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  • 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