, frequency of meetings and reporting relationships.

            • Audit Committee

              • HC-1.3.11

                The Agency requires all banks to establish an Audit Committee. The committee members must have sufficient technical expertise to enable the committee to perform its functions effectively. Preferably, there should be at least one qualified and appropriately experienced accountant in the committee. All members of the committee must be financially literate. The CEO may not be a member of this committee.

              • HC-1.3.12

                Responsibilities of the Audit Committee are as follows:

                a) To review the integrity of the bank's financial reporting (particularly with reference to information passed to the Board — see HC-1.2.6 a). This review should include the choice of accounting policies. The information needs of the Board to perform its monitoring responsibilities must be defined in writing, and regularly monitored by the Audit Committee;

                To oversee the selection and compensation of the external auditor for appointment and approval at the shareholders' meeting. The audit committee should oversee relations with the external auditors, including ensuring the external auditor's independence (in particular, making sure that the external audit firm and its partners have no other financial or business relationship without the Board's knowledge), the terms and conditions of the auditor's appointment and remuneration arrangements. The committee should monitor rotation arrangements for audit engagement partners. The audit committee should monitor the performance of the external auditor and the non-audit services provided by the external auditor. The committee should meet with the external auditor at least twice per year, and at least once per year in the absence of any members of executive management;
                b) To regularly review the activities and performance of the internal audit function;
                c) To review whether the bank complies with all relevant laws, regulations, codes and business practices, and ensure that the bank communicates with shareholders and relevant stakeholders (internal and external) openly and promptly, and with substance of compliance prevailing over form; and
                d) To review and supervise the implementation of, enforcement of and adherence to the bank's code of conduct.

              • HC-1.3.13

                Below the Audit Committee, the bank must set up an internal audit function, which reports directly to the Audit Committee (with a parallel reporting line to senior management for day-to-day matters as appropriate).

          • HC-1.4 HC-1.4 Transparency and Disclosure

            • Board's Responsibility for Disclosure

              • HC-1.4.1

                The Board should oversee the process of disclosure and communications with internal and external stakeholders. The Board should ensure that disclosures made by the bank are fair, transparent, comprehensive and timely and reflect the character of the bank and the nature, complexity and risks inherent in the bank's business activities. Disclosure policies must be reviewed for compliance with the Agency's disclosure requirements (see Rulebook Chapter PD-1).

          • HC-1.5 HC-1.5 Notification, reporting, and approval requirements for changes to activities, personnel and ownership, strategy, Board meetings and special purpose vehicles ("SPVs")

            • HC-1.5.1

              Banks must notify the Agency in writing of all major proposed changes to the strategy and/or corporate plan of the bank prior to implementation.

            • HC-1.5.2

              Banks must notify the Agency in writing of any proposed changes to senior positions or ownership changes mentioned in sections HC-2.1, HC-3.2 and HC-4.1 (whether in terms of structure or identity of personnel) prior to the change. The communication should include the reason for the departure of the personnel and the Curriculum Vitae of any new persons taking up the relevant positions in the bank. See also Section BR-5.1 for notification requirements concerning contact details of senior staff.

            • HC-1.5.3

              All locally incorporated banks, in addition to the requirements in paragraphs HC-1.5.1 and HC-1.5.2, should obtain the Agency's prior specific written approval before establishing any subsidiaries (including SPVs where the bank exercises a majority shareholding or has majority voting control by virtue of direct ownership or by proxy/nominee arrangements), branches and/or representative offices, either inside or outside of Bahrain. In order to avoid any delays and/or disruption in implementation of banks' plans in this context, the Agency should be approached as soon as possible, even at a very preliminary stage.

            • HC-1.5.4

              All locally incorporated banks are required to submit, on an annual basis, as an attachment to the year-end quarterly PIR, a report recording the meetings during the year by their Board of Directors. For a sample report, refer to Appendix BR-10.

            • HC-1.5.5

              All locally incorporated banks must notify the Agency if they intend to act as sponsor or manager of a special purpose vehicle ("SPV"), or if they intend to participate in the creation of an SPV, or if they intend to acquire shares in an SPV. All locally incorporated banks must notify the Agency if they are appointed as nominee shareholders of SPVs or hold votes by proxy arrangement in SPVs on behalf of other investors. In all cases listed above, the concerned bank must notify the Agency quarterly of any new commitments to, or engagements in business arrangements with SPVs. These reporting and notification arrangements apply in addition to arrangements under HC-1.5.3 where the SPV is a subsidiary.

            • HC-1.5.6

              The Agency requires any locally incorporated bank associated with an SPV to give the background to the following points in any notification under HC-1.5.5 above:

              a) the purpose of the SPV;
              b) the nature of the relationship between the bank and the SPV (i.e. sponsor, manager, investor, controller etc.);
              c) the external auditor's proposed consolidation/accounting treatment of the SPV;
              d) the availability of financial and other information relevant to the SPV and access to its business premises and records;
              e) whether the bank is providing any guarantees, warranties or financial/liquidity support of any kind to the SPV.

            • HC-1.5.7

              Where the SPV is consolidated into the accounts of a locally incorporated bank, the bank must provide separate accounting information on the SPV to the Agency on a quarterly basis. Furthermore, the annual audited financial statements of all consolidated SPVs must be submitted to the Agency within 3 months of the year end of the concerned SPV.

            • HC-1.5.8

              Where a locally incorporated bank has a controller or majority ownership relationship with an SPV, or acts as sponsor, the bank must obtain the prior approval of the Agency for any changes to the capital, ownership, management or control of the SPV. All locally incorporated banks must also notify the Agency of any significant events in relation to the SPV. If necessary, the Agency may require that formal information exchange arrangements are put in place (e.g. a memorandum of understanding) if the SPV is located in a foreign jurisdiction and its activities are not supervised locally.

        • HC-2 HC-2 Approved Persons

          • HC-2.1 HC-2.1 BMA Notification and Approval

            • General Requirement

              • HC-2.1.1

                All persons wishing to undertake a controlled function in a conventional bank licensee must be approved by the BMA prior to their appointment (subject to the variations contained in Rule HC-2.1.3).

              • HC-2.1.2

                Controlled functions are those of:

                (a) Director;
                (b) Chief Executive Officer or General Manager;
                (c) Senior Manager;
                (d) Compliance officer;
                (e) Money Laundering Reporting Officer; and
                (f) Financial Instruments Trader.

              • HC-2.1.3

                Prior approval is required for controlled functions (a), (b), (c), (d) and (e). Controlled functions (d) and (e) may be combined, however (see also FC-4.1, regarding the MLRO function). Controlled function (f) does not require prior approval: instead, notification only is required, once the person concerned has accepted to undertake that function.

            • Basis for Approval

              • HC-2.1.4

                Approval under Rule HC-2.1.1 is only granted by the BMA, if it is satisfied that the person is fit and proper to hold the particular position in the licensee concerned. "Fit and proper" is determined by the BMA on a case-by-case basis. The definition of "fit and proper" and associated guidance is provided in Sections HC-2.2 and HC-2.3 respectively.

            • Definitions

              • HC-2.1.5

                Director is any person who occupies the position of a Director, as defined in Article 173 of the Commercial Companies Law (Legislative Decree No. 21 of 2001).

              • HC-2.1.6

                The fact that a person may have "Director" in their job title does not of itself make them a Director within the meaning of the definition noted in Rule HC-2.1.5. For example, a 'Director of Marketing', is not necessarily a member of the Board of Directors and therefore may not fall under the definition of Rule HC-2.1.5.

              • HC-2.1.7

                The Chief Executive Officer or General Manager means a person who is responsible for the conduct of the licensee (regardless of actual title). The Chief Executive Officer or General Manager must be resident in Bahrain. This person is responsible, alone or jointly, for the conduct of the whole of the firm, or, in the case of an overseas conventional bank licensee, for all of the activities of the branch (in which case, he may hold the title of "Branch Manager").

              • HC-2.1.8

                Senior Manager means a person who, under the immediate authority of a Director or the Chief Executive Officer/General Manager, exercises major managerial responsibilities, is responsible for a significant business or operating unit, or has major managerial responsibility for maintaining accounts or other records of the licensee.

              • HC-2.1.9

                Whether a person is a Senior Manager will depend on the facts in each case and is not determined by the presence or absence of the word in their job title. Examples of Senior Managers might include, depending on the scale, nature and complexity of the business, a deputy Chief Executive Officer; and heads of departments such as Risk Management, or Internal Audit; or the Chief Financial Officer.

              • HC-2.1.10

                Financial Instruments Trader means a person who is engaged in buying or selling financial instruments.

              • HC-2.1.11

                Where a firm is in doubt as to whether a function should be considered a controlled function it must discuss the case with the BMA.

            • Notification Requirements and Process

              • HC-2.1.12

                Conventional bank licensees must obtain BMA approval before a person is formally appointed to a controlled function; the request for BMA approval must be made by submitting to BMA a duly completed Form 3 (Application for Approved Person status). In the case of a financial instruments trader, notification only is required (see Rule HC-2.1.3): this notification must also be made by submitting a Form 3.

              • HC-2.1.13

                In the case of license applications, the Form 3 must be marked for the attention of the Director, Licensing and Policy Directorate. When made by a conventional bank licensee, the Form 3 must be marked for the attention of either the Director, Retail Banks Supervision or the Director, Wholesale Banks Supervision, as appropriate.

              • HC-2.1.14

                Licensees should give the BMA a reasonable amount of notice in order for an application for approval to be reviewed. The BMA aims to respond within 2 weeks of receipt of an application, although in some cases, where referral to an overseas supervisor is required, the response time is likely to be longer.

              • HC-2.1.15

                Licensees seeking to appoint Board Directors should seek BMA approval for all the candidates to be put forward for election at a shareholder meeting, in advance of the agenda being issued to shareholders. BMA approval of the candidates does not in any way limit shareholders' rights to refuse those put forward for election.

              • HC-2.1.16

                All refusals by the BMA to grant a person approved person status have to be reviewed and approved by an Executive Director of the BMA. A notice of intent is issued to the person concerned, setting out the basis for the decision. The person has 30 calendar days from the date of the notice in which to appeal the decision. The BMA then has 30 calendar days from the date of the representation in which to make a final determination. See also Chapter EN-5.

              • HC-2.1.17

                Conventional bank licensees must immediately notify BMA when an approved person ceases to hold the controlled function for which they have been approved, for whatever reason.

              • HC-2.1.18

                Thus, licensees are required to notify BMA should an approved person transfer to another function within the licensee, or to another group entity; or else resign, be suspended or dismissed. BMA may require further clarification as to the reasons for the person's transfer or departure. BMA will automatically withdraw the individual's approved person status: should the person wish to undertake another controlled function, whether within the same licensee or in another licensee, then a new application should be resubmitted.

              • HC-2.1.19

                Conventional bank licensees must immediately notify the BMA should they become aware of information that could reasonably be viewed as calling into question an approved person's compliance with the BMA's "fit and proper" requirement (see HC-2.2).

          • HC-2.2 HC-2.2 "Fit and proper" requirement

            • HC-2.2.1

              Licensees seeking an approved person authorisation for an individual, must satisfy the BMA that the individual concerned is "fit and proper" to undertake the controlled function in question.

            • HC-2.2.2

              To be considered "fit and proper", those nominated must demonstrate:

              (a) personal integrity, honesty and good reputation;
              (b) professional competence, experience and expertise, sufficient for the controlled function for which authorisation is being applied for, and given the scale, complexity and nature of the conventional bank licensee concerned; and
              (c) financial soundness.

            • HC-2.2.3

              In assessing the conditions prescribed in Rule HC-2.2.2, the BMA will take into account the criteria contained in Section HC-2.3. The BMA reviews each application on a case-by-case basis, taking into account all relevant circumstances. A person may be considered "fit and proper" to undertake one type of controlled function but not another, depending on the function's job size and required levels of experience and expertise. Similarly, a person approved to undertake a controlled function in one conventional bank licensee may not be considered to have sufficient expertise and experience to undertake nominally the same controlled function but in a much bigger licensee.

            • HC-2.2.4

              Approved persons undertaking a controlled function must act prudently, and with honesty, integrity, care, skill and due diligence in the performance of their duties. They must avoid conflicts of interest arising whilst undertaking a controlled function.

            • HC-2.2.5

              In determining whether a conflict of interest may arise, factors that may be considered include whether:

              (a) a person has breached any fiduciary obligations to the company or terms of employment;
              (b) a person has undertaken actions that would be difficult to defend, when looked at objectively, as being in the interest of the licensee; and
              (c) a person has failed to declare a personal interest that has a material impact in terms of the person's relationship with the licensee.

          • HC-2.3 HC-2.3 Interpretative Guidance on "Fit and Proper" Requirement

            • HC-2.3.1

              In assessing a person's fitness and propriety, the BMA will consider previous professional and personal conduct (in Bahrain or elsewhere) including, but not limited to, the following:

              (a) the propriety of a person's conduct, whether or not such conduct resulted in a criminal offence being committed, the contravention of a law or regulation, or the institution of legal or disciplinary proceedings;
              (b) a conviction or finding of guilt in respect of any offence, other than a minor traffic offence, by any court or competent jurisdiction;
              (c) any adverse finding in a civil action by any court or competent jurisdiction, relating to fraud, misfeasance or other misconduct in connection with the formation or management of a corporation or partnership;
              (d) whether the person has been the subject of any disciplinary proceeding by any government authority, regulatory agency or professional body or association;
              (e) the contravention of any financial services legislation or regulation;
              (f) whether the person has ever been refused a license, authorisation, registration or other authority;
              (g) dismissal or a request to resign from any office or employment;
              (h) disqualification by a court, regulator or other competent body, as a Director or as a manager of a corporation;
              (i) whether the person has been a Director, partner or manager of a corporation or partnership which has gone into liquidation or administration or where one or more partners have been declared bankrupt whilst the person was connected with that partnership;
              (j) the extent to which the person has been truthful and open with supervisors;
              (k) the extent to which the person has appropriate professional and other qualifications for the controlled function in question;
              (l) the extent to which the person has sufficient experience, or is otherwise able to perform the functions of the controlled function in question;
              (m) whether the person has ever been adjudged bankrupt, entered into any arrangement with creditors in relation to the inability to pay due debts, or failed to satisfy a judgment debt under a court order.

            • HC-2.3.2

              With respect to HC-2.3.1(b), (c), (d) and (e), the BMA will take into account the length of time since any such event occurred, as well as the seriousness of the matter in question.

            • HC-2.3.3

              Further guidance on the process for assessing a person's "fit and proper" status is given in Module EN (Enforcement): see Chapter EN-8.

          • HC-2.4 [This section deleted 07/2006]

            [This Section was deleted in 07/2006: it has been left blank.]

        • HC-3 HC-3 Compliance officer/manager

          • HC-3.1 HC-3.1 Introduction

            • HC-3.1.1

              In order to promote best practice with respect to banks' internal systems and controls and international banking supervision, the Agency, in this chapter, outlines its requirements for the compliance function of banks. The expression "Compliance Function" in this Chapter is used to describe staff carrying out compliance duties.

            • HC-3.1.2

              The expression 'Compliance Risk', in this chapter refers to the risk of legal or regulatory sanctions, material or financial loss, or loss to reputation a bank may suffer as a result of its failure to comply with laws, regulations, rules, reporting requirements, standards and codes of conduct applicable to its activities, rather than compliance with a bank's internal limits or procedures.

            • HC-3.1.3

              For further information and guidance on compliance risk and the compliance function, banks should refer to the Basel Committee publication, "Compliance and the compliance function in banks" (www.bis.org/publ April 2005). The Agency expects banks to carry out a review of their compliance with the principles in this paper on a regular basis (either by way of a self-assessment or by way of a review by the internal or external audit function).

          • HC-3.2 HC-3.2 Requirement for and approval of a compliance officer/manager

            • HC-3.2.1

              All banks must appoint a senior member of staff with responsibility for the management of compliance risk as their Compliance Officer/Manager.

            • HC-3.2.2

              The compliance function must be independent (i.e. it must not be placed in a position where its other duties or responsibilities may cause a conflict of interest with its compliance risk management responsibilities). Therefore the compliance function must be separate from the internal audit function. The compliance officer or manager may however, perform other limited related compliance roles (e.g. the MLRO or legal advisor), subject to the Agency's prior approval.

            • HC-3.2.3

              The compliance officer/manager must be appropriately qualified and experienced and the compliance function must have adequate resources to carry out its functions effectively.

            • HC-3.2.4

              The appointment of a compliance manager/officer requires the Agency's prior approval and the submission of the appointee's Personal Questionnaire (Appendix LR 2) and Curriculum Vitae to the Agency. The bank must also outline how the compliance function fits into the bank's senior management reporting structure, and must give details of relevant reporting lines within the bank.

            • HC-3.2.5

              In the case of locally incorporated banks, the compliance officer/manager must have access to the Board of Directors in addition to the senior management.

        • HC-4 [This chapter deleted 07/2006]

          [This chapter deleted 07/2006 — left blank.]

      • HC HC High-level Controls [versions up to October 2010]

        • HC-A HC-A Introduction

          • HC-A.1 HC-A.1 Purpose

            • Executive Summary

              • HC-A.1.1

                This Module presents requirements that have to be met by conventional bank licensees with respect to:

                a) The role and composition of their Boards and Board Committees; and
                b) Related high-level controls and policies.
                October 07

              • HC-A.1.2

                In addition, this Module contains requirements for the notification and pre-approval of individuals, undertaking certain designated functions with respect to conventional bank licensees. These functions (called 'controlled functions'), include Directors and members of senior management. The controlled functions regime supplements the CBB's corporate governance requirements by ensuring that key persons involved in the running of conventional bank licensees are fit and proper. Those approved by the CBB to undertake controlled functions are called approved persons.

                October 07

              • HC-A.1.3

                Finally, this Module contains certain notification and approval requirements regarding the use of Special Purpose Vehicles ('SPVs'; see Section HC-1.5).

                October 07

              • HC-A.1.4

                This Module supplements various provisions relating to corporate governance contained in Legislative Decree No. 21 of 2001, with respect to promulgating the Commercial Companies Law ('Commercial Companies Law 2001'). In case of conflict, the Commercial Companies Law shall prevail. The Module also supplements (for companies listed on the Bahrain Stock Exchange), Stock Exchange regulations that are relevant to corporate governance and high-level controls. Compliance with this Module does not guarantee compliance with either the Commercial Companies Law 2001 or the BSE regulations.

                October 07

            • Legal Basis

              • HC-A.1.5

                This Module contains the CBB's Directive relating to high-level controls and is issued under the powers available to the CBB under Article 38 of the Central Bank of Bahrain and Financial Institutions Law 2006 ('CBB Law'). The Directive in this Module is applicable to conventional bank licensees.

                October 07

              • HC-A.1.6

                For an explanation of the CBB's rule-making powers and different regulatory instruments, see Section UG-1.1.

                October 07

          • HC-A.2 HC-A.2 Key requirements

            • Corporate governance

              • HC-A.2.1

                The Chairman of the Board should preferably be non-executive and independent. The role of Chairman and Chief Executive may not be exercised by the same person. (See Rule HC-1.3.9.)

                October 07

              • HC-A.2.2

                The Board must approve a code of conduct for itself, senior management and employees, and define the responsibilities of itself and senior management. This should include procedures for dealing with conflicts of interest, and a prohibition on insider trading. (See Paragraphs HC-1.2.9 to HC-1.2.13.)

                October 07

              • HC-A.2.3

                The Board should meet at least four times per year (see Paragraph HC-1.3.4).

                October 07

              • HC-A.2.4

                Boards must have an adequate number of members that are 'independent' and 'non-executive' to serve the interests of minority shareholders and other stakeholders. (See Paragraphs HC-1.3.5 and HC-1.3.6.)

                October 07

              • HC-A.2.5

                The Board should consider the setting up of committees to assist it in fulfilling its responsibilities. The setting up of an Audit Committee is mandatory. (See Paragraphs HC-1.3.11 to HC-1.3.14.)

                October 07

              • HC-A.2.6

                Conventional bank licensees are required to notify the CBB, in writing, of all major changes (regardless of type and/or effect) proposed to the strategy and/or corporate plan of the bank prior to implementation, as well as of any Special Purpose Vehicle they intend to establish as a subsidiary, or with respect to which they intend to act as sponsor or manager (see Section HC-1.5).

                October 07

            • Approved Persons

              • HC-A.2.7

                Conventional bank licensees are required to secure prior CBB approval for those persons wishing to undertake a controlled function. Such persons are assessed against CBB's 'fit and proper' requirements. Conventional bank licensees must also notify the CBB of any changes in their approved persons. (See Chapter HC-2)

                October 07

            • Compliance officer/manager

              • HC-A.2.8

                Conventional bank licensees must appoint a senior member of staff with responsibility for compliance. The Compliance Officer is a controlled function. (See Chapter HC-3.)

                October 07

          • HC-A.3 HC-A.3 Module History

            • Evolution of the Module

              • HC-A.3.1

                This Module was first issued in July 2004, as part of the initial release of Volume 1 of the CBB Rulebook. It was dated July 2004. Any material changes that have subsequently been made to this Module are annotated with the calendar quarter date in which the change was made: Chapter UG 3 provides further details on Rulebook maintenance and version control.

                October 07

              • HC-A.3.2

                When the CBB replaced the BMA in September 2006, the provisions of this Module remained in force. Volume 1 was updated in October 2007 to reflect the switch to the CBB; however, new calendar quarter dates were only issued where the update necessitated changes to actual requirements.

                October 07

              • HC-A.3.3

                A list of recent changes made to this Module is shown below:

                Module Ref. Change Date Description of Changes
                HC-1.5 01/04/05 Transparency requirements formalized.
                HC-1.6 01/04/05 Notification requirements formalized.
                HC-1.1, 1.2 & HC-1.4 01/10/05 High-level controls enhanced.
                HC-1.5 01/10/05 New SPV requirements.
                HC-3.1 – HC-3.2 01/10/05 Revised compliance function requirements.
                HC-1.5.3, HC-1.5.5 & HC-4.1 01/01/06 Revised notification requirements for SPVs and dealing staff.
                HC-2, HC-3 and HC-4 01/07/06 Requirements relating to controllers moved to Module GR; Remaining requirements relating to 'fit and proper' re-drafted to ensure consistency with other Rulebook Volumes (without changing the substance of the previous 'fit and proper' requirements); Requirements relating to dealers incorporated into the 'fit and proper' requirements.
                HC-1.2 & HC-1.3 01/10/07 Reordering of Paragraphs to separate Rules from Guidance.
                HC-A.1 10/2007 New Rule HC-A.1.5 introduced, categorising this Module as a Directive.
                HC-1.3.5 04/2008 Mandatory requirement for at least one independent non-executive director
                HC-2.1.16 01/2009 Amendment to notification process for "approved person" status
                HC-1.5.3 01/2009 Requirement to appoint a permanent replacement within 120 days when a controlled function falls vacant.
                HC-2.1.2 10/2009 CBB prior approval requirement for appointment of Deputy MLRO

              • HC-A.3.4

                The contents in this Module are effective from July 2004 or the dates depicted in HC-A.3.3. Section HC-1.3 is effective from October 2007.

                October 07

        • HC-B HC-B General guidance and best practice

          • HC-B.1 HC-B.1 Guidance provided by other international bodies

            • Basel Committee: Enhancing Corporate Governance in Banking Organisations and High-level Controls for Banks

              • HC-B.1.1

                These papers (see www.bis.org/publ/bcbs56.pdf) issued in September 1998 and September 1999 provide guidance on corporate governance and high-level controls in banks. These papers form part of an on-going effort by the Committee to strengthen procedures for risk management and disclosure in banks.

                October 07

              • HC-B.1.2

                The papers draw on supervisory experience with corporate governance problems at banking organisations and suggest the types of practices that could help to avoid such problems. They identify a number of practices as critical elements of any financial institution's corporate governance process.

                October 07

              • HC-B.1.3

                The CBB draws banks' attention to the Basel papers as benchmarks of best practice for corporate governance standards and high-level controls to be followed by banks operating in the Kingdom of Bahrain.

                October 07

          • HC-B.2 HC-B.2 Enforceability

            • HC-B.2.1

              The requirements of Chapter 1, Sections HC-1.1–HC-1.4 are binding requirements, which banks and their Boards should follow on an 'apply or explain' basis. If a Board or a bank elects not to follow these requirements, they must explain why to the Central Bank and document the reasons for not applying the concerned requirements in the Minutes of the Board. The remaining Chapters are binding requirements except where shown as guidance.

              October 07

        • HC-1 HC-1 Corporate Governance

          • HC-1.1 HC-1.1 Scope

            • HC-1.1.1

              The contents of this Chapter are applicable to locally incorporated banks. Bahrain branches of foreign banks must satisfy the Central Bank that equivalent arrangements are in place at the parent level and that these arrangements provide for effective high-level controls over activities conducted under the Bahrain license.

              October 07

            • HC-1.1.2

              This Chapter covers the high-level controls aspects of corporate governance of banks, and therefore focuses on the functions of the constituent parts of high-level controls, starting with the respective roles and responsibilities of the Board and senior management.

              October 07

            • HC-1.1.3

              This Chapter therefore does not cover matters of corporate governance relating to the Commercial Companies Law (e.g. General Meetings, the role of shareholders and other administrative matters) or Listing Requirements.

              October 07

            • HC-1.1.4

              The CBB has historically pursued a 'best practice' guidance approach to high-level controls and corporate governance, rather than a prescriptive rules-based approach. The Central Bank has chosen to notify licensees of international best practice standards, and allowed banks to interpret these, according to the scope of operations of the concerned bank. This Chapter blends a best practice-based approach with minimum requirements.

              October 07

            • HC-1.1.5

              Banks must satisfy the CBB that financial services activities conducted in subsidiaries and other group members including foreign branches are subject to the same or equivalent arrangements for ensuring effective high-level controls over their activities. In instances where local jurisdictional requirements are more stringent than those applicable in this Module, the local requirements are to be applied.

              October 07

            • HC-1.1.6

              Where a bank is unable to satisfy the CBB that its subsidiaries and other group members or foreign branches are subject to the same or equivalent arrangements, the CBB will assess the potential impact of risks – both financial and reputational – to the bank arising from inadequate high-level controls in the rest of the group of which it is a member. In such instances, the CBB may impose restrictions on dealings between the bank and other group members. Where weaknesses in controls are assessed by the CBB to pose a major threat to the stability of the bank, then its authorisation may be called into question.

              October 07

          • HC-1.2 HC-1.2 The Board of Directors – Its Functions and Responsibilities

            • Strategy

              • HC-1.2.1

                In most banks, shareholders, creditors, employees, depositors and investment account holders ('stakeholders') are unable to closely monitor management, its strategies and the bank's performance due to a lack of information and resources. A key responsibility of the Board is to fill the gap between uninformed stakeholders to whom it owes a duty of care, and the more fully informed executive management by monitoring management closely on behalf of stakeholders.

                October 07

              • HC-1.2.2

                The Board is ultimately accountable and responsible for the affairs and performance of the bank. The Board must establish the objectives of the bank and develop the strategies that direct the on-going activities of the bank to achieve these objectives. The strategies must be communicated throughout the bank, and be disclosed publicly (e.g. via the website or in the annual report in an abbreviated form as applicable). In its strategy document, the Board must demonstrate that it is able to proactively identify and understand the significant risks that the bank faces in achieving its business objectives through its business strategies and plans.

                October 07

              • HC-1.2.3

                The precise functions reserved for the Board, and those delegated to management and committees will vary, dependent upon the business of the institution, its size and ownership structure. However, as a minimum, the Board must establish and maintain a statement of its responsibilities for:

                a) The adoption and annual review of strategy;
                b) The adoption and review of management structure and responsibilities;
                c) The adoption and review of the systems and controls framework; and
                d) Monitoring the implementation of strategy by management.

                The Board may not delegate its ultimate responsibility to ensure that an adequate, effective, comprehensive and transparent corporate governance process is in place.

                October 07

              • HC-1.2.4

                In its strategy review process under Paragraphs HC-1.2.3 a) and d), the Board must:

                a) Review the bank's business plans and the inherent level of risk in these plans;
                b) Assess the adequacy of capital to support the business risks of the bank;
                c) Set performance objectives;
                d) Review the performance of executive management; and
                e) Oversee major capital expenditures, divestitures and acquisitions.
                October 07

              • HC-1.2.5

                The CBB expects the Board to have effective policies and processes in place for:

                a) Ensuring a formal and transparent Board nomination process;
                b) Appointing senior managers, and ensuring that they have the necessary integrity, technical and managerial competence, and experience;
                c) Overseeing succession planning and replacing key executives when necessary, and ensuring appropriate resources are available, and minimising reliance on key individuals;
                d) Reviewing the remuneration and incentive packages of the executive management and members of the Board of Directors and ensuring that such packages are consistent with the corporate values and strategy of the bank;
                e) Effectively monitoring and making formal (annual) evaluations of senior management's performance in implementing agreed strategy and business plans;
                f) Approving budgets and reviewing performance against those budgets and key performance indicators; and
                g) The management of the bank's compliance risk.
                October 07

            • Risk Recognition and Assessment

              • HC-1.2.6

                The Board is responsible for ensuring that the systems and controls framework, including the Board structure and organisational structure of the bank, is appropriate for the bank's business and associated risks (see HC-1.2.3 c)). The Board must ensure that collectively it has sufficient expertise to identify, understand and measure the significant risks to which the bank is exposed in its business activities.

                The Board must regularly assess the systems and controls framework of the bank. In its assessments, the Board must demonstrate to the CBB that:

                a) The bank's operations, individually and collectively are measured, monitored and controlled by appropriate, effective and prudent risk management systems commensurate with the scope of the bank's activities; and
                b) The bank's operations are supported by an appropriate control environment. The compliance, risk management and financial reporting functions must be adequately resourced, independent of business lines and must be run by individuals not involved with the day-to-day running of the various business areas. The Board must additionally ensure that management develops, implements and oversees the effectiveness of comprehensive know your customer standards, as well as on-going monitoring of accounts and transactions, in keeping with the requirements of relevant law, regulations and best practice (with particular regard to anti-money laundering measures). The control environment must maintain necessary client confidentiality and ensure that the privacy of the bank is not violated, and ensure that clients' rights and assets are properly safeguarded.
                c) Where the Board has identified any significant issues related to the bank's adopted governance framework, appropriate and timely action is taken to address any identified adverse deviations from the requirements of this Module.
                October 07

              • HC-1.2.7

                In its review of the systems and controls framework in Paragraph HC-1.2.6, the Board must:

                a) Make effective use of the work of external and internal auditors. The Board must ensure the integrity of the bank's accounting and financial reporting systems through regular independent review (by internal and external audit). Audit findings must be used as an independent check on the information received from management about the bank's operations and performance and the effectiveness of internal controls; and
                b) Make use of self-assessments, stress/scenario tests, and/or independent judgements made by external advisors. The Board should appoint supporting committees, and engage senior management to assist it in the oversight of risk management; and
                c) Ensure that senior management have put in place appropriate systems of control for the business of the bank and the information needs of the Board; in particular, there must be appropriate systems and functions for identifying as well as for monitoring risk, the financial position of the bank, and compliance with applicable laws, regulations and best practice standards. The systems must produce information on a timely basis.
                October 07

            • Corporate Ethics, Conflicts of Interest and Code of Conduct

              • HC-1.2.8

                Banks are subject to a wide variety of laws, regulations and codes of best practice that directly affect the conduct of business. Such laws involve the Bahraini Stock Exchange Law, the Labour Law, the Commercial Companies Law, occupational health and safety, even environment and pollution laws, as well as codes of conduct and regulations of the Central Bank. The Board sets the 'tone at the top' of a bank, and has a responsibility to oversee compliance with these various requirements. The Board should ensure that the staff conduct their affairs with a high degree of integrity, taking note of applicable laws, codes and regulations.

                October 07

              • HC-1.2.9

                The Board must establish corporate standards for itself, senior management, and employees. This requirement should be met by way of a documented and published code of conduct or similar document. These values must be communicated throughout the bank, so that the Board and senior management and staff understand the importance of conducting business based on good corporate governance values and understand their accountabilities to the various stakeholders of the licensee. Banks' Boards, senior management and staff must be informed of and be required to fulfil their fiduciary responsibilities to the bank's stakeholders.

                October 07

              • HC-1.2.10

                An internal code of conduct is separate from the business strategy of a bank. A code of conduct should outline the practices that Directors, senior management and staff should follow in performing their duties. Banks may wish to use procedures and policies to complement their codes of conduct. The suggested contents of a code of conduct are covered below:

                a) Commitment by the Board and management to the code. The code of conduct should be linked to the objectives of the bank, and its responsibilities and undertakings to customers, shareholders, staff and the wider community (see HC-1.2.8 and HC-1.2.9). The code should give examples or expectations of honesty, integrity, leadership and professionalism;
                b) Commitment to the law and best practice standards. This commitment would include commitments to following accounting standards, industry best practice (such as ensuring that information to clients is clear, fair, and not misleading), transparency, and rules concerning potential conflicts of interest (see HC-1.2.11);
                c) Employment practices. This would include rules concerning health and safety of employees, training, policies on the acceptance and giving of business courtesies, prohibition on the offering and acceptance of bribes, and potential misuse of company assets;
                d) How the company deals with disputes and complaints from clients and monitors compliance with the code; and
                e) Confidentiality. Disclosure of client or bank information should be prohibited, except where disclosure is required by law (see HC-1.2.6 b).
                October 07

              • HC-1.2.11

                The Board must establish and disseminate to its members and management, policies and procedures for the identification, reporting, disclosure, prevention, or strict limitation of potential conflicts of interest. It is senior management's responsibility to implement these policies. Rules concerning connected party transactions and potential conflicts of interest may be dealt with in the Code of Conduct (see HC-1.2.9). In particular, the Central Bank requires that any decisions to enter into transactions, under which Board members or any member of management would have conflicts of interest that are material, should be formally and unanimously approved by the full Board. Best practice would dictate that a Board member or member of senior management must:

                a) Not enter into competition with the bank;
                b) Not demand or accept substantial gifts from the bank for himself or his associates;
                c) Not misuse the banks' assets;
                d) Not use company privileged information or take advantage of business opportunities to which the company is entitled for himself or his associates;
                e) Report to the Board any (potential) conflict of interest in their activities with, and commitments to other organisations. In any case, all Board members and members of senior management must declare in writing all of their other interests in other enterprises or activities (whether as a shareholder of above 5% of the voting capital of a company, a manager, or other form of significant participation) to the Board (or the Nominations or Audit Committees) on an annual basis; and
                f) Absent themselves from any discussions or decision-making that involves a subject where they are incapable of providing objective advice, or which involves a subject or (proposed) transaction where a conflict of interest exists.
                October 07

              • HC-1.2.12

                The Central Bank expects that the Board and its members individually and collectively:

                a) Act with honesty, integrity and in good faith, with due diligence and care, with a view to the best interest of the bank and its shareholders and other stakeholders (see Paragraphs HC-1.2.8 to HC-1.2.11);
                b) Act within the scope of their responsibilities (which should be clearly defined – see HC-1.3.7 and HC-1.3.8 below) and not participate in the day-to-day management of the bank;
                c) Have a proper understanding of, and competence to deal with the affairs and products of the bank and devote sufficient time to their responsibilities;
                d) To independently assess and question the policies, processes and procedures of the bank, with the intent to identify and initiate management action on issues requiring improvement. (i.e. to act as checks and balances on management).
                October 07

              • HC-1.2.13

                All Directors whether non-executive or executive should exercise independence in their decision-making. To facilitate independence, the Board should agree procedures whereby the Board or its individual members (or committees) may take independent professional advice at the bank's expense.

                October 07

          • HC-1.3 HC-1.3 Board Composition and The Role of Committees

            • Board Composition & Frequency of Meetings

              • HC-1.3.1

                To fulfil its responsibility for the review of the systems and controls framework (HC-1.2.3 c), the Board must periodically assess its composition and size and, where appropriate, reconstitute itself and its committees by selecting new Directors to replace long-standing members or those members whose contribution to the bank or its committees (such as the audit committee) is not adequate.

                October 07

              • HC-1.3.2

                No Board member may have more than one Directorship of a Retail Bank or a Wholesale Bank. This would mean an effective cap of a maximum of two Directorships of financial institutions inside Bahrain. Two Directorships of licensees within the same Category (e.g. 'Retail Bank') would not be permitted. Banks may approach the Central Bank for exemption from this limit where the Directorships concern banks or financial institutions within the same group.

                October 07

              • HC-1.3.3

                The Board must meet sufficiently often to enable it to discharge its responsibilities effectively, taking into account the bank's scale and complexity.

                October 07

              • HC-1.3.4

                To meet its obligations under Rule HC-1.3.3 above, the full Board should meet preferably no less than four times per year. The Central Bank recommends that meetings should take place once every quarter to address the Board's responsibilities for management oversight and performance monitoring. Furthermore, Board rules should require members to step down if they are not actively participating in Board meetings.

                October 07

            • Independent and Non-Executive Directors

              • HC-1.3.5

                Where there is the potential for conflict of interest, or there is a need for impartiality, the Board must assign a sufficient number of independent non-executive Board members capable of exercising independent judgement. At a minimum, all locally incorporated banks must appoint one independent non-executive director. The Board must outline its criteria and materiality thresholds in the annual report for the definition of 'independence'. The Directors must be identified in the annual report as executive, non-executive, and independent non-executive, as follows:

                a) Executive Director (or 'Managing Director' under the Commercial Companies Law 'CCL') - A person who is involved in the day-to-day management and/or is in full-time employment of the bank and/or any of its affiliates or subsidiaries or parent companies. An Executive Director may not occupy the post of 'Chairman';
                b) Non-Executive Director - A person not involved in the day-to-day management and/or is not a full-time salaried employee of the bank and/or any of its affiliates, or subsidiaries or parent companies; and
                c) Independent Non-Executive Director - A non-Executive Director (as defined above), who also:
                •  Is not a 'controller' of the bank (see Section GR-5.2).
                •  Is not an Associate (see Section GR-5.2) of a Director or a member of senior management of the bank.
                •  Is not a professional advisor to the bank or group (A partner or member of senior management of an accountancy or law firm that provides services to the bank would not be perceived by the Central Bank as an independent non-Executive Director).
                •  Is not a large depositor with, or large borrower from the bank (i.e. whose deposits or credit facilities exceed 10% of the capital base of the bank).
                •  Has no significant contractual or business relationship with the bank or group which could be seen to materially interfere with the person's capacity to act in an independent manner.
                October 07
                Amended: April 2008

              • HC-1.3.6

                Independent non-executive Directors should be permitted to meet periodically (e.g. at separate meetings from the main Board) without executive management present.

                October 07

            • Checks and Balances

              • HC-1.3.7

                To ensure a clear segregation of duties, the Board must clearly define, document and enforce its own responsibilities, including those of its Chairman, as well as the delegated authorities, responsibilities and accountabilities of the Board and management committees, the bank's Chief Executive and senior management to the stakeholders of the bank.

                October 07

              • HC-1.3.8

                In particular, the Board must issue formal letters of appointment both to senior management and Board members, outlining their specific responsibilities and accountabilities. Wherever possible, these documents or a summary of responsibilities should be disclosed publicly, for example in the annual report. Letters of appointment facilitate better understanding of the respective accountabilities of the Board and management.

                October 07

            • Responsibilities of the Chairman

              • HC-1.3.9

                The Chairman is responsible for the leadership of the Board, and for the efficient functioning of the Board. The Chairman is responsible for ensuring that Board members are adequately briefed in sufficient time for issues arising at Board meetings; therefore it is vital that the Chairman commit sufficient time to perform his role effectively, taking into account the points below.

                a) The role of Chairman and Chief Executive may not be exercised by the same person; and
                b) Furthermore, there needs to be a clear division of responsibility between these two positions (see also HC-1.3.8 in this regard).
                October 07

              • HC-1.3.10

                The Chairman of the Board preferably should be non-executive and independent (see HC-1.3.5 for the definitions of 'non-executive' and 'independent').

                October 07

            • The benefits and functions of committees

              • HC-1.3.11

                In order to perform its duties more efficiently, the Board may set up committees where it feels appropriate with specific responsibilities, which must be documented. Where committees are set up, they should keep full minutes of their activities and meet regularly to fulfil their mandates. In particular, there are three areas where there is a need for checks and balances within the Board itself:

                a) The nomination of Directors;
                b) The remuneration of Directors; and
                c) The audit of the bank's financial performance.

                In these areas, executive Directors have clear potential conflicts of interest. Nomination is all about the continuation of their own jobs and the jobs of their colleagues and potential new colleagues. Remuneration is all about the rewards that executive Directors and/or senior management receive for their services to the bank. Audit concerns the probity of the financial and non-financial reporting of the performance of the company by the very same persons who are responsible for its performance.

                For larger banks that deal with the general public, committees can be a more efficient mechanism to assist the main Board in its monitoring and control of the activities of the bank. The establishment of committees should not mean that the role of the Board is diminished, or that the Board becomes fragmented. Each Committee must have a clear written mandate outlining its purpose, objectives and responsibilities, including composition, frequency of meetings and reporting relationships.

                October 07

            • Audit Committee

              • HC-1.3.12

                The Central Bank requires all banks to establish an Audit Committee. The committee members must have sufficient technical expertise to enable the committee to perform its functions effectively. There must be at least one qualified and appropriately experienced accountant in the committee. All members of the committee must be financially literate. The CEO may not be a member of this committee.

                October 07

              • HC-1.3.13

                Responsibilities of the Audit Committee are as follows:

                a) To review the integrity of the bank's financial reporting (particularly with reference to information passed to the Board - see HC-1.2.6 a). This review must include the choice of accounting policies. The information needs of the Board to perform its monitoring responsibilities must be defined in writing, and regularly monitored by the Audit Committee;
                b) To oversee the selection and compensation of the external auditor for appointment and approval at the shareholders' meeting. The audit committee must oversee relations with the external auditors, including ensuring the external auditor's independence (in particular, making sure that the external audit firm and its partners have no other financial or business relationship without the Board's knowledge), the terms and conditions of the auditor's appointment and remuneration arrangements. The committee must monitor rotation arrangements for audit engagement partners. The audit committee must monitor the performance of the external auditor and the non-audit services provided by the external auditor. The committee must meet with the external auditor at least twice per year, and at least once per year in the absence of any members of executive management;
                c) To regularly review the activities and performance of the internal audit function;
                d) To review whether the bank complies with all relevant laws, regulations, codes and business practices, and ensure that the bank communicates with shareholders and relevant stakeholders (internal and external) openly and promptly, and with substance of compliance prevailing over form; and
                e) To review and supervise the implementation of, enforcement of and adherence to the bank's code of conduct.
                October 07

              • HC-1.3.14

                Below the Audit Committee, the bank must set up an internal audit function, which reports directly to the Audit Committee (with a parallel reporting line to senior management for day-to-day matters as appropriate).

                October 07

          • HC-1.4 HC-1.4 Transparency and Disclosure

            • Board's Responsibility for Disclosure

              • HC-1.4.1

                The Board must oversee the process of disclosure and communications with internal and external stakeholders. The Board must ensure that disclosures made by the bank are fair, transparent, comprehensive and timely and reflect the character of the bank and the nature, complexity and risks inherent in the bank's business activities. Disclosure policies must be reviewed for compliance with the Central Bank's disclosure requirements (see Rulebook Chapter PD-1).

                October 07

          • HC-1.5 HC-1.5 Notification, reporting, and approval requirements for changes to activities, personnel and ownership, strategy, Board meetings and special purpose vehicles ('SPVs')

            • HC-1.5.1

              Banks must notify the CBB in writing of all major proposed changes to the strategy and/or corporate plan of the bank prior to implementation.

              October 07

            • HC-1.5.2

              Banks must notify the Central Bank in writing of any proposed changes to senior positions or ownership changes mentioned in Sections HC-2.1, HC-3.2 and HC-4.1 (whether in terms of structure or identity of personnel) prior to the change. The communication should include the reason for the departure of the personnel and the Curriculum Vitae of any new persons taking up the relevant positions in the bank (see also HC-2.1.17). See also Section BR-5.1 for notification requirements concerning contact details of senior staff.

              Amended January 2009
              October 07

            • HC-1.5.3

              If a controlled function falls vacant, the conventional bank licensee must appoint a permanent replacement (after obtaining CBB approval), within 120 calendar days of the vacancy occurring. Pending the appointment of a permanent replacement, the conventional bank licensee must make immediate interim arrangements to ensure continuity of the duties and responsibilities of the controlled function affected. These interim arrangements must be approved by the CBB.

              Added January 2009

            • HC-1.5.4

              All locally incorporated banks, in addition to the requirements in Paragraphs HC-1.5.1 and HC-1.5.2, should obtain the Central Bank's prior specific written approval before establishing any subsidiaries (including SPVs where the bank exercises a majority shareholding or has majority voting control by virtue of direct ownership or by proxy/nominee arrangements), branches and/or representative offices, either inside or outside of Bahrain. In order to avoid any delays and/or disruption in implementation of banks' plans in this context, the Central Bank should be approached as soon as possible, even at a very preliminary stage.

              Renumbered January 2009
              October 07

            • HC-1.5.5

              All locally incorporated banks are required to submit, on an annual basis, as an attachment to the year-end quarterly PIR, a report recording the meetings during the year by their Board of Directors. For a sample report, refer to Appendix BR-10.

              Renumbered January 2009
              October 07

            • HC-1.5.6

              All locally incorporated banks must notify the Central Bank if they intend to act as sponsor or manager of a special purpose vehicle ('SPV'), or if they intend to participate in the creation of an SPV, or if they intend to acquire shares in an SPV. All locally incorporated banks must notify the Central Bank if they are appointed as nominee shareholders of SPVs or hold votes by proxy arrangement in SPVs on behalf of other investors. In all cases listed above, the concerned bank must notify the Central Bank quarterly of any new commitments to, or engagements in business arrangements with SPVs. These reporting and notification arrangements apply in addition to arrangements under HC-1.5.4 where the SPV is a subsidiary.

              Renumbered January 2009
              October 07

            • HC-1.5.7

              The Central Bank requires any locally incorporated bank associated with an SPV to give the background to the following points in any notification under HC-1.5.6 above:

              a) The purpose of the SPV;
              b) The nature of the relationship between the bank and the SPV (i.e. sponsor, manager, investor, controller etc.);
              c) The external auditor's proposed consolidation/accounting treatment of the SPV;
              d) The availability of financial and other information relevant to the SPV and access to its business premises and records;
              e) Whether the bank is providing any guarantees, warranties or financial/liquidity support of any kind to the SPV.
              Renumbered January 2009
              October 07

            • HC-1.5.8

              Where the SPV is consolidated into the accounts of a locally incorporated bank, the bank must provide separate accounting information on the SPV to the Central Bank on a quarterly basis. Furthermore, the annual audited financial statements of all consolidated SPVs must be submitted to the Central Bank within 3 months of the year end of the concerned SPV.

              Renumbered January 2009
              October 07

            • HC-1.5.9

              Where a locally incorporated bank has a controller or majority ownership relationship with an SPV, or acts as sponsor, the bank must obtain the prior approval of the Central Bank for any changes to the capital, ownership, management or control of the SPV. All locally incorporated banks must also notify the Central Bank of any significant events in relation to the SPV. If necessary, the Central Bank may require that formal information exchange arrangements are put in place (e.g. a memorandum of understanding) if the SPV is located in a foreign jurisdiction and its activities are not supervised locally.

              Renumbered January 2009
              October 07

        • HC-2 HC-2 Approved Persons

          • HC-2.1 HC-2.1 CBB Notification and Approval

            • General Requirement

              • HC-2.1.1

                All persons wishing to undertake a controlled function in a conventional bank licensee must be approved by the CBB prior to their appointment (subject to the variations contained in Rule HC-2.1.3).

                October 07

              • HC-2.1.2

                Controlled functions are those of:

                (a) Director;
                (b) Chief Executive or General Manager;
                (c) Senior Manager;
                (d) Compliance officer;
                (e) Money Laundering Reporting Officer;
                (f) Deputy Money Laundering Reporting Officer; and
                (g) Financial Instruments Trader.
                Amended: October 2009
                October 2007

              • HC-2.1.3

                Prior approval is required for controlled functions (a), (b), (c), (d), (e) and (f). Controlled functions (d) and (e) may be combined, however (see also FC-4.1, regarding the MLRO function). Controlled function (g) does not require prior approval: instead, notification only is required, once the person concerned has accepted to undertake that function.

                Amended: October 2009
                October 2007

            • Basis for Approval

              • HC-2.1.4

                Approval under Rule HC-2.1.1 is only granted by the CBB, if it is satisfied that the person is fit and proper to hold the particular position in the licensee concerned. 'Fit and proper' is determined by the CBB on a case-by-case basis. The definition of 'fit and proper' and associated guidance is provided in Sections HC-2.2 and HC-2.3 respectively.

                October 07

            • Definitions

              • HC-2.1.5

                Director is any person who occupies the position of a Director, as defined in Article 173 of the Commercial Companies Law (Legislative Decree No. 21 of 2001).

                October 07

              • HC-2.1.6

                The fact that a person may have 'Director' in their job title does not of itself make them a Director within the meaning of the definition noted in Rule HC-2.1.5. For example, a 'Director of Marketing', is not necessarily a member of the Board of Directors and therefore may not fall under the definition of Rule HC-2.1.5.

                October 07

              • HC-2.1.7

                The Chief Executive or General Manager means a person who is responsible for the conduct of the licensee (regardless of actual title). The Chief Executive or General Manager must be resident in Bahrain. This person is responsible, alone or jointly, for the conduct of the whole of the firm, or, in the case of an overseas conventional bank licensee, for all of the activities of the branch (in which case, he may hold the title of 'Branch Manager').

                October 07

              • HC-2.1.8

                Senior Manager means a person who, under the immediate authority of a Director or the Chief Executive/General Manager, exercises major managerial responsibilities, is responsible for a significant business or operating unit, or has major managerial responsibility for maintaining accounts or other records of the licensee.

                October 07

              • HC-2.1.9

                Whether a person is a Senior Manager will depend on the facts in each case and is not determined by the presence or absence of the word in their job title. Examples of Senior Managers might include, depending on the scale, nature and complexity of the business, a deputy Chief Executive; and heads of departments such as Risk Management, or Internal Audit; or the Chief Financial Officer.

                October 07

              • HC-2.1.10

                Financial Instruments Trader means a person who is engaged in buying or selling financial instruments.

                October 07

              • HC-2.1.11

                Where a firm is in doubt as to whether a function should be considered a controlled function it must discuss the case with the CBB.

                October 07

            • Notification Requirements and Process

              • HC-2.1.12

                Conventional bank licensees must obtain CBB approval before a person is formally appointed to a controlled function; the request for CBB approval must be made by submitting to CBB a duly completed Form 3 (Application for Approved Person status). In the case of a financial instruments trader, notification only is required (see Rule HC-2.1.3): this notification must also be made by submitting a Form 3.

                October 07

              • HC-2.1.13

                In the case of license applications, the Form 3 must be marked for the attention of the Director, Licensing and Policy Directorate. When made by a conventional bank licensee, the Form 3 must be marked for the attention of either the Director, Retail Banks Supervision or the Director, Wholesale Banks Supervision, as appropriate.

                October 07

              • HC-2.1.14

                Licensees should give the CBB a reasonable amount of notice in order for an application for approval to be reviewed. The CBB aims to respond within 2 weeks of receipt of an application, although in some cases, where referral to an overseas supervisor is required, the response time is likely to be longer.

                October 07

              • HC-2.1.15

                Licensees seeking to appoint Board Directors should seek CBB approval for all the candidates to be put forward for election at a shareholder meeting, in advance of the agenda being issued to shareholders. CBB approval of the candidates does not in any way limit shareholders' rights to refuse those put forward for election.

                October 07

              • HC-2.1.16

                All refusals by the CBB to grant a person approved person status have to be reviewed and approved by an Executive Director of the CBB. A notice of intent is issued to the licensee concerned, setting out the basis for the decision. The licensee has 30 calendar days from the date of the notice in which to appeal the decision. The CBB then has 30 calendar days from the date of the representation in which to make a final determination. See also Chapter EN-5.

                Amended January 2009
                October 07

              • HC-2.1.17

                Conventional bank licensees must immediately notify CBB when an approved person ceases to hold the controlled function for which they have been approved, for whatever reason (see also HC-1.5.2).

                Amended January 2009
                October 07

              • HC-2.1.18

                Thus, licensees are required to notify CBB should an approved person transfer to another function within the licensee, or to another group entity; or else resign, be suspended or dismissed. CBB may require further clarification as to the reasons for the person's transfer or departure. CBB will automatically withdraw the individual's approved person status: should the person wish to undertake another controlled function, whether within the same licensee or in another licensee, then a new application should be resubmitted.

                October 07

              • HC-2.1.19

                Conventional bank licensees must immediately notify CBB should they become aware of information that could reasonably be viewed as calling into question an approved person's compliance with CBB's 'fit and proper' requirement (see HC-2.2).

                October 07

          • HC-2.2 HC-2.2 'Fit and proper' requirement

            • HC-2.2.1

              Licensees seeking an approved person authorisation for an individual, must satisfy the CBB that the individual concerned is 'fit and proper' to undertake the controlled function in question.

              October 07

            • HC-2.2.2

              To be considered 'fit and proper', those nominated must demonstrate:

              (a) Personal integrity, honesty and good reputation;
              (b) Professional competence, experience and expertise, sufficient for the controlled function for which authorisation is being applied for, and given the scale, complexity and nature of the conventional bank licensee concerned; and
              (c) Financial soundness.
              October 07

            • HC-2.2.3

              In assessing the conditions prescribed in Rule HC-2.2.2, the CBB will take into account the criteria contained in Section HC-2.3. The CBB reviews each application on a case-by-case basis, taking into account all relevant circumstances. A person may be considered 'fit and proper' to undertake one type of controlled function but not another, depending on the function's job size and required levels of experience and expertise. Similarly, a person approved to undertake a controlled function in one conventional bank licensee may not be considered to have sufficient expertise and experience to undertake nominally the same controlled function but in a much bigger licensee.

              October 07

            • HC-2.2.4

              Approved persons undertaking a controlled function must act prudently, and with honesty, integrity, care, skill and due diligence in the performance of their duties. They must avoid conflicts of interest arising whilst undertaking a controlled function.

              October 07

            • HC-2.2.5

              In determining whether a conflict of interest may arise, factors that may be considered include whether:

              (a) A person has breached any fiduciary obligations to the company or terms of employment;
              (b) A person has undertaken actions that would be difficult to defend, when looked at objectively, as being in the interest of the licensee; and
              (c) A person has failed to declare a personal interest that has a material impact in terms of the person's relationship with the licensee.
              October 07

          • HC-2.3 HC-2.3 Interpretative Guidance on 'Fit and Proper' Requirement

            • HC-2.3.1

              In assessing a person's fitness and propriety, the CBB will consider previous professional and personal conduct (in Bahrain or elsewhere) including, but not limited to, the following:

              (a) The propriety of a person's conduct, whether or not such conduct resulted in a criminal offence being committed, the contravention of a law or regulation, or the institution of legal or disciplinary proceedings;
              (b) A conviction or finding of guilt in respect of any offence, other than a minor traffic offence, by any court or competent jurisdiction;
              (c) Any adverse finding in a civil action by any court or competent jurisdiction, relating to fraud, misfeasance or other misconduct in connection with the formation or management of a corporation or partnership;
              (d) Whether the person has been the subject of any disciplinary proceeding by any government authority, regulatory agency or professional body or association;
              (e) The contravention of any financial services legislation or regulation;
              (f) Whether the person has ever been refused a license, authorisation, registration or other authority;
              (g) Dismissal or a request to resign from any office or employment;
              (h) Disqualification by a court, regulator or other competent body, as a Director or as a manager of a corporation;
              (i) Whether the person has been a Director, partner or manager of a corporation or partnership which has gone into liquidation or administration or where one or more partners have been declared bankrupt whilst the person was connected with that partnership;
              (j) The extent to which the person has been truthful and open with supervisors;
              (k) The extent to which the person has appropriate professional and other qualifications for the controlled function in question;
              (l) The extent to which the person has sufficient experience, or is otherwise able to perform the functions of the controlled function in question;
              (m) Whether the person has ever been adjudged bankrupt, entered into any arrangement with creditors in relation to the inability to pay due debts, or failed to satisfy a judgement debt under a court order.
              October 07

            • HC-2.3.2

              With respect to HC-2.3.1(b), (c), (d) and (e), the CBB will take into account the length of time since any such event occurred, as well as the seriousness of the matter in question.

              October 07

            • HC-2.3.3

              Further guidance on the process for assessing a person's 'fit and proper' status is given in Module EN (Enforcement): see Chapter EN-8.

              October 07

        • HC-3 HC-3 Compliance officer/manager

          • HC-3.1 HC-3.1 Introduction

            • HC-3.1.1

              In order to promote best practice with respect to banks' internal systems and controls and international banking supervision, the Central Bank, in this Chapter, outlines its requirements for the compliance function of banks. The expression 'Compliance Function' in this Chapter is used to describe staff carrying out compliance duties.

              October 07

            • HC-3.1.2

              The expression 'Compliance Risk', in this Chapter refers to the risk of legal or regulatory sanctions, material or financial loss, or loss to reputation a bank may suffer as a result of its failure to comply with laws, regulations, rules, reporting requirements, standards and codes of conduct applicable to its activities, rather than compliance with a bank's internal limits or procedures.

              October 07

            • HC-3.1.3

              For further information and guidance on compliance risk and the compliance function, banks should refer to the Basel Committee publication, 'Compliance and the compliance function in banks' (www.bis.org/publ April 2005). The Central Bank expects banks to carry out a review of their compliance with the principles in this paper on a regular basis (either by way of a self-assessment or by way of a review by the internal or external audit function).

              October 07

          • HC-3.2 HC-3.2 Requirement for and approval of a compliance officer/manager

            • HC-3.2.1

              All banks must appoint a senior member of staff with responsibility for the management of compliance risk as their Compliance Officer/Manager.

              October 07

            • HC-3.2.2

              The compliance function must be independent (i.e. it must not be placed in a position where its other duties or responsibilities may cause a conflict of interest with its compliance risk management responsibilities). Therefore the compliance function must be separate from the internal audit function. The compliance officer or manager may however, perform other limited related compliance roles (e.g. the MLRO or legal advisor), subject to the Central Bank's prior approval.

              October 07

            • HC-3.2.3

              The compliance officer/manager must be appropriately qualified and experienced and the compliance function must have adequate resources to carry out its functions effectively.

              October 07

            • HC-3.2.4

              The appointment of a compliance manager/officer requires the Central Bank's prior approval and the submission of the appointee's Personal Questionnaire (Appendix LR 2) and Curriculum Vitae to the Central Bank. The bank must also outline how the compliance function fits into the bank's senior management reporting structure, and must give details of relevant reporting lines within the bank.

              October 07

            • HC-3.2.5

              In the case of locally incorporated banks, the compliance officer/manager must have access to the Board of Directors in addition to the senior management.

              October 07

      • AU AU Auditors and Accounting Standards

        • AU-A AU-A Introduction

          • AU-A.1 AU-A.1 Purpose

            • AU-A.1.1

              This Module presents requirements that have to be met by conventional bank licensees with respect to the appointment of external auditors. This Module also sets out certain obligations that external auditors have to comply with, as a condition of their appointment by conventional bank licensees.

            • AU-A.1.2

              This Module is issued under the powers given the BMA under Article 41 of the BMA Law 1973. It supplements Article 79 of the BMA Law, which requires licensees to appoint an external auditor acceptable to the BMA.

          • AU-A.2 AU-A.2 Module History

            • Evolution of Module

              • AU-A.2.1

                This Module was first issued as Module AU (Audit Firms) in July 2004, as part of the first release of Volume 1 (conventional banks) of the BMA Rulebook. It was subsequently reissued in full in July 2006 (and renamed "Auditors and Accounting Standards").

              • AU-A.2.2

                The reissued Module was one of several Modules modified to reflect the introduction of the BMA's new integrated license framework. Although the new framework did not change the substance of the requirements contained in this Module, the Module was re-issued in order to simplify its drafting and layout and align it with equivalent Modules in other Volumes of the BMA Rulebook.

              • AU-A.2.3

                This Module is dated July 2006. Pages that are subsequently changed in this Module are updated with the end-calendar quarter date in which the change was made: Chapter UG-3 provides further details on Rulebook maintenance and version control.

              • AU-A.2.4

                A list of changes made to this Module is provided below:

                Module Reference Change Date Description of Changes
                Whole Module July 2006 Module renamed as Module AU (Auditors and Accounting Standards). Text redrafted but substance of requirements left unchanged.
                AU-A.1 10/2007 New Rule AU-A.1.3 introduced, categorising this Module as a Directive.
                AU-1.2 10/2007 Rule AU-1.2.3 redrafted to clarify reporting obligation.
                AU-1.5 10/2007 Paragraphs AU-1.5.4 and AU-1.5.6 updated to reflect CBB Law requirements on auditor independence.
                Amended: October 2007

            • Superseded Requirements

              • AU-A.2.5

                This Module supersedes the following provisions contained in circulars or other regulatory instruments, issued prior to the introduction of Volume 1 (conventional banks) of the BMA Rulebook:

                Circular Ref. Date of Issue Module Ref. (July 2004 version) Circular Subject
                BC/5/82 5 Aug 1982 AU-1.1 Approval of Appointment of Auditors
                ODG/59/99 15 Jul 1999 AU-1.1–AU-1.2 Audit Partners of External Auditors and Reporting Accountants of Locally Incorporated Banks
                BC/3/02 13 Mar 2002 AU-1.3 Additional Public Disclosure Requirements Amended Version — 2002
                BC/12/01
                (partial)
                26 Nov 2001 AU-1.4 The Monitoring and Control of Large Exposures of Banks Licensed by the Agency
                ODG/162/03
                (partial)
                21 May 2003 AU-2.2 Outsourcing
                BS/9/03
                (partial)
                14 Sep 2003 AU-1.4 Operational Risk Management
                BC/1/97 12 Feb 1997 AU-1.5 Request for Approval for Dividend Distribution
                14/86 19 Jun 1986 AU-2.1 Auditors' Relationship with Supervisors
                BC/2/99 21 Feb 1999 AU-3.2 Public Disclosure
                BMA/751/93
                (partial)
                8 Jul 1993 AU-3.2 Directors' Interest in the Shares of, and the Unaudited Quarterly Financial Statements of, Locally Incorporated Banks Quoted on the Bahrain Stock Exchange.
                BC/1/99 22 Feb 1999 AU-3.3 Enhancing Bank Transparency
                BC/07/02 26 Jun 2002 AU-3.4 Review of PIR by External Auditors
                ODG/50/98
                (partial)
                11 Sep 1998 AU-3.5 Market Risk Capital Regulations
                EDBC/6/01
                (partial)
                14 Oct 2001 AU-3.6 Money laundering Regulation
                BC/3/02 13 Mar 2002 AU-3.7 Additional Public Disclosure Requirements Amended Version — 2002
                BC/7/01
                (partial)
                23 Oct 2001 AU-3.7 Audited Financial Statement of Locally Incorporated Banks for the Year Ending 31 December 2001 and Subsequent Years.
                BC/8/01
                (partial)
                23 Oct 2001 AU-3.7 Audited Financial Statement of Branches of Foreign Banks for the Year Ending 31 December 2001 and Subsequent Years.
                BC/6/97 21 Apr 1997 AU-4 Reporting Accountants

        • AU-B AU-B Scope of Application

          • AU-B.1 AU-B.1 Conventional bank Licensees

            • AU-B.1.1

              The contents of this Module — unless otherwise stated — apply to all conventional bank licensees.

            • AU-B.1.2

              The contents of Chapters AU-1 to AU-4 apply to both Bahraini conventional bank licensees and overseas conventional bank licensees.

          • AU-B.2 AU-B.2 Auditors

            • AU-B.2.1

              Certain requirements in this Module extend to auditors, by virtue of their appointment by conventional bank licensees. Auditors appointed by conventional bank licensees must be independent (cf. Sections AU-1.4 and AU-1.5). Auditors who resign or are otherwise removed from office must inform the BMA in writing of the reasons for the termination of their appointment (cf. Sections AU-1.2). Other requirements are contained in Sections AU-1.3 (Audit partner rotation) and AU-3 (Auditor reports).

        • AU-1 AU-1 Auditor Requirements

          • AU-1.1 AU-1.1 Appointment of Auditors

            • AU-1.1.1

              Conventional bank licensees must obtain prior written approval from the BMA before appointing or re-appointing their auditors.

            • AU-1.1.2

              As the appointment of auditors normally takes place during the course of the firm's annual general meeting, conventional bank licensees should notify the BMA of the proposed agenda for the annual general meeting in advance of it being circulated to shareholders. The BMA's approval of the proposed auditors does not limit in any way shareholders' rights to subsequently reject the Board's choice.

            • AU-1.1.3

              The BMA, in considering the proposed (re-) appointment of an auditor, takes into account the expertise, resources and reputation of the audit firm, relative to the size and complexity of the licensee. The BMA will also take into account the track record of the audit firm in auditing conventional bank licensees within Bahrain; the degree to which it has generally demonstrated independence from management in its audits; and the extent to which it has identified and alerted relevant persons of significant matters. Finally, the BMA will also consider the audit firm's compliance with applicable laws and regulations (including legislative Decree No. 26 of 1996; the Ministry of Industry and Commerce's Ministerial Resolution No. 6 of 1998; and relevant Bahrain Stock Exchange regulations).

            • AU-1.1.4

              In the case of overseas conventional bank licensees, the BMA will also take into account who acts as the auditors of the parent firm. As a general rule, the BMA does not favour different parts of a banking firm or group having different auditors.

          • AU-1.2 AU-1.2 Removal or Resignation of Auditors

            • AU-1.2.1

              Conventional bank licensees must notify the BMA as soon as they intend to remove their auditors, with an explanation of their decision, or as soon as their auditors resign.

            • AU-1.2.2

              Conventional bank licensees must ensure that a replacement auditor is appointed (subject to BMA approval as per Section AU-1.1), as soon as reasonably practicable after a vacancy occurs, but no later than three months.

            • AU-1.2.3

              An auditor who resigns or is otherwise removed from the office of auditor must, within 30 days of the resignation or removal, write to the BMA setting out the reasons for the resignation or removal.

          • AU-1.3 AU-1.3 Audit Partner Rotation

            • AU-1.3.1

              Unless otherwise exempted by the BMA, conventional bank licensees must ensure that the audit partner responsible for their audit does not undertake that function more than five years in succession.

            • AU-1.3.2

              Conventional bank licensees must notify the BMA of any change in audit partner.

          • AU-1.4 AU-1.4 Auditor Independence

            • AU-1.4.1

              Before a conventional bank licensee appoints an auditor, it must take reasonable steps to ensure that the auditor has the required skill, resources and experience to carry out the audit properly, and is independent of the licensee.

            • AU-1.4.2

              For an auditor to be considered independent, it must, amongst other things, comply with the restrictions in Section AU-1.5.

            • AU-1.4.3

              If a conventional bank licensee becomes aware at any time that its auditor is not independent, it must take reasonable steps to remedy the matter and notify the BMA of the fact.

            • AU-1.4.4

              If in the opinion of the BMA, independence has not been achieved within a reasonable timeframe, then the BMA may require the appointment of a new auditor.

          • AU-1.5 AU-1.5 Licensee/Auditor Restrictions

            • Financial Transactions with Auditors

              • AU-1.5.1

                Conventional bank licensees must not lend to their auditors, nor enter into any contracts of professional indemnity insurance with their auditors.

            • Outsourcing to Auditors

              • AU-1.5.2

                Section OM-2.7 generally prohibits conventional bank licensees from outsourcing their internal audit function to the same firm that acts as their external auditors. However, the BMA may allow short-term outsourcing of internal audit operations to a conventional bank licensee's external auditor, to meet unexpected urgent or short-term needs (for instance, on account of staff resignation or illness). Any such arrangement will normally be limited to a maximum period of one year and is subject to BMA prior approval.

            • Other Relationships

              • AU-1.5.3

                Conventional bank licensees and their auditors must comply with the restrictions contained in Article 217(c) of the Commercial Companies Law (Legislative Decree No. (21) of 2001).

              • AU-1.5.4

                Article 217(c) prohibits an auditor from (i) being the chairman or a member of the Board of Directors of the company he/she audits; (ii) holding any managerial position in the company he/she audits; and (iii) acquiring any shares in the company he/she audits, or selling any such shares he/she may already own, during the period of his audit. Furthermore, the auditor must not be a relative (up to the second degree) of a person assuming management or accounting duties in the company.

              • AU-1.5.5

                The restriction in Paragraph AU-1.5.3 applies to overseas conventional bank licensees as well as Bahraini conventional bank licensees.

              • AU-1.5.6

                A partner, Director or manager on the engagement team of auditing a conventional bank licensee may not serve on the Board or in a controlled function of the licensee, for two years following the end of their involvement in the audit, without prior authorisation of the BMA.

              • AU-1.5.7

                Chapter HC-2 sets out the BMA's "controlled functions" requirements.

            • Definition of "Auditor"

              • AU-1.5.8

                For the purposes of Section AU-1.5, "auditor" means the partners, Directors and managers on the engagement team responsible for the audit of the conventional bank licensee.

        • AU-2 AU-2 Access

          • AU-2.1 AU-2.1 BMA Access to Auditors

            • AU-2.1.1

              Conventional bank licensees must waive any duty of confidentiality on the part of their auditors, such that their auditors may report to the BMA any concerns held regarding material failures by the conventional bank licensee to comply with BMA requirements.

            • AU-2.1.2

              The BMA may, as part of its on-going supervision of conventional bank licensees, request meetings with a licensee's auditors. If necessary, the BMA may direct that the meeting be held without the presence of the licensee's management or Directors.

          • AU-2.2 AU-2.2 Auditor Access to Outsourcing Providers

            • AU-2.2.1

              Rule OM-2.5.1(c) on outsourcing agreements between conventional bank licensees and outsourcing providers requires licensees to ensure that their internal and external auditors have timely access to any relevant information they may require to fulfil their responsibilities. Such access must allow them to conduct on-site examinations of the outsourcing provider, if required.

        • AU-3 AU-3 Auditor Reports

          • AU-3.1 AU-3.1 Review of Quarterly Prudential Information Returns

            • AU-3.1.1

              Conventional bank licensees must arrange for their auditors to review the licensee's quarterly Prudential Information Returns to the BMA, prior to their submission, unless otherwise exempted in writing by the BMA.

            • AU-3.1.2

              Conventional bank licensees are required to submit a quarterly Prudential Information Return (PIR). Conventional bank licensees may apply in writing to the BMA for an exemption from the requirement that the PIR be reviewed by the licensee's external auditors: this exemption would normally only be given where the licensee had established a track record of accurate and timely reporting, and there were no other supervisory issues of concern. Further details on the BMA's reporting and related requirements, including the precise scope of the auditor's review and attestation, are contained in Module BR (BMA Reporting).

          • AU-3.2 AU-3.2 Review of Financial Disclosures

            • AU-3.2.1

              Conventional bank licensees that are required to publish financial disclosures in accordance with Chapters PD-2 and PD-3 must arrange for their external auditors to review these prior to their publication, unless otherwise exempted in writing by the BMA.

            • AU-3.2.2

              Chapter PD-2 requires overseas conventional bank licensees operating as retail banks to publish on a semi-annual basis summary information on their balance sheet and profit and loss account, in the same format as their annual audited accounts. Chapter PD-3 requires all locally incorporated conventional bank licensees to publish quarterly financial statements, in accordance with International Accounting Standard 34 (Interim Financial Reporting).

          • AU-3.3 AU-3.3 Report on Compliance with Financial Crime Rules

            • AU-3.3.1

              Conventional bank licensees must arrange for their external auditors to report on the licensee's compliance with the requirements contained in Module FC (Financial Crime), at least once a year.

            • AU-3.3.2

              The report specified in Rule AU-3.3.1 must be in the form agreed by the BMA, and must be submitted to the BMA within four months of the licensee's financial year-end.

            • AU-3.3.3

              The context to the above requirement can be found in Section FC-4.3.

          • AU-3.4 AU-3.4 Review and Validation of internal models

            • AU-3.4.1

              Conventional bank licensees seeking BMA approval for their use of internal models for the calculation of regulatory capital requirements, must arrange for their external auditors to validate the soundness of the model concerned. This external review must be undertaken at least once a year, unless otherwise exempted in writing by the BMA.

            • AU-3.4.2

              Before granting its approval for Bahraini conventional bank licensees to use internal models for the measurement of market risk in the context of regulatory capital calculations, the BMA requires such models to be validated by both the internal and external auditors of the bank (see Chapter CA-9). The Agency will review the validation procedures performed by the internal and external auditors, and may independently carry out further validation procedures.

            • AU-3.4.3

              The specific requirements and procedures for external validation of models are contained in Section CA-9.8.

            • AU-3.4.4

              Exemptions from the external validation requirement are normally only given where a track record of satisfactory validations has been developed over several years, and where the BMA has no other material supervisory concerns regarding the licensee concerned.

        • AU-4 AU-4 Accounting Standards

          • AU-4.1 AU-4.1 General Requirements

            • AU-4.1.1

              Conventional bank licensees must comply with International Financial Reporting Standards / International Accounting Standards.

            • AU-4.1.2

              Overseas conventional bank licensees that do not, at the parent company level, apply IFRS/IAS are still required under Paragraph AU-4.1.1 to produce pro-forma accounts for the Bahrain branch in conformity with these standards. Where this requirement is difficult to implement, the Bahraini conventional bank licensee should contact the BMA in order to agree a solution.

            • AU-4.1.3

              Paragraph AU-4.1.1 requires conventional bank licensees that maintain Islamic 'windows' or units to apply relevant AAOIFI Financial Accounting Standards, depending on the type of Islamic finance contracts entered into. In particular, attention is drawn to AAOIFI Financial Accounting Standard 18, "Islamic Financial Services Offered by Conventional Financial Institutions".

      • GR GR General Requirements

        • GR-A GR-A Introduction

          • GR-A.1 GR-A.1 Purpose

            • GR-A.1.1

              The General Requirements Module presents a variety of different requirements that are not extensive enough to warrant their own stand-alone Module, but for the most part are generally applicable. These include general requirements on books and records; on the use of corporate and trade names; and on controllers. Each set of requirements is contained in its own Chapter: a table listing these and their application to licensees is given in Chapter GR-B.

          • GR-A.2 GR-A.2 Module History

            • Evolution of Module

              • GR-A.2.1

                This Module was first issued in July 2006, with immediate effect, as a new Module aimed at aligning the structure and contents of Volume 1 with other Volumes of the BMA Rulebook. It is dated July 2006. All subsequent changes to this Module are annotated with the end-calendar quarter date in which the change was made: Chapter UG-3 provides further details on Rulebook maintenance and version control.

              • GR-A.2.2

                The July 2006 version of Module GR does not introduce new requirements. Rather, it incorporates the record keeping requirements previously contained in Chapter LR-6 of the Licensing and Authorisation Requirement Module (reissued, in July 2006, as the Licensing Module). It also incorporates the requirements relating to controllers, previously contained in Chapter HC-2 of the High-Level Controls Module. Finally, Module GR expands on certain requirements that were previously contained only in the BMA Law 1973, such as the requirement to seek BMA approval for use of a corporate or trading name.

              • GR-A.2.3

                A list of recent changes made to this Module is detailed in the table below:

                Module Ref. Change Date Description of Changes
                     
                     
                     
                     

            • Superseded Requirements

              • GR-A.2.4

                This Module supersedes:

                Circular / other reference Provision Subject
                Module LR (April 2006 version) LR-6: Record Keeping Record keeping requirements were moved to GR-1, and edited down to simplify and avoid duplication of record keeping requirements contained in Module FC.
                Module HC (April 2006 version) HC-2: 'Fit and Proper Requirement' Requirements relating to controllers were moved to GR-5. Remaining 'fit and proper' elements regarding Directors and key employees of licensees were retained in HC-2, in a re-drafted form.
                     

        • GR-B GR-B Scope of Application

          • GR-B.1 GR-B.1 Conventional Bank Licensees

            • License categories

              • GR-B.1.1

                The requirements in Module GR (General Requirements) apply to both retail and wholesale conventional bank licensees.

            • Bahraini and overseas conventional bank licensees

              • GR-B.1.2

                The scope of application of Module GR (General Requirements) is as follows:

                Chapter Bahraini bank licensees Overseas bank licensees
                GR-1 GR-1.1 and GR-1.3 apply to the whole bank; GR-1.2 applies to business booked in Bahrain only. Applies to the Bahrain branch only.
                GR-2 Applies to the whole bank. Applies to the Bahrain branch only.
                GR-3 Applies to the whole bank. Doesn't apply.
                GR-4 Applies to the whole bank. Applies to the Bahrain branch only.
                GR-5 Applies to the whole bank. Applies to the whole bank.
                GR-6 [This chapter has been left blank.] [This chapter has been left blank.]
                GR-7 Applies to the whole bank. Applies to the Bahrain branch only.

              • GR-B.1.3

                In the case of Bahraini bank licensees, certain requirements apply to the whole bank, irrespective of the location of its business; other requirements apply only in respect to business booked in Bahrain. In the case of overseas conventional bank licensees, the requirements of Module GR mostly only apply to business booked in the Bahrain branch.

        • GR-1 GR-1 Books and Records

          • GR-1.1 GR-1.1 General Requirements

            • GR-1.1.1

              The requirements in Section GR-1.1 apply to Bahraini conventional bank licensees, with respect to the business activities of the whole bank (whether booked in Bahrain or in a foreign branch). The requirements in Section GR-1.1 also apply to overseas conventional bank licensees, but only with respect to the business booked in their branch in Bahrain.

            • GR-1.1.2

              All conventional bank licensees must maintain books and records (whether in electronic or hard copy form) sufficient to produce financial statements and show a complete record of the business undertaken by a licensee. These records must be retained for at least the minimum period specified under Bahrain law.

            • GR-1.1.3

              GR-1.1.2 includes accounts, books, files and other records (e.g. trial balance, general ledger, nostro/vostro statements, reconciliations and list of counterparties). It also includes records that substantiate the value of the assets, liabilities and off-balance sheet activities of the licensee (e.g. client activity files and valuation documentation). Finally, it includes email records, including email correspondence with customers and other third parties.

            • GR-1.1.4

              Bahrain law currently requires corporate records to be retained for at least 5 years (see Ministerial Order No. 23 of 2002, made pursuant to the Amiri Decree Law No. 4 of 2001).

            • GR-1.1.5

              Unless otherwise agreed with the BMA in writing, records must be kept in either English or Arabic; or else accompanied by a certified English or Arabic translation. Records must be kept current. The records must be sufficient to allow an audit of the licensee's business or an on-site examination of the licensee by the BMA.

            • GR-1.1.6

              If a licensee wishes to retain certain records in a language other than English or Arabic without translation, the licensee should write to the BMA, explaining which types of records it wishes to keep in a foreign language, and why systematically translating these may be unreasonable. Generally, only loan contracts or similar original transaction documents may be kept without translation. Where exemptions are granted by the BMA, the licensee is nonetheless asked to confirm that it will make available certified translations of such documents, if requested by the BMA for an inspection or other supervisory purpose.

            • GR-1.1.7

              Translations produced in compliance with Rule GR-1.1.5 may be undertaken in-house, by an employee or contractor of the licensee, providing they are certified by an appropriate officer of the licensee.

            • GR-1.1.8

              Records must be accessible at any time from within the Kingdom of Bahrain, or as otherwise agreed with the BMA in writing.

            • GR-1.1.9

              Where older records have been archived, or in the case of records relating to overseas branches of Bahraini conventional bank licensees, the BMA may accept that records be accessible within a reasonably short time frame (e.g. within 5 business days), instead of immediately. The BMA may also agree similar arrangements for overseas conventional bank licensees, as well as Bahraini conventional bank licensees, where elements of record retention and management have been centralised in another group company, whether inside or outside of Bahrain.

            • GR-1.1.10

              All original account opening documentation, due diligence and transaction documentation should normally be kept in Bahrain, if the business is booked in Bahrain. However, where a licensee books a transaction in Bahrain, but the transaction documentation is handled entirely by another (overseas) branch or affiliate of the licensee, the relevant transaction documentation may be held in the foreign office, provided electronic or hard copies are retained in Bahrain; the foreign office is located in a FATF member state; and the foreign office undertakes to provide the original documents should they be required.

            • GR-1.1.11

              Licensees should also note that to perform effective consolidated supervision of a group (or sub-group), the BMA needs to have access to financial information from foreign operations of a licensee, in order to gain a full picture of the financial condition of the group: see Module BR (BMA Reporting), regarding the submission of consolidated financial data. If a licensee is not able to provide to the BMA full financial information on the activities of its branches and subsidiaries, it should notify the BMA of the fact, to agree alternative arrangements: these may include requiring the group to restructure or limit its operations in the jurisdiction concerned.

            • GR-1.1.12

              In the case of Bahraini conventional bank licensees with branch operations overseas, where local record keeping requirements are different, the higher of the local requirements or those contained in this Chapter must be followed.

          • GR-1.2 GR-1.2 Transaction Records

            • GR-1.2.1

              Conventional bank licensees must keep completed transaction records for as long as they are relevant for the purposes for which they were made (with a minimum period in all cases of five years from the date when the transaction was completed). Records of completed transactions must be kept in their original form (whether in hard copy and / or electronic format), for at least five years from the date of the transaction.

            • GR-1.2.2

              For example, if the original documents are paper, they must be kept in their original form. Electronic payments and receipts may be kept electronically without the need for hard copies. The record format selected must be capable of producing complete and accurate financial, management and regulatory reports, and allow monitoring and review of all transactions.

            • GR-1.2.3

              Rule GR-1.2.1 applies to all transactions entered into by a Bahraini conventional bank licensee, whether booked in Bahrain or in an overseas branch. With respect to overseas conventional bank licensees, it applies only to transactions booked in the Bahrain branch.

            • GR-1.2.4

              In the case of overseas conventional bank licensees, Rule GR-1.2.1 therefore only applies to business booked in the Bahrain branch, not in the rest of the company.

          • GR-1.3 GR-1.3 Other Records

            • Corporate Records

              • GR-1.3.1

                Conventional bank licensees must maintain the following records in original form or in hard copy at their premises in Bahrain:

                (a) internal policies, procedures and operating manuals;
                (b) corporate records, including minutes of shareholders', Directors' and management meetings;
                (c) correspondence with the BMA and records relevant to monitoring compliance with BMA requirements;
                (d) reports prepared by the conventional bank licensee's internal and external auditors; and
                (e) employee training manuals and records.

              • GR-1.3.2

                In the case of Bahraini conventional bank licensees, these requirements apply to the licensee as a whole, including any overseas branches. In the case of overseas conventional bank licensees, all the requirements of Chapter GR-1 are limited to the business booked in their branch in Bahrain and the records of that branch (see Rule GR-1.1.1). They are thus not required to hold copies of shareholders' and Directors' meetings, except where relevant to the branch's operations.

            • Customer Records

              • GR-1.3.3

                Record keeping requirements with respect to customer records, including customer identification and due diligence records, are contained in Module FC (Financial Crime). These requirements address specific requirements under the Amiri Decree Law No. 4 of 2001, the standards promulgated by the Financial Action Task Force, as well as to the best practice requirements of the Basel Committee Core Principles methodology, and its paper on "Customer due diligence for banks".

        • GR-2 GR-2 Corporate and Trade Names

          • GR-2.1 GR-2.1 Vetting of Names

            • GR-2.1.1

              Conventional bank licensees must seek prior written approval from the BMA for their corporate name and any trade names, and those of their subsidiaries located in Bahrain.

            • GR-2.1.2

              GR-2.1.1 applies to overseas conventional bank licensees only with respect to their Bahrain branch.

            • GR-2.1.3

              Rules GR-2.1.1 and GR-2.1.2 implement the requirements contained in Article 62 of the BMA Law 1973.

            • GR-2.1.4

              In approving a corporate or trade name, the BMA seeks to ensure that it is sufficiently distinct as to reduce possible confusion with other unconnected businesses, particularly those operating in the financial services sector. The BMA also seeks to ensure that names used by unregulated subsidiaries do not suggest those subsidiaries are in fact regulated.

        • GR-3 GR-3 Dividends

          • GR-3.1 GR-3.1 BMA Non-Objection

            • GR-3.1.1

              Bahraini conventional bank licensees must obtain a letter of no-objection from the BMA to any dividend proposed, before submitting a proposal for a distribution of profits to a shareholder vote.

            • GR-3.1.2

              The BMA will grant a no-objection letter where it is satisfied that the level of dividend proposed is unlikely to leave the licensee vulnerable — for the foreseeable future — to breaching the BMA's capital requirements, taking into account (as appropriate) trends in the licensee's business volumes, expenses, overall performance and the adequacy of provisions against impaired loans or other assets.

            • GR-3.1.3

              To facilitate the prior approval required under Paragraph GR-3.1.1, conventional bank licensees subject to GR-3.1.1 should provide the BMA with a copy of the proposed agenda for the annual general meeting or other special meeting, noting the licensee's intended declared dividends for the coming year.

            • GR-3.1.4

              Conventional bank licensees must also comply with the provisions contained in Articles 72 to 75 of the BMA Law 1973.

        • GR-4 GR-4 Asset / Liability Transfers

          • GR-4.1 GR-4.1 [deleted] [1 July 2011 to 30 September 2012]

            [This Section was deleted in July 2011 as Regulation on Asset/Liability transfers currently under consultation].

            • GR-4.1.1 [deleted]

              Deleted: July 2011

            • GR-4.1.2 [deleted]

              Deleted: July 2011

            • GR-4.1.3 [deleted]

              Deleted: July 2011

            • GR-4.1.4 [deleted]

              Deleted: July 2011

            • GR-4.1.5 [deleted]

              Deleted: July 2011

            • GR-4.1.6 [deleted]

              Deleted: July 2011

          • GR-4.1 GR-4.1 BMA Approval

            • GR-4.1.1

              Conventional bank licensees must seek prior written approval from the BMA before transferring assets or liabilities of a material nature to a third party, except where such transfers are effected within the normal scope of the bank's operations.

            • GR-4.1.2

              Rule GR-4.1.1 is intended to apply to circumstances where a bank wishes to sell part of its business or a portfolio to a third party, or is undertaking winding up proceedings. It implements the provisions contained in Article 65(A)(2) of the BMA Law 1973.

            • GR-4.1.3

              For the purposes of Rule GR-4.1.1, assets or liabilities of a material nature would be assets or liabilities that comprise 5% or more of the total assets or liabilities of the bank concerned, and any deposit liabilities (regardless of amount).

            • GR-4.1.4

              In the case of a Bahraini conventional bank licensee, Chapter GR-4 applies to its assets and liabilities booked in Bahrain and in the bank's overseas branches. In the case of an overseas conventional bank licensee, Chapter GR-4 applies only to assets and liabilities booked in the bank's Bahrain branch.

            • GR-4.1.5

              Banks intending to apply to transfer assets or liabilities are advised to contact the BMA at the earliest possible opportunity, in order that the BMA may determine the nature and level of any documentation to be provided and the need for an auditor or other expert opinion to be provided. The BMA will grant its permission where the transfer will have no negative impact on the financial soundness of the bank, and does not otherwise compromise the interests of the bank's depositors and creditors. In all cases, the BMA will only grant its permission where the institution acquiring the assets or deposit liabilities holds the appropriate regulatory approvals and is in good regulatory standing.

        • GR-5 GR-5 Controllers

          • GR-5.1 GR-5.1 Key Provisions

            • GR-5.1.1

              Condition 3 of the BMA's licensing conditions specifies, amongst other things, that conventional bank licensees must satisfy the BMA that their controllers are suitable and pose no undue risks to the licensee. (See Paragraph LR-2.3.1.)

            • GR-5.1.2

              Applicants for a conventional bank license must provide details of their controllers, by submitting a duly completed Form 2 (Application for authorisation of controller). (See sub-paragraph LR-3.1.5(a)

            • GR-5.1.3

              Conventional bank licensees must obtain prior approval from the BMA for any of the following changes to its controllers (as defined in Section GR-5.2):

              (a) a new controller;
              (b) an existing controller increasing its holding from below 20% to above 20%;
              (c) an existing controller increasing its holding from below 33% to above 33%;
              (d) an existing controller increasing its holding from below 50% to above 50%; and
              (e) an existing controller increasing its holding from below 75% to above 75%.

            • GR-5.1.4

              For approval under Paragraph GR-5.1.3 to be granted, the BMA must be satisfied that the proposed increase in control poses no undue risks to the licensee. A duly completed Form 2 (Controllers) must be submitted as part of the request for a change in controllers.

            • GR-5.1.5

              If, as a result of circumstances outside the conventional bank licensee's knowledge and/or control, one of the changes specified in Paragraph GR-5.1.3 is triggered prior to BMA approval being sought or obtained, the conventional bank licensee must notify the BMA as soon as it becomes aware of the fact and no later than 7 days.

            • GR-5.1.6

              Conventional bank licensees are encouraged to notify the BMA as soon as they become aware of events that are likely to lead to changes in their controllers. The criteria by which the BMA assesses the suitability of controllers are set out in Section GR-5.3. The BMA aims to respond to requests for approval within 30 calendar days. The BMA may contact references and supervisory bodies in connection with any information provided to support an application for controller. The BMA may also ask for further information, in addition to that provided in Form 2, if required to satisfy itself as to the suitability of the applicant.

            • GR-5.1.7

              Conventional bank licensees must submit, within 3 months of their financial year-end, a report on their controllers. This report must identify all controllers of the licensee, as defined in Section GR-5.2.

          • GR-5.2 GR-5.2 Definition of Controller

            • GR-5.2.1

              A controller of a conventional bank licensee is a natural or legal person who:

              (a) holds 10% or more of the shares in the licensee ("L"), or is able to exercise (or control the exercise) of more than 10% of the voting power in L; or
              (b) holds 10% or more of the shares in a parent undertaking ("P") of L, or is able to exercise (or control the exercise) of more than 10% of the voting power in P; or
              (c) is able to exercise significant influence over the management of L or P.

            • GR-5.2.2

              For the purposes of Paragraph GR-5.2.1, "person" means the person ("H") or any of the person's associates, where associate includes:

              (a) the spouse, child or stepchild of H;
              (b) an undertaking of which H is a Director;
              (c) a person who is an employee or partner of H;
              (d) if H is a corporate entity, a Director of H, a subsidiary of H, or a Director of any subsidiary undertaking of H.

            • GR-5.2.3

              Associate also includes any other person or undertaking with which the person H has entered into an agreement or arrangement as to the acquisition, holding or disposal of shares or other interests in the conventional bank licensee, or under which they undertake to act together in exercising their voting power in relation to the conventional bank licensee.

          • GR-5.3 GR-5.3 Suitability of Controllers

            • GR-5.3.1

              A controller of a conventional bank licensee must satisfy the BMA of his suitability.

            • GR-5.3.2

              In assessing the suitability of controllers who are natural persons, the BMA has regard to their professional and personal conduct, including, but not limited to, the following:

              (a) the propriety of a person's conduct, whether or not such conduct resulted in conviction for a criminal offence, the contravention of a law or regulation, or the institution of legal or disciplinary proceedings;
              (b) a conviction or finding of guilt in respect of any offence, other than a minor traffic offence, by any court or competent jurisdiction;
              (c) any adverse finding in a civil action by any court or competent jurisdiction, relating to fraud, misfeasance or other misconduct in connection with the formation or management of a corporation or partnership;
              (d) whether the person has been the subject of any disciplinary proceeding by any government authority, regulatory agency or professional body or association;
              (e) the contravention of any financial services legislation or regulation;
              (f) whether the person has ever been refused a license, authorisation, registration or other authority;
              (g) dismissal or a request to resign from any office or employment;
              (h) disqualification by a court, regulator or other competent body, as a Director or as a manager of a corporation;
              (i) whether the person has been a Director, partner or manager of a corporation or partnership which has gone into liquidation or administration or where one or more partners have been declared bankrupt whilst the person was connected with that partnership;
              (j) the extent to which the person has been truthful and open with regulators; and
              (k) whether the person has ever been adjudged bankrupt, entered into any arrangement with creditors in relation to the inability to pay due debts, or failed to satisfy a judgement debt under a court order.

            • GR-5.3.3

              In addition, the following criteria are also taken into consideration:

              (a) the financial resources of the person and the likely stability of their shareholding;
              (b) existing directorships or ownership of more than 20% of the capital or voting rights of any financial institution in the Kingdom of Bahrain or elsewhere, and the potential for conflicts of interest that such directorships or ownership may imply;
              (c) the interests of depositors, creditors and shareholders of the licensee; and
              (d) the interests of Bahrain's banking and financial sector.

            • GR-5.3.4

              In assessing the suitability of corporate controllers, the BMA has regard to their financial standing, judicial and regulatory record, and standards of business practice and reputation, including, but not limited to, the following:

              (a) the financial strength of the controller, its parent(s) and other members of its group, its implications for the conventional bank licensee and the likely stability of the controller's shareholding;
              (b) whether the controller or members of its group have ever entered into any arrangement with creditors in relation to the inability to pay due debts;
              (c) the controller's jurisdiction of incorporation, location of Head Office, group structure and close links, and the implications for the conventional bank licensee as regards effective supervision of the conventional bank licensee and potential conflicts of interest;
              (d) the controller's (and other group members') propriety and general standards of business conduct, including the contravention of any laws or regulations, or the institution of disciplinary proceedings by a government authority, regulatory agency or professional body;
              (e) any adverse finding in a civil action by any court or competent jurisdiction, relating to fraud, misfeasance or other misconduct;
              (f) any criminal actions instigated against the controller or other members of its group, whether or not this resulted in an adverse finding; and
              (g) the extent to which the controller or other members of its group have been truthful and open with regulators and supervisors.

            • GR-5.3.5

              In addition, the following criteria are also taken into consideration:

              (a) the interests of depositors, creditors and shareholders of the licensee; and
              (b) the interests of Bahrain's banking and financial sector.

          • GR-5.4 GR-5.4 Approval Process

            • GR-5.4.1

              Following receipt of an approval request under Paragraph GR-5.1.3, the BMA will issue a written notice of objection if it is not satisfied that the person concerned is suitable to become a controller of the conventional bank licensee. The notice of objection will specify the reasons for the objection and specify the applicant's right of appeal.

            • GR-5.4.2

              Notices of objection have to be approved by an Executive Director of the BMA. The applicant has 30 calendar days from the date of the notice in which to make written representations. The BMA then has 30 calendar days from the date of the representation in which to consider any mitigating evidence submitted and make a final determination. See Module EN (Enforcement).

            • GR-5.4.3

              Where a person has become a controller by virtue of his shareholding in contravention of Paragraph GR-5.1.3, or a notice of objection has been served to him under Paragraph GR-5.4.1 and the period of appeal has expired, the BMA may, by notice in writing served on the person concerned, direct that his shareholding shall, until further notice, be subject to all or any of the following restrictions:

              (a) no voting right shall be exercisable in respect of those shares; and
              (b) except in a liquidation, no payment shall be made of any sum due on the shares from the conventional bank licensee, whether in respect of capital, dividend or otherwise.

        • GR-6 [This Chapter has been left blank.]

          [This Chapter has been left blank.]

        • GR-7 GR-7 Suspension of Business

          • GR-7.1 GR-7.1 BMA Approval

            • GR-7.1.1

              A conventional bank licensee wishing to suspend its operations and liquidate its business must notify the BMA in writing at least six months in advance of its intended suspension, setting out how it proposes to do so and, in particular, how it will treat any deposits that it holds.

            • GR-7.1.2

              The notice period under Rule GR-7.1.1 is a statutory requirement, specified in Article 91 of the BMA Law 1973. Article 91, however, also provides for the notice period to be reduced, by prior agreement with the BMA, if in the BMA's view the rights of depositors are safeguarded.

            • GR-7.1.3

              If the conventional bank licensee wishes to transfer assets or liabilities to a third party, it must comply with the requirements contained in Chapter GR-4.

            • GR-7.1.4

              If the conventional bank licensee wishes to liquidate its business, the BMA will revise its license to restrict the firm from entering into new business. The licensee must continue to comply with all applicable BMA requirements until such time as it is formally notified by the BMA that its obligations have been discharged and that it may surrender its license.

            • GR-7.1.5

              A conventional bank licensee in liquidation must continue to meet its contractual and regulatory obligations to depositors, other clients and creditors.

            • GR-7.1.6

              Once the conventional bank licensee believes that it has discharged all its remaining contractual obligations to depositors, clients and creditors, it must publish a notice in two national newspapers in Bahrain approved by the BMA (one being in English and one in Arabic), stating that is has settled all its dues and wishes to leave the market.

            • GR-7.1.7

              The notice referred to in Paragraph GR-7.1.6 must include a statement that written representations concerning the liquidation may be sent to the BMA before a specified day, which shall not be earlier than sixty days after the day of the first publication of the notice. The BMA will not decide on the application until after considering any representations made to the BMA before the specified day.

            • GR-7.1.8

              If no objections to the liquidation are upheld by the BMA, then the BMA may issue a written notice of approval for the surrender of the license.

        • GR-8 GR-8 BMA Fees

          • GR-8.1 GR-8.1 Annual License Fees

            • GR-8.1.1

              Conventional bank licensees must pay the relevant annual license fee to the BMA, upon the issuance of their license and thereafter on 1 January each year. The annual license fee charged upon issuance of a license is charged on a pro-rata basis, proportionate to the period remaining between the issuance of the license and the end of the calendar year in question (subject to a minimum charge of BD 1,000).

    • Business Standards

      • BC BC Business and Market Conduct

        • BC-A BC-A Introduction

          • BC-A.1 BC-A.1 Purpose

            • BC-A.1.1

              The purpose of this module is to lay down rules and guidelines that lay down the regulations and provide guidance on best practices that banks should adhere to in relation to business and market conduct.

            • BC-A.1.2

              This module provides support for certain other parts of the Rulebook, mainly:

              (a) Principles of Business;
              (b) Audit Firms;
              (c) Public Disclosure; and
              (d) BMA Reporting Requirements.

            • BC-A.1.3

              This module also provides support for certain aspects relating to business and market conduct in the Bahrain Commercial Companies Law of 2001 (as amended).

          • BC-A.2 BC-A.2 Key requirements

            • Promotion of financial products and services

              • BC-A.2.1

                The Agency should be sent copies of documentation relating to promotional schemes at least ten days prior to their launch for information purposes.

              • BC-A.2.2

                All documentation concerning promotional schemes should be in Arabic and English and, if relevant, any other language necessary for customers to fully understand and appreciate their terms and conditions. Such terms and conditions, including any related advertising, need to be clear, concise, truthful, unambiguous and complete so as to enable customers to make a fully informed decision.

            • Code of conduct for bank dealers and foreign exchange and money brokers in the foreign currency and deposit markets

              • BC-A.2.3

                Management of banks and money brokers are responsible for ensuring that their institutions are in full compliance with the Code.

              • BC-A.2.4

                Brokers should pass details verbally, and principals be prepared to receive them, normally within a few minutes after deals have been concluded.

            • Disclosure of information about individual accounts

              • BC-A.2.5

                Banks should not publish or release information to third parties concerning the accounts or activities of their individual customers, unless:

                (a) such information is requested by an authorised official from the BMA or by an order from the Courts; or
                (b) the release of such information is approved by the customer concerned.

            • Minimum balance and charges on savings accounts

              • BC-A.2.6

                Banks may impose no more than a monthly charge of BD 1/– when the monthly weighted average balance for savings accounts for individuals falls below BD 20/– (or equivalent in other currencies).

              • BC-A.2.7

                Orphans, widows, pensioners, individuals receiving social subsidies from the Ministry of Labour & Social Affairs, students and Bahraini nationals with a monthly salary below BD 250/– should be exempted from maintaining the above minimum balance requirement for savings accounts.

            • Dinar Certificates of Deposits — Rules

              • BC-A.2.8

                Certificates of Deposit may be issued for any amount subject only to a minimum denomination of BD 30,000.

              • BC-A.2.9

                Certificates of Deposit may be issued for any maturity between 183 days (6 months) and 5 years.

            • Disclosure of charges

              • BC-A.2.10

                Banks should also ensure that each customer is in receipt of its current list of charges. The list should specify standard charges and commissions that will be applied by the bank to individual services and transactions and to specific areas of business.

            • Accounts held for clubs and societies in Bahrain

              • BC-A.2.11

                The Full Commercial Bank (FCB) is requested to notify General Organisation for Youth and Sport (GOYS) when any club or society registered with GOYS requests the opening of an account with the bank.

            • Current accounts

              • BC-A.2.12

                FCBs levying fees on their low-balance customer current accounts, are required by the Agency to apply such fees to average balances when these fall below a prescribed level during a specified period.

            • Notification to the Agency on introduction of new or expanded customer products and facilities

              • BC-A.2.13

                All full commercial banks are required to notify the Agency before the introduction of any new or expanded customer products and facilities.

            • Penalty system for dishonoured cheques

              • BC-A.2.14

                On the first working day of each calendar month, each FCB will provide to the Agency a list of the names, supported with I.D. numbers (CPR or CR numbers (as applicable) for Bahrain residents, Passport or CR-equivalent numbers (as applicable) for non-Bahrain residents) of those customers to whom one (or more) written warning(s) has been sent in accordance with section BC-5.1 during the immediately preceding calendar month.

              • BC-A.2.15

                Concerned FCB(s) must not provide current account facilities to the abuser of cheques for the twelve calendar month period immediately following the date of issue of the relevant list (as mentioned in section BC-5.1) by the Agency. All other FCBs should, within a maximum period of one month after the issue of the relevant list, also withdraw current account facilities from that abuser of cheques for the same twelve calendar month period.

            • General guidance on administration of dishonoured cheques

              • BC-A.2.16

                FCBs that wish to issue cheque guarantee cards for an amount not exceeding BD 200/= may do so — subject to informing the Director of Banking Services at the Agency of their intention and the arrangements governing the issue of such cards.

            • Penalty charges on dishonoured cheques

              • BC-A.2.17

                The Agency will impose penalty charges of BD 5/= on each returned cheque for the reasons of 'Refer to Drawer', 'Not Arranged For', 'Re-present', and 'Account Closed'.

              • BC-A.2.18

                FCBs will be entitled to charge customers no more than BD 10/= in respect of each dishonoured cheque.

            • Installation of an off-site ATM in Bahrain

              • BC-A.2.19

                FCBs wishing to install an off-site ATM must submit an application (in writing) for the BMA's (Executive Director of Banking Supervision) approval. This application must be accompanied by a copy of a feasibility study for that particular ATM, as well as such other information as the BMA may request. In particular, a copy of the written permission (for installation of that off-site ATM) of the legal owner of the proposed location must be provided to the Agency, as well as a copy of the written permission of any other relevant authorities in this context (e.g. the Traffic & Licensing and Civil Defence & Fire Service Directorates of the Ministry of Interior).

            • GCC ATM network charges

              • BC-A.2.20

                The Agency requires that the charges on such customer withdrawals and other ATM services should not exceed BD 1/= per transaction.

            • Margin Trading System

              • BC-A.2.21

                FCBs may write to the Agency to obtain approval to provide margin trading facilities to their customers. FCBs must follow the rules and guidance in Chapter BC-7.

          • BC-A.3 BC-A.3 Regulation history

            • BC-A.3.1

              This module was first issued in July 2004 as part of the conventional principles volume. All regulations in this volume have been effective since this date. All subsequent changes are dated with the month and year at the base of the relevant page and in the Table of Contents. Chapter UG-3 of Module UG provides further details on Rulebook maintenance and control.

            • BC-A.3.2

              The most recent changes to this module are detailed in the table below:

              Summary of changes

              Module Ref. Change Date Description of Changes
              BC-4.1 01/01/05 New minimum balance and charges regulations
              BC-4.7 01/10/05 Streamlined notification requirements regarding new products
              BC-7 01/04/06 Margin trading rules and guidance
                   
                   

            • Effective date and evolution of the Module

              • BC-A.3.3

                Prior to the Rulebook, the Agency had issued various circulars representing regulations covering different aspects of Business and Market Conduct. The contents of this module are effective from the date depicted in the original circulars listed below or from the dates indicated in paragraph BC-A.3.2 above:

                Circular Ref. Date of Issue Module Ref. Circular Subject
                EDBC/73/96 1 May 1996 BC-1.1 Explanatory note on the promotion of Banking and Financial Products.
                BS.C7/91/442 10 Sep 1991 BC-1.1 Promotion of Banking Services
                85/25 2 May 1985 BC-2 Code of Conduct for Foreign Exchange Dealers and Brokers
                83/5 10 Apr 1983 BC-3 Disclosure of Information about Individual Accounts
                BS/11/2004 10 Aug 2004 BC-4.1 Min balances and savings accounts
                BS.C7/90/34 31 Jan 1990 BC-4.2 Dinar Certificates of Deposits
                EDBO/51/02 2 Apr 2002 BC-4.3 Charges to Customers
                BC/5/00 8 Mar 2000 BC-4.4 Accounts held for Clubs and Societies
                BSD(111)/94/157 24 Sep 1994 BC-4.5 Fees on Current Accounts
                BC/2/01 3 Mar 2001 BC-4.6 Brokerage Fees in Bahrain
                ODG/145/92 18 Aug 1992 BC-4.7 New products in the Retail Banking Field
                EDBO/46/03 8 Apr 2003 BC-4.8 Inheritance—Financial Procedures
                EDBO/27/96 25 Sep 1996 BC-5.1 Regulation for "Dishonoured Cheques"
                OG/399/94 28 Nov 1994 BC-5.2 Returned Cheques
                EDBO/49/01 6 May 2001 BC-5.3 Penalty Charges on Returned Cheques
                BC/8/98 24 May 1998 BC-6.1 Off-site ATMs
                EDBO/45/02 13 Mar 2002 BC-6.2 GCC ATM Network Charges
                BC/15/99 17 Jul 1999 BC-7.1 Margin Trading

        • BC-1 BC-1 Promotion of financial products and services

          • BC-1.1 BC-1.1 Promotion of financial products and services offered in/from Bahrain by means of incentives etc.

            • Introduction

              • BC-1.1.1

                The purpose of the content of this section is to set out regulations pertaining to the promotion of banking/financial products offered in/from Bahrain by means of incentives etc. (herein referred to as 'promotional schemes').

              • BC-1.1.2

                The Agency has no objection to the use of promotional schemes in general and, unless it otherwise specifically directs in any particular case, the Agency does not expect to be actively consulted/have its approval sought about the idea and/or substance of any promotional schemes. The Agency should, however, be sent copies of documentation relating to promotional schemes at least ten days prior to their launch for information purposes.

              • BC-1.1.3

                The Agency will monitor promotional schemes and, if thought appropriate in the interests of a bank or other financial institution (together herein referred to as 'institutions') and its customers in particular and/or the financial sector in general, may issue specific guidance in certain cases. Institutions should feel free to consult the Agency at any time regarding any matters referred to in the explanatory note set out in this section.

            • General requirements

              • BC-1.1.4

                Institutions should take care to ensure that promotional schemes do not involve a breach of Bahrain law or any other relevant applicable law, regulation or international practice. In addition, promotional schemes should not in any way be detrimental to the public good or public morals.

              • BC-1.1.5

                While there is to be no formal restriction on the types of incentive which may be used by institutions, care should be taken to ensure that promotional schemes do not negatively affect the integrity, reputation, good image and standing of Bahrain and/or its financial sector, and do not detrimentally affect Bahrain's economy.

              • BC-1.1.6

                Bearing in mind the reputation of, and the requirement to develop, the financial sector in Bahrain, as well as the need to act at all times in the best interests of the customer, institutions need to take adequate care to ensure that promotional schemes do not unreasonably divert the attention of the public from other important considerations in choosing an institution or a banking/financial product.

              • BC-1.1.7

                All documentation concerning promotional schemes should be in Arabic and English and, if relevant, any other language necessary for customers to fully understand and appreciate their terms and conditions. Such terms and conditions, including any related advertising, need to be clear, concise, truthful, unambiguous and complete so as to enable customers to make a fully informed decision.

              • BC-1.1.8

                Customers to whom promotional schemes are directed should enjoy equal opportunity in terms of access to, and treatment within, such schemes.

              • BC-1.1.9

                No costs (including funding costs), charges or levies associated with promotional schemes should be concealed from prospective customers.

              • BC-1.1.10

                Full and complete records should be maintained for promotional schemes, particularly where raffles/lotteries etc. are concerned.

              • BC-1.1.11

                Any raffles/lotteries etc. held as part of promotional schemes should be independently monitored (e.g. by the institution's external auditor) and adequate systems put in place to ensure fair play and impartiality.

              • BC-1.1.12

                An appropriate system should also exist for informing participants of the results of a raffle/lottery without delay. Institutions should note that raffles/lotteries etc. may be subject to rules and requirements (including prior authorisation/approval) laid down by the Ministry of Commerce.

              • BC-1.1.13

                Institutions may use small 'gifts' as an inducement to members of the public to use banks' services, provided such gifts are offered on a general basis and have a low monetary value.

              • BC-1.1.14

                Finally, due note should be taken of the overriding provisions of Bahrain (and any other relevant) law in relation to institutions' duties to customers to the extent (if any) that promotional schemes might impact on such duties.

        • BC-2 BC-2 Code of conduct for bank dealers and foreign exchange and money brokers in the foreign currency and deposit markets

          • BC-2.1 BC-2.1 Introduction

            • BC-2.1.1

              The Code of Conduct, which is prepared in cooperation with the Bankers' Society of Bahrain and foreign exchange brokers, provides rules in respect of certain kinds of practice which experience has shown may cause difficulty and may jeopardise the good standing of the Bahrain market. Management of banks and money brokers are responsible for ensuring that their institutions are in full compliance with the Code.

            • BC-2.1.2

              Every broker and dealer shall at all times comply with the criteria in respect to market practice, integrity and conduct. Failure to comply with such criteria will be regarded as a serious offence by the BMA, which reserves the right to investigate any complaints brought to its attention. All participants should adhere to the spirit as well as to the letter of the Code.

          • BC-2.2 BC-2.2 Market terminology and definitions

            • BC-2.2.1

              The use of generally accepted precise terminology should reduce misunderstandings and frustration, and to this end Appendix BC 5 sets out, without claiming to be exhaustive, accepted market terminology and definitions.

            • BC-2.2.2

              For the purpose of this chapter, the following definitions apply:

              (a) 'Broker' means a money and foreign exchange broker who is authorised by the BMA to operate in Bahrain.
              (b) 'Principal' means a party undertaking a transaction through a broker.
              (c) 'Bank' means any institution holding a banking license.

          • BC-2.3 BC-2.3 Confidentiality and market practice

            • BC-2.3.1

              Confidentiality is vital for the preservation of a reputable and efficient market. Accordingly, the exchange of confidential information in respect of third parties is forbidden.

            • BC-2.3.2

              The rules which follow are not intended to define exhaustively the obligations of dealers and brokers but set down specific ways in which confidentiality should be safeguarded and operations should be conducted.

              (a) Use of phrases and terms likely to identify the name of the principal should be avoided at all times.
              (b) In foreign exchange transactions brokers should not disclose the name of the principal until the deal is being closed.

              A broker asking for a specific support price should be prepared to qualify the principal in terms of geographical location, by country or by region when the broker genuinely believes it will enable business to be concluded satisfactorily to the benefit of both broker and principal.

              (c) In deposit transactions, brokers should not disclose the name of the borrower until the broker is satisfied that the potential lender seriously intends to do business. Once a lender has asked for the identity of the borrower ('Who pays?'), the lender is committed to do business at the rate quoted with an acceptable name, until the lending bank takes the broker 'off' or puts himself under reference. In the event of the first disclosed name being unacceptable to the lender, the lender will be prepared to check other acceptable names provided that such names are shown to the lender by the broker within a reasonable amount of time, which should be stipulated if necessary.
              (d) In the deposit market, banks should whenever possible give brokers prior indication of those categories of principals and of any centres and areas with which they would be unwilling to do business, in order that the smooth operation of markets be facilitated and frustration be minimized. Lenders should indicate the amounts they are prepared to place with particular categories of borrower. Brokers should classify bids with an indication of the type and quality of names they are in a position to pass.
              (e) Practices whereby banks reject a succession of names in order to assess the market and brokers offer banks deals which have no chance of being concluded, merely in order to establish their interest, are totally unacceptable.
              (f) A principal is urged whenever possible to specify to a broker the rate, the amount, the currency, and the period of his requirements. The principal shall be willing to deal in a marketable amount with acceptable names and shall remain bound so to deal at the quoted rate unless either:
              (i) the broker is informed otherwise at the time of acceptance, or
              (ii) a time limit was placed (for example, 'Firm for one minute only').

              A broker who quotes a firm rate without qualification shall be prepared to deal at the rate, in a marketable amount. A broker, if quoting only the basis of one or two names, shall qualify his quotation, e.g., 'one small offeror — only two names paying'. The broker should indicate whether prices are firm or simply for guidance and, if requested by the principal, should be willing to indicate the amount involved. Further he should confirm with banks at reasonable intervals that their interest is still firm.

              It is the responsibility of the principal to ensure the broker is made aware of any circumstances which materially affect the validity of the order placed with the broker.

              (g) A principal, by selecting to 'put a broker on', is deemed to have a serious intention of completing business, and should allow the broker sufficient time to quote the principal's interest to a potential counterparty with a view to doing business. In quantifying a 'sufficient time' factors such as the currency, market conditions and communication systems employed, should be taken into account.
              (h) A broker is held responsible for advising a principal on every occasion that his deposit rates are being checked by a potential counterparty. This action should help minimise the occasional difficulties that arise when a principal 'takes a broker off' simultaneously to having his prices checked.

              Whenever possible and subject to market conditions, a bank in the deposit market should, before he 'takes a broker off' either a single order or several orders, check whether the broker is already committed to deal on his behalf.

              (i) 'Under reference' orders placed by banks with brokers without having first being placed as 'firm', are to be discouraged. Firm orders which are later qualified by a request to 'put me under reference' indicate a principal's weakening desire to conclude business with that broker. 'Under reference' orders should not be left with a broker for more than a few minutes. A principal must ensure that the broker has the opportunity frequently to check the validity of an 'under reference' order.
              (j) No person may visit the dealing room of any broker or any bank except with the consent of a Manager or Director of that institution. A broker shall not in any circumstances permit any visitors from a bank to deal for his bank in the dealing room of that broker.
              (k) Management of banks should issue clear directions to staff on the monitoring, control and recording of 'after hours' dealing from premises other than bank dealing rooms. All deals of this kind must be properly authorised and confirmed.
              (l) A bank dealer shall not apply unfair pressure upon a broker to pass information which it would be improper for the broker to pass. Unfair pressure would for example include a statement made in any form that a failure to co-operate would lead to reduction in the business given by the principal or by other principals to the broker.
              (m) A principal should not place an order with a broker solely with the intention of finding out the name of a counterparty, who can be contacted directly with a view to concluding further deals.
              (n) Management of banks and brokers should lay down clear directions to staff on the extent to which dealing in foreign exchange or deposits for personal accounts is permitted. Any such dealing must be strictly controlled.
              (o) Care should be taken over the positioning of 2-way loudspeakers in dealing rooms.
              (p) Brokers and dealers should inform each other if conversations are being recorded. The use of such equipment is encouraged as a sensible means of enabling any subsequent disputes and differences to be settled.

          • BC-2.4 BC-2.4 Passing of details

            • BC-2.4.1

              The passing and recording of details forms an essential part of the transaction and the possibility of errors and misunderstanding is increased by delay and by the passing of details in batches. Brokers should pass details verbally, and principals should be prepared to receive them, normally within a few minutes after deals have been concluded.

            • BC-2.4.2

              When arranging and passing details on forward contracts in foreign exchange, banks and brokers must ensure that the rate applied to the spot end of the transaction bears a close relationship to the spot rate at the time the deal was concluded.

          • BC-2.5 BC-2.5 Confirmations

            • BC-2.5.1

              Written confirmation by a broker is the final check on the details of the transaction. The handling of confirmations must take account of the desire of brokers to have a realistic time-limit placed on their liability for differences. There is an obligation on recipients to check such confirmations. Initial confirmations should be sent out by telex without delay, and at the latest by close of business on the same working day. They should be followed up by written confirmation, normally hand-delivered and receipted before close of business on the following working day.

            • BC-2.5.2

              Banks must check all confirmations carefully upon receipt so that discrepancies shall be quickly revealed and differences minimised. Principals shall also make enquiries of brokers about particular confirmations which have not been received within an appropriate time (as above) or about any changes in contract terms.

            • BC-2.5.3

              In the case of deals where a bank pays against telex confirmation, the broker remains liable for differences until receipt of written confirmation is provided by the bank.

          • BC-2.6 BC-2.6 Differences and disputes

            • BC-2.6.1

              The majority of differences payable by brokers arise from errors occurring in payment or repayment instructions. They also arise from a broker, having in good faith indicated a firm rate, being unable to substantiate his quotation.

            • BC-2.6.2

              Any differences deemed payable by a broker to a bank (or by a bank to a broker) should be settled as soon as possible. The parties should provide each other with documents, setting out the exact details of and circumstances surrounding the deal.

            • BC-2.6.3

              It is acknowledged that differences are sometimes paid by 'points'. The management of broking firms should always ensure that this practice is strictly controlled and monitored.

            • BC-2.6.4

              All differences settled by direct payment should be advised in writing by the broker to the Director of Reserve Management, the BMA, (copied to the Bank) indicating the amount paid and the other party's name. The BMA reserves the right to ask for further information at its discretion.

          • BC-2.7 BC-2.7 Conduct

            • BC-2.7.1

              The BMA will regard any breaches of the rules stated below regarding gifts, favours, betting and entertainment unacceptable.

            • Gifts and favours

              • BC-2.7.2

                No broker, including management, employees and other persons acting on their behalf, shall offer or give inducements to dealing room personnel of a bank. No gifts or favours whatsoever shall be so given unless the broker is satisfied that the person responsible for dealing operations in the bank concerned has been informed of the nature of the gift or favour.

              • BC-2.7.3

                Employees of banks shall not solicit inducements from brokers, nor shall they receive unsolicited gifts or favours from brokers without informing the person responsible for dealing operations in the bank concerned of the nature of such gifts or favours.

            • Bets

              • BC-2.7.4

                The making or arranging of bets between brokers and bank dealers is totally unacceptable.

            • Entertaining

              • BC-2.7.5

                It shall be the responsibility of management in both banks and brokers to ensure that entertainment offered in the course of business does not exceed reasonable limits and does not infringe standards of propriety and decency.

          • BC-2.8 BC-2.8 Responsibility

            • BC-2.8.1

              Brokers shall be responsible for ensuring that:

              (a) their principals understand fully the limitations of the brokers' responsibilities for business and market conducted;
              (b) all their principals understand that they are required to conform, where appropriate, to the Code of Conduct;
              (c) their staff carrying out transactions on behalf of principals are adequately trained both in the practices of the market-place and in the firm's responsibilities to principals; and
              (d) the BMA is notified of any changes in broking staff, in accordance with the BMA requirements.

            • BC-2.8.2

              Bankers shall be responsible for ensuring that:

              (a) their dealing staff are adequately trained and supervised in the practices of the market (the requirement of this Code of Conduct should be fully understood by all staff involved in foreign exchange and currency deposit operations);
              (b) the BMA is notified of any changes in dealing staff, in accordance with BMA requirements;
              (c) their staff understand that the ultimate responsibility for assessing the creditworthiness of a borrower or lender lies with the bank and not the broker;
              (d) brokerage is normally payable at the end of the month in which the money passes, or otherwise by special arrangement; and
              (e) there is no pressure on brokers to reduce charges below the approved minimum rates.

          • BC-2.9 BC-2.9 Market regulations — Foreign exchange

            • Currencies

              • BC-2.9.1

                A broker will, in response to an enquiry from any bank, make known the currencies which it elects to quote and to make a service in.

              • BC-2.9.2

                Each broker shall provide, on request by a bank taking a service, general market information on all currencies handled (whether for the time being active or not) by that broker.

            • Brokerage

              • BC-2.9.3

                Brokers shall comply with the minimum scales of brokerage charges (see section BC-4.6) agreed in consultation with the Bankers' Society Council from time to time, or laid down by the BMA.

                In cases where there is no established minimum scale of brokerage charges, no deals shall be transacted until a rate has been agreed. Rates of brokerage in these cases should be agreed in advance, and only by Directors or senior managers on each side, and in no event by the dealers themselves.

              • BC-2.9.4

                Put-through deals may be net of brokerage.

              • BC-2.9.5

                Brokerage should be expressed in US dollars.

          • BC-2.10 BC-2.10 Market regulations — Currency deposits

            • Brokerage

              • BC-2.10.1

                Brokers shall comply with the minimum scales of brokerage charges (see section BC-4.6) agreed in consultation with the Bankers' Society Council from time to time, or laid down by the BMA. In cases where there is no established minimum scale of brokerage charges, no deals shall be transacted until a rate has been agreed. Rates of brokerage in these cases should be agreed in advance, and only by Directors or senior managers on each side, and in no event by the dealers themselves.

              • BC-2.10.2

                Calculation of brokerage on all currency deposits shall be worked out on a 360-day year, or a 365-day year, according to normally accepted market practice. For example, Sterling and Kuwaiti Dinars are on a 365-day year basis, and US dollars and Saudi Riyals are on a 360-day year basis.

                Brokers' confirmations and statements should express brokerage in US dollars.

              • BC-2.10.3

                In a forward-forward deposit (e.g. one month against six months) the brokerage to be charged shall be on the actual intervening period (i.e. in the above example — five months).

              • BC-2.10.4

                Put-through deals may be net of brokerage.

          • BC-2.11 BC-2.11 Market discipline

            • BC-2.11.1

              As part of its responsibility for supervising the conduct of brokers and dealers in the foreign exchange and currency markets, the Agency may, at its discretion:

              (a) Investigate any complains concerning the conduct of brokers and dealers;
              (b) Investigate possible breaches of this Code by brokers and banks; and/or
              (c) Take such further action as it considers appropriate, in the light of all the relevant facts.

          • BC-2.12 BC-2.12 Adjustment of value dates in case of unexpected banking closing dates

            • BC-2.12.1

              Spot transactions and outrights:

              (a) Original agreed upon value date for identical currency sold and purchased: extension of value date to next possible value date for both currencies.
              (b) Original agreed upon value date for non-identical currency sold and purchased (for instance, Friday for US Dollars and Saturday for Gulf Currencies): as unexpected banking closing days for non-Middle Eastern currencies are unlikely — value of non-Gulf currencies unchanged and value of Gulf currency on the next working day, adjusting spot or outright rate taking into account interest rate difference between the two currencies.

              For pure outrights it would be advisable to adopt the same system as for swaps; however, implied swap difference is not visible or identical for both parties.

              •  It can be assumed that, if the above rule would cause substantial losses for one party, dealers will re-negotiate a new rate, on a case-by case basis; if no agreement can be reached, the BMA — as final arbitrator — will fix the interest rates, prevailing at that time, which will be used to calculate the points difference, with which the outright rate will be adjusted.

              It is possible that payment instructions for counter-currency are already sent out and cannot be cancelled; in that case the paying party should be entitled to the proceeds of the unexpected use of funds by the receiving party.

            • BC-2.12.2

              Deposits:

              (a) Maturing on unexpected closing day(s): Extending deposit to next possible value date; interest to be calculated in the extended period at original agreed upon interest rate.
              (b) Starting on unexpected closing day(s) and maturing after unexpected closing day(s): Starting date will be extended to next possible value date without altering maturing date; interest to be calculated on the shortened period at the originally agreed upon interest rate.
              (c) Starting on unexpected closing day(s) and maturing before or on next possible value date: Cancellation of deal.
              1. If payment instructions are already sent out by lender and can only be executed on next possible value date, and cannot be cancelled, borrower ensures repayment will be done on the same next possible value date. If in that case borrower cannot repay because of deadline of receiving instructions by correspondent on same next possible value day, parties negotiate a new deal starting at value date of payment by lender and maturing according to new deal.
              2. If payment instructions are already sent out by lender for capital and by borrower for capital and interest both payments will be executed at same next possible value date, lender should refund to borrower unearned interest.

            • BC-2.12.3

              Swaps:

              (a) Maturing on unexpected closing day(s): Extending swap to next possible value date for both currencies, adjusting swap difference according to formula — swap difference divided by original number of days and multiplied by new number of days.
              (b) Starting on unexpected closing day(s) and maturing after unexpected closing day(s): Starting date for both currencies would be extended to next possible value date for both currencies without altering maturing date, adjusting swap difference according to Formula under paragraph BC-2.12.3(a).
              (c) Starting on unexpected closing day(s) and maturing before or on next possible value date: Deals are cancelled.

              If starting or maturing date of original swap under paragraph BC-2.12.1 or paragraph BC-2.12.2 are substantially different, per currency swap difference has to be recalculated in mutual agreement between the dealers;

              •  It is possible that payment instructions for counter currency are already sent out and cannot be cancelled — in that case paying party should be entitled to the proceeds of the unexpected use of funds by the receiving party;
              •  It is possible that payment instructions for Gulf currencies are already sent out and cannot be cancelled — in these cases rules according to paragraph BC-2.12.2(c)-1 and paragraph BC-2.12.2(c)-2 should be applied.

        • BC-3 BC-3 Client confidentiality

          • BC-3.1 BC-3.1 Disclosure of information about individual accounts

            • BC-3.1.1

              Banks should not publish or release information to third parties concerning the accounts or activities of their individual customers, unless:

              (a) such information is requested by an authorised official from the BMA or by an order from the Courts; or
              (b) the release of such information is approved by the customer concerned.

        • BC-4 BC-4 Customer account services and charges

          • BC-4.1 BC-4.1 Minimum balance and charges on savings accounts

            • BC-4.1.1

              Banks may impose no more than a monthly charge of BD 1/– when the monthly weighted average balance for savings accounts for individuals falls below BD 20/– (or equivalent in other currencies).

            • BC-4.1.2

              Orphans, widows, pensioners, individuals receiving social subsidies from the Ministry of Labour & Social Affairs, students and Bahraini nationals with a monthly salary below BD 250/– should be exempted from maintaining the above minimum balance requirement for savings accounts. Banks should establish criteria for determining the eligibility of a person for exemption from the above charges and should notify their concerned customers accordingly.

          • BC-4.2 BC-4.2 Dinar Certificates of Deposits — Rules

            • BC-4.2.1

              The purpose of the contents of this section is to set out rules governing the issue of Dinar Certificates of Deposit by commercial banks.

            • BC-4.2.2

              For the purpose of this section, 'Dinar Certificates of Deposit' are financial instruments payable in Bahraini Dinars. They must be negotiable — in accordance with the Law of Commerce (No. 7) of 1987 — and must satisfy the conditions set out in this section.

            • Issue

              • BC-4.2.3

                Dinar Certificates of Deposit may be issued only by full commercial banks and must be payable at their offices in Bahrain.

              • BC-4.2.4

                Commercial banks may issue Certificates of Deposit to both resident and non-resident customers and to other banks inside and outside Bahrain.

              • BC-4.2.5

                Commercial banks may not issue Certificates of Deposit until they receive the necessary funds.

            • Denominations

              • BC-4.2.6

                Certificates of Deposit may be issued for any amount subject only to a minimum denomination of BD 30,000.

            • Maturities

              • BC-4.2.7

                Certificates of Deposit may be issued for any maturity between 183 days (6 months) and 5 years.

            • Interest rates

              • BC-4.2.8

                The interest rates on Certificates of Deposit may be freely agreed between banks and their counterparties at the time of issue.

              • BC-4.2.9

                Interest may be payable by agreement at a fixed or floating rate. In the case of a floating interest rate, the formula for revising the rate must be specified at the time of issue.

              • BC-4.2.10

                Interest may be payable at maturity or on earlier dates specified at the time of issue.

              • BC-4.2.11

                As an alternative to paying interest, Certificates of Deposit may be issued (like Treasury bills) at a discount to their face value (the repayment amount).

              • BC-4.2.12

                Interest and discounted values should be calculated on the basis of a 360 day year.

            • Negotiability

              • BC-4.2.13

                In view of their negotiability, Certificates of Deposit may be freely traded between banks, and between banks and customers. Issuing banks are permitted to re-purchase their own Certificates.

            • Safe custody

              • BC-4.2.14

                Although it is not obligatory, holders of Certificates of Deposit are advised to keep these certificates with a bank for safe custody and to handle them with care at all times.

            • Reserve ratio

              • BC-4.2.15

                Outstanding Certificates of Deposit are subject to reserve requirements in accordance with the provisions set out under section BR-4.2.

            • Other conditions

              • BC-4.2.16

                Banks must not describe deposit receipts, confirmations and other non-negotiable documents relating to ordinary deposits as 'Certificates of Deposit' and must not include such liabilities among Certificates of Deposit in their monthly statistical reports (also see Module BR).

              • BC-4.2.17

                In their statistical reports (also see Module BR), banks should always classify their outstanding Certificates of Deposit according to the type of customer (e.g. resident etc.) to whom they were first issued.

          • BC-4.3 BC-4.3 Disclosure of charges

            • BC-4.3.1

              In order to improve customer awareness and enhance transparency of bank charging structures, full commercial banks should display, by notice in their banking halls (both head offices and branches), a list of current charges.

            • BC-4.3.2

              Banks should also ensure that each customer is in receipt of its current list of charges. The list should specify standard charges and commissions that will be applied by the bank to individual services and transactions and to specific areas of business.

            • BC-4.3.3

              The requirement in this section is in addition to the requirements set out under section CM-8.2 that require all full commercial banks to display, by a conspicuous notice, their current effective rate of interest.

          • BC-4.4 BC-4.4 Accounts held for clubs and societies in Bahrain

            • BC-4.4.1

              All clubs and societies registered with the General Organisation for Youth and Sports (GOYS), are permitted under GOYS rules to only have one account with FCBs in Bahrain.

            • BC-4.4.2

              The FCB is requested to notify GOYS when any club or society registered with GOYS requests the opening of an account with the bank. The purpose of the notification is to obtain clarification whether or not the account in question can be opened in accordance with the rules of GOYS.

            • BC-4.4.3

              For accounts already held with the FCBs for clubs and societies registered with GOYS (i.e. before the application of the regulation in this section), the bank is requested to provide details of such accounts to GOYS (by reference to account name, relevant society, date opened and type of account) as soon as possible. If appropriate, GOYS will contact the relevant club or society in writing (with a copy to the bank) with instructions (e.g. to close the account) regarding such account.

          • BC-4.5 BC-4.5 Current accounts

            • BC-4.5.1

              FCBs levying fees on their low-balance customer current accounts are required by the Agency to apply such fees to average balances when these fall below a prescribed level during a specified period.

            • BC-4.5.2

              In order to prevent incidences of returned cheques due to maintenance of low-balance current accounts, the banks may convert some low-balance and/or inactive current accounts to savings accounts.

          • BC-4.6 BC-4.6 Brokerage fees

            • BC-4.6.1

              The purpose of the contents of this section is to set out the new scale of brokerage fees effective for all banks in Bahrain.

            • BC-4.6.2

              The new scale of fees is the result of discussion and consultation between The Bankers' Society and the Bahrain Money Brokers.

          • BC-4.7 BC-4.7 Notification to the Agency on introduction of new or expanded customer products and facilities

            • BC-4.7.1

              The content of this section is applicable only to full commercial banks licensed by the Agency.

            • BC-4.7.2

              All institutions referred to under paragraph BC-4.7.1 are required to notify the Agency before the introduction of any new or expanded customer products and facilities. The Agency will respond to the concerned bank within one week of receipt of the notification if it has any observations on the new product.

            • BC-4.7.3

              Further, institutions should also advise the Agency, on a six-monthly basis, on the status of new or expanded products and facilities. The advice should cover the following aspects:

              (a) response to,
              (b) success of, and
              (c) difficulties in,

              the introduction of new or expanded products and facilities. The institution should also advise the Agency on any variances which are introduced to the terms and conditions applying to these products and facilities.

          • BC-4.8 BC-4.8 Procedures for inheritance of financial assets

            • BC-4.8.1

              The content of this section is applicable to all full commercial banks licensed by the Agency in the Kingdom of Bahrain.

            • BC-4.8.2

              The Agency requires all commercial banks to follow the undermentioned procedures regarding the distribution of the financial assets of a deceased customer.

              (a) Legal ownership of financial assets should only pass after sight of, and in accordance with, the relevant documentation issued by the Ministry of Justice (known as the "statutory portion").
              (b) Distribution of assets should be made to the order of an individual named in, and in accordance with, a mandate, duly certified by the Ministry of Justice, that reflects the permission of all inheritors that the named individual may act on their collective behalf.
              (c) Where minors are inheritors, the Ministry of Justice documentation must specifically refer to their inheritance and the instruction followed absolutely.

        • BC-5 BC-5 Dishonoured cheques

          • BC-5.1 BC-5.1 Penalty system for dishonoured cheques

            • BC-5.1.1

              The purpose of the contents of this section is to set out regulations relating to the system of penalising any person, whether natural or corporate in form, (referred to as a 'customer' in this chapter) whose cheque is

              (a) presented for payment, but is returned due to insufficient funds being available on his current account, where,
              (b) in the opinion of the FCB on whom the cheque is drawn, such cheque has been issued by the customer in bad faith.

              Cheques falling within this system are referred to as 'dishonoured cheques'. Due regard must be given by FCBs to the general provisions of Bahrain Law regarding joint accounts, partnership accounts and accounts in the name of corporate entities, as well as to the customer mandate in each case, to determine how such accounts may be dealt with for purposes of the Regulation in this chapter.

            • Procedures to be followed

              • BC-5.1.2

                On each occasion that an FCB becomes aware of a dishonoured cheque of one of its customers, that FCB will send a written warning to the relevant customer informing him/her of the existence of the dishonoured cheque, requesting him/her to immediately make good the insufficiency in his current account in order to clear the cheque. This written warning will also inform the customer of the provisions of this system with regard to dishonoured cheques and abusers of cheques.

              • BC-5.1.3

                On the first working day of each calendar month, each FCB should provide to the Agency a list of the names, supported with I.D. numbers (CPR or CR numbers (as applicable) for Bahrain residents, Passport or CR-equivalent numbers (as applicable) for non-Bahrain residents) of those customers to whom one (or more) written warning(s) has been sent in accordance with paragraph BC-5.1.2 above during the immediately preceding calendar month. This list should specify the number of written warnings relating to dishonoured cheques for each customer of the relevant FCB for the month in question and shall be in the form set out in Appendix BC 1. FCBs will be responsible for ensuring the accuracy of all details on their respective lists.

              • BC-5.1.4

                Using the lists referred to in paragraph BC-5.1.3 above, the Agency will prepare a further list (the 'Control List') of those customers to whom two or more written warnings were sent by any one or more FCB at any time within a maximum period of three consecutive calendar months. The Control List, which will be in the form set out in Appendix BC 2, will specify the name and I.D. numbers of each such customer, the total number of dishonoured cheques for that customer included in the lists referred to in paragraph BC-5.1.3 above, the name of the relevant FCB(s) on whose list(s) the customer's name has been included, and other relevant details for FCBs' information and checking in accordance with paragraph BC-5.1.5 below. Any customer to whom more than two written warnings relating to dishonoured cheques were sent by any one or more FCB at any time within a maximum period of three consecutive calendar months will be automatically deemed an abuser of cheques for the purposes of paragraph BC-5.1.7 below.

              • BC-5.1.5

                On the second working day of each calendar month, the Agency will circulate a draft copy of the Control List to FCBs. FCBs will be requested to check the accuracy of the Control List by reference to the information they have sent to the Agency in accordance with paragraph BC-5.1.3 above, and to notify the Agency within a maximum period of one week of receiving the list of any inaccuracies on the Control List. The Control List, as amended if appropriate, will be circulated to FCBs by the Agency on the second working day after it receives all responses from FCBs. FCBs will be required to monitor the customers on this Control List to establish whether any one or more of them issued another dishonoured cheque in the instant calendar month. Any FCB becoming aware of a dishonoured cheque of one or more of its customers on the Control List during this month should notify the Agency of this fact, using the relevant section in Appendix BC 1, on the first working day of each calendar month.

              • BC-5.1.6

                If the Agency does not receive any notification as contemplated in paragraph BC-5.1.5 above for a particular customer on the Control List, that customer's name shall be withdrawn from the next issue of the Control List. However, the Agency will monitor the names of customers appearing on the Control List during the three consecutive calendar months falling immediately after the calendar month in which a customer's name is taken off the Control List. If any such customer's name is again reported to the Agency pursuant to paragraph BC-5.1.3 above at any time during this three month period,

                (a) his name will be returned to the Control List on the date of its next issue if there is only one dishonoured cheque reported in this context, or
                (b) he will be automatically deemed an abuser of cheques for the purposes of paragraph BC-5.1.7 below if there is more than one dishonoured cheque reported in this context.

                If, however, his name is not reported to the Agency in this regard, the Agency will cease its monitoring thereof.

              • BC-5.1.7

                If the Agency does receive notification as contemplated in paragraph BC-5.1.5 above for a particular customer on the Control List, or if a customer is deemed to be an abuser of cheques within paragraph BC-5.1.4 or paragraph BC-5.1.6 above, such customer (herein referred to as an 'abuser of cheques') will be penalised as follows. Using Appendix BC 3, on the second working day of the calendar month following the receipt of the information referred to above, the Agency will circulate a draft list to FCBs. FCBs will be requested to check the accuracy of this list by reference to the information they have sent to the Agency in accordance with paragraph BC-5.1.5 above, and to notify the Agency within a maximum period of one week of receiving the list of any inaccuracies on that list. The list, as amended if appropriate, will be circulated to FCBs by the Agency on the second working day after it receives all responses from FCBs, and will direct the FCB(s) which has/have reported an abuser of cheques to withdraw all cheque books held by that abuser of cheques, and to close such person's current account(s) by transferring any balances therein to savings and/or any other accounts held with that/those FCB(s). Furthermore, that FCB(s) must not provide current account facilities to that abuser of cheques for the twelve calendar month period immediately following the date of issue of the relevant list. All other FCBs should, within a maximum period of one month after the issue of the relevant list, also withdraw current account facilities from that abuser of cheques for the same twelve calendar month period. FCBs will be entitled to recover any amounts due to them from abusers of cheques as a result of compliance with this system by availing of their set-off rights under Bahrain Law.

              • BC-5.1.8

                On Appendix BC 4, the Agency will notify FCBs of those abusers of cheques in respect of whom the twelve calendar month period referred to in paragraph BC-5.1.7 above has ended, and to whom FCBs may reinstate/offer current account facilities at their discretion.

              • BC-5.1.9

                Nothing in this Regulation shall prejudice the rights of banks against customers otherwise existing under Bahrain Law and/or under any particular bank/customer agreement. Furthermore, FCBs will be entitled to the same immunity from prosecution as the Agency for any harm suffered, or alleged to be suffered, by customers as a result of FCBs complying with the Regulation in this chapter.

              • BC-5.1.10

                The Regulation in this chapter may be amended, in whole or in part, from time to time by the Agency. In addition, the Agency may, at its discretion and as it so deems appropriate, issue specific directions to all or any FCBs regarding abusers of cheques or any particular abuser of cheques.

          • BC-5.2 BC-5.2 General guidance on administration of dishonoured cheques

            • BC-5.2.1

              FCBs that wish to issue cheque guarantee cards for an amount not exceeding BD 200 may do so — subject to informing the Director of Banking Services at the Agency of their intention and the arrangements governing the issue of such cards.

            • BC-5.2.2

              FCBs, generally, should take steps to extend their administrative supervision and control over current account customers (in particular those who are in repeated breach of normally-accepted behaviour), and to stress to account holders the need for an appropriate level of discipline in the usage of cheques.

            • BC-5.2.3

              FCBs should exercise greater vigilance over borrowers, especially in the area of consumer finance, where such borrowers maintain their current accounts at a bank or banks other than at the lending bank.

            • BC-5.2.4

              The Agency will monitor the incidence of returned cheques on a monthly basis (as stipulated in section BC-5.1) in order to determine the extent to which such incidence is being reduced or otherwise.

          • BC-5.3 BC-5.3 Penalty charges on dishonoured cheques

            • BC-5.3.1

              The Agency will impose penalty charges of BD 5/= (five Bahraini Dinars) on each returned cheque for the reasons of 'Refer to Drawer', 'Not Arranged For', 'Re-present', and 'Account Closed'. Individual banks will continue to be informed daily of any charges accruing to their accounts. The respective accounts will be debited on the same day.

            • BC-5.3.2

              FCBs will be entitled to charge customers no more than BD 10/= (ten Bahraini Dinars) in respect of each dishonoured cheque.

        • BC-6 BC-6 Automated Teller Machine (ATMs)

          • BC-6.1 BC-6.1 Installation of an off-site ATM in Bahrain

            • BC-6.1.1

              The purpose of the content of this section is to set out the criteria to be followed by banks for the installation and usage of off-site ATMs in the Kingdom of Bahrain.

            • BC-6.1.2

              Applications for the installation of off-site ATMs should be sent in writing, and in accordance with the requirements set out in paragraphs BC-6.1.3 to paragraphs BC-6.1.10, to the Executive Director of Banking Supervision at the Agency.

            • General criteria

              • BC-6.1.3

                Subject to the prior written approval of the Agency, off-site ATMs may be owned individually or jointly by licensed FCBs which are members of the BENEFIT Switch. Each relevant owning FCB must already have linked its bank's ATM capability to the BENEFIT Switch prior to requesting the BMA's permission to install an off-site ATM and, furthermore, must conform to the general standards set by the Benefit company.

              • BC-6.1.4

                Subject to the prior written approval of the Agency, off-site ATMs may, at each relevant owning FCB's discretion, be fully functioning or operate as cash dispensers only. In addition, off-site ATMs may, at each relevant owning FCB's discretion (and subject to the prior written approval of the Agency), be 'walk-up' or 'drive-in' machines.

              • BC-6.1.5

                Owning FCBs will bear full legal responsibility for their respective off-site ATMs, as well as all costs associated with such ATMs (including, but not limited to, cash replenishment, installation, security etc.).

              • BC-6.1.6

                FCBs wishing to install an off-site ATM must submit an application (in writing) for the BMA's approval. This application must be accompanied by a copy of a feasibility study for that particular ATM, as well as such other information as the BMA may request. In particular, a copy of the written permission (for installation of that off-site ATM) of the legal owner of the proposed location must be provided to the Agency, as well as a copy of the written permission of any other relevant authorities in this context (e.g. the Traffic & Licensing and Civil Defence & Fire Service Directorates of the Ministry of Interior).

              • BC-6.1.7

                Applications will generally be considered on a 'first come, first served' basis for a particular location. If more than one application is received to install an off-site ATM in the same location, the number of such applications which are approved will depend upon whether the location appears to the Agency to be capable of sustaining multiple off-site ATMs (subject, in addition, to the exact details of each individual application regarding security etc. being acceptable to the Agency).

              • BC-6.1.8

                Each application will be assessed on its individual merits, and at the Agency's discretion, taking into account factors which the Agency considers relevant including, but not limited to:

                (a) the suitability of the location in question,
                (b) the level of overall activities of the applicant in the market as well as the size and make-up of its customer base, and
                (c) the type and range of facilities which the applicant proposes offering through the off-site ATM at the location in question.

              • BC-6.1.9

                In addition to the information required by the Agency under paragraph BC-6.1.6, the Agency may require further information/clarification to be provided to it before it takes a decision regarding the application. The Agency's decision in this regard will be notified to each relevant applicant FCB in writing and will be final.

              • BC-6.1.10

                The Agency may, at its discretion, require an off-site ATM to be closed at any time. In addition, an owning FCB may request the Agency in writing for permission to close any of its off-site ATMs.

          • BC-6.2 BC-6.2 GCC ATM network charges

            • BC-6.2.1

              The purpose of this section is to set a limit on ATM charges imposed by full commercial banks in the Kingdom of Bahrain for customer withdrawals and other ATM services transactions relating to other banks in the GCC (i.e. linking to GCC ATM networks).

            • BC-6.2.2

              The limits in this section do not apply to ATM service charges on local ATM networks.

            • BC-6.2.3

              The Agency requires that the charges on such customer withdrawals and other ATM services should not exceed BD 1/= (one Bahraini Dinar) per transaction.

        • BC-7 BC-7 Margin Trading System

          • BC-7.1 BC-7.1 Introduction

            • BC-7.1.1

              This Chapter applies to all full commercial banks in Bahrain.

            • BC-7.1.2

              Investors purchasing securities (as defined from time to time by the Bahrain Stock Exchange ("BSE")) listed on the BSE may pay for them under the Margin Trading System ("The System") by borrowing a portion of the purchase price from a participating bank. The System is subject to relevant provisions of the BMA Law, the BSE Law, any rules and regulations issued pursuant to such Laws and this Module. The System applies to equities in companies listed on the BSE. Unless restrictions apply under Bahrain law in this regard, the System shall be available to Bahraini or non-Bahraini investors, whether resident or non-resident in Bahrain.

            • BC-7.1.3

              The main objective of introducing the System is to enhance the overall activity on the BSE, allowing investors to leverage their investments, in a controlled manner.

            • General criteria

              • BC-7.1.4

                Only Full Commercial Banks licensed by the Agency will be permitted to act as participating banks for the System. Participating banks must each receive the prior general written approval of the BMA in order to take part in the System. The BMA will notify the BSE of the identity of participating banks for the System. The BMA's approval may be withdrawn at its discretion.

              • BC-7.1.5

                Stock Exchange Brokers will not be permitted to act as lenders or financiers for the System.

          • BC-7.2 BC-7.2 Limits and Trading Rules

            • BC-7.2.1

              An investor may, through his relationship with any one individual participating bank under the System, invest a maximum of BD 200,000 in securities (i.e. BD 200,000 per investor/per individual participating bank, made up of BD 100,000 by way of the investor's own initial margin and BD 100,000 by way of financing from the relevant participating bank to that investor).

            • BC-7.2.2

              An investor may, through approaching more than one bank under the System, invest a maximum of BD 500,000 in securities (i.e. BD 500,000 per investor/from all participating banks, made up of BD 250,000 by way of the investor's own initial margin with all participating banks and BD 250,000 by way of total financing from all participating banks to that investor.

            • BC-7.2.3

              The amount of the margin facility made to an investor under the System shall be included as an exposure to that customer, and contribute towards the large exposures limit and the consumer finance limit for that person.

            • BC-7.2.4

              The total amount of financing granted by an individual participating bank to all investors under the System shall not, at any time exceed 15% of that participating bank's capital base, such percentage to be reviewed by the BMA at its discretion from time to time.

            • BC-7.2.5

              In relation to the aggregate limit under paragraph BC-7.2.2 above, the Agency will require participating banks to inform the Credit Risk Bureau of all facility limits approved to investors under the System from time to time. Participating banks must check with the CRB on the amount of facility limits outstanding under the System at any time to a particular investor.

            • Brokers

              • BC-7.2.6

                Only those brokers approved by the BSE will be permitted to act as brokers for the System. Generally, brokers will only be approved if they (a) hold a "Class A" license from the BSE, and (b) meet the requirements set for the System from time to time by the BSE and the BMA.

            • Documentation

              • BC-7.2.7

                Only standard-form documents (application forms and agreements) will be used for the System. Standard-form agreements, drafted and approved in advance by the BSE, will be entered into between the participating bank and the investor (in respect of financing), and between the participating bank and the investor and the broker (in respect of trading) and, as relevant, these agreements shall (amongst other things) confirm that:

                a. The investor is borrowing or financing a stated amount from the participating bank for the purpose of taking part in the System;
                b. The investor will repay such stated amount, together with any interest or charges thereon, when due and in accordance with the agreement;
                c. The investor understands the risks involved in margin trading as well as the implications of the undertakings given by him;
                d. The participating bank can sell the securities bought through the System if the relevant margin is called and not met, without further formalities being required;
                e. The broker is liable for marking the securities to market on a daily (or more frequent) basis and for keeping the participating bank updated as to the participating bank's exposure to the investor;
                f. The investor can place orders with the broker for the purchase of securities up to the limit permitted by the agreement;
                g. Each party to the agreement in question shall abide by the duty of confidentiality imposed on him in relation to the matters set out in the agreement; and
                h. There is an overriding obligation on the parties thereto to comply with Bahrain law in general and, in particular, with the share-ownership restrictions applying to certain types of securities.

            • Owner of the Securities bought using the System

              • BC-7.2.8

                For ease of transfer and sale of the securities in the event that a margin is called by the participating bank but not met by the investor, the securities will be registered in the participating bank's name (for the account of the investor) and held by a custodian.

              • BC-7.2.9

                Under paragraph BC-7.2.8 above: (a) the securities should not be considered as part of the bank's own assets for the purposes of determining ownership/control under Bahrain law, and (b) if the investor has discharged his obligations to the participating bank under the System and the securities have not been sold, the securities shall be transferred into the legal ownership of the investor.

            • Margin Percentage

              • BC-7.2.10

                For equities listed on the BSE, an investor shall have the right to borrow a loan the value of which shall not exceed 50% of the total value of the funds being invested (i.e. 1:1). The BMA and the BSE shall coordinate in making any change to the margin percentages set for the System.

            • Margin Call Top-up

              • BC-7.2.11

                The margin call top-up shall be 30% of the total value of the funds invested by an investor through a margin account with a participating bank. An investor shall settle a margin call on the settlement date (as determined by the BSE) by making a cash payment of such amount to the participating bank. Such cash payment may, at the investor's discretion and in whole or part, come from the sale of the securities bought through the System, or otherwise. Failure to meet such margin call will, however, give the participating bank the right to sell the securities bought through the System.

            • Margin Interest

              • BC-7.2.12

                The participating bank shall charge a rate of interest or impose charges on the financing amount granted to the investor at a rate or on a basis to be determined by the participating bank. In the event that investor's margin account is in credit in excess of the margin applicable thereto, interest or profit shall be paid on the excess at a rate to be determined by the participating bank.

      • CA CA Capital Adequacy

        • CA-A CA-A Introduction

          • CA-A.1 CA-A.1 Application

            • CA-A.1.1

              Regulations in this module are applicable to locally incorporated banks on both a stand-alone, including foreign branches, and consolidated group basis.

            • CA-A.1.2

              In addition to licensees mentioned in paragraph CA-A.1.1, certain of these regulations (in particular market risk requirements) are also applicable to full commercial branches of foreign banks.

          • CA-A.2 CA-A.2 Purpose

            • CA-A.2.1

              The purpose of this module is to set out the Agency's capital adequacy regulations and provide guidance on the risk measurement for the calculation of capital requirements by locally incorporated banks.

            • CA-A.2.2

              The module also sets out the minimum gearing requirements which relevant banks (referred to in section CA-A.1) must meet as a condition of their licensing.

            • CA-A.2.3

              The Agency requires in particular that the relevant banks maintain adequate capital, in accordance with the Regulation in this module, against their risks as capital provides banks with a cushion to absorb losses without endangering customer deposits. Due to this, the Agency also requires the relevant banks to maintain adequate liquidity and identify and control their large credit exposures that might otherwise be a source of loss to a licensee on a scale that might threaten its solvency.

            • CA-A.2.4

              This module provides support for certain other parts of the Rulebook, mainly:

              (a) Licensing and Authorisation Requirements;
              (b) BMA Reporting Requirements;
              (c) Credit Risk Management;
              (d) Market Risk Management;
              (e) Operational Risk Management;
              (f) Liquidity Risk Management;
              (g) High Level Controls:
              (h) Relationship with Audit Firms; and
              (i) Penalties and Fines.

          • CA-A.3 CA-A.3 Key requirements

            • CA-A.3.1

              All locally incorporated banks are required to measure and apply capital charges in respect of their credit and market risk capital requirements.

            • The capital requirement

              • CA-A.3.2

                Banks are allowed three classes of capital instruments (see section CA-2.2) to meet their capital requirements for credit risk and market risk, as set out below:

                Tier 1: Core capital — May be used to support credit risk and market risk;
                Tier 2: Supplementary capital — May be used to support credit risk and market risk; and
                Tier 3: Ancillary capital — May be used solely to support market risk.

            • Measuring credit risks

              • CA-A.3.3

                In measuring credit risk for the purpose of capital adequacy, banks are required to apply a simple risk-weighted approach through which claims of different categories of counterparties are assigned risk weights according to broad categories of relative riskiness.

            • Measuring market risks

              • CA-A.3.4

                For the measurement of their market risks, banks will have a choice, subject to the written approval of the Agency, between two broad methodologies. One alternative is to measure the risks in a standardised approach, using the measurement frameworks described in chapters CA-4 to CA-8 of these regulations. The second alternative methodology (i.e. the internal models approach) is set out in detail in chapter CA-9 including the procedure for obtaining the Agency's approval. This methodology is subject to the fulfilment of certain conditions. The use of this methodology is, therefore, conditional upon the explicit approval of the Agency.

            • Minimum capital ratio requirement

              • CA-A.3.5

                On a consolidated basis, the Agency has set a minimum Risk Asset Ratio ("RAR") of 12.0% for all locally incorporated banks. Furthermore, on a solo basis, the parent bank is required to maintain a minimum RAR of 8.0% (i.e. unconsolidated).

              • CA-A.3.6

                For banks that are required to complete only the PIR form, the Agency has set a minimum Risk Asset Ratio ("RAR") of 12.0%.

            • Maintaining minimum RAR

              • CA-A.3.7

                The Agency considers it a matter of basic prudential practice that, in order to ensure that these RARs are constantly met, banks set up internal "targets" of 12.5% (on a consolidated basis) and 8.5% (on a solo basis) to warn them of a potential fall by the bank below the Agency's required minimum RARs. Where a bank's capital ratio falls below its target ratio, the General Manager should notify the Agency immediately, however, no formal action plan will be necessary. The General Manager should explain what measures are being implemented to ensure that the bank will remain above its minimum RAR(s).

              • CA-A.3.8

                The bank will be required to submit form PIR (and PIRC where applicable) to the Agency on a monthly basis, until the RAR(s) exceeds its target ratio(s).

            • Gearing requirements

              • CA-A.3.9

                For Full Commercial Bank and Offshore Banking Unit licensees, deposit liabilities should not exceed 20 times the respective bank's capital and reserves.

              • CA-A.3.10

                For Investment Bank licensees, deposit liabilities should not exceed 10 times the respective bank's capital and reserves.

          • CA-A.4 CA-A.4 Regulation history

            • CA-A.4.1

              This module was first issued in July 2004 as part of the conventional principles volume. All regulations in this volume have been effective since this date. All subsequent changes are dated with the month and year at the base of the relevant page and in the Table of Contents. Chapter UG-3 of Module UG provides further details on Rulebook maintenance and control. The most recent changes made to this module are detailed in the table below:

              Summary of changes

              Module Ref. Change Date Description of Changes
                   
                   
                   
                   
                   

            • Evolution of the Module

              • CA-A.4.2

                Prior to the development of the Rulebook, the Agency had issued various circulars representing regulations relating to capital adequacy requirements. These circulars have now been consolidated into this module covering the capital adequacy regulation. These circulars and their evolution into this module are listed below:

                Circular Ref. Date of Issue Module Ref. Circular Subject
                ODG/50/98 11 Sep 1998 CA-1CA-9 Market Risk Capital Regulations
                BC/07/02 26 Jun 2002 CA-1.4 Review of PIR by External Auditors
                OG/78/01 20 Feb 2001 CA-2.5 Monitoring of Capital Adequacy
                BC/01/98 10 Jan 1998 CA-2.5 Risk Asset Ratio

            • Effective date

              • CA-A.4.3

                The contents in this module are effective from the date depicted in the original circulars (see Paragraph CA-A.4.2) from which the requirements are compiled.

        • CA-B CA-B General guidance and best practice

          • CA-B.1 CA-B.1 Introduction

            • CA-B.1.1

              This chapter provides general guidance on Capital adequacy requirements, unless otherwise stated.

            • CA-B.1.2

              It sets best practice standards and should generally be applied by all licensees to their activities.

          • CA-B.2 CA-B.2 Guidance provided by other international bodies

            • Basel Committee: Use of 'Backtesting' in Conjunction with the Internal Models Approach to Market Risk Capital Requirements

              • CA-B.2.1

                In January 1996, the Basel Committee on Banking Supervision issued technical guidance on the "use of 'Backtesting' in Conjunction with the Internal Models Approach to Market Risk Capital Requirements" (see http://www.bis.org/publ/bcbs22.htm).

              • CA-B.2.2

                This technical guidance presents a methodology for testing the accuracy of the internal models used by banks to measure market risks.

              • CA-B.2.3

                Backtesting offers the best opportunity for incorporating suitable incentives into the internal models in a consistent manner.

              • CA-B.2.4

                The Agency will rely upon technical guidance for its assessment and review of bank's market risk capital requirements including, but not limited to, the determination of the add-on factor.

            • Basel Committee: The management of banks' off-balance-sheet exposures — a supervisory perspective

              • CA-B.2.5

                In March 1986, the Basel Committee on Banking Supervision issued a paper titled "The management of banks' off-balance-sheet exposures — a supervisory perspective" (see www.bis.org/publ/bcbsc134.pdf).

              • CA-B.2.6

                This paper examines off-balance-sheet risks from three angles: market/position risk, credit risk and operational/control risk. Part III of this paper examines credit risk (including control of large exposures, settlement risk and country risk), with particular emphasis given to the assessment of the relative risks of the different types of off-balance-sheet activity.

          • CA-B.3 CA-B.3 Enforceability

            • CA-B.3.1

              This guidance should not be taken as legally binding requirements, unless otherwise embodied in Bahrain law or by regulation.

            • CA-B.3.2

              It should be noted that the provisions in this chapter are to be taken as guidance, unless otherwise stated, supplementing the Regulations set out in this module.

        • CA-1 CA-1 Scope and coverage of capital charges

          • CA-1.1 CA-1.1 Introduction

            • CA-1.1.1

              All locally incorporated banks are required to measure and apply capital charges in respect of their credit and market risk capital requirements.

            • CA-1.1.2

              Credit risk is defined as the potential that a bank's borrower or counterparty will fail to meet its obligations in accordance with agreed terms. Credit risk exists throughout the activities of a bank in the banking book and in the trading book including both on- and off-balance-sheet exposures.

            • CA-1.1.3

              Market risk is defined as the risk of losses in on- or off-balance-sheet positions arising from movements in market prices. The risks subject to the capital requirement of this module are:

              (a) the risks pertaining to interest rate related instruments and equities in the trading book: and
              (b) foreign exchange and commodities risks throughout the bank.

          • CA-1.2 CA-1.2 Measuring credit risks

            • CA-1.2.1

              In measuring credit risk for the purpose of capital adequacy, banks are required to apply a simple risk-weighted approach through which claims of different categories of counterparties are assigned risk weights according to broad categories of relative riskiness.

            • CA-1.2.2

              The framework of weights consists of four weights — 0%, 20%, 50% and 100% for on- and off-balance-sheet items, which based on a broad-brush judgment, are applied to the different types of assets and off-balance-sheet exposures (with the exception of derivative transactions) within the banking book.

            • CA-1.2.3

              The resultant different weighted assets and off-balance-sheet exposures are then added together to calculate the total credit-risk-weighted assets of the bank.

          • CA-1.3 CA-1.3 Measuring market risks

            • Trading book

              • CA-1.3.1

                The trading book means the bank's proprietary positions in financial instruments (including positions in derivative products and off-balance-sheet instruments) which are intentionally held for short-term resale and/or which are taken on by the bank with the intention of benefiting in the short-term from actual and/or expected differences between their buying and selling prices, or from other price or interest rate variations, and positions in financial instruments arising from matched principal brokering and market making, or positions taken in order to hedge other elements of the trading book.

              • CA-1.3.2

                Each bank should agree a written policy statement with the Agency on which activities are normally considered trading and which, therefore, constitute the trading book.

              • CA-1.3.3

                It is expected that the trading activities will be managed and monitored by a separate unit and that such activities should be identifiable because of their intent, as defined in paragraph CA-1.3.1 above.

            • Interest rate and equity risk

              • CA-1.3.4

                The capital charges for interest rate related instruments and equities will apply based on the current market values of items in a bank's trading book.

            • Foreign exchange and commodities risk

              • CA-1.3.5

                The capital charges for foreign exchange risk and for commodities risk will apply to a bank's total currency and commodity positions, with the exception of structural foreign exchange positions in accordance with section CA-6.3 of this module.

            • Exemptions

              • CA-1.3.6

                Banks will be allowed certain de minimis exemptions from the capital requirements for foreign exchange risk, as described in section CA-6.2. For the time being, there shall be no exemptions from the trading book capital requirements, or from the capital requirements for commodities risk.

            • Hedging instruments

              • CA-1.3.7

                A trading book exposure may be hedged, completely or partially, by an instrument that, in its own right, is not normally considered eligible to be a part of the trading book. Subject to the policy statement agreed by the bank with the Agency as explained in paragraph CA-1.3.2 above, and with the prior written approval of the Agency, banks will be allowed to include within their market risk measure non-trading instruments (on- or off-balance-sheet) which are deliberately used to hedge the trading activities. The positions in these instruments will attract counterparty risk capital requirements and general market risk, but not specific risk requirements.

              • CA-1.3.8

                Where a financial instrument which would normally qualify as part of the trading book is used to hedge an exposure in the banking book, it should be carved out of the trading book for the period of the hedge, and included in the banking book with the exposure it is hedging. Such instruments will be subject to the credit risk capital requirements.

              • CA-1.3.9

                It is possible that general market risk arising from the trading book may hedge positions in the banking book without reference to individual financial instruments. In such circumstances, there must nevertheless be underlying positions in the trading book. The positions in the banking book which are being hedged must remain in the banking book, although the general market risk exposure associated with them should be incorporated within the calculation of general market risk capital requirements for the trading book (i.e. the general market risk element on the banking book side of the hedge should be added to the trading book calculation, rather than that on the trading book side of the hedge being deducted from it). As no individual financial instruments are designated, there is no resultant specific risk requirement in the trading book and the risk-weighted assets in the banking book will not be reduced. Any such arrangement for the transfer of risk must be subject to the policy statement agreed with the Agency as explained in paragraph CA-1.3.2 above, and should have the specific prior written approval of the Agency.

            • Allocation of financial and hedging instruments

              • CA-1.3.10

                The allocation of a financial instrument between the trading book and the banking book, or the allocation of hedging instruments described in paragraph CA-1.3.7 above, or the transfer of general market risk as explained in paragraph CA-1.3.9 above, should be subject to appropriate and adequate documentation to ensure that it can be established through audit verification that the item is treated correctly for the purposes of capital requirements, in compliance with the bank's established criteria for allocating items to the trading or banking book, and subject to the policy statement agreed with the Agency.

              • CA-1.3.11

                The Agency intends to carefully monitor the way in which banks allocate financial instruments and will seek, in particular, to ensure that no abusive switching designed to minimise capital charges occurs and to prevent "gains trading" in respect of securities which are not marked to market.

            • Review of compliance by internal and external auditors

              • CA-1.3.12

                The bank's compliance with the established criteria for allocating items to the trading and banking books, and with the policy statement agreed with the Agency, should be reviewed by the bank's internal auditors at least on a quarterly basis, and by the external auditors at least once a year.

              • CA-1.3.13

                Any cases of non-compliance identified by the internal auditor should be immediately brought to the attention of the Agency, in writing, by the senior management of the bank. Any non-compliance identified by the external auditors, requires them to submit a written report directly to the Agency (in accordance with the requirements in section CA-9.8), in addition to a report to be submitted by the management.

            • Valuation requirements

              • CA-1.3.14

                To establish a relevant base for measuring the market risk in the trading book, all positions should be marked to market daily, including the recognition of accruing interest, dividends or other benefits as appropriate. Banks are required to have, and discuss with the Agency, a written policy statement on the subject of valuing trading book positions, which in particular should address the valuation process for those items where market prices are not readily available. This policy statement should have been developed in conjunction with the bank's internal and external auditors. Having arrived at a valuation mechanism for a single position or a group of similar positions, the valuation approach should be applied consistently. In addition to the considerations of prudence and consistency, the bank's valuation policy should reflect the points set out below:

                (a) A bank may mark to market positions using either a close-out valuation based on two-way prices (i.e., a long position shall be valued at its current bid price and a short position at its current offer price) or, alternatively, using a mid-market price but making a provision for the spread between bid and offer prices for different instruments. The bank must have due regard to the liquidity of the position concerned and any special factors which may adversely affect the closure of the position.
                (b) Where a bank has obtained the Agency's approval for the use of a risk assessment model in the calculation of the capital requirements for options (in accordance with chapter CA-9 of these regulations), it may value its options using the values derived from that model.
                (c) Where a bank does not use a model and the prices are not published for its options positions, it must determine the market value as follows:
                (i) For purchased options, the marked-to-market value is the product of the "in the money" amount and the quantity underlying the option; and
                (ii) For written options, the marked-to-market value is the initial premium received for the option plus the product of the amount by which the current "in the money" amount exceeds either the "in the money" amount at the time the contract was written, or zero if the contract was "out of the money" at the time that it was written; and the quantity underlying the option.
                (d) A bank must calculate the value of a swap contract or an FRA having regard to the net present value of the future cash flows of the contract, using current interest rates relevant to the periods in which the cash flows will arise.
                (e) Where a bank is a market maker in an instrument(s), the valuation should be the bank's own bid or offer price which should reflect the bank's exposure to the market as a whole and its views on future prices. Where the bank is the sole market maker in a particular instrument, it should take proper care to ensure that the valuation used is prudent in all circumstances.
                (f) In the event that a bank is only able to access indicative prices, having regard to the fact that they are only a guide, such prices may have to be adjusted to some degree in order to arrive at a prudent valuation.
                (g) In the event that the bank is only able to access mid-market or single values, it should have regard to the fact that these prices will have to be adjusted to some degree in order to arrive at a prudent valuation.

            • Consolidation

              • CA-1.3.15

                Both credit risk and market risk capital requirements will apply on a worldwide consolidated basis. Only a bank which is running a global consolidated book may apply the offsetting rules contained in the remainder of these regulations, on a consolidated basis with the prior written agreement of the Agency. However, where it would not be prudent to offset or net positions within the group as, for example, where there are obstacles to the quick repatriation of profits from a foreign subsidiary or where there are legal and procedural difficulties in carrying out the timely management of risks on a consolidated basis, the Agency will require the bank to take individual positions into account without any offsetting.

              • CA-1.3.16

                Notwithstanding that the market risk capital requirements will apply on a worldwide consolidated basis, the Agency retains the right to monitor the market risks of banks on a non-consolidated basis to ensure that significant imbalances within a group do not escape supervision. The Agency will be particularly vigilant to ensure that banks do not pass positions on reporting dates in such a way as to escape measurement.

            • Approach to measurement

              • CA-1.3.17

                For the measurement of their market risks, banks will have a choice, subject to the written approval of the Agency, between two broad methodologies. One alternative is to measure the risks in a standardised approach, using the measurement frameworks described in chapters CA-4 to CA-8 of these regulations. Chapters CA-4 to CA-7 deal with the four risks addressed by these regulations; namely interest rate risk, equity position risk, foreign exchange risk and commodities risk. Chapter CA-8 sets out a number of possible methods for measuring the price risk in options of all kinds. The capital charge under the standardised approach is the arithmetical sum of the risk measures obtained from the measurement frameworks in chapters CA-4 to CA-8.

              • CA-1.3.18

                The standardised approach uses a "building-block" approach in which the specific risk and the general market risk arising from interest rate and equity positions are calculated separately.

              • CA-1.3.19

                The second alternative methodology, which is subject to the fulfilment of certain conditions and the use of which is, therefore, conditional upon the explicit approval of the Agency, is set out in detail in chapter CA-9 including the procedure for obtaining the Agency's approval. This method allows banks to use risk measures derived from their own internal risk measurement models (Internal Models Approach), subject to seven sets of conditions which are described in detail in chapter CA-9.

              • CA-1.3.20

                The focus of most internal models currently used by banks is the general market risk exposure, typically leaving specific risk (i.e., exposures to specific issuers of debt securities or equities1) to be measured largely through separate credit risk measurement systems. Banks using internal models for the measurement of their market risk capital requirements will be subject to a separate capital charge for specific risk, to the extent that the model does not capture specific risk. The capital charge for banks which are modelling specific risk is set out in chapter CA-9.


                1 Specific risk includes the risk that an individual debt or equity security moves by more or less than the general market in day-to-day trading (including periods when the whole market is volatile) and event risk (where the price of an individual debt or equity security moves precipitously relative to the general market, e.g., on a take-over bid or some other shock event; such events would also include the risk of "default").

              • CA-1.3.21

                In measuring the price risk in options under the standardised approach, a number of alternatives with varying degrees of sophistication are allowed (see chapter CA-8). The more a bank is engaged in writing options, the more sophisticated its measurement method needs to be. In the longer term, banks with significant options business will be expected to move to comprehensive value-at-risk models and become subject to the full range of quantitative and qualitative standards set out in chapter CA-9.

              • CA-1.3.22

                All transactions, including forward sales and purchases, shall be included in the calculation of capital requirements as from the date on which they were entered into.

            • Monitoring

              • CA-1.3.23

                Banks are expected to manage their market risk in such a way that the capital requirements for market risk are being met on a continuous basis, i.e. at the close of each business day and not merely at the end of each calendar quarter, both in the case of banks that use the standardised approach and those that use internal models. Banks are also expected to maintain strict risk management systems to ensure that their intra-day exposures are not excessive.

              • CA-1.3.24

                Banks' daily compliance with the capital requirements for market risk shall be verified by the independent risk management department and the internal auditor. It is expected that the external auditors will perform appropriate tests of the banks' daily compliance with the capital requirements for market risk. Where a bank fails to meet the minimum capital requirements for market risk on any business day, the Agency should be informed in writing. The Agency will then seek to ensure that the bank takes immediate measures to rectify the situation.

              • CA-1.3.25

                Besides what is stated in paragraphs CA-1.3.2, CA-1.3.3, CA-1.3.10, CA-1.3.11, CA-1.3.19 and section CA-1.6, the Agency will consider a number of other appropriate and effective measures to ensure that banks do not "window-dress" by showing significantly lower market risk positions on reporting dates.

          • CA-1.4 CA-1.4 Reporting

            • CA-1.4.1

              Formal reporting, to the Agency, of capital adequacy shall be made in accordance with the requirements set out under section BR-3.1.

            • Review of Prudential Information Returns by External Auditors

              • CA-1.4.2

                The Agency requires all relevant banks to request their external auditors to conduct a review of the prudential returns on a quarterly basis in accordance with the requirements set out under section BR-3.1.

          • CA-1.5 CA-1.5 Summary of overall capital adequacy requirement

            • CA-1.5.1

              Each bank is expected to monitor and report the level of risk against which a capital requirement is to be applied, in accordance with section CA-1.3 above. The bank's overall minimum capital requirement will be:

              The credit risk requirements laid down by the Agency, excluding debt and equity securities in the trading book and all positions in commodities, but including the credit counterparty risk on all over-the-counter derivatives whether in the trading or the banking books: PLUS one of the following:

              (a) The capital charges for market risks calculated according to the measurement frameworks described in chapters CA-4 to CA-8, summed arithmetically: OR
              (b) The measure of market risk derived from the models approach set out in chapter CA-9 (with the prior written approval of the Agency for adopting this approach — see chapter CA-9); OR
              (c) A mixture of (a) and (b) above, summed arithmetically (with the prior written approval of the Agency for adopting a combination of the standardised approach and the internal models approach — see chapter CA-9).

          • CA-1.6 CA-1.6 Transitional provisions

            • CA-1.6.1

              Banks which start to use internal models for one or more risk categories should, over a reasonable period of time, extend the models to all of their operations, subject to the exceptions mentioned in paragraph CA-1.6.4 below, and to move towards a comprehensive model (i.e., one which captures all market risk categories).

            • CA-1.6.2

              On a transitional basis, banks will be allowed to use a combination of the standardised approach and the internal models approach to measure their market risks provided they should cover a complete risk category (e.g., interest rate risk or foreign exchange risk), i.e., a combination of the two methods will not be allowed within the same risk category1. However, for banks that are, at present, still implementing or further improving their internal models, they will be allowed some flexibility, even within risk categories, in including all their operations on a worldwide basis. This flexibility shall be subject to the specific prior written approval of the Agency, and such approval will be given on a case-by-case basis and reviewed by the Agency from time to time.


              1 This does not, however, apply to pre-processing techniques which are used to simplify the calculation and whose results become subject to the standardised methodology.

            • CA-1.6.3

              The Agency will closely monitor banks to ensure that there will be no "cherry-picking" between the standardised approach and the models approach within a risk category. Banks which adopt a model will not be permitted, save in exceptional circumstances, to revert to the standardised approach.

            • CA-1.6.4

              The Agency recognises that even a bank which uses a comprehensive model may still incur risks in positions which are not captured by their internal models2, for example, in remote locations, in minor currencies or in negligible business areas3. Any such risks that are not included in a model should be separately measured and reported using the standardised approach described in chapters CA-4 to CA-8.


              2 Banks may also incur interest rate and equity risks outside of their trading activities. However, there are no explicit capital charges for the price risk in such positions.

              3 For example, if a bank is hardly engaged in commodities it will not necessarily be expected to model its commodities risk.

            • CA-1.6.5

              Transitioning banks are required to move towards a comprehensive internal model approach.

            • CA-1.6.6

              The Agency will closely monitor the risk management practices of banks moving towards the models approach, to ensure that they will be in a position to meet all the standards once they are applying a fully-fledged model for any risk category.

        • CA-2 CA-2 The capital requirement

          • CA-2.1 CA-2.1 Introduction

            • CA-2.1.1

              Banks are allowed three types of capital instruments to meet their capital requirements for credit risk and market risk, as set out below:

              Tiers 1 and 2: May be used to support credit risk and market risk; and
              Tier 3: May be used solely to support market risk.

            • CA-2.1.2

              For a branch of a foreign bank operating as a full commercial branch, a designated capital is required, as agreed between the BMA and the licensee, taking into consideration the gearing requirement stated in section CA-10.1.

          • CA-2.2 CA-2.2 Definition of capital

            • Tier 1: Core capital

              • CA-2.2.1

                Tier 1 capital shall consist of the sum of items (a) to (c) below, less the sum of items (d) to (e) below:

                (a) Permanent shareholders' equity (including issued and fully paid ordinary shares / common stock and perpetual non-cumulative preference shares, but excluding cumulative preference shares);
                (b) Disclosed reserves, which are audited and approved by the shareholders, in the form of legal, general and other reserves created by appropriations of retained earnings, share premiums, capital redemption reserves and other surplus but excluding revaluation reserves; and
                (c) Minority interests, arising on consolidation, in the equity of subsidiaries which are less than wholly owned.

                LESS:
                (d) Goodwill; and
                (e) Current year's cumulative net losses which have been reviewed or audited as per the International Standards on Auditing (ISA) by the external auditors.

            • Tier 2: Supplementary capital

              • CA-2.2.2

                Tier 2 capital shall consist of the following items:

                (a) Interim retained profits which have been reviewed as per the ISA by the external auditors;
                (b) Asset revaluation reserves, which arise in two ways. Firstly, these reserves can arise from the revaluation of fixed assets from time to time in line with the change in market values, and are reflected on the face of the balance sheet as a revaluation reserve. Secondly, hidden values or "latent' revaluation reserves may be present as a result of long-term holdings of equity securities valued in the balance sheet at the historical cost of acquisition. Both types of revaluation reserve may be included in tier 2 capital, with the concurrence of the external auditors, provided that the assets are prudently valued, fully reflecting the possibility of price fluctuation and forced sale. In the case of "latent" revaluation reserves, a discount of 55% will be applied to the difference between the historical cost book value and the market value to reflect the potential volatility of this form of unrealised capital.
                (c) General provisions held against future, presently unidentified losses which are freely available to meet losses which subsequently materialise and, therefore, qualify for inclusion within supplementary elements of capital, subject to a maximum of 1.25% of total risk-weighted assets (both credit and market risk-weighted assets). Provisions ascribed to impairment of particular assets or known liabilities should be excluded.
                (d) Hybrid instruments, which include a range of instruments which combine characteristics of equity capital and of debt, and which meet the following requirements:
                •  They are unsecured, subordinated and fully paid-up;
                •  They are not redeemable at the initiative of the holder or without the prior consent of the Agency;
                •  They are available to participate in losses without the bank being obliged to cease trading (unlike conventional subordinated debt); and
                •  Although the capital instrument may carry an obligation to pay interest that cannot permanently be reduced or waived (unlike dividends on ordinary shareholders' equity), it should allow service obligations to be deferred (as with cumulative preference shares) where the profitability of the bank would not support payment.
                Cumulative preference shares, having the above characteristics, would be eligible for inclusion in tier 2 capital. Debt capital instruments which do not meet the above criteria may be eligible for inclusion in item (e) below.
                (e) Subordinated term debt, which comprises all conventional unsecured borrowing subordinated (in respect of both interest and principal) to all other liabilities of the bank except the share capital and limited life redeemable preference shares. To be eligible for inclusion in tier 2 capital, subordinated debt capital instruments should have a minimum original fixed term to maturity of over five years. During the last five years to maturity, a cumulative discount (or amortisation) factor of 20% per year will be applied to reflect the diminishing value of these instruments as a continuing source of strength. Unlike instruments included in item (d) above, these instruments are not normally available to participate in the losses of a bank which continues trading. For this reason, these instruments will be limited to a maximum of 50% of tier 1 capital.
                (f) 45% of unrealised gains on equity securities held as available-for-sale (on an aggregate net-basis).

            • Deduction from tiers 1 and 2 capital

              • CA-2.2.3

                The following item shall be deducted from tiers 1 and 2 capital on a pro-rata basis:

                —Investments in and lending of a capital nature to unconsolidated subsidiaries engaged in banking and financial activities. The assets representing the investments in subsidiary companies whose capital is deducted from that of the parent would not be included in total assets for the purpose of computing the capital ratio.

            • Tier 3: Trading book ancillary capital

              • CA-2.2.4

                Tier 3 capital will consist of short-term subordinated debt which, if circumstances demand, needs to be capable of becoming part of the bank's permanent capital and thus be available to absorb losses in the event of insolvency. It must, therefore, at a minimum meet the following conditions:

                (a) Be unsecured, subordinated and fully paid up;
                (b) Have an original maturity of at least two years;
                (c) Not be repayable before the agreed repayment date; and
                (d) Be subject to a lock-in clause which stipulates that neither interest nor principal may be paid (even at maturity) if such payment means that the bank falls below or remains below its minimum capital requirement.

          • CA-2.3 CA-2.3 Limits on the use of different forms of capital

            • Tier 1: Core capital

              • CA-2.3.1

                Tier 1 capital should represent at least half of the total eligible capital, i.e., the sum total of tier 2 plus tier 3 eligible capital should not exceed total tier 1 eligible capital.

            • Tier 2: Supplementary capital

              • CA-2.3.2

                Tier 2 elements may be substituted for tier 3 up to the tier 3 limit of 250% of tier 1 capital (as below) in so far as eligible tier 2 capital does not exceed total tier 1 capital, and long-term subordinated debt does not exceed 50% of tier 1 capital.

            • Tier 3: Ancillary capital

              • CA-2.3.3

                Tier 3 capital is limited to 250% of a bank's tier 1 capital that is required to support market risks. This means that a minimum of about 28.57% of market risks needs to be supported by tier 1 capital that is not required to support risks in the remainder of the book.

          • CA-2.4 CA-2.4 Calculation of the capital ratio

            • CA-2.4.1

              A bank should start the calculation of the capital ratio with the measure of market risk (i.e., specific risk plus general market risk) in accordance with the regulations in this module, including interest rate risk, equity risk, foreign exchange and commodities risks.

            • CA-2.4.2

              The bank should next calculate its credit risk-weighted assets in accordance with the regulations in this module.

            • CA-2.4.3

              The next step is to create an explicit numerical link between the capital requirements for credit and market risks. This is accomplished by multiplying the measure of market risk (calculated as stated in paragraphs CA-2.4.1 and CA-2.4.2 above) by 12.5 and adding the resulting figure to the sum of the credit risk-weighted assets. The capital ratio will then be calculated in relation to the sum of the two, using as the numerator only the eligible capital.

            • CA-2.4.4

              In calculating the eligible capital, it will be necessary first to calculate the bank's minimum capital requirement for credit risk, and only afterwards its market risk requirement, to establish how much tier 1 and tier 2 capital is available to support market risk. Eligible capital will be the sum of the whole of the bank's tier 1 capital, plus tier 2 capital under the limits set out in section CA-2.3 above. Tier 3 capital will be regarded as eligible only if it can be used to support market risks under the conditions set out in section CA-2.2 and CA-2.3 above. The quoted capital ratio will thus represent capital that is available to meet both credit risk and market risk. Where a bank has tier 3 capital, which meets the conditions set out in section CA-2.2 above and which is not at present supporting market risks, it may report that excess as unused but eligible tier 3 capital alongside its capital ratio. A worked example of the calculation of the capital ratio is set out in Appendix CA 1.

          • CA-2.5 CA-2.5 Minimum capital ratio requirement

            • Banking group

              • CA-2.5.1

                On a consolidated basis, the Agency has set a minimum Risk Asset Ratio ("RAR") of 12.0% for all locally incorporated banks. Furthermore, on a solo basis, the parent bank of a group is required to maintain a minimum RAR of 8.0% (i.e. unconsolidated).

              • CA-2.5.2

                This means where a bank is required to complete both form PIR (Appendix BR 5) and form PIRC (Appendix BR 6), 8.0% is the minimum RAR necessary for the solo bank (PIR), and 12.0% for the consolidated bank (PIRC).

            • Individual bank

              • CA-2.5.3

                For banks that are required to complete only the PIR form, the Agency has set a minimum Risk Asset Ratio ("RAR") of 12.0%.

            • Maintaining minimum RAR

              • CA-2.5.4

                To clarify the effect of these minimum ratios (as identified in paragraphs CA-2.5.1 to CA-2.5.3) on differing banking groups and individual banks, four examples (see Appendix CA 1) are given. In the examples, the parent and the subsidiary are Bahrain incorporated banks, but the cases could apply to overseas incorporated subsidiaries (with adjustment to the minimum RAR where appropriate in individual cases).

                (a) Case One: Compliant solo bank—No subsidiaries (PIR only).
                (b) Case Two: Compliant parent bank, compliant group (PIR and PIRC).
                (c) Case Three: Compliant parent bank, compliant subsidiary bank, but non-compliant group.
                (d) Case Four: Non-compliant parent bank, compliant subsidiary bank and compliant group.

                For detailed workings of the above cases, refer to Appendix CA 1.

              • CA-2.5.5

                All locally incorporated banks must give the Agency, immediate written notification of any actual breach by such banks of either or both of the above RARs. Where such notification is given, the bank must also:

                (a) provide the Agency no later than one calendar week after the notification, with a written action plan setting out how the bank proposes to restore the relevant RAR(s) to the required minimum level(s) set out above and, further, describing how the bank will ensure that a breach of such RAR(s) will not occur again in the future; and
                (b) report on a weekly basis thereafter on the bank's relevant RAR(s) until such RAR(s) have reached the required target level(s) set out below.

              • CA-2.5.6

                In addition, the Agency considers it a matter of basic prudential practice that, in order to ensure that these RARs are constantly met, banks set up internal "targets" of 12.5% (on a consolidated basis) and 8.5% (on a solo basis) to warn them of a potential fall by the bank below the Agency's required minimum RARs as set out above.

              • CA-2.5.7

                Where a bank's capital ratio falls below its target ratio, the General Manager should notify the Director of Banking Supervision at the Agency immediately. No formal action plan will be necessary, however the General Manager should explain what measures are being implemented to ensure that the bank will remain above its minimum RAR(s).

              • CA-2.5.8

                The bank will be required to submit form PIR (and PIRC where applicable) to the Agency on a monthly basis, until the RAR(s) exceeds its target ratio(s).

              • CA-2.5.9

                The Agency will notify banks in writing of any action required of them with regard to the corrective and preventive action (as appropriate) proposed by the bank pursuant to the above, as well as of any other requirement of the Agency in any particular case.

              • CA-2.5.10

                Banks should note that the Agency considers the breach of RARs to be a very serious matter. Consequently, the Agency may (at its discretion) subject a bank which breaches its RAR(s) to a formal licensing reappraisal. Such reappraisal may be effected either through the Agency's own inspection function or through the use of Reporting Accountants, as appropriate. Following such appraisal, the Agency will notify the bank concerned in writing of its conclusions with regard to the continued licensing of the bank.

              • CA-2.5.11

                The Agency recommends that the bank's compliance officer supports and cooperates with the Agency in the monitoring and reporting of the capital ratios and other regulatory reporting matters. Compliance officers should ensure that their banks have adequate internal systems and controls to comply with these regulations.

        • CA-3 CA-3 Credit risk

          • CA-3.1 CA-3.1 Introduction

            • CA-3.1.1

              This chapter describes the standardised approach for the measurement of the credit risk exposure in the bank's banking book.

            • CA-3.1.2

              As illustrated in sections CA-3.2, CA-3.3 and CA-3.4, banks are required to apply a simple risk-weighted approach through which claims of different categories of counterparties are assigned risk weights according to broad categories of relative risk.

          • CA-3.2 CA-3.2 Risk weighting — On-balance-sheet asset category

            • CA-3.2.1

              Risk weights by category of on-balance-sheet asset are illustrated in the table below:

              Risk weights Category of on-balance-sheet assets/claims
              0%
              (a) Cash and balances with Central Banks
              (b) Holdings of Gold bullion and other commodities
              (c) Claims on & guaranteed by:

              (i) The Government of Bahrain & Bahrain public sector entities
              (ii) Government-owned GCC companies incorporated in Bahrain
              (d) Claims on & guaranteed by or collateralised by cash or securities issued by central governments and central banks of Group A countries; and
              (e) Claims on the central governments and central banks of Group B countries, where denominated in national currency and funded in that currency.
              20%
              (a) Claims on and guaranteed by or collateralised by securities issued by multilateral development banks
              (b) Claims on and guaranteed by banks and securities firms incorporated in Group A countries
              (c) Claims on and guaranteed by banks incorporated in Group B countries with a residual maturity of 1 year or less
              (d) Claims on and guaranteed by public sector entities in Group A countries
              (e) Claims on and guaranteed by government-owned GCC companies incorporated outside Bahrain; and
              (f) Cash items in process of collection
              50% Claims secured by mortgage on residential property
              100%
              (a) Claims on related parties
              (b) Holdings of other (non-subsidiary) banks' and securities firms' capital instruments
              (c) Claims on and guaranteed by banks incorporated in Group B countries with a residual maturity over one year
              (d) Claims on central governments and central banks of Group B countries (not included above)
              (e) Claims on and guaranteed by public sector entities of Group B countries
              (f) Claims on and guaranteed by government-owned companies in non-GCC countries
              (g) Claims on and guaranteed by private sector persons and entities in and outside Bahrain
              (h) Premises and equipment, real estate investments and assets not reported elsewhere

          • CA-3.3 CA-3.3 Risk weighting — Off-balance-sheet items

            • CA-3.3.1

              The framework takes account of the credit risk on off-balance-sheet exposures by applying credit conversion factors to the different types of off-balance-sheet instruments or transactions (with the exception of derivatives).

            • CA-3.3.2

              The conversion factors are derived from the estimated size and likely occurrence of the credit exposure, as well as the relative degree of credit risk as identified in the Basel Committee's paper on "The management of banks' off-balance-sheet exposures: a supervisory perspective" (see www.bis.org/publ/bcbsc134.pdf) issued in March 1986.

            • CA-3.3.3

              The credit conversion factors applicable to the off-balance-sheet items are set out in the table below:

              Credit Conversion factors Off-balance-sheet items
              100% Direct credit substitutes, including general guarantees of indebtedness and acceptances
              50% Transaction-related contingent items (e.g. performance bonds, bid bonds, warranties and standby letters of credit related to particular transactions)
              20% Short-term self-liquidating trade-related contingencies (such as documentary credits collateralised by the underlying shipments)
              100% Sale and repurchase agreements and asset sales with recourse, where the credit risk remains with the bank
              100% Forward asset purchases, forward forward deposits and the unpaid part of partly-paid shares and securities, which represent commitments with certain draw-down
              50% Underwriting commitments under note issuance and revolving underwriting facilities (minus own holdings of notes underwritten)
              50% Other commitments (e.g. formal standby facilities and credit lines) with an original maturity of 1 year and over
              0% Similar commitments with an original maturity of up to 1 year, or which can be unconditionally cancelled at any time

            • CA-3.3.4

              The applicable credit conversion factors should be multiplied by the weights applicable to the category of the counterparty as set out below:

              Risk weights Counterparty
              0% Type (a)
              — The Government of Bahrain.
              — Bahrain public sector entities.
              — Government-owned (non-banking) GCC companies incorporated in Bahrain.
              — Central government and central banks of Group A countries.
              20% Type (b)
              — Banks incorporated in Bahrain or Group A countries and securities firms.
              — Banks incorporated in Group B countries (if the commitment has a residual life of 1 year or less).
              — Public sector entities in Group A countries.
              — Government-owned (non-banking) GCC companies incorporated outside Bahrain.
              100% Type (c)
              — Banks incorporated in Group B countries (if the commitment has a residual life of more than 1 year).
              — Central governments, central banks and public sector entities in Group B countries.
              — Government-owned companies incorporated in non-GCC countries.
              — Private sector persons and entities in Bahrain and abroad.

          • CA-3.4 CA-3.4 Treatment of derivatives contracts in the banking book

            • CA-3.4.1

              The treatment of forwards, swaps, purchased options and similar derivative contracts needs special attention because banks are not exposed to credit risk for the full face value of their contracts, but only to the potential cost of replacing the cash flow (on contracts showing positive value) if the counterparty defaults. The credit equivalent amounts (as referred to under paragraph CA-3.4.13) will depend inter alia on the maturity of the contract and on the volatility of the rates and prices underlying that type of instrument.

            • CA-3.4.2

              Instruments traded on exchanges may be excluded where they are subject to daily receipt and payment of cash variation margins.

            • CA-3.4.3

              Options purchased over-the-counter are included with the same conversion factors as other instruments.

            • Interest rate contracts

              • CA-3.4.4

                Interest rate contracts are defined to include single-currency interest rate swaps, basis swaps, forward rate agreements, interest rate futures, interest rate options purchased and similar instruments.

            • Exchange rate contracts

              • CA-3.4.5

                Exchange rate contracts include cross-currency interest rate swaps, forward foreign exchange contracts, currency futures, currency options purchased and similar instruments.

              • CA-3.4.6

                Exchange rate contracts with an original maturity of 14 calendar days or less may be excluded.

            • Equity contracts

              • CA-3.4.7

                Equity contracts include forwards, swaps, purchased options and similar derivative contracts based on individual equities or on equity indices.

            • Gold contracts

              • CA-3.4.8

                Gold contracts are treated the same as foreign exchange contracts for the purpose of calculating credit risk except that contracts with original maturity of 14 calendar days or less are included.

              • CA-3.4.9

                Precious metals other than gold receive a separate treatment (see section BR-4.1) and include forwards, swaps, purchased options and similar derivative contracts that are based on precious metals (e.g. silver, platinum, and palladium).

            • Other commodities

              • CA-3.4.10

                Other commodities are also treated separately (see section BR-4.1) and include forwards, swaps, purchased options and similar derivative contracts based on energy contracts, agricultural contracts, base metals (e.g. aluminium, copper, and zinc), and any other non-precious metal commodity contracts.

            • General guidance on treatment of derivatives contracts

              • CA-3.4.11

                The following points should be noted for the treatment of certain derivatives contracts:

                (a) For contracts with multiple exchange of principal, the add-on factors are to be multiplied by the number of remaining payments in the contracts.
                (i) For contracts that are structured to settle outstanding exposure following specified payment dates and where the terms are reset such that the market value of the contract is zero on these specified dates, the residual maturity would be set equal to the time until the next reset date.
                (ii) Forwards, swaps, purchased options and similar derivative contracts not covered in any of the above mentioned categories should be treated as "other commodities".
                (iii) No potential future credit exposure (as referred to under paragraph CA-3.4.12) would be calculated for single currency floating/floating interest rate swaps.

            • Calculation of weighted derivative exposures

              • CA-3.4.12

                Banks should calculate their weighted exposure under the above mentioned contracts according to the Current Exposure Method, which involves calculating the current replacement cost by marking contracts to market, thus capturing the current exposure without any need for estimation, and then adding a factor (the "add-on") to reflect the potential future exposure over the remaining life of the contract.

                The 'add-on' factor table:

                  Residual maturity of contracts
                1 year or less Over 1 year to 5 years Over 5 years
                Interest rate related contracts 0.000 0.005 0.015
                Foreign exchange & gold contracts 0.010 0.050 0.075
                Equity contracts 0.060 0.080 0.100
                Precious metals (except gold) 0.070 0.070 0.070
                Other commodities 0.120 0.120 0.150

              • CA-3.4.13

                In order to reflect counterparty risk, the total credit equivalent amount, which results from the calculation in paragraph CA-3.4.12 has to be broken down again according to type of counterparty, using the same classification into types (a), (b) and (c) given in section CA-3.3. Finally, the exposure to each type of counterparty has to be weighted as 0%, 20% or 50% respectively, and the total weighted exposure calculated.

        • CA-4 CA-4 Interest rate risk — Standardised approach

          • CA-4.1 CA-4.1 Introduction

            • CA-4.1.1

              This chapter describes the standardised approach for the measurement of the interest rate risk in the bank's trading book, in order to determine the capital requirement for this risk. The interest rate exposure captured includes exposure arising from interest-bearing and discounted financial instruments, derivatives which are based on the movement of interest rates, foreign exchange forwards, and interest rate exposure embedded in derivatives which are based on non-interest rate related instruments.

            • CA-4.1.2

              For the guidance of the banks, and without being exhaustive, the following list includes financial instruments in the trading book to which interest rate risk capital requirements will apply, irrespective of whether or not the instruments carry coupons:

              (a) bonds/loan stocks, debentures etc.;
              (b) non-convertible preference shares;
              (c) convertible securities such as preference shares and bonds, which are treated as debt instruments4;
              (d) mortgage backed securities and other securitised assets5;
              (e) Certificates of Deposit;
              (f) treasury bills, local authority bills, banker's acceptances;
              (g) commercial paper;
              (h) euronotes, medium term notes, etc.;
              (i) floating rate notes, FRCDs etc.;
              (j) foreign exchange forward positions;
              (k) derivatives based on the above instruments and interest rates; and
              (l) interest rate exposure embedded in other financial instruments.

              4 See section CA-5.1 for an explanation of the circumstances in which convertible securities should be treated as equity instruments. In other circumstances, they should be treated as debt instruments.

              5 Traded mortgage securities and mortgage derivative products possess unique characteristics because of the risk of pre-payment. It is possible that including such products within the standardised methodology as if they were similar to other securitised assets may not capture all the risks of holding positions in them. Banks which have traded mortgage securities and mortgage derivative products should discuss their proposed treatment with the Agency and obtain the Agency's prior written approval for it.

            • CA-4.1.3

              For instruments that deviate from the above structures, or could be considered complex, each bank should agree a written policy statement with the Agency about the intended treatment, on a case-by-case basis. In some circumstances, the treatment of an instrument may be uncertain, for example bonds whose coupon payments are linked to equity indices. The position risk of such instruments should be broken down into its components and allocated appropriately between the equity, interest rate and foreign exchange risk categories. Advice must be sought from the Agency in cases of doubt, particularly when a bank is trading an instrument for the first time.

            • CA-4.1.4

              A security which is the subject of a repurchase or securities lending agreement will be treated as if it were still owned by the lender of the security, i.e., it will be treated in the same manner as other securities positions.

            • CA-4.1.5

              The minimum capital requirement is expressed in terms of two separately calculated charges, one applying to the 'specific risk" of each position, and the other to the interest rate risk in the portfolio, termed "general market risk". The aggregate capital requirement for interest rate risk is the sum of the general market interest rate risk capital requirements across currencies, and the specific risk capital requirements.

            • CA-4.1.6

              The specific risk capital requirement recognises that individual instruments may change in value for reasons other than shifts in the yield curve of a given currency. The general risk capital requirement reflects the price change of these products caused by parallel and non-parallel shifts in the yield curve, as well as the difficulty of constructing perfect hedges.

            • CA-4.1.7

              There is general market risk inherent in all interest rate risk positions. This may be accompanied by one or more out of specific interest rate risk, counterparty risk, equity risk and foreign exchange risk, depending on the nature of the position. Banks should consider carefully which risks are generated by each individual position. It should be recognised that the identification of the risks will require the application of the appropriate level of technical skills and professional judgment.

            • CA-4.1.8

              Banks which have the intention and capability to use internal models for the measurement of general and specific interest rate risks and, hence, for the calculation of the capital requirement, should seek the prior written approval of the Agency for those models. The Agency's detailed rules for the recognition and use of internal models are included in chapter CA-9. Banks which do not use internal models should adopt the standardised approach to calculate the interest rate risk capital requirement, as set out in detail in this chapter.

          • CA-4.2 CA-4.2 Specific risk calculation

            • CA-4.2.1

              The capital charge for specific risk is designed to protect against a movement in the price of an individual instrument, owing to factors related to the individual issuer.

            • CA-4.2.2

              In measuring the specific risk for interest rate related instruments, a bank may net, by value, long and short positions (including positions in derivatives) in the same debt instrument to generate the individual net position in that instrument. Instruments will be considered to be the same where the issuer is the same, they have an equivalent ranking in a liquidation, and the currency, the coupon and the maturity are the same.

            • CA-4.2.3

              The specific risk capital requirement is determined by weighting the current market value of each individual net position, whether long or short, according to its allocation among the following five broad categories:

              (a) Eligible central government debt instrument 0.00%
              (b) Qualifying items with residual maturity up to 6 months 0.25%
              (c) Qualifying items with residual maturity between 6 and 24 months 1.00%
              (d) Qualifying items with residual maturity exceeding 24 months 1.60%
              (e) Non-qualifying items 8.00%

            • CA-4.2.4

              Eligible central "government" debt instruments will include all forms of government paper, including bonds, treasury bills and other short-term instruments, but the Agency reserves the right to apply a specific risk weight to securities issued by certain foreign governments, especially to securities denominated in a currency other than that of the issuing government.

            • CA-4.2.5

              Governments eligible are those which are members of either the Gulf Co-operation Council (GCC) or the Organisation for Economic Co-operation and Development (OECD).

            • CA-4.2.6

              The "qualifying" category includes securities issued by or fully guaranteed by public sector entities and multilateral development banks (refer to Appendix CA 2), plus other securities that are:

              (a) rated investment grade by at least two internationally recognised credit rating agencies (to be agreed with the Agency); or
              (b) deemed to be of comparable investment quality by the reporting bank, provided that the issuer is rated investment grade by at least two internationally recognised credit rating agencies (to be agreed with the Agency); or
              (c) rated investment grade by one credit rating agency and not less than investment grade by any internationally recognised credit rating agencies (to be agreed with the Agency); or
              (d) unrated (subject to the approval of the Agency), but deemed to be of comparable investment quality by the reporting bank and where the issuer has securities listed on a recognised stock exchange, may also be included.

          • CA-4.3 CA-4.3 General market risk calculation

            • CA-4.3.1

              The capital requirements for general market risk are designed to capture the risk of loss arising from changes in market interest rates, i.e. the risk of parallel and non-parallel shifts in the yield curve. A choice between two principal methods of measuring the general market risk is permitted, a "maturity" method and a "duration" method. In each method, the capital charge is the sum of the following four components:

              (a) the net short or long position in the whole trading book;
              (b) a small proportion of the matched positions in each time-band (the "vertical disallowance");
              (c) a larger proportion of the matched positions across different time-bands (the "horizontal disallowance"); and
              (d) a net charge for positions in options, where appropriate (see chapter CA-8).

            • CA-4.3.2

              Separate maturity ladders should be used for each currency and capital charges should be calculated for each currency separately and then summed, by applying the prevailing foreign exchange spot rates, with no off-setting between positions of opposite sign.

            • CA-4.3.3

              In the case of those currencies in which the value and volume of business is insignificant, separate maturity ladders for each currency are not required. Instead, the bank may construct a single maturity ladder and slot, within each appropriate time-band, the net long or short position for each currency. However, these individual net positions are to be summed within each time-band, irrespective of whether they are long or short positions, to arrive at the gross position figure for the time-band.

            • CA-4.3.4

              A combination of the two methods (referred to under paragraph CA-4.3.1) is not permitted. Any exceptions to this rule will require the prior written approval of the Agency. It is expected that such approval will only be given in cases where a bank clearly demonstrates to the Agency, the difficulty in applying, to a definite category of trading instruments, the method otherwise chosen by the bank as the normal method. It is further expected that the Agency may, in future years, consider recognising the duration method as the approved method, and the use of the maturity method may be discontinued.

          • CA-4.4 CA-4.4 Maturity method

            • CA-4.4.1

              A worked example of the maturity method is included in Appendix CA 3. The various time-bands and their risk weights, relevant to the maturity method, are illustrated in paragraph CA-4.4.2(a) below.

            • CA-4.4.2

              The steps in the calculation of the general market risk for interest rate positions, under this method, are set out below:

              (a) Individual long or short positions in interest-rate related instruments, including derivatives, are slotted into a maturity ladder comprising thirteen time-bands (or fifteen time-bands in the case of zero-coupon and deep-discount instruments, defined as those with a coupon of less than 3%), on the following basis:
              (i) fixed rate instruments are allocated according to their residual term to maturity (irrespective of embedded puts and calls), and whether their coupon is below 3%;
              (ii) floating rate instruments are allocated according to the residual term to the next repricing date;
              (iii) positions in derivatives, and all positions in repos, reverse repos and similar products are decomposed into their components within each time band. Derivative instruments are covered in greater detail in sections CA-4.6 to CA-4.9;
              (iv) opposite positions of the same amount in the same issues (but not different issues by the same issuer), whether actual or notional, can be omitted from the interest rate maturity framework, as well as closely matched swaps, forwards, futures and FRAs which meet the conditions set out in section CA-4.8. In other words, these positions are netted within their relevant time-bands; and
              (v) the Agency's advice must be sought on the treatment of instruments that deviate from the above structures, or which may be considered sufficiently complex to warrant the Agency's attention.

              Maturity method: time-bands and risk weights

                Coupon > 3% Coupon < 3% Risk weight
              Zone 1 1 month or less 1 month or less 0.00%
                1 to 3 months 1 to 3 months 0.20%
                3 to 6 months 3 to 6 months 0.40%
                6 to 12 months 6 to 12 months 0.70%
              Zone 2 1 to 2 years 1 to 1.9 years 1.25%
                2 to 3 years 1.9 to 2.8 years 1.75%
                3 to 4 years 2.8 to 3.6 years 2.25%
              Zone 3 4 to 5 years 3.6 to 4.3 years 2.75%
                5 to 7 years 4.3 to 5.7 years 3.25%
                7 to 10 years 5.7 to 7.3 years 3.75%
                10 to 15 years 7.3 to 9.3 years 4.50%
                15 to 20 years 9.3 to 10.6 years 5.25%
                > 20 years 10.6 to 12 years 6.00%
                  12 to 20 years 8.00%
                  > 20 years 12.50%
              (b) The market values of the individual long and short net positions in each maturity band are multiplied by the respective risk weighting factors given in paragraph CA-4.4.2(a) above.
              (c) Matching of positions within each maturity band (i.e. vertical matching) is done as follows:
              •  Where a maturity band has both weighted long and short positions, the extent to which the one offsets the other is called the matched weighted position. The remainder (i.e. the excess of the weighted long positions over the weighted short positions, or vice versa, within a band) is called the unmatched weighted position for that band.
              (d) Matching of positions, across maturity bands, within each zone (i.e. horizontal matching—level 1), is done as follows:
              •  Where a zone has both unmatched weighted long and short positions for various bands, the extent to which the one offsets the other is called the matched weighted position for that zone. The remainder (i.e. the excess of the weighted long positions over the weighted short positions, or vice versa, within a zone) is called the unmatched weighted position for that zone.
              (e) Matching of positions, across zones (i.e. horizontal matching—level 2), is done as follows:
              (i) The unmatched weighted long or short position in zone 1 may be offset against the unmatched weighted short or long position in zone 2. The extent to which the unmatched weighted positions in zones 1 and 2 are offsetting is described as the matched weighted position between zones 1 and 2.
              (ii) After step (i) above, any residual unmatched weighted long or short position in zone 2 may be matched by offsetting the unmatched weighted short or long position in zone 3. The extent to which the unmatched positions in zones 2 and 3 are offsetting is described as the matched weighted position between zones 2 and 3.
              The calculations in steps (i) and (ii) above may be carried out in reverse order (i.e. zones 2 and 3, followed by zones 1 and 2).

              (i) After steps (i) and (iii) above, any residual unmatched weighted long or short position in zone 1 may be matched by offsetting the unmatched weighted short or long position in zone 3. The extent to which the unmatched positions in zones 1 and 3 are offsetting is described as the matched weighted position between zones 1 and 3.
              (f) Any residual unmatched weighted positions, following the matching within and between maturity bands and zones as described above, will be summed.
              (g) The general interest rate risk capital requirement is the sum of:

              (i) Matched weighted positions in all maturity bands x 10%
              (ii) Matched weighted positions in zone 1 x 40%
              (iii) Matched weighted positions in zone 2 x 30%
              (iv) Matched weighted positions in zone 3 x 30%
              (v) Matched weighted positions between zones 1 & 2 x 40%
              (vi) Matched weighted positions between zones 2 & 3 x 40%
              (vii) Matched weighted positions between zones 1 & 3 x 100%
              (viii) Residual unmatched weighted positions x 100%

              Item (i) is referred to as the vertical disallowance, items (ii) through (iv) as the first set of horizontal disallowances, and items (v) through (vii) as the second set of horizontal disallowances.

          • CA-4.5 CA-4.5 Duration method

            • CA-4.5.1

              The duration method is an alternative approach to measuring the exposure to parallel and non-parallel shifts in the yield curve, and recognises the use of duration as an indicator of the sensitivity of individual positions to changes in market yields. Under this method, banks may use a duration-based system for determining their general interest rate risk capital requirements for traded debt instruments and other sources of interest rate exposures including derivatives. A worked example of the duration method is included in Appendix CA 4. The various time-bands and assumed changes in yield, relevant to the duration method, are illustrated below.

              Duration method: time-bands and assumed changes in yield

                Time-band Assumed change in yield
              Zone 1 1 month or less 1.00
                1 to 3 months 1.00
                3 to 6 months 1.00
                6 to 12 months 1.00
              Zone 2 1 to 1.9 years 0.90
                1.9 to 2.8 years 0.80
                2.8 to 3.6 years 0.75
              Zone 3 3.6 to 4.3 years 0.75
                4.3 to 5.7 years 0.70
                5.7 to 7.3 years 0.65
                7.3 to 9.3 years 0.60
                9.3 to 10.6 years 0.60
                10.6 to 12 years 0.60
                12 to 20 years 0.60
                > 20 years 0.60

            • CA-4.5.2

              Banks should notify the Agency of the circumstances in which they elect to use this method. Once chosen, the duration method must be consistently applied, in accordance with the requirements of section CA-4.3.

            • CA-4.5.3

              Where a bank has chosen to use the duration method, it is possible that it will not be suitable for certain instruments. In such cases, the bank should seek the advice of the Agency or obtain approval for application of the maturity method to the specific category(ies) of instruments, in accordance with the provisions of section CA-4.3.

            • CA-4.5.4

              The steps in the calculation of the general market risk for interest rate positions, under this method, are set out below:

              (a) The bank will determine the Yield-to-Maturity (YTM) for each individual net position in fixed rate and floating rate instruments, based on the current market value. The basis of arriving at individual net positions is explained in section CA-4.4 above. The YTM for fixed rate instruments is determined without any regard to whether the instrument is coupon bearing, or whether the instrument has any embedded options. In all cases, YTM for fixed rate instruments is calculated with reference to the final maturity date and, for floating rate instruments, with reference to the next repricing date.
              (b) The bank will calculate, for each debt instrument, the modified duration (M) on the basis of the following formula:

              M = D
                (1+r)
              where,  
              D (duration) =
              Σ m   t × C
              t=1   (1+r)t

              Σ m   C
              t=1   (1+r)t

              r = YTM % per annum expressed as a decimal

              C = Cash flow at time t

              t = time at which cash flows occur, in years

              m = time to maturity, in years
              (c) Individual net positions, at current market value, are allocated to the time-bands illustrated in paragraph CA-4.5.1, based on their modified duration.
              (d) The bank will then calculate the modified duration-weighted position for each individual net position by multiplying its current market value by the modified duration and the assumed change in yield.
              (e) Matching of positions within each time band (i.e. vertical matching) is done as follows:
              •  Where a time band has both weighted long and short positions, the extent to which the one offsets the other is called the matched weighted position. The remainder (i.e. the excess of the weighted long positions over the weighted short positions, or vice versa, within a band) is called the unmatched weighted position for that band.
              (f) Matching of positions, across time bands, within each zone (i.e. horizontal matching—level 1), is done as follows:
              •  Where a zone has both unmatched weighted long and short positions for various bands, the extent to which the one offsets the other is called the matched weighted position for that zone. The remainder (i.e. the excess of the weighted long positions over the weighted short positions, or vice versa, within a zone) is called the unmatched weighted position for that zone.
              (g) Matching of positions, across zones (i.e. horizontal matching—level 2), is done as follows:
              (i) The unmatched weighted long or short position in zone 1 may be offset against the unmatched weighted short or long position in zone 2. The extent to which the unmatched weighted positions in zones 1 and 2 are offsetting is described as the matched weighted position between zones 1 and 2.
              (ii) After step (i) above, any residual unmatched weighted long or short position in zone 2 may be matched by offsetting the unmatched weighted short or long position in zone 3. The extent to which the unmatched positions in zones 2 and 3 are offsetting is described as the matched weighted position between zones 2 and 3.
              The calculations in steps (i) and (ii) above may be carried out in reverse order (i.e. zones 2 and 3, followed by zones 1 and 2).

              (iii) After steps (a) and (b) above, any residual unmatched weighted long or short position in zone 1 may be matched by offsetting the unmatched weighted short or long position in zone 3. The extent to which the unmatched positions in zones 1 and 3 are offsetting is described as the matched weighted position between zones 1 and 3.
              (h) Any residual unmatched weighted positions, following the matching within and between maturity bands and zones as described above, will be summed.
              (i) The general interest rate risk capital requirement is the sum of:

              (i) Matched weighted positions in all maturity bands x 5%
              (ii) Matched weighted positions in zone 1 x 40%
              (iii) Matched weighted positions in zone 2 x 30%
              (iv) Matched weighted positions in zone 3 x 30%
              (v) Matched weighted positions between zones 1 & 2 x 40%
              (vi) Matched weighted positions between zones 2 & 3 x 40%
              (vii) Matched weighted positions between zones 1 & 3 x 100%
              (viii) Residual unmatched weighted positions x 100%

              Item (i) is referred to as the vertical disallowance, items (ii) through (iv) as the first set of horizontal disallowances, and items (v) through (vii) as the second set of horizontal disallowances.

          • CA-4.6 CA-4.6 Derivatives

            • CA-4.6.1

              Banks which propose to use internal models to measure the interest rate risk inherent in derivatives will seek the prior written approval of the Agency for using those models. The use of internal models to measure market risk, and the Agency's rules applicable to them, are discussed in detail in chapter CA-9.

            • CA-4.6.2

              Where a bank, with the prior written approval of the Agency, uses an interest rate sensitivity model, the output of that model is used, by the duration method, to calculate the general market risk as described in section CA-4.5.

            • CA-4.6.3

              Where a bank does not propose to use models, it must use the techniques described in the following paragraphs, for measuring the market risk on interest rate derivatives. The measurement system should include all interest rate derivatives and off-balance-sheet instruments in the trading book which react to changes in interest rates (e.g. forward rate agreements, other forward contracts, bond futures, interest rate and cross-currency swaps, options and forward foreign exchange contracts). Where a bank has obtained the approval of the Agency for the use of non-interest rate derivatives models, the embedded interest rate exposures should be incorporated in the standardised measurement framework described in sections CA-4.7 to CA-4.9.

            • CA-4.6.4

              Derivative positions will attract specific risk only when they are based on an underlying instrument or security. For instance, where the underlying exposure is an interest rate exposure, as in a swap based upon interbank rates, there will be no specific risk, but only counterparty risk. A similar treatment applies to FRAs, forward foreign exchange contracts and interest rate futures. However, for a swap based on a bond yield, or a futures contract based on a debt security or an index representing a basket of debt securities, the credit risk of the issuer of the underlying bond will generate a specific risk capital requirement. Future cash flows derived from positions in derivatives will generate counterparty risk requirements related to the counterparty in the trade, in addition to position risk requirements (specific and general market risk) related to the underlying security.

            • CA-4.6.5

              A summary of the rules for dealing with interest rate derivatives (other than options) is set out in section CA-4.9. The treatment of options, being a complex issue, is dealt with in detail in chapter CA-8.

          • CA-4.7 CA-4.7 Calculation of derivative positions

            • CA-4.7.1

              The derivatives should be converted to positions in the relevant underlying and become subject to specific and general market risk charges as described in sections CA-4.2 and CA-4.3, respectively. For the purpose of calculation by the standard formulae, the amounts reported are the market values of the principal amounts of the underlying or of the notional underlying. For instruments where the apparent notional amount differs from the effective notional amount, banks should use the latter.

            • CA-4.7.2

              The remaining paragraphs in this section include the guidelines for the calculation of positions in different categories of interest rate derivatives. Banks which need further assistance in the calculation, particularly in relation to complex instruments, should contact the Agency in writing.

            • Forward foreign exchange contracts

              • CA-4.7.3

                A forward foreign exchange position is decomposed into legs representing the paying and receiving currencies. Each of the legs is treated as if it were a zero coupon bond, with zero specific risk, in the relevant currency and included in the measurement framework as follows:

                (a) If the maturity method is used, each leg is included at the notional amount.
                (b) If the duration method is used, each leg is included at the present value of the notional zero coupon bond.

            • Deposit futures and FRAs

              • CA-4.7.4

                Deposit futures, forward rate agreements and other instruments where the underlying is a money market exposure will be split into two legs as follows:

                (a) The first leg will represent the time to expiry of the futures contract, or settlement date of the FRA as the case may be.
                (b) The second leg will represent the time to expiry of the underlying instrument.
                (c) Each leg will be treated as a zero coupon bond with zero specific risk.
                (d) For deposit futures, the size of each leg is the notional amount of the underlying money market exposure. For FRAs, the size of each leg is the notional amount of the underlying money market exposure discounted to present value, although in the maturity method, the notional amount may be used without discounting.

                For example, under the maturity method, a single 3-month Euro$ 1,000,000 deposit futures contract expiring in 3 months' time will have one leg of $ 1,000,000 representing the 8 months to contract expiry, and another leg of $ 1,000,000 in the 11 months' time-band representing the time to expiry of the deposit underlying the futures contract.

            • Bonds futures and forwards bond transactions

              • CA-4.7.5

                Bond futures, forward bond transactions and the forward leg of repos, reverse repos and other similar transactions will use the two-legged approach. A forward bond transaction is one where the settlement is for a period other than the prevailing norm for the market.

                (a) The first leg is a zero coupon bond with zero specific risk. Its maturity is the time to expiry of the futures or forward contract. Its size is the cash flow on maturity discounted to present value, although in the maturity method, the cash flow on maturity may be used without discounting.
                (b) The second leg is the underlying bond. Its maturity is that of the underlying bond for fixed rate bonds, or the time to the next reset for floating rate bonds. Its size is as set out in (c) and (d) below.
                (c) For forward bond transactions, the underlying bond and amount is used at the present spot price.
                (d) For bond futures, the principal amounts for each of the two legs is reckoned as the futures price times the notional underlying bond amount.
                (e) Where a range of deliverable instruments may be delivered to fulfil a futures contract (at the option of the "short"), then the following rules are used to determine the principal amount, taking account of any conversion factors defined by the exchange:
                (i) The "long" may use one of the deliverable bonds, or the notional bond on which the contract is based, as the underlying instrument, but this notional long leg may not be offset against a short cash position in the same bond.
                (ii) The "short" may treat the notional underlying bond as if it were one of the deliverable bonds, and it may be offset against a short cash position in the same bond.
                (f) For futures contracts based on a corporate bond index, the positions will be included at the market value of the notional underlying portfolio of securities.
                (g) A repo (or sell-buy or stock lending) involving exchange of a security for cash should be represented as a cash borrowing — i.e. a short position in a government bond with maturity equal to the repo and coupon equal to the repo rate. A reverse repo (or buy-sell or stock borrowing) should be represented as a cash loan — i.e. a long position in a government bond with maturity equal to the reverse repo and coupon equal to the repo rate. These positions are referred to as "cash legs".
                (h) It should be noted that, where a security owned by the bank (and included in its calculation of market risk) is repo'd, it continues to contribute to the bank's interest rate or equity position risk calculation.

            • Swaps

              • CA-4.7.6

                Swaps are treated as two notional positions in government securities with the relevant maturities.

                (a) Interest rate swaps will be decomposed into two legs, and each leg will be allocated to the maturity band equating to the time remaining to repricing or maturity. For example, an interest rate swap in which a bank is receiving floating rate interest and paying fixed is treated as a long position in a floating rate instrument of maturity equivalent to the period until the next interest fixing and a short position in a fixed rate instrument of maturity equivalent to the residual life of the swap.
                (b) For swaps that pay or receive a fixed or floating interest rate against some other reference price, e.g. a stock index, the interest rate component should be slotted into the appropriate repricing or maturity category, with the equity component being included in the equity risk measurement framework as described in chapter CA-5.
                (c) For cross currency swaps, the separate legs are included in the interest rate risk measurement for the currencies concerned, as having a fixed/floating leg in each currency. Alternatively, the two parts of a currency swap transaction are split into forward foreign exchange contracts and treated accordingly.
                (d) Where a swap has a deferred start, and one or both legs have been fixed, then the fixed leg(s) will be sub-divided into the time to the commencement of the leg and the actual swap leg with fixed or floating rate. A swap is deemed to have a deferred start when the commencement of the interest rate calculation periods is more than two business days from the transaction date, and one or both legs have been fixed at the time of the commitment. However, when a swap has a deferred start and neither leg has been fixed, there is no interest rate exposure, albeit there will be counterparty exposure.
                (e) Where a swap has a different structure from those discussed above, it may be necessary to adjust the underlying notional principal amount, or the notional maturity of one or both legs of the transaction.

              • CA-4.7.7

                Banks with large swap books may use alternative formulae for these swaps to calculate the positions to be included in the maturity or duration ladder. One method would be to first convert the cash flows required by the swap into their present values. For this purpose, each cash flow should be discounted using the zero coupon yields, and a single net figure for the present value of the cash flows entered into the appropriate time-band using procedures that apply to zero or low coupon (less than 3%) instruments. An alternative method would be to calculate the sensitivity of the net present value implied by the change in yield used in the duration method (as set out in section CA-4.5), and allocate these sensitivities into the appropriate time-bands.

              • CA-4.7.8

                Banks which propose to use the approaches described in paragraph CA-4.7.7, or any other similar alternative formulae, should obtain the prior written approval of the Agency. The Agency will consider the following factors before approving any alternative methods for calculating the swap positions:

                (a) Whether the systems proposed to be used are accurate;
                (b) Whether the positions calculated fully reflect the sensitivity of the cash flows to interest rate changes and are entered into the appropriate time-bands; and
                (c) Whether the positions are denominated in the same currency.

          • CA-4.8 CA-4.8 Netting of derivative positions

            • Permissible offsetting of fully matched positions for both specific and general market risk

              • CA-4.8.1

                Banks may exclude from the interest rate risk calculation, altogether, the long and short positions (both actual and notional) in identical instruments with exactly the same issuer, coupon, currency and maturity. A matched position in a future or a forward and its corresponding underlying may also be fully offset, albeit the leg representing the time to expiry of the future is included in the calculation.

              • CA-4.8.2

                When the future or the forward comprises a range of deliverable instruments, offsetting of positions in the futures or forward contract and its underlying is only permitted in cases where there is a readily identifiable underlying security which is most profitable for the trader with a short position to deliver. The price of this security, sometimes called the "cheapest-to-deliver", and the price of the future or forward contract should, in such cases, move in close alignment. No offsetting will be allowed between positions in different currencies. The separate legs of cross-currency swaps or forward foreign exchange contracts are treated as notional positions in the relevant instruments and included in the appropriate calculation for each currency.

            • Permissible offsetting of closely matched positions for general market risk only

              • CA-4.8.3

                For the purpose of calculation of the general market risk, in addition to the permissible offsetting of fully matched positions as described in paragraph CA-4.8.1 above, opposite positions giving rise to interest rate exposure can be offset if they relate to the same underlying instruments, are of the same nominal value and are denominated in the same currency and, in addition, fulfil the following conditions:

                (a) For futures:

                Offsetting positions in the notional or underlying instruments to which the futures contract relates should be for identical products and mature within seven days of each other.
                (b) For swaps and FRAs:

                The reference rate (for floating rate positions) must be identical and the coupons must be within 15 basis points of each other.
                (c) For swaps, FRAs and forwards:

                The next interest fixing date or, for fixed coupon positions or forwards, the residual maturity must correspond within the following limits:

                less than one month: same day;
                between one month and one year: within 7 days;
                over one year: within 30 days.

          • CA-4.9 CA-4.9 Calculation of capital charge for derivatives

            • CA-4.9.1

              After calculating the derivatives positions, taking account of the permissible offsetting of matched positions, as explained in section CA-4.8, the capital charges for specific and general market risk for interest rate derivatives are calculated in the same manner as for cash positions, as described earlier in this chapter.

              Summary of treatment of interest rate derivatives

              Instrument Specific risk charge* General market risk charge
              Exchange-traded futures
              — Government** debt security No Yes, as two positions
              — Corporate debt security Yes Yes, as two positions
              — Index on interest rates (e.g. LIBOR) No Yes, as two positions
              — Index on basket of debt securities Yes Yes, as two positions
              OTC forwards
              — Government** debt security No Yes, as two positions
              — Corporate debt security Yes Yes, as two positions
              — Index on interest rates No Yes, as two positions
              FRAs No Yes, as two positions
              Swaps
              — Based on interbank rates No Yes, as two positions
              — Based on Government** bond yields No Yes, as two positions
              — Based on corporate bond yields Yes Yes, as two positions
              Forward foreign exchange No Yes, as one position in each currency
              Options
              — Government** debt security No Either (a) or (b) as below (see chapter CA-8 for a detailed description):
              (a) Carve out together with the associated hedging positions, and use:
              — simplified approach; or
              — scenario analysis; or
              — internal models (see chapter CA-9).
              (b) General market risk charge according to the delta-plus method (gamma and vega should receive separate capital charges).
              — Corporate debt security Yes
              — Index on interest rates No
              — FRAs, swaps No
              * This is the specific risk charge relating to the issuer of the instrument. Under the credit risk rules, there remains a separate capital charge for the counterparty risk.

              ** As defined in section CA-4.2.

        • CA-5 CA-5 Equity position risk — Standardised approach

          • CA-5.1 CA-5.1 Introduction

            • CA-5.1.1

              This chapter sets out the minimum capital requirements to cover the risk of holding or taking positions in equities in the bank's trading book.

            • CA-5.1.2

              For the guidance of the banks, and without being exhaustive, the following list includes financial instruments in the trading book, including forward positions, to which equity position risk capital requirements will apply:

              (a) common stocks, whether voting or non-voting;
              (b) depository receipts (which should be included in the measurement framework in terms of the underlying shares);
              (c) convertible preference securities (non-convertible preference securities are treated as bonds);
              (d) convertible debt securities which convert into equity instruments and are, therefore, treated as equities (see paragraph CA-5.1.3 below);
              (e) commitments to buy or sell equity securities;
              (f) derivatives based on the above instruments.

            • CA-5.1.3

              Convertible debt securities must be treated as equities where:

              (a) the first date at which the conversion may take place is less than three months ahead, or the next such date (where the first date has passed) is less than a year ahead; and
              (b) the convertible is trading at a premium of less than 10%, where the premium is defined as the current marked-to-market value of the convertible less the marked-to-market value of the underlying equity, expressed as a percentage of the latter.

              In other instances, convertibles should be treated as either equity or debt securities, based reasonably on their market behaviour.

            • CA-5.1.4

              For instruments that deviate from the structures described in paragraphs CA-5.1.2 and CA-5.1.3 above, or which could be considered complex, each bank should agree a written policy statement with the Agency about the intended treatment, on a case-by-case basis. In some circumstances, the treatment of an instrument may be uncertain, for example bonds whose coupon payments are linked to equity indices. The position risk of such instruments should be broken down into its components and allocated appropriately between the equity, interest rate and foreign exchange risk categories. Advice must be sought from the Agency in cases of doubt, particularly when a bank is trading an instrument for the first time.

            • CA-5.1.5

              Where equities are part of a forward contract, a future or an option (i.e. a quantity of equities to be received or delivered), any interest rate or foreign currency exposure from the other leg of the contract should be included in the measurement framework as described in chapters CA-4 and CA-6, respectively.

            • CA-5.1.6

              As with interest rate related instruments, the minimum capital requirement for equities is expressed in terms of two separately calculated charges, one applying to the "specific risk" of holding a long or short position in an individual equity, and the other to the "general market risk" of holding a long or short position in the market as a whole.

            • CA-5.1.7

              Banks which have the intention and capability to use internal models for the measurement of general and specific equity risk and, hence, for the calculation of the capital requirement, should seek the prior written approval of the Agency for those models. The Agency's detailed rules for the recognition and use of internal models are included in chapter CA-9. Banks which do not use internal models should adopt the standardised approach to calculate the equity position risk capital requirement, as set out in detail in this chapter.

          • CA-5.2 CA-5.2 Calculation of equity positions

            • CA-5.2.1

              A bank may net long and short positions in the same equity instrument, arising either directly or through derivatives, to generate the individual net position in that instrument. For example, a future in a given equity may be offset against an opposite cash position in the same equity, albeit the interest rate risk arising out of the future should be calculated separately in accordance with the rules set out in chapter CA-4.

            • CA-5.2.2

              A bank may net long and short positions in one tranche of an equity instrument against another tranche only where the relevant tranches:

              (a) rank pari passu in all respects; and
              (b) become fungible within 180 days, and thereafter the equity instruments of one tranche can be delivered in settlement of the other tranche.

            • CA-5.2.3

              Positions in depository receipts may only be netted against positions in the underlying stock if the stock is freely deliverable against the depository receipt. If a bank takes a position in depository receipts against an opposite position in the underlying equity in different markets (i.e. arbitrage), it may offset the position provided that any costs on conversion are fully taken into account. Furthermore, the foreign exchange risk arising out of these positions should be included in the measurement framework as set out in chapter CA-6.

            • CA-5.2.4

              More detailed guidance on the treatment of equity derivatives is set out in section CA-5.5.

            • CA-5.2.5

              Equity positions, arising either directly or through derivatives, should be allocated to the country in which each equity is listed. Where an equity is listed in more than one country, the bank should discuss the appropriate country allocation with the Agency.

          • CA-5.3 CA-5.3 Specific risk calculation

            • CA-5.3.1

              Specific risk is defined as the bank's gross equity positions (i.e. the sum of all long equity positions and of all short equity positions), and is calculated for each country or equity market. For each national market in which the bank holds equities, it should sum the market values of its individual net positions as determined in accordance with section CA-5.2, irrespective of whether they are long or short positions, to produce the overall gross equity position for that market.

            • CA-5.3.2

              The capital charge for specific risk is 8%, unless the portfolio is both liquid and well-diversified, in which case the capital charge will be 4%. To qualify for the reduced 4% capital charge, the following requirements need to be met:

              (a) The portfolio should be listed on a recognised stock exchange;
              (b) No individual equity position shall comprise more than 10% of the gross value of the country portfolio; and
              (c) The total value of the equity positions which individually comprise between 5% and 10% of the gross value of the country portfolio, shall not exceed 50% of the gross value of the country portfolio.

          • CA-5.4 CA-5.4 General risk calculation

            • CA-5.4.1

              The general market risk is the difference between the sum of the long positions and the sum of the short positions (i.e. the overall net position) in each national equity market. In other words, to calculate the general market risk, the bank should sum the market value of its individual net positions for each national market, as determined in accordance with section CA-5.2, taking into account whether the positions are long or short.

            • CA-5.4.2

              The general market equity risk measure is 8% of the overall net position in each national market.

          • CA-5.5 CA-5.5 Equity derivatives

            • CA-5.5.1

              For the purpose of calculating the specific and general market risk by the standardised approach, equity derivative positions should be converted into notional underlying equity positions, whether long or short. All equity derivatives and off-balance-sheet positions which are affected by changes in equity prices should be included in the measurement framework. This includes futures and swaps on both individual equities and on stock indices.

            • CA-5.5.2

              The following guidelines will apply to the calculation of positions in different categories of equity derivatives. Banks which need further assistance in the calculation, particularly in relation to complex instruments, should contact the Agency.

              (a) Futures and forward contracts relating to individual equities should, in principle, be included in the calculation at current market prices.
              (b) Futures relating to stock indices should be included in the calculation, at the marked-to-market value of the notional underlying equity portfolio, i.e. as a single position based on the sum of the current market values of the underlying instruments.
              (c) Equity swaps are treated as two notional positions. For example, an equity swap in which a bank is receiving an amount based on the change in value of one particular equity or stock index, and paying a different index is treated as a long position in the former and a short position in the latter. Where one of the swap legs involves receiving/paying a fixed or floating interest rate, that exposure should be slotted into the appropriate time-band for interest rate related instruments as set out in chapter CA-4. The stock index leg should be covered by the equity treatment as set out in this chapter.
              (d) Equity options and stock index options are either "carved out" together with the associated underlying instruments, or are incorporated in the general market risk measurement framework, described in this chapter, based on the delta-plus method. The treatment of options, being a complex issue, is dealt with in detail in chapter CA-8.

            • CA-5.5.3

              A summary of the treatment of equity derivatives is set out in paragraph CA-5.5.8.

            • Specific risk on positions in equity indices

              • CA-5.5.4

                Positions in highly liquid equity indices whether they arise directly or through derivatives, attract a 2% capital charge in addition to the general market risk, to cover factors such as execution risk.

              • CA-5.5.5

                For positions in equity indices not regarded as highly liquid, the specific risk capital charge is the highest specific risk charge that would apply to any of its components, as set out in section CA-5.3.

              • CA-5.5.6

                In the case of the futures-related arbitrage strategies set out below, the specific risk capital charge described above may be applied to only one index with the opposite position exempt from a specific risk capital charge. The strategies are as follows:

                (a) where a bank takes an opposite position in exactly the same index, at different dates or in different market centres;
                (b) where a bank takes opposite positions in contracts at the same date in different but similar indices, provided the two indices contain at least 90% common components.

              • CA-5.5.7

                Where a bank engages in a deliberate arbitrage strategy, in which a futures contract on a broad-based index matches a basket of stocks, it will be allowed to carve out both positions from the standardised methodology on the following conditions:

                (a) the trade has been deliberately entered into, and separately controlled; and
                (b) the composition of the basket of stocks represents at least 90% of the index when broken down into its notional components.

                In such a case, the minimum capital requirement is limited to 4% (i.e. 2% of the gross value of the positions on each side) to reflect divergence and execution risks. This applies even if all of the stocks comprising the index are held in identical proportions. Any excess value of the stocks comprising the basket over the value of the futures contract or vice versa is treated as an open long or short position.

            • Counterparty risk

              • CA-5.5.8

                Derivative positions may also generate counterparty risk exposure related to the counterparty in the trade, in addition to position risk requirements (specific and general) related to the underlying instrument, e.g. counterparty risk related to OTC trades through margin payments, fees payable or settlement exposures. The credit risk capital requirements will apply to such counterparty risk exposure.

                Summary of treatment of equity derivatives

                Instrument Specific risk charge* General market risk charge
                Exchange-traded or OTC futures
                — Individual equity Yes Yes, as underlying
                — Index Yes
                (see section CA-5.5)
                Yes, as underlying
                Options
                — Individual equity Yes Either (a) or (b) as below (chapter CA-8 for a detailed description):
                (a) Carve out together with the associated hedging positions, and use:
                — simplified approach; or
                — scenario analysis; or
                — internal models (chapter CA-9).
                (b) General market risk charge according to the delta-plus method (gamma and vega should receive separate capital charges).
                — Index Yes
                * This is the specific risk charge relating to the issuer of the instrument. Under the credit risk rules, there remains a separate capital charge for the counterparty risk.

        • CA-6 CA-6 Foreign exchange risk — Standardised approach

          • CA-6.1 CA-6.1 Introduction

            • CA-6.1.1

              A bank which holds net open positions (whether long or short) in foreign currencies is exposed to the risk that exchange rates may move against it. The open positions may be either trading positions or, simply, exposures caused by the bank's overall assets and liabilities.

            • CA-6.1.2

              This chapter describes the standardised method for calculation of the bank's foreign exchange risk, and the capital required against that risk. The measurement of the foreign exchange risk involves, as a first step, the calculation of the net open position in each individual currency including gold6 and, as a second step, the measurement of the risks inherent in the bank's mix of long and short positions in different currencies.


              6 Positions in gold should be treated as if they were foreign currency positions, rather than as commodity positions, because the volatility of gold is more in line with that of foreign currencies and most banks manage it in a similar manner to foreign currencies.

            • CA-6.1.3

              The open positions and the capital requirements are calculated with reference to the entire business, i.e. the banking and trading books combined.

            • CA-6.1.4

              The open positions are calculated with reference to the bank's base currency, which will be either Bahraini Dinars or United States dollars.

            • CA-6.1.5

              Banks which have the intention and capability to use internal models for the measurement of their foreign exchange risk and, hence, for the calculation of the capital requirement, should seek the prior written approval of the Agency for those models. The Agency's detailed rules for the recognition and use of internal models are included in chapter CA-9. Banks which do not use internal models should adopt the standardised approach, as set out in detail in this chapter.

            • CA-6.1.6

              In addition to foreign exchange risk, positions in foreign currencies may be subject to interest rate risk and credit risk which should be treated separately.

          • CA-6.2 CA-6.2 De minimis exemptions

            • CA-6.2.1

              A bank doing negligible business in foreign currencies and which does not take foreign exchange positions for its own account may, at the discretion of the Agency evidenced by the Agency's prior written approval, be exempted from calculating the capital requirements on these positions. The Agency is likely to be guided by the following criteria in deciding to grant exemption to any bank:

              (a) the bank's holdings or taking of positions in foreign currencies, including gold, defined as the greater of the sum of the gross long positions and the sum of the gross short positions in all foreign currencies and gold, does not exceed 100% of its eligible capital; and
              (b) the bank's overall net open position, as defined in paragraph CA-6.3.1, does not exceed 2% of its eligible capital as defined in chapter CA-2.

            • CA-6.2.2

              The criteria listed in paragraph CA-6.2.1 above are only intended to be guidelines, and a bank will not automatically qualify for exemptions upon meeting them. The Agency may also, in its discretion, fix a minimum capital requirement for a bank which is exempted from calculating its foreign exchange risk capital requirement, to cover the risks inherent in its foreign currency business.

            • CA-6.2.3

              The Agency may, at a future date, revoke an exemption previously granted to a bank, if the Agency is convinced that the conditions on which the exemption was granted no longer exist.

          • CA-6.3 CA-6.3 Calculation of net open positions

            • CA-6.3.1

              A bank's exposure to foreign exchange risk in any currency is its net open position in that currency, which is calculated by summing the following items:

              (a) the net spot position in the currency (i.e. all asset items less all liability items, including accrued interest, other income and expenses, denominated in the currency in question, assets are included gross of provisions for bad and doubtful debts, except in cases where the provisions are maintained in the same currency as the underlying assets);
              (b) the net forward position in the currency (i.e. all amounts to be received less all amounts to be paid under forward foreign exchange contracts, in the concerned currency, including currency futures and the principal on currency swaps not included in the spot position);
              (c) guarantees and similar off-balance-sheet contingent items that are certain to be called and are likely to be irrecoverable where the provisions, if any, are not maintained in the same currency;
              (d) net future income/expenses not yet accrued but already fully hedged by forward foreign exchange contracts may be included provided that such anticipatory hedging is part of the bank's formal written policy and the items are included on a consistent basis;
              (e) profits (i.e. the net value of income and expense accounts) held in the currency in question;
              (f) specific provisions held in the currency in question where the underlying asset is in a different currency, net of assets held in the currency in question where a specific provision is held in a different currency; and
              (g) the net delta-based equivalent of the total book of foreign currency options (subject to a separately calculated capital charge for gamma and vega as described in chapter CA-8, alternatively, options and their associated underlying positions are dealt with by one of the other methods described in chapter CA-8).

              All assets and liabilities, as described above, should be included at closing mid-market spot exchange rates. Marked-to-market items should be included on the basis of the current market value of the positions. However, banks which base their normal management accounting on net present values are expected to use the net present values of each position, discounted using current interest rates and valued at current spot rates, for measuring their forward currency and gold positions.

            • CA-6.3.2

              Net positions in composite currencies, such as the SDR, may either be broken down into the component currencies according to the quotas in force and included in the net open position calculations for the individual currencies, or treated as a separate currency. In any case, the mechanism for treating composite currencies should be consistently applied.

            • CA-6.3.3

              For calculating the net open position in gold, the bank will first express the net position (spot plus forward) in terms of the standard unit of measurement (i.e. ounces or grams) and then convert it at the current spot rate into the base currency.

            • CA-6.3.4

              Forward currency and gold positions should be valued at current spot market exchange rates. Using forward exchange rates is inappropriate as it will result in the measured positions reflecting current interest rate differentials, to some extent.

            • CA-6.3.5

              Where gold is part of a forward contract (i.e. quantity of gold to be received or to be delivered), any interest rate or foreign currency exposure from the other leg of the contract should be reported as set out in chapter CA-4 or section CA-6.1 above, respectively.

            • Structural positions

              • CA-6.3.6

                Positions of a structural, i.e. non-dealing, nature as set out below, may be excluded from the calculation of the net open currency positions:

                (a) positions are taken deliberately in order to hedge, partially or totally, against the adverse effects of exchange rate movements on the bank's capital adequacy ratio;
                (b) positions related to items that are deducted from the bank's capital when calculating its capital base in accordance with the rules and guidelines in this module, such as investments in non-consolidated subsidiaries; and
                (c) Retained profits held for payout to parent.

                The Agency will consider approving the exclusion of the above positions for the purpose of calculating the capital requirement, only if the following conditions are met:

                (i) the concerned bank provides adequate documentary evidence to the Agency which establishes the fact that the positions proposed to be excluded are, indeed, of a structural, i.e. non-dealing, nature and are merely intended to protect the bank's capital adequacy ratio. For this purpose, the Agency may ask for written representations from the bank's management or Directors; and
                (ii) any exclusion of a position is consistently applied, with the treatment of the hedge remaining the same for the life of the associated assets or other items.

            • Derivatives

              • CA-6.3.7

                A currency swap is treated as a combination of a long position in one currency and a short position in the second currency.

              • CA-6.3.8

                There are a number of alternative approaches to the calculation of the foreign exchange risk in options. As stated in section CA-6.1, with the Agency's prior written approval, a bank may choose to use internal models to measure the options risk. Extra capital charges will apply to those option risks that the bank's internal model does not capture. The standardised framework for the calculation of options risks and the resultant capital charges is described, in detail, in chapter CA-8. Where, as explained in paragraph CA-6.3.1, the option delta value is incorporated in the net open position, the capital charges for the other option risks are calculated separately.

          • CA-6.4 CA-6.4 Calculation of the overall net open positions

            • CA-6.4.1

              The net long or short position in each currency is converted, at the spot rate, into the reporting currency. The overall net open position is measured by aggregating the following:

              (a) The sum of the net short positions or the sum of the net long positions, whichever is greater; plus
              (b) The net position (short or long) in gold, regardless of sign.

            • CA-6.4.2

              Where the bank is assessing its foreign exchange risk on a consolidated basis, it may be technically impractical in the case of some marginal operations to include the currency positions of a foreign branch or subsidiary of the bank. In such cases, the internal limit for that branch/subsidiary, in each currency, may be used as a proxy for the positions. The branch/subsidiary limits should be added, without regard to sign, to the net open position in each currency involved. When this simplified approach to the treatment of currencies with marginal operations is adopted, the bank should adequately monitor the actual positions of the branch/subsidiary against the limits, and revise the limits, if necessary, based on the results of the ex-post monitoring.

          • CA-6.5 CA-6.5 Calculation of the capital charge

            • CA-6.5.1

              The capital charge is 8% of the overall net open position.

            • CA-6.5.2

              The table below illustrates the calculation of the overall net open position and the capital charge:

              Example of the calculation of the foreign exchange overall net open position and the capital charge
              GBP EURO SAR US$ JPY Gold
              +100 +150 +50 –180 –20 –20
              +300 –200 20
              The capital charge is 8% of the higher of either the sum of the net long currency positions or the sum of the net short positions (i.e. 300) and of the net position in gold (i.e. 20) = 320 x 8% = 25.6

        • CA-7 CA-7 Commodities risk — Standardised approach

          • CA-7.1 CA-7.1 Introduction

            • CA-7.1.1

              This chapter sets out the minimum capital requirements to cover the risk of holding or taking positions in commodities, including precious metals, but excluding gold (which is treated as a foreign currency according to the methodology explained in chapter CA-6).

            • CA-7.1.2

              The commodities position risk and the capital charges are calculated with reference to the entire business of a bank, i.e., the banking and trading books combined.

            • CA-7.1.3

              The price risk in commodities is often more complex and volatile than that associated with currencies and interest rates. Commodity markets may also be less liquid than those for interest rates and currencies and, as a result, changes in supply and demand can have a more dramatic effect on price and volatility. Banks need also to guard against the risk that arises when a short position falls due before the long position. Owing to a shortage of liquidity in some markets, it might be difficult to close the short position and the bank might be "squeezed by the market". All these market characteristics of commodities can make price transparency and the effective hedging of risks more difficult.

            • CA-7.1.4

              For spot or physical trading, the directional risk arising from a change in the spot price is the most important risk. However, banks using portfolio strategies involving forward and derivative contracts are exposed to a variety of additional risks, which may well be larger than the risk of a change in spot prices (directional risk). These include:

              (a) 'basis risk', i.e., the risk that the relationship between the prices of similar commodities alters through time;
              (b) 'interest rate risk', i.e., the risk of a change in the cost of carry for forward positions and options; and
              (c) 'forward gap risk', i.e., the risk that the forward price may change for reasons other than a change in interest rates.

            • CA-7.1.5

              The capital charges for commodities risk envisaged by the rules within this chapter are intended to cover the risks identified in paragraph CA-7.1.4. In addition, however, banks face credit counterparty risk on over-the-counter derivatives, which must be incorporated into their credit risk capital requirements. Furthermore, the funding of commodities positions may well open a bank to interest rate or foreign exchange risk which should be captured within the measurement framework set out in chapters CA-4 and CA-6, respectively.7


              7 Where a commodity is part of a forward contract (i.e.. a quantity of commodity to be received or to be delivered), any interest rate or foreign exchange risk from the other leg of the contract should be captured, within the measurement framework set out in chapters 4 and 6, respectively. However, positions which are purely of a stock financing nature (i.e., a physical stock has been sold forward and the cost of funding has been locked in until the date of the forward sale) may be omitted from the commodities risk-calculation although they will be subject to the interest rate and counterparty risk capital requirements.

            • CA-7.1.6

              Banks which have the intention and capability to use internal models for the measurement of their commodities risks and, hence, for the calculation of the capital requirement, should seek the prior written approval of the Agency for those models. The Agency's detailed rules for the recognition and use of internal models are included in chapter CA-9. It is essential that the internal models methodology captures the directional risk, forward gap and interest rate risks, and the basis risk which are defined in paragraph CA-7.1.4. It is also particularly important that models take proper account of market characteristics, notably the delivery dates and the scope provided to traders to close out positions.

            • CA-7.1.7

              Banks which do not propose to use internal models should adopt either the maturity ladder approach or the simplified approach to calculate their commodities risk and the resultant capital charges. Both these approaches are described in sections CA-7.3 and CA-7.4, respectively.

          • CA-7.2 CA-7.2 Calculation of commodities positions

            • Netting

              • CA-7.2.1

                Banks should first express each commodity position (spot plus forward) in terms of the standard unit of measurement (i.e., barrels, kilograms, grams etc.). Long and short positions in a commodity are reported on a net basis for the purpose of calculating the net open position in that commodity. For markets which have daily delivery dates, any contracts maturing within ten days of one another may be offset. The net position in each commodity is then converted, at spot rates, into the bank's reporting currency.

              • CA-7.2.2

                Positions in different commodities cannot be offset for the purpose of calculating the open positions as described in paragraph CA-7.2.1 above. However, where two or more sub-categories8 of the same category are, in effect, deliverable against each other, netting between those sub-categories is permitted. Furthermore, if two or more sub-categories of the same category are considered as close substitutes for each other, and minimum correlation of 0.9 between their price movements is clearly established over a minimum period of one year, the bank may, with the prior written approval of the Agency, net positions in those sub-categories. Banks which wish to net positions based on correlations, in the manner discussed above, will need to satisfy the Agency of the accuracy of the method which it proposes to adopt.


                8 Commodities can be grouped into clans, families, sub-groups and individual commodities. For example, a clan might be Energy Commodities, within which Hydro-Carbons is a family with Crude Oil being a sub-group and West Texas Intermediate, Arabian Light and Brent being individual commodities.

            • Derivatives

              • CA-7.2.3

                All commodity derivatives and off-balance-sheet positions which are affected by changes in commodity prices should be included in the measurement framework for commodities risks. This includes commodity futures, commodity swaps, and options where the "delta plus" method is used9. In order to calculate the risks, commodity derivatives are converted into notional commodities positions and assigned to maturities as follows

                (a) futures and forward contracts relating to individual commodities should be incorporated in the measurement framework as notional amounts of barrels, kilograms etc., and should be assigned a maturity with reference to their expiry date;
                (b) commodity swaps where one leg is a fixed price and the other one is the current market price, should be incorporated as a series of positions equal to the notional amount of the contract, with one position corresponding to each payment on the swap and slotted into the maturity time-bands accordingly. The positions would be long positions if the bank is paying fixed and receiving floating, and short positions if vice versa. (If one of the legs involves receiving/paying a fixed or floating interest rate, that exposure should be slotted into the appropriate repricing maturity band for the calculation of the interest rate risk, as described in chapter CA-4);
                (c) commodity swaps where the legs are in different commodities should be incorporated in the measurement framework of the respective commodities separately, without any offsetting. Offsetting will only be permitted if the conditions set out in paragraphs CA-7.2.1 and CA-7.2.2 are met.

                9 For banks using other approaches to measure options risks, all Options and the associated underlying instruments should be excluded from both the maturity ladder approach and the simplified approach. The treatment of options is described, in detail, in chapter 8.

            • CA-7.3 CA-7.3 Maturity ladder approach

              • CA-7.3.1

                A worked example of the maturity ladder approach is set out in Appendix CA 5 and the table in paragraph CA-7.3.2 illustrates the maturity time-bands of the maturity ladder for each commodity.

              • CA-7.3.2

                The steps in the calculation of the commodities risk by the maturity ladder approach are:

                (a) The net positions in individual commodities, expressed in terms of the standard unit of measurement, are first slotted into the maturity ladder. Physical stocks are allocated to the first time-band. A separate maturity ladder is used for each commodity as defined in section CA-7.2 earlier in this chapter. The net positions in commodities are calculated as explained in section CA-7.2.
                (b) Long and short positions in each time-band are matched. The sum of the matched long and short positions is multiplied first by the spot price of the commodity, and then by a spread rate of 1.5% for each time-band as set out in the table below. This represents the capital charge in order to capture forward gap and interest rate risk within a time-band (which, together, are sometimes referred to as curvature/spread risk).

                Time-bands10
                0–1 months
                1–3 months
                3–6 months
                6–12 months
                1–2 years
                2–3 years
                over 3 years
                (c) The residual (unmatched) net positions from nearer time-bands are then carried forward to offset opposite positions (i.e. long against short, and vice versa) in time-bands that are further out. However, a surcharge of 0.6% of the net position carried forward is added in respect of each time-band that the net position is carried forward, to recognise that such hedging of positions between different time-bands is imprecise. The surcharge is in addition to the capital charge for each matched amount created by carrying net positions forward, and is calculated as explained in step (b) above.
                (d) At the end of step (c) above, there will be either only long or only short positions, to which a capital charge of 15% will apply. The Agency recognises that there are differences in volatility between different commodities, but has, nevertheless, decided that one uniform capital charge for open positions in all commodities shall apply in the interest of simplicity of the measurement, and given the fact that banks normally run rather small open positions in commodities. Banks will be required to submit, in writing, details of their commodities business, to enable the Agency to evaluate whether the models approach should be adopted by the bank, to capture the market risk on this business.

                10 For instruments, the maturity of which is on the boundary of two maturity time-bands, the instrument should be placed into the earlier maturity band. For example, instruments with a maturity of exactly one year are placed into the 6 to 12 months time-band.

            • CA-7.4 CA-7.4 Simplified approach

              • CA-7.4.1

                By the simplified approach, the capital charge of 15% of the net position, long or short, in each commodity is applied to capture directional risk. Net positions in commodities are calculated as explained in section CA-7.2.

              • CA-7.4.2

                An additional capital charge equivalent to 3% of the bank's gross positions, long plus short, in each commodity is applied to protect the bank against basis risk, interest rate risk and forward gap risk. In valuing the gross positions in commodity derivatives for this purpose, banks should use the current spot price.

        • CA-8 CA-8 Options risk — Standardised approach

          • CA-8.1 CA-8.1 Introduction

            • CA-8.1.1

              It is recognised that the measurement of the price risk of options is inherently a difficult task, which is further complicated by the wide diversity of banks' activities in options. The Agency has decided that the following approaches should be adopted to the measurement of options risks:

              (a) Banks which solely use purchased options are permitted to use the simplified (carve-out) approach described later in this chapter.
              (b) Banks which also write options should use either the delta-plus (buffer) approach or the scenario approach, or alternatively use a comprehensive risk management model. The Agency's detailed rules for the recognition and use of internal models are included in chapter CA-9.

            • CA-8.1.2

              The scenario approach and the internal models approach are generally regarded as more satisfactory for managing and measuring options risk, as they assess risk over a range of outcomes rather than focusing on the point estimate of the 'Greek' risk parameters as in the delta-plus approach. The more significant the level and/or complexity of the bank's options trading activities, the more the bank will be expected to use a sophisticated approach to the measurement of options risks. The Agency will monitor the banks' options trading activities, and the adequacy of the risk measurement framework adopted.

            • CA-8.1.3

              Where written option positions are hedged by perfectly matched long positions in exactly the same options, no capital charge for market risk is required in respect of those matched positions.

          • CA-8.2 CA-8.2 Simplified approach (carve-out)

            • CA-8.2.1

              In the simplified approach, positions for the options and the associated underlying (hedges), cash or forward, are entirely omitted from the calculation of capital charges by the standardised methodology and are, instead, "carved out" and subject to separately calculated capital charges that incorporate both general market risk and specific risk. The capital charges thus generated are then added to the capital charges for the relevant risk category, i.e., interest rate related instruments, equities, foreign exchange and commodities as described in chapters CA-4, CA-5, CA-6 and CA-7 respectively.

            • CA-8.2.2

              The capital charges for the carved out positions are as set out in the table below. As an example of how the calculation would work, if a bank holds 100 shares currently valued at $ 10 each, and also holds an equivalent put option with a strike price of $ 11, the capital charge would be as follows:

              [$ 1,000 x 16%11 ] minus [($ 11–$ 10)12 x 100] = $ 60

              A similar methodology applies to options whose underlying is a foreign currency, an interest rate related instrument or a commodity.

              Simplified approach: Capital charges
              Position Treatment
              Long cash and long put

              or

              Short cash and long call (i.e., hedged positions)
              The capital charge is:

              [Market value of underlying instrument13 x Sum of specific and general market risk charges14 for the underlying] minus [Amount, if any, the option is in the money15]

              The capital charge calculated as above is bounded at zero, i.e., it cannot be a negative number.
              Long call

              or

              Long put
              (i.e., naked option positions)
              The capital charge is the lesser of:

              i) Market value of the underlying instrument x Sum of specific and general market risk charges for the underlying; and

              ii) Market value of the option16.


              11 8% specific risk plus 8% general market risk.

              12 The amount the option is "in the money".

              13 In some cases such as foreign exchange, it may be unclear which side is the "underlying instrument"; this should be taken to be the asset which would be received if the option were exercised. In addition, the nominal value should be used for items where the market value of the underlying instrument could be zero, e.g., caps and floors, swaptions etc.

              14 Some options (e.g., where the underlying is an interest rate, a currency or a commodity) bear no specific risk, but specific risk is present in the case of options on certain interest rate related instruments (e.g., options on a corporate debt security or a corporate bond index — see chapter CA-4 for the relevant capital charges), and in the case of options on equities and stock indices (see chapter CA-5 for the relevant capital charges). The capital charge for currency options is 8% and for options on commodities is 15%.

              15 For options with a residual maturity of more than six months, the strike price should be compared with the forward, not the current, price. A bank unable to do this should take the "in the money" amount to be zero.

              16 Where the position does not fall within the trading book options on certain foreign exchange and commodities positions (not belonging to the trading book), it is acceptable to use the book value instead of the market value.

          • CA-8.3 CA-8.3 Delta-plus method (buffer approach)

            • CA-8.3.1

              Banks which write options are allowed to include delta-weighted option positions within the standardised methodology set out in chapters CA-4 through CA-7. Each option should be reported as a position equal to the market value of the underlying multiplied by the delta. The delta should be calculated by an adequate model with appropriate documentation of the process and controls, to enable the Agency to review such models, if considered necessary. A worked example of the delta-plus method is set out in Appendix CA 6.

            • CA-8.3.2

              Since delta does not sufficiently cover the risks associated with options positions, there will be additional capital buffers to cover gamma (which measures the rate of change of delta) and vega (which measures the sensitivity of the value of an option with respect to a change in volatility), in order to calculate the total capital charge. The gamma and vega buffers should be calculated by an adequate exchange model or the bank's proprietary options pricing model, with appropriate documentation of the process and controls, to enable the Agency to review such models, if considered necessary.

            • Treatment of delta

              • CA-8.3.3

                The treatment of the delta-weighted positions, for the calculation of the capital charges arising from delta risk, is summarised in paragraphs CA-8.3.4 to CA-8.3.9.

            • Where the underlying is a debt security or an interest rate

              • CA-8.3.4

                The delta-weighted option positions are slotted into the interest rate time-bands as set out in chapter CA-4. A two-legged approach should be used as for other derivatives, as explained in chapter CA-4, requiring one entry at the time the underlying contract takes effect and a second at the time the underlying contract matures. A few examples to elucidate the two-legged treatment are set out below:

                (a) A bought call option on a June three-month interest rate future will, in April, be considered, on the basis of its delta-equivalent value, to be a long position with a maturity of five months and a short position with a maturity of two months.
                (b) A written option with the same underlying as in (a) above, will be included in the measurement framework as a long position with a maturity of two months and a short position with a maturity of five months.
                (c) A two months call option on a bond future where delivery of the bond takes place in September will be considered in April, as being long the bond and short a five months deposit, both positions being delta-weighted.

              • CA-8.3.5

                Floating rate instruments with caps or floors are treated as a combination of floating rate securities and a series of European-style options. For example, the holder of a three-year floating rate bond indexed to six month LIBOR with a cap of 10% will treat it as:

                (a) a debt security that reprices in six months; and
                (b) a series of five written call options on an FRA with a reference rate of 10%, each with a negative sign at the time the underlying FRA takes effect and a positive sign at the time the underlying FRA matures.

              • CA-8.3.6

                The rules applying to closely matched positions, set out in paragraph CA-4.8.2, will also apply in this respect.

            • Where the underlying is an equity instrument

              • CA-8.3.7

                The delta-weighted positions are incorporated in the measure of market risk described in chapter CA-5. For purposes of this calculation, each national market is treated as a separate underlying.

            • Options on foreign exchange and gold positions

              • CA-8.3.8

                The net delta-based equivalent of the foreign currency and gold options are incorporated in the measurement of the exposure for the respective currency or gold position, as described in chapter CA-6.

            • Options on commodities

              • CA-8.3.9

                The delta-weighted positions are incorporated in the measurement of the commodities risk by the simplified approach or the maturity ladder approach, as described in chapter CA-7.

            • Calculation of the gamma and vega buffers

              • CA-8.3.10

                As explained in paragraph CA-8.3.2, in addition to the above capital charges to cover delta risk, banks are required to calculate additional capital charges to cover the gamma and vega risks. The additional capital charges are calculated as follows:

                Gamma

                (a) For each individual option position (including hedge positions), a gamma impact is calculated according to the following formula derived from the Taylor series expansion:

                Gamma impact = 0.5 x Gamma x VU
                where VU = variation of the underlying of the option, calculated as in (b) below
                (b) VU is calculated as follows:
                (i) For interest rate options17, where the underlying is a bond, the market value of the underlying is multiplied by the risk weights set out in section CA-4.4. An equivalent calculation is carried out where the underlying is an interest rate, based on the assumed changes in yield as set out in the table in section CA-4.5;
                (ii) For options on equities and equity indices17, the market value of the underlying is multiplied by 8%;
                (iii) For foreign exchange and gold options, the market value of the underlying is multiplied by 8%;
                (iv) For commodities options, the market value of the underlying is multiplied by 15%.
                (c) For the purpose of the calculation of the gamma buffer, the following positions are treated as the same underlying:
                (i) For interest rates, each time-band as set out in the table in section CA-4.4. Positions should be slotted into separate maturity ladders by currency. Banks using the duration method should use the time-bands as set out in the table in section CA-4.5;
                (ii) For equities and stock indices, each individual national market;
                (iii) For foreign currencies and gold, each currency pair and gold; and
                (iv) For commodities, each individual commodity as defined in section CA-7.2.
                (d) Each option on the same underlying will have a gamma impact that is either positive or negative. These individual gamma impacts are summed, resulting in a net gamma impact for each underlying that is either positive or negative. Only those net gamma impacts that are negative are included in the capital calculation.
                (e) The total gamma capital charge is the sum of the absolute value of the net negative gamma impacts calculated for each underlying as explained in (d) above.

                Vega

                (f) For volatility risk (vega), banks are required to calculate the capital charges by multiplying the sum of the vegas for all options on the same underlying, as defined above, by a proportional shift in volatility of ±25%.
                (g) The total vega capital charge is the sum of the absolute value of the individual vega capital charges calculated for each underlying.

                17 For interest rate and equity options, the present set of rules do not attempt to capture specific risk when calculating gamma capital charges. See section CA-8.4 for an explanation of the Agency's views on this subject.

              • CA-8.3.11

                The capital charges for delta, gamma and vega risks described in paragraphs CA-8.3.1 through CA-8.3.10 are in addition to the specific risk capital charges which are determined separately by multiplying the delta-equivalent of each option position by the specific risk weights set out in chapters CA-4 through CA-7.

              • CA-8.3.12

                To summarise, capital requirements for, say OTC options, using the delta-plus method are as follows:

                (a) Counterparty risk capital charges (on purchased options only), calculated in accordance with the credit risk regulations; PLUS
                (b) Specific risk capital charges (calculated as explained in paragraph CA-8.3.11); PLUS
                (c) Delta risk capital charges (calculated as explained in paragraphs CA-8.3.3 through CA-8.3.9) PLUS
                (d) Gamma and vega capital buffers (calculated as explained in paragraph CA-8.3.10).

          • CA-8.4 CA-8.4 Scenario approach

            • CA-8.4.1

              As stated in section CA-8.1, banks which have a significant level of options trading activities, or have complex options trading strategies, are expected to use more sophisticated methods for measuring and monitoring the options risks. Banks with the appropriate capability will be permitted, with the prior approval of the Agency, to base the market risk capital charge for options portfolios and associated hedging positions on scenario matrix analysis. Before giving its approval, the Agency will closely review the accuracy of the analysis that is constructed. Furthermore, like in the case of internal models, the banks' use of scenario analysis as part of the standardised methodology will also be subject to external validation, and to those of the qualitative standards listed in chapter CA-9 which are appropriate given the nature of the business.

            • CA-8.4.2

              The scenario matrix analysis involves specifying a fixed range of changes in the option portfolio's risk factors and calculating changes in the value of the option portfolio at various points along this "grid" or "matrix". For the purpose of calculating the capital charge, the bank will revalue the option portfolio using matrices for simultaneous changes in the option's underlying rate or price and in the volatility of that rate or price. A different matrix is set up for each individual underlying as defined in section CA-8.3 above. As an alternative, in respect of interest rate options, banks which are significant traders in such options are permitted to base the calculation on a minimum of six sets of time-bands. When using this alternative method, not more than three of the time-bands as defined in chapter CA-4 should be combined into any one set.

            • CA-8.4.3

              The first dimension of the matrix involves a specified range of changes in the option's underlying rate or price. The Agency has set the range for each risk category as follows:

              (a) Interest rate related instruments — The range for interest rates is consistent with the assumed changes in yield set out in section CA-4.5. Those banks using the alternative method of grouping time-bands into sets, as explained in paragraph CA-8.4.2, should use, for each set of time-bands, the highest of the assumed changes in yield applicable to the individual time-bands in that group. If, for example, the time-bands 3 to 4 years, 4 to 5 years and 5 to 7 years are combined, the highest assumed change in yield of these three bands would be 0.75 which would be applicable to that set.
              (b) For equity instruments, the range is ±8%.
              (c) For foreign exchange and gold, the range is ±8%.
              (d) For commodities, the range is ±15%,

              For all risk categories, at least seven observations (including the current observation) should be used to divide the range into equally spaced intervals.

            • CA-8.4.4

              The second dimension of the matrix entails a change in the volatility of the underlying rate or price. A single change in the volatility of the underlying rate or price equal to a shift in volatility of ±25% is applied.

            • CA-8.4.5

              The Agency will closely monitor the need to reset the parameters for the amounts by which the price of the underlying instrument and volatility must be shifted to form the rows and columns of the scenario matrix. For the time being, the parameters set, as above, only reflect general market risk (see paragraphs CA-8.4.10 to CA-8.4.12).

            • CA-8.4.6

              After calculating the matrix, each cell contains the net profit or loss of the option and the underlying hedge instrument. The general market risk capital charge for each underlying is then calculated as the largest loss contained in the matrix.

            • CA-8.4.7

              In addition to the capital charge calculated as above, the specific risk capital charge is determined separately by multiplying the delta-equivalent of each option position by the specific risk weights set out in chapters CA-4 through CA-7.

            • CA-8.4.8

              To summarise, capital requirements for, say OTC options, using the scenario approach are as follows:

              (a) Counterparty risk capital charges (on purchased options only), calculated in accordance with the credit risk regulations; PLUS
              (b) Specific risk capital charges (calculated as explained in paragraph CA-8.4.7); PLUS
              (c) Directional and volatility risk capital charges (i.e., the worst case loss from a given scenario matrix analysis).

            • CA-8.4.9

              Banks doing business in certain classes of complex exotic options (e.g. barrier options involving discontinuities in deltas etc.), or in options at the money that are close to expiry, are required to use either the scenario approach or the internal models approach, both of which can accommodate more detailed revaluation approaches. The Agency expects the concerned banks to work with it closely to produce an agreed method, within the framework of these rules. If a bank uses scenario matrix analysis, it must be able to demonstrate that no substantially larger loss could fall between the nodes.

            • CA-8.4.10

              In drawing up the delta-plus and the scenario approaches, the Agency's present set of rules do not attempt to capture specific risk other than the delta-related elements (which are captured as explained in paragraphs CA-8.4.7 and CA-8.4.11). The Agency recognises that introduction of those other specific risk elements will make the measurement framework much more complex. On the other hand, the simplifying assumptions used in these rules will result in a relatively conservative treatment of certain options positions.

            • CA-8.4.11

              In addition to the options risks described earlier in this chapter, the Agency is conscious of the other risks also associated with options, e.g., rho or interest rate risk (the rate of change of the value of the option with respect to the interest rate) and theta (the rate of change of the value of the option with respect to time). While not proposing a measurement system for those risks at present, the Agency expects banks undertaking significant options business, at the very least, to monitor such risks closely. Additionally, banks will be permitted to incorporate rho into their capital calculations for interest rate risk, if they wish to do so.

            • CA-8.4.12

              The Agency will closely review the treatment of options for the calculation of market risk capital charges, particularly in the light of the aspects described in paragraphs CA-8.4.10 and CA-8.4.11.

        • CA-9 CA-9 Use of internal models

          • CA-9.1 CA-9.1 Introduction

            • CA-9.1.1

              As stated in chapter CA-1, as an alternative to the standardised approach to the measurement of market risks (which is described in chapters CA-4 through CA-8), and subject to the explicit prior approval of the Agency, banks will be allowed to use risk measures derived from their own internal models.

            • CA-9.1.2

              This chapter describes the seven sets of conditions that should be met before a bank is allowed to use the internal models approach, namely:

              (a) general criteria regarding the adequacy of the risk management system;
              (b) qualitative standards for internal oversight of the use of models, notably by senior management;
              (c) guidelines for specifying an appropriate set of market risk factors (i.e., the market rates and prices that affect the value of a bank's positions);
              (d) quantitative standards setting out the use of common minimum statistical parameters for measuring risk;
              (e) guidelines for stress testing;
              (f) validation procedures for external oversight of the use of models; and
              (g) rules for banks which use a mixture of the internal models approach and the standardised approach.

            • CA-9.1.3

              The standardised methodology, described in chapters CA-4 through CA-8, uses a "building-block" approach in which the specific risk and the general market risk arising from debt and equity positions are calculated separately. The focus of most internal models is a bank's general market risk exposure, typically leaving specific risk (i.e., exposures to specific issuers of debt securities and equities) to be measured largely through separate credit risk measurement systems. Banks using models are subject to separate capital charges for the specific risk not captured by their models, which shall be calculated by the standardised methodology. The capital charge for banks which are modelling specific risk is set out in section CA-9.10.

            • CA-9.1.4

              While the models recognition criteria described in this chapter are primarily intended for comprehensive Value-at-Risk (VaR) models, nevertheless, the same set of criteria will be applied, to the extent that it is appropriate, to other pre-processing or valuation models the output of which is fed into the standardised measurement system, e.g., interest rate sensitivity models (from which the residual positions are fed into the duration ladders) and option pricing models (for the calculation of the delta, gamma and vega sensitivities).

            • CA-9.1.5

              As a number of strict conditions are required to be met before internal models can be recognised by the Agency, including external validation, banks which are contemplating using internal models should submit their detailed written proposals for the Agency's approval, immediately upon receipt of these regulations.

            • CA-9.1.6

              As the model approval process will encompass a review of both the model and its operating environment, it is not the case that a commercially produced model which is recognised for one bank will automatically be recognised for another bank.

          • CA-9.2 CA-9.2 General criteria

            • CA-9.2.1

              The Agency will give its approval for the use of internal models to measure market risks only if, in addition to the detailed requirements described later in this chapter, it is satisfied that the following general criteria are met:

              (a) that the bank's risk management system is conceptually sound and is implemented with integrity;
              (b) that the bank has, in the Agency's view, sufficient numbers of staff skilled in the use of sophisticated models not only in the trading area but also in the risk control, audit and the back office areas;
              (c) that the bank's models have, in the Agency's judgement, a proven track record of reasonable accuracy in measuring risk. The Agency recognises that the use of internal models is, for most banks in Bahrain, a relatively new development and, therefore, it is difficult to establish a track record of reasonable accuracy. The Agency, therefore, will require a period of initial monitoring and live testing of a bank's internal model before it is used for supervisory capital purposes; and
              (d) that the bank regularly conducts stress tests as outlined in section CA-9.7 and conducts backtesting as described in section CA-9.6.

          • CA-9.3 CA-9.3 Qualitative standards

            • CA-9.3.1

              In order to ensure that banks using models have market risk management systems that are conceptually sound and implemented with integrity, the Agency has set the following qualitative criteria that banks are required to meet before they are permitted to use the models-based approach. Apart from influencing the Agency's decision to permit a bank to use internal models, where such permission is granted, the extent to which the bank meets the qualitative criteria will further influence the level at which the Agency will set the multiplication factor for that bank, referred to in section CA-9.5. Only those banks whose models, in the Agency's judgement, are in full compliance with the qualitative criteria will be eligible for application of the minimum multiplication factor of 3. The qualitative criteria include the following:

              (a) The bank should have an independent risk management unit that is responsible for the design and implementation of the bank's risk management system. The unit should produce and analyse daily reports on the output of the bank's risk measurement model, including an evaluation of the relationship between the measures of risk exposure and the trading limits. This unit must be independent from the business trading units and should report directly to the senior management of the bank.
              (b) The independent risk management unit should conduct a regular backtesting programme, i.e. an ex-post comparison of the risk measure generated by the model against the actual daily changes in portfolio value over longer periods of time, as well as hypothetical changes based on static positions. The document issued by the Basel Committee on Banking Supervision in January 1996, titled "Supervisory framework for the use of 'backtesting' in conjunction with the internal models approach to market risk capital requirements" (see http://www.bis.org/publ/bcbs22.pdf), presents in detail the approach to be applied by banks for backtesting.
              (c) The Board of Directors and senior management of the bank should be actively involved in the risk management process and must regard such process as an essential aspect of the business to which significant resources need to be devoted18. In this regard, the daily reports prepared by the independent risk management unit must be reviewed by a level of management with sufficient seniority and authority to enforce both reductions of positions taken by individual traders and reductions in the bank's overall risk exposure.
              (d) The bank's internal model must be closely integrated into the day-to-day risk management process of the bank. Its output should, accordingly, be an integral part of the process of planning, monitoring and controlling the bank's market risk profile.
              (e) The risk measurement system should be used in conjunction with the internal trading and exposure limits. In this regard, the trading limits should be related to the bank's risk measurement model in a manner that is consistent over time and that is well-understood by both traders and senior management.
              (f) A routine and rigorous programme of stress testing, along the general lines set out in section CA-9.6, should be in place as a supplement to the risk analysis based on the day-to-day output of the bank's risk measurement model. The results of stress testing should be reviewed periodically by senior management and should be reflected in the policies and limits set by management and the Board of Directors. Where stress tests reveal particular vulnerability to a given set of circumstances, prompt steps should be taken to manage those risks appropriately (e.g., by hedging against that outcome or reducing the size of the bank's exposures).
              (g) The bank should have a routine in place for ensuring compliance with a documented set of internal policies, controls and procedures concerning the operation of the risk measurement system. The bank's risk measurement system must be well documented, for example, through a risk management manual that describes the basic principles of the risk management system and that provides an explanation of the empirical techniques used to measure market risk.
              (h) An independent review of the risk measurement system should be carried out regularly in the bank's own internal auditing process. This review should include both the activities of the business trading units and of the independent risk management unit. A review, by the internal auditor, of the overall risk management process should take place at regular intervals (ideally not less than once every six months) and should specifically address, at a minimum:
              (i) the adequacy of the documentation of the risk management system and process;
              (ii) the organisation of the risk management unit;
              (iii) the integration of market risk measures into daily risk management;
              (iv) the approval process for risk pricing models and valuation systems used by front- and back-office personnel;
              (v) the validation of any significant changes in the risk measurement process;
              (vi) the scope of market risks captured by the risk measurement model;
              (vii) the integrity of the management information system;
              (viii) the accuracy and completeness of position data;
              (ix) the verification of the consistency, timeliness and reliability of data sources used to run internal models, including the independence of such data sources;
              (x) the accuracy and appropriateness of volatility and correlation assumptions;
              (xi) the accuracy of valuation and risk transformation calculations;
              (xii) the verification of the model's accuracy through frequent backtesting as described in (b) above and in the Basel Committee's document referred to therein.

              18 The report, "Risk management guidelines for derivatives", issued by the Basel Committee in July 1994, further discusses the responsibilities of the Board of Directors and senior management.

          • CA-9.4 CA-9.4 Specification of market risk factors

            • CA-9.4.1

              An important part of a bank's internal market risk measurement system is the specification of an appropriate set of market risk factors, i.e. the market rates and prices that affect the value of the bank's trading positions. The risk factors contained in a market risk measurement system should be sufficient to capture the risks inherent in the bank's portfolio of on- and off-balance-sheet trading positions. Banks should follow the Agency's guidelines, set out below, for specifying the risk factors for their internal models. Where a bank has difficulty in specifying the risk factors for any currency or market within a risk category, in accordance with the following guidelines, the bank should immediately contact the Agency. The Agency will review and discuss the specific circumstances of each such case with the concerned bank, and will decide alternative methods of calculating the risks which are not captured by the bank's model.

              (a) For interest rates:
              There should be a set of risk factors corresponding to interest rates in each currency in which the bank has interest-rate-sensitive on- or off-balance-sheet positions.
              The risk measurement system should model the yield curve using one of a number of generally accepted approaches, for example, by estimating forward rates of zero coupon yields. The yield curve should be divided into various maturity segments in order to capture variation in the volatility of rates along the yield curve; there will typically be one risk factor corresponding to each maturity segment. For material exposures to interest rate movements in the major currencies and markets, banks must model the yield curve using a minimum of six factors. However, the number of risk factors used should ultimately be driven by the nature of the bank's trading strategies. For instance, a bank which has a portfolio of various types of securities across many points of the yield curve and which engages in complex arbitrage strategies would require a greater number of risk factors to capture interest rate risk accurately.
              The risk measurement system must incorporate separate risk factors to capture spread risk (e.g. between bonds and swaps). A variety of approaches may be used to capture the spread risk arising from less than perfectly correlated movements between government and other fixed-income interest rates, such as specifying a completely separate yield curve for non-government fixed-income instruments (for instance, swaps or municipal securities) or estimating the spread over government rates at various points along the yield curve.
              (b) For exchange rates (which includes gold):
              The risk measurement system should incorporate risk factors corresponding to the individual foreign currencies in which the bank's positions are denominated. Since the value-at-risk figure calculated by the risk measurement system will be expressed in the bank's reporting currency, any net position denominated in a currency other than the reporting currency will introduce a foreign exchange risk. Thus, there must be risk factors corresponding to the exchange rate between the reporting currency and each other currency in which the bank has a significant exposure.
              (c) For equity prices:
              There should be risk factors corresponding to each of the equity markets in which the bank holds significant positions.
              At a minimum, there should be a risk factor that is designed to capture market-wide movements in equity prices (e.g., a market index). Positions in individual securities or in sector indices may be expressed in "beta-equivalents"19 relative to this market-wide index.
              A somewhat more detailed approach would be to have risk factors corresponding to various sectors of the overall equity market (for instance, industry sectors or cyclical and non-cyclical sectors). As above, positions in individual stocks within each sector could be expressed in "beta-equivalents" relative to the sector index.
              The most extensive approach would be to have risk factors corresponding to the volatility of individual equity issues.
              The sophistication and nature of the modelling technique for a given market should correspond to the bank's exposure to the overall market as well as its concentration in individual equity issues in that market.
              (d) For commodity prices:
              There should be risk factors corresponding to each of the commodity markets in which the bank holds significant positions (also see section CA-7.1).
              For banks with relatively limited positions in commodity-based instruments, a straight-forward specification of risk factors is acceptable. Such a specification would likely entail one risk factor for each commodity price to which the bank is exposed. In cases where the aggregate positions are reasonably small, it may be acceptable to use a single risk factor for a relatively broad sub-category of commodities (for instance, a single risk factor for all types of oil). However, banks which propose to use this simplified approach should obtain the prior written approval of the Agency.
              For more active trading, the model should also take account of variation in the "convenience yield"20 between derivatives positions such as forwards and swaps and cash positions in the commodity.

              19 A "beta-equivalent" position would be calculated from a market model of equity (such as the CAPM model) by regressing the return on the individual stock or sector index or the risk-free rate of return and the return on the market index.

              20 The convenience yield reflects the benefits of direct ownership of the physical commodity (for example, the ability to profit from temporary market shortages), and is affected by both market conditions and factors such as physical storage costs.

          • CA-9.5 CA-9.5 Quantitative standards

            • CA-9.5.1

              The following minimum quantitative standards will apply for the purpose of calculating the capital charge.

              (a) "Value-at-risk" must be computed on a daily basis.
              (b) In calculating the value-at-risk, a 99th percentile, one-tailed confidence interval is to be used.
              (c) In calculating the value-at-risk, an instantaneous price shock equivalent to a 10-day movement in prices is to be used, i.e., the minimum "holding period" will be ten trading days. Banks may use value-at-risk numbers calculated according to shorter holding periods scaled up to ten days by the square root of time (for the treatment of options, also see (h) below).
              (d) The minimum historical observation period (sample period) for calculating value-at-risk is one year. For banks which use a weighting scheme or other methods for the historical observation period, the "effective" observation period must be at least one year (i.e., the weighted average time lag of the individual observations cannot be less than 6 months).

              The Agency may, as an exceptional case, require a bank to calculate its value-at-risk using a shorter observation period if, in the Agency's judgement, this is justified by a significant upsurge in price volatility.
              (e) Banks should update their data sets no less frequently than once every week and should also reassess them whenever market prices are subject to material changes.
              (f) No particular type of model is prescribed by the Agency. So long as each model used captures all the material risks run by the bank, as set out in section CA-9.4, banks will be free to use models based, for example, on variance-covariance matrices, historical simulations, or Monte Carlo simulations.
              (g) Banks shall have discretion to recognise empirical correlations within broad risk categories (i.e., interest rates, exchange rates, equity prices and commodity prices, including related options volatilities in each risk factor category). Banks are not permitted to recognise empirical correlations across broad risk categories without the prior approval of the Agency. Banks may apply, on a case-by-case basis, for empirical correlations across broad risk categories to be recognised by the Agency, subject to its satisfaction with the soundness and integrity of the bank's system for measuring those correlations.
              (h) Banks' models must accurately capture the unique risks associated with options within each of the broad risk categories. The following criteria shall apply to the measurement of options risk:
              banks' models must capture the non-linear price characteristics of options positions;
              banks are expected to ultimately move towards the application of a full 10-day price shock to options positions or positions that display option-like characteristics. In the interim period, banks may adjust their capital measure for options risk through other methods, e.g., periodic simulations or stress testing;
              each bank's risk measurement system must have a set of risk factors that captures the volatilities of the rates and prices underlying the option positions, i.e., vega risk. Banks with relatively large and/or complex options portfolios should have detailed specifications of the relevant volatilities. This means that banks should measure the volatilities of options positions broken down by different maturities.
              (i) Each bank must meet, on a daily basis, a capital requirement expressed as the higher of (i) and (ii) below, multiplied by a multiplication factor (see (j) below):
              (i) its previous day's value-at-risk number measured according to the parameters specified in (a) to (h) above; and
              (ii) an average of the daily value-at-risk measures on each of the preceding sixty business days.
              (j) The multiplication factor will be set by the Agency, separately for each individual bank, on the basis of the Agency's assessment of the quality of the bank's risk management system, subject to an absolute minimum of 3. Banks will be required to add to the factor set by the Agency, a "plus" directly related to the ex-post performance of the model, thereby introducing a built-in positive incentive to maintain the predictive quality of the model. The plus will range from 0 to 1 based on the outcome of the bank's backtesting. If the backtesting results are satisfactory and the bank meets all of the qualitative standards set out in section CA-9.3 above, the plus factor could be zero. The Basel Committee's document titled "Supervisory framework for the use of 'backtesting' in conjunction with the internal models approach to market risk capital requirements" (see http://www.bis.org/publ/bcbs22.htm), referred to earlier in section CA-9.3, presents in detail the approach to be followed for backtesting and the plus factor. Banks are expected to strictly comply with this approach.
              (k) As stated earlier in section CA-9.1, banks using models will also be subject to a capital charge to cover specific risk (as defined under the standardised approach) of interest rate related instruments and equity instruments. The manner in which the specific risk capital charge is to be calculated is set out in section CA-9.10.

          • CA-9.6 CA-9.6 Backtesting

            • CA-9.6.1

              The contents of this section outline the key requirements as set out in the Basel Committee's paper titled "Supervisory framework for the use of 'backtesting' in conjunction with the internal models approach to market risk capital requirements" (see http://www.bis.org/publ/bcbs22.htm). The paper presents in detail the approach to be followed for backtesting by banks.

            • Key requirements

              • CA-9.6.2

                The contents of this paper lay down recommendations for carrying out backtesting procedures in order to determine the accuracy and robustness of bank's internal models for measuring market risk capital requirements. These backtesting procedures typically consist of a periodic comparison of the bank's daily value-at-risk measures with the subsequent daily profit or loss ("trading outcome"). The procedure involves calculating and identifying the number of times over the prior 250 business days that observed daily trading losses exceed the bank's one-day, 99% confidence level VaR estimate (so-called "exceptions").

              • CA-9.6.3

                Based on the number of exceptions identified from the backtesting procedures, the banks will be classified into three exception categories for the determination of the "scaling factor" to be applied to the banks' market risk measure generated by its internal models. The three categories, termed as zones and distinguished by colours into a hierarchy of responses, are listed below:

                (a) Green zone
                (b) Yellow zone
                (c) Red zone

              • CA-9.6.4

                The green zone corresponds to backtesting results that do not themselves suggest a problem with the quality or accuracy of a bank's internal model. The yellow zone encompasses results that do raise questions in this regard, but where such a conclusion is not definitive. The red zone indicates a backtesting result that almost certainly indicates a problem with a bank's risk model.

              • CA-9.6.5

                The corresponding "scaling factors" applicable to banks falling into respective zones based on their backtesting results are shown in Table 2 of the paper mentioned in paragraph CA-9.6.1.

          • CA-9.7 CA-9.7 Stress testing

            • CA-9.7.1

              Banks that use the internal models approach for calculating market risk capital requirements must have in place a rigorous and comprehensive stress testing programme. Stress testing to identify events or influences that could greatly impact the bank is a key component of a bank's assessment of its capital position.

            • CA-9.7.2

              Banks' stress scenarios need to cover a range of factors that can create extraordinary losses or gains in trading portfolios, or make the control of risk in those portfolios very difficult. These factors include low-probability events in all major types of risks, including the various components of market, credit and operational risks. Stress scenarios need to shed light on the impact of such events on positions that display both linear and non-linear characteristics (i.e., options and instruments that have option-like characteristics).

            • CA-9.7.3

              Banks' stress tests should be both of a quantitative and qualitative nature, incorporating both market risk and liquidity aspects of market disturbances. Quantitative criteria should identify plausible stress scenarios to which banks could be exposed. Qualitative criteria should emphasise that two major goals of stress testing are to evaluate the capacity of the bank's capital to absorb potential large losses and to identify steps the bank can take to reduce its risk and conserve capital. This assessment is integral to setting and evaluating the bank's management strategy and the results of stress testing should be routinely communicated to senior management and, periodically, to the bank's Board of Directors.

            • CA-9.7.4

              Banks should combine the use of stress scenarios as advised under (a), (b) and (c) below by the Agency, with stress tests developed by the banks themselves to reflect their specific risk characteristics. The Agency may ask banks to provide information on stress testing in three broad areas, as discussed below.

              (a) Scenarios requiring no simulation by the bank

              Banks should have information on the largest losses experienced during the reporting period available for review by the Agency. This loss information will be compared with the level of capital that results from a bank's internal measurement system. For example, it could provide the Agency with a picture of how many days of peak day losses would have been covered by a given value-at-risk estimate.
              (b) Scenarios requiring simulation by the bank

              Banks should subject their portfolios to a series of simulated stress scenarios and provide the Agency with the results. These scenarios could include testing the current portfolio against past periods of significant disturbance, for example, the 1987 equity crash, the ERM crises of 1992 and 1993 or the fall in the international bond markets in the first quarter of 1994, the Far East and ex-Soviet bloc equity crises of 1997–99 and the collapse of the TMT equities market of 2000–01 incorporating both the large price movements and the sharp reduction in liquidity associated with these events. A second type of scenario would evaluate the sensitivity of the bank's market risk exposure to changes in the assumptions about volatilities and correlations. Applying this test would require an evaluation of the historical range of variation for volatilities and correlations and evaluation of the bank's current positions against the extreme values of the historical range. Due consideration should be given to the sharp variation that, at times, has occurred in a matter of days in periods of significant market disturbance. The four market events, cited above as examples, all involved correlations within risk factors approaching the extreme values of 1 and –1 for several days at the height of the disturbance.
              (c) Scenarios developed by the bank to capture the specific characteristics of its portfolio

              In addition to the general scenarios prescribed by the Agency under (a) and (b) above, each bank should also develop its own stress scenarios which it identifies as most adverse based on the characteristics of its portfolio (e.g. any significant political or economic developments that may result in a sharp move in oil prices). Banks should provide the Agency with a description of the methodology used to identify and carry out the scenarios as well as with a description of the results derived from these stress tests.

            • CA-9.7.5

              Once a stress scenario has been identified, it should be used for conducting stress tests at least once every quarter, as long as the scenario continues to be relevant to the bank's portfolio.

            • CA-9.7.6

              The results of all stress tests should be reviewed by senior management within 15 days from the time they are available, and should be promptly reflected in the policies and limits set by management and the Board of Directors. Moreover, if the testing reveals particular vulnerability to a given set of circumstances, the Agency would expect the bank to take prompt steps to manage those risks appropriately (e.g., by hedging against that outcome or reducing the size of its exposures).

          • CA-9.8 CA-9.8 External validation of models

            • CA-9.8.1

              Before granting its approval for the use of internal models by a bank, the Agency will require that the models are validated by both the internal and external auditors of the bank. The Agency will review the validation procedures performed by the internal and external auditors, and may independently carry out further validation procedures.

            • CA-9.8.2

              The internal validation procedures to be carried out by the internal auditors are set out in section CA-9.3. As stated in that paragraph, the internal auditor's review of the overall risk management process should take place at regular intervals (not less than once every six months). The internal auditor shall make a report to senior management and the Board of Directors, in writing, of the results of the validation procedures. The report shall be made available to the Agency for its review.

            • CA-9.8.3

              The validation of the models by the external auditors should include, at a minimum, the following steps:

              (a) verifying and ensuring that the internal validation processes described in section CA-9.3 are operating satisfactorily;
              (b) ensuring that the formulae used in the calculation process as well as for the pricing of options and other complex instruments are validated by a qualified unit, which in all cases should be independent from the trading area;
              (c) checking and ensuring that the structure of the internal models is adequate with respect to the bank's activities and geographical coverage;
              (d) checking the results of the bank's backtesting of its internal measurement system (i.e., comparing value-at-risk estimates with actual profits and losses) to ensure that the model provides a reliable measure of potential losses over time; and
              (e) making sure that data flows and processes associated with the risk measurement system are transparent and accessible.

            • CA-9.8.4

              The external auditors should carry out their validation/review procedures, at a minimum, once every year. Based on the above procedures, the external auditors shall make a report, in writing, on the accuracy of the bank's models, including all significant findings of their work. The report shall be addressed to the senior management and/or the Board of Directors of the bank, and a copy of the report shall be made available to the Agency. The mandatory annual review by the external auditors shall be carried out during the third quarter of the calendar year, and the Agency expects to receive their final report by 30 September each year. The results of additional validation procedures carried out by the external auditors at other times during the year, should be made available to the Agency promptly.

            • CA-9.8.5

              Banks are required to ensure that external auditors and the Agency's representatives are in a position to have easy access, whenever they judge it necessary and under appropriate procedures, to the models' specifications and parameters as well as to the results of, and the underlying inputs to, their value-at-risk calculations.

          • CA-9.9 CA-9.9 Letter of model recognition

            • CA-9.9.1

              As stated in section CA-9.1, banks which propose to use internal models for the calculation of their market risk capital requirements should submit their detailed proposals, in writing, to the Agency. The Agency will review these proposals, and upon ensuring that the bank's internal models meet all the criteria for recognition set out earlier in this chapter, and after satisfying itself with the results of validation procedures carried out by the internal and external auditors and/or by itself, will issue a letter of model recognition to the bank.

            • CA-9.9.2

              The letter of model recognition should be specific. It will set out the products covered, the method for calculating capital requirements on the products and the conditions of model recognition. In the case of pre-processing models, the bank will also be told how the output of recognised models should feed into the processing of other interest rate, equity, foreign exchange and commodities risk. The conditions of model recognition may include additional reporting requirements. The Agency's prior written approval should be obtained for any modifications proposed to be made to the models previously recognised by the Agency. In cases where a bank proposes to apply the model to new but similar products, there will be a requirement to obtain the Agency's prior approval. In some cases, the Agency may be able to give provisional approval for the model to be applied to a new class of products, in others it will be necessary to revisit the bank.

            • CA-9.9.3

              The Agency may withdraw its approval granted for any bank's model if it believes that the conditions on which the approval was based are no longer valid or have changed significantly.

          • CA-9.10 CA-9.10 Combination of internal models and the standardised methodology

            • CA-9.10.1

              Unless a bank's exposure to a particular risk factor is insignificant, the internal models approach will, in principle, require banks to have an integrated risk measurement system that captures the broad risk factor categories (i.e., interest rates, exchange rates (which includes gold), equity prices and commodity prices, with related options volatilities being included in each risk factor category). Thus, banks which start to use models for one or more risk factor categories will, over a reasonable period of time, be expected to extend the models to all their market risks.

            • CA-9.10.2

              A bank which has obtained the Agency's approval for the use of one or more models will no longer be able to revert to measuring the risk measured by those models according to the standardised methodology (unless the Agency withdraws its approval for the model(s), as explained in section CA-9.9). However, what constitutes a reasonable period of time for an individual bank which uses a combination of internal models and the standardised methodology to move to a comprehensive model, will be decided by the Agency after taking into account the relevant circumstances of the bank.

            • CA-9.10.3

              Notwithstanding the goal of moving to comprehensive internal models as set out in paragraph CA-9.10.1 above, for banks which, for the time being, will be using a combination of internal models and the standardised methodology, the following conditions will apply:

              (a) each broad risk factor category must be assessed using a single approach (either internal models or the standardised approach), i.e., no combination of the two methods will, in principle, be permitted within a risk factor category or across a bank's different entities for the same type of risk (see, however, the transitional provisions in section CA-1.6)21;
              (b) all of the criteria laid down in this chapter will apply to the models being used;
              (c) banks may not modify the combination of the two approaches which they are using, without justifying to the Agency that they have a valid reason for doing so, and obtaining the Agency's prior written approval;
              (d) no element of market risk may escape measurement, i.e. the exposure for all the various risk factors, whether calculated according to the standardised approach or internal models, would have to be captured; and
              (e) the capital charges assessed under the standardised approach and under the models approach should be aggregated using the simple sum method.

              21 However, banks may incur risks in positions which are not captured by their models, for example, in minor currencies or in negligible business areas. Such risks should be measured according to the standard methodology.

          • CA-9.11 CA-9.11 Treatment of specific risk

            • CA-9.11.1

              Banks using models will be permitted to base their specific risk capital charge on modelled estimates if they meet all of the qualitative and quantitative requirements for general risk models as well as the additional criteria set out in paragraph CA-9.11.2. Banks which are unable to meet these additional criteria will be required to base their specific risk capital charge on the full amount of the specific risk charge calculated by the standardised methodology (as illustrated in chapters CA-4 to CA-8).

            • CA-9.11.2

              The criteria for applying modelled estimates of specific risk require that a bank's model:

              •  explain the historical price variation in the portfolio22;
              •  demonstrably capture concentration (magnitude and changes in composition)23;
              •  be robust to an adverse environment24; and
              •  be validated through backtesting aimed at assessing whether specific risk is being accurately captured.

              In addition, the bank must be able to demonstrate that it has methodologies in place which allow it to adequately capture event and default risk for its traded debt and equity positions.


              22 The key measurement of model quality are "goodness-of-fit" measures which address the question of how much of the historical variation in price value is explained by the model. One measure of this type which can often be used is an R-squared measure from regression methodology. If this measure is to be used, the bank's model would be expected to be able to explain a high percentage, such as 90%, of the historical price variation or to explicitly include estimates of the residual variability not captured in the factors included in this regression. For some types of model, it may not be feasible to calculate a goodness-of-fit measure. In such an instance, a bank is expected to contact the Agency to define an acceptable alternative measure which would meet this regulatory objective.

              23 The bank should be expected to demonstrate that the model is sensitive to changes in portfolio construction and that higher capital charges are attracted for portfolios that have increasing concentrations.

              24 The bank should be able to demonstrate that the model will signal rising risk in an adverse environment. This could be achieved by incorporating in the historical estimation period of the model at least one full credit cycle and ensuring that the model would not have been inaccurate in modelling at least one full the downward portion of the cycle. Another approach for demonstrating this is through simulation of historical or plausible worst-case environments

            • CA-9.11.3

              Banks which meet the criteria set out above for models but do not have methodologies in place to adequately capture event and default risk will be required to calculate their specific risk capital charge based on the internal model measurements plus an additional prudential surcharge as defined in paragraph CA-9.11.4. The surcharge is designed to treat the modelling of specific risk on the same basis as a general market risk model that has proven deficient during backtesting. That is, the equivalent of a scaling factor of four would apply to the estimate of specific risk until such time as a bank can demonstrate that the methodologies it uses adequately capture event and default risk. Once a bank is able to demonstrate this, the minimum multiplication factor of three can be applied. However, a higher multiplication factor of four on the modelling of specific risk would remain possible if future backtesting results were to indicate a serious deficiency in the model.

            • CA-9.11.4

              For banks applying the surcharge, the total market risk measure will equal a minimum of three times the internal model's general and specific risk measure plus a surcharge in the amount of either:

              (a) the specific risk portion of the value-at-risk measure which should be isolated25; or, at the bank's option,
              (b) the value-at-risk measures of sub-portfolios of debt and equity positions that contain specific risk26.

              Banks using option (b) above are required to identify their sub-portfolios structure ahead of time and should not change it without the Agency's prior written consent.


              25 Techniques for separating general market risk and specific risk would include the following:

              Equities:

              The market should be identified with a single factor that is representative of the market as a whole, for example, a widely accepted broadly based stock index for the country concerned.

              Banks that use factor models may assign one factor of their model, or a single linear combination of factors, as their general market risk factor.

              Bonds:

              The market should be identified with a reference curve for the currency concerned. For example, the curve might be a government bond yield curve or a swap curve; in any case, the curve should be based on a well-established and liquid underlying market and should be accepted by the market as a reference curve for the currency concerned.

              Banks may select their own technique for identifying the specific risk component of the value-at-risk measure for purposes of applying the multiplier of 4. Techniques would include:
              •  Using the incremental increase in value-at-risk arising from the modelling of specific risk factors;
              •  Using the difference between the value-at-risk measure and a measure calculated by substituting each individual equity position by a representative index; or
              •  Using an analytic separation between general market risk and specific risk by a particular model.

              26 This would apply to sub-portfolios containing positions that would be subject to specific risk under the standardised approach.

            • CA-9.11.5

              Banks which apply modelled estimates of specific risk are required to conduct backtesting aimed at assessing whether specific risk is being accurately captured. The methodology a bank should use for validating its specific risk estimates is to perform separate backtests on sub-portfolios using daily data on sub-portfolios subject to specific risk. The key sub-portfolios for this purpose are traded debt and equity positions. However, if a bank itself decomposes its trading portfolio into finer categories (e.g., emerging markets, traded corporate debt, etc.), it is appropriate to keep these distinctions for sub-portfolio backtesting purposes. Banks are required to commit to a sub-portfolio structure and stick to it unless it can be demonstrated to the Agency that it would make sense to change the structure.

            • CA-9.11.6

              Banks are required to have in place a process to analyse exceptions identified through the backtesting of specific risk. This process is intended to serve as the fundamental way in which banks correct their models of specific risk in the event they become inaccurate. There will be a presumption that models that incorporate specific risk are "unacceptable" if the results at the sub-portfolio level produce a number of exceptions commensurate with the Red Zone27. Banks with "unacceptable" specific risk models are expected to take immediate action to correct the problem in the model and to ensure that there is a sufficient capital buffer to absorb the risk that, the backtest showed, had not been adequately captured.


              27 As defined in the Basel Committee's document titled "Supervisory framework for the use of backtesing in conjunction with the internal models approach to market risk capital requirements".

        • CA-10 CA-10 Gearing requirements

          • CA-10.1 CA-10.1 Gearing

            • CA-10.1.1

              The content of this chapter is applicable to locally incorporated banks and FCB branches (licensed by the Agency) of foreign banks.

            • Measurement

              • CA-10.1.2

                Gearing ratio is measured with reference to the ratio of deposit liabilities against the bank's capital and reserves as reported in its PIR.

            • Gearing limit

              • CA-10.1.3

                For Full Commercial Bank and Offshore Banking Unit licensees, deposit liabilities should not exceed 20 times the respective bank's capital and reserves.

              • CA-10.1.4

                For Investment Bank licensees, deposit liabilities should not exceed 10 times the respective bank's capital and reserves.

      • CA CA Capital Adequacy (October 2007)

        • CA-A CA-A Introduction

          • CA-A.1 CA-A.1 Application

            • CA-A.1.1

              Regulations in this Module are applicable to locally incorporated banks on both a stand-alone basis (i.e. including their foreign branches), and on a consolidated group basis (i.e. including their subsidiaries and any other investments which are included or consolidated into the group accounts or are required to be consolidated for regulatory purposes by the CBB).

              October 07

            • CA-A.1.2

              In addition to licensees mentioned in Paragraph CA-A.1.1, certain of these regulations (in particular gearing and market risk requirements) are also applicable to Bahrain branches of foreign retail bank licensees.

              October 07

          • CA-A.2 CA-A.2 Purpose

            • Executive Summary

              • CA-A.2.1

                The purpose of this Module is to set out the Central Bank's capital adequacy regulations and provide guidance on the calculation of capital requirements by locally incorporated banks. This requirement is supported by Article 44(c) of the Central Bank of Bahrain and Financial Institutions Law (Decree No. 64 of 2006).

                October 07

              • CA-A.2.2

                Principle 9 of the Principles of Business requires that conventional bank licensees maintain adequate human, financial and other resources, sufficient to run their business in an orderly manner (see Section PB-1.9). In addition, Condition 5 of CBB's Licensing Conditions (Section LR-2.5) requires conventional bank licensees to maintain financial resources in excess of the minimum requirements specified in Module CA (Capital Adequacy).

                October 07

              • CA-A.2.3

                The Module also sets out the minimum gearing requirements which relevant banks (referred to in Section CA-A.1) must meet as a condition of their licensing.

                October 07

              • CA-A.2.4

                The requirements specified in this Module vary according to the Category of conventional bank licensee concerned, their inherent risk profile, and the volume and type of business undertaken. The purpose of such requirements is to ensure that conventional bank licensees hold sufficient capital to provide some protection against unexpected losses, and otherwise allow conventional banks to effect an orderly wind-down of their operations, without loss to their depositors. The minimum capital requirements specified here may not be sufficient to absorb all unexpected losses.

                October 07

              • CA-A.2.5

                The Central Bank requires in particular that the relevant banks maintain adequate capital, in accordance with the requirements of this Module, against their risks.

                October 07

            • Legal Basis

              • CA-A.2.6

                This Module contains the CBB's Directive relating to the capital adequacy of conventional bank licensees, and is issued under the powers available to the CBB under Article 38 of the CBB Law. The Directive in this Module is applicable to all conventional bank licensees.

                October 07

              • CA-A.2.7

                For an explanation of the CBB's rule-making powers and different regulatory instruments, see Section UG-1.1.

                October 07

          • CA-A.3 CA-A.3 Module History

            • CA-A.3.1

              This Module was first issued in July 2004 as part of the conventional principles volume. All requirements in this volume have been effective since this date. Any material changes that have subsequently been made to this Module are annotated with the calendar quarter date in which the change was made: Chapter UG 3 provides further details on Rulebook maintenance and version control. The most recent changes made to this Module are detailed in the table below:

              Summary of changes

              Module Ref. Change Date Description of Changes
              CA-A.2 10/07 Change categorising Module as a Directive
              October 07

            • Evolution of the Module

              • CA-A.3.2

                Prior to the development of the Rulebook, the Central Bank had issued various circulars representing regulations relating to capital adequacy requirements. These circulars were consolidated into this Module. These circulars are listed below:

                Circular Ref. Date of Issue Module Ref. Circular Subject
                ODG/50/98 11 Sep 1998 CA-1 - CA-9 Market Risk Capital Regulations
                BC/07/02 26 Jun 2002 CA-1.4 Review of PIR by External Auditors
                OG/78/01 20 Feb 2001 CA-2.5 Monitoring of Capital Adequacy
                BC/01/98 10 Jan 1998 CA-2.5 Risk Asset Ratio
                October 07

            • Effective date

              • CA-A.3.3

                The contents in this Module are effective from the date depicted in the original circulars (see Paragraph CA-A.3.2) from which the requirements are compiled or from the dates mentioned in the Summary of Changes.

                October 07

        • CA-B CA-B General guidance and best practice

          • CA-B.1 CA-B.1 Guidance provided by other international bodies

            • Basel Committee: Use of 'Backtesting' in Conjunction with the Internal Models Approach to Market Risk Capital Requirements

              • CA-B.1.1

                In January 1996, the Basel Committee on Banking Supervision issued technical guidance on the 'use of 'Backtesting' in Conjunction with the Internal Models Approach to Market Risk Capital Requirements' (see http://www.bis.org/publ/bcbs22.htm).

                October 07

              • CA-B.1.2

                This technical guidance presents a methodology for testing the accuracy of the internal models used by banks to measure market risks.

                October 07

              • CA-B.1.3

                Backtesting offers the best opportunity for incorporating suitable incentives into the internal models in a consistent manner.

                October 07

              • CA-B.1.4

                The Central Bank will rely upon technical guidance for its assessment and review of bank's market risk capital requirements including, but not limited to, the determination of the add-on factor.

                October 07

            • Basel Committee: The management of banks' off-balance-sheet exposures – a supervisory perspective

              • CA-B.1.5

                In March 1986, the Basel Committee on Banking Supervision issued a paper titled 'The management of banks' off-balance-sheet exposures — a supervisory perspective' (see www.bis.org/publ/bcbsc134.pdf).

                October 07

              • CA-B.1.6

                This paper examines off-balance-sheet risks from three angles: market/position risk, credit risk and operational/control risk. Part III of this paper examines credit risk (including control of large exposures, settlement risk and country risk), with particular emphasis given to the assessment of the relative risks of the different types of off-balance-sheet activity.

                October 07

        • CA-1 CA-1 Scope and coverage of capital charges

          • CA-1.1 CA-1.1 Introduction

            • CA-1.1.1

              All locally incorporated banks are required to measure and apply capital charges in respect of their credit and market risk capital requirements.

              October 07

            • CA-1.1.2

              Credit risk is defined as the potential that a bank's borrower or counterparty will fail to meet its obligations in accordance with agreed terms. Credit risk exists throughout the activities of a bank in the banking book and in the trading book including both on- and off-balance-sheet exposures.

              October 07

            • CA-1.1.3

              Market risk is defined as the risk of losses in on- or off-balance-sheet positions arising from movements in market prices. The risks subject to the capital requirement of this Module are:

              (a) The risks pertaining to interest rate related instruments and equities in the trading book: and
              (b) Foreign exchange and commodities risks throughout the bank.
              October 07

          • CA-1.2 CA-1.2 Measuring credit risks

            • CA-1.2.1

              In measuring credit risk for the purpose of capital adequacy, banks are required to apply a simple risk-weighted approach through which claims of different categories of counterparties are assigned risk weights according to broad categories of relative riskiness.

              October 07

            • CA-1.2.2

              The framework of weights consists of four weights – 0%, 20%, 50% and 100% for on- and off-balance-sheet items, which based on a broad-brush judgement, are applied to the different types of assets and off-balance-sheet exposures (with the exception of derivative transactions) within the banking book.

              October 07

            • CA-1.2.3

              The resultant different weighted assets and off-balance-sheet exposures are then added together to calculate the total credit-risk-weighted assets of the bank.

              October 07

          • CA-1.3 CA-1.3 Measuring market risks

            • Trading book

              • CA-1.3.1

                The trading book means the bank's proprietary positions in financial instruments (including positions in derivative products and off-balance-sheet instruments) which are intentionally held for short-term resale and/or which are taken on by the bank with the intention of benefiting in the short-term from actual and/or expected differences between their buying and selling prices, or from other price or interest rate variations, and positions in financial instruments arising from matched principal brokering and market making, or positions taken in order to hedge other elements of the trading book.

                October 07

              • CA-1.3.2

                Each bank should agree a written policy statement with the Central Bank on which activities are normally considered trading and which, therefore, constitute the trading book.

                October 07

              • CA-1.3.3

                It is expected that the trading activities will be managed and monitored by a separate unit and that such activities should be identifiable because of their intent, as defined in Paragraph CA-1.3.1 above.

                October 07

            • Interest rate and equity risk

              • CA-1.3.4

                The capital charges for interest rate related instruments and equities will apply based on the current market values of items in a bank's trading book.

                October 07

            • Foreign exchange and commodities risk

              • CA-1.3.5

                The capital charges for foreign exchange risk and for commodities risk will apply to a bank's total currency and commodity positions, with the exception of structural foreign exchange positions in accordance with Section CA-6.3 of this Module.

                October 07

            • Exemptions

              • CA-1.3.6

                Banks will be allowed certain de minimis exemptions from the capital requirements for foreign exchange risk, as described in Section CA-6.2. For the time being, there shall be no exemptions from the trading book capital requirements, or from the capital requirements for commodities risk.

                October 07

            • Hedging instruments

              • CA-1.3.7

                A trading book exposure may be hedged, completely or partially, by an instrument that, in its own right, is not normally considered eligible to be a part of the trading book. Subject to the policy statement agreed by the bank with the Central Bank as explained in Paragraph CA-1.3.2 above, and with the prior written approval of the Central Bank, banks will be allowed to include within their market risk measure non-trading instruments (on- or off-balance-sheet) which are deliberately used to hedge the trading activities. The positions in these instruments will attract counterparty risk capital requirements and general market risk, but not specific risk requirements.

                October 07

              • CA-1.3.8

                Where a financial instrument which would normally qualify as part of the trading book is used to hedge an exposure in the banking book, it should be carved out of the trading book for the period of the hedge, and included in the banking book with the exposure it is hedging. Such instruments will be subject to the credit risk capital requirements.

                October 07

              • CA-1.3.9

                It is possible that general market risk arising from the trading book may hedge positions in the banking book without reference to individual financial instruments. In such circumstances, there must nevertheless be underlying positions in the trading book. The positions in the banking book which are being hedged must remain in the banking book, although the general market risk exposure associated with them should be incorporated within the calculation of general market risk capital requirements for the trading book (i.e. the general market risk element on the banking book side of the hedge should be added to the trading book calculation, rather than that on the trading book side of the hedge being deducted from it). As no individual financial instruments are designated, there is no resultant specific risk requirement in the trading book and the risk-weighted assets in the banking book will not be reduced. Any such arrangement for the transfer of risk must be subject to the policy statement agreed with the Central Bank as explained in Paragraph CA-1.3.2 above, and should have the specific prior written approval of the Central Bank.

                October 07

            • Allocation of financial and hedging instruments

              • CA-1.3.10

                The allocation of a financial instrument between the trading book and the banking book, or the allocation of hedging instruments described in Paragraph CA-1.3.7 above, or the transfer of general market risk as explained in Paragraph CA-1.3.9 above, should be subject to appropriate and adequate documentation to ensure that it can be established through audit verification that the item is treated correctly for the purposes of capital requirements, in compliance with the bank's established criteria for allocating items to the trading or banking book, and subject to the policy statement agreed with the Central Bank.

                October 07

              • CA-1.3.11

                The Central Bank intends to carefully monitor the way in which banks allocate financial instruments and will seek, in particular, to ensure that no abusive switching designed to minimise capital charges occurs and to prevent 'gains trading' in respect of securities which are not marked to market.

                October 07

            • Review of compliance by internal and external auditors

              • CA-1.3.12

                The bank's compliance with the established criteria for allocating items to the trading and banking books, and with the policy statement agreed with the Central Bank, should be reviewed by the bank's internal auditors at least on a quarterly basis, and by the external auditors at least once a year.

                October 07

              • CA-1.3.13

                Any cases of non-compliance identified by the internal auditor should be immediately brought to the attention of the Central Bank, in writing, by the senior management of the bank. Any non-compliance identified by the external auditors, requires them to submit a written report directly to the Central Bank (in accordance with the requirements in Section CA-9.8), in addition to a report to be submitted by the management.

                October 07

            • Valuation requirements

              • CA-1.3.14

                To establish a relevant base for measuring the market risk in the trading book, all positions should be marked to market daily, including the recognition of accruing interest, dividends or other benefits as appropriate. Banks are required to have, and discuss with the Central Bank, a written policy statement on the subject of valuing trading book positions, which in particular should address the valuation process for those items where market prices are not readily available. This policy statement should have been developed in conjunction with the bank's internal and external auditors. Having arrived at a valuation mechanism for a single position or a group of similar positions, the valuation approach should be applied consistently. In addition to the considerations of prudence and consistency, the bank's valuation policy should reflect the points set out below:

                (a) A bank may mark to market positions using either a close-out valuation based on two-way prices (i.e., a long position shall be valued at its current bid price and a short position at its current offer price) or, alternatively, using a mid-market price but making a provision for the spread between bid and offer prices for different instruments. The bank must have due regard to the liquidity of the position concerned and any special factors which may adversely affect the closure of the position.
                (b) Where a bank has obtained the Central Bank's approval for the use of a risk assessment model in the calculation of the capital requirements for options (in accordance with Chapter CA-9 of these regulations), it may value its options using the values derived from that model.
                (c) Where a bank does not use a model and the prices are not published for its options positions, it must determine the market value as follows:
                (i) For purchased options, the marked-to-market value is the product of the 'in the money' amount and the quantity underlying the option; and
                (ii) For written options, the marked-to-market value is the initial premium received for the option plus the product of the amount by which the current 'in the money' amount exceeds either the 'in the money' amount at the time the contract was written, or zero if the contract was 'out of the money' at the time that it was written; and the quantity underlying the option.
                (d) A bank must calculate the value of a swap contract or an FRA having regard to the net present value of the future cash flows of the contract, using current interest rates relevant to the periods in which the cash flows will arise.
                (e) Where a bank is a market maker in an instrument(s), the valuation should be the bank's own bid or offer price which should reflect the bank's exposure to the market as a whole and its views on future prices. Where the bank is the sole market maker in a particular instrument, it should take proper care to ensure that the valuation used is prudent in all circumstances.
                (f) In the event that a bank is only able to access indicative prices, having regard to the fact that they are only a guide, such prices may have to be adjusted to some degree in order to arrive at a prudent valuation.
                (g) In the event that the bank is only able to access mid-market or single values, it should have regard to the fact that these prices will have to be adjusted to some degree in order to arrive at a prudent valuation.
                October 07

            • Consolidation

              • CA-1.3.15

                Both credit risk and market risk capital requirements will apply on a worldwide consolidated basis. Only a bank which is running a global consolidated book may apply the offsetting rules contained in the remainder of these regulations, on a consolidated basis with the prior written agreement of the Central Bank. However, where it would not be prudent to offset or net positions within the group as, for example, where there are obstacles to the quick repatriation of profits from a foreign subsidiary or where there are legal and procedural difficulties in carrying out the timely management of risks on a consolidated basis, the Central Bank will require the bank to take individual positions into account without any offsetting.

                October 07

              • CA-1.3.16

                Notwithstanding that the market risk capital requirements will apply on a worldwide consolidated basis, the Central Bank retains the right to monitor the market risks of banks on a non-consolidated basis to ensure that significant imbalances within a group do not escape supervision. The Central Bank will be particularly vigilant to ensure that banks do not pass positions on reporting dates in such a way as to escape measurement.

                October 07

            • Approach to measurement

              • CA-1.3.17

                For the measurement of their market risks, banks will have a choice, subject to the written approval of the Central Bank, between two broad methodologies. One alternative is to measure the risks in a standardised approach, using the measurement frameworks described in Chapters CA-4 to CA-8 of these regulations. Chapters CA-4 to CA-7 deal with the four risks addressed by these regulations; namely interest rate risk, equity position risk, foreign exchange risk and commodities risk. Chapter CA-8 sets out a number of possible methods for measuring the price risk in options of all kinds. The capital charge under the standardised approach is the arithmetical sum of the risk measures obtained from the measurement frameworks in Chapters CA-4 to CA-8.

                October 07

              • CA-1.3.18

                The standardised approach uses a 'building-block' approach in which the specific risk and the general market risk arising from interest rate and equity positions are calculated separately.

                October 07

              • CA-1.3.19

                The second alternative methodology, which is subject to the fulfilment of certain conditions and the use of which is, therefore, conditional upon the explicit approval of the Central Bank, is set out in detail in Chapter CA-9 including the procedure for obtaining the Central Bank's approval. This method allows banks to use risk measures derived from their own internal risk measurement models (Internal Models Approach), subject to seven sets of conditions which are described in detail in Chapter CA-9.

                October 07

              • CA-1.3.20

                The focus of most internal models currently used by banks is the general market risk exposure, typically leaving specific risk (i.e. exposures to specific issuers of debt securities or equities1) to be measured largely through separate credit risk measurement systems. Banks using internal models for the measurement of their market risk capital requirements will be subject to a separate capital charge for specific risk, to the extent that the model does not capture specific risk. The capital charge for banks which are modelling specific risk is set out in Chapter CA-9.


                1 Specific risk includes the risk that an individual debt or equity security moves by more or less than the general market in day-to-day trading (including periods when the whole market is volatile) and event risk (where the price of an individual debt or equity security moves precipitously relative to the general market, e.g. on a take-over bid or some other shock event; such events would also include the risk of 'default').

                October 07

              • CA-1.3.21

                In measuring the price risk in options under the standardised approach, a number of alternatives with varying degrees of sophistication are allowed (see Chapter CA-8). The more a bank is engaged in writing options, the more sophisticated its measurement method needs to be. In the longer term, banks with significant options business will be expected to move to comprehensive value-at-risk models and become subject to the full range of quantitative and qualitative standards set out in Chapter CA-9.

                October 07

              • CA-1.3.22

                All transactions, including forward sales and purchases, shall be included in the calculation of capital requirements as from the date on which they were entered into.

                October 07

            • Monitoring

              • CA-1.3.23

                Banks are expected to manage their market risk in such a way that the capital requirements for market risk are being met on a continuous basis, i.e. at the close of each business day and not merely at the end of each calendar quarter, both in the case of banks that use the standardised approach and those that use internal models. Banks are also expected to maintain strict risk management systems to ensure that their intra-day exposures are not excessive.

                October 07

              • CA-1.3.24

                Banks' daily compliance with the capital requirements for market risk shall be verified by the independent risk management department and the internal auditor. It is expected that the external auditors will perform appropriate tests of the banks' daily compliance with the capital requirements for market risk. Where a bank fails to meet the minimum capital requirements for market risk on any business day, the Central Bank should be informed in writing. The Central Bank will then seek to ensure that the bank takes immediate measures to rectify the situation.

                October 07

              • CA-1.3.25

                Besides what is stated in Paragraphs CA-1.3.2, CA-1.3.3, CA-1.3.10, CA-1.3.11, CA-1.3.19 and Section CA-1.6, the Central Bank will consider a number of other appropriate and effective measures to ensure that banks do not 'window-dress' by showing significantly lower market risk positions on reporting dates.

                October 07

          • CA-1.4 CA-1.4 Reporting

            • CA-1.4.1

              Formal reporting, to the Central Bank, of capital adequacy shall be made in accordance with the requirements set out under Section BR-3.1.

              October 07

            • Review of Prudential Information Returns by External Auditors

              • CA-1.4.2

                The Central Bank requires all relevant banks to request their external auditors to conduct a review of the prudential returns on a quarterly basis in accordance with the requirements set out under Section BR-3.1.

                October 07

          • CA-1.5 CA-1.5 Summary of overall capital adequacy requirement

            • CA-1.5.1

              Each bank is expected to monitor and report the level of risk against which a capital requirement is to be applied, in accordance with Section CA-1.3 above. The bank's overall minimum capital requirement will be:

              The credit risk requirements laid down by the Central Bank, excluding debt and equity securities in the trading book and all positions in commodities, but including the credit counterparty risk on all over-the-counter derivatives whether in the trading or the banking books: PLUS one of the following:

              (a) The capital charges for market risks calculated according to the measurement frameworks described in Chapters CA-4 to CA-8, summed arithmetically: OR
              (b) The measure of market risk derived from the models approach set out in Chapter CA-9 (with the prior written approval of the Central Bank for adopting this approach - see Chapter CA-9); OR
              (c) A mixture of (a) and (b) above, summed arithmetically (with the prior written approval of the Central Bank for adopting a combination of the standardised approach and the internal models approach - see Chapter CA-9).
              October 07

          • CA-1.6 CA-1.6 Transitional provisions

            • CA-1.6.1

              Banks which start to use internal models for one or more market risk categories should, over a reasonable period of time, extend the models to all of their operations, subject to the exceptions mentioned in Paragraph CA-1.6.4 below, and to move towards a comprehensive model (i.e. one which captures all market risk categories).

              October 07

            • CA-1.6.2

              On a transitional basis, banks will be allowed to use a combination of the standardised approach and the internal models approach to measure their market risks provided they should cover a complete risk Category (e.g. interest rate risk or foreign exchange risk), i.e. a combination of the two methods will not be allowed within the same risk Category.2 However, for banks that are, at present, still implementing or further improving their internal models, they will be allowed some flexibility, even within risk categories, in including all their operations on a worldwide basis. This flexibility shall be subject to the specific prior written approval of the Central Bank, and such approval will be given on a case-by-case basis and reviewed by the Central Bank from time to time.


              2This does not, however, apply to pre-processing techniques which are used to simplify the calculation and whose results become subject to the standardised methodology.

              October 07

            • CA-1.6.3

              The Central Bank will closely monitor banks to ensure that there will be no 'cherry-picking' between the standardised approach and the models approach within a risk Category. Banks which adopt a model will not be permitted, save in exceptional circumstances, to revert to the standardised approach.

              October 07

            • CA-1.6.4

              The Central Bank recognises that even a bank which uses a comprehensive model may still incur risks in positions which are not captured by their internal models3, for example, in remote locations, in minor currencies or in negligible business areas4. Any such risks that are not included in a model should be separately measured and reported using the standardised approach described in Chapters CA-4 to CA-8.


              3Banks may also incur interest rate and equity risks outside of their trading activities. However, there are no explicit capital charges for the price risk in such positions.

              4 For example, if a bank is hardly engaged in commodities it will not necessarily be expected to model its commodities risk.

              October 07

            • CA-1.6.5

              Transitioning banks are required to move towards a comprehensive internal model approach.

              October 07

            • CA-1.6.6

              The Central Bank will closely monitor the risk management practices of banks moving towards the models approach, to ensure that they will be in a position to meet all the standards once they are applying a fully-fledged model for any risk Category.

              October 07

        • CA-2 CA-2 The capital requirement

          • CA-2.1 CA-2.1 Introduction

            • CA-2.1.1

              Regulatory Capital is the sum of the following three components (as defined in Rules CA-2.2.1 to CA-2.2.4), subject to the restrictions set out in Section CA-2.3:

              Tiers 1 and 2: May be used to support credit risk and market risk; and
              Tier 3: May be used solely to support market risk.
              October 07

            • CA-2.1.2

              For a branch of a foreign bank operating as a retail bank licensee, a designated amount of capital is required, as agreed between the CBB and the licensee, taking into consideration the gearing requirement stated in Section CA-10.1.

              October 07

          • CA-2.2 CA-2.2 Definition of capital

            • Tier 1: Core capital

              • CA-2.2.1

                Tier 1 capital shall consist of the sum of items (a) to (c) below, less the sum of items (d) to (e) below:

                (a) Permanent shareholders' equity (including issued and fully paid ordinary shares / common stock and perpetual non-cumulative preference shares, but excluding cumulative preference shares);
                (b) Disclosed reserves, which are audited and approved by the shareholders, in the form of legal, general and other reserves created by appropriations of retained earnings, share premiums, capital redemption reserves and other surplus but excluding revaluation reserves; and
                (c) Minority interests, arising on consolidation, in the equity of subsidiaries which are less than wholly owned.
                LESS:
                (d) Goodwill; and
                (e) Current year's cumulative net losses which have been reviewed or audited as per the International Standards on Auditing (ISA) by the external auditors.
                October 07

            • Tier 2: Supplementary capital

              • CA-2.2.2

                Tier 2 capital shall consist of the following items:

                (a) Interim retained profits which have been reviewed as per the ISA by the external auditors;
                (b) Asset revaluation reserves, which arise in two ways. Firstly, these reserves can arise from the revaluation of fixed assets from time to time in line with the change in market values, and are reflected on the face of the balance sheet as a revaluation reserve. Secondly, hidden values or 'latent' revaluation reserves may be present as a result of long-term holdings of equity securities valued in the balance sheet at the historical cost of acquisition. Both types of revaluation reserve may be included in tier 2 capital, with the concurrence of the external auditors, provided that the assets are prudently valued, fully reflecting the possibility of price fluctuation and forced sale. In the case of 'latent' revaluation reserves, a discount of 55% will be applied to the difference between the historical cost book value and the market value to reflect the potential volatility of this form of unrealised capital.
                (c) General provisions held against future, presently unidentified losses which are freely available to meet losses which subsequently materialise and, therefore, qualify for inclusion within supplementary elements of capital, subject to a maximum of 1.25% of total risk-weighted assets (both credit and market risk-weighted assets). Provisions ascribed to impairment of particular assets or known liabilities should be excluded.
                (d) Hybrid instruments, which include a range of instruments which combine characteristics of equity capital and of debt, and which meet the following requirements:
                •   They are unsecured, subordinated and fully paid-up;
                •   They are not redeemable at the initiative of the holder or without the prior consent of the Central Bank;
                •   They are available to participate in losses without the bank being obliged to cease trading (unlike conventional subordinated debt); and
                •   Although the capital instrument may carry an obligation to pay interest that cannot permanently be reduced or waived (unlike dividends on ordinary shareholders' equity), it should allow service obligations to be deferred (as with cumulative preference shares) where the profitability of the bank would not support payment.
                Cumulative preference shares, having the above characteristics, would be eligible for inclusion in tier 2 capital. Debt capital instruments which do not meet the above criteria may be eligible for inclusion in item (e) below.
                (e) Subordinated term debt, which comprises all conventional unsecured borrowing subordinated (in respect of both interest and principal) to all other liabilities of the bank except the share capital and limited life redeemable preference shares. To be eligible for inclusion in tier 2 capital, subordinated debt capital instruments should have a minimum original fixed term to maturity of over five years. During the last five years to maturity, a cumulative discount (or amortisation) factor of 20% per year will be applied to reflect the diminishing value of these instruments as a continuing source of strength. Unlike instruments included in item (d) above, these instruments are not normally available to participate in the losses of a bank which continues trading. For this reason, these instruments will be limited to a maximum of 50% of tier 1 capital.
                (f) 45% of unrealised gains on equity securities held as available-for-sale (on an aggregate net-basis).
                October 07

            • Deduction from tiers 1 and 2 capital

              • CA-2.2.3

                The following item shall be deducted from tiers 1 and 2 capital on a pro-rata basis:

                Investments in and lending of a capital nature to unconsolidated subsidiaries engaged in banking and financial activities. The assets representing the investments in subsidiary companies whose capital is deducted from that of the parent would not be included in total assets for the purpose of computing the capital ratio.
                October 07

            • Tier 3: Trading book ancillary capital

              • CA-2.2.4

                Tier 3 capital will consist of short-term subordinated debt which, if circumstances demand, needs to be capable of becoming part of the bank's permanent capital and thus be available to absorb losses in the event of insolvency. It must, therefore, at a minimum meet the following conditions:

                (a) Be unsecured, subordinated and fully paid up;
                (b) Have an original maturity of at least two years;
                (c) Not be repayable before the agreed repayment date; and
                (d) Be subject to a lock-in clause which stipulates that neither interest nor principal may be paid (even at maturity) if such payment means that the bank falls below or remains below its minimum capital requirement.
                October 07

          • CA-2.3 CA-2.3 Limits on the use of different forms of capital

            • Tier 1: Core capital

              • CA-2.3.1

                Tier 1 capital should represent at least half of the total eligible capital, i.e., the sum total of tier 2 plus tier 3 eligible capital should not exceed total tier 1 eligible capital.

                October 07

            • Tier 2 : Supplementary capital

              • CA-2.3.2

                Tier 2 elements may be substituted for tier 3 up to the tier 3 limit of 250% of tier 1 capital (as below) in so far as eligible tier 2 capital does not exceed total tier 1 capital, and long-term subordinated debt does not exceed 50% of tier 1 capital.

                October 07

            • Tier 3: Ancillary capital

              • CA-2.3.3

                Tier 3 capital is limited to 250% of a bank's tier 1 capital that is required to support market risks. This means that a minimum of about 28.57% of market risks needs to be supported by tier 1 capital that is not required to support risks in the remainder of the book.

                October 07

          • CA-2.4 CA-2.4 Calculation of the capital ratio

            • CA-2.4.1

              A bank should start the calculation of the capital ratio with the measure of market risk (i.e. specific risk plus general market risk) in accordance with the regulations in this Module, including interest rate risk, equity risk, foreign exchange and commodities risks.

              October 07

            • CA-2.4.2

              The bank should next calculate its credit risk-weighted assets in accordance with the regulations in this Module.

              October 07

            • CA-2.4.3

              The next step is to create an explicit numerical link between the capital requirements for credit and market risks. This is accomplished by multiplying the measure of market risk (calculated as stated in Paragraphs CA-2.4.1 and CA-2.4.2above) by 12.5 and adding the resulting figure to the sum of the credit risk-weighted assets. The capital ratio will then be calculated in relation to the sum of the two, using as the numerator only the eligible capital.

              October 07

            • CA-2.4.4

              In calculating the eligible capital, it will be necessary first to calculate the bank's minimum capital requirement for credit risk, and only afterwards its market risk requirement, to establish how much tier 1 and tier 2 capital is available to support market risk. Eligible capital will be the sum of the whole of the bank's tier 1 capital, plus tier 2 capital under the limits set out in Section CA-2.3 above. Tier 3 capital will be regarded as eligible only if it can be used to support market risks under the conditions set out in Section CA-2.2 and CA-2.3 above. The quoted capital ratio will thus represent capital that is available to meet both credit risk and market risk. Where a bank has tier 3 capital, which meets the conditions set out in Section CA-2.2 above and which is not at present supporting market risks, it may report that excess as unused but eligible tier 3 capital alongside its capital ratio. A worked example of the calculation of the capital ratio is set out in Appendix CA-1.

              October 07

          • CA-2.5 CA-2.5 Minimum capital ratio requirement

            • Banking group

              • CA-2.5.1

                On a consolidated basis, the Central Bank has set a minimum Risk Asset Ratio ('RAR') of 12.0% for all locally incorporated banks. Furthermore, on a solo basis, the parent bank of a group is required to maintain a minimum RAR of 8.0% (i.e. unconsolidated).

                October 07

              • CA-2.5.2

                This means where a bank is required to complete both form PIR (Appendix BR 5) and form PIRC (Appendix BR 6), 8.0% is the minimum RAR necessary for the solo bank (PIR), and 12.0% for the consolidated bank (PIRC).

                October 07

            • Individual bank

              • CA-2.5.3

                For banks that are required to complete only the PIR form, the Central Bank has set a minimum Risk Asset Ratio ('RAR') of 12.0%.

                October 07

            • Maintaining minimum RAR

              • CA-2.5.4

                To clarify the effect of these minimum ratios (as identified in Paragraphs CA-2.5.1 to CA-2.5.3) on differing banking groups and individual banks, four examples (see Appendix CA-1) are given. In the examples, the parent and the subsidiary are Bahrain incorporated banks, but the cases could apply to overseas incorporated subsidiaries (with adjustment to the minimum RAR where appropriate in individual cases).

                (a) Case One: Compliant solo bank - No subsidiaries (PIR only).
                (b) Case Two: Compliant parent bank, compliant group (PIR and PIRC).
                (c) Case Three: Compliant parent bank, compliant subsidiary bank, but non - compliant group.
                (d) Case Four: Non - compliant parent bank, compliant subsidiary bank and compliant group.

                For detailed workings of the above cases, refer to Appendix CA-1.

                October 07

              • CA-2.5.5

                All locally incorporated banks must give the Central Bank, immediate written notification of any actual breach by such banks of either or both of the above RARs. Where such notification is given, the bank must also:

                (a) Provide the Central Bank no later than one calendar week after the notification, with a written action plan setting out how the bank proposes to restore the relevant RAR(s) to the required minimum level(s) set out above and, further, describing how the bank will ensure that a breach of such RAR(s) will not occur again in the future; and
                (b) Report on a weekly basis thereafter on the bank's relevant RAR(s) until such RAR(s) have reached the required target level(s) set out below.
                October 07

              • CA-2.5.6

                In addition, the Central Bank considers it a matter of basic prudential practice that, in order to ensure that these RARs are constantly met, banks set up internal 'targets' of 12.5% (on a consolidated basis) and 8.5% (on a solo basis) to warn them of a potential fall by the bank below the Central Bank's required minimum RARs as set out above.

                October 07

              • CA-2.5.7

                Where a bank's capital ratio falls below its target ratio, the General Manager should notify the Director of Banking Supervision at the Central Bank immediately. No formal action plan will be necessary, however the General Manager should explain what measures are being implemented to ensure that the bank will remain above its minimum RAR(s).

                October 07

              • CA-2.5.8

                The bank will be required to submit form PIR (and PIRC where applicable) to the Central Bank on a monthly basis, until the RAR(s) exceeds its target ratio(s).

                October 07

              • CA-2.5.9

                The Central Bank will notify banks in writing of any action required of them with regard to the corrective and preventive action (as appropriate) proposed by the bank pursuant to the above, as well as of any other requirement of the Central Bank in any particular case.

                October 07

              • CA-2.5.10

                Banks should note that the Central Bank considers the breach of RARs to be a very serious matter. Consequently, the Central Bank may (at its discretion) subject a bank which breaches its RAR(s) to a formal licensing reappraisal. Such reappraisal may be effected either through the Central Bank's own inspection function or through the use of Reporting Accountants, as appropriate. Following such appraisal, the Central Bank will notify the bank concerned in writing of its conclusions with regard to the continued licensing of the bank.

                October 07

              • CA-2.5.11

                The Central Bank recommends that the bank's compliance officer supports and cooperates with the Central Bank in the monitoring and reporting of the capital ratios and other regulatory reporting matters. Compliance officers should ensure that their banks have adequate internal systems and controls to comply with these regulations.

                October 07

        • CA-3 CA-3 Credit risk

          • CA-3.1 CA-3.1 Introduction

            • CA-3.1.1

              This Chapter describes the standardised approach for the measurement of the credit risk exposure in the bank's banking book.

              October 07

            • CA-3.1.2

              As illustrated in Sections CA-3.2, CA-3.3 and CA-3.4, banks are required to apply a simple risk-weighted approach through which claims of different categories of counterparties are assigned risk weights according to broad categories of relative risk.

              October 07

          • CA-3.2 CA-3.2 Risk weighting – On-balance-sheet asset Category

            • CA-3.2.1

              Risk weights by Category of on-balance-sheet asset are illustrated in the table below:

              Risk weights Category of on-balance-sheet assets/claims
              0%
              (a) Cash and balances with Central Banks
              (b) Holdings of Gold bullion and other commodities
              (c) Claims on & guaranteed by:
              (i) The Government of Bahrain & Bahrain public sector entities
              (ii) Government-owned GCC companies incorporated in Bahrain
              (d) Claims on & guaranteed by or collateralised by cash or securities issued by central governments and central banks of Group A countries; and
              (e) Claims on the central governments and central banks of Group B countries, where denominated in national currency and funded in that currency.
                 
              20%
              (a) Claims on and guaranteed by or collateralised by securities issued by multilateral development banks
              (b) Claims on and guaranteed by banks and securities firms incorporated in Group A countries
              (c) Claims on and guaranteed by banks incorporated in Group B countries with a residual maturity of 1 year or less
              (d) Claims on and guaranteed by public sector entities in Group A countries
              (e) Claims on and guaranteed by government-owned GCC companies incorporated outside Bahrain; and
              (f) Cash items in process of collection
                 
              50% Claims secured by mortgage on residential property
              100%
              (a) Claims on related parties
              (b) Holdings of other (non-subsidiary) banks' and securities firms' capital instruments
              (c) Claims on and guaranteed by banks incorporated in Group B countries with a residual maturity over one year
              (d) Claims on central governments and central banks of Group B countries (not included above)
              (e) Claims on and guaranteed by public sector entities of Group B countries
              (f) Claims on and guaranteed by government-owned companies in non-GCC countries
              (g) Claims on and guaranteed by private sector persons and entities in and outside Bahrain
              (h) Premises and equipment, real estate investments and assets not reported elsewhere
              October 07

          • CA-3.3 CA-3.3 Risk weighting – Off-balance-sheet items

            • CA-3.3.1

              The framework takes account of the credit risk on off-balance-sheet exposures by applying credit conversion factors to the different types of off-balance-sheet instruments or transactions (with the exception of derivatives).

              October 07

            • CA-3.3.2

              The conversion factors are derived from the estimated size and likely occurrence of the credit exposure, as well as the relative degree of credit risk as identified in the Basel Committee's paper on 'The management of banks' off-balance-sheet exposures: a supervisory perspective' (see www.bis.org/publ/bcbsc134.pdf) issued in March 1986.

              October 07

            • CA-3.3.3

              The credit conversion factors applicable to the off-balance-sheet items are set out in the table below:

              Credit Conversion factors Off-balance-sheet items
              100% Direct credit substitutes, including general guarantees of indebtedness and acceptances
              50% Transaction-related contingent items (e.g. performance bonds, bid bonds, warranties and standby letters of credit related to particular transactions)
              20% Short-term self-liquidating trade-related contingencies (such as documentary credits collateralised by the underlying shipments)
              100% Sale and repurchase agreements and asset sales with recourse, where the credit risk remains with the bank
              100% Forward asset purchases, forward forward deposits and the unpaid part of partly-paid shares and securities, which represent commitments with certain draw-down
              50% Underwriting commitments under note issuance and revolving underwriting facilities (minus own holdings of notes underwritten)
              50% Other commitments (e.g. formal standby facilities and credit lines) with an original maturity of 1 year and over
              0% Similar commitments with an original maturity of up to 1 year, or which can be unconditionally cancelled at any time
              October 07

            • CA-3.3.4

              The applicable credit conversion factors should be multiplied by the weights applicable to the Category of the counterparty as set out below:

              Risk weights Counterparty
              0% Type (a)
               
              •   The Government of Bahrain.
              •   Bahrain public sector entities.
              •   Government-owned (non-banking) GCC companies incorporated in Bahrain.
              •   Central government and central banks of Group A countries.
              20% Type (b)
               
              •   Banks incorporated in Bahrain or Group A countries and securities firms.
              •   Banks incorporated in Group B countries (if the commitment has a residual life of 1 year or less).
              •   Public sector entities in Group A countries.
              •   Government-owned (non-banking) GCC companies incorporated outside Bahrain.
              100% Type (c)
               
              •   Banks incorporated in Group B countries (if the commitment has a residual life of more than 1 year).
              •   Central governments, central banks and public sector entities in Group B countries.
              •   Government-owned companies incorporated in non-GCC countries.
              •   Private sector persons and entities in Bahrain and abroad.
              October 07

          • CA-3.4 CA-3.4 Treatment of derivatives contracts in the banking book

            • CA-3.4.1

              The treatment of forwards, swaps, purchased options and similar derivative contracts needs special attention because banks are not exposed to credit risk for the full face value of their contracts, but only to the potential cost of replacing the cash flow (on contracts showing positive value) if the counterparty defaults. The credit equivalent amounts (as referred to under Paragraph CA-3.4.13) will depend inter alia on the maturity of the contract and on the volatility of the rates and prices underlying that type of instrument.

              October 07

            • CA-3.4.2

              Instruments traded on exchanges may be excluded where they are subject to daily receipt and payment of cash variation margins.

              October 07

            • CA-3.4.3

              Options purchased over-the-counter are included with the same conversion factors as other instruments.

              October 07

            • Interest rate contracts

              • CA-3.4.4

                Interest rate contracts are defined to include single-currency interest rate swaps, basis swaps, forward rate agreements, interest rate futures, interest rate options purchased and similar instruments.

                October 07

            • Exchange rate contracts

              • CA-3.4.5

                Exchange rate contracts include cross-currency interest rate swaps, forward foreign exchange contracts, currency futures, currency options purchased and similar instruments.

                October 07

              • CA-3.4.6

                Exchange rate contracts with an original maturity of 14 calendar days or less may be excluded.

                October 07

            • Equity contracts

              • CA-3.4.7

                Equity contracts include forwards, swaps, purchased options and similar derivative contracts based on individual equities or on equity indices.

                October 07

            • Gold contracts

              • CA-3.4.8

                Gold contracts are treated the same as foreign exchange contracts for the purpose of calculating credit risk except that contracts with original maturity of 14 calendar days or less are included.

                October 07

              • CA-3.4.9

                Precious metals other than gold receive a separate treatment (see Section BR-4.1) and include forwards, swaps, purchased options and similar derivative contracts that are based on precious metals (e.g. silver, platinum, and palladium).

                October 07

            • Other commodities

              • CA-3.4.10

                Other commodities are also treated separately (see Section BR-4.1) and include forwards, swaps, purchased options and similar derivative contracts based on energy contracts, agricultural contracts, base metals (e.g. aluminium, copper, and zinc), and any other non-precious metal commodity contracts.

                October 07

            • General guidance on treatment of derivatives contracts

              • CA-3.4.11

                The following points should be noted for the treatment of certain derivatives contracts:

                (a) For contracts with multiple exchange of principal, the add-on factors are to be multiplied by the number of remaining payments in the contracts.
                (i) For contracts that are structured to settle outstanding exposure following specified payment dates and where the terms are reset such that the market value of the contract is zero on these specified dates, the residual maturity would be set equal to the time until the next reset date.
                (ii) Forwards, swaps, purchased options and similar derivative contracts not covered in any of the above mentioned categories should be treated as 'other commodities'.
                (iii) No potential future credit exposure (as referred to under Paragraph CA-3.4.12) would be calculated for single currency floating/floating interest rate swaps.
                October 07

            • Calculation of weighted derivative exposures

              • CA-3.4.12

                Banks should calculate their weighted exposure under the above mentioned contracts according to the Current Exposure Method, which involves calculating the current replacement cost by marking contracts to market, thus capturing the current exposure without any need for estimation, and then adding a factor (the 'add-on') to reflect the potential future exposure over the remaining life of the contract.

                The 'add-on' factor table:

                  Residual maturity of contracts
                1 year or less Over 1 year to 5 years Over 5 years
                Interest rate related contracts 0.000 0.005 0.015
                Foreign exchange & gold contracts 0.010 0.050 0.075
                Equity contracts 0.060 0.080 0.100
                Precious metals (except gold) 0.070 0.070 0.070
                Other commodities 0.120 0.120 0.150
                October 07

              • CA-3.4.13

                In order to reflect counterparty risk, the total credit equivalent amount, which results from the calculation in Paragraph CA-3.4.12 has to be broken down again according to type of counterparty, using the same classification into types (a), (b) and (c) given in Section CA-3.3. Finally, the exposure to each type of counterparty has to be weighted as 0%, 20% or 50% respectively, and the total weighted exposure calculated.

                October 07

        • CA-4 CA-4 Interest rate risk - Standardised approach

          • CA-4.1 CA-4.1 Introduction

            • CA-4.1.1

              This Chapter describes the standardised approach for the measurement of the interest rate risk in the bank's trading book, in order to determine the capital requirement for this risk. The interest rate exposure captured includes exposure arising from interest-bearing and discounted financial instruments, derivatives which are based on the movement of interest rates, foreign exchange forwards, and interest rate exposure embedded in derivatives which are based on non-interest rate related instruments.

              October 07

            • CA-4.1.2

              For the guidance of the banks, and without being exhaustive, the following list includes financial instruments in the trading book to which interest rate risk capital requirements will apply, irrespective of whether or not the instruments carry coupons:

              (a) Bonds/loan stocks, debentures etc.;
              (b) Non-convertible preference shares;
              (c) Convertible securities such as preference shares and bonds, which are treated as debt instruments5;
              (d) Mortgage backed securities and other securitised assets6;
              (e) Certificates of Deposit;
              (f) Treasury bills, local authority bills, banker's acceptances;
              (g) Commercial paper;
              (h) Euronotes, medium term notes, etc.;
              (i) Floating rate notes, FRCDs etc.;
              (j) Foreign exchange forward positions;
              (k) Derivatives based on the above instruments and interest rates; and
              (l) Interest rate exposure embedded in other financial instruments.

              5See Section CA-5.1 for an explanation of the circumstances in which convertible securities, should be treated as equity instruments. In other circumstances, they should be treated as debt instruments.

              6 Traded mortgage securities and mortgage derivative products possess unique characteristics because of the risk of pre-payment. It is possible that including such products within the standardised methodology as if they were similar to other securitised assets may not capture all the risks of holding positions in them. Banks which have traded mortgage securities and mortgage derivative products should discuss their proposed treatment with the Central Bank and obtain the Central Bank's prior written approval for it.

              October 07

            • CA-4.1.3

              For instruments that deviate from the above structures, or could be considered complex, each bank should agree a written policy statement with the Central Bank about the intended treatment, on a case-by-case basis. In some circumstances, the treatment of an instrument may be uncertain, for example bonds whose coupon payments are linked to equity indices. The position risk of such instruments should be broken down into its components and allocated appropriately between the equity, interest rate and foreign exchange risk categories. Advice must be sought from the Central Bank in cases of doubt, particularly when a bank is trading an instrument for the first time.

              October 07

            • CA-4.1.4

              A security which is the subject of a repurchase or securities lending agreement will be treated as if it were still owned by the lender of the security, i.e., it will be treated in the same manner as other securities positions.

              October 07

            • CA-4.1.5

              The minimum capital requirement is expressed in terms of two separately calculated charges, one applying to the 'specific risk' of each position, and the other to the interest rate risk in the portfolio, termed 'general market risk'. The aggregate capital requirement for interest rate risk is the sum of the general market interest rate risk capital requirements across currencies, and the specific risk capital requirements.

              October 07

            • CA-4.1.6

              The specific risk capital requirement recognises that individual instruments may change in value for reasons other than shifts in the yield curve of a given currency. The general risk capital requirement reflects the price change of these products caused by parallel and non-parallel shifts in the yield curve, as well as the difficulty of constructing perfect hedges.

              October 07

            • CA-4.1.7

              There is general market risk inherent in all interest rate risk positions. This may be accompanied by one or more out of specific interest rate risk, counterparty risk, equity risk and foreign exchange risk, depending on the nature of the position. Banks should consider carefully which risks are generated by each individual position. It should be recognised that the identification of the risks will require the application of the appropriate level of technical skills and professional judgement.

              October 07

            • CA-4.1.8

              Banks which have the intention and capability to use internal models for the measurement of general and specific interest rate risks and, hence, for the calculation of the capital requirement, should seek the prior written approval of the Central Bank for those models. The Central Bank's detailed rules for the recognition and use of internal models are included in Chapter CA-9. Banks which do not use internal models should adopt the standardised approach to calculate the interest rate risk capital requirement, as set out in detail in this Chapter.

              October 07

          • CA-4.2 CA-4.2 Specific risk calculation

            • CA-4.2.1

              The capital charge for specific risk is designed to protect against a movement in the price of an individual instrument, owing to factors related to the individual issuer.

              October 07

            • CA-4.2.2

              In measuring the specific risk for interest rate related instruments, a bank may net, by value, long and short positions (including positions in derivatives) in the same debt instrument to generate the individual net position in that instrument. Instruments will be considered to be the same where the issuer is the same, they have an equivalent ranking in a liquidation, and the currency, the coupon and the maturity are the same.

              October 07

            • CA-4.2.3

              The specific risk capital requirement is determined by weighting the current market value of each individual net position, whether long or short, according to its allocation among the following five broad categories:

              (a) Eligible central government debt instrument 0.00%
              (b) Qualifying items with residual maturity up to 6 months 0.25%
              (c) Qualifying items with residual maturity between 6 and 24 months 1.00%
              (d) Qualifying items with residual maturity exceeding 24 months 1.60%
              (e) Non-qualifying items 8.00%
              October 07

            • CA-4.2.4

              Eligible central 'government' debt instruments will include all forms of government paper, including bonds, treasury bills and other short-term instruments, but the Central Bank reserves the right to apply a specific risk weight to securities issued by certain foreign governments, especially to securities denominated in a currency other than that of the issuing government.

              October 07

            • CA-4.2.5

              Governments eligible are those which are members of either the Gulf Co-operation Council (GCC) or the Organisation for Economic Co-operation and Development (OECD).

              October 07

            • CA-4.2.6

              The 'qualifying' Category includes securities issued by or fully guaranteed by public sector entities and multilateral development banks (refer to Appendix CA-2), plus other securities that are:

              (a) Rated investment grade by at least two internationally recognised credit rating agencies (to be agreed with the Central Bank); or
              (b) Deemed to be of comparable investment quality by the reporting bank, provided that the issuer is rated investment grade by at least two internationally recognised credit rating agencies (to be agreed with the Central Bank); or
              (c) Rated investment grade by one credit rating agency and not less than investment grade by any internationally recognised credit rating agencies (to be agreed with the Central Bank); or
              (d) Unrated (subject to the approval of the Central Bank), but deemed to be of comparable investment quality by the reporting bank and where the issuer has securities listed on a recognised stock exchange, may also be included.
              October 07

          • CA-4.3 CA-4.3 General market risk calculation

            • CA-4.3.1

              The capital requirements for general market risk are designed to capture the risk of loss arising from changes in market interest rates, i.e. the risk of parallel and non-parallel shifts in the yield curve. A choice between two principal methods of measuring the general market risk is permitted, a 'maturity' method and a 'duration' method. In each method, the capital charge is the sum of the following four components:

              (a) The net short or long position in the whole trading book;
              (b) A small proportion of the matched positions in each time-band (the 'vertical disallowance');
              (c) A larger proportion of the matched positions across different time-bands (the 'horizontal disallowance'); and
              (d) A net charge for positions in options, where appropriate (see Chapter CA-8).
              October 07

            • CA-4.3.2

              Separate maturity ladders should be used for each currency and capital charges should be calculated for each currency separately and then summed, by applying the prevailing foreign exchange spot rates, with no off-setting between positions of opposite sign.

              October 07

            • CA-4.3.3

              In the case of those currencies in which the value and volume of business is insignificant, separate maturity ladders for each currency are not required. Instead, the bank may construct a single maturity ladder and slot, within each appropriate time-band, the net long or short position for each currency. However, these individual net positions are to be summed within each time-band, irrespective of whether they are long or short positions, to arrive at the gross position figure for the time-band.

              October 07

            • CA-4.3.4

              A combination of the two methods (referred to under Paragraph CA-4.3.1) is not permitted. Any exceptions to this rule will require the prior written approval of the Central Bank. It is expected that such approval will only be given in cases where a bank clearly demonstrates to the Central Bank, the difficulty in applying, to a definite Category of trading instruments, the method otherwise chosen by the bank as the normal method. It is further expected that the Central Bank may, in future years, consider recognising the duration method as the approved method, and the use of the maturity method may be discontinued.

              October 07

          • CA-4.4 CA-4.4 Maturity method

            • CA-4.4.1

              A worked example of the maturity method is included in Appendix CA-3. The various time-bands and their risk weights, relevant to the maturity method, are illustrated in Paragraph CA-4.4.2(a) below.

              October 07

            • CA-4.4.2

              The steps in the calculation of the general market risk for interest rate positions, under this method, are set out below:

              (a) Individual long or short positions in interest-rate related instruments, including derivatives, are slotted into a maturity ladder comprising thirteen time-bands (or fifteen time-bands in the case of zero-coupon and deep-discount instruments, defined as those with a coupon of less than 3%), on the following basis:
              (i) Fixed rate instruments are allocated according to their residual term to maturity (irrespective of embedded puts and calls), and whether their coupon is below 3%;
              (ii) Floating rate instruments are allocated according to the residual term to the next repricing date;
              (iii) Positions in derivatives, and all positions in repos, reverse repos and similar products are decomposed into their components within each time band. Derivative instruments are covered in greater detail in Sections CA-4.6 to CA-4.9;
              (iv) Opposite positions of the same amount in the same issues (but not different issues by the same issuer), whether actual or notional, can be omitted from the interest rate maturity framework, as well as closely matched swaps, forwards, futures and FRAs which meet the conditions set out in Section CA-4.8. In other words, these positions are netted within their relevant time-bands; and
              (v) The Central Bank's advice must be sought on the treatment of instruments that deviate from the above structures, or which may be considered sufficiently complex to warrant the Central Bank's attention.
              Maturity method: time-bands and risk weights
                  Coupon > 3% Coupon < 3% Risk weight
                Zone 1 1 month or less 1 month or less 0.00%
                1 to 3 months 1 to 3 months 0.20%
                  3 to 6 months 3 to 6 months 0.40%
                  6 to 12 months 6 to 12 months 0.70%
                Zone 2 1 to 2 years 1 to 1.9 years 1.25%
                  2 to 3 years 1.9 to 2.8 years 1.75%
                  3 to 4 years 2.8 to 3.6 years 2.25%
                Zone 3 4 to 5 years 3.6 to 4.3 years 2.75%
                  5 to 7 years 4.3 to 5.7 years 3.25%
                  7 to 10 years 5.7 to 7.3 years 3.75%
                  10 to 15 years 7.3 to 9.3 years 4.50%
                  15 to 20 years 9.3 to 10.6 years 5.25%
                  > 20 years 10.6 to 12 years 6.00%
                    12 to 20 years 8.00%
                    >> 20 years 12.50%
              (b) The market values of the individual long and short net positions in each maturity band are multiplied by the respective risk weighting factors given in Paragraph CA-4.4.2(a) above.
              (c) Matching of positions within each maturity band (i.e. vertical matching) is done as follows:
              •   Where a maturity band has both weighted long and short positions, the extent to which the one offsets the other is called the matched weighted position. The remainder (i.e. the excess of the weighted long positions over the weighted short positions, or vice versa, within a band) is called the unmatched weighted position for that band.
              (d) Matching of positions, across maturity bands, within each zone (i.e. horizontal matching - level 1), is done as follows:
              (e) Where a zone has both unmatched weighted long and short positions for various bands, the extent to which the one offsets the other is called the matched weighted position for that zone. The remainder (i.e. the excess of the weighted long positions over the weighted short positions, or vice versa, within a zone) is called the unmatched weighted position for that zone.
              (f) Matching of positions, across zones (i.e. horizontal matching - level 2), is done as follows:
              (i) The unmatched weighted long or short position in zone 1 may be offset against the unmatched weighted short or long position in zone 2. The extent to which the unmatched weighted positions in zones 1 and 2 are offsetting is described as the matched weighted position between zones 1 and 2.
              (ii) After step (i) above, any residual unmatched weighted long or short position in zone 2 may be matched by offsetting the unmatched weighted short or long position in zone 3. The extent to which the unmatched positions in zones 2 and 3 are offsetting is described as the matched weighted position between zones 2 and 3.
              The calculations in steps (i) and (ii) above may be carried out in reverse order (i.e. zones 2 and 3, followed by zones 1 and 2).
              (iii) After steps (i) and (ii) above, any residual unmatched weighted long or short position in zone 1 may be matched by offsetting the unmatched weighted short or long position in zone 3. The extent to which the unmatched positions in zones 1 and 3 are offsetting is described as the matched weighted position between zones 1 and 3.
              (g) Any residual unmatched weighted positions, following the matching within and between maturity bands and zones as described above, will be summed.
              (h) The general interest rate risk capital requirement is the sum of:
              (i) Matched weighted positions in all maturity bands × 10%
              (ii) Matched weighted positions in zone 1 × 40%
              (iii) Matched weighted positions in zone 2 × 30%
              (iv) Matched weighted positions in zone 3 × 50%
              (v) Matched weighted positions between zones 1&2 × 40%
              (vi) Matched weighted positions between zones 2&3 × 40%
              (vii) Matched weighted positions between zones 1&3 × 100%
              (viii) Residual unmatched weighted positions × 100%

              Item (i) is referred to as the vertical disallowance, items (ii) through (iv) as the first set of horizontal disallowances, and items (v) through (vii) as the second set of horizontal disallowances.
              October 07

          • CA-4.5 CA-4.5 Duration method

            • CA-4.5.1

              The duration method is an alternative approach to measuring the exposure to parallel and non-parallel shifts in the yield curve, and recognises the use of duration as an indicator of the sensitivity of individual positions to changes in market yields. Under this method, banks may use a duration-based system for determining their general interest rate risk capital requirements for traded debt instruments and other sources of interest rate exposures including derivatives. A worked example of the duration method is included in Appendix CA-4. The various time-bands and assumed changes in yield, relevant to the duration method, are illustrated below.

              October 07

            • Duration method: time-bands and assumed changes in yield

                Time-band Assumed change in yield
              Zone 1 1 month or less 1.00
                1 to 3 months 1.00
                3 to 6 months 1.00
                6 to 12 months 1.00
              Zone 2 1 to 1.9 years 0.90
                1.9 to 2.8 years 0.80
                2.8 to 3.6 years 0.75
              Zone 3 3.6 to 4.3 years 0.75
                4.3 to 5.7 years 0.70
                5.7 to 7.3 years 0.65
                7.3 to 9.3 years 0.60
                9.3 to 10.6 years 0.60
                10.6 to 12 years 0.60
                12 to 20 years 0.60
                > 20 years 0.60
              October 07

              • CA-4.5.2

                Banks should notify the Central Bank of the circumstances in which they elect to use this method. Once chosen, the duration method must be consistently applied, in accordance with the requirements of Section CA-4.3.

                October 07

              • CA-4.5.3

                Where a bank has chosen to use the duration method, it is possible that it will not be suitable for certain instruments. In such cases, the bank should seek the advice of the Central Bank or obtain approval for application of the maturity method to the specific Category(ies) of instruments, in accordance with the provisions of Section CA-4.3.

                October 07

              • CA-4.5.4

                The steps in the calculation of the general market risk for interest rate positions, under this method, are set out below:

                (a) The bank will determine the Yield-to-Maturity (YTM) for each individual net position in fixed rate and floating rate instruments, based on the current market value. The basis of arriving at individual net positions is explained in Section CA-4.4 above. The YTM for fixed rate instruments is determined without any regard to whether the instrument is coupon bearing, or whether the instrument has any embedded options. In all cases, YTM for fixed rate instruments is calculated with reference to the final maturity date and, for floating rate instruments, with reference to the next repricing date.
                (b) The bank will calculate, for each debt instrument, the modified duration (M) on the basis of the following formula:

                M = D/(1+r)
                where, Sigma m t = 1 t × C/(1+r) t
                D (duration) = Sigma m t = 1 C/(1+r) t


                r = YTM % per annum expressed as a decimal

                C = Cash flow at time t

                t = time at which cash flows occur, in years

                m = time to maturity, in years
                (c) Individual net positions, at current market value, are allocated to the time-bands illustrated in Paragraph CA-4.5.1, based on their modified duration.
                (d) The bank will then calculate the modified duration-weighted position for each individual net position by multiplying its current market value by the modified duration and the assumed change in yield.
                (e) Matching of positions within each time band (i.e. vertical matching) is done as follows:
                •   Where a time band has both weighted long and short positions, the extent to which the one offsets the other is called the matched weighted position. The remainder (i.e. the excess of the weighted long positions over the weighted short positions, or vice versa, within a band) is called the unmatched weighted position for that band.
                (f) Matching of positions, across time bands, within each zone (i.e. horizontal matching - level 1), is done as follows:
                •   Where a zone has both unmatched weighted long and short positions for various bands, the extent to which the one offsets the other is called the matched weighted position for that zone. The remainder (i.e. the excess of the weighted long positions over the weighted short positions, or vice versa, within a zone) is called the unmatched weighted position for that zone.
                (g) Matching of positions, across zones (i.e. horizontal matching - level 2), is done as follows:
                (i) The unmatched weighted long or short position in zone 1 may be offset against the unmatched weighted short or long position in zone 2. The extent to which the unmatched weighted positions in zones 1 and 2 are offsetting is described as the matched weighted position between zones 1 and 2.
                (ii) After step (i) above, any residual unmatched weighted long or short position in zone 2 may be matched by offsetting the unmatched weighted short or long position in zone 3. The extent to which the unmatched positions in zones 2 and 3 are offsetting is described as the matched weighted position between zones 2 and 3.
                The calculations in steps (i) and (ii) above may be carried out in reverse order (i.e. zones 2 and 3, followed by zones 1 and 2).
                (iii) After steps (a) and (b) above, any residual unmatched weighted long or short position in zone 1 may be matched by offsetting the unmatched weighted short or long position in zone 3. The extent to which the unmatched positions in zones 1 and 3 are offsetting is described as the matched weighted position between zones 1 and 3.
                (h) Any residual unmatched weighted positions, following the matching within and between maturity bands and zones as described above, will be summed.
                (i) The general interest rate risk capital requirement is the sum of:
                (i) Matched weighted positions in all maturity bands × 5%
                (ii) Matched weighted positions in zone 1 × 40%
                (iii) Matched weighted positions in zone 2 × 30%
                (iv) Matched weighted positions in zone 3 × 30%
                (v) Matched weighted positions between zones 1 & 2 × 40%
                (vi) Matched weighted positions between zones 2 & 3 × 40%
                (vii) Matched weighted positions between zones 1 & 3 × 100%
                (viii) Residual unmatched weighted positions × 100%

                Item (i) is referred to as the vertical disallowance, items (ii) through (iv) as the first set of horizontal disallowances, and items (v) through (vii) as the second set of horizontal disallowances.
                October 07

          • CA-4.6 CA-4.6 Derivatives

            • CA-4.6.1

              Banks which propose to use internal models to measure the interest rate risk inherent in derivatives will seek the prior written approval of the Central Bank for using those models. The use of internal models to measure market risk, and the Central Bank's rules applicable to them, are discussed in detail in Chapter CA-9.

              October 07

            • CA-4.6.2

              Where a bank, with the prior written approval of the Central Bank, uses an interest rate sensitivity model, the output of that model is used, by the duration method, to calculate the general market risk as described in Section CA-4.5.

              October 07

            • CA-4.6.3

              Where a bank does not propose to use models, it must use the techniques described in the following Paragraphs, for measuring the market risk on interest rate derivatives. The measurement system should include all interest rate derivatives and off-balance-sheet instruments in the trading book which react to changes in interest rates (e.g. forward rate agreements, other forward contracts, bond futures, interest rate and cross-currency swaps, options and forward foreign exchange contracts). Where a bank has obtained the approval of the Central Bank for the use of non-interest rate derivatives models, the embedded interest rate exposures should be incorporated in the standardised measurement framework described in Sections CA-4.7 to CA-4.9.

              October 07

            • CA-4.6.4

              Derivative positions will attract specific risk only when they are based on an underlying instrument or security. For instance, where the underlying exposure is an interest rate exposure, as in a swap based upon interbank rates, there will be no specific risk, but only counterparty risk. A similar treatment applies to FRAs, forward foreign exchange contracts and interest rate futures. However, for a swap based on a bond yield, or a futures contract based on a debt security or an index representing a basket of debt securities, the credit risk of the issuer of the underlying bond will generate a specific risk capital requirement. Future cash flows derived from positions in derivatives will generate counterparty risk requirements related to the counterparty in the trade, in addition to position risk requirements (specific and general market risk) related to the underlying security.

              October 07

            • CA-4.6.5

              A summary of the rules for dealing with interest rate derivatives (other than options) is set out in Section CA-4.9. The treatment of options, being a complex issue, is dealt with in detail in Chapter CA-8.

              October 07

          • CA-4.7 CA-4.7 Calculation of derivative positions

            • CA-4.7.1

              The derivatives should be converted to positions in the relevant underlying and become subject to specific and general market risk charges as described in Sections CA-4.2 and CA-4.3, respectively. For the purpose of calculation by the standard formulae, the amounts reported are the market values of the principal amounts of the underlying or of the notional underlying. For instruments where the apparent notional amount differs from the effective notional amount, banks should use the latter.

              October 07

            • CA-4.7.2

              The remaining Paragraphs in this Section include the guidelines for the calculation of positions in different categories of interest rate derivatives. Banks which need further assistance in the calculation, particularly in relation to complex instruments, should contact the Central Bank in writing.

              October 07

            • Forward foreign exchange contracts

              • CA-4.7.3

                A forward foreign exchange position is decomposed into legs representing the paying and receiving currencies. Each of the legs is treated as if it were a zero coupon bond, with zero specific risk, in the relevant currency and included in the measurement framework as follows:

                (a) If the maturity method is used, each leg is included at the notional amount.
                (b) If the duration method is used, each leg is included at the present value of the notional zero coupon bond.
                October 07

            • Deposit futures and FRAs

              • CA-4.7.4

                Deposit futures, forward rate agreements and other instruments where the underlying is a money market exposure will be split into two legs as follows:

                (a) The first leg will represent the time to expiry of the futures contract, or settlement date of the FRA as the case may be.
                (b) The second leg will represent the time to expiry of the underlying instrument.
                (c) Each leg will be treated as a zero coupon bond with zero specific risk.
                (d) For deposit futures, the size of each leg is the notional amount of the underlying money market exposure. For FRAs, the size of each leg is the notional amount of the underlying money market exposure discounted to present value, although in the maturity method, the notional amount may be used without discounting.
                For example, under the maturity method, a single 3-month Euro$ 1,000,000 deposit futures contract expiring in 3 months' time will have one leg of $ 1,000,000 representing the 8 months to contract expiry, and another leg of $ 1,000,000 in the 11 months' time-band representing the time to expiry of the deposit underlying the futures contract.
                October 07

            • Bonds futures and forwards bond transactions

              • CA-4.7.5

                Bond futures, forward bond transactions and the forward leg of repos, reverse repos and other similar transactions will use the two-legged approach. A forward bond transaction is one where the settlement is for a period other than the prevailing norm for the market.

                (a) The first leg is a zero coupon bond with zero specific risk. Its maturity is the time to expiry of the futures or forward contract. Its size is the cash flow on maturity discounted to present value, although in the maturity method, the cash flow on maturity may be used without discounting.
                (b) The second leg is the underlying bond. Its maturity is that of the underlying bond for fixed rate bonds, or the time to the next reset for floating rate bonds. Its size is as set out in (c) and (d) below.
                (c) For forward bond transactions, the underlying bond and amount is used at the present spot price.
                (d) For bond futures, the principal amounts for each of the two legs is reckoned as the futures price times the notional underlying bond amount.
                (e) Where a range of deliverable instruments may be delivered to fulfil a futures contract (at the option of the 'short'), then the following rules are used to determine the principal amount, taking account of any conversion factors defined by the exchange:
                (i) The 'long' may use one of the deliverable bonds, or the notional bond on which the contract is based, as the underlying instrument, but this notional long leg may not be offset against a short cash position in the same bond.
                (ii) The 'short' may treat the notional underlying bond as if it were one of the deliverable bonds, and it may be offset against a short cash position in the same bond.
                (f) For futures contracts based on a corporate bond index, the positions will be included at the market value of the notional underlying portfolio of securities.
                (g) A repo (or sell-buy or stock lending) involving exchange of a security for cash should be represented as a cash borrowing - i.e. a short position in a government bond with maturity equal to the repo and coupon equal to the repo rate. A reverse repo (or buy-sell or stock borrowing) should be represented as a cash loan - i.e. a long position in a government bond with maturity equal to the reverse repo and coupon equal to the repo rate. These positions are referred to as 'cash legs'.
                (h) It should be noted that, where a security owned by the bank (and included in its calculation of market risk) is repo'd, it continues to contribute to the bank's interest rate or equity position risk calculation.
                October 07

            • Swaps

              • CA-4.7.6

                Swaps are treated as two notional positions in government securities with the relevant maturities.

                (a) Interest rate swaps will be decomposed into two legs, and each leg will be allocated to the maturity band equating to the time remaining to repricing or maturity. For example, an interest rate swap in which a bank is receiving floating rate interest and paying fixed is treated as a long position in a floating rate instrument of maturity equivalent to the period until the next interest fixing and a short position in a fixed rate instrument of maturity equivalent to the residual life of the swap.
                (b) For swaps that pay or receive a fixed or floating interest rate against some other reference price, e.g. a stock index, the interest rate component should be slotted into the appropriate repricing or maturity Category, with the equity component being included in the equity risk measurement framework as described in Chapter CA-5.
                (c) For cross currency swaps, the separate legs are included in the interest rate risk measurement for the currencies concerned, as having a fixed/floating leg in each currency. Alternatively, the two parts of a currency swap transaction are split into forward foreign exchange contracts and treated accordingly.
                (d) Where a swap has a deferred start, and one or both legs have been fixed, then the fixed leg(s) will be sub-divided into the time to the commencement of the leg and the actual swap leg with fixed or floating rate. A swap is deemed to have a deferred start when the commencement of the interest rate calculation periods is more than two business days from the transaction date, and one or both legs have been fixed at the time of the commitment. However, when a swap has a deferred start and neither leg has been fixed, there is no interest rate exposure, albeit there will be counterparty exposure.
                (e) Where a swap has a different structure from those discussed above, it may be necessary to adjust the underlying notional principal amount, or the notional maturity of one or both legs of the transaction.
                October 07

              • CA-4.7.7

                Banks with large swap books may use alternative formulae for these swaps to calculate the positions to be included in the maturity or duration ladder. One method would be to first convert the cash flows required by the swap into their present values. For this purpose, each cash flow should be discounted using the zero coupon yields, and a single net figure for the present value of the cash flows entered into the appropriate time-band using procedures that apply to zero or low coupon (less than 3%) instruments. An alternative method would be to calculate the sensitivity of the net present value implied by the change in yield used in the duration method (as set out in Section CA-4.5), and allocate these sensitivities into the appropriate time-bands.

                October 07

              • CA-4.7.8

                Banks which propose to use the approaches described in Paragraph CA-4.7.7, or any other similar alternative formulae, should obtain the prior written approval of the Central Bank. The Central Bank will consider the following factors before approving any alternative methods for calculating the swap positions:

                (a) Whether the systems proposed to be used are accurate;
                (b) Whether the positions calculated fully reflect the sensitivity of the cash flows to interest rate changes and are entered into the appropriate time-bands; and
                (c) Whether the positions are denominated in the same currency.
                October 07

          • CA-4.8 CA-4.8 Netting of derivative positions

            • Permissible offsetting of fully matched positions for both specific and general market risk

              • CA-4.8.1

                Banks may exclude from the interest rate risk calculation, altogether, the long and short positions (both actual and notional) in identical instruments with exactly the same issuer, coupon, currency and maturity. A matched position in a future or a forward and its corresponding underlying may also be fully offset, albeit the leg representing the time to expiry of the future is included in the calculation.

                October 07

              • CA-4.8.2

                When the future or the forward comprises a range of deliverable instruments, offsetting of positions in the futures or forward contract and its underlying is only permitted in cases where there is a readily identifiable underlying security which is most profitable for the trader with a short position to deliver. The price of this security, sometimes called the 'cheapest-to-deliver', and the price of the future or forward contract should, in such cases, move in close alignment. No offsetting will be allowed between positions in different currencies. The separate legs of cross-currency swaps or forward foreign exchange contracts are treated as notional positions in the relevant instruments and included in the appropriate calculation for each currency.

                October 07

            • Permissible offsetting of closely matched positions for general market risk only

              • CA-4.8.3

                For the purpose of calculation of the general market risk, in addition to the permissible offsetting of fully matched positions as described in Paragraph CA-4.8.1 above, opposite positions giving rise to interest rate exposure can be offset if they relate to the same underlying instruments, are of the same nominal value and are denominated in the same currency and, in addition, fulfil the following conditions:

                (a) For futures:
                Offsetting positions in the notional or underlying instruments to which the futures contract relates should be for identical products and mature within seven days of each other.
                (b) For swaps and FRAs:
                The reference rate (for floating rate positions) must be identical and the coupons must be within 15 basis points of each other.
                (c) For swaps, FRAs and forwards:
                The next interest fixing date or, for fixed coupon positions or forwards, the residual maturity must correspond within the following limits:
                •   less than one month: same day;
                •   between one month and one year: within 7 days;
                •   over one year: within 30 days.
                October 07

          • CA-4.9 CA-4.9 Calculation of capital charge for derivatives

            • CA-4.9.1

              After calculating the derivatives positions, taking account of the permissible offsetting of matched positions, as explained in Section CA-4.8, the capital charges for specific and general market risk for interest rate derivatives are calculated in the same manner as for cash positions, as described earlier in this Chapter.

              Summary of treatment of interest rate derivative

              Instrument Specific risk charge* General market risk charge
              Exchange-traded futures    
                   
              - Government** debt security No Yes, as two positions
                   
              - Corporate debt security Yes Yes, as two positions
                   
              - Index on interest rates (e.g. LIBOR) No Yes, as two positions
                   
              - Index on basket of debt securities Yes Yes, as two positions
                   
              OTC forwards    
                   
              - Government** debt security No Yes, as two positions
                   
              - Corporate debt security Yes Yes, as two positions
                   
              - Index on interest rates No Yes, as two positions
                   
              FRAs No Yes, as two positions
                   
              Swaps    
              - Based on interbank rates No Yes, as two positions
                   
              - Based on Government** bond yields No Yes, as two positions
                   
              - Based on corporate bond yields Yes Yes, as two positions
                   
              Forward foreign exchange No Yes, as one position in each currency
                   
              Options    
              - Government** debt security No Either (a) or (b) as below (see Chapter CA-8 for a detailed description):
                   
              •   Corporate debt security
              •   Index on interest rates
              •   FRAs, swaps
              Yes

              No

              No
              (a) Carve out together with the associated hedging positions, and use:
              •   simplified approach; or
              •   scenario analysis; or
              •   internal models (see Chapter CA-9).
              (b) General market risk charge according to the delta-plus method (gamma and vega should receive separate capital charges).
              *This is the specific risk charge relating to the issuer of the instrument. Under the credit risk rules, there remains a separate capital charge for the counterparty risk.

              **As defined in Section CA-4.2.
              October 07

        • CA-5 CA-5 Equity position risk - Standardised approach

          • CA-5.1 CA-5.1 Introduction

            • CA-5.1.1

              This Chapter sets out the minimum capital requirements to cover the risk of holding or taking positions in equities in the bank's trading book.

              October 07

            • CA-5.1.2

              For the guidance of the banks, and without being exhaustive, the following list includes financial instruments in the trading book, including forward positions, to which equity position risk capital requirements will apply:

              (a) Common stocks, whether voting or non-voting;
              (b) Depository receipts (which should be included in the measurement framework in terms of the underlying shares);
              (c) Convertible preference securities (non-convertible preference securities are treated as bonds);
              (d) Convertible debt securities which convert into equity instruments and are, therefore, treated as equities (see Paragraph CA-5.1.3 below);
              (e) Commitments to buy or sell equity securities;
              (f) Derivatives based on the above instruments.
              October 07

            • CA-5.1.3

              Convertible debt securities must be treated as equities where:

              (a) The first date at which the conversion may take place is less than three months ahead, or the next such date (where the first date has passed) is less than a year ahead; and
              (b) The convertible is trading at a premium of less than 10%, where the premium is defined as the current marked-to-market value of the convertible less the marked-to-market value of the underlying equity, expressed as a percentage of the latter.
              In other instances, convertibles should be treated as either equity or debt securities, based reasonably on their market behaviour.
              October 07

            • CA-5.1.4

              For instruments that deviate from the structures described in Paragraphs CA-5.1.2 and CA-5.1.3 above, or which could be considered complex, each bank should agree a written policy statement with the Central Bank about the intended treatment, on a case-by-case basis. In some circumstances, the treatment of an instrument may be uncertain, for example bonds whose coupon payments are linked to equity indices. The position risk of such instruments should be broken down into its components and allocated appropriately between the equity, interest rate and foreign exchange risk categories. Advice must be sought from the Central Bank in cases of doubt, particularly when a bank is trading an instrument for the first time.

              October 07

            • CA-5.1.5

              Where equities are part of a forward contract, a future or an option (i.e. a quantity of equities to be received or delivered), any interest rate or foreign currency exposure from the other leg of the contract should be included in the measurement framework as described in Chapters CA-4 and CA-6, respectively.

              October 07

            • CA-5.1.6

              As with interest rate related instruments, the minimum capital requirement for equities is expressed in terms of two separately calculated charges, one applying to the 'specific risk' of holding a long or short position in an individual equity, and the other to the 'general market risk' of holding a long or short position in the market as a whole.

              October 07

            • CA-5.1.7

              Banks which have the intention and capability to use internal models for the measurement of general and specific equity risk and, hence, for the calculation of the capital requirement, should seek the prior written approval of the Central Bank for those models. The Central Bank's detailed rules for the recognition and use of internal models are included in Chapter CA-9. Banks which do not use internal models should adopt the standardised approach to calculate the equity position risk capital requirement, as set out in detail in this Chapter.

              October 07

          • CA-5.2 CA-5.2 Calculation of equity positions

            • CA-5.2.1

              A bank may net long and short positions in the same equity instrument, arising either directly or through derivatives, to generate the individual net position in that instrument. For example, a future in a given equity may be offset against an opposite cash position in the same equity, albeit the interest rate risk arising out of the future should be calculated separately in accordance with the rules set out in Chapter CA-4.

              October 07

            • CA-5.2.2

              A bank may net long and short positions in one tranche of an equity instrument against another tranche only where the relevant tranches:

              (a) Rank pari passu in all respects; and
              (b) Become fungible within 180 days, and thereafter the equity instruments of one tranche can be delivered in settlement of the other tranche.
              October 07

            • CA-5.2.3

              Positions in depository receipts may only be netted against positions in the underlying stock if the stock is freely deliverable against the depository receipt. If a bank takes a position in depository receipts against an opposite position in the underlying equity in different markets (i.e. arbitrage), it may offset the position provided that any costs on conversion are fully taken into account. Furthermore, the foreign exchange risk arising out of these positions should be included in the measurement framework as set out in Chapter CA-6.

              October 07

            • CA-5.2.4

              More detailed guidance on the treatment of equity derivatives is set out in Section CA-5.

              October 07

            • CA-5.2.5

              Equity positions, arising either directly or through derivatives, should be allocated to the country in which each equity is listed. Where an equity is listed in more than one country, the bank should discuss the appropriate country allocation with the Central Bank.

              October 07

          • CA-5.3 CA-5.3 Specific risk calculation

            • CA-5.3.1

              Specific risk is defined as the bank's gross equity positions (i.e. the sum of all long equity positions and of all short equity positions), and is calculated for each country or equity market. For each national market in which the bank holds equities, it should sum the market values of its individual net positions as determined in accordance with Section CA-5.2, irrespective of whether they are long or short positions, to produce the overall gross equity position for that market.

              October 07

            • CA-5.3.2

              The capital charge for specific risk is 8%, unless the portfolio is both liquid and well-diversified, in which case the capital charge will be 4%. To qualify for the reduced 4% capital charge, the following requirements need to be met:

              (a) The portfolio should be listed on a recognised stock exchange;
              (b) No individual equity position shall comprise more than 10% of the gross value of the country portfolio; and
              (c) The total value of the equity positions which individually comprise between 5% and 10% of the gross value of the country portfolio, shall not exceed 50% of the gross value of the country portfolio.
              October 07

          • CA-5.4 CA-5.4 General risk calculation

            • CA-5.4.1

              The general market risk is the difference between the sum of the long positions and the sum of the short positions (i.e. the overall net position) in each national equity market. In other words, to calculate the general market risk, the bank should sum the market value of its individual net positions for each national market, as determined in accordance with Section CA-5.2, taking into account whether the positions are long or short.

              October 07

            • CA-5.4.2

              The general market equity risk measure is 8% of the overall net position in each national market.

              October 07

          • CA-5.5 CA-5.5 Equity derivatives

            • CA-5.5.1

              For the purpose of calculating the specific and general market risk by the standardised approach, equity derivative positions should be converted into notional underlying equity positions, whether long or short. All equity derivatives and off-balance-sheet positions which are affected by changes in equity prices should be included in the measurement framework. This includes futures and swaps on both individual equities and on stock indices.

              October 07

            • CA-5.5.2

              The following guidelines will apply to the calculation of positions in different categories of equity derivatives. Banks which need further assistance in the calculation, particularly in relation to complex instruments, should contact the Central Bank.

              (a) Futures and forward contracts relating to individual equities should, in principle, be included in the calculation at current market prices.
              (b) Futures relating to stock indices should be included in the calculation, at the marked-to-market value of the notional underlying equity portfolio, i.e. as a single position based on the sum of the current market values of the underlying instruments.
              (c) Equity swaps are treated as two notional positions. For example, an equity swap in which a bank is receiving an amount based on the change in value of one particular equity or stock index, and paying a different index is treated as a long position in the former and a short position in the latter. Where one of the swap legs involves receiving/paying a fixed or floating interest rate, that exposure should be slotted into the appropriate time-band for interest rate related instruments as set out in Chapter CA-4. The stock index leg should be covered by the equity treatment as set out in this Chapter.
              (d) Equity options and stock index options are either 'carved out' together with the associated underlying instruments, or are incorporated in the general market risk measurement framework, described in this Chapter, based on the delta-plus method. The treatment of options, being a complex issue, is dealt with in detail in Chapter CA-8.
              October 07

            • CA-5.5.3

              A summary of the treatment of equity derivatives is set out in Paragraph CA-5.5.8.

              October 07

            • Specific risk on positions in equity indices

              • CA-5.5.4

                Positions in highly liquid equity indices whether they arise directly or through derivatives, attract a 2% capital charge in addition to the general market risk, to cover factors such as execution risk.

                October 07

              • CA-5.5.5

                For positions in equity indices not regarded as highly liquid, the specific risk capital charge is the highest specific risk charge that would apply to any of its components, as set out in Section CA-5.3.

                October 07

              • CA-5.5.6

                In the case of the futures-related arbitrage strategies set out below, the specific risk capital charge described above may be applied to only one index with the opposite position exempt from a specific risk capital charge. The strategies are as follows:

                (a) Where a bank takes an opposite position in exactly the same index, at different dates or in different market centres;
                (b) Where a bank takes opposite positions in contracts at the same date in different but similar indices, provided the two indices contain at least 90% common components.
                October 07

              • CA-5.5.7

                Where a bank engages in a deliberate arbitrage strategy, in which a futures contract on a broad-based index matches a basket of stocks, it will be allowed to carve out both positions from the standardised methodology on the following conditions:

                (a) The trade has been deliberately entered into, and separately controlled; and
                (b) The composition of the basket of stocks represents at least 90% of the index when broken down into its notional components.

                In such a case, the minimum capital requirement is limited to 4% (i.e. 2% of the gross value of the positions on each side) to reflect divergence and execution risks. This applies even if all of the stocks comprising the index are held in identical proportions. Any excess value of the stocks compri