CA-4 CA-4 Credit Risk — The Standardized Approach
CA-4.1 CA-4.1 Introduction
CA-4.1.1
Credit risk exposures in Islamic financing arise in connection with accounts receivable in Murabaha contracts, counterparty risk in Salam contracts, accounts receivable and counterparty risk in Istisn'a contracts and lease payments receivable in Ijarah contracts, and Sukuk held to maturity in the banking book. Credit risk is measured according to the Standardised Approach as outlined in the Basel II guidelines, except for certain exposures arising from investments by means of Musharaka or Mudaraba contracts in assets in the banking book. The latter are to be treated as giving rise to credit risk (in the form of capital impairment risk), and are to be risk-weighted applying the supervisory slotting criteria for exposures in the nature of specialised financing and the risk weights applicable to equities for other equity exposures as detailed in the Musharaka and Mudaraba sections of this Rulebook.
Apr 08CA-4.1.2
Broadly, the assignment of Risk Weights (RW) under the standardised approach takes into consideration the following:
• The credit risk rating of an obligor or other counterparty, or a security, based on external credit assessment institutions (ECAI) ratings7. In determining the risk weights in the standardised approach, Islamic banks must use assessments by only those external credit assessment institutions which are recognised as eligible for capital purposes by CBB in accordance with the criteria defined in section CA-4.6.• Credit risk mitigation techniques adopted by the banks;• Types of the underlying assets that are sold and collateralised or leased by the banks; and• The amount of specific provisions made for the overdue portion of accounts receivable or lease payments receivable.
7 The notations follow the methodology used by one institution, Standard & Poor's. The use of Standard & Poor's credit ratings is an example only; those of some other external credit assessment institutions could equally well be used. The ratings used throughout this document, therefore, do not express any preferences or determinations on external assessment institutions by CBB.
Amended: April 2011
April 2008CA-4.1.3
Where a discount is applied on fair value of an asset (as explained in CA-2.1.4), the value of the asset will be adjusted to exclude that discount part. Refer to appendix CA-7.
Apr 08CA-4.2 CA-4.2 Segregation of Claims
Claims on Sovereigns
CA-4.2.1
Claims on governments of GCC member states (hereinafter referred to as GCC) and their central banks can be risk weighted at 0%. Claims on other sovereigns and their central banks are given a preferential risk weighting of 0% where such claims are denominated and funded in the relevant domestic currency of that sovereign/central bank (e.g. if a Bahraini bank has a claim on government of Australia and the loan is denominated and funded in Australian dollar, it will be risk weighted at 0%). Such preferential risk weight for claims on GCC/other sovereigns and their central banks will be allowed only if the relevant supervisor also allows 0% risk weighting to claims on its sovereign and central bank.
Apr 08CA-4.2.2
Claims on sovereigns other than those referred to in the previous paragraph must be assigned risk weights as follows:
Credit Assessment AAA to AA- A+ to A- BBB+ to BBB- BB+ to B- Below B- Unrated Risk Weight 0% 20% 50% 100% 150% 100% Apr 08Claims on International Organizations
CA-4.2.3.
Claims on the Bank for International Settlements, the International Monetary Fund and the European Central Bank must receive a 0% risk weight.
Apr 08Claims on Non-central Government Public Sectors Entities (PSEs)
CA-4.2.4
Claims on the Bahraini PSEs listed in Appendix CA-8 will be treated as claims on the government of Bahrain.
Apr 08CA-4.2.5
Where other supervisors also treat claims on named PSEs as claims on their sovereigns, claims to those PSEs are treated as claims on the respective sovereigns as outlined in paragraphs CA-4.2.1 and CA-4.2.2 above. These PSE's must be shown on a list maintained by the concerned central bank or financial regulator. Where PSE's are not on such a list, they must be subject to the treatment outlined in paragraph CA-4.2.6 below.
Apr 08CA-4.2.6
Claims on all other (foreign) PSEs (i.e. not having sovereign treatment) denominated and funded in the home currency of the sovereign must be risk weighted as allowed by their home country supervisors, provided the sovereign carries rating BBB- or above. Claims on PSEs with no explicit home country weighting or to PSEs in countries of BB+ sovereign rating and below are subject to ECAI ratings as per the following table:
Credit Assessment AAA to AA- A+ to A- BBB+ to BBB- BB+ to B- Below B- Unrated Risk Weight 20% 50% 100% 100% 150% 100% Apr 08CA-4.2.7
Claims on commercial companies owned by governments must be risk weighted as normal commercial entities unless they are covered by a government guarantee that satisfies the conditions in CA-4.7 below in which case they may take the risk weight of the concerned government.
Apr 08Claims on Multilateral Development Banks (MDB's)
CA-4.2.8
MDB's currently eligible for a 0% risk weight are: the World Bank Group comprised of the International Bank for Reconstruction and Development (IBRD) and the International Finance Corporation (IFC), the Asian Development Bank (ADB), the African Development Bank (AfDB), the European Bank for Reconstruction and Development (EBRD), the Inter-American Development Bank (IADB), the European Investment Bank (EIB), the European Investment Fund (EIF), the Nordic Investment Bank (NIB), the Caribbean Development Bank (CDB), the Islamic Development Bank (IDB), Arab Monetary Fund (AMF), the Council of Europe Development Bank (CEDB), the Arab Bank for Economic Development in Africa (ABEDA), Council of European Resettlement Fund (CERF) and the Kuwait Fund for Arab Economic Development (KFAED).
Apr 08CA-4.2.9
The claims on MDB's, which do not qualify for the 0% risk weighting, should be assigned risk weights as follows:
Banks Credit Quality Grades AAA to AA- A+ to A- BBB+ to BBB- BB+ to B- Below B- Un-rated Risk weights 20% 50% 50% 100% 150% 50% Apr 08Claims on Islamic Banks and Conventional Banks
CA-4.2.10
Claims on banks must be risk weighted as given in the following table. No claim on an unrated bank may receive a risk weight lower than that applied to claims on its sovereign of incorporation (see Guidance in Paragraph CA-4.2.11A for self-liquidating letters of credit).
Banks Credit Quality Grades AAA to AA- A+ to A- BBB+ to BBB- BB+ to B- Below B- Un-rated Standard risk weights 20% 50% 50% 100% 150% 50% Preferential risk weight 20% 20% 20% 50% 150% 20% Amended: April 2012
Apr 08CA-4.2.11
Short-term claims on locally incorporated banks may be assigned a risk weighting of 20% where such claims on the banks are of an original maturity of 3 months or less denominated and funded in either BD or US$. A preferential risk weight that is one category more favourable than the standard risk weighting may be assigned to claims on foreign banks licensed in Bahrain of an original maturity of 3 months or less denominated and funded in the relevant domestic currency (other than claims on banks that are rated below B-). Such preferential risk weight for short-term claims on banks licensed in other jurisdictions will be allowed only if the relevant supervisor also allows this preferential risk weighting to short-term claims on its banks.
Apr 08CA-4.2.11A
Self-liquidating letters of credit issued or confirmed by an unrated bank will be allowed a risk weighting of 50% or 20% without reference to the risk weight of the sovereign of incorporation. All other claims will be subject to the 'sovereign floor' of the country of incorporation of the concerned issuing or confirming bank.
Added: April 2012CA-4.2.12
Claims with an (contractual) original maturity under 3 months that are expected to be rolled over (i.e. where the effective maturity is longer than 3 months) will not qualify for a preferential treatment for capital adequacy purposes.
Apr 08Claims on Investment Firms
CA-4.2.13
Claims on category one and category two investment firms which are subject to direct supervisory and regulatory provisions from the CBB may be treated as claims on banks for risk weighting purposes but without the use of preferential risk weight for short-term claims. Claims on category three investment firms must be treated as claims on corporates for risk weighting purposes. Claims on investment firms in other jurisdictions will be treated as claims on corporates for risk weighting purposes. However, if the bank can demonstrate that the concerned investment firm is subject to a Basel II equivalent capital adequacy regime and is treated as a bank for risk weighting purposes by its home regulator, then claims on such investment firms may be treated as claims on banks.
Apr 08Claims on Corporates, including Insurance Companies
CA-4.2.14
Risk weighting for corporates including insurance companies is as follows:
Credit assessment AAA to AA- A+ to A- BBB+ to BB- Below BB- Unrated Risk weight 20% 50% 100% 150% 100% Apr 08CA-4.2.15
Risk weighting for unrated (corporate) claims will be reviewed and where appropriate, may be increased by the CBB. Credit facilities to small/medium enterprises may be placed in the regulatory retail portfolio in limited cases below.
Amended January 2009
Apr 08Claims included in the Regulatory Retail Portfolios
CA-4.2.16
No claim on any unrated corporate, where said corporate originates from a foreign jurisdiction, may be given a risk weight lower than that assigned to a corporate within its own jurisdiction, and in no case will it be below 100%.
Apr 08CA-4.2.17
Retail claims that are included in the regulatory retail portfolio must be risk weighted at 75%, except as provided in CA-4.2.21 for the past due receivables.
Apr 08CA-4.2.18
To be included in the regulatory retail portfolio, claims must meet the following criteria:
(a) Orientation — the exposure is to an individual person or persons or to a small business. A small business is a Bahrain-based business with annual turnover below BD 2mn.(b) Product — The exposure takes the form of any of the following: revolving credits and lines of credit (including credit cards and running finance), personal term finance and leases (e.g. instalment finance, auto finance and leases, student and educational finance, personal finance) and small business facilities and commitments. Islamic products which involve securities (such as Musharakah, Mudarabah, Sukuks and equities), whether listed or not, are specifically excluded from this category. Mortgage finance will be excluded if they qualify for treatment as claims secured by residential property (see below). Finance for purchase of shares are also excluded from the regulatory retail portfolios.(c) Granularity — The regulatory retail portfolio is sufficiently diversified to a degree that it reduces the risks in the portfolio, warranting a 75% risk weight. No aggregate exposure to one counterpart8 can exceed 0.2% of the overall regulatory retail portfolio.(d) The maximum aggregated retail exposure to one counterpart must not exceed an absolute limit of BD 250,000.
8 Aggregated exposure means gross amount (i.e. not taking any credit risk mitigation into account) of all forms of debt exposures (e.g. finances or commitments) that individually satisfy the three other criteria. In addition, "to one counterpart" means one or several entities that may be considered as a single beneficiary (e.g. in the case of a small business that is affiliated to another small business, the limit would apply to the bank's aggregated exposure on both businesses).
Amended January 2009
Apr 08Claims Secured by Residential Property
CA-4.2.19
Lending fully secured by first mortgages on residential property that is or will be occupied by the borrower, or that is leased, must carry a risk weighting of 75%. However, if the bank can justify foreclosure or repossession for a claim, a 35% risk weight will be allowed. To get this lower risk weight the bank must obtain a satisfactory legal opinion that foreclosure or repossession is possible without any impediment.
Apr 08Claims Secured by Commercial Real Estate
CA-4.2.20
Claims secured by mortgages on commercial real estate are subject to a minimum of 100% risk weight. If the borrower is rated below BB-, the risk-weight corresponding to the rating must be applied.
Apr 08Past Due Receivables
CA-4.2.21
In the event that accounts receivable or lease payments receivable become past due, the exposure shall be risk-weighted in accordance with the following table. The exposures should be risk weighted net of specific provisions (see CA-4.3.5 for exposures risk-weighted under Supervisory Slotting Criteria).
Type RW % of Specific Provisions for Past Due Receivables Unsecured exposure (other than a qualifying residential mortgage loan) that is past due more than 90 days, net of specific provisions 150%
100%Less than 20% of the outstanding receivables.
At least 20% of the outstanding receivables.Exposure secured by RRE 100% For receivables that are past due for more than 90 days, net of specific provisions. Apr 08CA-4.2.22
For the purposes of defining the secured portion of a past due loan, eligible collateral and guarantees will be the same as for credit risk mitigation purposes.
Apr 08CA-4.2.23
Past due retail loans are to be excluded from the overall regulatory retail portfolio when assessing the granularity criterion, for risk-weighting purposes.
Apr 08Investments in Equities and Funds
CA-4.2.24
Investments in listed equities must be risk weighted at 100% while equities other than listed must be risk weighted at 150%. For risk-weighting of Sukuk, refer to Section CA-3.8.
Apr 08CA-4.2.25
Investments in funds (e.g. mutual funds, Collective Investment Undertakings etc.) must be risk weighted as follows:
• If the instrument (e.g. units) is rated, it should be risk-weighted according to its external rating (for risk-weighting, it must be treated as a "claim on corporate");• If not rated, such investment should be treated as an equity investment and risk weighted accordingly (i.e. 100% for listed and 150% for others);• The bank can apply to CBB for using the look-through approach for such investments if it can demonstrate that the look-through approach is more appropriate to the circumstances of the bank;• If there are no voting rights attached to investment in funds, the investment will not be subjected to consolidation and deduction requirements (except large exposure limits);• For the purpose of determining "large exposure limit" for investment in funds, the look-through approach should be used (even if the look-through approach is not used to risk weight the investment).Apr 08CA-4.2.26
CBB may enforce a bank to adopt the 'Simple Risk Weight Method' for equities (Section CA-4.4) if the CBB considers that bank's equity portfolio is significant.
Apr 08Holdings of Real Estate
CA-4.2.27
All holdings of real estate by banks (i.e. owned directly or by way of investments in Real Estate Companies, subsidiaries or associate companies or other arrangements such as trusts, funds or REITs) must be risk-weighted at 200%. Premises occupied by the bank may be weighted at 100%. Investments in Real Estate Companies will be subject to the materiality thresholds for commercial companies described in Module PCD and therefore any holdings which amount to 15% or more of regulatory capital will be subject to deduction. The holdings below the 15% threshold will be weighted at 200%.
Apr 08Other Assets
CA-4.2.28
Gold bullion held in own vaults or on an allocated basis to the extent backed by bullion liabilities may be treated as cash and therefore risk-weighted at 0%. In addition, cash items in the process of collection must be risk-weighted at 20%. The standard risk weight for all other assets will be 100%. Investments in regulatory capital instruments issued by banks or investment firms must be risk weighted at a minimum of 100%, unless they are deducted from the capital base according to the Prudential Consolidation and Deduction Requirements Module.
Apr 08Underwriting of Non-trading Book items
CA-4.2.29
Where a bank has acquired assets on its balance sheet in the banking book which it is intending to place with third parties under a formal arrangement and is underwriting the placement, the following risk weightings apply during the underwriting period (which may not last for more than 90 days). Once the underwriting period has expired, the usual risk weights should apply.
1. For holdings of private equity, a risk weighting of 100% will apply instead of the usual 150% (see CA-4.2.24).2. For holdings of Real Estate, a risk weight of 100% will apply instead of the usual 200% risk weight (see CA-4.2.27).Apr 08CA-4.3 CA-4.3 Supervisory Slotting Criteria
CA-4.3.1
Equity exposures in the nature of specialized financing will be risk-weighted as per the supervisory slotting criteria as detailed below. Specialized lending is basically a typical kind of exposure in which some special underlying assets are both the source of repayment and security. This may include financing extended to:
• Power plants, chemical processing plants, mines, transportation infrastructure, environment, telecommunications infrastructure, ships, aircraft, satellites, railcars, fleets, crude oil, metals, crops, office buildings to let, retail space, multifamily residential buildings, industrial or warehouse space, hotels, High volatility real estate etc.• Retail space;• Multifamily residential buildings;• Industrial or warehouse space;• Hotels.Amended: April 2011
April 2008CA-4.3.2
A bank is required to map its RW into four supervisory categories as set out in the Appendix CA-1 (specialised financing) for Limited and Non-Recourse Istisna'a exposures, Mudarabah exposures, Sukuk exposures and Musharakah in a business venture exposures, where the RW for each category is as follows:
Supervisory Categories Strong Good Satisfactory Weak External Credit Assessments BBB- or better BB+ or BB BB- to B+ B to C- Risk Weights 70% 90% 115% 250% Apr 08CA-4.3.3
A bank with Diminishing Musharaka exposures in real estate are required to map its RW into the four supervisory categories as set out in Appendix CA-2 (Diminishing Musharaka in real estate) where the RW of each category is as follows:
Supervisory Categories Strong Good Satisfactory Weak Risk Weights 90% 110% 135% 270% Apr 08CA-4.3.4
The above RW under the slotting criteria for specialised financing include an additional fixed factor, equal to a 20% RW, to cater for the potential decline in the Musharakah's net asset value.
Apr 08CA-4.3.5
If any exposure which is to be risk-weighted under this sub-section becomes past due, it will be risk-weighted at the higher of risk-weight applicable under CA-4.2.21 or the risk-weight applicable under this sub-section e.g. if an exposure getting 90% risk-weight under CA-4.3.2 above becomes past due, it will be risk-weighted under CA-4.2.21 (at 100% or 150% whichever is applicable). However if an exposure getting 250% risk-weight under CA-4.3.2 above becomes past due, it will continue to be risk-weighted at 250%.
Apr 08CA-4.4 CA-4.4 Simple Risk-weight Method
CA-4.4.1
As stated in CA-4.2.26, CBB may enforce a bank to adopt this treatment for equities if the CBB considers that bank's equity portfolio is significant.
Apr 08CA-4.4.2
The RW under simple risk weight method for equity position risk in respect of an equity exposure shall be 300% for listed and 400% for others less any specific provisions for impairment. If there is a third party guarantee to make good impairment losses, the RW of the guarantor shall be substituted for that of the assets for the amount of any such guarantee.
Apr 08CA-4.5 CA-4.5 Risk Weighting - Off-balance-sheet Items
CA-4.5.1
Off-balance-sheet items must be converted into credit exposure equivalents using credit conversion factors (CCFs).
Apr 08CA-4.5.2
Commitments with an original maturity of up to one year and commitments with an original maturity of over one year will receive a CCF of 20% and 50%, respectively.
Apr 08CA-4.5.3
Any commitments that are unconditionally cancellable at any time by the bank without prior notice, or that are subject to automatic cancellation due to deterioration in a borrowers' creditworthiness, will receive a 0% CCF.
Apr 08CA-4.5.4
A CCF of 100% must be applied to the lending of banks' securities or the posting of securities as collateral by banks.
Apr 08CA-4.5.5
For short-term self-liquidating trade letters of credit arising from the movement of goods a 20% CCF must be applied to both issuing and confirming banks.
Apr 08CA-4.5.6
Where there is an undertaking to provide a commitment on an off-balance sheet item, banks are to apply the lower of the two applicable CCF's.
Apr 08CA-4.5.7
Direct credit substitutes, e.g. general guarantees of indebtedness (including standby letters of credit serving as financial guarantees for finance and securities) and acceptances (including endorsements with the character of acceptances) must be applied a CCF of 100%.
Apr 08CA-4.5.8
Sale and repurchase agreements and asset sales with recourse, where the credit risk remains with the bank, must be applied a CCF of 100%.
Apr 08CA-4.5.9
Forward asset purchases, forward deposits and partly-paid shares and securities, which represent commitments with certain drawdown must be applied a CCF of 100%.
Apr 08CA-4.5.10
Certain transaction-related contingent items (e.g. performance bonds, bid bonds, warranties and standby letters of credit related to particular transactions) must be applied a CCF of 50%.
Apr 08CA-4.5.11
Note issuance facilities and revolving underwriting facilities must be applied a CCF of 50%.
Apr 08CA-4.5.12
Banks must closely monitor securities, commodities, and foreign exchange transactions that have failed, starting the first day they fail. A capital charge to failed transactions must be calculated in accordance with CBB guidelines set forth in Appendix CA-5 - 'Capital treatment for failed trades and non DvP transactions'.
Apr 08CA-4.5.13
With regard to unsettled securities, commodities, and foreign exchange transactions, banks are encouraged to develop, implement and improve systems for tracking and monitoring the credit risk exposure arising from unsettled transactions as appropriate for producing management information that facilitates action on a timely basis.
Apr 08CA-4.5.14
Furthermore, when such transactions are not processed through a delivery-versus-payment (DvP) or payment-versus-payment (PvP) mechanism, banks must calculate a capital charge as set forth in Appendix CA-5.
Please Note: An import or export financing, which is based on Murabahah where the underlying goods/shipment are collateralised and insured, shall attract a 20% credit conversion factor to the banks that issues or confirms the letter of credit. This treatment of collateral assumes there are no obstacles to the exercise of rights over it by the issuer or confirmer (see "Pledge of assets as collateral as detailed below under Credit Risk Mitigation).Apr 08CA-4.6 CA-4.6 External Credit Assessments
The Recognition Process and Eligibility Criteria
CA-4.6.1
CBB will assess all External Credit Assessment Institutions (ECAI) according to the six criteria below. Any failings, in whole or in part, to satisfy these to the fullest extent will result in the respective ECAI's methodology and associated resultant rating not being accepted by the CBB:
(a) Objectivity: The methodology for assigning credit assessments must be rigorous, systematic, and subject to some form of validation based on historical experience. Moreover, assessments must be subject to ongoing review and responsive to changes in financial condition. Before being recognized by the CBB, an assessment methodology for each market segment, including rigorous back testing, must have been established for an absolute minimum of one year and with a preference of three years;(b) Independence: An ECAI must show independence and should not be subject to political or economic pressures that may influence the rating. The assessment process should be as free as possible from any constraints that could arise in situations where the composition of the board of directors, political pressure, the shareholder structure of the assessment institution or any other aspect could be seen as creating a conflict of interest;(c) International access/Transparency: The individual assessments should be available to both domestic and foreign institutions with legitimate interests and at equivalent terms. The general methodology used by the ECAI has to be publicly available;(d) Disclosure: An ECAI is required to disclose the following information: its assessment methodologies, including the definition of default, the time horizon, and the meaning of each rating; the actual default rates experienced in each assessment category; and the transitions of the assessments, e.g. the likelihood of a slide in the ratings of an exposure from one class to another over time;(e) Resources: An ECAI must have sufficient resources to carry out high quality credit assessments. These resources should allow for substantial ongoing contact with senior and operational levels within the entities assessed in order to add value to the credit assessments. Such assessments will be based on methodologies combining qualitative and quantitative approaches; and(f) Credibility: Credibility, to a certain extent, can derive from the criteria above. In addition, the reliance on an ECAI's external credit assessments by independent parties (investors, insurers, trading partners) may be evidence of the credibility of the assessments of an ECAI. The credibility of an ECAI will also be based on the existence of internal procedures to prevent the misuse of confidential information. In order to be eligible for recognition, an ECAI does not have to assess firms in more than one country.Amended: April 2011
April 2008CA-4.6.2
The CBB recognizes Standard and Poor's, Moody's, Fitch IBCA, Capital Intelligence and the Islamic International Rating Agency as eligible ECAIs. With respect to the possible recognition of other rating agencies as eligible ECAIs, CBB will update this paragraph subject to the rating agencies satisfying the eligibility requirements. (See Appendix CA-6 for mapping of eligible ECAIs).
Apr 08CA-4.6.3
Banks must use the chosen ECAIs and their ratings consistently for each type of claim, for both risk weighting and risk management purposes. Banks will not be allowed to "cherry-pick" the assessments provided by different eligible ECAIs.
Apr 08CA-4.6.4
Banks must disclose ECAIs that they use for the risk weighting of their assets by type of claims, the risk weights associated with the particular rating grades as determined by CBB through the mapping process as well as the aggregated risk-weighted assets for each risk weight based on the assessments of each eligible ECAI.
Apr 08Multiple Assessments
CA-4.6.5
If there are two assessments by eligible ECAIs chosen by a bank which map into different risk weights, the higher risk weight must be applied.
Apr 08CA-4.6.6
If there are three or more assessments by eligible ECAIs chosen by a bank which map into different risk weights, the assessments corresponding to the two lowest risk weights should be referred to and the higher of those two risk weights must be applied.
Apr 08Issuer Versus Issues Assessment
CA-4.6.7
Where a bank invests in a particular issue that has an issue-specific assessment, the risk weight of the claim will be based on this assessment. Where the bank's claim is not an investment in a specific assessed issue, the following general principles apply:
(a) In circumstances where the borrower has a specific assessment for an issued debt — but the bank's claim is not an investment in this particular debt — a high quality credit assessment (one which maps into a risk weight lower than that which applies to an unrated claim) on that specific debt may only be applied to the bank's un-assessed claim if this claim ranks pari passu or senior to the claim with an assessment in all respects. If not, the credit assessment cannot be used and the un-assessed claim will receive the risk weight for unrated claims; and(b) In circumstances where the borrower has an issuer assessment, this assessment typically applies to senior unsecured claims on that issuer. Consequently, only senior claims on that issuer will benefit from a high quality issuer assessment. Other un-assessed claims of a highly assessed issuer will be treated as unrated. If either the issuer or a single issue has a low quality assessment (mapping into a risk weight equal to or higher than that which applies to unrated claims), an un-assessed claim on the same counterparty will be assigned the same risk weight as is applicable to the low quality assessment.Amended: April 2011
April 2008CA-4.6.8
Whether the bank intends to rely on an issuer- or an issue-specific assessment, the assessment must take into account and reflect the entire amount of credit risk exposure the bank has with regard to all payments owed to it.9
9 For example, if a bank is owed both principal and interest, the assessment must fully take into account and reflect the credit risk associated with repayment of both principal and interest.
Apr 08CA-4.6.9
In order to avoid any double counting of credit enhancement factors, no recognition of credit risk mitigation techniques will be taken into account if the credit enhancement is already reflected in the issue specific rating (see paragraph CA-4.7.3).
Apr 08Domestic Currency and Foreign Currency Assessments
CA-4.6.10
Where unrated exposures are risk weighted based on the rating of an equivalent exposure to that borrower, the general rule is that foreign currency ratings would be used for exposures in foreign currency. Domestic currency ratings, if separate, would only be used to risk weight claims denominated in the domestic currency.
Apr 08CA-4.6.11
However, when an exposure arises through a bank's participation in a loan that has been extended, or has been guaranteed against convertibility and transfer risk, by certain MDBs, its convertibility and transfer risk can be considered by CBB, on a case by case basis, to be effectively mitigated. To qualify, MDBs must have preferred creditor status recognised in the market and be included in MDB's qualifying for 0% risk rate under CA-4.2.8. In such cases, for risk weighting purposes, the borrower's domestic currency rating may be used instead of its foreign currency rating. In the case of a guarantee against convertibility and transfer risk, the local currency rating can be used only for the portion that has been guaranteed. The portion of the loan not benefiting from such a guarantee will be risk-weighted based on the foreign currency rating.
Apr 08Short-term/Long-term Assessments
CA-4.6.12
For risk-weighting purposes, short-term assessments are deemed to be issue-specific. They can only be used to derive risk weights for claims arising from the rated facility. They cannot be generalised to other short-term claims, except under the conditions of paragraph CA-4.6.14. In no event can a short-term rating be used to support a risk weight for an unrated long-term claim. Short-term assessments may only be used for short-term claims against banks and corporates. The table below provides a framework for banks' exposures to specific short-term facilities, such as a particular issuance of commercial paper: For any Sharia contract with an original maturity of up to three months that is not rolled over, the short-term RW as set out in the following table shall be applied.
Credit assessment A-1/P-110 A-2/P-2 A-3/P-3 Others11 Risk weight 20% 50% 100% 150%
10The notations follow the methodology used by Standard & Poor's and by Moody's Investors Service. The A-1 rating of Standard & Poor's includes both A-1+ and A-1-.
11This category includes all non-prime and B or C ratings.
Apr 08CA-4.6.13
If a short-term rated facility attracts a 50% risk-weight, unrated short-term claims cannot attract a risk weight lower than 100%. If an issuer has a short-term facility with an assessment that warrants a risk weight of 150%, all unrated claims, whether long-term or short-term, should also receive a 150% risk weight, unless the bank uses recognised credit risk mitigation techniques for such claims.
Apr 08CA-4.6.14
For short-tem claims on banks, the interaction with specific short-term assessments is expected to be the following:
(a) The general preferential treatment for short-term claims, as defined under paragraphs CA-4.2.11 and CA-4.2.12, applies to all claims on banks of up to three months original maturity when there is no specific short-term claim assessment.(b) When there is a short-term assessment and such an assessment maps into a risk weight that is more favourable (i.e. lower) or identical to that derived from the general preferential treatment, the short-term assessment should be used for the specific claim only. Other short-term claims would benefit from the general preferential treatment.(c) When a specific short-term assessment for a short term claim on a bank maps into a less favourable (higher) risk weight, the general short-term preferential treatment for inter-bank claims cannot be used. All unrated short-term claims should receive the same risk weighting as that implied by the specific short-term assessment.Apr 08CA-4.6.15
When a short-term assessment is to be used, the institution making the assessment needs to meet all of the eligibility criteria for recognising ECAIs as presented in paragraph CA-4.6.1 in terms of its short-term assessment.
Apr 08Level of Application of the Assessment
CA-4.6.16
External assessments for one entity within a corporate group must not be used to risk weight other entities within the same group.
Apr 08Unsolicited Ratings
CA-4.6.17
As a general rule, banks should use solicited ratings from eligible ECAIs but they are also allowed to use unsolicited ratings in the same way as solicited ratings. However, there may be the potential for ECAIs to use unsolicited ratings to put pressure on entities to obtain solicited ratings. If such behaviour is identified, CBB may disallow the use of unsolicited ratings.
Apr 08CA-4.7 CA-4.7 Credit Risk Mitigation
CA-4.7.1
The exposure in respect of an obligor or other, counterparty can be further adjusted or reduced by taking into account the credit risk mitigation (CRM) techniques employed by Islamic banks (off-balance sheet items will first be converted into on-balance sheet equivalents prior to the CRM being applied). Banks use a number of techniques to mitigate the credit risks to which they are exposed. For example, exposures may be collateralised by first priority claims, in whole or in part with cash or securities or an exposure may be guaranteed by a third party. Additionally banks may agree to net exposure amounts owed to them against deposits from the same counterparty.
Apr 08General Remarks
CA-4.7.2
No transaction in which CRM techniques are used should receive a higher capital requirement than an otherwise identical transaction where such techniques are not used.
Apr 08CA-4.7.3
The effects of CRM will not be double counted. Therefore, no additional recognition of CRM for regulatory capital purposes will be applicable on claims for which an issue-specific rating is used that already reflects that CRM. As stated in paragraph CA-4.6.8 of the section on the standardised approach, principal-only ratings will also not be allowed within the framework of CRM.
Apr 08CA-4.7.4
While the use of CRM techniques reduces or transfers credit risk, it simultaneously may increase other risks (residual risks). Residual risks include legal, operational, liquidity and market risks. Therefore, it is imperative that banks employ robust procedures and processes to control these risks, including strategy; consideration of the underlying credit; valuation; policies and procedures; systems; control of roll-off risks; and management of concentration risk arising from the bank's use of CRM techniques and its interaction with the bank's overall credit risk profile. Where these risks are not adequately controlled, the CBB may impose additional capital charges or take supervisory actions.
Apr 08CA-4.7.5
Market Discipline requirements must also be observed for banks to obtain capital relief in respect of any CRM techniques.
Apr 08Legal Certainty
CA-4.7.6
In order for banks to obtain capital relief for any use of CRM techniques, the following minimum standards for legal documentation must be met.
Apr 08CA-4.7.7
All documentation used in collateralised transactions and for documenting on- balance sheet netting and guarantees must be binding on all parties and legally enforceable in all relevant jurisdictions. Banks must have conducted sufficient legal review to verify this and have a well founded legal basis to reach this conclusion, and undertake such further review as necessary to ensure continuing enforceability.
Apr 08CRM Techniques
The CRM techniques that are commonly employed by the bank are as follows:
Amended: April 2011
April 2008Hamish Jiddiyyah (Security Deposit held as Collateral)
CA-4.7.8
Hamish Jiddiyyah (HJ), a refundable security deposit taken by the bank prior to establishing a contract, carries a limited recourse to the extent of damages incurred by the bank when the purchase orderer fails to honour a binding promise to purchase (PP) or promise to lease (PL). The bank has recourse to the clients in the PP/PL if the HJ is insufficient to cover for the damages.
Apr 08CA-4.7.9
In the case of a non-binding PP/PL, the HJ shall be refunded in full to the clients, and hence is not considered as an eligible CRM.
Apr 08Urbun (Earnest Money held after a Contract is Established as Collateral to Guarantee Contract Performance)
CA-4.7.10
The urbun taken from a purchaser or lessee when a contract is established accrues to the benefit of the bank if the purchaser or lessee breaches the contract within the agreed upon term.
Apr 08Guarantee from a Third Party (Recourse or Non-recourse Guarantee)
CA-4.7.11
The guarantor may or may not have recourse to the debtor (i.e. purchaser or lessee) and the guarantee can be for a fixed period and for a limited amount, without any consideration being received by the guarantor. However, a claim should first be made against the debtor, and then against the guarantor, unless an option is provided to make the claim against either the debtor or the guarantor.
Apr 08CA-4.7.12
The guarantee can also be given in a 'blanket' form that covers an unknown amount or a future receivable. However, this type of guarantee (sometimes known as a "market/business guarantee" or "guarantee of contractual obligation") is revocable at any time prior to the existence of the future receivables and does not qualify as an eligible CRM.
Apr 08Leased Assets used as Collateral
CA-4.7.13
Assets leased under Ijarah or IMB contracts fulfill a function similar to that of collateral, in that they may normally be repossessed by the lessor in the event of default by the lessee (see residential real estate CA-4.2.19 and below).
Apr 08CA-4.7.14
The value of such assets may be offset against the exposure amount to the customer, subject to the regulatory haircuts under the Standard Supervisory Haircut 12 Approach (CA-4.7.32 onwards) for leased assets mentioned in the paragraph CA-4.7.39. Ijarah receivables which comprise Residential Real Estate do not generally satisfy the conditions laid out in Paragraph CA-4.7.23 and therefore such receivables will be weighted at 75% and the collateral will not be recognised for risk mitigation purposes. If the bank can show legal evidence that it may exercise foreclosure, a risk weighting of 35% may be applied to the lease receivable in the case of residential property occupied by the customer. Commercial real estate may be used as collateral for Ijarah transactions as long as it satisfies the criteria of paragraph CA-4.7.23 (and the supervisory haircut is then applied).
12 The term 'haircut' in this context refers to a discount on the depreciated value of an asset as collateral after taking into consideration some inherent risks that affect the volatility of the market price or value of the asset. It is commonly expressed in terms of a percentage by which an asset's value as collateral is reduced.
Apr 08CA-4.7.15
The leased asset to be used as collateral must be a Sharia compliant tangible asset of monetary value that can be lawfully owned, and is saleable, specifiable, deliverable and free of encumbrance.
Apr 08CA-4.7.16
The collateralisation under the concept of "rahn" or "kafālah" shall be properly documented in a security agreement or, in the body of a contract to the extent permissible by Sharia, and must be binding on all parties and legally enforceable in the relevant jurisdictions.
Apr 08CA-4.7.17
The banks must additionally document its procedures for the valuation of leased assets to be used as collateral as described above. This valuation would normally be the depreciated value of the asset as reported in the financial statement.
Apr 08Guarantees
CA-4.7.18
Capital relief for the use of a guarantee shall be given when the following conditions are satisfied:
(a) The guarantee represents the bank's direct claim on the guarantor;(b) The guarantee is irrevocable and does not allow the guarantor to unilaterally cancel the guarantee after creation of the receivables;(c) The guarantee is unconditional and provides no protection clause that prevents the guarantor from being obliged to pay out in a timely manner in the event that the original counterparty fails to make payments due;(d) The bank has the right to pursue, in a timely manner, the guarantor for monies outstanding, rather than having to pursue the original counterparty to recover its exposure;(e) The guarantee shall be an explicitly documented obligation assumed by the guarantor; and(f) The guarantee shall cover all types of expected payments made under the contract in the event that the original counterparty defaults.(g) Portions of claims guaranteed by the entities detailed in paragraph CA-4.2.1 above, where the guarantee is denominated in the domestic currency (and US$ in case of a guarantee provided by the Government of Bahrain and CBB) may get a 0% risk-weighting. A claim may be covered by a guarantee that is indirectly counter-guaranteed by such entities. Such a claim may be treated as covered by a sovereign guarantee provided that:• the sovereign counter-guarantee covers all credit risk elements of the claim;• both the original guarantee and the counter-guarantee meet all operational requirements for guarantees, except that the counter-guarantee need not be direct and explicit to the original claim; and• CBB is satisfied that the cover is robust and that no historical evidence suggests that the coverage of the counter-guarantee is less than effectively equivalent to that of a direct sovereign guarantee.
Please Note: Though insurance is normally part and parcel of the project risk financing, it is not regarded by CBB as a credit risk mitigation technique.Amended: April 2011
April 2008Collateralised Transactions
CA-4.7.19
Where banks take eligible financial collateral as defined in paragraph CA.4.7.28, they are allowed to reduce their credit exposure to a counterparty when calculating their capital requirements to take account of the risk mitigating effect of the collateral (except residential real estate - see CA-4.7.14).
Apr 08Overall Framework and Minimum Conditions
CA-4.7.20
Banks may opt for either the simple approach, which substitutes the risk weighting of the collateral for the risk weighting of the counterparty for the collateralised portion of the exposure (generally subject to a 20% floor), or for the standard supervisory haircuts approach which allows fuller offset of collateral against exposures, by effectively reducing the exposure amount by the value ascribed to the collateral.
Apr 08CA-4.7.21
Banks may operate under either, but not both, approaches in the banking book, but only under the standard supervisory haircuts approach in the trading book. Partial collateralisation is recognised in both approaches. Mismatches in the maturity of the underlying exposure and the collateral will only be allowed under the standard supervisory haircuts approach.
Apr 08CA-4.7.22
However, before capital relief will be granted in respect of any form of collateral, the standards set out below in paragraphs CA-4.7.23 to CA-4.7.26 must be met under either approach.
Apr 08CA-4.7.23
In addition to the general requirements for legal certainty set out in paragraphs CA-4.7.6 and CA-4.7.7, the legal mechanism by which collateral is pledged or transferred must ensure that the bank has the right to liquidate or take legal possession of it, in a timely manner, in the event of the default, insolvency or bankruptcy (or one or more otherwise-defined credit events set out in the transaction documentation) of the counterparty (and, where applicable, of the custodian holding the collateral). Furthermore banks must take all steps necessary to fulfill those requirements under the law applicable to the bank's interest in the collateral for obtaining and maintaining an enforceable security interest, e.g. by registering it with a registrar, or for exercising a right to net or set off in relation to title transfer collateral.
Apr 08CA-4.7.24
In order for collateral to provide protection, the credit quality of the counterparty and the value of the collateral must not have a material positive correlation. For example, securities issued by the counterparty — or by any related group entity — would provide little protection and so would be ineligible.
Apr 08CA-4.7.25
Banks must have clear and robust procedures for the timely liquidation of collateral to ensure that any legal conditions required for declaring the default of the counterparty and liquidating the collateral are observed, and that collateral can be liquidated promptly.
Apr 08CA-4.7.26
Where the collateral is held by a custodian, banks must take reasonable steps to ensure that the custodian segregates the collateral from its own assets.
Apr 08Types of Collateral
CA-4.7.27
The types of collateral given in the next paragraph are eligible for relief in respect of the above CRM techniques.
Apr 08CA-4.7.28
(a) Hamish jiddiyyah (security deposit) only for agreements to purchase or lease preceded by a binding promise.(b) Urbun(c) Profit sharing investment account or cash on deposit13 with the bank which is incurring the exposure(d) Sukuk rated by an external rating agency which is issued by:(i) Sovereigns and PSEs (treated as sovereigns) with a minimum rating of BB-;or(ii) Issuers other than the above, with a minimum rating of BBB- or A-3 / P-3.(e) Sukuk that is unrated by an ECAI but fulfill each of the following criteria:(i) Issued by an Islamic bank or a conventional bank or a sovereign;(ii) Listed on a recognised exchange;(iii) All other rated issues by the Islamic bank or conventional bank of the same seniority of at least BBB - or A-3/P-3 by a recognised ECAI, as determined by the CBB;(iv) The Islamic bank which incurs the exposure or is holding the collateral has no information to suggest that the issue would justify a rating below BBB- or A-3/P-3; and(v) The CBB is sufficiently confident about the market liquidity of the securities.(f) Equities and units in collective investment schemes.(g) Guarantees issued by third parties that fall within the following categories:(i) Sovereigns and central banks;(ii) PSEs;(iii) MDBs;(iv) International organisations/official entities with 0% RW(v) Islamic banks or conventional banks; and(vi) Corporate entities (including insurance and securities firms) either by the parent, subsidiary and affiliates, of a minimum rating of A-.(h) Leased assets as stated under "Leased assets used as collateral" above.
13 Must be supported by an agreement or documentation that gives bank the right of set-off against the amount of receivables due.
Amended: April 2011
April 2008CA-4.7.29
Any portion of the exposure which is not collateralised shall be assigned the RW of the counterparty.
Apr 08CA-4.7.30
As stated earlier, banks may opt for either of the two approaches listed below:
Apr 08The Simple Approach
CA-4.7.31
In the simple approach the risk weighting of the collateral instrument collateralising or partially collateralising the exposure is substituted for the risk weighting of the counterparty.
Apr 08The Standard Supervisory Haircuts Approach
CA-4.7.32
In this approach, when taking collateral, banks must calculate their adjusted exposure to a counterparty for capital adequacy purposes in order to take account of the effects of that collateral. Using haircuts, banks are required to adjust both the amount of the exposure to the counterparty and the value of any collateral received in support of that counterparty to take account of possible future fluctuations in the value of either14, occasioned by market movements. This will produce volatility adjusted amounts for both exposure and collateral. Unless either side of the transaction is cash, the volatility adjusted amount for the exposure will be higher than the exposure and for the collateral it will be lower.
14 Exposure amounts may vary where, for example, securities are being lent.
Apr 08CA-4.7.33
Additionally where the exposure and collateral are held in different currencies an additional downwards adjustment must be made to the volatility adjusted collateral amount to take account of possible future fluctuations in exchange rates.
Apr 08CA-4.7.34
Where the volatility-adjusted exposure amount is greater than the volatility-adjusted collateral amount (including any further adjustment for foreign exchange risk), banks shall calculate their risk-weighted assets as the difference between the two multiplied by the risk weight of the counterparty. The framework for performing these calculations is set out in paragraphs CA-4.7.36 to CA-4.7.38.
Apr 08CA-4.7.35
Banks must use standard supervisory haircuts given in paragraph CA-4.7.39.
Apr 08Calculation of Capital Requirement Employing the Standard Supervisory Haircuts
CA-4.7.36
For a collateralised transaction, the exposure amount after risk mitigation is calculated as follows:
E* = max {0, [E x (1 + He) - C x (1 - Hc - Hfx)]}
where:
E* = the exposure value after risk mitigation
E = current value of the exposure
He = haircut appropriate to the exposure
C = the current value of the collateral received
Hc = haircut appropriate to the collateral
Hfx = haircut appropriate for currency mismatch between the collateral and exposureApr 08CA-4.7.37
The exposure amount after risk mitigation will be multiplied by the risk weight of the counterparty to obtain the risk-weighted asset amount for the collateralised transaction. The treatment for transactions where there is a mismatch between the maturity of the counterparty exposure and the collateral is given in paragraphs CA-4.7.47 to CA-4.7.50.
Apr 08CA-4.7.38
Where the collateral is a basket of assets, the haircut on the basket will be H = Σi ai Hi, where ai is the weight of the asset (as measured by units of currency) in the i basket and Hi the haircut applicable to that asset.
Apr 08The Standard Supervisory Haircuts
CA-4.7.39
Both the amount of exposure to counterparty and the value of collateral received are adjusted by using standard supervisory haircuts as set out below:
Types of Collateral* Residual Maturity (yrs) Haircuts (%) Sovereigns15 Others Cash All 0 0 Sukuk
Long-term: AAA to AA- and
Short-term: A-1
≤ 1
> 1 to ≤ 5
> 50.5
2
41
4
8Sukuk
Long-term: A+ to BBB- and
Short-term: A-2 to A-3≤ 1
> 1 to ≤ 5
> 51
3
62
6
12Sukuk
Long-term: BB+ to BB-All 15 15 Sukuk (unrated) All 25 25 Equities (included in main index)
Equities (not included in main index but listed)
Units in collective investment schemesAll
All
All15
25
Depending on the underlying assets as above15
25
Depending on the underlying assets as aboveLeased assets used as collateral (except residential real estate -see CA-4.2.19) and other assets All >=30 >=30 * Collateral denominated in different currency will also be subject to additional 8% haircut to cater for foreign exchange risk.
15 Includes PSEs and MDBs
Apr 08CA-4.7.40
The standard haircut for currency risk where exposure and collateral are denominated in different currencies is 8% (also based on a 10-business day holding period and daily mark-to-market). For transactions in which the bank lends non-eligible instruments (e.g. non- investment grade securities), the haircut to be applied on the exposure should be the same as the one for equity traded on a recognised exchange that is not part of a main index.
Apr 08The Simple Approach
The Minimum Conditions
CA-4.7.41
For collateral to be recognised in the simple approach, the collateral must be pledged for at least the life of the exposure and it must be marked to market and revalued with a minimum frequency of six months. Those portions of claims collateralised by the market value of recognised collateral receive the risk weight applicable to the collateral instrument. The risk weight on the collateralised portion will be subject to a floor of 20% except under the conditions specified in paragraphs CA-4.7.42. The remainder of the claim should be assigned to the risk weight appropriate to the counterparty.
Apr 08Exceptions to the Risk Weight Floor
CA-4.7.42
The 20% floor for the risk weight on a collateralised transaction will not be applied and a 0% risk weight can be applied where the exposure and the collateral are denominated in the same currency, and either:
(a) The collateral is cash on deposit; or(b) The collateral is in the form of sovereign/PSE securities eligible for a 0% risk weight, and its market value has been discounted by 20%Amended: April 2011
April 2008Treatment of Pools of CRM Techniques
CA-4.7.43
In the case where a bank has multiple CRM techniques covering a single exposure (e.g. a bank has both collateral and guarantee partially covering an exposure), the bank will be required to subdivide the exposure into portions covered by each type of CRM technique (e.g. portion covered by collateral, portion covered by guarantee) and the risk-weighted assets of each portion must be calculated separately.
Apr 08Credit Risk Mitigation for Mudarabah Classified as Equity Exposures
CA-4.7.44
A placement of funds made under a Mudarabah contract may be subject to a Sharia compliant guarantee from a third party. Such a guarantee relates only to the Mudarabah capital, not to the return. In such cases, the capital should be treated as subject to credit risk with a risk-weighting equal to that of the guarantor provided that the RW of that guarantor is lower than the RW of the Mudarib as a counterparty. Otherwise, the RW of the Mudarib shall apply.
Apr 08CA-4.7.45
In Mudarabah investment in project finance, collateralisation of the progress payments made by the ultimate customers can be used to mitigate the exposures of unsatisfactory performance by the Mudarib.
Apr 08CA-4.7.46
The bank may also place liquid funds with a central bank or another bank on a short-term Mudarabah basis in order to obtain a return on those funds. Such placements serve as an interbank market with maturities ranging from an overnight market up to three months, but the funds may be withdrawn on demand before the maturity date in which case the return is calculated proportionately on the basis of duration and amount. Although from a juristic point of view the amounts so placed do not constitute debts, since (in the absence of misconduct or negligence) Mudarabah capital does not constitute a liability for the institution that acts as Mudarib, in practice the operation of this interbank market requires that the Mudarib should effectively treat them as liabilities. Hence a bank placing funds on this basis may treat them as cash equivalents and, for risk weighting purposes, apply the risk weight applicable to the Mudarib as counterparty.
Apr 08Maturity Mismatches
CA-4.7.47
For the purposes of calculating risk-weighted assets, a maturity mismatch occurs when the residual maturity of CRM is less than that of the underlying exposure.
Apr 08CA-4.7.48
The maturity of the underlying exposure and the maturity of the CRM should both be defined conservatively. The effective maturity of the underlying should be gauged as the longest possible remaining time before the counterparty is scheduled to fulfill its obligation, taking into account any applicable grace period.
Apr 08CA-4.7.49
CRM with maturity mismatches are only recognised when their original maturities are greater than or equal to one year. As a result, the maturity of CRM for exposures with original maturities of less than one year must be matched to be recognised. In all cases, CRM with maturity mismatches will no longer be recognised when they have a residual maturity of three months or less.
Apr 08CA-4.7.50
When there is a maturity mismatch with recognised credit risk mitigants, the following adjustment will be applied.
Pa = P x (t - 0.25) / (T - 0.25)
where:
Pa = value of the credit protection adjusted for maturity mismatch
P = credit protection (e.g. collateral amount, guarantee amount) adjusted for any haircuts
t = min (T, residual maturity of the credit protection arrangement) expressed in years
T = min (5, residual maturity of the exposure) expressed in years.Apr 08
