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 sheetexposures .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
