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  • 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.