1. Categorisation of Exposures
CA-5.2.2
Under the IRB approach, banks must categorise banking-book exposures into broad classes of assets with different underlying risk characteristics, subject to the definitions set out below. The classes of assets are (a) corporate, (b) sovereign, (c) bank, (d) retail, and (e) equity. Within the corporate asset class, five sub-classes of specialised lending are separately identified. Within the retail asset class, three sub-classes are separately identified. Within the corporate and retail asset classes, a distinct treatment for purchased receivables may also apply provided certain conditions are met.
Apr 08CA-5.2.3
Some banks may use different classifications to those listed above in their internal risk management and measurement systems. While it is not the intention of the CBB to require banks to change the way in which they manage their business and risks, banks are required to apply the appropriate treatment to each exposure for the purposes of deriving their minimum capital requirement. Banks must demonstrate to CBB that their methodology for assigning exposures to different classes is appropriate and consistent over time.
Apr 08CA-5.2.4
For a discussion of the IRB treatment of securitisation exposures, see chapter CA-6.
Apr 08(i) Definition of Corporate Exposures
CA-5.2.5
In general, a corporate exposure is defined as a debt obligation of a corporation, partnership, or proprietorship. Banks are permitted to distinguish separately exposures to small- and medium-sized entities (SME), as defined in paragraph CA-5.3.4.
Apr 08CA-5.2.6
Within the corporate asset class, five sub-classes of specialised lending (SL) are identified. Such lending possesses all the following characteristics, either in legal form or economic substance:
(a) The exposure is typically to an entity (often a special purpose entity (SPE)) which was created specifically to finance and/or operate physical assets;(b) The borrowing entity has little or no other material assets or activities, and therefore little or no independent capacity to repay the obligation, apart from the income that it receives from the asset(s) being financed;(c) The terms of the obligation give the lender a substantial degree of control over the asset(s) and the income that it generates; and(d) As a result of the preceding factors, the primary source of repayment of the obligation is the income generated by the asset(s), rather than the independent capacity of a broader commercial enterprise.Apr 08CA-5.2.7
The five sub-classes of specialised lending are project finance, object finance, commodities finance, income-producing real estate, and high-volatility commercial real estate. Each of these sub-classes is defined below.
Apr 08Project Finance
CA-5.2.8
Project finance (PF) is a method of funding in which the lender looks primarily to the revenues generated by a single project, both as the source of repayment and as security for the exposure. This type of financing is usually for large, complex and expensive installations that might include, for example, power plants, chemical processing plants, mines, transportation infrastructure, environment, and telecommunications infrastructure. Project finance may take the form of financing of the construction of a new capital installation, or refinancing of an existing installation, with or without improvements.
Apr 08CA-5.2.9
In such transactions, the lender is usually paid solely or almost exclusively out of the money generated by the contracts for the facility's output, such as the electricity sold by a power plant. The borrower is usually an SPE that is not permitted to perform any function other than developing, owning, and operating the installation. The consequence is that repayment depends primarily on the project's cash flow and on the collateral value of the project's assets. In contrast, if repayment of the exposure depends primarily on a well established, diversified, credit-worthy, contractually obligated end user for repayment, it is considered a secured exposure to that end-user.
Apr 08Object Finance
CA-5.2.10
Object finance (OF) refers to a method of funding the acquisition of physical assets (e.g. ships, aircraft, satellites, railcars, and fleets) where the repayment of the exposure is dependent on the cash flows generated by the specific assets that have been financed and pledged or assigned to the lender. A primary source of these cash flows might be rental or lease contracts with one or several third parties. In contrast, if the exposure is to a borrower whose financial condition and debt-servicing capacity enables it to repay the debt without undue reliance on the specifically pledged assets, the exposure should be treated as a collateralised corporate exposure.
Apr 08Commodities Finance
CA-5.2.11
Commodities finance (CF) refers to structured short-term lending to finance reserves, inventories, or receivables of exchange-traded commodities (e.g. crude oil, metals, or crops), where the exposure will be repaid from the proceeds of the sale of the commodity and the borrower has no independent capacity to repay the exposure. This is the case when the borrower has no other activities and no other material assets on its balance sheet. The structured nature of the financing is designed to compensate for the weak credit quality of the borrower. The exposure's rating reflects its self-liquidating nature and the lender's skill in structuring the transaction rather than the credit quality of the borrower.
Apr 08CA-5.2.12
The CBB believes that such lending can be distinguished from exposures financing the reserves, inventories, or receivables of other more diversified corporate borrowers. Banks are able to rate the credit quality of the latter type of borrowers based on their broader ongoing operations. In such cases, the value of the commodity serves as a risk mitigant rather than as the primary source of repayment.
Apr 08Income-producing Real Estate
CA-5.2.13
Income-producing real estate (IPRE) refers to a method of providing funding to real estate (such as, office buildings to let, retail space, multifamily residential buildings, industrial or warehouse space, and hotels) where the prospects for repayment and recovery on the exposure depend primarily on the cash flows generated by the asset. The primary source of these cash flows would generally be lease or rental payments or the sale of the asset. The borrower may be, but is not required to be, an SPE, an operating company focused on real estate construction or holdings, or an operating company with sources of revenue other than real estate. The distinguishing characteristic of IPRE versus other corporate exposures that are collateralised by real estate is the strong positive correlation between the prospects for repayment of the exposure and the prospects for recovery in the event of default, with both depending primarily on the cash flows generated by a property.
Apr 08High-volatility Commercial Real Estate
CA-5.2.14
High-volatility commercial real estate (HVCRE) lending is the financing of commercial real estate that exhibits higher loss rate volatility (i.e. higher asset correlation) compared to other types of SL. HVCRE includes:
(a) Commercial real estate exposures secured by properties of types that are categorised by the CBB periodically as sharing higher volatilities in portfolio default rates;(b) Loans financing any of the land acquisition, development and construction (ADC) phases for properties of those types in such jurisdictions; and(c) Loans financing ADC of any other properties where the source of repayment at origination of the exposure is either the future uncertain sale of the property or cash flows whose source of repayment is substantially uncertain (e.g. the property has not yet been leased to the occupancy rate prevailing in that geographic market for that type of commercial real estate), unless the borrower has substantial equity at risk.Apr 08CA-5.2.15
Where other supervisors categorise certain types of commercial real estate exposures as HVCRE in their jurisdictions, Bahraini banks are also required to classify such exposures in those jurisdictions as HVCRE.
Apr 08(ii) Definition of Sovereign Exposures
CA-5.2.16
This asset class covers all exposures to counterparties treated as sovereigns under the standardised approach. This includes sovereigns (and their central banks), certain PSEs identified as sovereigns in the standardised approach, MDBs that are given a 0% risk weight under the standardised approach, and the entities referred to in paragraph CA-3.2.3.
Apr 08(iii) Definition of Bank Exposures
CA-5.2.17
This asset class covers exposures to banks and those investment firms outlined in paragraph CA-3.2.13. Bank exposures also include claims on domestic PSEs that are treated like claims on banks under the standardised approach, and MDBs that are not assigned a 0% risk weight under the standardised approach.
Apr 08(iv) Definition of Retail Exposures
CA-5.2.18
An exposure is categorised as a retail exposure if it meets all of the following criteria:
Nature of Borrower or Low Value of Individual Exposures
(a) Exposures to individuals — such as revolving credits and lines of credit (e.g. credit cards, overdrafts, and retail facilities secured by financial instruments) as well as personal term loans and leases (e.g. installment loans, auto loans and leases, student and educational loans, personal finance, and other exposures with similar characteristics). There will be an exposure threshold of BD250,000 to distinguish between retail and corporate exposures;(b) Residential mortgage loans (including first and subsequent liens, term loans and revolving home equity lines of credit) are eligible for retail treatment regardless of exposure size so long as the credit is extended to an individual that is an owner- occupier of the property (with buildings containing only a few rental units — otherwise they are treated as corporate). Loans secured by a single or small number of condominium or co-operative residential housing units in a single building or complex also fall within the scope of the residential mortgage category. CBB may set limits on the maximum number of housing units per exposure, on a case by case basis;(c) Loans extended to small businesses and managed as retail exposures are eligible for retail treatment provided the total exposure of the banking group to a small business borrower (on a consolidated basis where applicable) is less than BD 250,000 . Small business loans extended through or guaranteed by an individual are subject to the same exposure threshold; and(d) CBB will provide flexibility in the practical application of such thresholds such that banks are not forced to develop extensive new information systems simply for the purpose of ensuring perfect compliance. CBB will however, check on regular basis to ensure that such flexibility (and the implied acceptance of exposure amounts in excess of the thresholds that are not treated as violations) is not being abused.Amended: April 2011
Apr 08Large Number of Exposures
CA-5.2.19
The exposure must be one of a large pool of exposures, which are managed by the bank on a pooled basis. CBB may, on a case by case basis, set a minimum number of exposures within a pool for exposures in that pool to be treated as retail:
(a) Small business exposures below BD 250,000 may be treated as retail exposures if the bank treats such exposures in its internal risk management systems consistently over time and in the same manner as other retail exposures. This requires that such an exposure be originated in a similar manner to other retail exposures. Furthermore, it must not be managed individually in a way comparable to corporate exposures, but rather as part of a portfolio segment or pool of exposures with similar risk characteristics for purposes of risk assessment and quantification. However, this does not preclude retail exposures from being treated individually at some stages of the risk management process. The fact that an exposure is rated individually does not by itself deny the eligibility as a retail exposure.Amended: April 2011
Apr 08CA-5.2.20
Within the retail asset class category, banks are required to identify separately three sub-classes of exposures: (a) exposures secured by residential properties as defined above, (b) qualifying revolving retail exposures, as defined in the following paragraph, and (c) all other retail exposures.
Apr 08(v) Definition of Qualifying Revolving Retail Exposures
CA-5.2.21
All of the following criteria must be satisfied for a sub-portfolio to be treated as a qualifying revolving retail exposure (QRRE). These criteria must be applied at a sub-portfolio level consistent with the bank's segmentation of its retail activities generally. Segmentation at the national or country level (or below) should be the general rule:
(a) The exposures are revolving, unsecured, and uncommitted (both contractually and in practice). In this context, revolving exposures are defined as those where customers' outstanding balances are permitted to fluctuate based on their decisions to borrow and repay, up to a limit established by the bank;(b) The exposures are to individuals;(c) The maximum exposure to a single individual in the sub-portfolio is BD 25,000 or less;(d) Because the asset correlation assumptions for the QRRE risk-weight function are markedly below those for the other retail risk-weight function at low PD values, banks must demonstrate that the use of the QRRE risk-weight function is constrained to portfolios that have exhibited low volatility of loss rates, relative to their average level of loss rates, especially within the low PD bands. CBB will review the relative volatility of loss rates across the QRRE subportfolios, as well as the aggregate QRRE portfolio;(e) Data on loss rates for the sub-portfolio must be retained in order to allow analysis of the volatility of loss rates; and(f) CBB must concur that treatment as a qualifying revolving retail exposure is consistent with the underlying risk characteristics of the sub-portfolio.Amended: April 2011
Apr 08(vi) Definition of Equity Exposures
CA-5.2.22
In general, equity exposures are defined on the basis of the economic substance of the instrument. They include both direct and indirect ownership interests,31 whether voting or non-voting, in the assets and income of a commercial enterprise or of a financial institution that is not consolidated or deducted pursuant to Prudential Consolidation and Deduction Requirements Module. An instrument is considered to be an equity exposure if it meets all of the following requirements:
(a) It is irredeemable in the sense that the return of invested funds can be achieved only by the sale of the investment or sale of the rights to the investment or by the liquidation of the issuer;(b) It does not embody an obligation on the part of the issuer; and(c) It conveys a residual claim on the assets or income of the issuer.
31 Indirect equity interests include holdings of derivative instruments tied to equity interests, and holdings in corporations, partnerships, limited liability companies or other types of enterprises that issue ownership interests and are engaged principally in the business of investing in equity instruments.
Apr 08CA-5.2.23
Additionally any of the following instruments must be categorised as an equity exposure:
(a) An instrument with the same structure as those permitted as Tier 1 capital for banking organisations;(b) An instrument that embodies an obligation on the part of the issuer and meets any of the following conditions:• The issuer may defer indefinitely the settlement of the obligation;• The obligation requires (or permits at the issuer's discretion) settlement by issuance of a fixed number of the issuer's equity shares;• The obligation requires (or permits at the issuer's discretion) settlement by issuance of a variable number of the issuer's equity shares and (ceteris paribus) any change in the value of the obligation is attributable to, comparable to, and in the same direction as, the change in the value of a fixed number of the issuer's equity shares;32 or,• The holder has the option to require that the obligation be settled in equity shares, unless either (i) in the case of a traded instrument, the CBB is content that the bank has demonstrated that the instrument trades more like the debt of the issuer than like its equity, or (ii) in the case of non- traded instruments, the CBB is content that the bank has demonstrated that the instrument should be treated as a debt position. In cases (i) and (ii), the bank may decompose the risks for regulatory purposes, with the consent of the CBB.
32For certain obligations that require or permit settlement by issuance of a variable number of the issuer's equity shares, the change in the monetary value of the obligation is equal to the change in the fair value of a fixed number of equity shares multiplied by a specified factor. Those obligations meet the conditions of this bullet if both the factor and the referenced number of shares are fixed. For example, an issuer may be required to settle an obligation by issuing shares with a value equal to three times the appreciation in the fair value of 1,000 equity shares. That obligation is considered to be the same as an obligation that requires settlement by issuance of shares equal to the appreciation in the fair value of 3,000 equity shares.
Amended: April 2011
Apr 08CA-5.2.24
Debt obligations and other securities, partnerships, derivatives or other vehicles structured with the intent of conveying the economic substance of equity ownership are considered an equity holding.33 This includes liabilities from which the return is linked to that of equities.34 Conversely, equity investments that are structured with the intent of conveying the economic substance of debt holdings or securitisation exposures would not be considered an equity holding.
33Equities that are recorded as a loan but arise from a debt/equity swap made as part of the orderly realisation or restructuring of the debt are included in the definition of equity holdings. However, these instruments may not attract a lower capital charge than would apply if the holdings remained in the debt portfolio.
34Such liabilities are not required to be included where they are directly hedged by an equity holding, such that the net position does not involve material risk.
Apr 08CA-5.2.25
The CBB may, on a case by case basis, re-characterise debt holdings as equities for regulatory purposes or otherwise ensure the proper treatment of holdings.
Apr 08(vii) Definition of Eligible Purchased Receivables
CA-5.2.26
Eligible purchased receivables are divided into retail and corporate receivables as defined below.
Apr 08Retail Receivables
CA-5.2.27
Purchased retail receivables, provided the purchasing bank complies with the IRB rules for retail exposures, are eligible for the top-down approach as permitted within the existing standards for retail exposures. The bank must also apply the minimum operational requirements as set forth in sections CA-5.6 and CA-5.8.
Apr 08
