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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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) requiresconventional bank licensees to maintain financial resources in excess of the minimum requirements specified in Module CA (Capital Adequacy).October 07CA-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 thatIslamic 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 07Legal 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 allIslamic bank licensees .October 07CA-A.2.7
For an explanation of the CBB's rule-making powers and different regulatory instruments, see Section UG-1.1.
October 07CA-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 07CA-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 07Evolution 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 07Effective 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 07CA-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-sheetexposures – a supervisory perspectiveOctober 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 .October 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07Murabaha 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 07Mudaraba 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 07CA-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 07CA-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 07Musharaka 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 07CA-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 07CA-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 07Ijarah / 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 07CA-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 07Istisna'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 07CA-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 07Salam 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 07CA-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 07Participations 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 07CA-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 07Intra 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 07CA-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 07CA-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 07CA-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 07CA-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 07Equity 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 07Foreign 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 07Exemptions
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 07Bank'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 07Consolidation
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 07CA-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 07Approach 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 07CA-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 07CA-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 07Monitoring
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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07Tier 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 07Tier 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 equitysecurities held as available-for-sale (on an aggregate net-basis).October 07Deductions 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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07Maintaining 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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 theBasel 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 07CA-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 07CA-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 andsecurities 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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-4.3.2
The general market equity risk measure is 8% of the overall net position in each national market.
October 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07Structural 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 07CA-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 07Calculation 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 signOctober 07CA-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 07CA-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 07CA-5.4.2
The table below illustrates the calculation of the overall net open foreign currency position and the capital charge:
October 07Example 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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07CA-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 07Measurement
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 07Gearing 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
