• 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 ("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 2 (Islamic Banks) covers all Islamic banks licensed by the Agency. Conventional banks are covered in Volume 1, and representative offices of banks are covered 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 2 (Islamic Banks);
              (b) the structure and design of the Rulebook; and
              (c) its maintenance and version control.

          • UG-A.2 UG-A.2 Regulation history

            • UG-A.2.1

              This User's Guide — Module UG — was first issued in January 2005 together with the rest of Volume 2 (Islamic 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-2.3 & UG-3.1 4/2006 Explanation of revised dating and numbering system
                   
                   
                   
                   

        • UG-1 UG-1 Rulebook status and application

          • UG-1.1 UG-1.1 Legal basis

            • UG-1.1.1

              Volume 2 (Islamic Banks) of the BMA Rulebook is issued by 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 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 2 of the BMA Rulebook apply to all Islamic 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 conventional banks which are covered in Volume 1.

            • UG-1.3.2

              Where relevant, individual sections of Volume 2 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

              Version 1 of Volume 2 (Islamic Banks) of the BMA Rulebook was first issued in January 2005. It replaces all regulations previously issued with respect to Islamic 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; 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 Standards
                (b) Business Standards
                (c) Regulatory Reporting 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 version number 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 third 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 version number 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

            • UG-3.2.1

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

            • 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

        • BMA Rulebook Order Form

          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
          (Due Oct 2004)
             
          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 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 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 CDROM 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 Islamic 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 Islamic banking services are required to be licensed by BMA as an Islamic bank licensee. Regulated Islamic banking services consist of three determinant activities — the acceptance of Shari'a money placements/deposits, the managing of Shari'a profit sharing investment accounts, and the offering of Shari'a financing contracts. In addition, various supplementary activities may also be undertaken. All these activities are defined in Rule LR-1.3.1. Islamic bank licensees must operate all their operations in compliance with Shari'a economic principles; and only Islamic bank licensees may hold themselves out to be a fully Shari'a compliant institution.

              • LR-A.1.4

                In other words, to be licensed as an Islamic bank licensee, a person must undertake the activity of accepting Shari'a money placements/deposits, and/or managing Shari'a profit sharing investment accounts. In addition, the activity of offering Shari'a financing contracts must also be undertaken. In addition, they may undertake any of the other activities falling within the definition of regulated Islamic banking services, providing these are in conformity with Shari'a economic principles.

            • License Categories

              • LR-A.1.5

                Islamic bank licensees are divided into two sub-categories: Islamic retail bank licensees and Islamic 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

                Islamic retail bank licensees may undertake transactions in any currency, with both Bahraini residents and non-residents. To qualify as an Islamic retail bank licensee, the activity of offering Shari'a financing contracts 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

                Islamic 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 (in summary, BD 7 million or more for the activities of taking Shari'a money placements/deposits, and offering Shari'a financing contracts, and US$ 250,000 or more for any of the other activities falling within the definition of regulated Islamic banking services).

              • LR-A.1.8

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

            • Licensing Conditions

              • LR-A.1.9

                Islamic 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 and IFSB (Islamic Financial Services Board) standards.

            • Retaining Licensed Status

              • LR-A.1.10

                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.1.11

                Chapter LR-3 specifies the processes and information requirements that have to be followed for applicants seeking an Islamic 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 BMA.

            • Representative Offices and Ancillary Services Providers

              • LR-A.1.12

                Representative offices of overseas Islamic bank licensees are not covered in Volume 2 (Islamic 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.1.13

                Until such time as Volume 5 (Specialised Activities) of the BMA Rulebook is issued, representative offices of overseas Islamic 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.1.14

                Providers of ancillary services to the financial sector are not covered in Volume 2 (Islamic Banks) of the Rulebook. Requirements covering ancillary services providers will instead be included in Volume 5, to be issued in 2007.

              • LR-A.1.15

                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.1.16

                Unless the context suggests otherwise, references elsewhere in Volume 2 to Full Commercial Bank should be taken as referring to Islamic retail bank licensees, and references to Offshore Banking Units and Investment Bank Licensees should be taken as referring to Islamic 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 2.

          • 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 January 2005, as part of the initial release of Volume 2 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 Islamic 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 were 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 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
                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 January 2005 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 January 2005 version of this Module unchanged, as follows:

                Circular Reference 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
                BS/07/04 06/05/04 LR-6 Record Keeping Requirements

        • 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 Islamic 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 BMA as an Islamic 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 Islamic Bank Licensees

            • General Prohibitions

              • LR-1.1.1

                No person may:

                (a) undertake (or hold themselves out to undertake) regulated Islamic 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 Islamic banking services (or regulated 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 Islamic 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, 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 BMA.

              • LR-1.1.9

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

              • LR-1.1.10

                All applicants for an Islamic bank license 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, Islamic bank licensees must maintain these criteria on an ongoing basis.

              • LR-1.1.11

                Islamic 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, Islamic bank licensees must be licensed either as an Islamic retail bank licensee or as an Islamic 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 Islamic retail bank licensee category replaces the Full Commercial Bank (Islamic principles) category that existed prior to July 2006; the Islamic wholesale bank licensee category replaces the Offshore Banking Unit and Investment Bank License (Islamic 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 BMA, and the issuance of a new license certificate. Where (prior to July 2006), the same legal entity holds multiple licenses, BMA will agree transitional measures aimed at rationalizing the number of licenses held.

            • Islamic Retail Bank Licensees

              • LR-1.2.4

                Islamic 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 an Islamic retail bank licensee, the person concerned must undertake (as a minimum), the activity of accepting Shari'a money placements/deposits, and/or managing Shari'a profit sharing investment accounts, as well as the activity of offering Shari'a financing contracts (as defined in Rules LR-1.3.16, LR-1.3.17 and LR-1.3.18). The activity of offering Shari'a financing contracts must be a significant part of the bank's business, relative to other activities.

              • LR-1.2.6

                When assessing the significance of Shari'a financing contracts, in the context of Rule LR-1.2.5, the BMA would normally expect to see such contracts 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 financing-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 cease 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.

              • LR-1.2.8

                The purpose of Rule LR-1.2.5 is to ensure that, besides the activity of accepting Shari'a money placements/deposits, and managing Shari'a profit sharing investment accounts, that the core banking activity of providing finance also forms part of the definition of Islamic retail bank licensees, and accounts for a significant share of their business, in keeping with their intermediation function.

            • Islamic Wholesale Bank Licensees

              • LR-1.2.9

                Islamic 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-1.2.15, LR-1.2.17 and LR-1.2.19. 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 Islamic 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 an Islamic wholesale bank licensee, the person concerned must undertake (as a minimum), the activity of accepting Shari'a money placements/deposits and/or managing Shari'a profit sharing investment accounts (as defined in Rules LR-1.3.16 and LR-1.3.17), together with the activity of offering Shari'a financing contracts (as defined in Rule LR-1.3.18).

              • LR-1.2.12

                The purpose of Rule LR-1.2.11 is to ensure that the core Islamic banking activities of accepting Shari'a money placements/deposits, and managing Shari'a profit sharing investment accounts, form part of the definition of Islamic wholesale bank licensees. However, unlike Islamic retail bank licensees, there is no requirement that the activity of providing Shari'a financing contracts must be a significant part of the bank's business, relative to other activities. This is to allow Islamic 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 and profit sharing investors may be exposed. Rule LR-1.2.11 does not in any way prevent Islamic wholesale bank licensees from providing Shari'a-compliant finance as a major activity, should they wish to.

              • LR-1.2.13

                Islamic wholesale bank licensees may transact with residents of Bahrain and/or in Bahrain Dinar, with respect to the activities (a) and (b) 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 placement/deposit must be BD 7 million or above (or its equivalent in foreign currency); however, subsequent additions and withdrawals from the 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 Shari'a-compliant financing transactions, the initial facility amount advised must be 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

                Islamic wholesale bank licensees may transact with residents of Bahrain and/or in Bahrain Dinar, with respect to the activities (c) to (j) listed in Rule LR-1.3.1, only where the initial transaction is US$ 250,000 or above (or its foreign currency equivalent), and where the financial instruments concerned are Shari'a compliant.

              • LR-1.2.17

                With respect to activity (c) (managing Shari'a profit sharing investment accounts), the threshold refers to the initial amount placed as an investment. With respect to activities (d) and (e) (dealing in financial instruments as principal / agent), the threshold refers to the individual transaction size. With respect to activities (f) and (g) (managing / safeguarding financial instruments), the threshold refers to the initial investment amount. With respect to activity (h), (operating a Collective Investment Undertaking), the threshold refers to the minimum investment required for participation in the scheme. With respect to activities (i) and (j) (arranging / advising on deals in 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 (c), (d) and (e) 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 money placement /financing 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

                Islamic wholesale bank licensees may only undertake activities (k) and (l) 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 (k) and (l) 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, Islamic 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 PIRI Form), and BMA bank licensees. Islamic wholesale bank licensees may also transact in Bahraini Dinar for any amount, where required to fund their normal operating expenses; 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 Islamic 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 BMA, and these exemptions went further than those now being applied across the board to all Islamic wholesale bank licensees.

              • LR-1.2.23

                Islamic wholesale bank licensees wishing to undertake transactions of the type specified in Rules LR-1.2.13, LR-1.2.16 or 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 BMA to monitor the initiation of such business by Islamic 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 Islamic 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

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

              • LR-1.2.26

                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 BMA and may be amended in response to market developments.

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

            • LR-1.3.1

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

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

            • LR-1.3.2

              Upon application, the BMA may exclude specific transactions from the definition of regulated Islamic 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 Islamic banking service by way of business means:

              (a) undertaking for commercial gain, at a minimum, either or both of the activities of accepting Shari'a money placements/deposits and managing Shari'a profit sharing investment accounts, together with the activity of offering Shari'a financing contracts; in addition, any of the remaining activities specified in Rule LR-1.3.1 may also be undertaken;
              (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 Islamic 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 Islamic banking services does not mean that it is prohibited. In transitioning to the new licensing framework, 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 Islamic 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 Islamic 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 holding of money as a rent-guarantee in connection with the rental of a property would not be considered a regulated Islamic banking service, since it satisfies the exemptions in Rule LR-1.3.7.

              • LR-1.3.9

                A person does not carry on an activity constituting a regulated Islamic 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 Islamic 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 Islamic 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, commercial companies entering into bay salam or istisna transactions in order to protect themselves against future fluctuations in the price of their products, would not be considered to be dealing in financial instruments as principal, and would not therefore require to be licensed as an Islamic bank licensee.

              • LR-1.3.13

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

            • Accepting Shari'a money placements/deposits

              • LR-1.3.16

                Accepting Shari'a money placements is defined as the acceptance of sums of money for safe-keeping ('al-wadia', 'q'ard') in a Shari'a 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.

            • Managing Shari'a profit sharing investment accounts

              • LR-1.3.17

                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, such as a mudaraba or musharaka partnership.

            • Offering Shari'a Financing Contracts

              • LR-1.3.18

                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.

            • Dealing in Shari'a compliant financial instruments as principal

              • LR-1.3.19

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

              • LR-1.3.20

                Rule LR-1.3.22 includes the underwriting of equity and other financial instruments. It also includes the temporary sale of a financial instrument through a repo transaction.

              • LR-1.3.21

                A person does not carry on an activity specified in Rule LR-1.3.19 if the activity relates to the person issuing his own financial instrument.

            • Dealing in Shari'a compliant financial instruments as agent

              • LR-1.3.22

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

              • LR-1.3.23

                A licensee that carries on an activity of the kind specified by Rule LR-1.3.22 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 Shari'a Compliant Financial Instruments

              • LR-1.3.24

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

              • LR-1.3.25

                The activities included under the definition of Rule LR-1.3.24 include activities such as asset management.

            • Safeguarding Shari'a Compliant Financial Instruments (i.e. Custodian)

              • LR-1.3.26

                Safeguarding Shari'a compliant financial instruments means the safeguarding of Shari'a compliant financial instruments for the account of clients.

              • LR-1.3.27

                A person does not carry on an activity specified in Rule LR-1.3.26 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-1.3.28

                A person does not carry on an activity specified in Rule LR-1.3.26 if a third person, namely a qualifying custodian, accepts responsibility with regard to the financial instrument.

              • LR-1.3.29

                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-1.3.26; or
                (b) an exempt person in relation to activities of that kind.

              • LR-1.3.30

                A person does not carry on an activity specified in Rule LR-1.3.26 if they are managing a central depository, which is part of an exchange recognised by BMA.

              • LR-1.3.31

                The following are examples of activities, when taken in isolation, are unlikely to be regarded an activity of the kind specified under Rule LR-1.3.26:

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

              • LR-1.3.32

                A person undertaking an activity of the kind specified under Rule LR-1.3.26 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-1.3.33

                Operating a collective investment undertaking means operating, establishing or winding up a collective investment undertaking.

              • LR-1.3.34

                For the purposes of LR-1.3.33, 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-1.3.35

                A person does not carry on an activity specified in Rule LR-1.3.33 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-1.3.36

                Collective investment undertakings of the kind specified in Rule LR-1.3.33 may be open-ended (i.e. with shares continuously issued and redeemed to meet investor demand) or closed-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 Shari'a compliant financial instruments

              • LR-1.3.37

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

              • LR-1.3.38

                A person does not carry on an activity specified in Rule LR-1.3.37 if the arrangement does not bring about the transaction to which the arrangement relates.

              • LR-1.3.39

                A person does not carry on an activity specified in Rule LR-1.3.37 if a person's activities are limited solely to introducing clients to licensees.

              • LR-1.3.40

                The exclusion in Rule LR-1.3.39 does not apply if the agent receives from any person, other than the client, any pecuniary reward or other advantage, for 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-1.3.41

                A person does not carry on an activity specified in Rule LR-1.3.37 merely by providing the means of communication between two parties to a transaction.

              • LR-1.3.42

                A person does not carry on an activity specified in Rule LR-1.3.37 if they operate an exchange, duly recognised and authorised by the BMA.

              • LR-1.3.43

                Negotiating terms for an investment on behalf of a client is an example of an activity which maybe regarded as activities of the kind specified in Rule LR-1.3.37.

              • LR-1.3.44

                The following are examples of activities, when taken in isolation, are unlikely to be regarded as an activity of the kind specified in Rule LR-1.3.37:

                (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 Shari'a compliant financial instruments

              • LR-1.3.45

                Advising on Shari'a compliant 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 Shari'a compliant financial instrument or exercising any right conferred by such a financial instrument.

              • LR-1.3.46

                The following are examples of activities, which may be regarded as an activity as defined by Rule LR-1.3.45:

                (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 or credit facility concerned.

              • LR-1.3.47

                A person does not carry on an activity specified in Rule LR-1.3.45 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-1.3.45; nor
                (b) that of leading or enabling persons to buy, sell, subscribe for or underwrite a financial instrument.

              • LR-1.3.48

                The following are examples of activities, when taken in isolation, are unlikely to be regarded as an activity as defined by Rule LR-1.3.45:

                (a) explaining the structure, or the terms and conditions of a financial instrument or credit facility;
                (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-1.3.49

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

            • Issuing / administering means of payment

              • LR-1.3.50

                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 an Islamic bank licensee must be:

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

            • LR-2.1.2

              Where the Islamic 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 Islamic 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

              Islamic bank licensees with their Registered Office in the Kingdom of Bahrain must maintain their Head Office in the Kingdom. Overseas Islamic 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 an Islamic 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 — to be resident in Bahrain. In the case of overseas Islamic bank licensees, the BMA requires the branch of a foreign 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, as well as the General Manager of the branch to be resident in Bahrain.

          • LR-2.3 LR-2.3 Condition 3: Controllers

            • LR-2.3.1

              Islamic bank licensees must satisfy the BMA that their controllers are suitable and pose no undue risks to the licensee. Islamic bank licensees must also satisfy the BMA that their group structures do not prevent the effective supervision of the Islamic 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 an Islamic bank licensee, or who are otherwise able to exert significant influence on the Islamic 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 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 BMA's approved persons requirements.

            • LR-2.4.3

              The Islamic 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. Islamic 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

                Islamic 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

                Islamic 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 BMA).

              • LR-2.5.3

                Persons seeking a license as an Islamic 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 an Islamic 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 Islamic bank licensees, funds placed with the bank by way of call and/or unrestricted investment accounts (or similar) must not exceed 20 times their capital and reserves. For overseas Islamic 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

                Islamic bank licensees must maintain sufficient liquid assets to meet their obligations as they fall due in the normal course of their business. Islamic 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 BMA and documented in the liquidity management policy.

            • Reserve Requirements

              • LR-2.5.10

                Islamic bank licensees must maintain a minimum daily cash reserve balance with the BMA, equivalent to 5% of its total non-bank Bahraini Dinar funds, whether placed by way of call or unrestricted investment accounts (or similar), as well as taken through the issuance of Bahraini Dinar denominated Islamic investment certificates.

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

            • LR-2.6.1

              Islamic 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

              Islamic 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

              Islamic bank licensees must appoint external auditors, subject to 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

                Islamic 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 the Financial Accounting Standards issued by the accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), or with International Financial Reporting Standards (IFRS) / International Accounting Standards (IAS), where no relevant AAOIFI standard exists. 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

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

            • General Conduct

              • LR-2.8.3

                Islamic bank licensees must conduct their activities in a professional and orderly manner, in keeping with good market practice. Islamic 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

                Islamic 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

                Islamic 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 2, to address specific risks. For instance, a license may be granted subject to strict limitations on intra-group transactions.

              • LR-2.8.9

                Islamic retail bank licensees are subject to the deposit protection scheme of eligible deposits held with the Bahrain offices of the licensee, with respect to certain of their liabilities (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 an Islamic 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 an Islamic bank license. The applicant may choose to have an authorized representative, acting on its behalf. In instances where the applicant uses an authorized representative, 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

              Islamic bank licensees, who were licensed prior to the publication of the new LR Module of Volume 2, 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 Islamic 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 BMA for its approval as part of the Phase 2 documentation.

            • LR-3.1.9

              The purpose of Rule LR-3.1.8 is to allow BMA to verify that the contents of the Private Placement Memorandum are consistent with other information supplied to 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 languages. 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 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 principal" approval has been granted for Phase 1, the applicant must submit within 6 months of the "in principal" 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

              Islamic bank licensees must seek prior BMA approval before undertaking new regulated Islamic 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, an Islamic bank licensee requesting BMA approval to undertake a new regulated Islamic 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 Islamic 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

                Islamic bank licensees must satisfy 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 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 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 BMA, BMA will only effect the cancellation once a licensee has discharged all its regulatory responsibilities to customers. Until such time, 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 an adequate system and procedures to ensure:

              (a) compliance with 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 on 1st January 2005 as part of the Islamic 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 3 of Module UG provides further details on Rulebook maintenance and control.

            • PB-A.2.2

              A list of 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. Banks' management must safeguard not only the interests of shareholders of the bank, but also those of the Profit Sharing Investment Account (PSIA) holders.

          • 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. Again the bank's management must bear in mind the interests of shareholders and PSIA holders.

          • 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 of Directors and Shari'a Board (where applicable) and management must take reasonable care to organise and control the affairs of the licensee responsibly and effectively with adequate risk management systems. The organisational structure should be clearly delineated and reporting lines completely transparent to promote full disclosure.

          • PB-1.6 PB-1.6 Market conduct

            • PB-1.6.1

              All relevant persons should observe proper standards of market conduct. In particular, the Agency requires that banks comply with all AAOIFI issued accounting standards as well as the Shari'a pronouncements issued by the Shari'a Board of AAOIFI.

          • 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 Islamic 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 Islamic 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 Islamic 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 must 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 must meet at least four times per year (see Rule 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 and a Shari'a Committee is mandatory. (See Paragraphs HC-1.3.10 to HC-1.3.13.)

              • HC-A.2.6

                All licensees must submit their organisational structure as approved by the Board of Directors. All licensees must establish independent functions for Internal Audit and Risk Management.

              • HC-A.2.7

                Islamic 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.2.8

                Islamic 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. Islamic bank licensees must also notify the BMA of any changes in their approved persons. (See Chapter HC-2)

            • Compliance officer/manager

              • HC-A.2.9

                Islamic bank licensees must appoint a senior member of staff with responsibility for compliance. The Compliance Officer is a controlled function. (See Chapter HC-3.1.)

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

            • Evolution of the Module

              • HC-A.3.1

                This Module was first issued in January 2005, as part of the initial release of Volume 2 of the BMA Rulebook. It was dated January 2005. 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 01/07/05 Transparency requirements formalised
                HC-1.6 01/07/05 Notification concerning senior positions/controllers
                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 Agency 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 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 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 license.

            • 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 clients 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 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.

              • 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 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.

              • 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-1.3.6 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).

            • Shari'a Supervision Committee

              • HC-1.3.14

                The Agency requires all banks to establish an independent Shari'a Supervision Committee complying with AAOIFI's governance standards for Islamic Financial Institutions No. 1 and No. 2.

              • HC-1.3.15

                All banks must comply with all AAOIFI issued accounting standards as well as the Shari'a pronouncement issued by the Shari'a Board of AAOIFI. The bank must have a separate function of Shari'a review to verify compliance with the above. This internal Shari'a review must be carried out in accordance with AAOIFI's governance standard No. 3. The Shari'a review function may be located in the Internal Audit function of the bank.

          • HC-1.4 HC-1.4 Transparency of Structure and Strategy

            • 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-1.4.2

                To promote sound corporate governance, the bank must submit its organizational structure approved by the Board of Directors, which notes the designations and responsibilities of its key management personnel, highlighting their qualifications and relevant industry experience. The organizational structure should be clearly delineated and reporting lines completely transparent to promote full disclosure. It is the General Manager's responsibility to ensure that this occurs.

              • HC-1.4.3

                The bank must submit a statement of its strategy and objectives to the Agency at the time of licensing. This statement should cover a minimum period of three years. The Agency may request a formal review by the Board of the bank's statement from time to time.

          • 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 an Islamic bank licensee must be notified to the BMA prior to their appointment and, where required, approved by the BMA (see Rule HC-2.1.3).


              • HC-2.1.2

                Controlled functions are those of:

                (a) Director;
                (b) Member of Shari'a Supervisory Board
                (c) Chief Executive or General Manager;
                (d) Senior Manager;
                (e) Compliance officer;
                (f) Money Laundering Reporting Officer; and
                (g) Financial Instruments Trader.

              • HC-2.1.3

                Prior approval is required for controlled functions (a), (b), (c), (d), (e) and (f). Controlled functions (e) and (f) may be combined, however. Controlled function (g) 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 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 Islamic 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/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; 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

                Islamic 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 an Islamic bank licensee, the Form 3 must be marked for the attention of the Director, Islamic Financial Institutions.

              • 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

                Islamic bank licensees must immediately notify BMA when an approved person ceases to hold the controlled function, for which they have been approved, and 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

                Islamic bank licensees must immediately notify BMA should they become aware of information that could reasonably be viewed as calling into question an approved person's compliance with 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 Islamic 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 Islamic 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 [deleted]

            [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 purely 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, the Agency recommends that banks refer to the Basel Committee publication, "Compliance and the compliance function in banks" (see www.bis.org/publ published 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 perform other limited related compliance roles (e.g. 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 [deleted]

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

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

        • HC-A HC-A Introduction[versions up to October 2010]

          • HC-A.1 HC-A.1 Purpose[versions up to October 2010]

            • HC-A.1.1 [versions up to October 2010]

              This Module presents requirements that have to be met by Islamic 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 [versions up to October 2010]

              In addition, this Module contains requirements for the notification and pre-approval of individuals, undertaking certain designated functions with respect to Islamic 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 Islamic 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 [versions up to October 2010]

              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 [versions up to October 2010]

              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[versions up to October 2010]

              • HC-A.1.5 [versions up to October 2010]

                This Module contains the CBB's Directive relating to the credit risk management of Islamic 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 Islamic bank licensees.

                October 07

              • HC-A.1.6 [versions up to October 2010]

                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[versions up to October 2010]

            • Corporate governance[versions up to October 2010]

              • HC-A.2.1 [versions up to October 2010]

                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.)

                Amended: October 2009
                October 2007

              • HC-A.2.2 [versions up to October 2010]

                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-1.2.11.)

                October 07

              • HC-A.2.3 [versions up to October 2010]

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

                Amended: October 2009
                October 2007

              • HC-A.2.4 [versions up to October 2010]

                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 [versions up to October 2010]

                The Board should consider the setting up of committees to assist it in fulfilling its responsibilities. The setting up of an Audit Committee and a Shari'a Committee is mandatory. (See Paragraphs HC-1.3.11 to HC-1.3.16.)

                October 07

              • HC-A.2.6 [versions up to October 2010]

                All licensees must submit their organisational structure as approved by the Board of Directors. All licensees must establish independent functions for Internal Audit and Risk Management.

                October 07

              • HC-A.2.7 [versions up to October 2010]

                Islamic 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[versions up to October 2010]

              • HC-A.2.8 [versions up to October 2010]

                Islamic 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. Islamic bank licensees must also notify the CBB of any changes in their approved persons. (See Chapter HC-2)

                October 07

            • Compliance officer/manager[versions up to October 2010]

              • HC-A.2.9 [versions up to October 2010]

                Islamic bank licensees must appoint a senior member of staff with responsibility for compliance. The Compliance Officer is a controlled function. (See Chapter HC-3.1.)

                October 07

          • HC-A.3 HC-A.3 Module History[versions up to October 2010]

            • Evolution of the Module[versions up to October 2010]

              • HC-A.3.1 [versions up to October 2010]

                This Module was first issued in January 2005, as part of the initial release of Volume 2 of the CBB Rulebook. It was dated January 2005. 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 [versions up to October 2010]

                When the CBB replaced the BMA in September 2006, the provisions of this Module remained in force. Volume 2 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 [versions up to October 2010]

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

                Module Ref. Change Date Description of Changes
                HC-1.5 01/07/05 Transparency requirements formalised
                HC-1.6 01/07/05 Notification requirements formalised
                HC-1.1, 1.2 & 1.4 01/10/05 High-level controls
                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, 1.5.5 & 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 and 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 [versions up to October 2010]

                The contents in this Module are effective from July 2004 and 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[versions up to October 2010]

          • HC-B.1 HC-B.1 Guidance provided by other international bodies[versions up to October 2010]

            • Basel Committee: Enhancing Corporate Governance in Banking Organisations and High-level Controls for Banks[versions up to October 2010]

              • HC-B.1.1 [versions up to October 2010]

                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 [versions up to October 2010]

                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 [versions up to October 2010]

                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[versions up to October 2010]

            • HC-B.2.1 [versions up to October 2010]

              The requirements of Chapter 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 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[versions up to October 2010]

          • HC-1.1 HC-1.1 Scope[versions up to October 2010]

            • HC-1.1.1 [versions up to October 2010]

              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 [versions up to October 2010]

              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 [versions up to October 2010]

              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 [versions up to October 2010]

              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 [versions up to October 2010]

              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 [versions up to October 2010]

              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[versions up to October 2010]

            • Strategy[versions up to October 2010]

              • HC-1.2.1 [versions up to October 2010]

                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 [versions up to October 2010]

                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 [versions up to October 2010]

                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 [versions up to October 2010]

                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 [versions up to October 2010]

                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[versions up to October 2010]

              • HC-1.2.6 [versions up to October 2010]

                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 should 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 [versions up to October 2010]

                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 judgments made by external advisors. The Board may 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[versions up to October 2010]

              • HC-1.2.8 [versions up to October 2010]

                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 [versions up to October 2010]

                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 fulfill their fiduciary responsibilities to the bank's stakeholders.

                October 07

              • HC-1.2.10 [versions up to October 2010]

                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 [versions up to October 2010]

                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 [versions up to October 2010]

                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-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 [versions up to October 2010]

                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 Committee[versions up to October 2010]

            • Board Composition & Frequency of Meetings[versions up to October 2010]

              • HC-1.3.1 [versions up to October 2010]

                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 [versions up to October 2010]

                No Board member may have more than one Directorship of a Retail Bank and a Wholesale Bank. This would mean an effective cap of a maximum of two Directorships of licensees 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.

                Amended January 2009
                October 07

              • HC-1.3.3 [versions up to October 2010]

                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 [versions up to October 2010]

                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[versions up to October 2010]

              • HC-1.3.5 [versions up to October 2010]

                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. 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 [versions up to October 2010]

                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[versions up to October 2010]

              • HC-1.3.7 [versions up to October 2010]

                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 [versions up to October 2010]

                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[versions up to October 2010]

              • HC-1.3.9 [versions up to October 2010]

                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 [versions up to October 2010]

                The Chairman of the Board should preferably 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[versions up to October 2010]

              • HC-1.3.11 [versions up to October 2010]

                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[versions up to October 2010]

              • HC-1.3.12 [versions up to October 2010]

                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 Audit Committee must be composed of non-executive Directors only. The CEO may not be a member of this committee.

                October 07

              • HC-1.3.13 [versions up to October 2010]

                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 [versions up to October 2010]

                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

            • Sharia Supervision Committee[versions up to October 2010]

              • HC-1.3.15 [versions up to October 2010]

                The Central Bank requires all banks to establish an independent Shari'a Supervision Committee complying with AAOIFI's governance standards for Islamic Financial Institutions No. 1 and No.2

                October 07

              • HC-1.3.16 [versions up to October 2010]

                All banks must comply with all AAOIFI issued accounting standards as well as the Shari'a pronouncement issued by the Shari'a Board of AAOIFI. The bank must have a separate function of Shari'a review to verify compliance with the above. This internal Shari'a review must be carried out in accordance with AAOIFI's governance standards No. 3. The Shari'a review function may be located in the Internal Audit function of the bank.

                October 07

          • HC-1.4 HC-1.4 Transparency and Disclosure[versions up to October 2010]

            Board's Responsibility for Disclosure

            October 07

            • HC-1.4.1 [versions up to October 2010]

              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 Central Bank's disclosure requirements (see Rulebook Chapter PD-1).

              October 07

            • HC-1.4.2 [versions up to October 2010]

              To promote sound corporate governance, the bank must submit its organisational structure approved by the Board of Directors, which notes the designations and responsibilities of its key management personnel, highlighting their qualifications and relevant industry experience. The organisational structure should be clearly delineated and reporting lines completely transparent to promote full disclosure. It is the General Manager's responsibility to ensure that this occurs.

              October 07

            • HC-1.4.3 [versions up to October 2010]

              The bank must submit a statement of its strategy and objectives to the Central Bank at the time of licensing. This statement should cover a minimum period of three years. The Central Bank may request a formal review by the Board of the bank's statement from time to time.

              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')[versions up to October 2010]

            • HC-1.5.1 [versions up to October 2010]

              Banks must notify the Central Bank 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 [versions up to October 2010]

              Banks must notify the Central Bank in writing of any proposed changes to senior positions or ownership changes mentioned in Sections HC-2.1 and HC-3.2 (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: October 2009
              Amended: January 2009
              October 2007

            • HC-1.5.3 [versions up to October 2010]

              If a controlled function falls vacant, all banks 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 bank 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 [versions up to October 2010]

              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 [versions up to October 2010]

              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 [versions up to October 2010]

              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 [versions up to October 2010]

              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 [versions up to October 2010]

              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 [versions up to October 2010]

              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[versions up to October 2010]

          • HC-2.1 HC-2.1 CBB Notification and Approval[versions up to October 2010]

            • General Requirement[versions up to October 2010]

              • HC-2.1.1 [versions up to October 2010]

                All persons wishing to undertake a controlled function in an Islamic bank licensee must be notified to the CBB prior to their appointment and, where required, approved by the CBB (see Rule HC-2.1.3).

                October 07

              • HC-2.1.2 [versions up to October 2010]

                Controlled functions are those of:

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

              • HC-2.1.3 [versions up to October 2010]

                Prior approval is required for controlled functions (a), (b), (c), (d), (e), (f) and (g). Controlled functions (e) and (f) may be combined, however (see also FC-4.1, regarding the MLRO function). Controlled function (h) 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[versions up to October 2010]

              • HC-2.1.4 [versions up to October 2010]

                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[versions up to October 2010]

              • HC-2.1.5 [versions up to October 2010]

                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 [versions up to October 2010]

                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 [versions up to October 2010]

                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 Islamic 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 [versions up to October 2010]

                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 [versions up to October 2010]

                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 [versions up to October 2010]

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

                October 07

              • HC-2.1.11 [versions up to October 2010]

                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[versions up to October 2010]

              • HC-2.1.12 [versions up to October 2010]

                Islamic 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 [versions up to October 2010]

                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 an Islamic bank licensee, the Form 3 must be marked for the attention of the Director, Islamic Financial Institutions.

                October 07

              • HC-2.1.14 [versions up to October 2010]

                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 [versions up to October 2010]

                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 [versions up to October 2010]

                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
                Added October 2007

              • HC-2.1.17 [versions up to October 2010]

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

                Amended January 2009
                October 07

              • HC-2.1.18 [versions up to October 2010]

                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 [versions up to October 2010]

                Islamic 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[versions up to October 2010]

            • HC-2.2.1 [versions up to October 2010]

              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 [versions up to October 2010]

              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 Islamic bank licensee concerned; and
              (c) financial soundness.
              October 07

            • HC-2.2.3 [versions up to October 2010]

              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 Islamic 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 [versions up to October 2010]

              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 [versions up to October 2010]

              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[versions up to October 2010]

            • HC-2.3.1 [versions up to October 2010]

              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 [versions up to October 2010]

              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 [versions up to October 2010]

              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-2.4 [This Section was deleted in 07/2006: it has been left blank.][versions up to October 2010]

        • HC-3 HC-3 Compliance officer/manager[versions up to October 2010]

          • HC-3.1 HC-3.1 Introduction[versions up to October 2010]

            • HC-3.1.1 [versions up to October 2010]

              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 [versions up to October 2010]

              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 [versions up to October 2010]

              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[versions up to October 2010]

            • HC-3.2.1 [versions up to October 2010]

              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 [versions up to October 2010]

              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 [versions up to October 2010]

              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 [versions up to October 2010]

              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 [versions up to October 2010]

              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

        • HC-4 [This Chapter deleted 07/2006 – left blank.][versions up to October 2010]

      • 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 Islamic 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 Islamic 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 January 2005, as part of the first release of Volume 2 (Islamic 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.

            • Superseded Requirements

              • AU-A.2.5

                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
                PIRI Pack - - - - - AU 1.4, AU 3.7 Prudential Information Returns for Islamic Financial Institutions
                ODG/162/03 (partial) 21 May 2003 AU 1.4–AU 1.4, AU 2.2 Outsourcing
                BS/9/03 (partial) 14 Sep 2003 AU 1.5 Operational Risk Management
                BC/1/97 12 Feb 1997 AU 1.6 Request for Approval for Dividend Distribution
                BC/4/99 (partial) 17 Mar 1999 AU 1.6, AU 3.7 Annual Accounts for the Year Ending 31 December 1999
                14/86 19 Jun 1986 AU 2.1 Auditors' Relationship with Supervisors
                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
                EDBC/6/01 (partial) 14 Oct 2001 AU 3.4 Money laundering Regulation
                BC/6/97 21 Apr 1997 AU 4 Reporting Accountants

        • AU-B AU-B Scope of Application

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

            • AU-B.1.1

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

            • AU-B.1.2

              The contents of Chapters AU-1 to AU-4 apply to both Bahraini Islamic bank licensees and overseas Islamic 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 Islamic bank licensees. Auditors appointed by Islamic 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. Section 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

              Islamic 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, Islamic 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 Islamic 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 Islamic bank licensees, the BMA will also take into account who act 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

              Islamic 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

              Islamic 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, Islamic 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

              Islamic 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 an Islamic 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, among things, comply with the restrictions in Section AU-1.5.

            • AU-1.4.3

              If an Islamic 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

                Islamic 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 Islamic 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 an Islamic 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

                Islamic 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 Islamic bank licensees as well as Bahraini Islamic bank licensees.

              • AU-1.5.6

                A partner, Director or manager on the engagement team of auditing an Islamic 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 Islamic bank licensee.

        • AU-2 AU-2 Access

          • AU-2.1 AU-2.1 BMA Access to Auditors

            • AU-2.1.1

              Islamic 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 Islamic bank licensee to comply with BMA requirements.

            • AU-2.1.2

              The BMA may, as part of its on-going supervision of Islamic bank licensees, request meetings with a licensee's auditors. If necessary, 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 Islamic 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 Financial Disclosures

            • AU-3.1.1

              Islamic 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 BMA.

            • AU-3.1.2

              Chapter PD-2 requires overseas Islamic bank licensees operating as retail banks to publish on 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 Islamic bank licensees to publish quarterly financial statements, in accordance with Financial Accounting Standards (FAS) issued by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI). For products and activities not covered by AAOIFI, International Accounting Standards (IAS) should be followed.

          • AU-3.2 AU-3.2 Report on Compliance with Financial Crime Rules

            • AU-3.2.1

              Islamic 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-3.2.2

              The report specified in Rule AU-3.2.1 must be in the form agreed by BMA, and must be submitted to the BMA within four months of the licensee's financial year-end.

            • AU-3.2.3

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

          • AU-3.3 AU-3.3 Review of Compliance with relevant laws

            • AU-3.3.1

              Islamic bank licensees must arrange for their external auditors to review the bank's compliance with applicable laws and declare, in the auditors report, that no material violations of the following laws and regulations have taken place:

              (a) The Bahrain Commercial Companies Law of 2001;
              (b) The BMA Law 1973; and
              (c) The BMA's licensing conditions, and other rules contained in Volume 2 of the BMA Rulebook.

            • AU-3.3.2

              For the purposes of Rule AU-3.3.1, material violations are violations that have any material impact on the financial statements of the bank.

          • AU-3.4 AU-3.4 Report on material differences

            • AU-3.4.1

              Islamic bank licensees must arrange for their external auditors to provide to the BMA explanations for any material differences in data reported in the bank's audited accounts and in the following reports provided to the BMA:

              (a) Prudential Information Returns for Islamic Banks (PIRI); and
              (b) Monthly Statements of Assets and Liabilities.

          • AU-3.5 AU-3.5 Report on behavioural adjustments

            • AU-3.5.1

              Islamic bank licensees that have been given BMA approval to apply behavioural adjustments to the liquidity data provided in Section E of the PIRI Form, must arrange for their external auditors to verify the supporting data used to support the behavioural adjustments made.

            • AU-3.5.2

              Please refer to Module LM and to Section BR-5.2. Banks that have at least 2 years' worth of supporting data may seek BMA approval to apply behavioural adjustments to certain of their reported liquidity data, instead of reporting contractual maturities.

        • AU-4 AU-4 Accounting Standards

          • AU-4.1 AU-4.1 General Requirements

            • AU-4.1.1

              Islamic bank licensees must comply with Financial Accounting Standards (FAS) issued by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI). For products and activities not covered by AAOIFI, International Financial Reporting Standards (IFRS) / International Accounting Standards (IAS) must be followed.

      • 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 2 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 Islamic Bank Licensees

            • License categories

              • GR-B.1.1

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

            • Bahraini and overseas Islamic bank licensees

              • GR-B.1.2

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

                Chapter Bahraini Islamic 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 Islamic 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 Islamic 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 Islamic 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 Islamic bank licensees, but only with respect to the business booked in their branch in Bahrain.

            • GR-1.1.2

              All Islamic 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 lists 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 any email records that are directly related to transactions (such as payment instructions from customers or 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 financing contracts or similar original transaction documents may be kept without translation. Where exemptions are granted by BMA, the licensee is nonetheless asked to confirm that it will make available certified translations of such documents, if requested by 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 Islamic 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 Islamic bank licensees, as well as Bahraini Islamic 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 Islamic 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

              Islamic 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 Islamic bank licensee, whether booked in Bahrain or in an overseas branch. With respect to overseas Islamic bank licensees, it applies only to transactions booked in the Bahrain branch.

            • GR-1.2.4

              In the case of overseas Islamic 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

                Islamic 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, and Shari'a board meetings;
                (c) correspondence with the BMA and records relevant to monitoring compliance with BMA requirements;
                (d) reports prepared by the Islamic bank licensee's internal and external auditors; and
                (e) employee training manuals and records.

              • GR-1.3.2

                In the case of Bahraini Islamic bank licensees, these requirements apply to the licensee as a whole, including any overseas branches. In the case of overseas Islamic 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, and Shari'a board 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

              Islamic 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 Islamic 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 Islamic 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, Islamic 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

              Islamic 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 BMA Approval

            • GR-4.1.1

              Islamic 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 amounts placed with the banks through investment accounts and safe-keeping accounts.

            • GR-4.1.4

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

            • GR-4.1.5

              Islamic 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 investment accounts holders, depositors and creditors. In all cases, the BMA will only grant its permission where the institution acquiring the assets or investment account/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 BMA's licensing conditions specifies, amongst other things, that Islamic 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 an Islamic 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

              Islamic 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 Islamic 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 Islamic 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

              Islamic 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

              Islamic 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 an Islamic 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 Islamic bank licensee, or under which they undertake to act together in exercising their voting power in relation to the Islamic bank licensee.

          • GR-5.3 GR-5.3 Suitability of Controllers

            • GR-5.3.1

              A controller of an Islamic bank licensee must satisfy the BMA of his suitability.

            • GR-5.3.2

              In assessing the suitability of controllers who are natural persons, 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, 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 Islamic 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 Islamic bank licensee as regards effective supervision of the Islamic 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 investment account holders, 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 Islamic 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 Islamic bank licensee, whether in respect of capital, dividend or otherwise.

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

          [This page has been left blank.]

        • GR-7 GR-7 Suspension of Business

          • GR-7.1 GR-7.1 BMA Approval

            • GR-7.1.1

              An Islamic 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 Shari'a money placements/deposits, and investment accounts, 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 Islamic 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 Islamic 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

              An Islamic 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 Islamic bank licensee believes that it has discharged all its remaining contractual obligations to investment account holders, 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

              Islamic 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 the 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;
              (d) High Level Controls;
              (e) Enforcement; and
              (f) 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 interbank market

              • 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 be the customer concerned.

            • Minimum balance and charges on saving investment accounts

              • BC-A.2.6

                Banks may impose no more than a monthly charge of BD 1 when the monthly weighted average balance for saving investment 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 saving investment accounts.

            • Disclosure of charges

              • BC-A.2.8

                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.2.9

                The FCB is requested to notify GOYS when any club or society registered with GOYS requests the opening of an account with the bank.

            • Current accounts

              • BC-A.2.10

                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.2.11

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

            • Penalty system for dishonoured cheques

              • BC-A.2.12

                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.2.13

                Concerned FCB(s) will be required not to 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.2.14

                FCBs which 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.2.15

                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'.

              • BC-A.2.16

                FCBs will be entitled to charge customers no more than BD 10 (ten Bahraini Dinars) in respect of each dishonoured cheque.

            • Installation of an off-site ATM in Bahrain

              • BC-A.2.17

                FCBs wishing to install an off-site ATM must submit an application (in writing) for the BMA's (Executive Director of Financial Institutions 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.2.18

                The Agency requires that the charges on such customer withdrawals and other ATM services should not exceed BD 1 (one Bahraini Dinar) per transaction.

            • Minimum terms and conditions

              • BC-A.2.19

                All Mudaraba contracts entered into by a bank (whether new or renewed contracts) should meet the standards referred to under paragraph BC-7.1.1.

              • BC-A.2.20

                Banks must have a policy statement as to the policies and procedures in place to safeguard the interest of the PSIA holders. The banks must agree the Policy Statement with the Agency before 20 January 2002.

            • 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-8.

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

            • BC-A.3.1

              This module was first issued on 1st January 2005 as part of the Islamic 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 3 of Module UG provides further details on Rulebook maintenance and control.

            • BC-A.3.2

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

              Summary of changes

              Module Ref. Change Date Description of Changes
              BC-4.6 01/10/05 Streamlined requirements for new products
              BC-8 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 covering different aspects of Business and Market Conduct. These circulars have now been consolidated into this module. 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 offered in/from Bahrain by Means of Incentives etc.
                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.C7/90/34 31 Jan 1990 BC-4.2 Dinar Certificates of Deposits
                EDBO/51/02 2 Apr 2002 BC-4.2 Charges to Customers
                BC/5/00 8 Mar 2000 BC-4.3 Accounts held for Clubs and Societies in Bahrain
                BSD(111)/94/1507 24 Sep 1994 BC-4.4 Fees on Current Accounts
                BC/2/01 3 Mar 2001 BC-4.5 Brokerage Fees in Bahrain
                ODG/145/92 18 Aug 1992 BC-4.6 New or expanded products and facilities in the Retail Banking Field
                EDBO/46/03 8 Apr 2003 BC-4.7 Inheritance — Financial Procedures
                EDBO/27/96 25 Sep 1996 BC-5.1 Regulation Relating to a Penalty System 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
                EDBC/105/96 26 June 1996 BC-7 Mudaraba Contracts — Minimum Terms and Conditions
                BS/11/2004 10 August 2004 BC-4 Bank Charges on Savings Accounts



        • 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 mean 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 interbank market

          • 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 the foreign exchange brokers, provide 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-2.1.3

              The code is shown in full, although many paragraphs are not strictly relevant for Islamic banks. Treasury staff should refer to the relevant paragraphs as appropriate.

          • 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 centers 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 the broker is:
              (i) 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 deposit for personal account 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 form 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 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, 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 banks 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 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 adapt 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-3.3.1

              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 accounts

            • BC-4.1.1

              Banks may impose no more than a monthly charge of BD 1 when the monthly weighted average balance for saving investment 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 saving investment 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 Disclosure of Charges

            • BC-4.2.1

              In order to improve customer awareness and enhance transparency of bank charging structures, retail banks should display in Arabic and in English, by notice in their banking halls (both head offices and branches), a list of all current charges.

              Amended April 2011
              October 2007

            • BC-4.2.2

              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.

              October 07

            • BC-4.2.3

              [This Paragraph was deleted in July 2012].

              Deleted: July 2012

          • BC-4.2 BC-4.2 Disclosure of charges

            • BC-4.2.1

              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-4.2.2

              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 BC-4.3 Accounts held for clubs and societies in Bahrain

            • BC-4.3.1

              All clubs and societies registered with the General Organisation for Youth and Sports (GOYS), are permitted under GOYS rule to only have one account with FCBs in Bahrain.

            • BC-4.3.2

              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-4.3.3

              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-4.4 BC-4.4 Current accounts

            • BC-4.4.1

              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-4.4.2

              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-4.5 BC-4.5 Brokerage fee

            • BC-4.5.1

              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-4.5.2

              The new scale of fees is the result of discussion and consultation between The Bankers' Society and the Bahrain Money Brokers.

          • BC-4.6 BC-4.6 Notification to the Agency on introduction of new or expanded customer products and facilities

            • BC-4.6.1

              The content of this section is applicable only to full commercial banks licensed by the Agency.

            • BC-4.6.2

              All institutions referred to under paragraph BC-4.6.1 are required to consult 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-4.6.3

              Further, institutions should also advise the Agency, on a six-monthly basis, on the status of new or expanded products and facilities. The advise 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-4.7 BC-4.7 Procedures for inheritance of financial assets

            • BC-4.7.1

              The content of this section is applicable to all full commercial banks licensed by the Agency in the Kingdom of Bahrain.

            • BC-4.7.2

              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-4.17 BC-4.17 Blocking Customer Accounts

            • BC-4.17.1

              Islamic retail bank licensees must not block the accounts of a customer (who has a financing arrangement with it) due to customer’s termination from his or her employment or retirement regardless of the bank’s contractual rights to take such action. Banks instead must agree on other arrangements with the customer for the repayment of the financing.

              Added: April 2020

        • 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 saving and/or any other accounts held with that/those FCB(s). Furthermore, those FCB(s) will be required not to 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 which 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 (ATM)

          • 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 service 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 Mudaraba contracts

          • BC-7.1 BC-7.1 Minimum terms and conditions

            • BC-7.1.1

              As part of its ongoing supervision of Islamic banks, the Agency has set out in Appendix BC 7 details of the type of terms and conditions which it believes Islamic banks should include, as a minimum, in such Mudaraba contracts.

            • BC-7.1.2

              All such Mudaraba contracts entered into by a bank (whether new or renewed contracts) should meet the standards referred to under paragraph BC-7.1.1.

            • BC-7.1.3

              Banks must have a policy statement as to the policies and procedures in place to safeguard the interest of the PSIA holders. The statement must, as a minimum, cover the following areas:

              (a) Basis for allocation of profit or loss to the PSIA;
              (b) Policy for making provisions and reserves against assets and equity for PSIA (refer to FAS 11, issued by AAOIFI, for recognition and measurement of provisions and reserves) and to whom these provisions and reserves revert to in case of write-back or recovery;
              (c) Policy on the priority for investment of own funds and those of unrestricted investment account holders; and
              (d) Basis for allocating expenses to the PSIA.

              Banks must agree their Policy Statements with the Agency.

        • BC-8 BC-8 Margin Trading System

          • BC-8.1 BC-8.1 Introduction

            • BC-8.1.1

              This Chapter applies to all full commercial banks in Bahrain.

            • BC-8.1.2

              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-8.1.3

              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-8.1.4

                Only Full Commercial Banks will be permitted 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. The BMA's approval may be withdrawn at its discretion.

              • BC-8.1.5

                BSE Brokers will not be permitted to act as lenders for the System.

          • BC-8.2 BC-8.2 Limits and Trading Rules

            • BC-8.2.1

              An investor may, through his relationship with any one individual participating bank under the System, invest a maximum of BD200,000 in securities (i.e. BD200,000 per investor/per individual participating bank, made up of BD100,000 by way of the investor's own initial margin and BD100,000 by way of financing from the relevant participating bank to that investor).

            • BC-8.2.2

              An investor may, through approaching more than one bank under the System, invest a maximum of BD500,000 in securities (i.e. BD500,000 per investor/from all participating banks, made up of BD250,000 by way of the investor's own initial margin with all participating banks and BD250,000 by way of total financing from all participating banks to that investor.

            • BC-8.2.3

              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-8.2.4

              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-8.2.5

              In relation to the aggregate limit under paragraph BC-8.2.2 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-8.2.6

                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-8.2.7

                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-8.2.8

                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-8.2.9

                Under paragraph BC-8.2.8 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-8.2.10

                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-8.2.11

                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 Charges

              • BC-8.2.12

                The participating bank shall 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, 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 their foreign branches, and on a consolidated group basis.

            • CA-A.1.2

              In addition to licensees mentioned in paragraph CA-A.1.1, certain of these regulations (in particular gearing requirements) are also applicable to full commercial branches of foreign banks in the Kingdom.

          • 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 banks referred to under CA-A.1.1.

            • 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 accounts. 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

              The regulations contained in this section are consistent in all substantial respects with the approach recommended by the Basel Committee on Banking Supervision and the Statement on the Purpose and Calculation of the Capital Adequacy Ratio for Islamic Banks issued by Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI).

            • CA-A.2.5

              The Agency recognises that the Basel Committee guidelines may not address specific characteristics of the various products and services offered by Islamic banks. Therefore, the Agency has adopted a risk-based approach and has tailored the regulations to address the specific risk characteristics for Islamic banks.

            • CA-A.2.6

              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;
              (i) Enforcement; and
              (j) 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 two 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 — Supports the calculation of credit risk weighted assets and at least 28.57% of market risk.
                Tier 2: Supplementary capital — Supports credit risk and market risk subject to limitations.

            • 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

                The minimum capital requirement for equities is expressed in terms of two separately calculated charges, one relating to the "specific risk" of holding a long position in an individual equity, and the other to the "general market risk" of holding a long position in the market as a whole.

            • Measuring foreign exchange risk

              • CA-A.3.5

                The measurement of the foreign exchange risk involves, as a first step, the calculation of the net open position in each individual currency including gold and as a second step, the measurement of the risks inherent in the bank's mix of assets and liabilities positions in different currencies.

            • Measuring commodities risk

              • CA-A.3.6

                Banks should adopt either the simplified approach to calculate their commodities risk and the resultant capital charges or the maturity ladder approach. Where banks have Salam and Parallel Salam contracts, the maturity ladder approach must be used.

            • Minimum capital ratio requirement

              • CA-A.3.7

                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).

            • Maintaining minimum RAR

              • CA-A.3.8

                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 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) and report on a weekly basis thereafter on the bank's relevant RAR(s) until such RAR(s) have reached the required target level(s).

              • CA-A.3.9

                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.3.10

                The bank will be required to submit the PIRI forms to the Agency on a monthly basis, until the RAR(s) exceeds its target ratio(s).

            • Gearing requirements

              • CA-A.3.11

                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.3.12

                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 on 1st January 2005 as part of the Islamic 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 3 of Module UG provides further details on Rulebook maintenance and control.

            • CA-A.4.2

              A list of 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.4.3

                Prior to the development of 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
                PIRI
                BC/09/01
                26 Nov 2001 CA Prudential Information Returns for Islamic Financial Institutions
                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.4.4

                The contents in this module are effective from the date depicted in the original circulars (see paragraph CA-A.4.3) 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: The management of banks' off balance sheet exposures — a supervisory perspective

              • CA-B.2.1

                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.2.2

                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

              These 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 fiduciary and displacement risk, credit and market risk capital requirements.

            • CA-1.1.2

              Fiduciary and displacement risk is defined as [ref IFSB].

            • CA-1.1.3

              Credit risk is defined as the potential that a bank's 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-1.1.4

              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 equities in the trading book;
              (b) foreign exchange risk throughout the bank; and
              (c) commodity risk throughout the bank.

          • CA-1.2 CA-1.2 Measuring fiduciary and displacement risks

            • CA-1.2.1

              Islamic banks mobilise funds on a profit and loss sharing basis (PLS). However, certain risks are associated with such PLS accounts. These risks are referred to as fiduciary and displaced commercial risk.

            • CA-1.2.2

              To cater for these risks the Agency has accepted the recommendations contained in the AAOIFI's statements and requires the inclusion of 50% of the risk weighted assets of the Profit Sharing Investment Accounts (PSIA) in the denominator of the capital adequacy ratio.

          • CA-1.3 CA-1.3 Measuring credit risks

            • CA-1.3.1

              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-1.3.2

              The Agency has adopted the risk weightings recommended by the Basel Committee on Banking Supervision, where applicable. However, the Basel Committee does not define the risk weightings for some of the specific Islamic contracts.

            • CA-1.3.3

              In Islamic banking, the legal form is as important as the substance of the transaction otherwise the transaction would not be permissible under Shari'a. Therefore, when assigning risk weights to the various Islamic contracts, banks should consider the legal form of the transactions as well as the substance.

            • CA-1.3.4

              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 within the banking book.

            • CA-1.3.5

              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-1.3.6

              The Agency has addressed the issue of the risk weightings for some of the commonly used Islamic contracts. If banks are involved in contracts not covered below they should contact the Agency and agree on an appropriate risk-weighting category.

            • Murabaha and Murabaha to the purchase orderer

              • CA-1.3.7

                The Agency as a policy requires that all Murabaha contracts be based on binding promises. The Murabaha receivables should be assigned a risk weight based on the credit standing of the obligor as recommended by the Basel Committee.

            • Mudaraba contracts

              • CA-1.3.8

                Mudaraba contracts should be assigned a risk weighting according to the underlying investments. Where Mudaraba funds are invested in securities listed on recognised exchanges and the price volatility is based on market movements, these should be removed from credit risk weightings and subject to market risk regulations. Examples would be equity Mudarabas where banks may have direct exposure in the value of the underlying equities or commodity Mudarabas.

              • CA-1.3.9

                Investments in other Mudarabas such as real estate or leasing should be assigned risk weightings according to the standing of the underlying investment as per the Basel Capital Accord.

              • CA-1.3.10

                Where a Mudaraba fund invests in another Mudaraba contract, which in turn makes investments at its own discretion, the risk weight would be based on the credit standing of the counterparty (investee Mudarib) as recommended by the Basel Committee. Investments in particular asset classes made at the discretion of the (investor) Mudaraba fund should be assigned risk weighting according to the underlying investments, where possible.

            • Musharaka contracts

              • CA-1.3.11

                Musharaka contracts refer to partnerships in specific transactions or projects. These exclude participation in the share capital (equity) of other enterprises. Risk weights should be assigned in accordance with the standings of the underlying investment as per the guidelines of the Basel Committee. Musharaka in real estate, plant and machinery or other similar assets attract a 100% risk weighting.

              • CA-1.3.12

                Musharakas in trading transactions will attract risk weighting as per the standing of the underlying investment, which in all cases would attract a 100% risk weighting. Where the transaction involves trading in commodities which may be traded in secondary markets, these should be removed from credit risk weighting and subjected to market risk regulations.

              • CA-1.3.13

                In cases where it is difficult to ascertain the composition of the underlying asset, risk weight would be assigned based on the credit standing of the counterparty.

            • Ijarah / Ijarah Muntahia Bittamleek assets

              • CA-1.3.14

                Under Shari'a, substantial risks and rewards of ownership of assets may not be transferred to lessees. Therefore, assets acquired for the purpose of leasing under Ijarah or Ijarah Muntahia Bittamleek contracts should be carried on the balance sheet of the lessor and assigned a risk weighting of 100%.

              • CA-1.3.15

                However, where these are residential properties, leased under Ijarah Muntahia Bittamleek with the lessee's option to buy at the end of the lease term and to use the properties for residential purposes, a 50% risk weighting is assigned, where the lessor has a first enforceable charge on the assets.

            • Istisna'a and parallel Istisna'a contracts

              • CA-1.3.16

                The accounting for these contracts should be in accordance with Financial Accounting Standard (FAS) No. 10: Istisna'a and Parallel Istisna'a, issued by AAOIFI.

              • CA-1.3.17

                Istisna'a and parallel Istisna'a contracts would attract risk weighting as per the credit standing of the respective counterparties in accordance with the Basel Committee.

            • Salam and parallel Salam

              • CA-1.3.18

                Amounts paid in respect of Salam contracts (for which there exists a parallel Salam contract) should normally be assigned a risk weight as per the credit standing of the customer in accordance with the Basel Committee.

              • CA-1.3.19

                Salam and parallel Salam contracts would attract risk weighting as per the credit standing of the respective counterparties in accordance with the Basel Committee.

            • Participations and equity investments

              • CA-1.3.20

                The supervision of banks for capital adequacy purposes is carried out on a consolidated basis, taking into account all holdings of the capital of other entities by the concerned bank. For subsidiaries, the preferred mode of consolidation is to add the assets and liabilities into the accounts of the parent on a line-by-line basis. For associate companies (i.e. where the parent bank owns 20% or more of the voting stock, and/or has voting control of the concerned company), the assets and liabilities should also be consolidated on a line-by-line basis. If banks do not wish to consolidate subsidiaries or associates (that meet the above criteria), they must contact the Agency to agree on the accounting treatment to be used. Participations and investments which amount to below 20% of the voting capital of the concerned company should be accounted for at fair value and weighted at 100%.

              • CA-1.3.21

                Banks which have subsidiary and associate companies must also be supervised for capital adequacy on a solo basis (i.e. after deducting all holdings of the share capital of all subsidiaries and associates (that meet the criteria in paragraph CA-1.3.20 above) and excluding all their assets and liabilities from the accounts of the parent bank). Holdings of other participations and equity investments need not be deducted on a solo basis, but should be accounted for at fair value and weighted at 100%. Banks should note paragraph CA-2.2.6 in respect of the treatment described in this paragraph and in paragraph CA-1.3.20.

            • Intra fund balances

              • CA-1.3.22

                Transactions between the corporate book (i.e. self-financed and financed by unrestricted investment accounts) and restricted investment accounts are not allowed, unless approved by the Agency on a temporary basis.

              • CA-1.3.23

                If permitted by the Agency, on a temporary basis, the following weightings will be applied:

                (a) Corporate or unrestricted investment funds invested in Restricted Investment Accounts.

                Risk weighting would be assigned on the underlying asset as per the Basel Committee Guidelines and in accordance with the guidance set out under chapters CA-1 to CA-6.
                (b) Restricted investment account funds invested in corporate books.
                (i) In the corporate books, the assets financed by restricted investment accounts would be included as part of the corporate assets and risk weighting assigned in accordance with the guidelines.
                (ii) 0% risk weighting should be assigned to the funds invested by the restricted investment accounts in the corporate books in order to avoid double counting as the resultant assets are already risk weighted in the Bank's books.
                (iii) Banks must agree with the Agency on the treatment of investments by restricted investment accounts in the corporate book. The Agency will consider each case on its merit.

          • CA-1.4 CA-1.4 Measuring market risks

            • Trading book

              • CA-1.4.1

                The trading book means the bank's positions in financial instruments (including off balance sheet instruments that 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 variations, and positions in financial instruments arising from matched principal brokering and market making). Treatment of risks associated with any option transactions should be agreed in advance with the Agency, who will consider the issue on a case by case basis.

              • CA-1.4.2

                Each bank should agree to a written policy statement with the Agency as to which activities are normally considered trading and constitute part of the trading book. Trading book's definition should be consistently applied by the bank from year to year.

              • CA-1.4.3

                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-1.4.1 above.

            • Equity risk

              • CA-1.4.4

                The capital charges for equities will apply based on the current market values of items in a bank's trading book.

            • Foreign exchange and commodities risk

              • CA-1.4.5

                The capital charges for foreign exchange risk and for commodity 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-5.3 of these regulations.

            • Exemptions

              • CA-1.4.6

                Banks will be allowed certain de minimis exemptions from the capital requirements for foreign exchange risk, as described in section CA-5.2 of these regulations. For the time being, there shall be no exemptions from the trading requirements, or from the capital requirements for commodity risk.

            • Bank's own fund and Profit and Loss Sharing Investment Accounts (PSIA)

              • CA-1.4.7

                Banks must compute capital charges for own funds subject to market risk, as well as those of the PSIA. For the purpose of computing the capital adequacy ratio, 50% of the bank's market risk weighted assets relating to the PSIA (restricted and unrestricted) must be included in accordance with AAOIFI's Statement on Purpose and Calculation of the Capital Adequacy Ratio for Islamic Banks.

            • Consolidation

              • CA-1.4.8

                As with the credit risk capital requirements, the market risk capital requirements 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, 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-1.4.9

                Notwithstanding that the market risk capital requirements apply on a worldwide consolidated basis, the Agency also monitors the market risks of banks on a non-consolidated basis to ensure that significant imbalances within a group do not escape supervision. The Agency is 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-1.4.10

                For the measurement of their market risks, banks will measure the risks in a standardised manner, using the measurement framework described in chapters CA-4 to CA-6.

              • CA-1.4.11

                The standardised methodology uses a "building block" in which the capital charge for each risk category is determined separately. For equity positions risk, separate capital charge for specific risk and the general market risk arising from these positions are calculated. The specific market risk is defined as the risk of loss caused by an adverse price movement of a security/ units due principally to factors related to the issuer. The general market risk is defined as the risk of loss arising from adverse changes in aggregate market prices. For commodities and foreign exchange, there is only one general market risk capital requirement.

              • CA-1.4.12

                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-1.4.13

                Formal reporting, to the Agency, of the market risk exposure and capital adequacy shall take place as at the end of each calendar quarter. The returns relating to any quarter should be submitted to the Agency by the 20th day of the first month of the following quarter. Furthermore, 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). Banks are also expected to maintain strict risk management systems to ensure that their intra-day exposures are not excessive.

              • CA-1.4.14

                Banks' daily compliance with the capital requirements for market risk will 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 bank's 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 must be informed in writing. The Agency will then seek to ensure that the bank takes immediate measures to rectify the situation.

              • CA-1.4.15

                Besides what is stated in paragraph CA-1.4.14 above, 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-1.5 CA-1.5 Reporting

            • CA-1.5.1

              Formal reporting, to the Agency, of capital adequacy shall be made in accordance with the requirements set out under section BR-3.1.

          • CA-1.6 CA-1.6 Summary of overall capital adequacy requirements

            • CA-1.6.1

              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-1.4. The bank's overall minimum capital requirement will be:

              (a) the credit risk requirements laid down in these regulations; PLUS
              (b) the capital charges for market risks calculated according to the measurement frameworks described in chapters CA-4 to CA-6, summed arithmetically.

        • CA-2 CA-2 The capital requirement

          • CA-2.1 CA-2.1 Introduction

            • CA-2.1.1

              Islamic banks are allowed two types of own funds to meet their capital requirements for credit risk and market risk, as set out below:

              — Tier 1: Supports the calculation of credit risk weighted assets and at least 28.57% of market risk.
              — Tier 2: Supports credit risk and market risk subject to limitations.

            • CA-2.1.2

              For the purpose of calculating its Capital Adequacy Ratio (CAR), the risk-weighted assets of an Islamic bank consist of the sum of the risk-weighted assets financed by the Islamic bank's own capital and liabilities, plus 50% of the risk-weighted assets financed by the Islamic bank's PSIA. This applies to both unrestricted PSIA that are accounted for on the Islamic bank's balance sheet and restricted PSIA that are accounted for off the balance sheet.

          • CA-2.2 CA-2.2 Definition of capital

            • Tier capital

              • CA-2.2.1

                Tier Capital forms the numerator of the Capital Adequacy Ratio. It is defined as the cornerstone of a bank's strength.

              • CA-2.2.2

                The essential characteristics of capital are that it should:

                (a) Represent a permanent and unrestricted commitment of funds;
                (b) Be freely available to absorb losses and thereby enable a bank to keep operating whilst any problems are resolved;
                (c) Not impose any unavoidable charge on the earnings of the bank.

              • CA-2.2.3

                For the purpose of defining Tier capital, the Agency has broadly adopted the recommendations contained in AAOIFI's Statement on the Purpose and Calculation of Capital Adequacy for Islamic Banks. However, some restrictions have been placed on the inclusion of profit equalisation and investment risk reserve as Tier 2 capital. For components of Tier 1 and Tier 2 capital refer to paragraphs CA-2.2.4 to CA-2.2.5.

            • Tier 1: Core capital

              • CA-2.2.4

                Tier 1 capital shall consist of the sum of items (a) to (b) below, less the sum of items (c) to (d) below:

                (a) Bank's permanent share capital and disclosed reserves in the form of legal, general and other reserves created by appropriations of retained earnings, share premium, capital redemption reserves and other surplus (as shown in its balance sheet), but excluding revaluation reserves and prudential reserves (profit equalisation reserves and investment risk reserve as defined in the AAOIFI's Financial Accounting Standard No: 11 Provisions and Reserves).

                In case of an Islamic fund having participation and / or "B" class shares (not carrying voting rights), their treatment as capital or unrestricted investment accounts (for the purpose these regulations) must be agreed with the Agency. The Agency will consider each case on its merit.
                (b) Minority interests, arising on consolidation, in the equity of subsidiaries that are less than wholly owned.

                LESS:

                (c) Goodwill
                (d) Current year's cumulative net losses which have been reviewed as per the International Standards on Auditing (ISA) by the external auditors.

            • Tier 2: Supplementary capital

              • CA-2.2.5

                Tier 2 capital shall consist of the following items:

                (a) Interim retained profits that 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 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 the future, presently unidentified, losses are freely available to meet losses that 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). Prescriptions ascribed to impairment of particular assets or known liabilities should be excluded.
                (d) Profit equalisation reserve and investment risk reserve as defined in FAS No. 11: Provisions and Reserves, issued by AAOIFI, up to a maximum amount equal to the capital charge pertaining to the 50% the risk weighted assets financed by unrestricted and restricted investment account holders.
                (e) 45% of unrealised gains on equity securities held as available-for-sale (on an aggregate net-basis).

            • Deductions from Tier 1 and Tier 2 capital

              • CA-2.2.6

                For the calculation of capital adequacy on a solo basis, the following item shall be deducted from the sum of Tier 1 and Tier 2 capital (goodwill will have been already deducted from Tier 1 capital):

                (a) Investments in and financing of a capital nature to unconsolidated subsidiaries and associates. 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 adequacy ratio.
                (b) Holdings of own shares and any financing facility provided to the parent company to finance the shares of the subsidiary.

          • CA-2.3 CA-2.3 Limits on the use of different forms of capital

            • CA-2.3.1

              The following constraints apply to the CAR calculations:

              Constraint 1: Tier 2 capital allocated to credit risk (see section A20.7 of guidelines in Appendix BR 3)

              should be less than or equal to

              50% of the Tier 1 capital allocated to credit risk (see section A20.6 of guidelines in Appendix BR 3)
              Constraint 2: Tier 2 capital allocated to market risk (see section A20.13 of guidelines in Appendix BR 3) plus Tier 2 capital allocated to credit risk (see section A20.7 of guidelines in Appendix BR 3)

              should be less than or equal to

              Total Tier 1 capital available (see section A20.1 of guidelines in Appendix BR 3)

          • CA-2.4 CA-2.4 Calculation of the CAR for Islamic banks

            • CA-2.4.1

              Firstly, the banks should calculate minimum capital required (section A20.4 or A9.14 of guidelines in Appendix BR 3) by reference to credit risk in accordance with these regulations, excluding equity securities in the trading book and all positions in commodities. This figure will constitute minimum capital required to cover credit risk (section A20.5 of guidelines in Appendix BR 3).

            • CA-2.4.2

              Secondly, the banks should calculate minimum capital required (section A20.9 or A17.14 of guidelines in Appendix BR 3) by reference to the measure of market risk (i.e. specific risk plus general market risk) in accordance with the regulations contained in section CA-1.4. This figure will constitute minimum capital required to cover market risk (section A21.10 of guidelines in Appendix BR 3).

            • CA-2.4.3

              Thirdly, the amount resulting from the above requirement (section A20.10 of guidelines in Appendix BR 3) should be multiplied by 28.57%. This is the minimum capital charge which should be supported by Tier 1 capital allocated to market risk weighted exposures (section A20.12 of guidelines in Appendix BR 3); therefore, the balance amount in Tier 1 capital should be the amount allocated to support credit risk weighted assets (section A20.6 of guidelines in Appendix BR 3).

            • CA-2.4.4

              The balance of the credit risk weighted assets may be supported by Tier 2 capital amount in section A20.7 of guidelines in Appendix BR 3 (subject to constraint stated in section CA-2.3).

            • CA-2.4.5

              Further, the residual amount in Tier 2 capital (section A20.13 of guidelines in Appendix BR 3) may be used to support the balance subject to the condition stated in paragraph CA-2.4.3.

          • CA-2.5 CA-2.5 Minimum capital ratio requirement

            • CA-2.5.1

              The Agency has established that the minimum capital ratio required for all Islamic banks incorporated in Bahrain is 12%. Furthermore, on a solo basis, the parent bank of a group is required to maintain a minimum RAR of 8.0% (i.e. unconsolidated).

            • Maintaining minimum RAR

              • CA-2.5.2

                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 provide the Agency:

                (a) 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) with a weekly report thereafter on the bank's relevant RAR(s) until such RAR(s) have reached the required target level(s) set out below.

              • CA-2.5.3

                In addition, the Agency considers it a matter of best practice that, in order to ensure that these RARs are constantly met, that 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-2.5.4

                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-2.5.5

                The bank will be required to submit the PIRI forms to the Agency on a monthly basis, until the RAR(s) exceeds its target ratio(s).

              • CA-2.5.6

                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-2.5.7

                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-2.5.8

                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 and CA-3.3, 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;

              (b) Holdings of Gold bullion and coins;

              (c) The government of Bahrain & Bahrain public sector entities;

              (d) Government-owned GCC companies incorporated in Bahrain;

              (e) Central governments and central banks of GCC and OECD countries; and

              (f) Central governments and central banks of classified countries where denominated and funded in local currency.
              20%
              (a) Cash items in process of collection;

              (b) Multilateral development banks;

              (c) Banks and securities firms incorporated in Bahrain, other GCC and OECD countries;

              (d) Banks incorporated in classified countries with a residual maturity less than 1 year;

              (e) Public sector entities in GCC and OECD countries; and

              (f) Government-owned GCC companies incorporated outside Bahrain.
              50% Mortgages backed by residential property
              100%
              (a) Related parties

              (b) Holdings of other banks' and securities firms' capital instruments

              (c) Banks incorporated in classified countries with a residual maturity of over 1 year

              (d) Central governments and central banks of classified countries (not included above)

              (e) Public sector entities of classified countries

              (f) Government-owned companies in non-GCC countries

              (g) Private sector persons and entities in and outside Bahrain

              (h) Istisna'a assets*

              (i) Ijarah / Ijarah Muntahia Bittamleek assets

              (j) Real estate investments

              (k) Other assets not reported elsewhere**

              * This represents balance in Work in Progress/ cost account less billings. However, Istisna'a receivables should be reported against the risk weighting category of the counterparty.

              ** Salam Contracts are subject to market risk and should not be included here.

          • 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.

            • 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
              50% Transaction-related contingent
              20% Trade-related contingencies
              100% Sale and repurchase agreements
              100% Forward asset purchases
              50% Underwriting commitments
              50% Commitments with an original maturity of over 1 year, not unconditionally cancellable at anytime
              0% Commitments with an original maturity of less than 1 year, unconditionally cancellable at anytime

            • 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 GCC and OECD member countries.
              20% Type (b)
              — Banks incorporated in Bahrain or GCC and OECD countries and securities firms.
              — Banks incorporated in classified countries (if the commitment has a residual life of 1 year or less).
              — Public sector entities in GCC and OECD countries.
              — Government-owned (non-banking) GCC companies incorporated outside Bahrain.
              100% Type (c)
              — Banks incorporated in classified countries (if the commitment has a residual life of more than 1 year).
              — Central governments, central banks and public sector entities in classified countries.
              — Government-owned companies incorporated in non-GCC countries.
              — Private sector persons and entities in Bahrain and abroad.

        • CA-4 CA-4 Equity risk

          • CA-4.1 CA-4.1 Introduction

            • CA-4.1.1

              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-4.1.2

              The minimum capital requirement for equities is expressed in terms of two separately calculated charges, one relating to the "specific risk" of holding a long position in an individual equity, and the other to the "general market risk" of holding a long position in the market as a whole.

            • CA-4.1.3

              Where the bank has invested in shares/units of equity funds on Mudaraba financing and the bank has direct exposures in the equities which are traded in a recognised stock exchange, the shares/units are considered to be subject to equity risk. The equity position would be considered to be the net asset value as at the reporting date.

          • CA-4.2 CA-4.2 Specific risk calculation

            • CA-4.2.1

              Specific risk is defined as the bank's gross equity positions (i.e. the sum of all equity positions and is calculated for each country or equity market).

            • CA-4.2.2

              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-4.2.3

              To qualify for reduced 4% capital charge on equity funds, the bank should acquire prior written approval from the Agency.

          • CA-4.3 CA-4.3 General risk calculation

            • CA-4.3.1

              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, taking into account whether the positions are long or short.

            • CA-4.3.2

              The general market equity risk measure is 8% of the overall net position in each national market.

        • CA-5 CA-5 Foreign exchange risk

          • CA-5.1 CA-5.1 Introduction

            • CA-5.1.1

              This section describes the standardised method for calculation of the bank's foreign exchange risk, and the capital required against that risk.

            • CA-5.1.2

              The measurement of the foreign exchange risk involves, as a first step, the calculation of the net open position in each individual currency including gold1 and as a second step, the measurement of the risks inherent in the bank's mix of assets and liabilities positions in different currencies.


              1 Positions in gold should be treated as if they were foreign currency positions, rather than 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.

            • CA-5.1.3

              A bank that holds net open positions (whether assets or liabilities) 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. Where the bank is involved in option transactions, these should be agreed in advance with the Agency. The Agency will consider the appropriate treatment on a case by case basis.

            • CA-5.1.4

              The open positions and the capital requirements are calculated with reference to the entire business (i.e. the banking and trading books).

            • CA-5.1.5

              The open positions are calculated with reference to the bank's base currency, which will be either Bahraini Dinars (BD) or United States dollars (USD).

            • CA-5.1.6

              In addition to foreign exchange risk, positions in foreign currencies may be subject to credit risk which should be treated separately.

          • CA-5.2 CA-5.2 De Minimis exemptions

            • CA-5.2.1

              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 and as 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 asset positions and the sum of the gross liability position in all foreign positions and gold, does not exceed 100% of its eligible capital; and
              (b) The bank's overall net open position, as defined in section CA-5.3, does not exceed 2% of its eligible capital.

            • CA-5.2.2

              The criteria listed in paragraph CA-5.2.1 above are only intended to be guidelines, and a bank will not automatically qualify for exemptions upon meeting them. Banks doing negligible foreign currency business, which do not take foreign exchange positions for the bank's own account, and wish to seek exemption from foreign exchange risk capital requirements, should submit an application to the Agency, in writing. The Agency will have the discretion to grant such exemptions. The Agency may also, at its discretion, fix a minimum capital requirement for a bank that is exempted from calculating its foreign exchange risk capital requirement, to cover the risks inherent in its foreign currency business.

            • CA-5.2.3

              The Agency may, at a future date, revoke an exemption granted to a bank, if the Agency is convinced that the conditions on which the exemption was granted no longer exist.

          • CA-5.3 CA-5.3 Calculation of net open positions

            • CA-5.3.1

              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 profit, 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);
              (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) Profits (i.e. the net value of income and expense accounts) held in the currency in question; and
              (e) 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.

            • CA-5.3.2

              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-5.3.3

              Where gold is part of a forward contract (i.e. quantity of gold to be received or to be delivered), any foreign currency exposure from the other leg of the contract should be reported.

            • Structural positions

              • CA-5.3.4

                Positions of a structural nature (i.e. non-dealing), may be excluded from the calculation of the net open currency positions, these include positions related to items that are deducted from the bank's capital when calculating its capital base in accordance with the rules and guidelines issued by the Agency, such as investments denominated in foreign currencies in non-consolidated subsidiaries.

              • CA-5.3.5

                The Agency will consider approving the exclusion of the above positions for the purpose of calculating the capital requirement, only if each of the following conditions is met:

                (a) 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 nature (i.e. non-dealing) and are merely intended to protect the bank's capital adequacy ratio. For this purpose, the Agency may ask written representations from the bank's management or Directors.
                (b) Any exclusion of a position is consistently applied, with the treatment of the structural positions remaining the same for the life of the associated assets or other items.

            • Calculation of the overall net open position

              • CA-5.3.6

                The net 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 liabilities positions or the sum of the net asset positions whichever is greater
                (b) The net position (liabilities and assets) in gold, regardless of sign

              • CA-5.3.7

                Where the bank is assessing its foreign exchange 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-5.4 CA-5.4 Calculation of the capital charge

            • CA-5.4.1

              The capital charge is 8% of the overall net open foreign currency position.

            • CA-5.4.2

              The table below illustrates the calculation of the overall net open foreign currency position and the capital charge:

              Example of the calculation of the foreign exchange overall net open position and the capital charge

              GBP DEM SAR US$ JPY GOLD
              +200 +100 +70 −190 −40 −50
                         
              +370
              −230
              50

              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. 370) and of the net position in gold (i.e. 50) = 420 @ 8% = 33.6

            • CA-5.4.3

              For illustration and calculation of the overall net open position and the capital charge for unrestricted / restricted investment account and corporate book, refer to section CA-5.3.

        • CA-6 CA-6 Commodities risk

          • CA-6.1 CA-6.1 Introduction

            • CA-6.1.1

              This section 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-5).

            • CA-6.1.2

              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-6.1.3

              The price risk in commodities is often more complex and volatile than that associated with currencies. Banks need to guard against the risk that arises when a liability (i.e. in a Parallel Salam transaction) position falls due before the asset position (i.e. a failure associated with or delay in the Salam contract). Owing to a shortage of liquidity in some markets, it might be difficult to close the Parallel Salam position and the bank might be "squeezed by the market". All these commodity market characteristics can result in price transparency and the effective management of risk.

            • CA-6.1.4

              All contracts (Salam, Musharaka or Mudaraba) involving commodities as defined in section CA-1.3 are subject to commodities risk and a capital charge as per the provisions outlined in sections CA-6.2 to CA-6.4 should be computed.

            • CA-6.1.5

              Banks should adopt either the simplified approach to calculate their commodities risk and the resultant capital charges or the maturity ladder approach. Where banks have Salam and Parallel Salam contracts, the maturity ladder approach must be used.

          • CA-6.2 CA-6.2 Calculation of commodities positions

            • CA-6.2.1

              Banks will first express each commodity position (i.e. Salam and Parallel Salam) in terms of the standard unit of measurement (i.e. barrels, kilograms, grams, etc). Asset and liability 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-6.2.2

              Positions in different commodities cannot be offset for the purpose of calculating the open-positions as described in paragraph CA-6.2.1 above. However, where one or more sub-categories2 of the same category is in effect and are directly deliverable against each other, netting between those sub-categories is permitted. Furthermore, if two or more sub-categories of the same category is 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.


              2 Commodities can be grouped into clan, 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.

            • CA-6.2.3

              Banks, which wish to net positions based on correlation (in the manner discussed in paragraph CA-6.2.2 above), will need to satisfy the Agency of the accuracy of the method which it proposes to adopt.

          • CA-6.3 CA-6.3 Maturity Ladder Approach

            • CA-6.3.1

              A worked example of the maturity ladder approach is set out in Appendix CA 1 and the table below illustrates the maturity time-bands of the maturity ladder for each commodity. As stated in section CA-6.1, banks having Salam and Parallel Salam transactions must use the maturity ladder approach.

            • CA-6.3.2

              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-6.2. The net positions in commodities are calculated as explained in section CA-6.2.
              (b) Asset and liability positions in the same time-band are matched. The sum of the matched asset and liability positions is multiplied first by the spot price of the commodity, and then by a spread of 1.5% for each time-band as set out in the table below. This represents the capital charge in order to capture all risks within a time-band (which, together, are sometimes referred to as curvature risk).

              Time band3
              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. asset against liability 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 management 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), there will be either asset or liability 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 in order to capture the market risk on this business and to enable the Agency to evaluate whether the models approach should be adopted by the bank.

              3 Instruments, where the maturity is on the boundary of two maturity time-bands, 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-6.4 CA-6.4 Simplified Approach

            • CA-6.4.1

              Banks who do not enter into Salam and Parallel Salam transactions and do not have any short positions in commodities may use the simplified approach to compute the capital charge. In the simplified approach, the capital charge is computed at 15% of the net position. Net positions in commodities are calculated as explained in section CA-6.2. For the time being the Agency is not requiring additional 3% capital charge for basis risk.

        • CA-7 CA-7 Gearing requirements

          • CA-7.1 CA-7.1 Gearing

            • CA-7.1.1

              The content of this chapter is applicable to locally incorporated banks and FCB branches (licensed by the Agency) of foreign banks.

            • Measurement

              • CA-7.1.2

                The Gearing ratio is measured with reference to the ratio of deposit liabilities against the bank's capital and reserves as reported in its PIRI.

            • Gearing limit

              • CA-7.1.3

                For Full Commercial Bank and Offshore Banking Unit licensees, deposit liabilities should not exceed 20 times the respective bank's capital and reserves.

              • CA-7.1.4

                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

            • 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 risk measurement for the calculation of capital requirements by banks referred to under CA-A.1.1. 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

              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.2.3

              The Central Bank requires in particular that the relevant banks maintain adequate capital, in accordance with the Regulation in this Module, against their risks.

              October 07

            • CA-A.2.4

              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.2.5

              The requirements specified in this Module vary according to the Category of Islamic bank licensee concerned, their inherent risk profile, and the volume and type of business undertaken. The purpose of such requirements is to ensure that Islamic 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

            • Legal Basis

              • CA-A.2.6

                This Module contains the CBB's Directive relating to the capital adequacy of Islamic 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 Islamic 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 on 1st January 2005 as part of the Islamic principles volume. All regulations 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.

              October 07

            • CA-A.3.2

              A list of 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.1 10/2007 New Rule CA-A.1.4 introduced, categorising this Module as a Directive.
              CA-1.1 10/2007 Minor change to notification period in Rule CA-1.1.4.
              October 07

            • Evolution of the Module

              • CA-A.3.3

                Prior to the development of Rulebook, the Central Bank had issued various circulars 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
                PIRI BC/09/01 26 Nov 2001 CA Prudential Information Returns for Islamic Financial Institutions
                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.3.4

                The contents in this Module are effective from the date depicted in the original circulars (see Paragraph CA-A.3.3) 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: The management of banks' off-balance-sheet exposures – a supervisory perspective

            October 07

            • CA-B.1.1

              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.1.2

              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 fiduciary and displaced commercial risk, credit and market risk capital requirements.

              October 07

            • CA-1.1.2

              Fiduciary Risk is outlined in the IFSB Guiding Principles on Corporate Governance (Principle 2.1, Paragraphs 22 onward). Displaced Commercial Risk is defined in the IFSB Exposure Draft No4 (Paragraphs 83 onward). Both papers are available at the IFSB website (www.ifsb.org).

              October 07

            • CA-1.1.3

              Credit risk is defined as the potential that a bank's 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-1.1.4

              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 equities in the trading book;
              (b) Foreign exchange risk throughout the bank; and
              (c) Commodity risk throughout the bank.
              October 07

          • CA-1.2 CA-1.2 Measuring fiduciary and displacement risks

            • CA-1.2.1

              Islamic banks mobilise funds on a profit and loss sharing basis (PLS). However, certain risks are associated with such PLS accounts. These risks are referred to as fiduciary and displaced commercial risk.

              October 07

            • CA-1.2.2

              To cater for these risks the Central Bank has accepted the recommendations contained in the AAOIFI's statements and requires the inclusion of 50% of the risk weighted assets of the Profit Sharing Investment Accounts (PSIA) in the denominator of the capital adequacy ratio.

              October 07

          • CA-1.3 CA-1.3 Measuring credit risks

            • CA-1.3.1

              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-1.3.2

              The Central Bank has adopted the risk weightings recommended by the Basel Committee on Banking Supervision, where applicable. However, the Basel Committee does not define the risk weightings for some of the specific Islamic contracts.

              October 07

            • CA-1.3.3

              In Islamic banking, the legal form is as important as the substance of the transaction otherwise the transaction would not be permissible under Shari'a. Therefore, when assigning risk weights to the various Islamic contracts, banks should consider the legal form of the transactions as well as the substance.

              October 07

            • CA-1.3.4

              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 within the banking book.

              October 07

            • CA-1.3.5

              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-1.3.6

              The Central Bank has addressed the issue of the risk weightings for some of the commonly used Islamic contracts. If banks are involved in contracts not covered below they should contact the Central Bank and agree on an appropriate risk-weighting Category.

              October 07

            • Murabaha and Murabaha to the purchase orderer

              • CA-1.3.7

                The Central Bank as a policy requires that all Murabaha contracts be based on binding promises. The Murabaha receivables should be assigned a risk weight based on the credit standing of the obligor as recommended by the Basel Committee.

                October 07

            • Mudaraba contracts

              • CA-1.3.8

                Mudaraba contracts should be assigned a risk weighting according to the underlying investments. Where Mudaraba funds are invested in securities listed on recognised exchanges and the price volatility is based on market movements, these should be removed from credit risk weightings and subject to market risk regulations. Examples would be equity Mudarabas where banks may have direct exposure in the value of the underlying equities or commodity Mudarabas.

                October 07

              • CA-1.3.9

                Investments in other Mudarabas such as real estate or leasing should be assigned risk weightings according to the standing of the underlying investment as per the Basel Capital Accord.

                October 07

              • CA-1.3.10

                Where a Mudaraba fund invests in another Mudaraba contract, which in turn makes investments at its own discretion, the risk weight would be based on the credit standing of the counterparty (investee Mudarib) as recommended by the Basel Committee. Investments in particular asset classes made at the discretion of the (investor) Mudaraba fund should be assigned risk weighting according to the underlying investments, where possible.

                October 07

            • Musharaka contracts

              • CA-1.3.11

                Musharaka contracts refer to partnerships in specific transactions or projects. These exclude participation in the share capital (equity) of other enterprises. Risk weights should be assigned in accordance with the standings of the underlying investment as per the guidelines of the Basel Committee. Musharaka in real estate, plant and machinery or other similar assets attract a 100% risk weighting.

                October 07

              • CA-1.3.12

                Musharakas in trading transactions will attract risk weighting as per the standing of the underlying investment, which in all cases would attract a 100% risk weighting. Where the transaction involves trading in commodities which may be traded in secondary markets, these should be removed from credit risk weighting and subjected to market risk regulations.

                October 07

              • CA-1.3.13

                In cases where it is difficult to ascertain the composition of the underlying asset, risk weight would be assigned based on the credit standing of the counterparty.

                October 07

            • Ijarah / Ijarah Muntahia Bittamleek assets

              • CA-1.3.14

                Under Shari'a, substantial risks and rewards of ownership of assets may not be transferred to lessees. Therefore, assets acquired for the purpose of leasing under Ijarah or Ijarah Muntahia Bittamleek contracts should be carried on the balance sheet of the lessor and assigned a risk weighting of 100%.

                October 07

              • CA-1.3.15

                However, where these are residential properties, leased under Ijarah Muntahia Bittamleek with the lessee's option to buy at the end of the lease term and to use the properties for residential purposes, a 50% risk weighting is assigned, where the lessor has a first enforceable charge on the assets.

                October 07

            • Istisna'a and parallel Istisna'a contracts

              • CA-1.3.16

                The accounting for these contracts should be in accordance with Financial Accounting Standard (FAS) No. 10: Istisna'a and Parallel Istisna'a, issued by AAOIFI.

                October 07

              • CA-1.3.17

                Istisna'a and parallel Istisna'a contracts would attract risk weighting as per the credit standing of the respective counterparties in accordance with the Basel Committee.

                October 07

            • Salam and parallel Salam

              • CA-1.3.18

                Amounts paid in respect of Salam contracts (for which there exists a parallel Salam contract) should normally be assigned a risk weight as per the credit standing of the customer in accordance with the Basel Committee.

                October 07

              • CA-1.3.19

                Salam and parallel Salam contracts would attract risk weighting as per the credit standing of the respective counterparties in accordance with the Basel Committee.

                October 07

            • Participations and equity investments

              • CA-1.3.20

                The supervision of banks for capital adequacy purposes is carried out on a consolidated basis, taking into account all holdings of the capital of other entities by the concerned bank. For subsidiaries, the preferred mode of consolidation is to add the assets and liabilities into the accounts of the parent on a line-by-line basis. For associate companies (i.e. where the parent bank owns 20% or more of the voting stock, and/or has voting control of the concerned company), the assets and liabilities should also be consolidated on a line-by-line basis. If banks do not wish to consolidate subsidiaries or associates (that meet the above criteria), they must contact the Central Bank to agree on the accounting treatment to be used. Participations and investments which amount to below 20% of the voting capital of the concerned company should be accounted for at fair value and weighted at 100%.

                October 07

              • CA-1.3.21

                Banks which have subsidiary and associate companies must also be supervised for capital adequacy on a solo basis (i.e. after deducting all holdings of the share capital of all subsidiaries and associates (that meet the criteria in Paragraph CA-1.3.20 above) and excluding all their assets and liabilities from the accounts of the parent bank). Holdings of other participations and equity investments need not be deducted on a solo basis, but should be accounted for at fair value and weighted at 100%. Banks should note Paragraph CA-2.2.6 in respect of the treatment described in this Paragraph and in Paragraph CA-1.3.20.

                October 07

            • Intra fund balances

              • CA-1.3.22

                Transactions between the corporate book (i.e. self-financed and financed by unrestricted investment accounts) and restricted investment accounts are not allowed, unless approved by the Central Bank on a temporary basis.

                October 07

              • CA-1.3.23

                If permitted by the Central Bank, on a temporary basis, the following weightings will be applied:

                (a) Corporate or unrestricted investment funds invested in Restricted Investment Accounts.

                Risk weighting would be assigned on the underlying asset as per the Basel Committee Guidelines and in accordance with the guidance set out under Chapters CA-1 to CA-6.
                (b) Restricted investment account funds invested in corporate books.
                (i) In the corporate books, the assets financed by restricted investment accounts would be included as part of the corporate assets and risk weighting assigned in accordance with the guidelines.
                (ii) 0% risk weighting should be assigned to the funds invested by the restricted investment accounts in the corporate books in order to avoid double counting as the resultant assets are already risk weighted in the Bank's books.
                (iii) Banks must agree with the Central Bank on the treatment of investments by restricted investment accounts in the corporate book. The Central Bank will consider each case on its merit.
                October 07

          • CA-1.4 CA-1.4 Measuring market risks

            • Trading book

              • CA-1.4.1

                The trading book means the bank's positions in financial instruments (including off-balance sheet instruments that 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 variations, and positions in financial instruments arising from matched principal brokering and market making). Treatment of risks associated with any option transactions should be agreed in advance with the Central Bank, who will consider the issue on a case by case basis.

                October 07

              • CA-1.4.2

                Each bank should agree to a written policy statement with the Central Bank as to which activities are normally considered trading and constitute part of the trading book. Trading book's definition should be consistently applied by the bank from year to year.

                October 07

              • CA-1.4.3

                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-1.4.1 above.

                October 07

            • Equity risk

              • CA-1.4.4

                The capital charges for 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-1.4.5

                The capital charges for foreign exchange risk and for commodity 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-5.3 of these regulations.

                October 07

            • Exemptions

              • CA-1.4.6

                Banks will be allowed certain de minimis exemptions from the capital requirements for foreign exchange risk, as described in Section CA-5.2 of these regulations. For the time being, there shall be no exemptions from the trading requirements, or from the capital requirements for commodity risk.

                October 07

            • Bank's own fund and Profit and Loss Sharing Investment Accounts (PSIA)

              • CA-1.4.7

                Banks must compute capital charges for own funds subject to market risk, as well as those of the PSIA. For the purpose of computing the capital adequacy ratio, 50% of the bank's market risk weighted assets relating to the PSIA (restricted and unrestricted) must be included in accordance with AAOIFI's Statement on Purpose and Calculation of the Capital Adequacy Ratio for Islamic Banks.

                October 07

            • Consolidation

              • CA-1.4.8

                As with the credit risk capital requirements, the market risk capital requirements 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, 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-1.4.9

                Notwithstanding that the market risk capital requirements apply on a worldwide consolidated basis, the Central Bank also monitors 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 is 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-1.4.10

                For the measurement of their market risks, banks will measure the risks in a standardised manner, using the measurement framework described in Chapters CA-4 to CA-6.

                October 07

              • CA-1.4.11

                The standardised methodology uses a 'building block' in which the capital charge for each risk Category is determined separately. For equity positions risk, separate capital charge for specific risk and the general market risk arising from these positions are calculated. The specific market risk is defined as the risk of loss caused by an adverse price movement of a security/ units due principally to factors related to the issuer. The general market risk is defined as the risk of loss arising from adverse changes in aggregate market prices. For commodities and foreign exchange, there is only one general market risk capital requirement.

                October 07

              • CA-1.4.12

                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-1.4.13

                Formal reporting, to the Central Bank, of the market risk exposure and capital adequacy shall take place as at the end of each calendar quarter. The returns relating to any quarter should be submitted to the Central Bank by the 20th day of the first month of the following quarter. Furthermore, 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). Banks are also expected to maintain strict risk management systems to ensure that their intra-day exposures are not excessive.

                October 07

              • CA-1.4.14

                Banks' daily compliance with the capital requirements for market risk will 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 bank's 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 must 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-1.4.15

                Besides what is stated in Paragraph CA-1.4.14 above, 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-1.5 CA-1.5 Reporting

            • CA-1.5.1

              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

          • CA-1.6 CA-1.6 Summary of overall capital adequacy requirements

            • CA-1.6.1

              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-1.4. The bank's overall minimum capital requirement will be:

              (a) The credit risk requirements laid down in these regulations; PLUS
              (b) The capital charges for market risks calculated according to the measurement frameworks described in Chapters CA-4 to CA-6, summed arithmetically.
              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 components (as defined in Rules CA-2.2.1 to CA-2.2.6), subject to the restrictions set out in Section CA-2.3:

              •   Tier 1: Supports the calculation of credit risk weighted assets and at least 28.57% of market risk.
              •   Tier 2: Supports credit risk and market risk subject to limitations.
              October 07

            • CA-2.1.2

              For the purpose of calculating its Capital Adequacy Ratio (CAR), the risk-weighted assets of an Islamic bank consist of the sum of the risk-weighted assets financed by the Islamic bank's own capital and liabilities, plus 50% of the risk-weighted assets financed by the Islamic bank's PSIA. This applies to both unrestricted PSIA that are accounted for on the Islamic bank's balance sheet and restricted PSIA that are accounted for off the balance sheet.

              October 07

          • CA-2.2 CA-2.2 Definition of capital

            • Tier 1 capital

              • CA-2.2.1

                Tier Capital forms the numerator of the Capital Adequacy Ratio. It is defined as the cornerstone of a bank's strength.

                October 07

              • CA-2.2.2

                The essential characteristics of capital are that it should:

                (a) Represent a permanent and unrestricted commitment of funds;
                (b) Be freely available to absorb losses and thereby enable a bank to keep operating whilst any problems are resolved;
                (c) Not impose any unavoidable charge on the earnings of the bank.
                October 07

              • CA-2.2.3

                For the purpose of defining Tier capital, the Central Bank has broadly adopted the recommendations contained in AAOIFI's Statement on the Purpose and Calculation of Capital Adequacy for Islamic Banks. However, some restrictions have been placed on the inclusion of profit equalisation and investment risk reserve as Tier 2 capital. For components of Tier 1 and Tier 2 capital refer to Paragraphs CA-2.2.1 to CA-2.2.6.

                October 07

            • Tier 1: Core capital

              • CA-2.2.4

                Tier 1 capital shall consist of the sum of items (a) to (b) below, less the sum of items (c) to (d) below:

                (a) Bank's permanent share capital and disclosed reserves in the form of legal, general and other reserves created by appropriations of retained earnings, share premium, capital redemption reserves and other surplus (as shown in its balance sheet), but excluding revaluation reserves and prudential reserves (profit equalisation reserves and investment risk reserve as defined in the AAOIFI's Financial Accounting Standard No: 11 Provisions and Reserves).

                In case of an Islamic fund having participation and / or 'B' class shares (not carrying voting rights), their treatment as capital or unrestricted investment accounts (for the purpose these regulations) must be agreed with the Central Bank. The Central Bank will consider each case on its merit.
                (b) Minority interests, arising on consolidation, in the equity of subsidiaries that are less than wholly owned.

                LESS:
                (c) Goodwill
                (d) Current year's cumulative net losses which have been reviewed as per the International Standards on Auditing (ISA) by the external auditors.
                October 07

            • Tier 2: Supplementary capital

              • CA-2.2.5

                Tier 2 capital shall consist of the following items:

                (a) Interim retained profits that 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 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 the future, presently unidentified, losses are freely available to meet losses that 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). Prescriptions ascribed to impairment of particular assets or known liabilities should be excluded.
                (d) Profit equalisation reserve and investment risk reserve as defined in FAS No. 11: Provisions and Reserves, issued by AAOIFI, up to a maximum amount equal to the capital charge pertaining to the 50% the risk weighted assets financed by unrestricted and restricted investment account holders.
                (e) 45% of unrealised gains on equity securities held as available-for-sale (on an aggregate net-basis).
                October 07

            • Deductions from Tier 1 and Tier 2 capital

              • CA-2.2.6

                For the calculation of capital adequacy on a solo basis, the following item shall be deducted from the sum of Tier 1 and Tier 2 capital (goodwill will have been already deducted from Tier 1 capital):

                (a) Investments in and financing of a capital nature to unconsolidated subsidiaries and associates. 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 adequacy ratio.
                (b) Holdings of own shares and any financing facility provided to the parent company to finance the shares of the subsidiary.
                October 07

          • CA-2.3 CA-2.3 Limits on the use of different forms of capital

            • CA-2.3.1

              The following constraints apply to the CAR calculations:

              Constraint 1: Tier 2 capital allocated to credit risk (see Section A20.7 of guidelines in Appendix BR-3)

              should be less than or equal to


              50% of the Tier 1 capital allocated to credit risk (see Section A20.6 of guidelines in Appendix BR-3)
              Constraint 2: Tier 2 capital allocated to market risk (see Section A20.13 of guidelines in Appendix BR-3) plus Tier 2 capital allocated to credit risk (see Section A20.7 of guidelines in Appendix BR-3)

              should be less than or equal to

              Total Tier 1 capital available (see Section A20.1 of guidelines in Appendix BR-3)
              October 07

          • CA-2.4 CA-2.4 Calculation of the CAR for Islamic banks

            • CA-2.4.1

              Firstly, the banks should calculate minimum capital required (Section A20.4 or A9.14 of guidelines in Appendix BR-3) by reference to credit risk in accordance with these regulations, excluding equity securities in the trading book and all positions in commodities. This figure will constitute minimum capital required to cover credit risk (Section A20.5 of guidelines in Appendix BR-3).

              October 07

            • CA-2.4.2

              Secondly, the banks should calculate minimum capital required (Section A20.9 or A17.14 of guidelines in Appendix BR-3) by reference to the measure of market risk (i.e. specific risk plus general market risk) in accordance with the regulations contained in Section CA-1.4. This figure will constitute minimum capital required to cover market risk (Section A21.10 of guidelines in Appendix BR-3).

              October 07

            • CA-2.4.3

              Thirdly, the amount resulting from the above requirement (Section A20.10 of guidelines in Appendix BR-3) should be multiplied by 28.57%. This is the minimum capital charge which should be supported by Tier 1 capital allocated to market risk weighted exposures (Section A20.12 of guidelines in Appendix BR-3); therefore, the balance amount in Tier 1 capital should be the amount allocated to support credit risk weighted assets (Section A20.6 of guidelines in Appendix BR-3).

              October 07

            • CA-2.4.4

              The balance of the credit risk weighted assets may be supported by Tier 2 capital amount in Section A-20.7 of guidelines in Appendix BR-3 (subject to constraint stated in Section CA-2.3).

              October 07

            • CA-2.4.5

              Further, the residual amount in Tier 2 capital (Section A-20.13 of guidelines in Appendix BR-3) may be used to support the balance subject to the condition stated in Paragraph CA-2.4.3.

              October 07

          • CA-2.5 CA-2.5 Minimum capital ratio requirement

            • CA-2.5.1

              The Central Bank has established that the minimum capital ratio required for all Islamic banks incorporated in Bahrain is 12%. 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

            • Maintaining minimum RAR

              • CA-2.5.2

                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 provide the Central Bank:

                (a) 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) With a weekly report 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-2.5.3

                In addition, the Central Bank considers it a matter of best practice that, in order to ensure that these RARs are constantly met, that 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-2.5.4

                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-2.5.5

                The bank will be required to submit the PIRI forms to the Central Bank on a monthly basis, until the RAR(s) exceeds its target ratio(s).

                October 07

              • CA-2.5.6

                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-2.5.7

                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-2.5.8

                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 and CA-3.3, 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;
              (b) Holdings of Gold bullion and coins;
              (c) The government of Bahrain & Bahrain public sector entities;
              (d) Government-owned GCC companies incorporated in Bahrain;
              (e) Central governments and central banks of GCC and OECD countries; and
              (f) Central governments and central banks of classified countries where denominated and funded in local currency.
              20%
              (a) Cash items in process of collection;
              (b) Multilateral development banks;
              (c) Banks and securities firms incorporated in Bahrain, other GCC and OECD countries;
              (d) Banks incorporated in classified countries with a residual maturity less than 1 year;
              (e) Public sector entities in GCC and OECD countries; and
              (f) Government-owned GCC companies incorporated outside Bahrain.
              50% Mortgages backed by residential property
              100%
              (a) Related parties
              (b) Holdings of other banks' and securities firms' capital instruments
              (c) Banks incorporated in classified countries with a residual maturity of over 1 year
              (d) Central governments and central banks of classified countries (not included above)
              (e) Public sector entities of classified countries
              (f) Government-owned companies in non-GCC countries
              (g) Private sector persons and entities in and outside Bahrain
              (h) Istisna'a assets*
              (i) Ijarah / Ijarah Muntahia Bittamleek assets
              (j) Real estate investments
              (k) Other assets not reported elsewhere**

              * This represents balance in Work in Progress/ cost account less billings. However, Istisna'a receivables should be reported against the risk weighting Category of the counterparty.

              ** Salam Contracts are subject to market risk and should not be included here.

              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.

              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
              50% Transaction-related contingent
              20% Trade-related contingencies
              100% Sale and repurchase agreements
              100% Forward asset purchases
              50% Underwriting commitments
              50% Commitments with an original maturity of over 1 year, not unconditionally cancellable at anytime
              0% Commitments with an original maturity of less than 1 year, unconditionally cancellable at anytime
              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 GCC and OECD member countries.
              20% Type (b)
               
              •  Banks incorporated in Bahrain or GCC and OECD countries and securities firms.
              •  Banks incorporated in classified countries (if the commitment has a residual life of 1 year or less).
              •  Public sector entities in GCC and OECD countries.
              •  Government-owned (non-banking) GCC companies incorporated outside Bahrain.
              100% Type (c)
               
              •  Banks incorporated in classified countries (if the commitment has a residual life of more than 1 year).
              •  Central governments, central banks and public sector entities in classified countries.
              •  Government-owned companies incorporated in non-GCC countries.
              •  Private sector persons and entities in Bahrain and abroad.
              October 07

        • CA-4 CA-4 Equity risk

          • CA-4.1 CA-4.1 Introduction

            • CA-4.1.1

              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-4.1.2

              The minimum capital requirement for equities is expressed in terms of two separately calculated charges, one relating to the 'specific risk' of holding a long position in an individual equity, and the other to the 'general market risk' of holding a long position in the market as a whole.

              October 07

            • CA-4.1.3

              Where the bank has invested in shares/units of equity funds on Mudaraba financing and the bank has direct exposures in the equities which are traded in a recognised stock exchange, the shares/units are considered to be subject to equity risk. The equity position would be considered to be the net asset value as at the reporting date.

              October 07

          • CA-4.2 CA-4.2 Specific risk calculation

            • CA-4.2.1

              Specific risk is defined as the bank's gross equity positions (i.e. the sum of all equity positions and is calculated for each country or equity market).

              October 07

            • CA-4.2.2

              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-4.2.3

              To qualify for reduced 4% capital charge on equity funds, the bank should acquire prior written approval from the Central Bank.

              October 07

          • CA-4.3 CA-4.3 General risk calculation

            • CA-4.3.1

              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, taking into account whether the positions are long or short.

              October 07

            • CA-4.3.2

              The general market equity risk measure is 8% of the overall net position in each national market.

              October 07

        • CA-5 CA-5 Foreign exchange risk

          • CA-5.1 CA-5.1 Introduction

            • CA-5.1.1

              This Section describes the standardised method for calculation of the bank's foreign exchange risk, and the capital required against that risk.

              October 07

            • CA-5.1.2

              The measurement of the foreign exchange risk involves, as a first step, the calculation of the net open position in each individual currency including gold1 and as a second step, the measurement of the risks inherent in the bank's mix of assets and liabilities positions in different currencies.


              1 Positions in gold should be treated as if they were foreign currency positions, rather than 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.

              October 07

            • CA-5.1.3

              A bank that holds net open positions (whether assets or liabilities) 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. Where the bank is involved in option transactions, these should be agreed in advance with the Central Bank. The Central Bank will consider the appropriate treatment on a case by case basis.

              October 07

            • CA-5.1.4

              The open positions and the capital requirements are calculated with reference to the entire business (i.e. the banking and trading books).

              October 07

            • CA-5.1.5

              The open positions are calculated with reference to the bank's base currency, which will be either Bahrain Dinars (BD) or United States dollars (USD).

              October 07

            • CA-5.1.6

              In addition to foreign exchange risk, positions in foreign currencies may be subject to credit risk which should be treated separately.

              October 07

          • CA-5.2 CA-5.2 De Minimis exemptions

            • CA-5.2.1

              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 Central Bank and as evidenced by the Central Bank's prior written approval, be exempted from calculating the capital requirements on these positions. The Central Bank 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 asset positions and the sum of the gross liability position in all foreign positions and gold, does not exceed 100% of its eligible capital; and
              (b) The bank's overall net open position, as defined in Section CA-5.3, does not exceed 2% of its eligible capital.
              October 07

            • CA-5.2.2

              The criteria listed in Paragraph CA-5.2.1 above are only intended to be guidelines, and a bank will not automatically qualify for exemptions upon meeting them. Banks doing negligible foreign currency business, which do not take foreign exchange positions for the bank's own account, and wish to seek exemption from foreign exchange risk capital requirements, should submit an application to the Central Bank, in writing. The Central Bank will have the discretion to grant such exemptions. The Central Bank may also, at its discretion, fix a minimum capital requirement for a bank that is exempted from calculating its foreign exchange risk capital requirement, to cover the risks inherent in its foreign currency business.

              October 07

            • CA-5.2.3

              The Central Bank may, at a future date, revoke an exemption granted to a bank, if the Central Bank is convinced that the conditions on which the exemption was granted no longer exist.

              October 07

          • CA-5.3 CA-5.3 Calculation of net open positions

            • CA-5.3.1

              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 profit, 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);
              (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) Profits (i.e. the net value of income and expense accounts) held in the currency in question; and
              (e) 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.
              October 07

            • CA-5.3.2

              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.

              October 07

            • CA-5.3.3

              Where gold is part of a forward contract (i.e. quantity of gold to be received or to be delivered), any foreign currency exposure from the other leg of the contract should be reported.

              October 07

            • Structural positions

              • CA-5.3.4

                Positions of a structural nature (i.e. non-dealing), may be excluded from the calculation of the net open currency positions, these include positions related to items that are deducted from the bank's capital when calculating its capital base in accordance with the rules and guidelines issued by the Central Bank, such as investments denominated in foreign currencies in non-consolidated subsidiaries.

                October 07

              • CA-5.3.5

                The Central Bank will consider approving the exclusion of the above positions for the purpose of calculating the capital requirement, only if each of the following conditions is met:

                (a) The concerned bank provides adequate documentary evidence to the Central Bank which establishes the fact that the positions proposed to be excluded are, indeed, of a structural nature (i.e. non-dealing) and are merely intended to protect the bank's capital adequacy ratio. For this purpose, the Central Bank may ask written representations from the bank's management or Directors.
                (b) Any exclusion of a position is consistently applied, with the treatment of the structural positions remaining the same for the life of the associated assets or other items.
                October 07

            • Calculation of the overall net open position

              • CA-5.3.6

                The net 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 liabilities positions or the sum of the net asset positions whichever is greater
                (b) The net position (liabilities and assets) in gold, regardless of sign
                October 07

              • CA-5.3.7

                Where the bank is assessing its foreign exchange 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.

                October 07

          • CA-5.4 CA-5.4 Calculation of the capital charge

            • CA-5.4.1

              The capital charge is 8% of the overall net open foreign currency position.

              October 07

            • CA-5.4.2

              The table below illustrates the calculation of the overall net open foreign currency position and the capital charge:

              October 07

            • Example of the calculation of the foreign exchange overall net open position and the capital charge

              GBP DEM SAR US$ JPY GOLD
              +200 +100 +70 -190 -40 -50
                         
              +370 -230 50

              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. 370) and of the net position in gold (i.e. 50) = 420 @ 8% = 33.6

              October 07

              • CA-5.4.3

                For illustration and calculation of the overall net open position and the capital charge for unrestricted / restricted investment account and corporate book, refer to Section CA-5.3.

                October 07

        • CA-6 CA-6 Commodities risk

          • CA-6.1 CA-6.1 Introduction

            • CA-6.1.1

              This Section 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-5).

              October 07

            • CA-6.1.2

              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).

              October 07

            • CA-6.1.3

              The price risk in commodities is often more complex and volatile than that associated with currencies. Banks need to guard against the risk that arises when a liability (i.e. in a Parallel Salam transaction) position falls due before the asset position (i.e. a failure associated with or delay in the Salam contract). Owing to a shortage of liquidity in some markets, it might be difficult to close the Parallel Salam position and the bank might be 'squeezed by the market'. All these commodity market characteristics can result in price transparency and the effective management of risk.

              October 07

            • CA-6.1.4

              All contracts (salam, musharaka or mudaraba) involving commodities as defined in Section CA-1.3 are subject to commodities risk and a capital charge as per the provisions outlined in Sections CA-6.2 to CA-6.4 should be computed.

              October 07

            • CA-6.1.5

              Banks should adopt either the simplified approach to calculate their commodities risk and the resultant capital charges or the maturity ladder approach. Where banks have Salam and Parallel Salam contracts, the maturity ladder approach must be used.

              October 07

          • CA-6.2 CA-6.2 Calculation of commodities positions

            • CA-6.2.1

              Banks will first express each commodity position (i.e. Salam and Parallel Salam) in terms of the standard unit of measurement (i.e. barrels, kilograms, grams, etc). Asset and liability 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.

              October 07

            • CA-6.2.2

              Positions in different commodities cannot be offset for the purpose of calculating the open-positions as described in Paragraph CA-6.2.1 above. However, where one or more sub-categories2 of the same Category are in effect and are directly 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 Central Bank, net positions in those sub-categories.


              2 Commodities can be grouped into clan, 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.

              October 07

            • CA-6.2.3

              Banks, which wish to net positions based on correlation (in the manner discussed in Paragraph CA-6.2.2 above), will need to satisfy the Central Bank of the accuracy of the method which it proposes to adopt.

              October 07

          • CA-6.3 CA-6.3 Maturity Ladder Approach

            • CA-6.3.1

              A worked example of the maturity ladder approach is set out in Appendix CA-1 and the table below illustrates the maturity time-bands of the maturity ladder for each commodity. As stated in Section CA-6.1, banks having Salam and Parallel Salam transactions must use the maturity ladder approach.

              October 07

            • CA-6.3.2

              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-6.2. The net positions in commodities are calculated as explained in Section CA-6.2.
              (b) Asset and liability positions in the same time-band are matched. The sum of the matched asset and liability positions is multiplied first by the spot price of the commodity, and then by a spread of 1.5% for each time-band as set out in the table below. This represents the capital charge in order to capture all risks within a time-band (which, together, are sometimes referred to as curvature risk).
              Time band3
              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. asset against liability 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 management 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), there will be either asset or liability positions, to which a capital charge of 15% will apply. The Central Bank 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 in order to capture the market risk on this business and to enable the Central Bank to evaluate whether the models approach should be adopted by the bank.

              3 Instruments, where the maturity is on the boundary of two maturity time-bands, 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.

              October 07

          • CA-6.4 CA-6.4 Simplified Approach

            • CA-6.4.1

              Banks who do not enter into Salam and Parallel Salam transactions and do not have any short positions in commodities may use the simplified approach to compute the capital charge. In the simplified approach, the capital charge is computed at 15% of the net position. Net positions in commodities are calculated as explained in Section CA-6.2. For the time being the Central Bank is not requiring additional 3% capital charge for basis risk.

              October 07

        • CA-7 CA-7 Gearing requirements

          • CA-7.1 CA-7.1 Gearing

            • CA-7.1.1

              The content of this Chapter is applicable to locally incorporated banks and Bahrain retail bank branches of foreign banks.

              October 07

            • Measurement

              • CA-7.1.2

                The Gearing ratio is measured with reference to the ratio of deposit liabilities against the bank's capital and reserves as reported in its PIRI.

                October 07

            • Gearing limit

              • CA-7.1.3

                For Retail Bank and Wholesale bank licensees, deposit liabilities should not exceed 20 times the respective bank's capital and reserves.

                October 07

      • CA CA Capital Adequacy (April 2008)

        • PART 1: PART 1: Definition of Capital

          • CA-A CA-A Introduction

            • CA-A.1 CA-A.1 Application

              • CA-A.1.1

                Rules 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 Central Bank of Bahrain ('CBB')).

                Amended: January 2011
                Apr 08

              • CA-A.1.2

                In addition to licensees mentioned in Paragraph CA-A.1.1, certain of these Rules (in particular gearing and market risk requirements) are also applicable to Bahrain branches of foreign retail bank licensees.

                Amended: January 2011
                Apr 08

              • CA-A.1.3

                Rules in this Module are applicable to locally incorporated Islamic banks (hereinafter referred to as "the banks") on both a stand-alone and consolidated group basis.

                Amended: January 2011
                Apr 08

              • CA-A.1.4

                If the banks have investments in other entities, the banks must also apply the Rules set out in the Prudential Consolidation and Deduction Requirements Module (Module PCD) for the calculation of their solo and consolidated Capital Adequacy Ratio (CAR).

                Amended: January 2011
                Apr 08

            • CA-A.2 CA-A.2 Purpose

              • Executive Summary

                • CA-A.2.1

                  The purpose of this Module is to set out the CBB's capital adequacy Rules and provide guidance on the risk measurement for the calculation of capital requirements by banks referred to under Paragraph CA-A.1.1. This requirement is supported by Article 44(c) of the Central Bank of Bahrain and Financial Institutions Law (Decree No. 64 of 2006).

                  Amended: January 2011
                  Apr 08

                • 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.

                  Apr 08

                • CA-A.2.3

                  Principle 9 of the Principles of Business requires that Islamic bank licensees maintain adequate human, financial and other resources, sufficient to run their business in an orderly manner (see Section PB-1.1.9). In addition, Condition 5 of CBB's Licensing Conditions (Section LR-2.5) requires Islamic bank licensees to maintain financial resources in excess of the minimum requirements specified in Module CA (Capital Adequacy).

                  Apr 08

                • CA-A.2.4

                  The requirements specified in this Module vary according to the Category of Islamic bank licensee concerned, their inherent risk profile, and the volume and type of business undertaken. The purpose of such requirements is to ensure that Islamic 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.

                  Apr 08

              • Legal Basis

                • CA-A.2.5

                  This Module contains the CBB's Directive (as amended from time to time) relating to the capital adequacy of Islamic 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 Islamic bank licensees.

                  Amended: January 2011
                  Apr 08

                • CA-A.2.6

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

                  Apr 08

                • CA-A.2.7

                  The CBB requires in particular that the banks maintain adequate capital, in accordance with the Rules in this Module, against their risks as capital provides banks with a cushion to absorb losses without endangering customer accounts. As such, the CBB also requires the relevant banks to maintain adequate liquidity and identify and control their large exposures which might otherwise be a source of loss to a licensee on a scale that might threaten its solvency.

                  Amended: January 2011
                  Apr 08

                • CA-A.2.8

                  These Rules are consistent in all substantial respects with the approach recommended by the Basel Committee on Banking Supervision and Islamic Financial Services Board (IFSB) for capital adequacy.

                  Amended: January 2011
                  Apr 08

                • CA-A.2.9

                  The CBB recognises that the Basel Committee guidelines may not address specific characteristics of the various products and services offered by Islamic banks. Therefore, the CBB has adopted a risk-based approach and has tailored the Rules to address the specific risk characteristics of Islamic banks. The structure of these Rules is explained on the next page.

                  Amended: January 2011
                  Apr 08

                • CA-A.2.10

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

                  (a) Prudential Consolidation and Deduction Requirements;
                  (b) Licensing and Authorisation Requirements;
                  (c) CBB Reporting Requirements;
                  (d) Credit Risk Management;
                  (e) Market Risk Management;
                  (f) Operational Risk Management;
                  (g) Liquidity Risk Management;
                  (h) High Level Controls;
                  (i) Relationship with Audit Firms; and
                  (j) Penalties and Fines.

                  Amended: January 2011
                  Apr 08

            • CA-A.3 CA-A.3 Capital Adequacy Ratio

              • CA-A.3.1

                Historically, on a consolidated basis, the CBB has set a minimum Capital Adequacy Ratio ("CAR") of 12.0% for all locally incorporated banks. Furthermore, on a solo basis, the parent bank has been required to maintain a minimum CAR of 8.0% (i.e. unconsolidated). The arrangements outlined below will apply once banks have been subject to a Pillar 2 risk profile assessment by the CBB or an acceptable audit firm. Until such an assessment has been completed, the existing 12% and 8% minimum capital ratio requirements (as outlined in Module CA-2.5 October 2006 edition) will remain in place.

                Apr 08

              • CA-A.3.2

                CAR will be calculated by applying the regulatory capital to the numerator and risk-weighted assets (RWAs) to the denominator.

                Eligible Capital


                { Total Risk-weighted Assets (Creditb + Marketb Risks) Plus Operational Risks

                Less

                Risk-weighted Assets funded by Restricted PSIAc (Creditb + Marketb Risks)

                Less

                (1 - α) [Risk-weighted Assets funded by Unrestricted PSIAc (Creditb + Marketb Risks)]

                Less

                α [Risk-weighted Assets funded by PER and IRR of Unrestricted PSIAe (Creditb +

                Marketb Risks)]}

                (a) Total RWA include those financed by both restricted and unrestricted Profit Sharing Investment Accounts (PSIA);
                (b) Credit and market risks for on- and off-balance sheet exposures;
                (c) Where the funds are commingled, the RWA funded by PSIA are calculated based on their pro-rata share of the relevant assets. PSIA balances include PER and Investment risk reserve (IRR) or equivalent reserves;
                (d) — α refers to the proportion assets funded by unrestricted PSIA which, as determined by the CBB, is 30%; and
                (e) The relevant proportion of risk-weighted assets funded by the PSIA's share of PER and by IRR is deducted from the denominator. The PER has the effect of reducing the displaced commercial risk and the IRR has the effect of reducing any future losses on the investment financed by the PSIA.

                The above formula is applicable as the Islamic banks may smooth income to the Investment Account Holders (IAHs) as part of a mechanism to minimise withdrawal risk and is concerned with systemic risk.
                Amended: April 2011
                April 2008

              • CA-A.3.3

                All locally incorporated banks are required to maintain a capital ratio both on a solo (and a consolidated basis where applicable) above the minimum "trigger" CAR of 8%. Failure to remain above the trigger ratio will result in Enforcement and other measures as outlined in Section CA-1.4.

                Apr 08

              • CA-A.3.4

                All locally incorporated banks will be required to maintain capital ratios above individually set "target" CARs on a solo and on a consolidated basis. These target CARs will be set at an initial minimum of 8.5% and may in the case of high risk banks be set at levels above the 12.5% target ratio set prior to January 2008. Failure to remain above the target ratio will result in Enforcement and other measures as outlined in Section CA-1.4.

                Apr 08

              • Eligible Capital

                • CA-A.3.5

                  Banks are allowed two classes of capital (see section CA-2.2) to meet their capital requirements for credit risk, operational risk and market risk, as set out below:

                  Tier 1: Core capital — Supports the calculation of credit risk weighted assets, operational risk and market risk.

                  Tier 2: Supplementary capital — Supports credit risk, operational risk and market risk subject to limitations.

                  Apr 08

              • Risk-weighted Assets

                • CA-A.3.6

                  Total risk-weighted assets are determined by:

                  (i) Multiplying the capital requirements for market risk and operational risk by 12.5; and
                  (ii) Adding the resulting figures to the sum of risk-weighted assets for credit risk.
                  Amended: January 2011
                  Apr 08

                • CA-A.3.7

                  Islamic banks are not contractually obliged to make good losses arising from Islamic financing assets funded by the investment accounts, unless these losses arise from the negligence on the part of the Islamic bank as manager (Mudarib) or as agent (Wakeel). However to be prudent, the CBB requires Islamic banks to provide regulatory capital to cover minimum requirement arising from 30% of the risk weighted assets and contingencies financed by the unrestricted investment accounts. Therefore, for the purpose of calculating its Capital Adequacy Ratio (CAR), the risk-weighted assets of an Islamic bank consist of the sum of the risk-weighted assets financed by the Islamic bank's own capital and liabilities, plus 30% of the risk-weighted assets financed by the Islamic bank's unrestricted PSIAs.

                  Amended: January 2011
                  Apr 08

                • CA-A.3.8

                  In measuring credit risk for the purpose of capital adequacy, banks must apply the standardised approach through which claims of different categories of counterparties are assigned risk weights (RWs) according to broad categories of relative riskiness.

                  Apr 08

                • CA-A.3.9

                  For the measurement of their operational risks, banks have a choice, subject to the written approval of the CBB, between two broad methodologies:

                  (a) One alternative is to measure the risks using a basic indicator approach, applying the measurement framework described in Chapter CA-6 of this Module; and
                  (b) The second methodology (i.e. the standardised approach) is set out in detail in Chapter CA-6 including the procedure for obtaining the CBB's approval. This methodology is subject to the fulfillment of certain conditions. The use of this methodology is, therefore, conditional upon the explicit approval of the CBB.
                  Amended: January 2011
                  Apr 08

                • CA-A.3.10

                  In measuring market risk for the purpose of capital adequacy, banks must apply the approach set out in relevant sections.

                  Apr 08

                • CA-A.3.11

                  If an Islamic bank wants to adopt an advanced approach (IRB for credit risk and/or IMA for market risk), it will need to apply to the CBB for prior approval.

                  Apr 08

            • CA-A.4 CA-A.4 Module History

              • CA-A.4.1

                This Module was first issued in January 2005 as part of the Islamic principles volume. 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.

                Apr 08

              • CA-A.4.2

                A list of 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 10/2007 New Rule CA-A.2.5 introduced, categorising this Module as a Directive.
                CA-1 to CA-6 01/2008 Basel II implementation.
                CA-1.5 01/2008 Review of PIR by external auditors
                CA-4.6 04/2008 Recognition of IIRA as ECAI and mapping of ratings
                CA-4.2.15–18 01/2009 New guidance and rules on SMEs
                CA-A 01/2011 Various minor amendments to ensure consistency in CBB Rulebook.
                CA-A.2.5 01/2011 Clarified legal basis.
                CA-5.1 & CA-5.3 01/2012 Changes in respect of July 2009 and February 2011 amendments to Basel II.
                CA-4.2.10 and CA-4.2.11A 04/2012 Amendment made for claims on banks dealing with self-liquidating letters of credit.
                CA-2.1.4(g) 10/2013 Added Rule to include limited general provision against unidentified future losses as part of Tier 2.
                CA-2.1.4(f), CA-2.1.4A to CA-2.1.4C and CA-2.2.1 10/2013 Added Rules to deal with subordinated issued for Tier 2 capital.
                CA-5.5.13 10/2013 Clarified Rules on structural positions for foreign exchange risk.

              • Evolution of the Module

                • CA-A.4.3

                  Prior to the development of this Rulebook, the CBB issued various circulars representing regulations relating to capital adequacy requirements. These circulars were consolidated into this Module and are listed below:

                  Circular Ref. Date of Issue Module Ref. Circular Subject
                  OG/78/01 20 Feb 2001 CA-A.3 and CA-1.4 Monitoring of Capital Adequacy
                  BC/01/98 10 Jan 1998 CA-A.3 and CA-1.4 Capital Adequacy Ratio
                  Apr 08

              • Effective Date

                • CA-A.4.4

                  The contents retained from the previous module (Capital Adequacy-Islamic banks) are effective from the date depicted in the above circulars from which the requirements are compiled. The updated module is effective from January 01, 2008.

                  Apr 08

          • CA-1 CA-1 Scope and Coverage of Capital Charges

            • CA-1.1 CA-1.1 Application

              • CA-1.1.1

                All locally incorporated banks are required to measure and apply capital charges with respect to their credit, operational, market risk fiduciary and displacement risk, capital requirements.

                Apr 08

              • CA-1.1.2

                Credit risk is defined as the potential that a bank's 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.

                Apr 08

              • CA-1.1.3

                Operational risk is defined as the risk of losses resulting from inadequate or failed internal processes, people and systems or from external events, which includes but is not limited to, legal risk and Sharia compliance risk. This definition excludes strategic and reputational risks.

                Apr 08

              • CA-1.1.4

                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 equities in the trading book;
                (b) Foreign exchange risk throughout the bank; and
                (c) Commodity risk throughout the bank.
                Amended: April 2011
                April 2008

              • CA-1.1.5

                The CBB has adopted the IFSB definitions of fiduciary and displacement risk for the purpose of this volume.

                Apr 08

              • CA-1.1.6

                Banks must compute capital charges for own funds as well as those of the unrestricted PSIAs. For the purpose of computing the Capital Adequacy Ratio, 30% of the bank's risk weighted assets relating to the unrestricted PSIAs must be included in accordance with the IFSB guidelines.

                Apr 08

            • CA-1.2 CA-1.2 Monitoring of Risks

              • CA-1.2.1

                Banks are required to manage their risks, especially market risks, in such a way that the capital requirements 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. Banks are also required to maintain strict risk management systems to ensure that their intra-day exposures are not excessive.

                Apr 08

              • CA-1.2.2

                Banks' daily compliance with the capital requirements for credit and market risks must be verified by an independent risk management department and internal audit. It is expected that external auditors will perform appropriate tests of the bank's daily compliance with the capital requirements for credit and market risks. Where a bank fails to meet the minimum capital requirements for credit and market risk on any business day, the CBB must be informed in writing by no later than the following business day. The CBB will then seek to ensure that the bank takes immediate measures to rectify the situation.

                Apr 08

            • CA-1.3 CA-1.3 Investments in other Entities and Consolidation

              • CA-1.3.1

                The banks must also apply the rules set in the Prudential Consolidation and Deduction Requirements Module where the bank has investments in other entities.

                Apr 08

              • CA-1.3.2

                These capital adequacy regulations must be applied on a worldwide consolidated basis as well as on a solo basis. Guidance on consolidation and related matters is provided in the Prudential Consolidation and Deduction Requirements Module.

                Apr 08

            • CA-1.4 CA-1.4 Reporting

              • CA-1.4.1

                Formal reporting, to the CBB, of capital adequacy must be made in accordance with the requirements set out under section BR 3.1.

                Apr 08

              • CA-1.4.2

                Where a bank's CAR falls below its individual target ratio either on a solo basis (or on a consolidated basis), the General Manager of the bank must notify the CBB by the following business day, however no formal action plan will be necessary. The General Manager must explain what measures are being implemented to ensure that the bank will remain above its minimum target CAR(s).

                Apr 08

              • CA-1.4.3

                The bank will be required to submit form PIRI to the CBB on a monthly basis, until the concerned CAR exceeds its target ratio.

                Apr 08

              • CA-1.4.4

                The CBB 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 CBB in any particular case.

                Apr 08

              • CA-1.4.5

                All locally incorporated banks must provide the CBB, with immediate written notification (i.e. by no later than the following business day) of any actual breach of the minimum trigger CAR of 8%. Where such notification is given, the bank must also provide the CBB:

                (a) No later than one calendar week after the notification, with a written action plan setting out how the bank proposes to restore the relevant CAR(s) to the required minimum level(s) set out above and, further, describing how the bank will ensure that a breach of such CAR(s) will not occur again in the future; and
                (b) Report on a weekly basis thereafter on the bank's relevant CAR(s) until such CAR(s) have reached the required target level(s) described above.
                Amended: April 2011
                April 2008

              • CA-1.4.6

                Banks must note that the CBB considers the breach of CARs to be a very serious matter. Consequently, the CBB may (at its discretion) subject a bank which breaches its CAR(s) to a formal licensing reappraisal. Such reappraisal may be effected either through the CBB's own inspection function or through the use of Reporting Accountants, as appropriate. Following such appraisal, the CBB will notify the bank concerned in writing of its conclusions with regard to the continued licensing of the bank.

                Apr 08

              • CA-1.4.7

                The CBB recommends that the bank's compliance officer support and cooperate with the CBB in the monitoring and reporting of the CARs and other regulatory reporting matters. Compliance officers should ensure that their banks have adequate internal systems and controls to comply with these regulations.

                Apr 08

            • CA-1.5 CA-1.5 Review of Prudential Information Returns by External Auditors

              • CA-1.5.1

                The CBB 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 . However, if a bank provides prudential returns without any reservation from auditors for two consecutive quarters, it can apply for exemption from such review for a period to be decided by CBB.

                Apr 08

          • CA-2 CA-2 Regulatory Capital

            • CA-2.1 CA-2.1 Regulatory Capital

              • CA-2.1.1

                Islamic banks are allowed two types of own funds to meet their capital requirements for credit risk, market risk and operational risk as set out below:

                Tier 1: Core capital — Supports the calculation of credit risk weighted assets, operational risk and market risk.

                Tier 2: Supplementary capital — Supports credit risk, operational risk and market risk subject to limitations.

                Apr 08

              • CA-2.1.2

                For the purpose of defining Tier capital, the CBB has broadly adopted the recommendations contained in IFSB's guidelines. However, some restrictions have been placed on the inclusion of profit equalisation and investment risk reserve as Tier 2 capital. For components of Tier 1 and Tier 2 capital refer to paragraphs CA-2.1.3 to CA-2.1.4.

                Apr 08

              • Tier 1: Core Capital

                • CA-2.1.3

                  Tier 1 capital shall consist of the sum of items (a) to (e) below, less the sum of items (f) through (j) below:

                  (a) Issued and fully paid ordinary shares;

                  For Islamic funds with participation and / or "B" class shares (not carrying voting rights), the treatment for the purpose of these regulations must be agreed with the CBB. The CBB will consider each case on its merit.
                  (b) Disclosed reserves
                  •  General reserves
                  •  Legal / statutory reserves
                  •  Share premium
                  •  Capital redemption reserves
                  •  Excluding fair value reserves1
                  (c) Retained profit brought forward;
                  (d) Unrealized net gains arising from fair valuing equities2; and
                  (e) Minority interests in subsidiaries Tier 1 equity, arising on consolidation, in the equity of subsidiaries that are less than wholly owned. Further guidance on minority interests is provided in the Prudential Consolidation and Deduction Requirements Module.

                  LESS:

                  (f) Goodwill;
                  (g) Current interim cumulative net losses;
                  (h) Unrealized gross losses arising from fair valuing equity securities3;
                  (i) Other deductions made on a pro-rata basis between Tier 1 and Tier 2;
                  (j) Reciprocal cross holdings of other banks' capital.

                  1 This refers to unrealised fair value gains reported directly in equity (such gross gains are included in Tier 2).

                  2This refers to unrealised net fair value gains taken through P&L (which have been audited). Please note that the unrealised net gains related to unlisted equities taken through P&L arising on or after January 1, 2008 will be subject to 55% discount as stated in CA-2.1.4(c)ii.

                  3 This refers to both 'net losses taken through P&L' and 'gross losses reported directly in equity'.

                  Apr 08

              • Tier 2: Supplementary Capital

                • CA-2.1.4

                  Tier 2 capital shall consist of the following items:

                  (a) Current interim retained profits that have been reviewed as per the ISA by the external auditors;
                  (b) Asset revaluation reserves, which arise from the revaluation of fixed assets and real estate 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. Similarly, gains may also arise from revaluation of Investment Properties (real estate). These reserves (including the net gains on investment properties) 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 and forced sale. 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) Unrealised gains arising from fair valuing equities:
                  (i) For unrealized gross gains reported directly in equity, a discount factor of 55% will be applied before inclusion in Tier 2 capital. Note for gross losses, the whole amount of such unrealised loss should be deducted from the Tier 1 capital;
                  (ii) For unrealized net gains reported in income, a discount factor of 55% will apply on any such unrealized net gains from unlisted equity instruments before inclusion in Tier 1 capital (for audited gains) or Tier 2 capital (for reviewed gains) as appropriate. This discount factor will be applied to the incremental net gains related to unlisted equities arising on or after January 1, 2008;
                  (d) Banks should note that the Central bank will discuss the applicability of the discount factor under paragraph (c) above with individual banks. This discount factor relating to CA-2.1.4(c)ii may be reassessed by the CBB if the bank arranges an independent review (which has been performed for the bank's systems and controls relating to FV gains on financial instruments) and meets all the requirements of the paper 'Supervisory guidance on the use of the fair value option for financial instruments by banks' issued by Basel Committee on Banking Supervision in June 2006;
                  (e) Profit equalisation reserve and investment risk reserve, up to a maximum amount equal to the capital charge pertaining to 30% of the risk weighted assets financed by unrestricted investment account holders;
                  (f) Subordinated term capital instruments, which comprise all unsecured term instruments subordinated (with respect to both profit and principal) to all other liabilities of the bank except the share capital. To be eligible for inclusion in Tier 2 capital, subordinated term 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. 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. Subordinated term capital instruments must also satisfy the conditions outlined in the paragraphs below; and
                  (g) Credit facilities loss provisions held against future, presently unidentified losses and are freely available to meet such losses which subsequently materialise. Such general provisions/general credit facilities-loss reserves eligible for inclusion in Tier 2 will be limited to a maximum of 1.25 percentage points of credit risk-weighted risk assets. Provisions ascribed to identified deterioration of particular assets or known liabilities, whether individual or grouped, must be excluded.
                  Amended: October 2013
                  Amended: April 2011
                  April 2008

                • CA-2.1.4A

                  Subordinated term capital instruments agreed to on a case by case basis by CBB, must meet the following conditions. They must be:

                  (a) Issued and fully paid;
                  (b) Neither be secured nor covered by a guarantee of the issuer or related entity or other arrangement that legally or economically enhances the seniority of the claim vis-à-vis bank creditors;
                  (c) The main features of such instruments must be easily understood and publicly disclosed;
                  (d) Proceeds must be immediately available without limitation to the issuing bank; and
                  (e) The bank must have discretion over the amount and timing of distributions, subject only to prior waiver of distributions on the bank's common stock, and banks must have full access to waived payments.
                  Added: October 2013

                • CA-2.1.4B

                  A bank may not exercise a call on a subordinated term capital instrument, partially or in full, prior to the end of its term, unless it has received the CBB's prior written approval, and there is a clear statement in support of the call in the original documentation.

                  Added: October 2013

                • CA-2.1.4C

                  Where Paragraph CA-2.1.4B applies, the CBB will take into consideration whether the bank has received confirmation from its external auditor that the bank will continue to satisfy the CBB's capital adequacy requirements after such early call and the bank has sufficient liquidity to repay the subordinated term capital instrument. This can be done by assessing the impact of such redemption on the capital adequacy ratio of the bank.

                  Added: October 2013

            • CA-2.2 CA-2.2 Limits on the use of Different Forms of Capital

              • CA-2.2.1

                Tier 1 capital should represent at least half of the total eligible capital, i.e., Tier 2 capital is limited to the 100% of Tier 1 capital. Subordinated term capital instruments are limited to a maximum of 50% of Tier 1 capital.

                Amended: October 2013
                Apr 08

              • CA-2.2.2

                The limit on Tier 2 capital is based on the amount of Tier 1 capital after all deductions of investments pursuant to Prudential Consolidation and Deduction Requirements Module (see Appendix PCD-2 of PCD module for an example of the deduction effects and the caps).

                Apr 08

        • PART 2: PART 2: Credit Risk

          • CA-3 CA-3 The Banking Book — Minimum Capital Requirements for Islamic Financing Assets

            • CA-3.1 CA-3.1 Background

              • CA-3.1.1

                Due to the nature of Islamic banking transactions, Islamic banks, as opposed to their conventional counterparts, are additionally exposed to price risk in their banking book. CBB recognizes that such risks need to be identified and measured for regulatory capital purposes.

                Apr 08

              • CA-3.1.2

                Sections CA-3.2 to CA-3.8 describe the minimum capital requirements for the treatment of exposures, taking into account both credit and market risks including price risk within the banking book for each of the seven classes of Islamic financing assets.

                Apr 08

            • CA-3.2 CA-3.2 Murabahah and Murabahah to the Purchase Orderer

              • Introduction

                • CA-3.2.1

                  This section sets out the minimum capital adequacy requirements to cover the transactions that are based on the Sharia rules and principles of Murabahah and Murabahah to the Purchase Orderer (MPO).

                  Apr 08

                • CA-3.2.2

                  In Murabahah and MPO, the capital adequacy requirement for credit risk refers to the risk of a counterparty not paying the agreed price of an asset to the bank. In the case of binding MPOs, the risks faced by the Islamic banks are different at the various stages of the contract.

                  Apr 08

                • CA-3.2.3

                  This section is broadly divided into (a) Murabahah and non-binding MPO and (b) binding MPO, as the types of risk faced by the bank are different at the various stages of the contract for the two categories.

                  Apr 08

                • CA-3.2.4

                  This classification and the distinctions between a non-binding MPO and a binding MPO are subject to the criteria and opinions set by the respective SSB of the bank or any other SSB as specified by the CBB.

                  Apr 08

                • CA-3.2.5

                  A Murabahah contract refers to an agreement whereby the bank sells to a customer at acquisition cost (purchase price plus other direct costs) plus an agreed profit margin, a specified kind of asset that is already in its possession. An MPO contract refers to an agreement whereby the bank sells to a customer at cost (as above) plus an agreed profit margin, a specified kind of asset that has been purchased and acquired by the bank based on a Promise to Purchase (PP) by the customer which can be a binding or non-binding PP.

                  Apr 08

                • Murabahah and Non-binding MPO

                  • CA-3.2.6

                    In a Murabahah transaction, the bank sells an asset that is already available in its possession, whereas in a MPO transaction the bank acquires an asset in anticipation that the asset will be purchased by the orderer/customer.

                    Apr 08

                  • CA-3.2.7

                    This price risk in Murabahah contracts ceases and is replaced by credit risk for the amount receivable from the customer following delivery of the asset. Likewise, in a non-binding MPO transaction, the bank is exposed to credit risk on the amount receivable from the customer when the latter accepts delivery and assumes ownership of the asset.

                    Apr 08

                • Binding MPO

                  • CA-3.2.8

                    In a binding MPO, the bank has no 'long' position in the asset that is the subject of the transaction, as there is a binding obligation on the customer to take delivery of the asset at a pre-determined price. The bank is exposed to counterparty risk in the event that the orderer in a binding MPO does not honour his/her obligations under the PP, resulting in the bank selling the asset to a third party at a selling price which may be lower than the cost to the bank. The risk of selling at a loss is mitigated by securing a Hamish Jiddiyyah (HJ) (a security deposit held as collateral upon entering into agreement to purchase or agreement to lease) upon executing the PP with the customer, as commonly practised in the case of binding MPO.

                    Apr 08

                • Collateralisation

                  • CA-3.2.9

                    As one of the CRM techniques, the bank can secure a pledge of the sold asset/underlying asset or another tangible asset ("collateralised Murabahah"). The collateralisation is not automatically provided in a Murabahah contract but must be explicitly stated or must be documented in a separate security agreement at or before the time of signing of the Murabahah contract. The bank may employ other techniques such as pledge of deposits or a third party financial guarantee. The RW of a financial guarantor can be substituted for the RW of the purchaser provided that the guarantor has a better credit rating than the purchaser and that the guarantee is legally enforceable.

                    Apr 08

                  • CA-3.2.10

                    In financing transactions that are collateralised, the pricing of the Murabahah assets and determination of the required amount of HJ would normally take into consideration the market value and forced-sale value of the assets; and the CRM would take into account of any 'haircut' applicable to the collateralised assets (if these assets are eligible collateral or acceptable to the Central Bank). Thus, fluctuations in the market value and forced sale value of the collateralised assets are dealt with under credit risk assessment. For full details of CRM techniques, and the eligibility of collateral, refer to Section CA-4.7.

                    Apr 08

              • Credit Risk

                • Murabahah and Non-binding MPO

                  • CA-3.2.11

                    The credit exposure must be measured based on accounts receivable in Murabahah (the term used herein includes MPO), which is recorded at their cash equivalent value i.e. amount due from the customers at the end of the reporting quarter less any provision for doubtful debts.

                    Apr 08

                  • CA-3.2.12

                    The accounts receivable (net of specific provisions) amount arising from the selling of a Murabahah asset must be assigned a RW based on the credit standing of the obligor (purchaser or guarantor) as rated by an ECAI that is approved by the CBB. In case the obligor is unrated, a RW of 100% shall apply. (See Section CA-4.2).

                    Apr 08

                • Binding MPO

                  • CA-3.2.13

                    In a binding MPO, the bank is exposed to default on the purchase orderer's obligation to pay fully for the asset at the agreed price. In the event of the orderer defaulting on its PP, the bank will dispose of the asset to a third party. The bank will have recourse to any HJ paid by the orderer, and (a) may have a right to recoup from the orderer any loss on disposing of the asset, after taking account of the HJ or (b) may have no such legal rights. In both cases, this risk is mitigated by the asset in possession as well as any HJ paid by the purchase orderer.

                    Apr 08

                  • CA-3.2.14

                    In case (a) the bank has the right to recoup any loss (as indicated in the previous paragraph) from the orderer, that right constitutes a claim receivable which is exposed to credit risk, and the exposure shall be measured as the amount of the asset's total acquisition cost to the bank, (less the market value of the asset as collateral subject to any haircut, and less the amount of any HJ, provided that the collateral is an eligible collateral or has been agreed as acceptable to the CBB). The applicable RW must be based on the standing of the obligor as rated by an ECAI that is approved by the CBB, and in the case the obligor is unrated, a RW of 100% shall apply. (See Section CA-4.2).

                    Apr 08

                  • CA-3.2.15

                    In case (b) the bank has no such right, and the cost of the asset to the bank constitutes a market risk (as in the case on a non-binding MPO), but this market risk exposure is reduced by the amount of any HJ that the bank has the right to retain.

                    Apr 08

                  • CA-3.2.16

                    In applying the treatment as set out in paragraph CA-3.2.14, the bank should ensure that the PP is properly documented and is legally enforceable.

                    Apr 08

                  • CA-3.2.17

                    Upon selling the asset, the accounts receivable (net of specific provisions) amount must be assigned a RW based on the credit standing of the obligor as rated by an ECAI that is approved by the CBB. In case the obligor is unrated, a RW of 100% shall apply. (See Section CA-4.2).

                    Apr 08

                • Exclusions

                  • CA-3.2.18

                    The capital requirement is to be calculated on the receivable amount, net of (i) specific provisions, (ii) any amount that is secured by eligible collateral (as defined in section CA-4.7) and/or (iii) any amount that is past due by more than 90 days. The portions that are collateralised and past due are subject to the treatment as set out in chapter CA-4.

                    Apr 08

                • Assignment of Risk Weights

                  • CA-3.2.19

                    Islamic financing assets are to be categorized as per the claim categories detailed in section CA-4.2, and risk weighted accordingly. Banks should ensure that the appropriate risk weight is used based on the claim category for each transaction.

                    Apr 08

              • Market Risk

                • Murabahah and Non-binding MPO

                  • CA-3.2.20

                    In the case of an asset in possession for a Murabahah transaction and an asset acquired specifically for resale to a customer in a non-binding MPO transaction, the asset would be treated as inventory of the bank and will be subject to price risk as per section CA-5.2. This capital charge is also applicable to assets held by a bank for incomplete non-binding MPO transactions at the end of a financial period.

                    Apr 08

                  • CA-3.2.21

                    Assets in possession on a 'sale or return' basis (with such an option included in the contract) are treated as accounts receivable from the vendor and as such would be offset against the related accounts payable to the vendor. If these accounts payable have been settled, the assets shall attract a RW based on rating of the vendor (100% in case of unrated), subject to (a) the availability of documentation evidencing such an arrangement with the vendor, and (b) the period for returning the assets to the vendor not having been exceeded. If the above conditions are not satisfied, capital charge will be provided as per paragraph CA-3.2.20.

                    Apr 08

                • Binding MPO

                  • CA-3.2.22

                    In a binding MPO the orderer has the obligation to purchase the asset at the agreed price, and the bank as the seller is only exposed to credit risk as indicated in paragraph CA-3.1.13 above.

                    Apr 08

                • Foreign Exchange Risk

                  • CA-3.2.23

                    If the funding of an asset purchase or the selling of an asset opens a bank to foreign exchange exposures, the relevant positions should be included in the measurement of foreign exchange risk described in section CA-5.5.

                    Apr 08

              • Summary of Capital Requirement at Various Stages of the Contract

                • CA-3.2.24

                  The following table sets out the applicable period of the contract that attracts capital charges:

                  (a) Murabahah and Non-binding MPO
                  Applicable Stage of the Contract Credit RW Market Risk Capital Charge
                  Asset available for sale (asset on balance sheet)* Not applicable Price risk (15% Capital charge)
                  Asset is sold and delivered to a customer and the selling price (accounts receivable) is due from the customer. Based on customer's rating or 100% RW for unrated customer (see paragraphs CA-3.2.11 and CA-3.2.12) NA
                  Upon full settlement of the purchase price. NA NA

                  * Also includes an asset which is in possession due to cancellation of PP by a non-binding MPO customer. Any HJ taken, if any, is not considered as eligible collateral and shall not be offset against the value of the asset.

                  (b) Binding MPO
                  Applicable Stage of the Contract Credit RW Market Risk Capital Charge
                  Asset available for sale (asset on balance sheet)* - If the bank has legal right to recoup from the customer any loss on disposing of the asset Asset acquisition cost less [market value of asset if eligible as collateral (net of any haircut**) plus any HJ] x applicable RW (see chapter CA-4) NA
                  Asset available for sale (asset on balance sheet)* - If the bank has no legal right to recoup from the customer any loss on disposing of the asset NA Price risk 15% Capital charge minus HJ(if the bank has legal right to the HJ)
                  Asset is sold and delivered to a customer and the selling price (accounts receivable) is due from the customer. Based on customer's rating or 100% RW for unrated customer (see section CA-4.2) NA
                  Upon full settlement of the purchase price. NA NA

                  * Also includes an asset which is in possession due to cancellation of PP by a customer.

                  ** Please refer to CRM section CA-4.7 for eligibility of collateral and application of haircuts.

                  Amended: April 2011
                  April 2008

            • CA-3.3 CA-3.3 Salam and Parallel Salam

              • Introduction

                • CA-3.3.1

                  This section sets out the minimum capital requirement to cover credit and market (price) risks arising from entering into contracts or transactions that are based on the Sharia rules and principles of Salam. The bank is exposed to the (a) credit (counterparty) risk of not receiving the purchased commodity after disbursing the purchase price to the seller, and (b) price risk that the bank incurs from the date of execution of a Salam contract, which is applicable throughout the period of the contract and beyond the maturity date of the contract as long as the commodity remains on the balance sheet of the bank.

                  Apr 08

                • CA-3.3.2

                  This section is applicable to (a) Salam contracts that are executed without any Parallel Salam contracts and (b) Salam contracts that are backed by independently executed Parallel Salam contracts.

                  Apr 08

                • CA-3.3.3

                  A Salam contract refers to an agreement to purchase, at a predetermined price, a specified kind of commodity4 which is to be delivered on a specified future date in a specified quantity and quality. The bank as the buyer makes full payment of the purchase price upon execution of a Salam contract or within a subsequent period not exceeding two or three days as deemed permissible by its Sharia Supervisory Board (SSB).


                  4 A commodity is defined as a physical product which is and can be traded on a secondary market, e.g. agricultural products, minerals (including oil) and precious metals. The commodity may or may not be traded on an organised exchange.

                  Apr 08

                • CA-3.3.4

                  In certain cases the bank may enter into a back-to-back contract (Parallel Salam) to sell a commodity with the same specification as the purchased commodity under a Salam contract to a party other than the original seller. The Parallel Salam allows the bank to sell the commodity for future delivery at a predetermined price (thus hedging the price risk on the original Salam contract) and protects the bank from having to take delivery of the commodity and warehousing it.

                  Apr 08

                • CA-3.3.5

                  The non-delivery of the commodity by a Salam seller (i.e. counterparty risk) does not discharge the bank's obligations to deliver the commodity under a Parallel Salam contract, and thus exposes the bank to potential loss in obtaining the supply elsewhere.

                  Apr 08

                • CA-3.3.6

                  The obligations of a bank under Salam and Parallel Salam are not inter-conditional or interdependent, which implies that there is no legal basis for offsetting credit exposures between the contracts.

                  Apr 08

                • CA-3.3.7

                  In the absence of a Parallel Salam contract, a bank may sell the subject-matter of the original Salam contract in the spot market upon receipt, or, alternatively, the bank may hold the commodity in anticipation of selling it at a higher price. In the latter case, the bank is exposed to price risk on its position in the commodity until the latter is sold.

                  Apr 08

              • Credit Risk

                • CA-3.3.8

                  The amount paid for the purchase of a commodity based on a Salam contract shall be assigned a RW based on the credit standing of the counterparties involved in the contracts as rated by an ECAI that is approved by the CBB. If a counterparty is unrated, a RW of 100% will apply. (See Section CA-4.2).

                  Apr 08

                • Exclusions

                  • CA-3.3.9

                    The capital requirement is to be calculated on the amount paid, net of (i) specific provisions, (ii) any amount that is secured by eligible collateral (as defined in section CA-4.7) and/or (iii) any amount which is past due by more than 90 days. The portions that are collateralised and past due are subject to the treatment as set out in chapter CA-4.

                    Apr 08

                • Applicable Period

                  • CA-3.3.10

                    The credit RW will be applied from the date of the contract made between both parties until the maturity of the Salam contract, which is upon receipt of the purchased commodity. However, between the date of contract and disbursement of funds to the customer the exposure is a commitment (off-balance sheet) and a credit conversion factor (CCF) of 20% will be applied before applying the relevant RW.

                    Apr 08

                • Offsetting Arrangement between Credit Exposures of Salam and Parallel Salam

                  • CA-3.3.11

                    The credit exposure amount of a Salam contract is not to be offset against the exposure amount of a Parallel Salam contract, as an obligation under one contract does not discharge an obligation to perform under the other contract.

                    Apr 08

              • Market Risk

                • CA-3.3.12

                  The price risk on the commodity exposure in Salam can be measured in two ways, either the maturity ladder approach in accordance with paragraphs CA-5.6.9 to CA-5.6.12 or price risk in accordance with paragraph CA-5.2.2.

                  Apr 08

                • CA-3.3.13

                  The long and short positions in a commodity, which are positions of Salam and Parallel Salam, may be offset under either approach for the purpose of calculating the net open positions provided that the positions are in the same group of commodities.

                  Apr 08

                • Foreign Exchange Risk

                  • CA-3.3.14

                    It the funding of a commodity purchase or selling of a commodity leaves a bank open to foreign exchange exposures, the relevant positions should be included in the measures of foreign exchange risk described in section CA-5.5.

                    Apr 08

              • Summary of Capital Requirement at Various Stages of the Contract

                • CA-3.3.15

                  The following table sets out the applicable period of the contract that attracts capital charges:

                  (a) Salam with Parallel Salam
                  Applicable Stage of Contract Credit RW Market Risk Capital Charge
                  Payment of purchase price by the bank of a Salam customer Based on customer's rating or 100% RW for unrated customer.

                  No Netting of Salam exposures against parallel Salam exposures.

                  (See section CA-4.2)
                  Two approaches are available.

                  Maturity Ladder Approach (see paragraphs CA-5.6.9 to CA-5.6.12 of chapter CA-5)

                  Price risk (see CA-5.2.2 of chapter CA-5)
                  Receipt of the purchased commodity by the bank. Asset available for delivery to the customer. If the bank has legal right to recoup from the customer any loss on disposing of the asset Based on customer's rating or 100% RW for unrated customer.

                  No Netting of Salam exposures against parallel Salam exposures.

                  (See section CA-4.2)
                  NA
                  Receipt of the purchased commodity by the bank. Asset available for delivery to the customer - If the bank has no legal right to recoup from the customer any loss on disposing of the asset NA Two approaches are available.

                  Maturity Ladder Approach (see paragraphs CA-5.6.9 to CA-5.6.12 of chapter CA-5)

                  Price risk (see paragraph CA-5.2.2 of chapter CA-5)
                  The purchased commodity is sold and delivered to the buyer and the amount is received. NA NA
                  (b) Salam without Parallel Salam
                  Applicable Stage of Contract Credit RW Market Risk Capital Charge
                  Payment of purchase price by the bank of a Salam customer. At this stage of the contract, only one of credit or market risk is possible at the same time. To be prudent, higher of the two should be provided (not both). The higher of the following (credit or market)
                  Based on customer's rating or 100% RW for unrated customer.

                  (See section CA-4.2)
                  Price risk but without additional 3 %. (see paragraph 5.2.2 of chapter CA-5)
                  Receipt of the purchased commodity by the bank NA Price risk but without additional 3 %. (see paragraph 5.2.2 of chapter CA-5)
                  The purchased commodity is sold and delivered to the buyer. NA NA
                  Amended: April 2011
                  April 2008

            • CA-3.4 CA-3.4 Istisna'a and Parallel Istisna'a

              • Introduction

                • CA-3.4.1

                  This section sets out the minimum capital adequacy requirement to cover credit and market (price) risks arising from entering into contracts or transactions that are based on the Sharia rules and principles of Istisna'a.

                  Apr 08

                • CA-3.4.2

                  Istisna'a and parallel Istisna'a contracts would attract a risk weighting as per the credit standing of the respective counterparties (See section CA-4.2).

                  Apr 08

                • CA-3.4.3

                  An Istisna'a contract refers to an agreement to sell to or buy from a customer, a non-existent asset which is to be manufactured or built according to the ultimate buyer's specifications and is to be delivered on a specified future date at a predetermined selling price.

                  Apr 08

                • CA-3.4.4

                  The bank, as the seller, has the option to manufacture or build the asset on its own or to engage the services of a party other than the Istisna'a ultimate buyer as supplier or subcontractor, by entering into a Parallel Istisna'a contract (please refer to paragraph CA-3.4.12).

                  Apr 08

                • CA-3.4.5

                  The exposures under Istisna'a involve credit and market risks, as described below. Credit exposures arise once the work is billed to the customer, while market (price) exposures arise on unbilled work-in-process (WIP).

                  Apr 08

                • CA-3.4.6

                  There is a capital requirement to cater for the credit (counterparty) risk of the bank not receiving the selling price of the asset from the customer or project sponsor either in pre-agreed stages of completion and/or upon full completion of the manufacturing or construction process.

                  Apr 08

                • CA-3.4.7

                  This section also sets out the capital adequacy requirement to cater for the market risk that a bank incurs from the date of manufacturing or construction, which is applicable throughout the period of the contract on unbilled WIP inventory.

                  Apr 08

                • CA-3.4.8

                  This section is applicable to both (a) Istisna'a contracts that are executed without a Parallel Istisna'a contract and (b) Istisna'a contracts that are backed by independently executed Parallel Istisna'a contracts.

                  Apr 08

                • CA-3.4.9

                  This section makes distinctions between the two main categories of Istisna'a:

                  (a) Full Recourse Istisna'a

                  The receipt of the selling price by the bank is dependent on the financial strength or payment capability of the customer for the subject matter of Istisna'a, where the source of payment is derived from the various other commercial activities of the customer and is not solely dependent on the cash flows from the underlying asset/project; and
                  (b) Limited and Non-recourse Istisna'a

                  The receipt of the selling price by the bank is dependent partially or primarily on the amount of revenue generated by the asset being manufactured or constructed by selling its output or services to contractual or potential third party buyers. This form of Istisna'a faces "revenue risk" arising from the asset's ability to generate cash flows, instead of the creditworthiness of the customer or project sponsor.
                  Apr 08

                • CA-3.4.10

                  In full, limited and non-recourse Istisna'a contracts, the bank assumes the completion risk that is associated with the failure to complete the project at all, delay in completion, cost overruns, occurrence of a force majeure event and unavailability of qualified personnel and reliable seller(s) or subcontractors in a Parallel Istisna'a.

                  Apr 08

                • CA-3.4.11

                  The selling price of an asset sold based on Istisna'a is agreed or determined on the contractual date and such a contract is binding. The price cannot be increased or decreased on account of an increase or decrease in commodity prices or labour cost. The price can be changed subject to the mutual consent of the contracting parties due to alteration or modifications to the contract or unforeseen contingencies, which is a matter for the commercial decision of the bank and can result in a lower profit margin.

                  Apr 08

                • CA-3.4.12

                  In cases where a bank enters into Parallel Istisna'a to procure an asset from a party other than the original Istisna'a customer (buyer), the price risk relating to input materials is mitigated. The bank remains exposed to the counterparty risk of the Parallel Istisna'a seller in delivering the asset on time and in accordance with the Istisna'a ultimate buyer's specifications. This is the risk of not being able to recover damages from the Parallel Istisna'a seller for the losses resulting from the breach of contract.

                  Apr 08

                • CA-3.4.13

                  The failure of the Parallel Istisna'a seller to deliver a completed asset which meets the buyer's specifications does not discharge the bank's obligations to deliver the asset ordered under an Istisna'a contract, and thus exposes the bank to potential loss in making good the shortcomings or obtaining the supply elsewhere. The obligations of a bank under Istisna'a and Parallel Istisna'a contracts are not inter-conditional or interdependent, which implies that there is no legal basis for offsetting credit exposures between the contracts.

                  Apr 08

              • Credit Risk

                • Full Recourse Istisna'a

                  • CA-3.4.14

                    The receivable amount generated from the selling of an asset based on an Istisna'a contract with full recourse to the customer (buyer) shall be assigned a RW based on the credit standing of the customer as rated by an ECAI that is approved by the CBB. In case the buyer is unrated, a RW of 100% shall apply. (See section CA-4.2).

                    Apr 08

                • Limited and Non-Recourse Istisna'a

                  • CA-3.4.15

                    When the project is rated by an ECAI, the RW based on the credit rating of the project is applied to calculate the capital adequacy requirement. Otherwise, the RW shall be based on the 'Supervisory Slotting Criteria' approach for Specialised Financing (Project Finance) as set out in section CA-4.3.

                    Apr 08

                  • CA-3.4.16

                    In cases where a group of contractors are engaged in a particular project, the risk rating or weightage will follow the obligations of various contractors. If the risk is undertaken by a main contractor, the risk rating of the main contractor is to be used.

                    Apr 08

                  • CA-3.4.17

                    The limited and non-recourse Istisna'a financing structure is required to meet the characteristics as set out below in order to qualify for the treatment mentioned in paragraph CA-3.4.15 above:

                    (a) The segregation of the project's liabilities from the balance sheet of the Istisna'a ultimate buyer (or project sponsor) from a commercial and accounting perspective which is generally achieved by having the Istisna'a contract made with a special purpose entity set up to acquire and operate the asset/project concerned;
                    (b) The ultimate buyer is dependent on the income received from the assets acquired/ projects to pay the purchase price;
                    (c) The contractual obligations give the manufacturer/constructor/bank a substantial degree of control over the asset and the income it generates, for example under BOT (built, operate and transfer) arrangement where the manufacturer builds a highway and collects tolls for a specified period as a consideration for the selling price; and
                    (d) The primary source of repayment is the income generated by the asset/project rather than relying on the capacity of the buyer.
                    Amended: April 2011
                    April 2008

                  • CA-3.4.18

                    Please Note: Insurance is normally part and parcel of the project risk financing. However, it is not regarded as a credit risk mitigating technique.

                    Apr 08

                • Exclusions

                  • CA-3.4.19

                    The capital requirement is to be calculated on the receivable amount, net of (i) specific provisions, (ii) any amount that is secured by eligible collateral (as defined in section CA-4.7) and/or (iii) any amount which is past due by more than 90 days. The portions that are collateralised and past due are subject to the treatment as set out in chapter CA-4.

                    Apr 08

                  • CA-3.4.20

                    Any portion of an Istisna'a contract that is covered by an advanced payment shall carry a RW of 0%, or the amount of the advanced payment shall be offset against the total amount receivable or amounts owing from progress billings.

                    Apr 08

                • Applicable Period

                  • CA-3.4.21

                    The credit RW is to be applied from the date when the manufacturing or construction process commences and until the selling price is fully settled by the bank, either in stages and/or on the maturity of the Istisna'a contract, which is upon delivery of the manufactured asset to the Istisna'a ultimate buyer.

                    Apr 08

                • Offsetting Arrangement between Credit Exposures of Istisna'a and Parallel Istisna'a

                  • CA-3.4.22

                    The credit exposure amount of an Istisna'a contract is not to be offset against the credit exposure amount of a Parallel Istisna'a contract because an obligation under one contract does not discharge an obligation to perform under the other contract.

                    Apr 08

              • Market Risk

                • Full Recourse Istisna'a

                  • (a)Istisna'a with Parallel Istisna'a

                    • CA-3.4.23 CA-3.4.23

                      There is no capital charge for market risk to be applied in addition to provisions in paragraphs CA-3.4.14 to CA-3.4.22 above, subject to there being no provisions in the Parallel Istisna'a contract that allow the seller to increase or vary its selling price to the bank, under unusual circumstances. Any variations in a Parallel Istisna'a contract that are reflected in the corresponding Istisna'a contract which effectively transfers the whole of the price risk to an Istisna'a customer (buyer), is also eligible for this treatment.

                      Apr 08

                      • CA-3.4.24 CA-3.4.24

                        However, if the seller is allowed to vary the selling price of the asset, then under the price risk will be calculated in accordance with paragraph CA-5.2.2 of chapter CA-5.

                        Apr 08

                        • (b)Istisna'a without Parallel Istisna'a

                          • CA-3.4.25 CA-3.4.25

                            A capital charge of 1.6% (equivalent to a 20% RW) is to be applied to the balance of unbilled WIP inventory to cater for market risk, in addition to the credit RW stated in paragraphs CA-3.4.14 to CA-3.4.22 above.

                            Apr 08

                            • CA-3.4.26 CA-3.4.26

                              This inventory is held subject to the binding order of the Istisna'a buyer and is exposed to the price risk as described in CA-3.4.11.

                              Apr 08

                              • Foreign Exchange Risk

                                • CA-3.4.27

                                  Any foreign exchange exposures arising from the purchasing of input materials, or from Parallel Istisna'a contracts made, or the selling of a completed asset in foreign currency should be included in the measures of foreign exchange risk described in section CA-5.5.

                                  Apr 08

              • Summary of Capital Requirement at Various Stages of the Contract

                • CA-3.4.28

                  The following tables set out the applicable period of the contract that attracts capital charges for (a) Full Recourse Istisna'a (b) Limited and Non-Recourse Istisna'a.

                  (a) Full Recourse Istisna'a
                  (i) Istisna'a with Parallel Istisna'a
                  Applicable Stage of the Contract Credit RW Market Risk Capital Charge
                  Unbilled work-in-progress Based on ultimate buyer's rating or 100% RW for unrated buyer.

                  No netting of Istisna'a exposures against Parallel Istisna'a exposures.

                  (See paragraphs CA-3.4.14 to CA-3.4.22)

                  (See section CA-4.2)
                  Nil provided that there is no provision in the Parallel Istisna'a contract that allows the seller to increase or vary the selling price. See paragraph CA-3.4.23 If the seller is allowed to vary the selling price of the asset, then under the market risk treatment 15% capital charge on net long or short position plus 3% capital charge on gross positions.
                  Amount receivable after contract billings
                  Upon full settlement price by an Istisna'a buyer. NA NA
                  (ii) Istisna'a without Parallel Istisna'a
                  Applicable Stage of the Contract Credit RW Market Risk Capital Charge
                  Unbilled work-in-progress Based on ultimate buyer's rating or 100% RW for unrated buyer. 1.6% capital charge on work in progress inventory.

                  See relevant paragraphs under CA-3.4.25 to CA-3.4.26
                  Progress billing to customer. Based on ultimate buyer's rating or 100% RW for unrated buyer.

                  (See paragraphs CA-3.4.14 to CA-3.4.22) (See section CA-4.2)
                  NA
                  Upon full settlement price by and Istisna'a buyer. NA NA
                  (b) Limited and Non-Recourse Istisna'a

                  Istisna'a with Parallel Istisna'a (for project finance)
                  Applicable Stage of the Contract Credit RW Market Risk Capital Charge
                  Unbilled work-in-progress Based on project's ECAI rating if available or supervisory slotting criteria that ranges from 70% to 250% RW.

                  No netting of Istisna'a exposures against Parallel Istisna'a exposures.

                  (See sections CA-4.2 and CA -4.3)
                  NA
                  Amount receivable after contract billings NA
                  Upon full settlement price by and Istisna'a buyer. NA NA
                  Apr 08

            • CA-3.5 CA-3.5 Ijarah and Ijarah Muntahia Bittamleek

              • Introduction

                • CA-3.5.1

                  This section sets out the minimum capital requirement to cover counterparty risk and residual value risk of leased assets, arising from a bank entering into contracts or transactions that are based on the Sharia rules and principles of Ijarah and Ijarah Muntahia Bittamleek (IMB), also known as Ijarah wa Iqtinā. The section also covers the market (price) risk of assets acquired for Ijarah and IMB.

                  Apr 08

                • CA-3.5.2

                  In an Ijarah contract (either operating or IMB), the bank as the lessor maintains its ownership in the leased asset whilst transferring the right to use the asset, or usufruct, to an enterprise as the lessee, for an agreed period at an agreed consideration. All liabilities and risks pertaining to the leased asset are to be borne by the bank including obligations to restore any impairment and damage to the leased asset arising from wear and tear and natural causes which are not due to the lessee's misconduct or negligence.

                  Apr 08

                • CA-3.5.3

                  Thus, in both Ijarah and IMB, the risks and rewards remain with the lessor, except for the residual value risk at the term of an IMB which is borne by the lessee. The lessor is exposed to price risk on the asset while it is in the lessor's possession prior to the signature of the lease contract, except where the asset is acquired following a binding promise to lease as described in paragraph CA-3.5.5 below.

                  Apr 08

                • CA-3.5.4

                  In an IMB contract, the lessor promises to transfer its ownership of the leased asset to the lessee at the end of the contract as a gift or as a sale at a specified consideration, provided that (a) the promise is separately expressed and independent of the underlying Ijarah; or (b) a gift contract is entered into conditional upon fulfillment of all the Ijarah obligations, and thereby ownership shall be automatically transferred thereupon.

                  Apr 08

                • CA-3.5.5

                  In both operating Ijarah and IMB, the Bank either possesses the asset before entering into a leased contract or enters into the contract based on specific description of an asset to be leased and acquired in the future before it is delivered to the lessee. This agreement to lease may be considered as binding (binding Promise to Lease (PL)) or as non-binding (non-binding PL) depending on the applicable Sharia interpretations.

                  Apr 08

                • Operating Ijarah

                  • CA-3.5.6

                    This section sets out the minimum capital requirements to cater for the lessor's exposures to (a) the credit risk of the lessee as counterparty in servicing the lease rentals, and (b) the market (price) risk attaching to the residual value of the leased assets either at the end of the Ijarah contract or at the time of repossession upon default, i.e. the risk of losing money on the resale of the leased asset.

                    Apr 08

                • IMB

                  • CA-3.5.7

                    In IMB, once the lease contract is signed, the lessor is exposed to credit risk for the lease payments receivable from the lessee (a credit risk mitigated by the asset's value as collateral5 in most cases) and to a type of operational risk in respect of the need to compensate the lessee if the asset is permanently impaired through no fault of the latter. If the leased asset is permanently impaired and is uninsured, the bank suffers a loss equal to the carrying value of the leased asset, just as it would if any of its fixed assets were permanently impaired. In the event that the lessee exercises its right to cancel the lease, the lessor is exposed to the residual value of the leased asset being less than the refund of payments due to the lessee. In such case, the price risk, if any, is already reflected in a 'haircut' to be applied to the value of the leased asset as collateral. Therefore, the price risk, if any, is not applicable in the context of the IMB.


                    5 The collateral used in the context of IMB is of the usufruct or use value of the asset, as the bank is the owner of the asset.

                    Apr 08

                  • CA-3.5.8

                    This section sets out the minimum capital adequacy requirement to cater for the credit risk of the lessee as counterparty with respect to servicing the lease rentals. The credit risk exposure in respect of the lease rentals is mitigated by the collateral represented by the value of the leased asset on repossession, provided that the bank is able to repossess the asset, which may be subject to doubt, especially in the case of movable assets or residential real estate. Insofar as there is doubt as to the lessor's ability to repossess the asset, the residual fair value of the asset that was assumed in fixing the lease rentals is also exposed to credit risk.

                    Apr 08

                  • CA-3.5.9

                    The bank may be exposed to losses in case a lessee acquiring an asset under IMB decides not to continue with the contract. In such a case, the lessor is required to refund to the lessee the capital payments (instalments of the purchase price) that were included in the periodic lease rentals (subject to deduction of any amounts due for unpaid rentals). If the value of the repossessed asset is less than the amount to be refunded (before any such deduction), the difference constitutes a loss to the lessor. This exposes the bank as lessor to a form of market risk.

                    Apr 08

                  • CA-3.5.10

                    In theory, a situation could arise in which, when an IMB contract arrives at its term, the lessee decides not to exercise its option to complete the purchase by making the contractually agreed final payment (The option to purchase places no obligation on the lessee to do so.). The bank may thus be exposed to market risk, in respect of a potential loss from disposing of the asset for an amount lower than its net book value. Generally, however, the lessor's exposure in such a case would not be significant, as the option to purchase can be exercised by making a payment of a token amount and the lessee would have no reason to refrain from exercising it.

                    Apr 08

                  • CA-3.5.11

                    Moreover, the net book value of the asset at the term of the IMB (i.e. its residual fair value as assumed in fixing the lease rentals) would be zero or close to zero.

                    Apr 08

              • Credit Risk

                • CA-3.5.12

                  In a binding PL, when a bank is exposed to default on the lease orderer's obligation to execute the lease contract, the exposure shall be measured as the amount of the asset's total acquisition cost to the bank, less the market value of the asset as collateral subject to any haircut, and less the amount of any urbun received from the lease orderer. The applicable RW shall be based on the standing of the obligor as rated by an ECAI that is approved by the CBB, and in the case the obligor is unrated, a RW of 100% shall apply (refer to chapter CA-4). The bank may or may not have the right to recoup from the customer any loss on leasing or disposing of the asset after taking account of the HJ.

                  Apr 08

                • CA-3.5.13

                  In applying the treatment as set out in paragraph CA-3.5.12, the bank must ensure that the PL is properly documented and is legally enforceable. In the absence of proper documentation and legal enforceability, the asset is to be treated similarly to one in a non-binding PL which is exposed to market (price) risk, using the measurement approach as set out in paragraph CA-3.5.18(a).

                  Apr 08

                • Operating Ijarah

                  • CA-3.5.14

                    When the lessee gets the right to use the asset, the lessor is exposed to credit risk for the estimated value of the lease payments in respect of the remaining period of the Ijarah. This exposure is mitigated by the market value of the leased asset (subject to the applicable haircut) which may be repossessed (except in the case of residential real estate). The net credit risk exposure shall be assigned a RW based on the credit standing of the lessee/counterparty as rated by an ECAI that is approved by the CBB. In the case that the lessee is unrated, a RW of 100% shall apply.

                    Apr 08

                • IMB

                  • CA-3.5.15

                    When the lessee gets the right to use the asset, the capital requirement for IMB is based on the total estimated future ijarah receivable amount over the duration of the lease contract. This exposure is mitigated by the market value of the leased asset which may be repossessed (except in the case of residential real estate). The net credit risk exposure shall be assigned a RW based on the credit standing of the lessee/counterparty as rated by an ECAI that is approved by the CBB. In the case that the lessee is unrated, a RW of 100% shall apply. (See section CA-4.2).

                    Apr 08

                  • CA-3.5.16

                    The estimated future ijarah receivable amount as indicated in paragraph CA-3.5.15 (a) above, shall be risk-weighted based on the credit standing of the lessee as rated by an ECAI or at 100%, after deduction of the value of the leased asset as collateral (subject to any haircut). (See chapter CA-4).

                    Apr 08

                • Exclusions

                  • CA-3.5.17

                    The capital requirement is to be calculated on the receivable amount, net of (i) specific provisions, (ii) any amount that is secured by eligible collateral (as defined in section CA-4.7) and/or (iii) any amount which is past due by more than 90 days. The portions that are collateralised and past due are subject to the treatment as set out in chapter CA-4.

                    Apr 08

              • Market Risk

                • CA-3.5.18

                  In the case of an asset acquired and held for the purpose of either operating Ijarah or IMB, the capital charge to cater for market (price) risk in respect of the leased asset from its acquisition date until its disposal can be categorised into the following:

                  (a) Non-binding PL

                  The asset for leasing will be treated as inventory of the bank and capital charge will be provided for the price risk in accordance with section CA-5.2.
                  (b) Binding PL

                  In a binding PL, a bank is exposed to default on the lease orderer's obligation to lease the asset in its possession. In the event of the lease orderer defaulting on its PL, the bank will either lease or dispose of the asset to a third party. The bank will have recourse to any HJ paid by the customer6, and (i) may have a right to recoup from the customer any loss on leasing or disposing of the asset after taking account of the HJ, or (ii) may have no such right, depending on the legal situation. In both cases, this risk is mitigated by the asset in possession (if eligible) as well as any HJ paid by the lease orderer.

                  6 The amount can only be deducted for damages, i.e. difference between the asset acquisition cost and the total of lease rentals (when the asset is leased to a third party) or selling price (when the asset is sold to a third party), whichever is applicable.

                  Apr 08

                • CA-3.5.19

                  In case (i), the bank has the right to recoup any loss (as indicated in the previous paragraph) from the customer, that right constitutes a claim receivable which is exposed to credit risk, and the exposure shall be measured as the amount of the asset's total acquisition cost to the bank, less the market value of the asset as collateral subject to any haircut, and less the amount of any HJ. The applicable RW shall be based on the standing of the customer as rated by an ECAI that is approved by CBB, and in the case the obligor is unrated, a RW of 100% shall apply. (see section CA-4.2).

                  Apr 08

                • CA-3.5.20

                  In case (ii) the bank has no such right, and the cost of the asset to the bank constitutes a market risk (as in the case on a non-binding PL), but this market risk exposure is reduced by the amount of any HJ that the bank has the right to retain.

                  Apr 08

                • Operating Ijarah

                  • CA-3.5.21

                    The residual value of the asset will be subject to capital charge of 8%. Upon expiry of the lease contract, the carrying value of the leased asset shall carry a capital charge for price risk in accordance with section CA-5.2 until the asset is re-leased or disposed of.

                    Apr 08

                • IMB

                  • CA-3.5.22

                    In the event that the lessee exercises its right to cancel the lease, the lessor is exposed to the residual value of the leased asset being less than the refund of payments due to the lessee. In such a case, the price risk, if any, is already reflected in a 'haircut' to be applied to the value of the leased asset as collateral in credit risk. Therefore, the price risk, if any, is not applicable in the context of the IMB.

                    Apr 08

              • Summary of Capital Requirement at Various Stages of the Contract

                • CA-3.5.23

                  The following tables set out the applicable period of the contract that attracts capital charges:

                  Operating Ijarah

                  Applicable Stage of the Contract Credit RW Market Risk Capital Charge
                  Asset available for lease (prior to signing a lease contract) - If the bank has legal right to recoup from the customer any loss on disposing of the asset Binding PL Asset acquisition cost less (a) market value of asset fulfilling function of collateral (net of any haircuts) and (b) any 'hamish jiddiyyah' multiply with the customer's rating or 100% RW for unrated customer. (See section CA-4). Non-binding PL 15% capital charge until lessee takes possession.
                  Asset available for lease (prior to signing a lease contract) - If the bank has no legal right to recoup from the customer any loss on disposing of the asset NA 15% capital charge until lessee takes possession minus urbun (If the bank has legal right to it).
                  When the lessee gets the right to use the asset and the lease rental payments are due from the lessee Total contractual obligation of the lease rental receivable over the duration of the lease contract less the recovery value* (if eligible) of the leased asset shall be risk-weighted according to the lessee's rating. (100% RW for an unrated lessee.). (See chapter CA-4). The residual value will be subject to capital charge of 8%
                  Maturity of contract term and the leased asset is returned to the bank Not applicable 15% capital charge of the carrying value of the asset

                  * Recovery value should be based on the entire Ijarah asset value.

                  IMB

                  Applicable Stage of the Contract Credit RW Market Risk Capit Charge
                  Asset available for lease (prior to signing a lease contract) - If the bank has legal right to recoup from the customer any loss on disposing of the asset Binding PL Asset acquisition cost less (a) market value of asset fulfilling function of collateral (net of any haircuts) and (b) any 'hamish jiddiyyah' multiply with the customer's rating or 100% RW for unrated customer. (See chapter CA-4). Non-binding PL 15% capital charge until lessee takes possession
                  Asset available for lease (prior to signing a lease contract) - If the bank has no legal right to recoup from the customer any loss on disposing of the asset NA 15% capital charge until lessee takes possession minus urbun (If the bank has legal right to it).
                  When the lessee gets the right to use the asset and the lease rental payments are due from the lessee Total contractual obligation of the lease rental receivable over the duration of the lease contract less recovery value of the asset* (if eligible) shall be risk-weighted according to the lessee's rating (100% RW for an unrated lessee. (See chapter CA-4). Not applicable
                  Maturity of contract term and the leased asset is returned to the bank Not applicable Not applicable

                  * Recovery value should be based on the entire Ijarah asset value.

                  Apr 08

            • CA-3.6 CA-3.6 Musharakah and Diminishing Musharakah

              • Introduction

                • CA-3.6.1

                  This section sets out the minimum capital adequacy requirement to cover the risk of loss on invested capital arising from entering into contracts or transactions that are based on the Sharia rules and principles of Musharakah and Diminishing Musharakah where the bank and their customers/partner(s) contribute to the capital of the partnership and shares its profit or loss.

                  Apr 08

                • CA-3.6.2

                  This section is applicable to both (a) Musharakah in which all the partners' share remain constant throughout the contract period; and (b) Diminishing Musharakah in which the share of the bank shall be gradually reduced during the tenure of the contract until it is fully sold to the other partner(s).

                  Apr 08

                • CA-3.6.3

                  Musharakah contracts refer to partnerships in specific transactions or projects. These exclude participation in the share capital (equity) of other enterprises.

                  Apr 08

                • CA-3.6.4

                  A Musharakah is an agreement between the bank and a customer to contribute capital in various proportions to an enterprise, whether existing or new, or to ownership of a real estate or moveable asset, either on a permanent basis, or on a diminishing basis where the customer progressively buys out the share of the bank ("Diminishing Musharakah"). Profits generated by that enterprise or real estate/asset are shared in accordance with the terms of Musharakah agreement whilst losses are shared in proportion to the respective contributor's share of capital.

                  Apr 08

                • CA-3.6.5

                  A bank may enter into a Musharakah contract with a customer as a means of providing a financing to the latter on a profit sharing and loss bearing basis. In this case, the Musharakah is normally of the diminishing type, in which the customer gradually purchases the bank's partnership share over the life of the contract. This type of financing is one of the Sharia compliant alternatives to avoid a conventional term loan repayable by instalments, and as such it is exposed to credit risk for the customer's purchase payments as well as to the risk attached to the bank's share of the underlying assets.

                  Apr 08

                • Musharakah

                  • CA-3.6.6

                    This section sets out the minimum capital adequacy requirement to cater for "capital impairment risk", the risk of losing the amount contributed to an enterprise or ownership of an asset. The bank acts as a partner in a Musharakah contract and is exposed to the risk of losing its capital upon making payment of its share of capital in a Musharakah contract. A Musharakah can expose the bank either to capital impairment risk or to 'credit risk', depending on the structure and purpose of the Musharakah and the types of asset in which the funds are invested. The invested capital is redeemable either by liquidation of the Musharakah assets at the end of the contract which has a fixed tenure or as mutually agreed by the partners, or upon divestment of partnership in an on-going Musharakah subject to giving a notice to other partners. The amount of capital redemption is represented by the value of a share of capital, which is dependent on the quality of the underlying investments or assets, and ability to generate profits and cash flows from the Musharakah.

                    Apr 08

                  • CA-3.6.7

                    As a partner to a Musharakah contract, the bank is not entitled to a fixed rate of return and is thus exposed to variable profits generated by the partnership which are shared on a basis as agreed in the Musharakah contract, whereas losses are to be borne by the bank and its partners according to their respective ratio of invested capital. Therefore, the bank is exposed to entrepreneurial risk of an active partner that manages the partnership and business risks associated with the underlying activities and types of investments or assets of the partnership.

                    Apr 08

                • Diminishing Musharakah

                  • CA-3.6.8

                    This form of Musharakah is a means whereby a bank can provide term finance to a client on a profit and loss sharing basis. The bank enters into this type of Musharakah with the objective of transferring the ownership to the partner/customer, where the bank acts as a joint-owner of the asset with a promise by the partner to purchase the bank's share making a payment on one or more specified future dates. The bank's selling price is normally based on the fair value of the partnership share being transferred on the date of each purchase, which may expose the bank to the risk of selling its share of ownership below the acquisition price.

                    Apr 08

                  • CA-3.6.9

                    As a joint-owner, the bank is also entitled to its share of revenue generated from the assets of the Musharakah, such as Ijarah lease rentals in which the rental entitlements to the bank shall be adjusted periodically according to the bank's share of ownership in the asset.

                    Apr 08

                  • CA-3.6.10

                    The bank's position in a Diminishing Musharakah thus entails two kinds of exposure. The amounts due from the partner to purchase the agreed shares of the asset on the agreed dates are subject to credit risk in respect of the partner's ability and willingness to pay, with the shares of the partner in the asset providing credit risk mitigation as collateral. The capital invested by the bank is also subject to the risk that the amounts recoverable from the partner may be less than the amount invested because the value of the Musharakah assets has decreased (capital impairment risk).

                    Apr 08

              • Equity Position Risk - Musharakah

                • CA-3.6.11

                  Musharakah exposures, unless deducted for regulatory capital purposes according to the Prudential Consolidation and Deduction Requirements, will be treated as stated in paragraphs CA-3.6.12 to CA-3.6.14.

                  Apr 08

                • CA-3.6.12

                  Musharakah exposures in the nature of specialized financing will be risk-weighted as per the supervisory slotting criteria as detailed in section CA-4.3.

                  Apr 08

                • CA-3.6.13

                  Other Musharakah exposures will be risk-weighted using the risk weights applicable to equities as explained in section CA-4.2.

                  Apr 08

                • CA-3.6.14

                  If the bank demonstrates that a Musharakah exposure meets the definition of trading book given in chapter CA-5, capital charge will be calculated as per market risk rules detailed in chapter CA-5.

                  Apr 08

              • Equity Position Risk - Diminishing Musharakah

                • CA-3.6.15

                  The equity exposure in a Diminishing Musharakah contract, where the bank intends to transfer its full ownership in movable assets and working capital to the other partner over the life of the contract, is calculated based on the remaining balance of the amount invested (measured at historical cost including any share of undistributed profits) less any specific provision for impairment. The exposure shall be risk weighted according to the nature of the underlying assets as set out in paragraph CA-3.6.11 to CA-3.6.14 above. If a third party guarantee exists, to make good impairment losses, the RW of the guarantor shall be substituted for that of the assets (if lower) for the amount of any such guarantee.

                  Apr 08

              • Summary of Capital Requirement at Various Stages of the Contract

                • CA-3.6.16

                  The following table sets out the Musharakah categories that attract capital charges:

                  Musharakah Category Credit RW Market Risk Capital Charge
                  Specialized financing Supervisory slotting criteria should be applied.

                  Between 90-270% RW of the contributed amount* to the business venture based on the four categories.
                  NA
                  Other 150% RW** of the contributed amount to the business venture less any specific provisions (if there is a third party guarantee, the RW of the guarantor shall be substituted for that of the assets for the amount of any such guarantee, if lower). NA
                  Musharakah meeting the definition of trading book   As set out in the applicable market risk section (Chapter CA-5).

                  * In the case of Diminishing Musharakah, the contributed amount is based on the remaining balance of the invested amount.

                  ** 100% RW may be applied if the funds can be withdrawn by the bank at short notice of 5 working days.

                  Apr 08

            • CA-3.7 CA-3.7 Mudarabah

              • Introduction

                • CA-3.7.1

                  This section sets out the minimum capital adequacy requirement to cover the risk of losing invested capital arising from entering into contracts or transactions that are based on the Sharia rules and principles of Mudarabah where the bank assumes the role of capital provider. This section is applicable to both restricted and unrestricted Mudarabah financing.

                  Apr 08

                • CA-3.7.2

                  A Mudarabah is an agreement between the bank and a customer whereby the bank would contribute capital to an enterprise or activity which is to be managed by the customer as the (labour provider or) Mudarib.

                  Apr 08

                • CA-3.7.3

                  Profits generated by that enterprise or activity are shared in accordance with the terms of the Mudarabah agreement whilst losses are to be borne solely by the bank unless the losses are due to the Mudarib's misconduct, negligence or breach of contracted terms.

                  Apr 08

                • CA-3.7.4

                  A Mudarabah financing can be carried out on either:

                  (a) A restricted basis, where the capital provider allows the Mudarib to make investments subject to specified investment criteria or certain restrictions such as types of instrument, sector or country exposures; and
                  (b) An unrestricted basis, where the capital provider allows the Mudarib to invest funds freely based on the latter's skills and expertise.
                  Amended: April 2011
                  April 2008

                • CA-3.7.5

                  As the fund provider, the bank is exposed to the risk of losing its capital investment or 'capital impairment risk' upon making payment of the capital to the Mudarib. Any loss on the investment is to be borne solely by the capital provider, but is limited to the amount of his capital. Losses that are due to misconduct, negligence or breach of contractual terms, are to be borne by the Mudarib.

                  Apr 08

                • CA-3.7.6

                  However, while it is not permissible for a Mudarib to give a guarantee against such losses, such a guarantee may be given by a third party on the basis of tabarru (donation). In such a case, the amount of the Mudarabah capital so guaranteed may be considered as subject to credit risk with a risk weighting equal to that of the guarantor.

                  Apr 08

                • CA-3.7.7

                  In particular, such guarantees may be given when liquid funds are placed in an Islamic interbank market under a Mudarabah contract.

                  Apr 08

              • Equity Position Risk

                • CA-3.7.8

                  Mudarabah exposures, unless deducted for regulatory capital purposes according to the Prudential Consolidation and Deduction Requirements, will be treated as stated in paragraphs CA-3.7.9 to CA-3.7.11.

                  Apr 08

                • CA-3.7.9

                  Mudarabah exposures in the nature of specialized financing will be risk-weighted as per the supervisory slotting criteria as detailed in section CA-4.3.

                  Apr 08

                • CA-3.7.10

                  Other Mudarabah exposures will be risk-weighted using the risk weights applicable to equities as explained in section CA-4.2.

                  Apr 08

                • CA-3.7.11

                  If the bank demonstrates that a Mudarabah exposure meets the definition of trading book given in chapter CA-5, capital charge will be calculated as per market risk rules detailed in chapter CA-5.

                  Apr 08

              • Summary of Capital Requirements for Mudarabah Categories

                • CA-3.7.12

                  The following tables set out the Mudarabah categories that attract capital charges:

                  Mudarabah Category Credit RW Market Risk Capital Charge
                  Specialized financing Supervisory slotting method will be applied.

                  Between 90-270% RW of the contributed amount to the business venture based on the four categories.
                  NA
                  Other 150% RW* of the contributed amount to the business venture less any specific provisions (if there is a third party guarantee, the RW of the guarantor shall be substituted for that of the assets for the amount of any such guarantee). NA
                  Mudarabah meeting the definition of trading book   As set out in the applicable market risk section (See chapter CA-5).

                  * 100% RW may be applied if the funds can be withdrawn by the bank at short notice of 5 working days.

                  Apr 08

            • CA-3.8 CA-3.8 Sukuk

              • Introduction

                • CA-3.8.1

                  This section sets out the minimum capital adequacy requirement to cover the credit risk and market risk arising from the holding of Sukuk.

                  Apr 08

                • CA-3.8.2

                  This section is applicable only to Sukuk or certificates that represent the holder's proportionate ownership in an undivided part of an underlying asset where the holder assumes all rights and obligations to such asset. This section does not cover certificates that give the holders the entitlement to receive returns on an asset of which the ownership is not transferred to the Sukuk holders.

                  Apr 08

                • CA-3.8.3

                  Sukuk can be broadly categorised into:

                  (a) Asset-based Sukuk, where the underlying assets offer fairly predictable returns to the Sukuk holders, such as in the case of Salam, Istisna'a and Ijarah (Note: the assets in question may be held by a Musharakah or Mudarabah which is securitised. This is not the same as the Musharakah or Mudarabah Sukuk mentioned below).
                  (b) Equity-based Sukuk, where the returns are determined on a profit and loss sharing in the underlying investment which does not offer fairly predictable returns (e.g. Musharakah or Mudarabah for trading purposes).
                  Amended: April 2011
                  April 2008

                • CA-3.8.4

                  CBB has the discretion to specify measurement approaches as it thinks appropriate for other types of Sukuk which are not listed in this section, provided they are approved by a Sharia board.

                  Apr 08

                • Salam Sukuk

                  • CA-3.8.5

                    A Salam Sukuk represents fractional ownership of the capital of a Salam transaction, where the Salam capital is constituted by an advance payment to a counterparty as supplier of a commodity (the subject-matter) to be delivered at a future date. This type of Sukuk is non-tradable, since the subject-matter is considered to be a financial asset (a receivable). The gross return to the Sukuk holders consists of the margin or spread between the purchase price of the subject-matter and its selling price following delivery. In certain Sukuk issues, a third party gives an undertaking that the subject-matter will be sold at a price exceeding the purchase price by a specified margin. This may be achieved by means of a parallel Salam transaction in which a third party purchases the subject-matter for delivery on the same delivery date as in the original Salam contract.

                    Apr 08

                • Istisna'a Sukuk

                  • CA-3.8.6

                    An Istisna'a Sukuk represents a fractional share in the project financing of an undertaking to manufacture or construct an asset for a customer at a price to be paid in future instalments, the total of which equals the total face value of the Sukuk, in addition to mark-up. The Sukuk can be in the form of serial notes or certificates with different maturity dates that match the progress schedule of instalments as agreed between the buyer/customer of the asset and the manufacturer/bank. Istisna'a Sukuk are tradable as the subject-matter is considered to be a non-financial asset (work-in-process inventory).

                    Apr 08

                • Ijarah Sukuk

                  • CA-3.8.7

                    An Ijarah Sukuk represents the holder's proportionate ownership in a leased asset where the Sukuk holders will collectively assume the rights and obligations of the lessor. The Sukuk holder will enjoy a share of the lease rental in proportionate to the ownership share in the leased asset. An Ijarah Sukuk is tradable from the issuance date as the subject-matter is a non-financial asset owned by the Sukuk holders. As a part-owner, the Ijarah Sukuk holder assumes a proportionate share of any loss if the leased asset is destroyed or of the cost of meeting the obligation to provide an alternative asset, failing which, the lessee can terminate the lease without paying future rentals.

                    Apr 08

                • Musharakah Sukuk

                  • CA-3.8.8

                    A Musharakah Sukuk represents the direct pro-rata ownership of the holder in the assets of a private commercial enterprise or project where the subscription money is normally employed in purchasing non-liquid assets or such as real estate or moveable assets. A Musharakah Sukuk is a profit and loss sharing instrument where the exposure is of the nature of an equity position in the banking book, except in the case of investments (normally short-term) in assets for trading purposes. A Musharakah certificate can be tradable provided that non-cash and receivable assets are not less than 30% of market capitalisation.

                    Apr 08

                • Mudarabah (Muqaradah) Sukuk

                  • CA-3.8.9

                    Sukuk holders subscribe to the certificates issued by a Mudarib and share the profit and bear any losses arising from the Mudarabah operations. The returns to the holders are dependent on the revenue generated by the underlying investment. The rule regarding tradability of the certificates is the same as for Musharakah certificates.

                    Apr 08

              • Calculation of Capital Charge

                • CA-3.8.10

                  If the Sukuk has the characteristics of a claim (or debt) then the Sukuk should be risk weighted using its issue specific rating according to the nature of the issuer (i.e. sovereign, bank or corporate etc). If the Sukuk is unrated and has the characteristics of a claim or debt, the risk weight applicable will be based on the risk weight applicable to the issuer.

                  Apr 08

                • CA-3.8.11

                  If the Sukuk is equity in nature, such investment should be treated as an equity investment and risk weighted accordingly (i.e. 100 % for listed and 150 % for others).

                  Apr 08

                • CA-3.8.12

                  The bank can apply to CBB for using look-through approach for such investment if it can demonstrate that look-through approach is more appropriate to the circumstances of the bank.

                  Apr 08

                • CA-3.8.13

                  If there are no voting rights attached to investment in Sukuk, the investment will not be subjected to consolidation and deduction requirements (except large exposure limit).

                  Apr 08

                • CA-3.8.14

                  For the purpose of determining "large exposure limit" for investment in Sukuk, look-through approach should be used (despite the fact that look-through approach is not used to risk weight the investment).

                  Apr 08

                • CA-3.8.15

                  If the bank demonstrates that a Sukuk exposure meets the definition of trading book given in chapter CA-5, capital charge will be calculated as per market risk rules detailed in chapter CA-5.

                  Apr 08

              • Summary of Capital Requirements for Sukuk Exposures

                • CA-3.8.16

                  The following tables summarises the capital requirements for Sukuk exposures:

                  Sukuk Category Credit RW Market Risk Capital Charge
                  In nature of claim or debt Risk-weighted according to the external rating of the Sukuk (where rated) or according to the risk weight applicable to the issuer (where unrated) NA
                  In nature of equity -Listed 100% RW NA
                  In nature of equity- Not listed 150% RW* NA
                  If the bank gets approval to apply "look-through approach" RWs applicable to the underlying assets NA
                  Sukuk meeting the definition of trading book NA As set out in the applicable market risk section (See chapter CA-5).

                  * 100% RW may also be applied if the funds can be withdrawn by the bank at short notice of 5 working days.

                  Apr 08

          • CA-4 CA-4 Credit Risk — The Standardized Approach

            • CA-4.1 CA-4.1 Introduction

              • CA-4.1.1

                Credit risk exposures in Islamic financing arise in connection with accounts receivable in Murabaha contracts, counterparty risk in Salam contracts, accounts receivable and counterparty risk in Istisn'a contracts and lease payments receivable in Ijarah contracts, and Sukuk held to maturity in the banking book. Credit risk is measured according to the Standardised Approach as outlined in the Basel II guidelines, except for certain exposures arising from investments by means of Musharaka or Mudaraba contracts in assets in the banking book. The latter are to be treated as giving rise to credit risk (in the form of capital impairment risk), and are to be risk-weighted applying the supervisory slotting criteria for exposures in the nature of specialised financing and the risk weights applicable to equities for other equity exposures as detailed in the Musharaka and Mudaraba sections of this Rulebook.

                Apr 08

              • CA-4.1.2

                Broadly, the assignment of Risk Weights (RW) under the standardised approach takes into consideration the following:

                •   The credit risk rating of an obligor or other counterparty, or a security, based on external credit assessment institutions (ECAI) ratings7. In determining the risk weights in the standardised approach, Islamic banks must use assessments by only those external credit assessment institutions which are recognised as eligible for capital purposes by CBB in accordance with the criteria defined in section CA-4.6.
                •   Credit risk mitigation techniques adopted by the banks;
                •   Types of the underlying assets that are sold and collateralised or leased by the banks; and
                •   The amount of specific provisions made for the overdue portion of accounts receivable or lease payments receivable.

                7 The notations follow the methodology used by one institution, Standard & Poor's. The use of Standard & Poor's credit ratings is an example only; those of some other external credit assessment institutions could equally well be used. The ratings used throughout this document, therefore, do not express any preferences or determinations on external assessment institutions by CBB.

                Amended: April 2011
                April 2008

              • CA-4.1.3

                Where a discount is applied on fair value of an asset (as explained in CA-2.1.4), the value of the asset will be adjusted to exclude that discount part. Refer to appendix CA-7.

                Apr 08

            • CA-4.2 CA-4.2 Segregation of Claims

              • Claims on Sovereigns

                • CA-4.2.1

                  Claims on governments of GCC member states (hereinafter referred to as GCC) and their central banks can be risk weighted at 0%. Claims on other sovereigns and their central banks are given a preferential risk weighting of 0% where such claims are denominated and funded in the relevant domestic currency of that sovereign/central bank (e.g. if a Bahraini bank has a claim on government of Australia and the loan is denominated and funded in Australian dollar, it will be risk weighted at 0%). Such preferential risk weight for claims on GCC/other sovereigns and their central banks will be allowed only if the relevant supervisor also allows 0% risk weighting to claims on its sovereign and central bank.

                  Apr 08

                • CA-4.2.2

                  Claims on sovereigns other than those referred to in the previous paragraph must be assigned risk weights as follows:

                  Credit Assessment AAA to AA- A+ to A- BBB+ to BBB- BB+ to B- Below B- Unrated
                  Risk Weight 0% 20% 50% 100% 150% 100%
                  Apr 08

              • Claims on International Organizations

                • CA-4.2.3.

                  Claims on the Bank for International Settlements, the International Monetary Fund and the European Central Bank must receive a 0% risk weight.

                  Apr 08

              • Claims on Non-central Government Public Sectors Entities (PSEs)

                • CA-4.2.4

                  Claims on the Bahraini PSEs listed in Appendix CA-8 will be treated as claims on the government of Bahrain.

                  Apr 08

                • CA-4.2.5

                  Where other supervisors also treat claims on named PSEs as claims on their sovereigns, claims to those PSEs are treated as claims on the respective sovereigns as outlined in paragraphs CA-4.2.1 and CA-4.2.2 above. These PSE's must be shown on a list maintained by the concerned central bank or financial regulator. Where PSE's are not on such a list, they must be subject to the treatment outlined in paragraph CA-4.2.6 below.

                  Apr 08

                • CA-4.2.6

                  Claims on all other (foreign) PSEs (i.e. not having sovereign treatment) denominated and funded in the home currency of the sovereign must be risk weighted as allowed by their home country supervisors, provided the sovereign carries rating BBB- or above. Claims on PSEs with no explicit home country weighting or to PSEs in countries of BB+ sovereign rating and below are subject to ECAI ratings as per the following table:

                  Credit Assessment AAA to AA- A+ to A- BBB+ to BBB- BB+ to B- Below B- Unrated
                  Risk Weight 20% 50% 100% 100% 150% 100%
                  Apr 08

                • CA-4.2.7

                  Claims on commercial companies owned by governments must be risk weighted as normal commercial entities unless they are covered by a government guarantee that satisfies the conditions in CA-4.7 below in which case they may take the risk weight of the concerned government.

                  Apr 08

              • Claims on Multilateral Development Banks (MDB's)

                • CA-4.2.8

                  MDB's currently eligible for a 0% risk weight are: the World Bank Group comprised of the International Bank for Reconstruction and Development (IBRD) and the International Finance Corporation (IFC), the Asian Development Bank (ADB), the African Development Bank (AfDB), the European Bank for Reconstruction and Development (EBRD), the Inter-American Development Bank (IADB), the European Investment Bank (EIB), the European Investment Fund (EIF), the Nordic Investment Bank (NIB), the Caribbean Development Bank (CDB), the Islamic Development Bank (IDB), Arab Monetary Fund (AMF), the Council of Europe Development Bank (CEDB), the Arab Bank for Economic Development in Africa (ABEDA), Council of European Resettlement Fund (CERF) and the Kuwait Fund for Arab Economic Development (KFAED).

                  Apr 08

                • CA-4.2.9

                  The claims on MDB's, which do not qualify for the 0% risk weighting, should be assigned risk weights as follows:

                  Banks Credit Quality Grades AAA to AA- A+ to A- BBB+ to BBB- BB+ to B- Below B- Un-rated
                  Risk weights 20% 50% 50% 100% 150% 50%
                  Apr 08

              • Claims on Islamic Banks and Conventional Banks

                • CA-4.2.10

                  Claims on banks must be risk weighted as given in the following table. No claim on an unrated bank may receive a risk weight lower than that applied to claims on its sovereign of incorporation (see Guidance in Paragraph CA-4.2.11A for self-liquidating letters of credit).

                  Banks Credit Quality Grades AAA to AA- A+ to A- BBB+ to BBB- BB+ to B- Below B- Un-rated
                  Standard risk weights 20% 50% 50% 100% 150% 50%
                  Preferential risk weight 20% 20% 20% 50% 150% 20%
                  Amended: April 2012
                  Apr 08

                • CA-4.2.11

                  Short-term claims on locally incorporated banks may be assigned a risk weighting of 20% where such claims on the banks are of an original maturity of 3 months or less denominated and funded in either BD or US$. A preferential risk weight that is one category more favourable than the standard risk weighting may be assigned to claims on foreign banks licensed in Bahrain of an original maturity of 3 months or less denominated and funded in the relevant domestic currency (other than claims on banks that are rated below B-). Such preferential risk weight for short-term claims on banks licensed in other jurisdictions will be allowed only if the relevant supervisor also allows this preferential risk weighting to short-term claims on its banks.

                  Apr 08

                • CA-4.2.11A

                  Self-liquidating letters of credit issued or confirmed by an unrated bank will be allowed a risk weighting of 50% or 20% without reference to the risk weight of the sovereign of incorporation. All other claims will be subject to the 'sovereign floor' of the country of incorporation of the concerned issuing or confirming bank.

                  Added: April 2012

                • CA-4.2.12

                  Claims with an (contractual) original maturity under 3 months that are expected to be rolled over (i.e. where the effective maturity is longer than 3 months) will not qualify for a preferential treatment for capital adequacy purposes.

                  Apr 08

              • Claims on Investment Firms

                • CA-4.2.13

                  Claims on category one and category two investment firms which are subject to direct supervisory and regulatory provisions from the CBB may be treated as claims on banks for risk weighting purposes but without the use of preferential risk weight for short-term claims. Claims on category three investment firms must be treated as claims on corporates for risk weighting purposes. Claims on investment firms in other jurisdictions will be treated as claims on corporates for risk weighting purposes. However, if the bank can demonstrate that the concerned investment firm is subject to a Basel II equivalent capital adequacy regime and is treated as a bank for risk weighting purposes by its home regulator, then claims on such investment firms may be treated as claims on banks.

                  Apr 08

              • Claims on Corporates, including Insurance Companies

                • CA-4.2.14

                  Risk weighting for corporates including insurance companies is as follows:

                  Credit assessment AAA to AA- A+ to A- BBB+ to BB- Below BB- Unrated
                  Risk weight 20% 50% 100% 150% 100%
                  Apr 08

                • CA-4.2.15

                  Risk weighting for unrated (corporate) claims will be reviewed and where appropriate, may be increased by the CBB. Credit facilities to small/medium enterprises may be placed in the regulatory retail portfolio in limited cases below.

                  Amended January 2009
                  Apr 08

              • Claims included in the Regulatory Retail Portfolios

                • CA-4.2.16

                  No claim on any unrated corporate, where said corporate originates from a foreign jurisdiction, may be given a risk weight lower than that assigned to a corporate within its own jurisdiction, and in no case will it be below 100%.

                  Apr 08

                • CA-4.2.17

                  Retail claims that are included in the regulatory retail portfolio must be risk weighted at 75%, except as provided in CA-4.2.21 for the past due receivables.

                  Apr 08

                • CA-4.2.18

                  To be included in the regulatory retail portfolio, claims must meet the following criteria:

                  (a) Orientation — the exposure is to an individual person or persons or to a small business. A small business is a Bahrain-based business with annual turnover below BD 2mn.
                  (b) Product — The exposure takes the form of any of the following: revolving credits and lines of credit (including credit cards and running finance), personal term finance and leases (e.g. instalment finance, auto finance and leases, student and educational finance, personal finance) and small business facilities and commitments. Islamic products which involve securities (such as Musharakah, Mudarabah, Sukuks and equities), whether listed or not, are specifically excluded from this category. Mortgage finance will be excluded if they qualify for treatment as claims secured by residential property (see below). Finance for purchase of shares are also excluded from the regulatory retail portfolios.
                  (c) Granularity — The regulatory retail portfolio is sufficiently diversified to a degree that it reduces the risks in the portfolio, warranting a 75% risk weight. No aggregate exposure to one counterpart8 can exceed 0.2% of the overall regulatory retail portfolio.
                  (d) The maximum aggregated retail exposure to one counterpart must not exceed an absolute limit of BD 250,000.

                  8 Aggregated exposure means gross amount (i.e. not taking any credit risk mitigation into account) of all forms of debt exposures (e.g. finances or commitments) that individually satisfy the three other criteria. In addition, "to one counterpart" means one or several entities that may be considered as a single beneficiary (e.g. in the case of a small business that is affiliated to another small business, the limit would apply to the bank's aggregated exposure on both businesses).

                  Amended January 2009
                  Apr 08

              • Claims Secured by Residential Property

                • CA-4.2.19

                  Lending fully secured by first mortgages on residential property that is or will be occupied by the borrower, or that is leased, must carry a risk weighting of 75%. However, if the bank can justify foreclosure or repossession for a claim, a 35% risk weight will be allowed. To get this lower risk weight the bank must obtain a satisfactory legal opinion that foreclosure or repossession is possible without any impediment.

                  Apr 08

              • Claims Secured by Commercial Real Estate

                • CA-4.2.20

                  Claims secured by mortgages on commercial real estate are subject to a minimum of 100% risk weight. If the borrower is rated below BB-, the risk-weight corresponding to the rating must be applied.

                  Apr 08

              • Past Due Receivables

                • CA-4.2.21

                  In the event that accounts receivable or lease payments receivable become past due, the exposure shall be risk-weighted in accordance with the following table. The exposures should be risk weighted net of specific provisions (see CA-4.3.5 for exposures risk-weighted under Supervisory Slotting Criteria).

                  Type RW % of Specific Provisions for Past Due Receivables
                  Unsecured exposure (other than a qualifying residential mortgage loan) that is past due more than 90 days, net of specific provisions 150%


                  100%
                  Less than 20% of the outstanding receivables.

                  At least 20% of the outstanding receivables.
                  Exposure secured by RRE 100% For receivables that are past due for more than 90 days, net of specific provisions.
                  Apr 08

                • CA-4.2.22

                  For the purposes of defining the secured portion of a past due loan, eligible collateral and guarantees will be the same as for credit risk mitigation purposes.

                  Apr 08

                • CA-4.2.23

                  Past due retail loans are to be excluded from the overall regulatory retail portfolio when assessing the granularity criterion, for risk-weighting purposes.

                  Apr 08

              • Investments in Equities and Funds

                • CA-4.2.24

                  Investments in listed equities must be risk weighted at 100% while equities other than listed must be risk weighted at 150%. For risk-weighting of Sukuk, refer to Section CA-3.8.

                  Apr 08

                • CA-4.2.25

                  Investments in funds (e.g. mutual funds, Collective Investment Undertakings etc.) must be risk weighted as follows:

                  •   If the instrument (e.g. units) is rated, it should be risk-weighted according to its external rating (for risk-weighting, it must be treated as a "claim on corporate");
                  •   If not rated, such investment should be treated as an equity investment and risk weighted accordingly (i.e. 100% for listed and 150% for others);
                  •   The bank can apply to CBB for using the look-through approach for such investments if it can demonstrate that the look-through approach is more appropriate to the circumstances of the bank;
                  •   If there are no voting rights attached to investment in funds, the investment will not be subjected to consolidation and deduction requirements (except large exposure limits);
                  •   For the purpose of determining "large exposure limit" for investment in funds, the look-through approach should be used (even if the look-through approach is not used to risk weight the investment).
                  Apr 08

                • CA-4.2.26

                  CBB may enforce a bank to adopt the 'Simple Risk Weight Method' for equities (Section CA-4.4) if the CBB considers that bank's equity portfolio is significant.

                  Apr 08

              • Holdings of Real Estate

                • CA-4.2.27

                  All holdings of real estate by banks (i.e. owned directly or by way of investments in Real Estate Companies, subsidiaries or associate companies or other arrangements such as trusts, funds or REITs) must be risk-weighted at 200%. Premises occupied by the bank may be weighted at 100%. Investments in Real Estate Companies will be subject to the materiality thresholds for commercial companies described in Module PCD and therefore any holdings which amount to 15% or more of regulatory capital will be subject to deduction. The holdings below the 15% threshold will be weighted at 200%.

                  Apr 08

              • Other Assets

                • CA-4.2.28

                  Gold bullion held in own vaults or on an allocated basis to the extent backed by bullion liabilities may be treated as cash and therefore risk-weighted at 0%. In addition, cash items in the process of collection must be risk-weighted at 20%. The standard risk weight for all other assets will be 100%. Investments in regulatory capital instruments issued by banks or investment firms must be risk weighted at a minimum of 100%, unless they are deducted from the capital base according to the Prudential Consolidation and Deduction Requirements Module.

                  Apr 08

              • Underwriting of Non-trading Book items

                • CA-4.2.29

                  Where a bank has acquired assets on its balance sheet in the banking book which it is intending to place with third parties under a formal arrangement and is underwriting the placement, the following risk weightings apply during the underwriting period (which may not last for more than 90 days). Once the underwriting period has expired, the usual risk weights should apply.

                  1. For holdings of private equity, a risk weighting of 100% will apply instead of the usual 150% (see CA-4.2.24).
                  2. For holdings of Real Estate, a risk weight of 100% will apply instead of the usual 200% risk weight (see CA-4.2.27).
                  Apr 08

            • CA-4.3 CA-4.3 Supervisory Slotting Criteria

              • CA-4.3.1

                Equity exposures in the nature of specialized financing will be risk-weighted as per the supervisory slotting criteria as detailed below. Specialized lending is basically a typical kind of exposure in which some special underlying assets are both the source of repayment and security. This may include financing extended to:

                •   Power plants, chemical processing plants, mines, transportation infrastructure, environment, telecommunications infrastructure, ships, aircraft, satellites, railcars, fleets, crude oil, metals, crops, office buildings to let, retail space, multifamily residential buildings, industrial or warehouse space, hotels, High volatility real estate etc.
                •   Retail space;
                •   Multifamily residential buildings;
                •   Industrial or warehouse space;
                •   Hotels.
                Amended: April 2011
                April 2008

              • CA-4.3.2

                A bank is required to map its RW into four supervisory categories as set out in the Appendix CA-1 (specialised financing) for Limited and Non-Recourse Istisna'a exposures, Mudarabah exposures, Sukuk exposures and Musharakah in a business venture exposures, where the RW for each category is as follows:

                Supervisory Categories Strong Good Satisfactory Weak
                External Credit Assessments BBB- or better BB+ or BB BB- to B+ B to C-
                Risk Weights 70% 90% 115% 250%
                Apr 08

              • CA-4.3.3

                A bank with Diminishing Musharaka exposures in real estate are required to map its RW into the four supervisory categories as set out in Appendix CA-2 (Diminishing Musharaka in real estate) where the RW of each category is as follows:

                Supervisory Categories Strong Good Satisfactory Weak
                Risk Weights 90% 110% 135% 270%
                Apr 08

              • CA-4.3.4

                The above RW under the slotting criteria for specialised financing include an additional fixed factor, equal to a 20% RW, to cater for the potential decline in the Musharakah's net asset value.

                Apr 08

              • CA-4.3.5

                If any exposure which is to be risk-weighted under this sub-section becomes past due, it will be risk-weighted at the higher of risk-weight applicable under CA-4.2.21 or the risk-weight applicable under this sub-section e.g. if an exposure getting 90% risk-weight under CA-4.3.2 above becomes past due, it will be risk-weighted under CA-4.2.21 (at 100% or 150% whichever is applicable). However if an exposure getting 250% risk-weight under CA-4.3.2 above becomes past due, it will continue to be risk-weighted at 250%.

                Apr 08

            • CA-4.4 CA-4.4 Simple Risk-weight Method

              • CA-4.4.1

                As stated in CA-4.2.26, CBB may enforce a bank to adopt this treatment for equities if the CBB considers that bank's equity portfolio is significant.

                Apr 08

              • CA-4.4.2

                The RW under simple risk weight method for equity position risk in respect of an equity exposure shall be 300% for listed and 400% for others less any specific provisions for impairment. If there is a third party guarantee to make good impairment losses, the RW of the guarantor shall be substituted for that of the assets for the amount of any such guarantee.

                Apr 08

            • CA-4.5 CA-4.5 Risk Weighting - Off-balance-sheet Items

              • CA-4.5.1

                Off-balance-sheet items must be converted into credit exposure equivalents using credit conversion factors (CCFs).

                Apr 08

              • CA-4.5.2

                Commitments with an original maturity of up to one year and commitments with an original maturity of over one year will receive a CCF of 20% and 50%, respectively.

                Apr 08

              • CA-4.5.3

                Any commitments that are unconditionally cancellable at any time by the bank without prior notice, or that are subject to automatic cancellation due to deterioration in a borrowers' creditworthiness, will receive a 0% CCF.

                Apr 08

              • CA-4.5.4

                A CCF of 100% must be applied to the lending of banks' securities or the posting of securities as collateral by banks.

                Apr 08

              • CA-4.5.5

                For short-term self-liquidating trade letters of credit arising from the movement of goods a 20% CCF must be applied to both issuing and confirming banks.

                Apr 08

              • CA-4.5.6

                Where there is an undertaking to provide a commitment on an off-balance sheet item, banks are to apply the lower of the two applicable CCF's.

                Apr 08

              • CA-4.5.7

                Direct credit substitutes, e.g. general guarantees of indebtedness (including standby letters of credit serving as financial guarantees for finance and securities) and acceptances (including endorsements with the character of acceptances) must be applied a CCF of 100%.

                Apr 08

              • CA-4.5.8

                Sale and repurchase agreements and asset sales with recourse, where the credit risk remains with the bank, must be applied a CCF of 100%.

                Apr 08

              • CA-4.5.9

                Forward asset purchases, forward deposits and partly-paid shares and securities, which represent commitments with certain drawdown must be applied a CCF of 100%.

                Apr 08

              • CA-4.5.10

                Certain transaction-related contingent items (e.g. performance bonds, bid bonds, warranties and standby letters of credit related to particular transactions) must be applied a CCF of 50%.

                Apr 08

              • CA-4.5.11

                Note issuance facilities and revolving underwriting facilities must be applied a CCF of 50%.

                Apr 08

              • CA-4.5.12

                Banks must closely monitor securities, commodities, and foreign exchange transactions that have failed, starting the first day they fail. A capital charge to failed transactions must be calculated in accordance with CBB guidelines set forth in Appendix CA-5 - 'Capital treatment for failed trades and non DvP transactions'.

                Apr 08

              • CA-4.5.13

                With regard to unsettled securities, commodities, and foreign exchange transactions, banks are encouraged to develop, implement and improve systems for tracking and monitoring the credit risk exposure arising from unsettled transactions as appropriate for producing management information that facilitates action on a timely basis.

                Apr 08

              • CA-4.5.14

                Furthermore, when such transactions are not processed through a delivery-versus-payment (DvP) or payment-versus-payment (PvP) mechanism, banks must calculate a capital charge as set forth in Appendix CA-5.

                Please Note: An import or export financing, which is based on Murabahah where the underlying goods/shipment are collateralised and insured, shall attract a 20% credit conversion factor to the banks that issues or confirms the letter of credit. This treatment of collateral assumes there are no obstacles to the exercise of rights over it by the issuer or confirmer (see "Pledge of assets as collateral as detailed below under Credit Risk Mitigation).

                Apr 08

            • CA-4.6 CA-4.6 External Credit Assessments

              • The Recognition Process and Eligibility Criteria

                • CA-4.6.1

                  CBB will assess all External Credit Assessment Institutions (ECAI) according to the six criteria below. Any failings, in whole or in part, to satisfy these to the fullest extent will result in the respective ECAI's methodology and associated resultant rating not being accepted by the CBB:

                  (a) Objectivity: The methodology for assigning credit assessments must be rigorous, systematic, and subject to some form of validation based on historical experience. Moreover, assessments must be subject to ongoing review and responsive to changes in financial condition. Before being recognized by the CBB, an assessment methodology for each market segment, including rigorous back testing, must have been established for an absolute minimum of one year and with a preference of three years;
                  (b) Independence: An ECAI must show independence and should not be subject to political or economic pressures that may influence the rating. The assessment process should be as free as possible from any constraints that could arise in situations where the composition of the board of directors, political pressure, the shareholder structure of the assessment institution or any other aspect could be seen as creating a conflict of interest;
                  (c) International access/Transparency: The individual assessments should be available to both domestic and foreign institutions with legitimate interests and at equivalent terms. The general methodology used by the ECAI has to be publicly available;
                  (d) Disclosure: An ECAI is required to disclose the following information: its assessment methodologies, including the definition of default, the time horizon, and the meaning of each rating; the actual default rates experienced in each assessment category; and the transitions of the assessments, e.g. the likelihood of a slide in the ratings of an exposure from one class to another over time;
                  (e) Resources: An ECAI must have sufficient resources to carry out high quality credit assessments. These resources should allow for substantial ongoing contact with senior and operational levels within the entities assessed in order to add value to the credit assessments. Such assessments will be based on methodologies combining qualitative and quantitative approaches; and
                  (f) Credibility: Credibility, to a certain extent, can derive from the criteria above. In addition, the reliance on an ECAI's external credit assessments by independent parties (investors, insurers, trading partners) may be evidence of the credibility of the assessments of an ECAI. The credibility of an ECAI will also be based on the existence of internal procedures to prevent the misuse of confidential information. In order to be eligible for recognition, an ECAI does not have to assess firms in more than one country.
                  Amended: April 2011
                  April 2008

                • CA-4.6.2

                  The CBB recognizes Standard and Poor's, Moody's, Fitch IBCA, Capital Intelligence and the Islamic International Rating Agency as eligible ECAIs. With respect to the possible recognition of other rating agencies as eligible ECAIs, CBB will update this paragraph subject to the rating agencies satisfying the eligibility requirements. (See Appendix CA-6 for mapping of eligible ECAIs).

                  Apr 08

                • CA-4.6.3

                  Banks must use the chosen ECAIs and their ratings consistently for each type of claim, for both risk weighting and risk management purposes. Banks will not be allowed to "cherry-pick" the assessments provided by different eligible ECAIs.

                  Apr 08

                • CA-4.6.4

                  Banks must disclose ECAIs that they use for the risk weighting of their assets by type of claims, the risk weights associated with the particular rating grades as determined by CBB through the mapping process as well as the aggregated risk-weighted assets for each risk weight based on the assessments of each eligible ECAI.

                  Apr 08

              • Multiple Assessments

                • CA-4.6.5

                  If there are two assessments by eligible ECAIs chosen by a bank which map into different risk weights, the higher risk weight must be applied.

                  Apr 08

                • CA-4.6.6

                  If there are three or more assessments by eligible ECAIs chosen by a bank which map into different risk weights, the assessments corresponding to the two lowest risk weights should be referred to and the higher of those two risk weights must be applied.

                  Apr 08

              • Issuer Versus Issues Assessment

                • CA-4.6.7

                  Where a bank invests in a particular issue that has an issue-specific assessment, the risk weight of the claim will be based on this assessment. Where the bank's claim is not an investment in a specific assessed issue, the following general principles apply:

                  (a) In circumstances where the borrower has a specific assessment for an issued debt — but the bank's claim is not an investment in this particular debt — a high quality credit assessment (one which maps into a risk weight lower than that which applies to an unrated claim) on that specific debt may only be applied to the bank's un-assessed claim if this claim ranks pari passu or senior to the claim with an assessment in all respects. If not, the credit assessment cannot be used and the un-assessed claim will receive the risk weight for unrated claims; and
                  (b) In circumstances where the borrower has an issuer assessment, this assessment typically applies to senior unsecured claims on that issuer. Consequently, only senior claims on that issuer will benefit from a high quality issuer assessment. Other un-assessed claims of a highly assessed issuer will be treated as unrated. If either the issuer or a single issue has a low quality assessment (mapping into a risk weight equal to or higher than that which applies to unrated claims), an un-assessed claim on the same counterparty will be assigned the same risk weight as is applicable to the low quality assessment.
                  Amended: April 2011
                  April 2008

                • CA-4.6.8

                  Whether the bank intends to rely on an issuer- or an issue-specific assessment, the assessment must take into account and reflect the entire amount of credit risk exposure the bank has with regard to all payments owed to it.9


                  9 For example, if a bank is owed both principal and interest, the assessment must fully take into account and reflect the credit risk associated with repayment of both principal and interest.

                  Apr 08

                • CA-4.6.9

                  In order to avoid any double counting of credit enhancement factors, no recognition of credit risk mitigation techniques will be taken into account if the credit enhancement is already reflected in the issue specific rating (see paragraph CA-4.7.3).

                  Apr 08

              • Domestic Currency and Foreign Currency Assessments

                • CA-4.6.10

                  Where unrated exposures are risk weighted based on the rating of an equivalent exposure to that borrower, the general rule is that foreign currency ratings would be used for exposures in foreign currency. Domestic currency ratings, if separate, would only be used to risk weight claims denominated in the domestic currency.

                  Apr 08

                • CA-4.6.11

                  However, when an exposure arises through a bank's participation in a loan that has been extended, or has been guaranteed against convertibility and transfer risk, by certain MDBs, its convertibility and transfer risk can be considered by CBB, on a case by case basis, to be effectively mitigated. To qualify, MDBs must have preferred creditor status recognised in the market and be included in MDB's qualifying for 0% risk rate under CA-4.2.8. In such cases, for risk weighting purposes, the borrower's domestic currency rating may be used instead of its foreign currency rating. In the case of a guarantee against convertibility and transfer risk, the local currency rating can be used only for the portion that has been guaranteed. The portion of the loan not benefiting from such a guarantee will be risk-weighted based on the foreign currency rating.

                  Apr 08

              • Short-term/Long-term Assessments

                • CA-4.6.12

                  For risk-weighting purposes, short-term assessments are deemed to be issue-specific. They can only be used to derive risk weights for claims arising from the rated facility. They cannot be generalised to other short-term claims, except under the conditions of paragraph CA-4.6.14. In no event can a short-term rating be used to support a risk weight for an unrated long-term claim. Short-term assessments may only be used for short-term claims against banks and corporates. The table below provides a framework for banks' exposures to specific short-term facilities, such as a particular issuance of commercial paper: For any Sharia contract with an original maturity of up to three months that is not rolled over, the short-term RW as set out in the following table shall be applied.

                  Credit assessment A-1/P-110 A-2/P-2 A-3/P-3 Others11
                  Risk weight 20% 50% 100% 150%

                  10The notations follow the methodology used by Standard & Poor's and by Moody's Investors Service. The A-1 rating of Standard & Poor's includes both A-1+ and A-1-.

                  11This category includes all non-prime and B or C ratings.

                  Apr 08

                • CA-4.6.13

                  If a short-term rated facility attracts a 50% risk-weight, unrated short-term claims cannot attract a risk weight lower than 100%. If an issuer has a short-term facility with an assessment that warrants a risk weight of 150%, all unrated claims, whether long-term or short-term, should also receive a 150% risk weight, unless the bank uses recognised credit risk mitigation techniques for such claims.

                  Apr 08

                • CA-4.6.14

                  For short-tem claims on banks, the interaction with specific short-term assessments is expected to be the following:

                  (a) The general preferential treatment for short-term claims, as defined under paragraphs CA-4.2.11 and CA-4.2.12, applies to all claims on banks of up to three months original maturity when there is no specific short-term claim assessment.
                  (b) When there is a short-term assessment and such an assessment maps into a risk weight that is more favourable (i.e. lower) or identical to that derived from the general preferential treatment, the short-term assessment should be used for the specific claim only. Other short-term claims would benefit from the general preferential treatment.
                  (c) When a specific short-term assessment for a short term claim on a bank maps into a less favourable (higher) risk weight, the general short-term preferential treatment for inter-bank claims cannot be used. All unrated short-term claims should receive the same risk weighting as that implied by the specific short-term assessment.
                  Apr 08

                • CA-4.6.15

                  When a short-term assessment is to be used, the institution making the assessment needs to meet all of the eligibility criteria for recognising ECAIs as presented in paragraph CA-4.6.1 in terms of its short-term assessment.

                  Apr 08

              • Level of Application of the Assessment

                • CA-4.6.16

                  External assessments for one entity within a corporate group must not be used to risk weight other entities within the same group.

                  Apr 08

              • Unsolicited Ratings

                • CA-4.6.17

                  As a general rule, banks should use solicited ratings from eligible ECAIs but they are also allowed to use unsolicited ratings in the same way as solicited ratings. However, there may be the potential for ECAIs to use unsolicited ratings to put pressure on entities to obtain solicited ratings. If such behaviour is identified, CBB may disallow the use of unsolicited ratings.

                  Apr 08

            • CA-4.7 CA-4.7 Credit Risk Mitigation

              • CA-4.7.1

                The exposure in respect of an obligor or other, counterparty can be further adjusted or reduced by taking into account the credit risk mitigation (CRM) techniques employed by Islamic banks (off-balance sheet items will first be converted into on-balance sheet equivalents prior to the CRM being applied). Banks use a number of techniques to mitigate the credit risks to which they are exposed. For example, exposures may be collateralised by first priority claims, in whole or in part with cash or securities or an exposure may be guaranteed by a third party. Additionally banks may agree to net exposure amounts owed to them against deposits from the same counterparty.

                Apr 08

              • General Remarks

                • CA-4.7.2

                  No transaction in which CRM techniques are used should receive a higher capital requirement than an otherwise identical transaction where such techniques are not used.

                  Apr 08

                • CA-4.7.3

                  The effects of CRM will not be double counted. Therefore, no additional recognition of CRM for regulatory capital purposes will be applicable on claims for which an issue-specific rating is used that already reflects that CRM. As stated in paragraph CA-4.6.8 of the section on the standardised approach, principal-only ratings will also not be allowed within the framework of CRM.

                  Apr 08

                • CA-4.7.4

                  While the use of CRM techniques reduces or transfers credit risk, it simultaneously may increase other risks (residual risks). Residual risks include legal, operational, liquidity and market risks. Therefore, it is imperative that banks employ robust procedures and processes to control these risks, including strategy; consideration of the underlying credit; valuation; policies and procedures; systems; control of roll-off risks; and management of concentration risk arising from the bank's use of CRM techniques and its interaction with the bank's overall credit risk profile. Where these risks are not adequately controlled, the CBB may impose additional capital charges or take supervisory actions.

                  Apr 08

                • CA-4.7.5

                  Market Discipline requirements must also be observed for banks to obtain capital relief in respect of any CRM techniques.

                  Apr 08

              • Legal Certainty

                • CA-4.7.6

                  In order for banks to obtain capital relief for any use of CRM techniques, the following minimum standards for legal documentation must be met.

                  Apr 08

                • CA-4.7.7

                  All documentation used in collateralised transactions and for documenting on- balance sheet netting and guarantees must be binding on all parties and legally enforceable in all relevant jurisdictions. Banks must have conducted sufficient legal review to verify this and have a well founded legal basis to reach this conclusion, and undertake such further review as necessary to ensure continuing enforceability.

                  Apr 08

              • CRM Techniques

                The CRM techniques that are commonly employed by the bank are as follows:

                Amended: April 2011
                April 2008

                • Hamish Jiddiyyah (Security Deposit held as Collateral)

                  • CA-4.7.8

                    Hamish Jiddiyyah (HJ), a refundable security deposit taken by the bank prior to establishing a contract, carries a limited recourse to the extent of damages incurred by the bank when the purchase orderer fails to honour a binding promise to purchase (PP) or promise to lease (PL). The bank has recourse to the clients in the PP/PL if the HJ is insufficient to cover for the damages.

                    Apr 08

                  • CA-4.7.9

                    In the case of a non-binding PP/PL, the HJ shall be refunded in full to the clients, and hence is not considered as an eligible CRM.

                    Apr 08

                • Urbun (Earnest Money held after a Contract is Established as Collateral to Guarantee Contract Performance)

                  • CA-4.7.10

                    The urbun taken from a purchaser or lessee when a contract is established accrues to the benefit of the bank if the purchaser or lessee breaches the contract within the agreed upon term.

                    Apr 08

                • Guarantee from a Third Party (Recourse or Non-recourse Guarantee)

                  • CA-4.7.11

                    The guarantor may or may not have recourse to the debtor (i.e. purchaser or lessee) and the guarantee can be for a fixed period and for a limited amount, without any consideration being received by the guarantor. However, a claim should first be made against the debtor, and then against the guarantor, unless an option is provided to make the claim against either the debtor or the guarantor.

                    Apr 08

                  • CA-4.7.12

                    The guarantee can also be given in a 'blanket' form that covers an unknown amount or a future receivable. However, this type of guarantee (sometimes known as a "market/business guarantee" or "guarantee of contractual obligation") is revocable at any time prior to the existence of the future receivables and does not qualify as an eligible CRM.

                    Apr 08

                • Leased Assets used as Collateral

                  • CA-4.7.13

                    Assets leased under Ijarah or IMB contracts fulfill a function similar to that of collateral, in that they may normally be repossessed by the lessor in the event of default by the lessee (see residential real estate CA-4.2.19 and below).

                    Apr 08

                  • CA-4.7.14

                    The value of such assets may be offset against the exposure amount to the customer, subject to the regulatory haircuts under the Standard Supervisory Haircut 12 Approach (CA-4.7.32 onwards) for leased assets mentioned in the paragraph CA-4.7.39. Ijarah receivables which comprise Residential Real Estate do not generally satisfy the conditions laid out in Paragraph CA-4.7.23 and therefore such receivables will be weighted at 75% and the collateral will not be recognised for risk mitigation purposes. If the bank can show legal evidence that it may exercise foreclosure, a risk weighting of 35% may be applied to the lease receivable in the case of residential property occupied by the customer. Commercial real estate may be used as collateral for Ijarah transactions as long as it satisfies the criteria of paragraph CA-4.7.23 (and the supervisory haircut is then applied).


                    12 The term 'haircut' in this context refers to a discount on the depreciated value of an asset as collateral after taking into consideration some inherent risks that affect the volatility of the market price or value of the asset. It is commonly expressed in terms of a percentage by which an asset's value as collateral is reduced.

                    Apr 08

                  • CA-4.7.15

                    The leased asset to be used as collateral must be a Sharia compliant tangible asset of monetary value that can be lawfully owned, and is saleable, specifiable, deliverable and free of encumbrance.

                    Apr 08

                  • CA-4.7.16

                    The collateralisation under the concept of "rahn" or "kafālah" shall be properly documented in a security agreement or, in the body of a contract to the extent permissible by Sharia, and must be binding on all parties and legally enforceable in the relevant jurisdictions.

                    Apr 08

                  • CA-4.7.17

                    The banks must additionally document its procedures for the valuation of leased assets to be used as collateral as described above. This valuation would normally be the depreciated value of the asset as reported in the financial statement.

                    Apr 08

                • Guarantees

                  • CA-4.7.18

                    Capital relief for the use of a guarantee shall be given when the following conditions are satisfied:

                    (a) The guarantee represents the bank's direct claim on the guarantor;
                    (b) The guarantee is irrevocable and does not allow the guarantor to unilaterally cancel the guarantee after creation of the receivables;
                    (c) The guarantee is unconditional and provides no protection clause that prevents the guarantor from being obliged to pay out in a timely manner in the event that the original counterparty fails to make payments due;
                    (d) The bank has the right to pursue, in a timely manner, the guarantor for monies outstanding, rather than having to pursue the original counterparty to recover its exposure;
                    (e) The guarantee shall be an explicitly documented obligation assumed by the guarantor; and
                    (f) The guarantee shall cover all types of expected payments made under the contract in the event that the original counterparty defaults.
                    (g) Portions of claims guaranteed by the entities detailed in paragraph CA-4.2.1 above, where the guarantee is denominated in the domestic currency (and US$ in case of a guarantee provided by the Government of Bahrain and CBB) may get a 0% risk-weighting. A claim may be covered by a guarantee that is indirectly counter-guaranteed by such entities. Such a claim may be treated as covered by a sovereign guarantee provided that:
                    •   the sovereign counter-guarantee covers all credit risk elements of the claim;
                    •   both the original guarantee and the counter-guarantee meet all operational requirements for guarantees, except that the counter-guarantee need not be direct and explicit to the original claim; and
                    •   CBB is satisfied that the cover is robust and that no historical evidence suggests that the coverage of the counter-guarantee is less than effectively equivalent to that of a direct sovereign guarantee.

                    Please Note: Though insurance is normally part and parcel of the project risk financing, it is not regarded by CBB as a credit risk mitigation technique.
                    Amended: April 2011
                    April 2008

                • Collateralised Transactions

                  • CA-4.7.19

                    Where banks take eligible financial collateral as defined in paragraph CA.4.7.28, they are allowed to reduce their credit exposure to a counterparty when calculating their capital requirements to take account of the risk mitigating effect of the collateral (except residential real estate - see CA-4.7.14).

                    Apr 08

                • Overall Framework and Minimum Conditions

                  • CA-4.7.20

                    Banks may opt for either the simple approach, which substitutes the risk weighting of the collateral for the risk weighting of the counterparty for the collateralised portion of the exposure (generally subject to a 20% floor), or for the standard supervisory haircuts approach which allows fuller offset of collateral against exposures, by effectively reducing the exposure amount by the value ascribed to the collateral.

                    Apr 08

                  • CA-4.7.21

                    Banks may operate under either, but not both, approaches in the banking book, but only under the standard supervisory haircuts approach in the trading book. Partial collateralisation is recognised in both approaches. Mismatches in the maturity of the underlying exposure and the collateral will only be allowed under the standard supervisory haircuts approach.

                    Apr 08

                  • CA-4.7.22

                    However, before capital relief will be granted in respect of any form of collateral, the standards set out below in paragraphs CA-4.7.23 to CA-4.7.26 must be met under either approach.

                    Apr 08

                  • CA-4.7.23

                    In addition to the general requirements for legal certainty set out in paragraphs CA-4.7.6 and CA-4.7.7, the legal mechanism by which collateral is pledged or transferred must ensure that the bank has the right to liquidate or take legal possession of it, in a timely manner, in the event of the default, insolvency or bankruptcy (or one or more otherwise-defined credit events set out in the transaction documentation) of the counterparty (and, where applicable, of the custodian holding the collateral). Furthermore banks must take all steps necessary to fulfill those requirements under the law applicable to the bank's interest in the collateral for obtaining and maintaining an enforceable security interest, e.g. by registering it with a registrar, or for exercising a right to net or set off in relation to title transfer collateral.

                    Apr 08

                  • CA-4.7.24

                    In order for collateral to provide protection, the credit quality of the counterparty and the value of the collateral must not have a material positive correlation. For example, securities issued by the counterparty — or by any related group entity — would provide little protection and so would be ineligible.

                    Apr 08

                  • CA-4.7.25

                    Banks must have clear and robust procedures for the timely liquidation of collateral to ensure that any legal conditions required for declaring the default of the counterparty and liquidating the collateral are observed, and that collateral can be liquidated promptly.

                    Apr 08

                  • CA-4.7.26

                    Where the collateral is held by a custodian, banks must take reasonable steps to ensure that the custodian segregates the collateral from its own assets.

                    Apr 08

                • Types of Collateral

                  • CA-4.7.27

                    The types of collateral given in the next paragraph are eligible for relief in respect of the above CRM techniques.

                    Apr 08

                  • CA-4.7.28

                    (a) Hamish jiddiyyah (security deposit) only for agreements to purchase or lease preceded by a binding promise.
                    (b) Urbun
                    (c) Profit sharing investment account or cash on deposit13 with the bank which is incurring the exposure
                    (d) Sukuk rated by an external rating agency which is issued by:
                    (i) Sovereigns and PSEs (treated as sovereigns) with a minimum rating of BB-;or
                    (ii) Issuers other than the above, with a minimum rating of BBB- or A-3 / P-3.
                    (e) Sukuk that is unrated by an ECAI but fulfill each of the following criteria:
                    (i) Issued by an Islamic bank or a conventional bank or a sovereign;
                    (ii) Listed on a recognised exchange;
                    (iii) All other rated issues by the Islamic bank or conventional bank of the same seniority of at least BBB - or A-3/P-3 by a recognised ECAI, as determined by the CBB;
                    (iv) The Islamic bank which incurs the exposure or is holding the collateral has no information to suggest that the issue would justify a rating below BBB- or A-3/P-3; and
                    (v) The CBB is sufficiently confident about the market liquidity of the securities.
                    (f) Equities and units in collective investment schemes.
                    (g) Guarantees issued by third parties that fall within the following categories:
                    (i) Sovereigns and central banks;
                    (ii) PSEs;
                    (iii) MDBs;
                    (iv) International organisations/official entities with 0% RW
                    (v) Islamic banks or conventional banks; and
                    (vi) Corporate entities (including insurance and securities firms) either by the parent, subsidiary and affiliates, of a minimum rating of A-.
                    (h) Leased assets as stated under "Leased assets used as collateral" above.
                    (i) Collateral under "Murabaha" accepted by CBB (see paragraphs CA-3.2.10 and CA-3.2.14).

                    13 Must be supported by an agreement or documentation that gives bank the right of set-off against the amount of receivables due.

                    Amended: April 2011
                    April 2008

                  • CA-4.7.29

                    Any portion of the exposure which is not collateralised shall be assigned the RW of the counterparty.

                    Apr 08

                  • CA-4.7.30

                    As stated earlier, banks may opt for either of the two approaches listed below:

                    Apr 08

                • The Simple Approach

                  • CA-4.7.31

                    In the simple approach the risk weighting of the collateral instrument collateralising or partially collateralising the exposure is substituted for the risk weighting of the counterparty.

                    Apr 08

                • The Standard Supervisory Haircuts Approach

                  • CA-4.7.32

                    In this approach, when taking collateral, banks must calculate their adjusted exposure to a counterparty for capital adequacy purposes in order to take account of the effects of that collateral. Using haircuts, banks are required to adjust both the amount of the exposure to the counterparty and the value of any collateral received in support of that counterparty to take account of possible future fluctuations in the value of either14, occasioned by market movements. This will produce volatility adjusted amounts for both exposure and collateral. Unless either side of the transaction is cash, the volatility adjusted amount for the exposure will be higher than the exposure and for the collateral it will be lower.


                    14 Exposure amounts may vary where, for example, securities are being lent.

                    Apr 08

                  • CA-4.7.33

                    Additionally where the exposure and collateral are held in different currencies an additional downwards adjustment must be made to the volatility adjusted collateral amount to take account of possible future fluctuations in exchange rates.

                    Apr 08

                  • CA-4.7.34

                    Where the volatility-adjusted exposure amount is greater than the volatility-adjusted collateral amount (including any further adjustment for foreign exchange risk), banks shall calculate their risk-weighted assets as the difference between the two multiplied by the risk weight of the counterparty. The framework for performing these calculations is set out in paragraphs CA-4.7.36 to CA-4.7.38.

                    Apr 08

                  • CA-4.7.35

                    Banks must use standard supervisory haircuts given in paragraph CA-4.7.39.

                    Apr 08

                • Calculation of Capital Requirement Employing the Standard Supervisory Haircuts

                  • CA-4.7.36

                    For a collateralised transaction, the exposure amount after risk mitigation is calculated as follows:

                    E* = max {0, [E x (1 + He) - C x (1 - Hc - Hfx)]}

                    where:

                    E* = the exposure value after risk mitigation

                    E = current value of the exposure

                    He = haircut appropriate to the exposure

                    C = the current value of the collateral received

                    Hc = haircut appropriate to the collateral

                    Hfx = haircut appropriate for currency mismatch between the collateral and exposure

                    Apr 08

                  • CA-4.7.37

                    The exposure amount after risk mitigation will be multiplied by the risk weight of the counterparty to obtain the risk-weighted asset amount for the collateralised transaction. The treatment for transactions where there is a mismatch between the maturity of the counterparty exposure and the collateral is given in paragraphs CA-4.7.47 to CA-4.7.50.

                    Apr 08

                  • CA-4.7.38

                    Where the collateral is a basket of assets, the haircut on the basket will be H = Σi ai Hi, where ai is the weight of the asset (as measured by units of currency) in the i basket and Hi the haircut applicable to that asset.

                    Apr 08

                • The Standard Supervisory Haircuts

                  • CA-4.7.39

                    Both the amount of exposure to counterparty and the value of collateral received are adjusted by using standard supervisory haircuts as set out below:

                    Types of Collateral* Residual Maturity (yrs) Haircuts (%)
                    Sovereigns15 Others
                    Cash All 0 0
                    Sukuk
                    Long-term: AAA to AA- and
                    Short-term: A-1
                    ≤ 1
                    > 1 to ≤ 5
                    > 5
                    0.5
                    2
                    4
                    1
                    4
                    8
                    Sukuk
                    Long-term: A+ to BBB- and
                    Short-term: A-2 to A-3
                    ≤ 1
                    > 1 to ≤ 5
                    > 5
                    1
                    3
                    6
                    2
                    6
                    12
                    Sukuk
                    Long-term: BB+ to BB-
                    All 15 15
                    Sukuk (unrated) All 25 25
                    Equities (included in main index)
                    Equities (not included in main index but listed)
                    Units in collective investment schemes
                    All
                    All
                    All
                    15
                    25
                    Depending on the underlying assets as above
                    15
                    25
                    Depending on the underlying assets as above
                    Leased assets used as collateral (except residential real estate -see CA-4.2.19) and other assets All >=30 >=30

                    * Collateral denominated in different currency will also be subject to additional 8% haircut to cater for foreign exchange risk.


                    15 Includes PSEs and MDBs

                    Apr 08

                  • CA-4.7.40

                    The standard haircut for currency risk where exposure and collateral are denominated in different currencies is 8% (also based on a 10-business day holding period and daily mark-to-market). For transactions in which the bank lends non-eligible instruments (e.g. non- investment grade securities), the haircut to be applied on the exposure should be the same as the one for equity traded on a recognised exchange that is not part of a main index.

                    Apr 08

                • The Simple Approach

                  • The Minimum Conditions

                    • CA-4.7.41 CA-4.7.41

                      For collateral to be recognised in the simple approach, the collateral must be pledged for at least the life of the exposure and it must be marked to market and revalued with a minimum frequency of six months. Those portions of claims collateralised by the market value of recognised collateral receive the risk weight applicable to the collateral instrument. The risk weight on the collateralised portion will be subject to a floor of 20% except under the conditions specified in paragraphs CA-4.7.42. The remainder of the claim should be assigned to the risk weight appropriate to the counterparty.

                      Apr 08

                      • Exceptions to the Risk Weight Floor

                        • CA-4.7.42 CA-4.7.42

                          The 20% floor for the risk weight on a collateralised transaction will not be applied and a 0% risk weight can be applied where the exposure and the collateral are denominated in the same currency, and either:

                          (a) The collateral is cash on deposit; or
                          (b) The collateral is in the form of sovereign/PSE securities eligible for a 0% risk weight, and its market value has been discounted by 20%
                          Amended: April 2011
                          April 2008

                          • Treatment of Pools of CRM Techniques

                            • CA-4.7.43 CA-4.7.43

                              In the case where a bank has multiple CRM techniques covering a single exposure (e.g. a bank has both collateral and guarantee partially covering an exposure), the bank will be required to subdivide the exposure into portions covered by each type of CRM technique (e.g. portion covered by collateral, portion covered by guarantee) and the risk-weighted assets of each portion must be calculated separately.

                              Apr 08

                              • Credit Risk Mitigation for Mudarabah Classified as Equity Exposures

                                • CA-4.7.44 CA-4.7.44

                                  A placement of funds made under a Mudarabah contract may be subject to a Sharia compliant guarantee from a third party. Such a guarantee relates only to the Mudarabah capital, not to the return. In such cases, the capital should be treated as subject to credit risk with a risk-weighting equal to that of the guarantor provided that the RW of that guarantor is lower than the RW of the Mudarib as a counterparty. Otherwise, the RW of the Mudarib shall apply.

                                  Apr 08

                                  • CA-4.7.45 CA-4.7.45

                                    In Mudarabah investment in project finance, collateralisation of the progress payments made by the ultimate customers can be used to mitigate the exposures of unsatisfactory performance by the Mudarib.

                                    Apr 08

                                    • CA-4.7.46 CA-4.7.46

                                      The bank may also place liquid funds with a central bank or another bank on a short-term Mudarabah basis in order to obtain a return on those funds. Such placements serve as an interbank market with maturities ranging from an overnight market up to three months, but the funds may be withdrawn on demand before the maturity date in which case the return is calculated proportionately on the basis of duration and amount. Although from a juristic point of view the amounts so placed do not constitute debts, since (in the absence of misconduct or negligence) Mudarabah capital does not constitute a liability for the institution that acts as Mudarib, in practice the operation of this interbank market requires that the Mudarib should effectively treat them as liabilities. Hence a bank placing funds on this basis may treat them as cash equivalents and, for risk weighting purposes, apply the risk weight applicable to the Mudarib as counterparty.

                                      Apr 08

                                      • Maturity Mismatches

                                        • CA-4.7.47 CA-4.7.47

                                          For the purposes of calculating risk-weighted assets, a maturity mismatch occurs when the residual maturity of CRM is less than that of the underlying exposure.

                                          Apr 08

                                          • CA-4.7.48 CA-4.7.48

                                            The maturity of the underlying exposure and the maturity of the CRM should both be defined conservatively. The effective maturity of the underlying should be gauged as the longest possible remaining time before the counterparty is scheduled to fulfill its obligation, taking into account any applicable grace period.

                                            Apr 08

                                            • CA-4.7.49 CA-4.7.49

                                              CRM with maturity mismatches are only recognised when their original maturities are greater than or equal to one year. As a result, the maturity of CRM for exposures with original maturities of less than one year must be matched to be recognised. In all cases, CRM with maturity mismatches will no longer be recognised when they have a residual maturity of three months or less.

                                              Apr 08

                                              • CA-4.7.50 CA-4.7.50

                                                When there is a maturity mismatch with recognised credit risk mitigants, the following adjustment will be applied.

                                                Pa = P x (t - 0.25) / (T - 0.25)

                                                where:

                                                Pa = value of the credit protection adjusted for maturity mismatch

                                                P = credit protection (e.g. collateral amount, guarantee amount) adjusted for any haircuts

                                                t = min (T, residual maturity of the credit protection arrangement) expressed in years

                                                T = min (5, residual maturity of the exposure) expressed in years.

                                                Apr 08

                                                • PART 3: PART 3: Other Risks

                                                  • CA-5 CA-5 Market Risk

                                                    • CA-5.1 CA-5.1 Trading Book

                                                      • Definition of the Trading Book

                                                        • CA-5.1.1

                                                          The following definition of the trading book replaces the previous definition.

                                                          Apr 08

                                                        • CA-5.1.2

                                                          A trading book consists of positions in financial instruments and commodities held either with trading intent or in order to hedge other elements of the trading book. To be eligible for trading book capital treatment, financial instruments must either be free of any restrictive covenants on their tradability or able to be hedged completely. In addition, positions should be frequently and accurately valued, and the portfolio should be actively managed (at the present time, open equity stakes in hedge funds, private equity investments and real estate holdings do not meet the definition of the trading book, owing to significant constraints on the ability of banks to liquidate these positions and value them reliably on a daily basis. Such holdings must therefore be held in the bank's banking book and treated as equity holding in corporates, except real estate which should be treated as per Paragraph CA-4.2.27).

                                                          Amended: January 2012
                                                          Apr 08

                                                        • CA-5.1.3

                                                          A financial instrument is any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. Financial instruments include both primary financial instruments (or cash instruments) and forward financial instruments. A financial asset is any asset that is cash, the right to receive cash or another financial asset; or the contractual right to exchange financial assets on potentially favourable terms, or an equity instrument. A financial liability is the contractual obligation to deliver cash or another financial asset or to exchange financial liabilities under conditions that are potentially unfavourable.

                                                          Apr 08

                                                        • CA-5.1.4

                                                          Positions held with trading intent are those held intentionally for short-term resale and/or with the intent of hedging proprietary or client positions.

                                                          Apr 08

                                                        • CA-5.1.5

                                                          Banks must have clearly defined policies and procedures for determining which exposures to include in, and to exclude from, the trading book for purposes of calculating their regulatory capital, to ensure compliance with the criteria for trading book set forth in this section and taking into account the bank's risk management capabilities and practices. Compliance with these policies and procedures must be fully documented and subject to periodic internal audit.

                                                          Apr 08

                                                        • CA-5.1.6

                                                          These policies and procedures should, at a minimum, address the following general considerations:

                                                          (a) The activities the bank considers to be trading and as constituting part of the trading book for regulatory capital purposes;
                                                          (b) The extent to which an exposure can be marked-to-market daily by reference to an active, liquid two-way market;
                                                          (c) For exposures that are marked-to-model, the extent to which the bank can:
                                                          •   Identify the material risks of the exposure;
                                                          •   Hedge (Sharia compliant hedging) the material risks of the exposure and the extent to which hedging instruments would have an active, liquid two-way market;
                                                          •   Derive reliable estimates for the key assumptions and parameters used in the model.
                                                          (d) The extent to which the bank can and is required to generate valuations for the exposure that can be validated externally in a consistent manner;
                                                          (e) The extent to which legal restrictions or other operational requirements would impede the bank's ability to effect an immediate liquidation of the exposure;
                                                          (f) The extent to which the bank is required to, and can, actively risk manage the exposure within its trading operations; and
                                                          (g) The extent to which the bank may transfer risk or exposures between the banking and the trading books and criteria for such transfers.
                                                          The list above is not intended to provide a series of tests that a product or group of related products must pass to be eligible for inclusion in the trading book. Rather, the list provides a minimum set of key points that must be addressed by the policies and procedures for overall management of a firm's trading book.
                                                          Apr 08

                                                        • CA-5.1.7

                                                          The following will be the basic requirements for positions eligible to receive trading book capital treatment.

                                                          (a) Clearly documented trading strategy for the position/instrument or portfolios, approved by senior management (which would include expected holding horizon).
                                                          (b) Clearly defined policies and procedures for the active management of the position, which must include:
                                                          •   Positions are managed on a trading desk;
                                                          •   Position limits are set and monitored for appropriateness;
                                                          •   Dealers have the autonomy to enter into/manage the position within agreed limits and according to the agreed strategy;
                                                          •   Positions are marked to market at least daily and when marking to model the parameters must be assessed on a daily basis;
                                                          •   Positions are reported to senior management as an integral part of the institution's risk management process; and
                                                          •   Positions are actively monitored with reference to market information sources (assessment should be made of the market liquidity or the ability to hedge positions or the portfolio risk profiles). This would include assessing the quality and availability of market inputs to the valuation process, level of market turnover, sizes of positions traded in the market, etc.
                                                          (c) Clearly defined policy and procedures to monitor the positions against the bank's trading strategy including the monitoring of turnover and stale positions in the bank's trading book.
                                                          Apr 08

                                                      • Prudent Valuation Guidance

                                                        • CA-5.1.8

                                                          This section provides banks with guidance on prudent valuation for positions in the trading book. This guidance is especially important for less liquid positions which, although they will not be excluded from the trading book solely on grounds of lesser liquidity, raise CBB's concerns about prudent valuation.

                                                          Apr 08

                                                        • CA-5.1.8.A

                                                          Positions in the bank's own eligible regulatory capital instruments are deducted from capital. Positions in other banks', securities firms', and other financial entities' eligible regulatory capital instruments, as well as intangible assets, are subject to the same treatment as that set down by the CBB for such assets held in the banking book (see Module PCD).

                                                          Added: January 2012

                                                        • CA-5.1.9

                                                          This section provides banks with guidance on prudent valuation for positions that are accounted for at fair value, whether they are in the trading book or in the banking book. This guidance is especially important for positions without actual market prices or observable inputs to valuation, as well as less liquid positions which, although they will not be excluded from the trading book solely on grounds of lesser liquidity, raise supervisory concerns about prudent valuation. The valuation guidance set forth below is not intended to require banks to change valuation procedures for financial reporting purposes. The CBB will assess a bank's valuation procedures for consistency with this guidance. One factor in the CBB's assessment of whether a bank must take a valuation adjustment for regulatory purposes under Paragraphs CA-5.1.18.A to CA-5.1.20 is the degree of consistency between the bank's valuation procedures and these guidelines.

                                                          Added: January 2012

                                                        • CA-5.1.9A

                                                          A framework for prudent valuation practices should at a minimum include the following:

                                                          Amended: January 2012
                                                          Apr 08

                                                      • Systems and Controls

                                                        • CA-5.1.10

                                                          Banks must establish and maintain adequate systems and controls sufficient to give management and CBB the confidence that their valuation estimates are prudent and reliable. These systems must be integrated with other risk management systems within the organisation (such as credit analysis). Such systems must include:

                                                          (a) Documented policies and procedures for the process of valuation. This includes clearly defined responsibilities of the various areas involved in the determination of the valuation, sources of market information and review of their appropriateness, guidelines for the use of unobservable inputs reflecting the bank's assumptions of what market participants would use in pricing position, frequency of independent valuation, timing of closing prices, procedures for adjusting valuations, end of the month and ad-hoc verification procedures; and
                                                          (b) Clear and independent (i.e. independent of front office) reporting lines for the department accountable for the valuation process. The reporting line should ultimately be to a main board executive director.
                                                          Amended: January 2012
                                                          Apr 08

                                                      • Valuation Methodologies

                                                        • Marking to Market

                                                          • CA-5.1.11

                                                            Marking-to-market is at least the daily valuation of positions at readily available close out prices that are sourced independently. Examples of readily available close out prices include exchange prices, screen prices, or quotes from several independent reputable brokers.

                                                            Apr 08

                                                          • CA-5.1.12

                                                            Banks must mark-to-market as much as possible. The more prudent side of bid/offer must be used unless the institution is a significant market maker in a particular position type and it can close out at mid-market. Banks should maximise the use of relevant observable inputs and minimise the use of unobservable inputs when estimating fair value using a valuation technique. However, observable inputs or transactions may not be relevant, such as in a forced liquidation or distressed sale, or transactions may not be observable, such as when markets are inactive. In such cases, the observable data should be considered, but may not be determinative.

                                                            Amended: January 2012
                                                            Apr 08

                                                        • Marking to Model

                                                          • CA-5.1.13

                                                            Only where marking-to-market is not possible, should banks may mark-to-model, but this must be demonstrated to be prudent. Marking-to-model is defined as any valuation which has to be benchmarked, extrapolated or otherwise calculated from a market input.

                                                            Amended: January 2012
                                                            Apr 08

                                                          • CA-5.1.14

                                                            When marking to model, an extra degree of conservatism is appropriate. The CBB will consider the following in assessing whether a mark-to-model valuation is prudent:

                                                            (a) Senior management should be aware of the elements of the trading book or of other fair-valued positions which are subject to mark to model and should understand the materiality of the uncertainty this creates in the reporting of the risk/performance of the business;
                                                            (b) Market inputs should be sourced, to the extent possible, in line with market prices (as discussed above). The appropriateness of the market inputs for the particular position being valued should be reviewed regularly;
                                                            (c) Where available, generally accepted valuation methodologies for particular products should be used as far as possible;
                                                            (d) Where the model is developed by the institution itself, it should be based on appropriate assumptions, which have been assessed and challenged by suitably qualified parties independent of the development process. The model should be developed or approved independently of the front office. It should be independently tested. This includes validating the mathematics, the assumptions and the software implementation;
                                                            (e) There should be formal change control procedures in place and a secure copy of the model should be held and periodically used to check valuations;
                                                            (f) Risk management should be aware of the weaknesses of the models used and how best to reflect those in the valuation output;
                                                            (g) The model should be subject to periodic review to determine the accuracy of its performance (e.g. assessing continued appropriateness of the assumptions, analysis of P&L versus risk factors, comparison of actual close out values to model outputs); and
                                                            (h) Valuation adjustments should be made as appropriate, for example, to cover the uncertainty of the model valuation.
                                                            Amended: January 2012
                                                            Apr 08

                                                        • Independent Price Verification

                                                          • CA-5.1.15

                                                            Independent price verification is distinct from daily mark-to-market. It is the process by which market prices or model inputs are regularly verified for accuracy. While daily marking-to-market may be performed by dealers, verification of market prices or model inputs should be performed by a unit independent of the dealing room, at least monthly (or, depending on the nature of the market/trading activity, more frequently). It need not be performed as frequently as daily mark-to-market, since the objective, i.e. independent, marking of positions, should reveal any error or bias in pricing, which should result in the elimination of inaccurate daily marks.

                                                            Apr 08

                                                          • CA-5.1.16

                                                            Independent price verification entails a higher standard of accuracy in that the market prices or model inputs are used to determine profit and loss figures, whereas daily marks are used primarily for management reporting in between reporting dates. For independent price verification, where pricing sources are more subjective, e.g. only one available broker quote, prudent measures such as valuation adjustments may be appropriate.

                                                            Apr 08

                                                      • Valuation Adjustments

                                                        • CA-5.1.17

                                                          As part of their procedures for marking to market, banks must establish and maintain procedures for considering valuation adjustments. The CBB expects banks using third-party valuations to consider whether valuation adjustments are necessary. Such considerations are also necessary when marking to model.