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).

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

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).

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.

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.

CA-A.2.6

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

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.

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.

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.

CA-A.2.10

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

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.

CA-A.3.6

Total risk-weighted assets are determined by:

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.

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.

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:

CA-A.3.10

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

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.

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:

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.

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:

LESS:

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'.

CA-2.1.4

Tier 2 capital shall consist of the following items:

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:

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.

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.

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).

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.

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.

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.

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.

Murabahah and Non-binding MPO

Binding MPO

Collateralisation

Murabahah and Non-binding MPO

Binding MPO

Exclusions

Assignment of Risk Weights

Murabahah and Non-binding MPO

Binding MPO

Foreign Exchange Risk

CA-3.2.24

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

* 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.

* 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.

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.

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.

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.

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.

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.

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.

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.

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).

Exclusions

Applicable Period

Offsetting Arrangement between Credit Exposures of Salam and Parallel Salam

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.

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.

Foreign Exchange Risk

CA-3.3.15

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

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.

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).

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.

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).

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).

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.

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.

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.

CA-3.4.9

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

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.

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.

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.

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.

Full Recourse Istisna'a

Limited and Non-Recourse Istisna'a

Exclusions

Applicable Period

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

Full Recourse Istisna'a

Foreign Exchange Risk

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.

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.

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.

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.

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.

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.

Operating Ijarah

IMB

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.

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).

Operating Ijarah

IMB

Exclusions

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:

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.

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).

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.

Operating Ijarah

IMB

CA-3.5.23

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

Operating Ijarah

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

IMB

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

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.

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).

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.

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.

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.

Musharakah

Diminishing 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.

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.

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.

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.

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.

CA-3.6.16

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

* 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.

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.

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.

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.

CA-3.7.4

A Mudarabah financing can be carried out on either:

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.

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.

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.

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.

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.

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.

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.

CA-3.7.12

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

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

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.

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.

CA-3.8.3

Sukuk can be broadly categorised into:

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.

Salam Sukuk

Istisna'a Sukuk

Ijarah Sukuk

Musharakah Sukuk

Mudarabah (Muqaradah) Sukuk

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.

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).

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.

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).

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).

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.

CA-3.8.16

The following tables summarises the capital requirements for Sukuk exposures:

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

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.

CA-4.2.2

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

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.

CA-4.2.4

Claims on the Bahraini PSEs listed in Appendix CA-8 will be treated as claims on the government of Bahrain.

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.

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:

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.

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).

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:

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).

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.

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.

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.

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.

CA-4.2.14

Risk weighting for corporates including insurance companies is as follows:

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.

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%.

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.

CA-4.2.18

To be included in the regulatory retail portfolio, claims must meet the following criteria:

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).

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.

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.

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).

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.

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.

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.

CA-4.2.25

Investments in funds (e.g. mutual funds, Collective Investment Undertakings etc.) must be risk weighted as follows:

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.

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%.

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.

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.

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:

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).

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.

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.

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.

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.

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:

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.

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).

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.

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.

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.

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.

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.

CA-4.6.14

For short-tem claims on banks, the interaction with specific short-term assessments is expected to be the following:

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.

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.

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.

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.

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.

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.

CA-4.7.5

Market Discipline requirements must also be observed for banks to obtain capital relief in respect of any CRM techniques.

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.

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.

Hamish Jiddiyyah (Security Deposit held as Collateral)

Urbun (Earnest Money held after a Contract is Established as Collateral to Guarantee Contract Performance)

Guarantee from a Third Party (Recourse or Non-recourse Guarantee)

Leased Assets used as Collateral

Guarantees

Collateralised Transactions

Overall Framework and Minimum Conditions

Types of Collateral

The Simple Approach

The Standard Supervisory Haircuts Approach

Calculation of Capital Requirement Employing the Standard Supervisory Haircuts

The Standard Supervisory Haircuts

The Simple Approach

CA-5.1.1

The following definition of the trading book replaces the previous definition.

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).

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.

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.

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.

CA-5.1.6

These policies and procedures should, at a minimum, address the following general considerations:

CA-5.1.7

The following will be the basic requirements for positions eligible to receive trading book capital treatment.

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.

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).

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.

CA-5.1.9A

A framework for prudent valuation practices should at a minimum include the following:

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:

Marking to Market

Marking to Model

Independent Price Verification

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.

CA-5.1.18

The CBB expects the following valuation adjustments/reserves to be formally considered at a minimum: unearned profit, close-out costs, operational risks, early termination, investing and funding costs, and future administrative costs and, where appropriate, model risk.

CA-5.1.18.A

Banks must establish and maintain procedures for judging the necessity of and calculating an adjustment to the current valuation of less liquid positions for regulatory capital purposes. This adjustment may be in addition to any changes to the value of the position required for financial reporting purposes and should be designed to reflect the illiquidity of the position. The CBB expects banks to consider the need for an adjustment to a position's valuation to reflect current illiquidity whether the position is marked to market using market prices or observable inputs, third-party valuations or marked to model.

CA-5.1.19

Bearing in mind that the underlying 10-day assumptions made about liquidity in the market risk capital charge may not be consistent with the bank's ability to sell or hedge out less liquid positions, where appropriate, banks must take an adjustment to the current valuation of these positions, and review their continued appropriateness on an on-going basis. Reduced liquidity may have arisen from market events. Additionally, close-out prices for concentrated positions and/or stale positions should be considered in establishing the adjustment. Banks must consider all relevant factors when determining the appropriateness of the adjustments for less liquid positions. These factors may include, but are not limited to, the amount of time it would take to hedge out the position/risks within the position, the average volatility of bid/offer spreads, the availability of independent market quotes (number and identity of market makers), the average and volatility of trading volumes (including trading volumes during periods of market stress), market concentrations, the aging of positions, the extent to which valuation relies on marking-to-model, and the impact of other model risks not included in Paragraph CA-5.1.18.A.

CA-5.1.20

[This Paragraph was deleted in January 2012]

CA-5.3.1

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. 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-5.3.2

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) and is calculated for each country or equity market. For each national market in which the bank holds equities, it should sum the market values of its individual net positions irrespective of whether they are long or short positions, to produce the overall gross equity position for that market.

CA-5.3.3

The capital charge for specific risk is 8%.

CA-5.3.4

[This Paragraph was deleted in January 2012]

CA-5.3.5

The general market risk is calculated by first determining 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-5.3.6

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

CA-5.4.1

In the case of Sukuk in the trading book, the specific risk charge must be provided on the RW of the issue and the term to maturity of the Sukuk, as follows:

* CBB has the discretion to apply a different specific risk weight to sukuk issued by certain foreign government.

CA-5.4.2

The general market risk¹⁶ must be provided on the residual term to maturity or to the next repricing date, using a simplified form of the Maturity Method on the net positions in each time-band in accordance with the table below:

¹⁶ At the CBB's discretion, the bank may alternatively use the duration method as set out in the Market risk section of the Basel II Accord (June 2006).

CA-5.4.3

In the case of equity investments made by means of a Musharaka or a Mudaraba contract where the underlying assets are commodities, the market risk provisions for commodities, as described below, will be applicable.

CA-5.5.1

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

CA-5.5.2

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

CA-5.5.3

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 must be agreed in advance with the CBB. The CBB will consider the appropriate treatment on a case by case basis.

CA-5.5.4

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

CA-5.5.5

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-5.5.6

In addition to foreign exchange risk, positions in foreign currencies may be subject to credit risk which should be treated separately. For the purposes of calculating "Foreign Exchange Risk" only, positions in those GCC currencies which are pegged to US$, will be treated as positions in US$.

CA-5.5.7

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 CBB and as evidenced by the CBB's prior written approval, be exempted from calculating the capital requirements on these positions. The CBB is likely to be guided by the following criteria in deciding to grant exemption to any bank:

CA-5.5.8

The criteria listed 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 CBB, in writing. The CBB will have the discretion to grant such exemptions. The CBB 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-5.5.9

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

CA-5.5.10

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:

CA-5.5.11

For calculating the net open position in gold and/or silver, the bank must 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-5.5.12

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

CA-5.5.13

Positions of a structural nature (i.e. non-dealing), may be excluded from the calculation of the net open currency positions. These may include:

CA-5.5.14

The CBB 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:

CA-5.5.15

The net position in each currency is converted at the spot rate, into the reporting currency. The overall net open position must be measured by aggregating the following:

CA-5.5.16

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-5.5.17

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

CA-5.5.18

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

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 and/or silver (i.e. 50) = 420 @ 8% = 33.6

CA-5.6.1

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 and silver (which is treated as a foreign currency according to the methodology explained in section CA-5.5).

CA-5.6.2

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-5.6.3

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-5.6.4

All contracts (Salam, Musharakah or Mudarabah) involving commodities as defined in chapters CA-3.3, CA-3.6 and CA-3.7 are subject to commodities risk and a capital charge as per the relevant provisions must be computed.

CA-5.6.5

Banks should adopt either the simplified approach to calculate their commodities risk and the resultant capital charges or the maturity ladder approach.

CA-5.6.6

Banks must 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). Assets and liabilities 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-5.6.7

Positions in different commodities cannot be offset for the purpose of calculating the open-positions as described above. However, where one or more sub-categories¹⁷ 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 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 CBB, net positions in those sub-categories.

¹⁷ 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-5.6.8

Banks, which wish to net positions based on correlation (in the manner discussed above), must satisfy the CBB of the accuracy of the method which it proposes to adopt.

CA-5.6.9

A worked example of the maturity ladder approach is set out in Appendix CA-3 and the table below illustrates the maturity time-bands of the maturity ladder for each commodity.

CA-5.6.10

The steps in the calculation of the commodities risk by the maturity ladder approach are:

¹⁸ 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-5.6.11

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.

CA-5.6.12

At the end of step (c), there will be either asset or liability positions, to which a capital charge of 15% will apply. The CBB 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 CBB to evaluate whether the models approach should be adopted by the bank.

CA-6.2.3

Banks using the Basic Indicator Approach must hold capital for operational risk equal to the average over the previous three years of a fixed percentage (denoted alpha) of positive annual gross income. Figures for any year in which annual gross income is negative or zero should be excluded from both the numerator and denominator when calculating the average.¹⁹ The charge may be expressed as follows:

K_BIA = [Σ (GI_1..n α n)]/n

where:

K_BIA = the capital charge under the Basic Indicator Approach

GI = annual gross income, where positive, over the previous three years (audited financial years)

N = number of the previous three years for which gross income is positive

α = 15%, relating the industry wide level of required capital to the industry wide level of the indicator.

¹⁹ If negative gross income distorts a bank's Pillar 1 capital charge, CBB will consider appropriate supervisory action.

CA-6.2.4

The extent of losses arising from non-compliance with Sharia rules and principles cannot be ascertained owing to the lack of data. Therefore, banks are not required to set aside any additional amount over and above the 15% of average annual gross income over the preceding three years for operational risk.

CA-6.2.5

Gross income is defined as:

CA-6.2.6

Gross income includes income attributable to restricted and unrestricted Profit Sharing Investment Accounts' funds, but excludes extraordinary or exceptional income. Net income from investment activities includes the bank's share of profit from Musharakah and Mudarabah financing activities.

CA-6.2.7

Banks applying this approach are encouraged to comply with the principles set in section OM-1.2 of Operational Risk Management Module.

CA-6.2.8

In the Standardised Approach, banks' activities are divided into eight business lines: corporate finance, trading & sales, retail banking, commercial banking, payment & settlement, agency services, asset management, and retail brokerage. The business lines are defined in detail in Appendix CA-4. The bank must meet the requirements detailed in section OM-1.3 to qualify for the use of standardised approach.

CA-6.2.9

Within each business line, gross income is a broad indicator that serves as a proxy for the scale of business operations and thus the likely scale of operational risk exposure within each of these business lines. The capital charge for each business line is calculated by multiplying gross income by a factor (denoted beta) assigned to that business line. Beta serves as a proxy for the industry-wide relationship between the operational risk loss experience for a given business line and the aggregate level of gross income for that business line. It should be noted that in the Standardised Approach, gross income is measured for each business line, not the whole institution, i.e. in corporate finance, the indicator is the gross income generated in the corporate finance business line.

CA-6.2.10

The total capital charge is calculated as the three-year average of the simple summation of the regulatory capital charges across each of the business lines in each year. In any given year, negative capital charges (resulting from negative gross income) in any business line can not off-set positive capital charges in other business lines. Where the aggregate capital charge across all business lines within a given year is negative, then the input to the numerator for that year will be zero.²⁰ The total capital charge may be expressed as:

K _TSA={Σ _{years 1-3} max[(GI_1-8 xβ_1-8, 0] }/3

where:

K_TSA = the capital charge under the Standardised Approach
GI _1-8 = annual gross income in a given year, as defined above in the Basic Indicator Approach, for each of the eight business lines
β_1-8 = a fixed percentage, relating the level of required capital to the level of the gross income for each of the eight business lines.
The values of the betas are detailed below.

²⁰ As under the Basic Indicator Approach, if negative gross income distorts a bank's Pillar 1 capital charge under the Standardised Approach, CBB will consider appropriate supervisory action.

CA-7.1.5

The bank can take precautionary steps by setting up prudential reserve accounts to minimise the adverse impact of income smoothing for PSIA on its shareholders' returns and to meet unexpected losses (UL) that would be borne by the IAH on investments financed by PSIA, namely:

²¹ In some countries, the appropriation of income is to be made out of after tax income.

CA-8.1.2

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.

CA-8.1.3

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