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.