Capital Adequacy Framework (Basel II - Risk Weighted Assets)

513 Pages·2015·2.78 MB·English

Capital Adequacy Framework
(Basel II - Risk Weighted Assets)
Concept Paper

Issued on: 15 July 2015
PART A OVERVIEW ........................................................................ 1
A.1 EXECUTIVE SUMMARY.................................................... 1
A.2 APPLICABILITY ................................................................ 3
A.3 LEGAL PROVISION .......................................................... 3
A.4 LEVEL OF APPLICABILITY .............................................. 3
PART B CREDIT RISK .................................................................... 5
B.1 INTRODUCTION ................................................................ 5
B.2 THE STANDARDISED APPROACH FOR CREDIT RISK . 8
B.2.1 EXTERNAL CREDIT ASSESSMENTS .............................. 8
B.2.2 DEFINITION OF EXPOSURES ........................................ 11
Exposures to Sovereigns and Central Banks ................... 12
Exposures to Non-Federal Government Public Sector
Entities (PSEs) ................................................................. 13
Exposures to Multilateral Development Banks (MDBs) .... 14
Exposures to Banking Institutions and Corporates ........... 14
Exposures to Insurance Companies, Securities Firms and
Fund Managers ................................................................ 16
Exposures Included in the Regulatory Retail Portfolio ...... 16
Loans Secured by Residential Properties......................... 17
Defaulted Exposures ........................................................ 20
Higher Risk Assets ........................................................... 21
Other Assets ..................................................................... 21
B.2.3 TREATMENT FOR THE COMPUTATION OF CREDIT
RISK-WEIGHTED ASSETS FOR ISLAMIC CONTRACTS .
......................................................................................... 22
MURĀBAHAH .................................................................. 22
BAI’ BITHAMAN AJIL (BBA) AND BAI’ INAH ................... 24
SALAM ............................................................................. 25
ISTISNĀ` .......................................................................... 26
IJĀRAH ............................................................................. 27
MUSHĀRAKAH ................................................................ 29
MUDĀRABAH .................................................................. 33
SUKŪK ............................................................................. 36

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QARDH ............................................................................ 37
B.2.4 OFF-BALANCE SHEET ITEMS ....................................... 38
B.2.5 CREDIT RISK MITIGATION ............................................ 40
Minimum Conditions for the Recognition of Credit Risk
Mitigation Techniques....................................................... 41
Credit Risk Mitigation Techniques .................................... 42
Other Aspects of Credit Risk Mitigation ............................ 65
B.3 THE INTERNAL RATINGS BASED APPROACH ........... 68
B.3.1 ADOPTION OF THE IRB APPROACH ............................ 68
Adoption of IRB Across Asset Classes ............................. 68
Adoption of IRB for Islamic Banking Assets ..................... 71
Implementation Timelines and Transition Period .............. 72
Determination of Capital Requirements under the IRB
approach .......................................................................... 74
B.3.2 CATEGORIES OF EXPOSURES .................................... 75
Definition of Corporate Exposures, including Specialised
Lending ............................................................................. 76
Definition of Bank Exposures ........................................... 80
Definition of Retail Exposures .......................................... 80
Definition of Equity Exposures .......................................... 83
Definition of Purchased Receivables Exposures .............. 84
B.3.3 RISK COMPONENTS ...................................................... 86
Risk Components for Corporate, Sovereign and Bank
Exposures ........................................................................ 86
Risk Components for Retail Exposures ............................ 95
Risk Components for Equity Exposures ........................... 97
B.3.4 CREDIT RISK MITIGATION (CRM) ................................. 98
Minimum Conditions for the Recognition of Credit Risk
Mitigation Techniques....................................................... 99
Collateralised Transactions ............................................ 100
Guarantees and Credit Derivatives ................................ 113
On-Balance Sheet Netting .............................................. 121
Other Aspects of Credit Risk Mitigation .......................... 122
B.3.5 RISK-WEIGHTED ASSETS ........................................... 126

Issued on: 15 July 2015
Risk-Weighted Assets for Corporate, Sovereign and Bank
Exposures ...................................................................... 126
Risk-Weighted Assets for Retail Exposures ................... 130
Risk-Weighted Assets for Equity Exposures .................. 132
Risk-Weighted Assets for Purchased Receivables ......... 136
Risk-Weighted Assets for Leasing .................................. 141
B.3.6 CALCULATION OF MINIMUM CAPITAL REQUIREMENT .
....................................................................................... 142
Regulatory Capital .......................................................... 142
Calculation of Expected Losses ..................................... 143
Calculation of Provisions ................................................ 144
Risk-Weighted Assets .................................................... 145
Parallel Calculation ......................................................... 145
Prudential Capital Floor .................................................. 146
B.3.7 MINIMUM REQUIREMENTS FOR THE IRB APPROACH ..
....................................................................................... 147
Rating System Design .................................................... 149
Rating System Operation ............................................... 160
Risk Estimation ............................................................... 166
Governance, Oversight and Use of Internal Ratings ...... 195
Validation of Rating Systems and Internal Estimates ..... 201
B.3.8 QUALIFICATION ........................................................... 208
Overview of Approval and Review Process .................... 208
General Qualification Process ........................................ 208
Home-Host Supervisory Issues ...................................... 210
Changes to IRB Implementation and Adoption ............... 211
PART C OPERATIONAL RISK .................................................... 213
C.1 INTRODUCTION ............................................................ 213
C.1.1 SOUND PRACTICES FOR OPERATIONAL RISK
MANAGEMENT ............................................................. 213
C.1.2 TOTAL OPERATIONAL RISK CAPITAL CHARGE ...... 214
C.2 THE BASIC INDICATOR APPROACH (BIA) ................ 215
C.3 THE STANDARDISED APPROACH AND ALTERNATIVE
STANDARDISED APPROACH ..................................... 218

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C.3.1 THE STANDARDISED APPROACH (TSA) ................... 218
C.3.2 THE ALTERNATIVE STANDARDISED APPROACH
(ASA) ............................................................................. 222
PART D MARKET RISK .............................................................. 225
D.1 INTRODUCTION ............................................................ 225
Scope of the Capital Charges ......................................... 225
Approaches of Measuring Market Risks ......................... 226
Standardised Approach .................................................. 226
Internal Models Approach ............................................... 226
D.1.1 PRUDENT VALUATION GUIDANCE ............................ 227
Systems and Controls .................................................... 227
Valuation Methodologies ................................................ 228
Independent Price Verification ........................................ 229
Valuation Adjustments .................................................... 230
D.1.2 CLASSIFICATION OF FINANCIAL INSTRUMENTS .... 230
Trading Book Policy Statement ...................................... 230
Definition of Trading Book .............................................. 232
Classification of Specific Financial Instruments .............. 234
D.1.3 TREATMENT OF MONEY MARKET INSTRUMENTS IN
TRADING BOOK ........................................................... 234
Controls to Prevent Regulatory Capital Arbitrage ........... 235
Treatment of Hedging Positions ..................................... 236
D.1.4 TREATMENT OF COUNTERPARTY CREDIT RISK IN
THE TRADING BOOK ................................................... 238
Credit Derivatives ........................................................... 239
D.2 THE STANDARDISED MARKET RISK APPROACH ... 240
D.2.1 INTEREST/PROFIT RATE RISKS ................................. 240
Specific Risk ................................................................... 241
Specific Risk Capital Charges for Issuer Risk ................ 241
Specific Risk Capital Charges for Positions Hedged by
Credit Derivatives ........................................................... 243
General Interest/Profit Rate Risk .................................... 245
Offsetting of Matched Positions ...................................... 246

Issued on: 15 July 2015
Maturity Method .............................................................. 246
Vertical Disallowance ..................................................... 247
Horizontal Disallowance ................................................. 248
Duration Method ............................................................. 249
Treatment of Interest/Profit Rate Derivatives, Repo and
Reverse Repo Transactions ........................................... 250
Example 1: Calculation of General Risk (Maturity Method)
for Interest/Profit Rate Related Financial Instruments .... 257
D.2.2 EQUITY POSITION RISK .............................................. 260
Specific and General Risk .............................................. 260
Specific Risk ................................................................... 260
General Risk ................................................................... 261
Treatment of Equity Derivatives ..................................... 263
Offsetting of Matched Equity Derivative Positions .......... 263
Arbitrage ......................................................................... 264
Example 2: Calculation of Equity Risk for Equity Arbitrage
Strategies ....................................................................... 265
D.2.3 FOREIGN EXCHANGE RISK (INCLUDING GOLD AND
SILVER POSITIONS) ..................................................... 267
The Treatment of Structural Positions ............................ 267
Measuring the Exposure in a Single Currency ............... 268
The Treatment of Interest/Profit, Other Income and
Expenses in Foreign Currency ....................................... 269
Measuring the Foreign Exchange Risk in a Portfolio of
Foreign Currency Positions ............................................ 270
D.2.4 COMMODITIES RISK .................................................... 271
Simplified Approach........................................................ 273
Maturity Ladder Approach .............................................. 273
Models for Measuring Commodities Risk ....................... 275
Example 3: Maturity Ladder Approach for Commodities
Risk ................................................................................ 276
D.2.5 TREATMENT OF OPTIONS .......................................... 279
Underlying Position Approach ........................................ 279
Simplified Approach........................................................ 281
Delta-Plus Method .......................................................... 282
Scenario Approach ......................................................... 285

Issued on: 15 July 2015
Example 4: Delta-Plus Methods for Options ................... 287
Example 5: The Scenario Approach for Options ............ 294
D.3 INTERNAL MODELS APPROACH ............................... 298
D.3.1 COMBINATION OF INTERNAL MODELS AND THE
STANDARDISED MARKET RISK MEASUREMENT
APPROACH ................................................................... 299
D.3.2 QUALITATIVE STANDARDS ........................................ 301
D.3.3 QUANTITATIVE STANDARDS ..................................... 304
D.3.4 SPECIFICATION OF MARKET RISK FACTORS .......... 306
D.3.5 MODELLING OF SPECIFIC RISK ................................. 309
D.3.6 STRESS TESTING ........................................................ 314
D.3.7 MODEL VALIDATION STANDARDS ............................ 316
D.3.8 MODEL REVIEW ........................................................... 318
D.3.9 FRAMEWORK FOR THE USE OF BACK TESTING .... 319
PART E LARGE EXPOSURE RISK REQUIREMENTS ............... 328
E.1 LERR FOR BANKING INSTITUTIONS ......................... 328
E.2 LERR FOR INVESTMENT BANKS ............................... 329
PART F SECURITISATION FRAMEWORK ................................ 330
F.1 INTRODUCTION ............................................................ 330
F.2 OPERATIONAL REQUIREMENTS FOR CAPITAL
RELIEF .......................................................................... 332
F.2.1 Operational Requirements for Traditional
Securitisations .............................................................. 333
F.2.2 Operational Requirements for Synthetic Securitisations
....................................................................................... 334
F.3 STANDARDISED APPROACH FOR SECURITISATION
EXPOSURES ................................................................. 336
F.3.1 TREATMENT OF ON-BALANCE SHEET
SECURITISATION EXPOSURES .................................. 336
F.3.2 TREATMENT OF OFF-BALANCE SHEET
SECURITISATION EXPOSURES .................................. 338

Issued on: 15 July 2015
F.3.3 TREATMENT OF OVERLAPPING EXPOSURES ......... 339
F.3.4 TREATMENT OF COUNTERPARTY CREDIT RISK FOR
SECURITISATION EXPOSURES .................................. 339
F.3.5 TREATMENT OF SECURITISATION OF REVOLVING
UNDERLYING EXPOSURES WITH EARLY
AMORTISATION PROVISIONS .................................... 340
F.3.6 TREATMENT OF CREDIT RISK MITIGATION FOR
SECURITISATION EXPOSURES .................................. 345
F.4 INTERNAL RATINGS-BASED APPROACH FOR
SECURITISATION EXPOSURES .................................. 346
F.5 OTHER OPERATIONAL REQUIREMENTS .................. 347
F.5.1 OPERATIONAL REQUIREMENTS AND TREATMENT OF
CLEAN-UP CALLS ........................................................ 347
F.5.2 TREATMENT FOR IMPLICIT SUPPORT ...................... 348
F.5.3 ELIGIBLE OFF-BALANCE SHEET SECURITISATION
EXPOSURES ................................................................. 350
F.5.4 REQUIREMENTS FOR USE OF EXTERNAL RATINGS ....
....................................................................................... 352
PART G REQUIREMENTS FOR APPROVED FINANCIAL
HOLDING COMPANIES ................................................ 355
G.1 GENERAL REQUIREMENTS ........................................ 355
G.2 Regulatory approval process for the adoption of an
advanced approach ...................................................... 355
Appendix I Areas of National Discretion ....................................... 358
Appendix II Eligibility Criteria for External Credit Assessment
Institution (ECAI) Recognition .................................... 365
Appendix III Risk Weights and Rating Categories .......................... 371
Appendix IV Summary of Risk Weights for Loans Secured by
Residential Mortgages ................................................. 375
Appendix V Definition of Default ..................................................... 376
Appendix Va Diagrammatic Illustration of Re-ageing via
Restructuring ................................................................ 379

Issued on: 15 July 2015
Appendix VI Illustration on Risk-Weighted Asset (RWA) Calculation
for Defaulted Exposures and Exposures Risk-Weighted
at 150% .......................................................................... 380
Appendix VII Minimum Requirements on Supervisory Slotting
Criteria Method ............................................................. 382
Appendix VIIa Supervisory Slotting Criteria for Specialised
Lending/Financing Exposures .................................... 388
Appendix VIII Counterparty Credit Risk and Current Exposure
Method........................................................................... 410
Appendix VIIIaSample Computation of the Capital Requirement and
Exposure at Default (EAD) for a Portfolio of Derivative
Contracts....................................................................... 418
Appendix VIIIb “Add-on” Factors for Derivatives Contracts ............. 419
Appendix VIIIc Example for Calculation of Residual Maturity (for
Forward Rate Agreements and Over-The-Counter
Interest Rate Contracts of Similar Nature which are
Settled in Cash on Start Date) ..................................... 422
Appendix VIIId Discount Factor and Range of Residual Maturity ............
....................................................................................... 423
Appendix IX Capital Treatment for Failed Trades and Non-DvP
Transactions ................................................................. 424
Appendix X List of Recognised Exchanges* .................................. 428
Appendix XI Recognition Criteria for Physical Collateral Used For
Credit Risk Mitigation Purposes of Islamic Banking
Exposures ..................................................................... 430
Appendix XII Summary Table of Gross Income Computation ........ 436
Appendix XIII Mapping of Business Lines ......................................... 438
Appendix XIV Illustration of the Offsetting Rules Between Negative
and Positive OR Capital Charge in Any Business Lines.
....................................................................................... 439
Appendix XV Illustration of Computation of Exposures with Credit
Risk Mitigation Effects ................................................. 440
Appendix XVI Information Requirements for Application to Adopt the
Internal Ratings Based Approach for Credit Risk ..... 445
Appendix XVII Information Requirements for Application to Adopt the
Internal Models Approach for Market Risk................. 448

Issued on: 15 July 2015
Appendix XVIII Illustration of Computation of Large Exposure Risk
Requirement ................................................................. 454
Appendix XIX Capital Treatment for Sell and Buyback Agreement
(SBBA)/ Reverse SBBA Transactions ........................ 456
Appendix XX Securitisation Framework – Definitions and General
Terminology .................................................................. 459
Appendix XXI Legal and Regulatory Requirements .......................... 465
Appendix XXII IRB Coverage ................................................................ 469
Appendix XXIII Assessment of Credit Risk based on Shariah Contracts
....................................................................................... 471
Appendix XXIV The “Look-Through” Approach for Specific and Loss-
Bearing Fund Placement ............................................. 483
Appendix XXV Transitional Arrangements and Approval Process ... 486
Appendix XXVI Credit Conversion Factors for Off-Balance Sheet Items
under the IRB Approach .............................................. 492
Appendix XXVIII llustrative IRB Risk Weights ........................................ 494
Appendix XXVIII Potential Evidence of Likely Compliance with the Use
Test ................................................................................ 497
Appendix XXIX Data-Enhancing and Benchmarking Tools ................ 498
Appendix XXX Illustration on the treatment of underwriting exposures
....................................................................................... 502

Issued on: 15 July 2015